Business Psychology - Latest Findings

Article No. 207
Business Practice Findings, by James Larsen, Ph.D.

Performance and Age of the Firm

Researcher learns of tradeoffs in business strategy and their effects on performance.

There's a specialized field in the study of management known as organizational ecology that maddens business owners. Researchers in this specialty compare the life of a company as it ages to an individual's life span, and they search for universal pressures that lead to business failure. These researchers are responsible for catchy phrases like "liability of newness," "adolescence," and "obsolescence," and they often fill the role of a doomsayer who warns of dangers that lie ahead.

Andrew Henderson of Columbia University is a critic of this management specialty, and he conducted a study to explore two weaknesses in the field.

First, he noted with dismay that these researchers can't help companies identify which problems they are most likely to encounter (liability of newness, adolescence, or obsolescence), and second, he noticed that they only looked for conditions that caused business failure. They neglected to search for conditions that led to positive outcomes like rising sales, growth, and profitability.

Henderson examined the personal computer industry from 1975 through 1992. During this period 649 firms entered the industry. Henderson guessed that differences in business strategy would influence how these firms aged, and that these differences would create tradeoffs across different important outcomes like sales and profitability. He was right; they did.

Henderson compared companies that followed a marketing strategy with those that followed a hierarchy strategy. With a marketing strategy, firms obtained components to produce their products from the market. They bought subcomponents, engineering know-how, and other skills from vendors and consulting firms and concentrated on sales.

Firms following a hierarchy strategy employed extensive, proprietary research and development to produce a product, so their products often relied upon unique technologies. These firms required more specialized people to get a product out the door and to provide after-sales service. Henderson found these firms failing at a greater rate throughout the 17-year period he studied. The burden of many people depending upon the fortunes of the firm for their livelihood surpassed the ability of many firms to meet this need.

Henderson also found that firms following a marketing strategy were more nimble in responding to changing requirements posed by customers and by evolving technologies. Hierarchy firms also had greater difficulty getting started because of larger requirements for initial capital and unreliable technology.

At this point Henderson's research painted a very bleak picture for hierarchy firms, but then he examined profitability.

Although it was true that hierarchy firms failed much more frequently than marketing firms, it was also much more likely that the remaining firms would be big winners and far surpass the profitability of marketing firms. Indeed, it seemed to be a tradeoff. Firms that chose a marketing strategy faced an easier future than hierarchy firms, but they had no chance to soar in profits. They could only expect to age gracefully and to look forward to their competitors making sure they didn't make too much money.

Conversely, hierarchy firms that survived more than 7 years created isolating conditions that thwarted competitors and fostered outstanding performance in these older firms. They carved out niches and had them for themselves.

With this research Henderson has turned organizational ecology on its head and given it a new definition. Age dependence is not a universal tendency. Rather it is a collection of performance outcomes that vary by strategy, and executives choose the strategy that best suits their proclivities. Now we know what may lie ahead for us.

Reference: Henderson, Andrew D. (1997) Firm Strategy and Age Dependence: A Contingent View of the Liabilities of Newness, Adolescence, and Obsolescence. Academy of Management Best Paper Proceedings from the Fifty-Seventh Annual Meeting of the Academy of Management, 263-266.

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