Firm Performance: Path Dependent - Essay Example

Firm Performance: Path Dependent? Submitted Submitted by: Introduction Strategic management involves the determination of the ways and means of how the firm can perform well. Those who pursue the field are interested in being able to understand what makes a firm succeed in the market. One theory that seeks to address the issue is that of Path Dependency which states that ‘history matters’. This theory basically states that small events in the beginning of a path can define outcomes in the present. The interest of this paper lies in determining whether firm performance is indeed path-independent or not. To address this issue, I will be first defining the meaning of firm performance and path-dependency. Arguments for and against are presented to make the reader aware of the issues surrounding the topic. In the end, a synthesis shall be made of the ideas presented and a conclusion on whether firm performance is indeed path dependent or not is made. Defining Firm Performance Firm performance is at the very heart of business management because it is the time test of any business strategy and theories. Nonetheless, there is little consensus on how to best measure the construct. Researchers and experts with strong finance or economic background use the term to refer to how efficient the firm utilizes its assets in generating profits. While this is certainly an appealing definition, it can be considered to be too narrow the reason being that it disregards the social performance of the firm. This definition only focuses on the financial part whereas firm performance can also be related to how happy its employees, suppliers and customers with its services. In this paper, I will be holding a stakeholder’s perspective and consider firm performance as a combination of financial and social performance. To illustrate this construct further, I will be using the model developed by North (1990) as shown in Figure 1: Figure 1: Firm Performance Model (North, 1990) The reason for our choice of defining firm performance as a function of financial and social constructs is that both have an effect on the other. Consider for example that to reduce costs and increase returns, a firm wishes to outsource. While the firm can improve financially, it can suffer socially due to employee morale decline and customer dissatisfaction. We can see this already happening with business entities with Chinese-sourced products. Enhancing employee satisfaction and job security may increase the social performance of the firm but it can also corrode its financial standing. Thus, we need to consider both as necessary constructs in understanding firm performance. This definition will prove to be invaluable in analyzing whether firms are indeed path dependent or not. Defining Path Dependence There is much academic and scholarly words discussing the theory of Path Dependency but to make it easier to understand, I will be using a hiking analogy to describe the concept. When a person goes hiking, steps and turns taken in the beginning or in the course of the travel will ultimately define its present status. For example, a wrong turn could lead a person getting lost or ending up in a wrong checkpoint. A small decision could provide good or severe consequences in the outcome of the hiking experience. Following this analogy, Path Dependency argues that small, even inconsequential and random events at the beginning or in the course of the path can define the options and decisions available at the present state of affairs (Pierson, 2000). Firm Resources and Path Dependency In the 1980’s, there was a view stating that the performance of firms can only be understood thru an analysis of resources and mobility independent of particular historical events and other idiosyncratic attributes (Levin et al 1987). However, the importance of the path-dependent theory has since been recognized. In this section, the path-dependency of firm performance is explored through the analysis of firm resources. Barney and Clark (2006) expounds on the path-dependence of firm performance and competitive advantage through deductive reasoning of their resource-based theory. For firms to operate, they must have the necessary resources which include a mix of physical, financial, human and organizational capital. For firms to succeed, they must have resources in their possession that offers them a sustained competitive advantage over other firms. Common firm resources provide the necessary basis for survival but certain valuable and rare organizational sources termed by Lippman and Rumelt (2002) as imperfectly imitable provide the means to financially and socially perform well. The acquisition of imperfectly imitable resources often depends on a specific time and place. When the time and place have passed, firms that were able to obtain these resources find themselves in a financially and socially advantageous position. As an example, a firm that locates its production or a servicing facility in a certain area which turns out to have a much more valuable significance or contribution to the firm’s performance than what was anticipated presents a physical capital resource. Firms with specialists such as scientists and technology developers who can make a scientific breakthrough can perform well as they have human capital resources. A firm can also have their performance determined by the organizational culture developed in its early formation s. For example, a multinational company such as IBM is better positioned to manage and utilize its multicultural human resources than most companies as it has significantly developed its human resources department to cope with national and organizational cultures that tends to cripple the operations of a firm operating internationally. Traditional business strategy writers such as Ansoff (1995) and Stinchcombe (1998) often cited the unique circumstances surrounding the firm’s founding as a determinant of its long term-performance. Arthur (1984) and Kaniovski (1994) also posited firm performance, is not solely dependent on the particular point in time which it finds itself but also the path followed by the firm through its history to arrive where it is. Additionally, imitation of resources can be minimized by unique historical conditions. While certain entities may find it easy to imitate a resource such as establishing a manufacturing facility in a location same as that of the original firm, it can fail because it did not developed the same managerial resources or organizational culture necessary to produce the same performance as that of the other. Non-Path Dependency of Firm Performance Mahoney (2000) arguing against Path Dependency of firm performance points out the effects of extraneous events and the non-assurance of increasing returns. There are certain extraneous events, one that is way beyond the control and expectation of the firm, which can undermine any efforts in the past. The bankruptcy of one major bank in the United States, for examples, had a domino effect on the entire global economy. Companies such as Ford, WalMart and other global giants with business models being widely praised in economic and business literature did not escape the crisis. These companies have made significant investments and have acquired and developed several rare and valuable resources but they tumbled upon an event that was way behind their control. The extensive damage to firms of the downfall of one bank indicate that even with past historical precautions or steps, one contemporary extraneous event can undermine all historical efforts. Thelen (1999) provides another counter-argument to Path Dependency as he focused on the suggested perfect transmission of firm values from one generation to the next. Every person entering the firm undergoes a socialization process wherein he learns of the ways and means of the company. However, there is no assurance of complete and perfect assimilation of historical firm values on the individual. In most managerial hiring cases, people are brought in the company to bring significant change and improvement. Actors consciously reshape reuse and reshape organizations and not the institutions (with its history) determine the interests of the actor. The rejection of past practices is also common among firms as they try to develop. Indeed, the inevitability of incremental and evolutionary change is one of the foremost complaints on the static nature suggested by path-dependency. Schwartz (2007) argued that there is also the problem of replication of the environment in which historical events determined the firm’s performance. More often than not, businesses will find themselves in situations that are highly unlikely to be same as that experienced before. Generally, competing firms in the industry could have learned from the moves made by the firm in the past and would have formed strategies to address them so that the firm could not outperform them. Thus, there is the issue of full-scale replication. A process or an action that had positive effects in the past may have negative effects in the future again thanks to the inevitability of change. Synthesis Whether or not a firm’s performance is path-dependent or not is indeed hard to determine as both sides presents equally logical arguments to support their thesis. An event or an action taken in the past can indeed determine our present actions especially in critical junctures. However, the propensity to adopt and embrace change in an organization which is significantly different from past events indicates that firm performance is not entirely path-dependent. In our definition of firm performance, we have identified the combination of financial and social performance as the determinants of the construct. Path-dependency indicates that the acquisition of financial, physical and human capital resources can determine the present firm performance. This has truth in it as certainly many companies have succeeded because of the rare and valuable resources they have acquired and the decisions they made early in the formation of the firm. However, many firms have also performed well with the introduction of major initiatives and sometimes an overhaul in their operations and processes. Again, the conclusion that we may draw from this is that performance of firms can either be path-dependent or not. The question now is what governs most of the time. For my own point of view and in lieu of the arguments that I have presented, I have come to the conclusion that firm’s performance is ‘mostly’ non-path dependent. There are four reasons for this conclusion. First is that the ever changing nature of the market implies that firms are subjected to change to be better suited to competing in the industry. While past events can serve as historical reference in the actions and moves to be taken, there is most certainly a high probability that what happened before is not entirely applicable to the present. Often, innovations drive the key to growth especially in technology industry. Secondly, rare and invaluable resources acquired in its historical path can make the firm succeed in the present. However, this is highly subject to uncertainty. The premise is that certain resources ‘may’ turn to be more valuable than anticipated which indicates chances whose degree nobody knows until it is recognized in the present. This is rather a stroke of fortune rather than a dominant determinant of firm performance. More often than not, these strokes of luck come from extraneous events such as the proclamation of an area to be developed or from coercion of some government officials to force the values of resources to go up. Again, this is not a function of small events in the past. Third is that while certain events in the past can hinder firms from making certain decisions, most companies often find it necessary to divest itself of its previous practices or renegotiate its values and outlook especially in serious cases such as total failure. Present decisions that out of the normal practice are often made in spite of the hindrances of historical paths. Innovation drives growth as the saying goes. Thus, firm performance cannot be considered as entirely path-independent. References: Levin, Richard C., Alvin K. Klevorick, Richard R. Nelson, and Sidney G. Winter (1987): “Appropriating the Returns from Industrial R&D”,Brookings Papers on Economic Activity, 783-820. Mahoney, James (2000). “Path Dependence in Historical Sociology.” Theory and Society 29:4, 507-548. North, Douglass. (1990). Institutions, Institutional Change and Economic Performance. New York: Camb ridge University Press. Schwartz, Cynthia A. (2007): Resource-based and Evolutionary Theories of the Firm: Towards a Synthesis. Kluwer Academic Publishers. Thelen, Kathleen (1999). “Historical Institutionalism in Comparative Politics.” Annual Review of Political Science 369-404. Read More