This is actually a revision of an old paper but here is the introduction.
The question of why some firms develop more valuable resources and capabilities than others has been a central one for strategy researchers. The resource-based view (RBV) of the firm has been a central theoretical framework for explaining heterogeneity in firm performance (Barney, 1991; Peteraf, 1993; Wernerfelt, 1984). There is a growing consensus that differences in firm performance are driven by higher order capabilities to develop or reconfigure bundles of resources that will generate value over time (Teece et al., 1997; Winter, 2003).
However, we still do not understand the source of dynamic capabilities and why some managers are able to develop more valuable resources than others. A growing stream of literature examines how managers may play an active, cognitive role in making bets and predicting which resources and capabilities will be more valuable than others. Managers face numerous biases as they attempt to understand the competitive environment and its trends in enough detail to search for a cluster of resources that will provide competitive advantage (Gavetti and Rivkin, 2007). Cognitive representations have been identified by prior research as important in shaping decision-making as well as focus and interpretation (Huff and Jenkins, 2002, Fiol and Huff, 1992, Walsh, 1995, Simon, 1991, Weick, 1995, Narduzzo, Rocco and Warglien, 2000). Yet, existing work has focused on the content of mental models rather than on the use of mental models for certain capabilities, such as predicting what resources will be more valuable in the near future.
The purpose of this paper is to address the gap in our understanding of the sources of dynamic capabilities. We show that one initial source of firm-level dynamic capabilities is the cognitive representations of its founder(s) that result from their careers. Conceptually linking the individual and firm levels, we extend the line of work that recognizes that strategy arises from managers’ cognitive theories about the world (Gavetti and Rivkin, 2007, Huff and Jenkins, 2002, Porac, Thomas and Baden-Fuller, 1989). We demonstrate that improved cognitive maps of industry trends and causal relationships come from specific types of industry experience and guide the successful recombination of resources, routines and capabilities.
We extend the microfoundations of strategy (Gavetti, 2005) and seek to answer the question: When organizations are putting together new bundles of routines and capabilities, what determines who puts together the more valuable and difficult to imitate bundles? Specifically this paper is interested in whether firms gain a competitive advantage through dynamic capabilities in the form of improved cognitive representations that the founders acquired via prior work experience? The results support the main thesis of the paper that the answer is yes. We suggest a novel mechanism through which dynamic capability arises from improved cognitive maps of the competitive landscape. We examine the micro-foundations of resource and capability development by theorizing how cross-functional experience results in variation in cognition due to the well-known psychological phenomenon of partition dependence. We extend and build on prior research that has suggested that differences in managerial cognition lead to variation in strategic decisions (Tripsas and Gavetti, 2000, Adner and Helfat, 2003, Porac et al., 1989). Our primary proposition, Hypothesis 1, that individuals with cross-functional experience will build more accurate cognitive representations, resulting in assembling more valuable combinations of resources/capabilities was supported. Our analysis shows both environmental and individual-level contingencies when improved cognitive representations are expected to be of greater importance for making predictions on trends and the future value of resource positions. Hypothesis 2a was also supported in that those remaining in the same industry context experienced higher performance. Hypothesis 2b was that after a significant industry disruption, cognitive representations built up through prior cross-functional experience would become a liability. The results show that post-1997 the impact of cross-functional experience became negative and significant as individuals who had built up mental models before the internet boom mistakenly attempted to apply them after the disruption to the industry. Similarly, when we separately ran the analysis on the pre-1997 time period and post-1997 time period, the coefficients on cross-functional experience are positive and significant for the pre- time period and are significantly lower (indistinguishable from zero) for the post-1997 time period. The data tended to support hypothesis 3, that cross-functional experience leads those who experienced success to higher performance. After initial results in Table 3 showed that more highly educated individuals appeared to benefit more, once additional controls were introduced, we failed to continue to find support for hypothesis 4. The results appear to support the idea that a more recent cross-functional experience is more useful and that the benefit fades with time, supporting hypothesis 5. This result supports the notion that for predicting trends, a more recent cross-functional experience is quite important. The overall pattern of results, under a number of different specifications, appears to provide robust evidence consistent with an account where experience with a broader set of responsibilities and functional decision rights leads to more balanced cognitive representations to guide strategic decisions.
This study extends and challenges existing work on the resource-based view and particularly on the ability to restructuring and identify more valuable assets and capability bundles. Prior work on the sources of performance-enhancing resources and capabilities has focused on the inheritance of search routines or superior information. While this moves our understanding forward, we still lack a psychological foundation for identifying where differences arise in cognition or beliefs about the future value of routines, resources or capabilities. Rather than asking what forces constrain the strategic options under consideration or factors that lead to greater homogeneity and mimicry in strategic choices, we examine how certain managers and firms uniquely make predictions leading to differentiation and higher performance. We build on work showing the strategic importance of framing and individual level cognition (Kaplan and Tripsas, 2008; Tripsas and Gavetti, 2000). We examine a different cognitive spillover mechanism: where individuals appear to transfer to a subsequent firm more accurate representations as a result of the prior founding experience. We build on the theoretical framework for the psychological foundations of capabilities’ development laid out around cognition and the integration of knowledge (Grant, 1996; Gavetti and Rivkin, 2007; Gavetti, 2005) by extending the theory to propose mechanisms by which differences in cognition emerge around variation in work experiences. Similarly, we provide previously missing theoretical account for when the managers of firms notice trends and change the bundles of routines and capabilities they hold and for how they know in what directions to change them.
Extending earlier efforts to disaggregate the influence on business-unit profits of industry, corporate-parent and market share effects, scholars have examined the influence of firm-level effects (Schmalensee, 1985). Examining lower levels of analysis shows that industry-level effects are approximately half as important as business effects in determining business-unit profits (Rumelt, 1991, McGahan and Porter, 1997). Yet, with the exception of work on top management teams and entrepreneurship, much less work has looked at the influence of even lower levels of analysis (including individuals) on performance (Higgins and Gulati, 2006, Johnson, 2007, Mollick, 2008). Why do some firms outperform others even when in the same industry? Prior work has shown that individuals with firm-specific human capital can be a source of competitive advantage (Hatch and Dyer, 2004). Our contribution is to use psychological foundations to show how cognitive representations specific to the competitive landscape embedded in individuals can function as a difficult to imitate dynamic capability, guiding firms to build competitive advantages.
Much prior work has focused on the content of cognitive representations, but significantly less is known about their origins and the usefulness of certain types of representations (Walsh, 1995). We provide evidence that certain types of work experience can lead to representations that have a higher likelihood of breaking out of the strategic status quo and predicting the development of resources leading to greater performance. However, we also show the downside of relying on these models when a very significant industry change occurs. In a very fluid phase in the industry, cognitive flexibility appears to be more important (Furr, 2009). As noted in Walsh’s (1995) review, we still have unanswered questions for future research about the relationship between the content of a cognitive representation and the information environment it represents. Others have shown that there are differences between accuracy and the usefulness of cognitive representations when simplifying and screening out unnecessary information may be of greater importance (Starbuck and Milliken, 1988), especially as the amount of information available multiplies.
The findings also have implications for the entrepreneurship literature. Our account provides a complementary theory of why managers and entrepreneurs may leave and go outside of their firms to work for others or to start their own ventures. Most organizations tend to become more rigid over time. If individuals within the same firm can develop substantially different cognitive representations of the competitive landscape due to differences in types of work experience and the accumulation of psychological biases, then individuals can begin to have fundamental disagreements with the organization. Furthermore, due to the inertia and rigidity of the existing bundles of capabilities, it becomes increasingly difficult to move the organization to a new set of resources and capabilities that individuals perceive will provide competitive advantage according to their representations of the competitive landscape. Some individuals leave for new organizations due to increased rigidity in bundles combined with cognitive maps drifting away from the increasingly small set of recombinations possible within the firm or from an inability to convince others to select their bundles of capabilities. Differences in the accuracy of cognitive representations, particularly concerning trends and shifts in the competitive landscape may also be a reason why individuals voluntarily leave firms. Individuals may choose to move to other firms or start their own new ventures when disagreements arise, when they see opportunities others do not, or when the existing firm seems incapable of exploiting quickly due to inertia or loss of plasticity (Klepper and Sleeper, 2005; Klepper, 2007).
In conclusion, we have developed and tested a model that links psychological theory to dynamic capabilities and heterogeneity in firm performance. Variation in career experiences leads to variation in the extent of known psychological biases such as partitioning dependence, and then variation in the extent of these biases results in differences in cognitive representations that function as a dynamic capability providing a map to future bundles of resources that will provide a performance advantage.