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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 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

Average rate

of profit

Time

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 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 / Chain

Trajectory
Examples / Original equipment assembly (OEA)
Original equipment manufacture
OEM / Original design manufacture / Original brand manufacture / Moving chains – e.g. from black and white TV tubes to computer monitors
Degree of knowledge-intensity / 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.
  • 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.

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 these counts. This is much more difficult (and of course requires much more funding…)