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1. The Approach
We need to locate this project in a theoretical context, not just for our own
sake, but it’s a strong message that we have been getting from Neeley and
others.
One way into this is by undertaking a literature(s) search(es) and identifying
the hole(s). I would caution against this; there are so many (overlapping)
literatures out there that this is an unmanageable task and will surely run foul
of many specialisms.
Instead I suggest we be bold. On the basis of our experience, we identify a
theory-related issue with practical implications for the firm, and we then show
how this relates to various sets of literatures.
We should say, as did our external evaluator, that this is a bold and
pioneering step, and therefore that we have to proceed cautiously. The
primary objective at his stage is to develop an overview, a taxonomy, and
then to assess the extent to which different sets of firms (varying by sector
and size) relate to the challenge we have identified. A second stage of the
search would be to generate a larger variety of measurable indicators which
can be utilised as stretch-points in programmes of continuous improvement.
2. The Theoretical Challenge
(some of this abstracted from my recent book I am afraid)
The challenge for the firm is sustainable profitability. In a highly competitive
world, this requires the development both of internal dynamic capabilities, and
the ability to influence the external world. Our challenge is with the dynamic
capabilities side of this story.
Profitability is defined by the ability to construct or take advantage of barriers
to the entry of competitors. Economists refer to this as the ability to
appropriate “rents”, that is to take advantage of scarcity:
Rent describes a situation where the parties who control a particular
set of resources are able to gain from scarcity by insulating themselves
from competition. This is achieved by taking advantage of, or by
creating barriers to the entry of competitors.
Schumpeter provided an analytical framework to show how scarcity can be
constructed. He distinguished the process of “invention” (having an original
idea, a “new combination” in his words) from that of “innovation” (turning a
new idea to commercial advantage), Entrepreneurship is defined in the act of
innovation. If this innovation proves to be difficult to copy, then the
entrepreneur earns a super-profit which exceeds not only the cost of the
invention and the associated innovation, but the returns to economic activity in
other activities which are less well protected from competition. Over time this
innovation is copied (the act of “diffusion”) or superseded by a new, superior
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innovation. It is this “Schumpeterian motor”, the search for producer rents,
which spurs the innovation process and subsequent diffusion and which
drives forward economic growth. For Schumpeter, the entrepreneurial rents
were almost always dynamic.
Figure 3.4 shows the process at work. In each industry the equilibrium is
defined by the “average” rate of profit. Following the introduction of a “new
combination”, the entrepreneur reaps an “entrepreneurial surplus” which
provides for abnormal high incomes. Then as the new combination is copied
and diffuses, the producer surplus is whittled away, and is transformed into a
consumer surplus as prices fall and new and better quality products are made
widely available. But all this does is to renew the search for “new
combinations”, either by the same entrepreneur or another entrepreneur.
Figure 3.4: The generation and dissipation of entrepreneurial surplus
Rate of profit
Innovation
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Innovation
2
Innovation
3
Average rate
of profit
Entrepreneurial Surplus
Summary Box Section
Time
3.1. Getting it wr
ng
It is obvious from this that the link between innovation and income is to be
found in barriers to entry which keep out competition. Given that a product is
being produced which consumers want, the greater the barriers to entry, the
more likely incomes will be high. So, the key questions for the producer are how impervious are these barriers?; can the “new combination” be easily
copied?; can it be circumvented, perhaps by using a similar process?; or, can
it be superseded, by a new and even better combination? Thus it is that
barriers to entry are a central component of the theory of rent, and similarly
that the theory of rent provides the key to understanding the availability and
sustainability of high incomes.
In the current era, with the rapid progress of China, India and other low wage
economies (including those in Eastern Europe), the barriers to entry are
tending to be eroded in the physical transformation links in many value
chains. In the development of dynamic capabilities, these are the easiest to
master and “manufacturing” capabilities are becoming increasingly
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widespread. Conversely, the most enduring barriers to entry are increasingly
found in knowledge-intensive sectors and activities, such as design, chain
coordination (Tesco!) and marketing. This involves a combination of both
moving to knowledge-intensive links in the chain ((fnctional upgrading in the
value chain literature), and into knowledge-intensive activities within each link
in the chain (process and product upgrading).
The East Asian countries which have successfully industrialised in the last
quarter of the twentieth century, based in large part on the export of
manufactures have been very systematic about this strategic positioning.
Figure 4.6. shows the upgrading path which they have used. It is a path which
begins with the simple assembly of components (OEA – original equipment
assembly), and upgrades into the manufacture and assembly of products sold
under the brandnames of other firms (OEM – original equipment
manufacture). Then, when manufacturing in these sectors become too
competitive, they have developed their own brands (OBM – own brand
manufacturing), such as Daewoo and Samsung. But when even this is unable
to protect their rents, they branch out into new chains. As Figure 4.6 shows,
this is an upgrading path in which disembodied-knowledge rather than
production skills alone becomes increasingly important.
Figure 4.6: The ideal-type of a successful value chain upgrading strategy
Type of upgrading
Process
Product
Functional
Original
design
manufacture
Original
brand
manufacture
Chain
Trajectory
Examples
Degree of
knowledgeintensity
Original
equipment
assembly
(OEA)
Moving
chains – e.g.
from black
and white TV
tubes to
computer
monitors
Original
equipment
manufacture
OEM
Disembodied content of value added increases
progressively
To summarise:
 Sustainable incomes arise from barriers to entry and involve the
appropriate of rents
 The lower the knowledge-intensity in production, the more likely that
firms will see their rents (and hence their profitability) eroded.
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 The ability to command and generate knowledge is thus the key
component of dynamic capabilities and long term and sustainable
profitability.
3. Translating theory into practice
(Based on our earlier work and comments received at Sept workshop)
(This is also a palace where we can heavily cross refer to other literatures)
How does this theoretical challenge translate into firm-level practice? Here we
need to take account of the following issues:
3.1. Knowledge stocks and knowledge flows
Knowledge must be seen in dynamic context – it is both a stock and a flow.
 The stocks refer to the accumulated knowledge within the firm
 The flows refer to both inflows of knowledge, and outflows of
knowledge.
Many firms have weak routines for assessing their knowledge stocks, and
maximising the potential returns from these knowledge stocks
To sustain barriers to entry and rents, firms have an active interest in
minimising the outflow of knowledge
However, because firms are incorporated in chains, and because they are
engaged in dynamic repositioning within their chains, they also have a
simultaneous interest maximising inflows of knowledge, and outflows as well
(for example, in supply chain development).
3.2. Embodied and disembodied knowledge
Knowledge can be incorporate in machinery and products – economists refer
to this as embodied knowledge. It can also be incorporated in people,
routines, on paper and in electronic form – economists refer to this as
disembodied knowledge
3.3. Knowledge can be tacit or codified
Knowledge can be codified – in written-down routines, in structured
programmes of knowledge management, in IPRs. But they can also be tacit,
embodied in the minds of humans, routines and structures.
In general, without IPRs, the greater the codifiability of knowledge, the lower
the barriers to entry. Codification is thus a danger. But at the same time, the
absence of codifiability may often mean that firms may fail to systematise their
knowledge base and maximise the returns from their knowledge stocks and
knowledge flows.
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4. Towards a Taxonomy
Based on these observations, we can think of an overview for “Knowledge
Control”. Using the water/plumbing metaphor, the firm needs to :
 Plumb the depths – make optimism use of knowledge stocks
 Maximise inflows of appropriate knowledge and filter out the inflows of
“kn owledge-noise”, ie inappropriate knowledge
 Minimise outflows of inappropriate knowledge, and maximise outflows
of appropriate knowledge
 These needs to take account of both embodied and disembodied
knowledge, and of tacit and codified knowledge.
Based on this, a taxonomical architecture might look something like this:
Tacit
knowledge
Codified
knowledge
Embodied
knowledge
Disembodied
Knowledge
Knowledge stocks
Knowledge inflows:
Maximising appropriate inflows
Minimising inappropriate inflows
Knowledge outflows
Minimising outflows of knowledge
targeted as dynamic capabilities
Maximising outflows of core rigidities
5. Out task
Our task in this stage of the research is to develop methods for determining
the extent to which firms:
 Are aware of each of these cells
 Have procedures for dealing with each of these cells
And seeing how this varies by sector and firm-size (within the SME category?)
Our benchmark tool at this stage is merely a way of their assessing their
comparative capabilities in relation to this overview and awareness
The next stage of our research – having tested this architecture in Phase 1 –
is to develop methods for assessing comparative performance on each of
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these counts. This is much more difficult (and of course requires much more
funding…)