Firm-Level Capability Development Trade-offs


Name Impact of Growth Opportunities and Competition on Firm-Level Capability Development Trade-offs
Modeler Hazhir Rahmandad
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The Issue You Tackled

How should managers prioritize among production, product development, branding, internationalization, and other capabilities and resources? This question is central to the resource-based view, and the answer depends not only on the direct returns on investment in each capability but also on the trade-offs in using those returns for future growth or survival in a competitive market.

Focusing on the investment allocation between operational and dynamic capabilities, this paper asks the following questions: (1) What fraction of the investment should go to operational versus dynamic capabilities? (2) How does this fraction depend on a firm’s growth opportunities? (3) How does this fraction depend on competitive forces in a market? And finally, (4) how do firm characteristics (e.g., initial capability endowments) and market features (e.g., economies of scale) change the value of different capabilities?

What You Actually Did

Through simulation experiments, this study examines firm-level capability development trade-offs in the context of a firm’s market-level competition and growth. Two features distinguish the contributions of this paper. First, prior studies have not addressed the impact of endogenous changes in the investment flow available for capability development. However, investment flow is “endogenous”; i.e., it depends on the market performance of the firm, which in turn is dependent on the firm’s capabilities. Such endogeneity can be consequential. In Alpha’s example, the company could benefit from investing significantly in process improvement capability. However, that investment might be better applied to the fast-payoff coding capability because this alternative allows the firm to grow quickly and expand the resources available for further investment. Considering the endogeneity of investment flow refocuses analyses on nonequilibrium growth and decline dynamics and, given the added complexity, calls for the use of simulation models. Second, the impact of competitive pressures on the viability of longterm capabilities is considered. Under competitive pressures, survival may depend on developing short-term capabilities. Even though large investments in long-term capabilities may promise high downstream rewards, a firm may not be able to sustain the required investments in the face of an eroding market share

The Results

It is found that investing in operational capabilities (which enhance short-term performance) gains priority over investing in long-term dynamic capabilities when the operational capability investment strengthens the reinforcing loop between performance, investment flow, and capability development. Such operational capability investment provides growth opportunities and competitive advantage. Moreover, in strategic competition, firms anticipating rivals’ focus on short-term growth need to further ignore dynamic (long-term) capability building in order to survive. Testable propositions are offered as to how trade-offs between short-term and long-term investments depend on different firm and industry characteristics. The results may explain why short-term-focused firm behavior persists in firms even in the absence of discounting, short-term managerial incentives, decision biases, or learning failures.


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Did You Know?

System Dynamics Forrester Award

The Jay Wright Forrester Award recognizes the authors of the best contribution to the field of System Dynamics in the preceding five years. In 2016, the award was presented to Hazhir Rahmandad for his winning work “Impact of Growth Opportunities and Competition on Firm-Level Capability Development Tradeoffs.”, published by Organization Science; Vol. 23, No. 1, January–February 2012, pp. 138–154. To read the Forrester Award Citation by Professor Khalid Saeed, please visit the page.
(Jul 2015)