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Chapter 1: The critical path - the meaning of ‘dynamics’
Clarifying the issue of ‘dynamics’ – explaining the time-path of strategic performance
Strategic resources determine performance
Existing understanding of what determines ‘performance’
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The challenge and responsibility facing strategic managers is to understand and direct the time-path of performance for their enterprise (whether stated in terms of financial or other objectives). It is vital to understand that time-path, not just qualitatively, but including the specifics of scale and timing.
Dynamic issues of strategic importance to the firm may consist of either opportunities to be exploited or damage to be limited. They may be largely driven by forces internal to the firm, or by rivalry and other external pressures. Many such challenges will concern the business at large, but others may be largely centred upon particular functions within the organisation. The time-scale over which the issue will play out may range from many years down to just a few weeks or months in especially fast-moving sectors.
It has long been understood that current performance is a direct function of the strategic resources that the enterprise either owns, or has reasonably reliable access to, at this moment in time. The same is true at all times in the past, and will be true in the future, so if the time-path of performance is to be understood and managed, the management team needs the means to understand how resource levels change through time, and how that process can be controlled.
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Chapter 2: Strategic Resources- the fuel of firm performance
Identifying and defining strategic resources
How resources support sustained performance
Understanding how resources accumulate and deplete over time
Some simple, but critical, arithmetic
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The first step in building the resources needed for future performance is to define them properly, both tangible and intangible items, and identify those that apply to your enterprise (whether to pursue current objectives or alternative opportunities). It is also vital to identify clear measures for strategic resources, and sources for this information.
Resources provide advantage if they are durable, and not easy for rivals to buy, copy or substitute with alternatives. However, these are neither black-and-white nor static criteria – performance over time depends on how much of the necessary resources you have, and at what rate they are being accumulated. Consequently, viewing resource ownership as a simple ‘barrier to entry’ is of little value.
Resources must also be complementary – i.e. work well together, both to build upon each other and to deliver performance. So for managers to use resources to build performance over time, some mechanism for understanding complementarity is vital.
Although firms possess a rich array of strategic resources, those that directly determine current performance are largely tangible items. The key challenge for management is therefore to identify, win and keep these resources. Resources share a common characteristic – they accumulate and deplete over time, so the level of resource at any moment depends on the total of all historic gains and losses.
To understand resource-changes properly, they must be clearly defined and measured. Their rate of change is always defined in the same units ‘per time-period’. Since rates of gain and loss are critical to future resource-levels, the drivers of these gains and losses for each resource must be identified and the strength of their influence understood. These drivers will include issues under management’s control, other factors internal to the firm, and external forces.
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Chapter 3: Getting specific – quantifying change
Calculating resource-changes from rates of gain and loss
Using time-charts to show the dynamics of change
Developing and exploiting potential resources
Developing resources throughout the business – and beyond
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To be precise about resource-levels at any future time, it is necessary to calculate gains and losses in each period, then add or subtract the net change from the current level. Repeating this process enables time-charts of resource-levels and flows to be created. These are a powerful means for communicating the evolution of resources, but care is needed to ensure accuracy.
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Resources are frequently developed from potential resources existing in the outside world. Early in the firm’s development, such potential resources may be plentiful, but the potential pool drains as it becomes exploited, slowing down further growth in captured resources.
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Resource-levels may be subject to a step-change if there is a sudden acquisition or loss of a large ‘lump’ of resource. Acquisitions and mergers are common mechanisms to achieve such step-shifts in resource-levels across the firm. However, care is needed to ensure that subsequent resource-losses are as intended or expected.
Once captured by the firm, many resources ‘develop’ through different stages – what is lost from one stage is transferred to the next. It is essential to ensure that the same type of item flows from stage to stage, and is ‘conserved’ in the process – every unit must be accounted for.
Furthermore, resources may continue to develop, and have sustained impact on firm performance, even when the resource may be outside the firm’s immediate ownership.
To have a good grasp of strategic performance requires constant awareness and management of all the flows of resource through such chains – from capturing potential resources initially, through their development within the firm and on beyond the firm’s direct control.
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Chapter 4: Building the machine - reinforcing feedback between resources
Complementary resources depend upon each other to grow
Feedback between resources – another source of dynamic complexity
Reinforcing feedback builds performance, but also create the danger of collapse
Communicating the logic of growth.
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Linkages between activities, both within the business and with its suppliers and customers, are conventionally tackled with some form of ‘value chain’ analysis. However, since performance at any moment depends on current resource-levels the dynamics of performance make it necessary to understand how growth and decline arise from linkages between resources.
Managers can only build any resource by using others to which they already have access. Consequently, the more of any resource is in place at any moment, the faster others can be grown – provided that no balancing limit has been reached. Moreover, most resources can be used without themselves being depleted (the main exception being cash).
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The self-reinforcing feedback that arises from these interdependencies amongst the firm’s set of resources can cause exponential growth - or collapse. Some resources can even reinforce their own growth.
Financial outcomes arise from the firm’s resource-system, but also create the possibility for further reinforcement, as increasing revenues are deployed in the growth of those very resources that gave rise to those revenues in the first place. Management policy can be used deliberately to design-in such mechanisms.
Established approaches to laying out a firm’s value chain can be adapted to portray its dynamics, by identifying separately the costs of building, holding and retaining each resource. In addition, it is necessary to include the asset-stock that drives revenues – i.e. customers – and to be clear about where revenues arise – from the in-flow of customers, or from the continuing customer-base.
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Chapter 5: Removing the brakes - balancing feedback holds back growth
Resources can constrain, as well as enable, each others’ growth
There are dangers in pushing the business beyond its capacity
Time delays make matters worse – causing overshoot and reversal
Self-balancing effects arise in developing potential resources
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Growth of any resource will ultimately be limited by the availability of other resources required, or by its own potential.
Attempts to push the business beyond that limit will commonly trigger feedback that drives increasingly powerful out-flows that hold back the firm’s growth. Eventually, these outflows match any gains that are achieved. Continued efforts to grow can push the business badly out of balance, with dire consequences for service quality, stress on staff, and other difficulties.
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Delays arising from the time needed to notice or react to such imbalances can cause the business to over-shoot a stable state or even swing repeatedly from over-stretched to under-loaded. This can make it extremely difficult to interpret the true state of the business, and cause management to make decisions that may be wildly inaccurate or even precisely the opposite of those required.
Spreadsheet-thinking, and the ubiquitous tools used for this purpose, are inherently ill-suited to capturing or communicating the behaviour of business (or other) systems through time. System dynamics provides the proper method for these tasks, and the software tools to implement the approach.
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Chapter 6: The strategic architecture - designing the system to perform
A process for developing a strategic architecture for any situation facing any single enterprise
Illustrating the strategy dynamics analysis for a new-car launch
Using the strategic architecture to seek means for substantially up-rating business performance
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A disciplined, organised process is essential for building up a picture of the strategic architecture for the firm (or a part of it), focused on the issue of concern. Identify the time-path of the particular performance item in question, identify the relevant resources, and select the few core items only. Put time-charts on these resources, and on the in- and out-flows for each, then identify the other items on which these flows depend. Take care to capture how these dependencies actually operate, rather than how you may wish them to or how standard assumptions or models dictate that they should. Combine these interdependencies into a single map of the firm’s architecture. Finally, get quantitative again, by completing the time-charts for any new items and performance outcomes that have arisen as the complete picture is put together.
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There are common structures that recur in many sectors of business, but it is always necessary to build up the structure that applies to your situation. Similarities also arise between the issues that arise in such cases, but the actual behaviour of each case can never be inferred by reference to other cases, only by close attention to what is happening here and now.
In new ventures, or extreme cases requiring transformation, it may be necessary to lay out a business architecture that is not currently in existence. However, for most continuing businesses, the current architecture provides a foundation for seeking performance improvements.
Such improvement opportunities can be discovered by following a process of investigation (in the correct order). First, seek to minimise losses or key resources, then make sure that any inward flows or development flows of resource are responding properly to the forces that should be driving them. Look to identify and remove any imbalances that may be holding back growth, and free up or initiate new reinforcing feedback mechanisms. Look most carefully for any structures that could trigger catastrophic collapse and identify means to cut critical connections in such cases.
If the changes required to the level of a single resource cannot be practically accomplished sufficiently quickly through normal gain and loss processes, seek means to acquire or lose tranches of resource through one-off events or programmes. Make sure, though, that the rest of the system remains in balance, and that any adverse secondary consequences are protected against. Major, organisation-wide acquisitions, disposals or rationalisations should be scrutinised to ensure they comply with the same criteria for performance and robustness.
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Chapter 7: The hard face of soft factors - the power of intangible resources
The characteristics, measurement and importance of intangible resources
‘Indirect’ resources – reflecting how people feel about important issues, and the resulting impact on resource flows
Direct drivers of change affecting intangible resources
Resource ‘attributes’ – qualities that change as resources are won or lost
The impact of time delays and changes in perceptions over time
Dealing with ‘negative’ perceptions
Coping with changing expectations
Integrating intangibles into the strategic architecture
An example of intangibles – professional services
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Intangible factors have a powerful impact on business performance over time, by affecting strongly the rates at which tangible resources are won or lost.
Since intangible factors have such a strong impact on performance, it is essential to define and measure them clearly, and to track how their values change over time.
Indirect resources reflect the perceptions and attitudes of key participants in the business system – the feelings of staff and customers are most common, but investors, suppliers, dealers and business partners may also be important.
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Attribute resources are the second intangible category, reflecting important qualities of tangible items. Gains and losses of tangible resources always carry with them gains and losses of these attributes, just as water entering or leaving a bath-tub carries its temperature with it. Attributes may also change directly, with no change to the quantity of tangible resource.
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Time-delays arise where indirect resources or other perceptions by key people adjust in response to changing realities. These time-delays may obstruct managerial efforts to make improvements, e.g. when service quality increases go unrecognised, but can also store up trouble for the future. It is therefore important to track such perceptions, and act to influence them where possible.
Certain intangibles may be ‘negative’ resources, for example reflecting some irritation or annoyance amongst customers, investors, staff or others. These negative resources hold down the rate at which the organisation can build other resources or cause other damage. More seriously, they can reach tolerance levels where substantial behaviour changes are triggered by seemingly small events.
The core strategic architecture for the business, built up as described in Chapter 6, can be adjusted by adding the structures and time-path behaviour caused by key intangible factors.
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Chapter 8: Into battle - the dynamics of rivalry
The fight to capture new customers arises in growth sectors, but also in many mature markets. This process also stimulates industries’ entire development
Competitors also battle to steal resources controlled by their rivals
In many markets, resources are non-exclusive, so firms fight to win share of attention
The three types of rivalry commonly operate together
Grouping competitors according to similarities between their resources and strategies can simplify complicated cases
The same mechanisms explain organisations’ relative success in winning and retaining any contested resource – e.g. skilled staff
These challenges are equally important to the performance of charitable, public service and other non-commercial cases
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Since performance through time depends on building and sustaining resources, rivalry must play out through the battle for resources. Since most research into business performance has focused on competition in commercial product-markets, attention has been dominated by concern over customers. However, since organisations’ performance reflects the effectiveness of their entire system, an adequate method for tackling rivalry should address the process of winning and keeping any contested resource. Three rivalry mechanisms cover all cases:
(Type 1 Rivalry) As new potential customers develop (or staff etc.), rivals fight to win them for their own business. Fighting to capture new customers depletes the remaining stock of potential customers, and slows rivals’ ability to build their business. Competitors, collectively, also seek to develop this potential pool, a process that is enabled or constrained by external factors, such as economic or social conditions. Although type-1 rivalry is most evident in emerging markets, it continues to arise wherever new potential customers are developing – which is the case in the majority of situations. The rate at which customers choose one firm over another reflects the benefit vs. price that they expect from each, but moderated by financial and other costs they have to incur.
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(Type 2 Rivalry) Competitors also battle to steal resources that have already been developed and are controlled by their rivals. At the same time, they fight to prevent their own resources being stolen. The rate at which customers choose to leave one firm for another reflects the change in benefit vs. price that they expect from changing, but moderated by financial and other switching costs they will incur.
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(Type 3 Rivalry) The first two forms of competitive dynamics arise whenever customers commit exclusively to one supplier, rather than its rivals. In many cases, though, customers (and others, such as advertisers and investors) share their favours between several firms. In these cases, firms fight to win share of attention. Since switching costs are generally near zero in such cases, share-of-business can swing between rivals quickly. Firms also, then, compete to pull customers into their stock of exclusive clients.
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Organisations commonly identify with one or two key competitors, with whom they are most directly engaged in the battle for resources. Where rivalry is occurring amongst multiple competitors, thinking through the dynamics of customer-flows becomes too complex. This challenge can be simplified by identifying strategic groups of similar competitors, and treating them as a single rival. Organisations may be similar to each other (and different from firms in other groups) in their strategic architectures and in the strategies they pursue. Any single firm’s dynamic performance therefore reflects the rate at which it wins and retains resources vs. individual rivals of its own type, and vs. whole groups of other competitors. Most cases feature a ‘war for talent’ in attracting and retaining good staff, but depending on the context, investors, dealers, suppliers and other resources are also fought over - media and communications firms fight to win advertisers, for example. As in the case of rivalry for customers, organisations efforts can stimulate the development of potential resources– young people choose careers in promising industries, for example – a process that is also enabled or constrained by the external environment.
The performance of non-profit organisations, such as charities, governmental, public service, and political entities, is also fundamentally dependent upon their success in winning and keeping resources, so they too will benefit from understanding and tackling the competitive processes described in this Chapter.
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Chapter 9: Building the capability to perform
Capabilities – enabling strategic resources to be built and sustained
Capabilities combine skills and organisational processes for getting things done
Learning as capability-building
The impact of capabilities on performance
Clarifying ‘core competences’ and the competence of leadership
Defining organisational learning – and avoiding organisational forgetting
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Since performance through time depends on building and sustaining resources, capabilities must operate through enabling resources to be built and sustained (though a few special cases arise where capabilities contribute to immediate business performance). Capabilities capture how effectively teams in an organisation get things done, and come about from the combination of individuals’ skills and carefully designed procedures and processes. These processes are built up over time, and since people carry their skills with them, capabilities accumulate and deplete in just the same way as do resources.
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Any one resource may be dependent on several capabilities, so it is important to distinguish these, and follow a careful process to identify the order, scale, cost and performance outcomes from potential improvements.
Since the business depends on the entire resource-system being in good shape, performance is strongly influenced by the strength of all capabilities throughout the organisation’s architecture. Consequently, the quest for what many refer to as a ‘core competence’ (a magic bullet that alone will ensure success) is doomed – although the concept has valuable application for strategy in multi-business situations.
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Team-learning is measurable as the rate at which any capability is building through time – a process that arises through feedback from experience at tackling the task of building, developing or sustaining a resource. This learning occurs through accumulating better procedures, whether these are codified or merely habits that the team adopts. Learning, when it occurs across all critical capabilities, has a powerful impact on the organisation’s resource-levels over time, and hence contributes to growing strong, sustainable performance. However, there are powerful mechanisms that drive organisations to forget – many of which have been inadvertently chosen in response to investor pressures.
‘Competence’ is a term reserved here for senior management’s ability to design a sound strategic architecture of resources, processes and policies, to adapt this architecture in the light of emerging problems and opportunities, and to steer performance once the architecture is in place.
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Chapter 10: Keeping the wheels on the road – steering the dynamics of strategy
Goal-and-control structure of management policy
Diagnosing causes of changes to performance
Limits to decision-making abilities
Interference between goals and policies
Building on the balanced score-card and value based management
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Management directs performance by comparing (whether explicitly or implicitly) the current state and trajectory of certain measures against goals or targets for those same items. ‘Policy’ consists of somewhat simple guidelines for decisions that seek to close this gap between the actual and desired state of affairs.
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To ensure that policies are sound and mutually consistent, management faces a difficult task in disentangling the outcomes that arise when two or more decision-items interfere. This can be accomplished by carefully dissecting the resource-accumulation and causal effects of each. Use of correlation methods to separate such effects must never be used when an accumulating resource arises between the item we wish to explain and possible explanatory factors.
Decision-making is far from being perfectly rational, being constrained by unavoidable uncertainties in the information available and its implications, together with ambiguity and conflict between the different goals and pressures on management. However, in making any particular decision, a sound understanding of the organisation’s strategic architecture enables interference between decisions to be understood. It is therefore possible to adjust current decisions to allow for the consequences of prior decisions.
A rigorous portrayal of the strategic architecture, populated with quantified information on the organisation’s performance through time constitutes a truly dynamic balanced score-card. This provides a sound basis for continuous and coherent monitoring and revision of strategy, and for the targets and incentives for the organisation.
Using the strategic architecture to build an internally consistent projection of business performance and free cash flow outcomes provides a much-needed bridge between business strategy and the financial evaluation of firms, and of the strategic decisions made by management.
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Chapter 11: Further developments on existing strategy concepts
Firm-level, industry level and strategy process themes
The dynamic basis of the experience curve
Avoiding dangers from poor development of strategy dynamics, and using advisors
The industry-level perspective, viewed as rivalry between firm-systems
Incorporating exogenous forces and building fact-based scenarios for assessing strategic options
Easing the process of Strategy development and delivery with a clear business architecture
The further potential from applying a rigorously dynamic approach to Corporate-level strategy questions
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Some form of value chain analysis is the most common tool of strategy analysis to be applied at the firm level. However, this essentially financial perspective often loses any connection with the underlying business resources or, crucially, with their gains and losses that are so essential. However, components of the value chain can be populated with cost streams based on sound, dynamic appraisal of resources, thus reducing the widespread risk that arises when strategy takes insufficient account of important interdependencies. One particular tool of firm-strategy, the experience curve, can be better understood in terms of the underlying resource-dynamics.
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Any appraisal of strategy dynamics will soon need to go beyond what can comfortably be handled on paper, or white-board, and will become increasingly complex. Inevitably, then, management will either need to develop modelling expertise within the firm or rely on outside advisors. It is vital, in such cases, for management to keep control of the process and avoid either being led into abstraction and excessive complexity, or bemused by seductive computer simulations that are poorly grounded in their business reality.
Most strategy insight over the last 20 years arises from industry-level analysis. The development of entire industry structures, though, is an evolving struggle between the resource-systems of participating firms. Furthermore, the development, maturity and decline of entire sectors depends on the relative strength of those sector-systems, as compared with those of rival sectors offering substitute goods and services. The interaction of the five generic forces exerting pressure on industry margins are readily understood in terms of management’s boundedly rational assessment of earnings opportunities offered by the industry structure as it develops through time.
These processes of industry evolution are unavoidably dynamic, so the static strategy guidelines derived from traditional, correlation-based research amongst large samples of firms are fundamentally and inescapably flawed.
The strategic architecture of both individual firms and entire sectors can take account of the most influential exogenous forces traditionally dealt with by analysis of political, social, economic and technological factors. By doing so, management can construct fact-based, internally consistent, and quantitative scenarios, against which to assess their strategic options.
Although primarily concerned with the substance of firm-strategy, the resource-system also offers contributions to the strategy process. A crystal clear, fact-based picture of the firm’s strategic performance, prospects and direction both eases the negotiation of strategic choices amongst the top team, and offers clarity of purpose and direction to others in the organisation.
Beyond the concerns of those who lead focused businesses, there is considerable further scope to improve matters by applying a rigorously dynamic approach to Corporate-level strategy : diversification, mergers, acquisitions, alliances, business webs, multi-national strategy, regional and national strategic advantage.
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Appendix: theoretical foundations
The strategy dynamics approach is built on essentially simple, but important theoretical foundations, that connect well to certain key concepts in the Strategic Management field, in particular the notion that resources and capabilities are both classes of ‘accumulating asset stocks’. The defining characteristic of such factors is that their quantity at any moment is not ‘explained’ by any other variables but the sum of every quantity ever gained, minus every quantity ever lost. For example, today’s total staff is the sum of everyone ever hired, minus everyone who was ever fired or resigned. This relationship is a mathematical identity, not a matter of statistical coincidence or opinion.
The mathematics that explain this behaviour integral calculus, so the ‘integration’ of asset-stock levels through time must be linked to other well-known relationships in order to construct a coherent model of firm performance. The most important of these other relationships are:
The performance outcomes that derive from current resource-levels (earnings derive from revenues minus costs, revenues reflect customer numbers, and costs reflect quantities of staff and production capacity, for example), and
The rate of growth and retention of each resource depends on the existing levels of other resources (customer-acquisition rates depend on current quantities of sales staff, product range and reputation, for example)
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The strategy dynamics perspective builds through a series of logical relationships:1. … the performance of the firm, Õ, at time T depends on the levels of resources R1 to Rn, on discretionary management choices, M (notably chosen spending rates), and on exogenous factors at that time E.
2. … the current level of resource R at time T is the sum of its net rates of accumulation r since time t=0, plus its initial quantity.
3. … the current rate of accumulation ri of resource i at time T is a function of the current level of all existing resources, including that of resource i itself, on management choices, M, and on exogenous factors E.
Certain other factors must be added to these three simple, core relationships. First, firms must usually accumulate certain resources from ‘potential’ stocks, outside their current control (e.g. we can only win customers who might potentially have a use for our product or service), so
(3b) … the firm’s accumulation of resource i at time T is dependent also upon the availability of potential resource at that time, P,(T).
To account for competitive effects, the model must recognise that any particular firm can win resource not only from potential sources, but also from rivals. Competitive performance thus depends on the firm’s success at persuading customers, skilled staff and other contestable resources to switch to the firm and remain with it into the future. Since each firm’s ability to accumulate and retain any one resource depends upon its existing stock of resources, so
(3c)… the net accumultion rate of any resource i by firm j depends on the firm’s existing resource-levels R1-n,j, rivals’ resource levels R1-n,1-m,, levels of potential resources P1-n, managerial choices of firms 1 to m, and exogenous factors, E.
In addition, any pool of potential resource P may itself accumulate (as when new groups of customers become interested in a new product or service for the first time), so
(4) … the rate, pi, at which any potential industry resource, Pi, grows at any time T depends on the existing stock of resources and potential resources in the industry, the managerial choices of all firms, and exogenous factors
These relationships are extended to reflect important attributes of resources, such as customer-size, staff-skills and product functionality.
In addition, success in accumulating and retaining resources is also constrained or enabled by the organisation’s capabilities, i.e.a firm’s capacity to build and sustain a particular resource, for any given availability of the other resources needed for that task, that is developed over time.Capability Ci is thus a moderating factor on the existing resource-building rate, ri, given by Equation 3c. The more experience a firm gains in each resource-building task, the more opportunities it has to develop effective organisational processes, information, and information flows to enhance its effectiveness. This implies that
(5)… the rate of accumulation, ci, of capability Ci, is a function of the corresponding resource-building rate, ri.
Firms do not exhibit a uniform tendency to accumulate capability in any resource-building task, in spite of relatively equal opportunities to learn. In practice, therefore, equation 5 can be extended to reflect the firm’s learning effectiveness.
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