- Be able to discuss other theories about firm success and failure beyond resource-based theory.
- Be able to apply different theories to help explain competition in different industries.
Table 4.11 Other Theories about Firm Performance
Resource-based theory is currently perhaps the most popular way of explaining why some firms succeed and other fail, but it is far from the only explanation. Below we illustrate several other prominent theories using examples from the airline industry.
|Enactment suggests that organizations can, in part, create their environment through outstanding strategies. This puts a firm in control of its destiny. Although no airline has ever been able to do so, Microsoft and Apple are two firms that seemed to have enacted their environments.
|Environmental determinism contends that external factors drive a firm’s fate. In its early days, the federal government controlled airlines’ routes and prices. After the airline industry was deregulated in the late 1970s, a series of large airlines fell prey to bad environment conditions such as recession, overcapacity in the industry, and fuel shortages. Many industry experts claim that the demise of Braniff Airlines, and others was inevitable.
|Institutional theory is interested in the extent to which firms copy each other’s strategies. After American Airlines became the first major airline to create a frequent flyer program in 1981, its competitors quickly developed their own frequent flyer programs. In the late 2000s, a new idea of charging passengers to check their luggage was copied by one airline after another.
Transaction cost economics centers on whether it is cheaper for a firm to make or to buy the products that it needs. Choosing efficient options enhances profits. No airline has ever chosen “make” when needing new airplanes. Buying airplanes from Boeing or Airbus is much more efficient than would be trying to backwardly integrate into the airplane manufacturing business.
Although resource-based theory stands as perhaps the most popular explanation of why some organizations prosper while others do not, several other theories are popular. Enactment treats executives as the masters of their domains. Enactment contends that an organization can, at least in part, create an environment for itself that is beneficial to the organization. This is accomplished by putting strategies in place that reshape competitive conditions in a favorable way (Table 4.11 “Other Theories about Firm Performance”).
By the 1990s, Microsoft had been so successful at reshaping the software industry to its benefit that the firm was the subject of a lengthy antitrust investigation by the federal government. More recently, Apple has been able to reshape its environment by introducing products such as the iPhone and the iPad that transcend the traditional boundaries between the cell phone, digital camera, music player, and computer businesses. No airline has ever been able to enact the environment, however, perhaps because the airline industry is so fragmented.
Environmental determinism offers a completely opposite view from enactment on why some firms succeed and others fail. Environmental determinism views organizations much like biological theories view animals—organizations (and animals) are very limited in their ability to adapt to the conditions around them. Thus just as harsh environmental changes are believed to have made dinosaurs extinct, changes in the business environment can destroy organizations regardless of how clever and insightful executives are.
Until 1978, the federal government regulated the airline industry by dictating what routes each airline would fly and what prices it would charge. Once these controls were removed, airlines were subjected to a series of negative environmental trends, including recession, overcapacity in the industry, new entrants, fierce price competition, and fuel shortages. Perhaps not surprisingly, dozens of airlines have been crushed by these conditions.
An old saying notes that “imitation is the sincerest form of flattery.” This flattery is the focus of institutional theory. In particular, institutional theory centers on the extent to which firms copy one another’s strategies. Consider, for example, fast-food hamburger restaurants. Innovations such as dollar menus and drive-through windows tend to be introduced by one firm and then duplicated by the others.
Airlines also seem to follow a “monkey see, monkey do” mentality. To build passenger loyalty, American Airlines introduced a frequent flyer program called AAdvantage in 1981. After flying a certain number of miles on American flights, AAdvantage members were rewarded with a free flight. The idea was to make passengers less likely to shop around for the cheapest ticket. Ironically, AAdvantage turned out to be not much of an advantage at all. Many of American’s rivals quickly developed their own frequent-flyer programs, and today most airlines reward frequent passengers. In recent years, ideas such as charging passengers to check their luggage and eliminating free food on flights have been copied by one airline after another.
Transaction cost economics is a theory that centers on just one element of business activity: whether it is cheaper for a firm to make or to buy the products that it needs. This is an important element, however, because choosing the more efficient option can enhance a firm’s profits. Automakers such as Ford and General Motors face a wide variety of make-or-buy decisions because so many different parts are needed to build cars and trucks. Sometimes Ford and GM make these products, and other times they purchase them from outside suppliers. These firms’ financial situations are improved when these decisions are made wisely and harmed when they are made poorly.
In contrast, airlines always buy (or rent) their airplanes. Large planes are generally bought from Boeing or Airbus, while modest-sized airliners are purchased from companies such as Brazil’s Embraer. It would be simply too costly for an airline to pursue a backward integration strategy and enter the airplane manufacturing business. Insights such as these are powerful enough that the creator of transaction cost economics, Professor Oliver Williamson, was awarded a Nobel Prize in Economic Sciences in 2009.
Each of these theories—enactment, environmental determinism, institutional theory, and transaction cost economics—is useful for understanding some situations and some important business decisions. Thus executives should keep these perspectives in mind as they attempt to lead their firms to greater levels of success. However, one important advantage that resource-based theory offers over the alternatives is that only resource-based theory does a good job of explaining firm performance across a wide variety of contexts. Thus resource-based theory offers the point of view of business that has the strongest value for most executives.
- Although resource-based theory is the dominant perspective to predict performance in the strategic management field, other theories exist to explain firm behavior. In some industries, explanations provided by these theories can be very convincing.
- What theory of the firm do you think best explains competition in the fast-food industry?
- What is an example of an industry in which institutional theory seems to explain the behavior of firms?