Pattern in Corporate Evolution. - Review - book reviews

Administrative Science Quarterly,  Sept, 1998  by Neil Fligstein

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Neil M. Kay. New York: Oxford University Press, 1997. 319 pp. $65.00.

Neil Kay attempts to produce a general theory of the firm, one inspired by Oliver Williamson's transaction cost analysis but ultimately critical of it. Kay's ambitious book tries to present a view of the dynamics of strategic management that explains the evolution of large firms' strategy and structure over time. He argues that the main features of modern management's strategies can be accounted for by managerial attempts to produce firm growth by capitalizing on their core resources. In his argument, the boundaries of firms are drawn by managerial conceptions of those capabilities, and changes in those boundaries represent the outcome of managers' search for new uses of existing capabilities. This search will be constrained by the nature of the markets in which firms find themselves (growing, stable, declining). It will also be constrained by what exists, i.e., existing firm capacities will suggest new opportunities. For instance, the Boeing Corporation found itself in the position after World War II of declining markets for military aircraft and a high degree of competency in aerospace technology. These two conditions stimulated management to find new opportunities that would use their assets, and they turned to commercial aircraft production.

Kay uses this deceptively simple argument in a set of fairly cunning ways. One implication of the argument is that we would expect the development of firms, both individually and as a group, to be path dependent. Firms building on competencies would tend to stick with those competencies and develop new products and competencies in directions that make sense given where they started from. For Kay, the evolution of firms from single product to dominant product, to multinational, to product related and conglomerate, and now to joint ventures, alliances, and networks, is a natural cycle that is related to how managers seek out and exploit opportunities. For firms to grow, managers must find new business opportunities, and they will look for them in places that make sense given what they do. So managers turn first to producing the same or related products for overseas markets. All of the strategies of firms are an outcome of this search for more uses for existing resources. This evolutionary theory of business explains why large corporations are mostly diversified. Simply put, you can't keep growing if you stay with a single product. You must figure out what your resources are and use them to find new markets to exploit to continue to grow and remain profitable. It also explains why large firms rarely die. If parts of the firms are in markets in decline, firms can choose to invest in or reorganize those competencies. If firms are in markets in which technology change has made products obsolete, they can choose to sell off or close down "resources." They buy new resources (i.e., other firms) in markets that better exploit their competencies. Mergers are a natural way for firms to grow, particularly as they get larger. They allow firms to purchase new competencies and, in particular, competencies that might mesh well with existing competencies.

Kay claims that once large firms reach a certain size, it gets difficult for them to buy one another out so frequently. He provocatively argues that the increase in joint ventures that we have seen so much of in the past ten years actually reflects the fact that the largest firms find it difficult to absorb one another and all of their competencies, so that it makes more sense to make joint investments that exploit existing competencies of both firms but limit their participation. Kay argues that networks and, more generally, alliances are the current "highest" stage of firm development. He suggests that in their search for growth opportunities, firms will find it advantageous to get closer to firms that they perceive to be like themselves. These will produce looser alliances between multiple sets of firms that will give firms clues about how to find new opportunities to exploit their resources. Larger groups of firms will form alliances, networks, or clubs with multiple partners so as to hedge bets, find out information on new opportunities, or for collective protection from outsiders.

Kay makes interesting attacks on transaction cost analysis and population ecology. Williamson's focus on asset specificity explains whether or not firms should integrate, but Kay argues that the idea of asset specificity cannot account for why firms diversify. Diversification, by definition, concerns integrating assets into a firm that are nonspecific to a particular application. Firms take existing assets and figure out what they are generally good for and find new opportunities, which explains both integration and diversification. He broadly criticizes the ecologist view that merger or divestiture of firms is about organizational death. His view of firms as resources suggests that the competencies of firms are embedded in their product divisions. From this perspective, instead of seeing merger as the death of one firm, the original firm's divisions (i.e., resources) continue to survive. He shows that given this definition, competencies are preserved in mergers. If one looks at mergers this way, the largest firms in the economy have survived at rates over 98 percent since 1917.