Strategic Management Journal Strat. Mgmt. J., 34: 622–633 (2013) Published online EarlyView in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2026 Received 6 June 2011 ; Final revision received 5 October 2012
RESEARCH NOTES AND COMMENTARIES TOO MUCH OF A GOOD THING? ABSORPTIVE CAPACITY, FIRM PERFORMANCE, AND THE MODERATING ROLE OF ENTREPRENEURIAL ORIENTATION WILLIAM J. WALES,1* VINIT PARIDA,2 and PANKAJ C. PATEL3 1
James Madison University, Harrisonburg, Virginia, U.S.A. ˚ Lulea˚ University of Technology, ETS/Entreprenuership and Innovation, Lulea, Sweden 3 Miller College of Business, Ball State University, Muncie, Indiana, U.S.A. 2
Absorptive capacity (ACAP) refers to a firm’s ability to acquire, assimilate, transform, and exploit new knowledge. Research has yet to acknowledge the possibility of limits to the financial returns of this important strategic construct. This study suggests an inverted-U shaped relationship between ACAP and financial performance. Based on data from 285 technology-based small and medium enterprises, we observe gains within three prospective, secondary measures of growth to diminish beyond lower levels of ACAP, even turning negative and becoming harmful beyond intermediate levels. We find that entrepreneurial orientation (EO) moderates the ACAPperformance relationship, enhancing financial gains at lower levels of ACAP and mitigating the decline in financial performance at higher levels of ACAP. Further, with higher EO, higher ACAP can be achieved before financial returns diminish. Copyright 2012 John Wiley & Sons, Ltd.
INTRODUCTION Over the past two decades, studies within the strategic management literature have highlighted the important role of absorptive capacity (ACAP) in achieving higher firm performance. Zahra and George (2002) define ACAP as a firm’s ability to acquire, assimilate, transform, and exploit new knowledge. Prior research generally suggests a Keywords: firm strategy; absorptive capacity; entrepreneurial orientation; curvilinearity; firm financial performance *Correspondence to: William J. Wales, James Madison University, Department of Management 800 S. Main Street, Harrisonburg, VA 22801, U.S.A. E-mail:
[email protected]
Copyright 2012 John Wiley & Sons, Ltd.
positive linear relationship between ACAP and firm performance (Cohen and Levinthal, 1990; Leonard-Barton, 1995; Tsai, 2001; Zahra and George, 2002). The rationale offered to explain this positive direct relationship is that firms must continuously strive to develop their knowledge bases if they are to prosper and sustain their competitiveness (Griffiths-Hemans and Grover, 2006). Nonetheless, counter to the prevailing assumption of linearity, there is reason to posit that increases in ACAP may be subject to diminishing returns in firm financial performance. While the benefits of ACAP have traditionally been exalted, the literature has almost universally ignored the costs associated with this firm-level capability (Foss and Mahnke, 2003; Volberda, Foss, and
Research Notes and Commentaries Lyles, 2010). When costs are accounted for, it can be suggested that increased levels of ACAP may, after a point, be counterproductive to gains in firm financial performance. However, we propose that the costs associated with increases in ACAP may potentially be offset through consideration of the firm’s strategic orientation. In particular, we suggest that an entrepreneurial orientation (EO) may enable firms to more effectively leverage increases within their ACAP. EO captures an organizational decisionmaking posture favoring entrepreneurial activities, strategic decisions, and managerial philosophies (Covin and Slevin, 1989; Simsek, Heavey, and Veiga, 2010). Furthermore, we argue that EO moderates the proposed curvilinear relationship between ACAP and financial performance by enabling firms to mitigate the decline in financial performance when returns begin to diminish. Thus, the purpose of the present study is to critically examine the nature of the relationship between ACAP and firm financial performance. In line with this research agenda, data from 285 Swedish small- to medium-sized enterprises (SMEs) were collected to examine the possibility of diminishing financial returns associated with higher levels of ACAP as well as the potential moderating role that EO may have on this relationship. In this study, we present indirect evidence that costs associated with ACAP produce an inverted U-shaped relationship with financial performance and examine how EO may enhance returns to investments in ACAP.
LITERATURE REVIEW AND HYPOTHESES ACAP and firm financial performance Previous empirical investigations have generally provided support for the notion that the higher a firm’s ACAP, the greater its financial performance (Chen, Lin, Chang, 2009; Rhee, 2008; Tsai, 2001; Zahra and Hayton, 2008). From a learning perspective, by enhancing knowledge transfer, ACAP has been theorized to contribute to firm innovation and, in turn, facilitate sustainable competitive advantage (Chen et al ., 2009; Lenox and King, 2004; Tsai, 2001; Zhang et al ., 2010). As each piece of new knowledge attained by a firm may contribute to innovation success and thereby represent a possible source of competitive advantage Copyright 2012 John Wiley & Sons, Ltd.
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(Barney, 1991), learning-based rationales suggest a strong, positive relationship between ACAP and firm performance (Volberda et al ., 2010). However, going beyond learning-based rationales, we believe that it is important to consider a new perspective on the ACAP-performance relationship, one based on financial costs as opposed to knowledge accumulation and that suggests the possibility of diminishing financial returns from increases in ACAP. At least two rationales based on increasing costs at higher levels of ACAP support the notion of a curvilinear (inverted-U shaped) relationship. In particular, linear rationales based on knowledge accumulation ignore the possibility that costs associated with the acquisition of new knowledge, after a certain point, may increase faster than the benefits as well as the potential for escalating costs associated with the assimilation and transformation of that knowledge. Thus, the first rationale for diminishing financial performance is that the acquisition of new knowledge sources is increasingly costly (Leiponen and Helfat, 2010). Fundamentally, ACAP drives firms to absorb new external knowledge through long-term investments and collaborations (Zahra and George, 2002). However, as a firm’s ACAP increases, it must look progressively further afield to find novel knowledge. This may be referred to as the ‘well-is-drying-up’ premise. Since prior investments serve to circumscribe the scope of this search (Cohen and Levinthal, 1990; Zahra and George, 2002), once available knowledge sources are exhausted, firms must invest additional resources to expand the scope of their search. Moreover, in terms of collaborations, Nooteboom and colleagues (2007: 1031) observed that while a firm’s past investments in building technological knowledge enhance a firm’s ‘ability to understand and appreciate novelty value in collaboration, there are decreasing returns to knowledge in finding further novelty: the more one knows the further away one has to look for novelty.’ This notion suggests that as ACAP increases, firms must also work harder to locate partners with sufficient cognitive distances to provide novelty. Thus, resource investments and collaborations are likely to become progressively less efficient as the resource commitments necessary to acquire new knowledge increase as the scope of search broadens and firms must go to increasingly extraordinary lengths to locate novel knowledge. Strat. Mgmt. J., 34: 622–633 (2013) DOI: 10.1002/smj
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Our second rationale for curvilinearity in the relationship between ACAP and firm financial performance is that the assimilation and transformation of new knowledge sources is costly. Assimilation costs increase as external knowledge sources are often context specific and, thus, more difficult and resource intensive to assimilate (Szulanski, 1996). As firms’ search for distant knowledge intensifies, they are more likely to encounter knowledge sources with which they do not share a common language (technical or otherwise) with greater regularity. This lack of commonality contributes to distortion and loss of information when firms attempt to decode, interpret, and ultimately assimilate the information that they acquire (Schramm, 1961). Furthermore, the transformation of newly acquired knowledge is likely to not occur instantaneously or without effort. Prior knowledge is central to a firm’s ability to value new knowledge (Zahra and George, 2002). As firms acquire knowledge from farther afield sources, it is less likely that the firm will possess the prior knowledge necessary to fully comprehend and appropriately value its discoveries, leading to missed opportunities. Building upon Cohen and Levinthal (1990), this phenomenon arises due to the limitations firms experience with achieving sufficient knowledge diversity to value all possible discoveries. Thus, at high levels of ACAP, prior knowledge limitations further restrict the efficiency of knowledge assimilation efforts. Taken together, the costs associated with the acquisition, assimilation, and transformation of new knowledge would be expected to overtake the financial returns associated with the exploitation of that knowledge at high levels of ACAP. Therefore, we theorize that after a point, increases in ACAP will be counterproductive to gains in firm financial performance. Hypothesis 1: The relationship between ACAP and financial performance is curvilinear (inverted U-shaped) with the highest financial performance occurring at an intermediate level of ACAP . ACAP and EO While ACAP captures ‘a set of organizational routines and processes by which firms acquire, assimilate, transform, and exploit knowledge’ (Zahra and Copyright 2012 John Wiley & Sons, Ltd.
George, 2002: 186), EO refers to the ‘strategymaking practices, management philosophies, and firm-level behaviors that are entrepreneurial in nature’ (Anderson, Covin, and Slevin, 2009: 220). As such, EO captures a firm-level strategic posture toward the pursuit of new opportunities for organizational growth and renewal (Covin and Wales, 2012). According to Miller (1983, 2011), firmlevel entrepreneurship can be viewed as the shared variance of three key behavioral dimensions: innovativeness, risk taking, and proactiveness. Innovativeness reflects a firm’s willingness to support technological leadership, new products, and dramatic product changes; proactiveness refers to a firm’s propensity to launch new products, services, and technologies before their competitors; and risk taking is associated with a firm’s proclivity for bold, high risk projects that maximize the firm’s potential for substantial gains. Core to the notion of an EO strategic posture is that firms are more likely to embrace the creation and pursuit of new entries (Lumpkin and Dess, 1996; Miller, 2011). As such, EO may affect the curvilinear relationship between ACAP and firm financial performance through enhancing the commercialization of firm knowledge and the critical exploitation aspect of firms’ ACAP. With greater EO, firms may identify trends and opportunities to leverage their knowledge-based resources in advance of their competitors and to take the risks necessary to pioneer new offerings in prospective markets. As ACAP increases, diminishing returns to financial performance may be mitigated through more effective leveraging of the firm’s knowledge-based resources toward opportunities for new entry, or more broadly the commercialization of ‘new or established markets with new or existing products or services’ (Lumpkin and Dess, 1996: 136). As noted by Wiklund and Shepherd (2003), the ability to generate returns from a firm’s knowledge-based assets depends on the intensity with which firms grasp and enthusiastically pursue the exploitation of new product-market opportunities. Moreover, as a firm-level strategic posture, EO motivates and supports firm efforts to leverage absorbed knowledge into value-creating resource bundles (Griffith, Noble, and Chen, 2006; Wiklund and Shepherd, 2003). Resource bundling and leveraging are critical to enhancing performance and avoiding diminishing returns as rarely is the simple act of acquiring a resource sufficient to Strat. Mgmt. J., 34: 622–633 (2013) DOI: 10.1002/smj
Research Notes and Commentaries appropriate all of its value (Ireland, Hitt, and Sirmon, 2003). EO firms tend to be creative resource bundlers that embrace bootstrapping and seek the highest possible returns from their available resources (Stevenson and Gumpert, 1985). With a more proactive strategic orientation, firms become more responsive to externally acquired knowledge (Liao, Welsch, and Stoica, 2003). Additionally, with higher levels of EO, firms improve performance through intensifying their information utilization efforts (Keh, Nguyen, and Ng, 2007). Thus, EO may enable firms to translate higher levels of ACAP into greater firm financial performance by motivating the pursuit of new opportunities to capitalize on knowledgebased discoveries, and enhancing the ability of firms to configure their knowledge-based resources into commercially valuable resource bundles. Therefore, as a moderator within the proposed nonlinear relationship between ACAP and firm-financial performance we posit: Hypothesis 2: Entrepreneurial orientation will moderate the inverted U-shaped relationship between ACAP and financial performance such that at low levels of ACAP, higher levels of EO will reinforce the positive relationship between ACAP and financial performance, and at high levels of ACAP, higher levels of EO will mitigate the declining relationship between ACAP and financial performance.
METHODS Two data sources were used for the present study: a postal survey and archival data sources to compile performance data. Data collected through the postal survey were gathered from Swedish technology-based SMEs in the Swedish Standard Industrial Classification code 72 220— consultancy-related computer system or computer software firms. Focusing on a single industry limits potential confounding effects due to heterogeneous industry factors on ACAP. Moreover, as technology-based SMEs seek to develop and utilize new knowledge, the accumulation of knowledge-based resources is particularly important to these firms. Finally, the Swedish government requires all firms to report financial performance certified by a chartered accountant. Copyright 2012 John Wiley & Sons, Ltd.
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In 2007, firms were sampled from a Swedish business database (Aff¨arsdata). After constraining the sample to firms with fewer than 250 employees (i.e., according to the European Union definition of SMEs) and more than one million Swedish Krona (approximately 100,000 Euro) in sales to ensure active firms, we were left with a population of 1,500 firms for the survey. Questionnaires were mailed between March and May of 2007. The questionnaire was addressed to the chief executive officer (CEO) of the SME with a letter explaining the purpose of the study. A total of 285 complete usable questionnaires were received. A nonresponse bias analysis showed no significant differences with respect to firm age, size, profit, sales, and capital. Dependent variables As widely acknowledged in the literature (e.g. Gilbert, McDougall, and Audretsch, 2006), growth is a key indicator of successful small firms and a central ambition of technology-based firms. As measuring growth from multiple perspectives helps ensure the robustness of the proposed relationships, we used prospective compounded three-year growth rates for the years 2008, 2009, and 2010 from Aff¨arsdata to measure sales growth, operating profit growth, and return on assets (ROA) growth. Sales are measured annually in Swedish Krona. Operating profit is sales minus the cost of goods sold, and ROA is the ratio of net profit, or EBIT, to year-end asset value in Swedish Krona. Finally, we industry-adjusted all firm growth rates by subtracting their median scale values. Independent variable—ACAP In this study, ACAP was based on the scale developed by Jansen, Van den Bosch, and Volberda (2005), which measures the acquisition (six items), assimilation (three items), transformation (six items), and exploitation (six items) of new knowledge. The questions were originally based on a business-unit level and were modified to fit the context of SMEs. The lowest item loading1 was 0.802 (t = 6.974), and the scale showed acceptable reliability (α = 0.83). 1
Supplementary tables and results for item loadings are available upon request. Strat. Mgmt. J., 34: 622–633 (2013) DOI: 10.1002/smj
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Moderating variable—EO EO was measured based on the Covin and Slevin (1989) scale, which examines innovativeness (three items), risk taking (three items), and proactiveness (three items). The lowest item loading was 0.770 (t = 8.405), and the scale showed acceptable reliability (α = 0.88).
Control variables Firm age (years since founding) and size (number of employees) were obtained from Aff¨arsdata. We controlled for labor productivity growth and equity ownership over the three-year period using secondary data matched through Aff¨arsdata. Labor productivity growth may contribute to firm performance due to high performance work practices or elements pertaining to organizational culture. Equity stake is an indicator of effort that an individual may expend in the firm. The task environment was controlled for as dynamic and hostile environments have been shown to influence the strength of ACAP and EO effectiveness. We used self-reported hostility (α = 0.76) and dynamism (α = 0.78) scales proposed by Miller and Friesen (1982). Additionally, broader geographical focus may lead to economies of scope for increasing sales and leveraging existing resources to enhance profit and asset performance. We created an index from self-report measures for each of the geographical markets in which a firm operates: local, regional, national, and international. If a firm operated in a certain geographical market, we assigned a score of ‘1’ and ‘0’ otherwise. Finally, diversity in a firm’s exchange activities may create economies of scope for internal resources. We created a market sector index assigning ‘1’ for each area in which a firm operated: manufacturing, services, and trading.
Analysis Common method bias was not observed as Harman’s one-factor analysis led to seven factors explaining 88.30 percent of the variance and the first factor explained 17.35 percent of the variance. Additionally, in a separate test, inclusion of a method factor did not show significantly improved fit over a model with all items Copyright 2012 John Wiley & Sons, Ltd.
loading on their respective factors.2 Colinearity tests indicate that all variance inflation factors were less than 2.738, which suggests that multicolinearity was also not a problem. Moreover, confirmatory factor analysis shows adequate fit (χ 2 = 547.822, df = 269, comparative fix index = 0.953, Tucker-Lewis Index = 0.946, root mean square error of approximation = 0.034), while the average variance extracted for EO (average variance extracted = 0.77) and ACAP (average variance extracted = 0.73) were above 0.5 (Anderson and Gerbing, 1988). The Pearson correlations and descriptive statistics are listed in Table 1. To test our hypothesized relationships we use moderated hierarchical regression across three models for each performance variable: a direct effects, nonlinear, and moderation model. Based on Aiken, West, and Reno (1991), we mean-centered the independent and moderating variables. To assess model significance, we tested differences in F-stat and adjustedR2 values. As shown in Table 2, each model significantly added to the explanatory power.
RESULTS Recall that Hypothesis 1 predicted an inverted-U shaped relationship between ACAP and performance. The results support an inverted-U relationship (sales growth: β = −.029; p < 0.05; operating profit growth: β = −.038; p < 0.05; ROA growth: β = −.038; p < 0.05). These findings provide meaningful indirect evidence of the costs associated with increasing ACAP. Further, in Table 3 we draw on Blanchflower (2007) and Lind and Mehlum (2010) to assess the validity of an inverted-U relationship between ACAP and performance. First, we test the joint significance of the direct and squared terms of ACAP, followed by Sasabuchi’s (1980) test for an inverted U-shaped relationship (H0 : the relationship is U-shaped). The inverted U-shaped relationship is observed to be significant for the direct effects of ACAP on the three performance outcomes. Then, we estimated the extreme point of effect of ACAP and calculated confidence intervals based on Fieller’s standard error and the Delta 2
Supplementary tables and results for the common method bias tests are available upon request. Strat. Mgmt. J., 34: 622–633 (2013) DOI: 10.1002/smj
Copyright 2012 John Wiley & Sons, Ltd.
Mean
SD
1
2
Mean, standard deviations, and Pearson correlations
Notes.N=285 * p
