Why Do Firms Differ, and How Does it Matter? TORIo Richard R. Nelson Strategic Management Journal, Vol 12, Special Issue: Fundamental Research Issues in Strategy and Economics (Winter, 1991), 61-74 Stable url: http://links.jstor.org/sici?sici=0143-2095%028199124%02912%3c61%03awdfdah%o3e2.0.c0%03b2-i trategic Management Journal is currently published by John Wiley Sons Your use of the jStOR archive indicates your acceptance of JSTOR,'s Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://wwwjstor.org/journals/jwiley.html Each copy of any part of a STOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission jStOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support @ jstor. org http://www」]stor.org Wed nov211:34:43200
Strategic Management Journal, VoL. 12, 61-74(1991) WHY DO FIRMS DIFFER, AND HOW DOES IT MATTER? RICHARDR. NELSON School of International and Public Affairs, Columbia University New York, U.S.A. for students of business management and strategy, firm differences are at the heart of their inquiry. This paper explores the reasons behind this stark difference in viewpoint It argues that economists really ought to recognize firm differences explicity INTRODUCTION position certainly has been influenced by the work of scholars of firm management who have This paper is concerned with the sources and persuasively documented significant differences nificance of interfirm differences, from the among firms in an industry in behavior and viewpoint of an economist. How might an performance, and proposed that these difference economist's perspective on this differ, say, from largely reflect different choices made by firms that of a student of business management? I However, because the interests of those authors would argue that the most important difference have differed from the interests of economists, is that economists tend to see firms as players in almost no attention has been paid to the industry a multi actor economic game, and their interest or economy wide implications of such different is in the game and its outcomes, rather than in choices. Thus while the management literature the particular play or performance of individual provides a start for my argument, there is much firms. That is, economists are interested that I need to build myself, in cooperation with how the automobile industry works, and its like thinking friends erformance in ns. and not It should be recognized that, in trying to General Motors or Toyota per se, but only insofar make a case for the economic significance of as the particularities of these firms influence the discretionary firm differences, I and my co industry more broadly. This perspective is quite arguers are fighting against a strong tide in different, it seems to me, than that of a student economics, particularly in theoretical economics, behavior and performance of individual firms in such differences. The argument in economics is their own righ not that firms are all alike; economists recognize My objective in this essay is to make a strong that computer firms differ from textile firms, and case for the economic significance, in the sense in both industries, German firms almost certainly above, of discretionary firm differences. My differ from Taiwanese firms. Rather, the position is that the differences arent discretionary, but rather reflect differences in the contexts in which Key words: Firms, innovation, evolution, competition firms operate: computer design and production
62 R.R. Nelson technology and the computer market differ from modes of organizing economic activity. Finally the situation in textiles. Factor prices and a repris availabilities and product markets in Germany differ from those in Taiwan. Thus. firms are forced to be different THE DIVERGENT LITERATURES ON The tendency to ignore discretionary firm 'COMPETITIVENESS differences in part reflects that economists are not interested in behavior and performance The differences in perspective can be seen clearly t the level of firms, but rather in broader in the divergent literatures concerned with what aggregates-industry or economy wide perform- now popularly is called the competitiveness ance, It reflects, as well, some strong theoretical issue- the recent weakness of American firms, views held by most main line economists about particularly vis-a-vis Japanese ones, in industries what economic activity is all about, and about where not so long ago U.S. firms were doing the role and nature of firms in economic activity. very well. There is a sharp split between studies My argument that discretionary firm differences that focus on the differences between American within an industry exist and do matter significantly and Japanese firms, and studies by economists is part and parcel of my broader argument that that are focused on more aggregated variables neoclassical economic theory is badly limited Made in America, a publication put out in the Let me flag here, for future elaboration, what summer of 1989 by the MIT ComI do and don' t mean by the term 'discretionary. Industrial Productivity, is a good example, and I do mean to imply a certain looseness of summary, of the former line of research. While constraints, both in the short and long run, that the staff of the Commission undertook consider- gives room so that firms that differ in certain able research on its own, the multifaceted important respects can be viable in the same diagnosis it presents is quite consistent with that economic environment. I do mean that to some presented in a number of prior studies concerned extent these differences are the result of different with why American firms have been losing out. strategies that are used to guide decision making American firms are hooked on old style mass at various levels in firms. On the other hand, I production methods, in an era where flexible do not mean that what a firm is and does is manufacturing has become a more effective mode under the tight control of high level decision of operation. Similarly, our hierarchical mode makers. And I certainly do not mean that what of organization and custom of specifying job makes a firm strong or weak at any time is well assignments narrowly, while perhaps appropriate understood. even within the firms themselves in an earlier era. now are sources of weakness although there well may be an articulated point Research and product design and development of view on this. more on these matters later stand too distant from manufacturing and pro The remainder of this essay is structured as duction engineering; thus it takes American follows. In the following section I shall flesh out companies much longer than the Japanese to my above remarks about the very significant go from conception to production, and our differences in perspective between scholars production costs and quality often are inferior trained or inclined to see discretionary firm level American firms are myopic, both in the sense of variables as important, and economists who see their failure to look at world rather than national firm differences as determined largely by more markets, and in the sense that time horizons are aggregative economic forces. Then I focus on the short. The latter partly has to do with the higl basic theoretical preconceptions of neoclassical cost of capital in the United States, but also with economic theory that lead to this position, and the way our managers think and the tools of hich make it very difficult to move any analysis they are taught in business schools distance from it. I follow with an exploration of Compared with the Japanese and Germans, our evolutionary economic theory which provides a blue collar work force comes to the work place very different view of what economic activity is poorly trained by the public education system all about and within which firm differences are This is compounded by a weakness of in-company central, and go on to consider the role of firm training and retraining programs. Together, this differences in the evolution of technology and puts American firms at a significant disadvantage
Why Do Firms Differ? 63 regarding labor skills. American firms are less diagnosis of lagging American productivity growth willing to cooperate with each other on matters rates, and the convergence of productivity and where cooperation would yield pay-off, partly living standards among the major industrial because of the attitudes of managers, but also nations. The focus of Productivity and American rtly because government looks on cooperation Leadership: The Long View(1989) is usually at with suspicion or hostility. More generally, the level of the national economy, and sometimes business and government seldom work together at the level of the sector or industry. The and often are at odd variables considered are national savings and Others might summarize the central arguments investment rates, investments in education, pro omewhat differently, but I believe the above cesses through which technology flows from oes represent fairly the kinds of propositions creators to followers, and the like. There is about firm differences made in the report. The scarcely a word about discretionary behavior at arguments are plausible and provocative, and the level of firms may provide important guidance to American It is strongly tempting, and I think right management, and for public policy headed, to propose that each of the studies has However, there are two important issues one described part of the elephant. The argument in can raise about the conclusions of the study. the MIT study, that many of the difficulties First, one can question the confidence one should American firms are having are self inflicted, is place in the causal connections asserted in studies quite persuasive. At the same time the econom like Made in America. Second, one also can ist,s proposition, that to a considerable extent question whether the variables treated there as firms are molded by the broader economic basic really are so, as contrasted with themselves conditions surrounding them, is compelling. What being determined by broader forces seems sorely needed is an analysis that sees both At this stage I want only to flag the former of these matters, in a coherent way ssue. However, there really is a big question While the authors of Made in America never about just what Japanese firms in the automobile quite got into serious analyses of environmental dustry, or the semiconductor industry, are variables, it does not seem difficult to augment doing that lies behind their evident stronger an analysis that starts at the firm level to consider performance, in various dimensions, than Amer- the environments that firms are in. Two new ican or European firms. Late this essay I books are exemplary in that they do shall focus on this uncertainty, and some of its this. Both recognize explicitly that national or implications environmental variables strongly influence firm For the present I want to focus on the latter strategy and structure, and that firms have question, because it gets sharply into view the considerable range of choice about these vari ontrast between analyses like Made in America, ables. Chandler's Scale and Scope (1990)describes and the standard views of economists about the in considerable depth how the different economi determinants of 'competitiveness'. There is some conditions, institutions, and cultures of the U. S discussion in Made in America of macro or Great Britain, and Germany, molded the nature national level variables, like the exchange rate, of the modern manufacturing firms that grew up the cost of capital, or more generally the system in these different countries in the first decade of corporate finance, the effectiveness of the of the twentieth century, and influenced the public education system, government policies, industries in which the nations developed special etc. However, this is not where the focus is. It strength. However, there is nothing deterministic is firm level variables that receive the top billing, about Chandler's description of how the environ and it is presumed that these are discretionary ment shapes firms and influences their perform to a considerable degree. In contrast, the ance inclination of economists is to focus on macro, Porter's The Competitive Advantage of Nations or environmental level variables, and to play (1990)presents a similar perspective in which down or ignore the role of firm discretion environmental influences matter greatly, but the The same year that Made in America was firms have a considerable range of freedom published, three economists, Baumol, Blackman, regarding whether, or just how, they will take and Wolff, published their interpretation and advantage of the opportunities the environment
4R. R. Nelson affords. Indeed both authors see the firms as to put forth a strong general theoretical challenge some extent molding their own environment as, to the effect that innovation ought to be the for example, in calling forth significant public center of economic analysis. But it is hard to investments in education in the U.S. and Ger- overestimate the degree to which economists many continue to see the central economic problem as Chandler is an historian by training. Porter's that of meeting preferences as well as possible formal training is in economics, but his career given resources, and prevailing technologies and has been at a Business School and his research institutions. This perspective implies a rather focus has been on management. It should be limited view of what firms are about recognized that the orientation of these authors Second, partly reflecting this general orien- to 'firms' is quite different than that in most of tation, but not the only possible formulation of economics. Indeed it is apparent that for both firms'decision processes consistent authors the center of attention is the firms, and economists became wedded to a theory of firm the central questions are how are they doing behavior that posited that firms face given and and 'what makes them strong or weak. They known choice sets(constrained for example by are drawn to wider economic mechanisms and available technologies) and have no difficulty in institutions in the search for answers to these choosing the action within those sets that is the questions. Now firm performance clearly is best for them, given their objectives(generally related to broader economic performance, but I assumed to be as much profit as possible). Thus have argued above they are not the same thing. the 'economic problemis basically about getting Since neither Chandler nor Porter presents a private incentives right, not about identifying the coherent statement of the economy wide problem, best things to be doing, which is assumed to be their analyses stop considerably short of providing no problem an answer that would satisfy economists to the The perspective on the economic problem and question of why do firms differ and how does the theory of firm behavior described above do matte not invite a careful inquiry into what goes on in firms. However, the tradition in economics of treating firms as'black boxes, was not inevitable FIRMS IN NEOCLASSICAL ECONOMIC either. The fact that until recently at least, this THEORY has been the norm deserves recognition in its own right To get at that question from an economists The overall result is a view that what firms do perspective, one needs to start with a broad is determined by the conditions they face, and Inderstanding of what economic activity is all (possibly) by certain unique attributes(say a about, and what constitutes good economic choice location, or a proprietary technology )they performance or poor. Neoclassical theory, which possess. Firms facing different markets will vides the current conventional wisdom on behave and perform differently, but if the market these matters for economists, militates against conditions were reversed so would be firm paying attention to firm differences as an behaviors. Where the theory admits product portant variable affecting economic perform- differentiation, different firms will produce differ ent products but, in the theoretical literature The first is the perception of what economic any firm can choose any niche. Thus there all about. Since the formulation of are firm differ general equilibrium theory almost a century ago, autonomous quality to them the focus has largely been on how well an The theoretical orientation in economics thus and technologies. This position is far from cretionary firm differences matter. Of course universal. Empirically oriented economists have economists studying empirical or policy questions been interested in things like technical change have a proclivity to wander away from the tethers and, recently, there has been a rash of work on of theory when the facts of the matter compel economic institutions and how and why these them to do so. Thus in doing industry studies, change over time. Schumpeter some time ago economists often have been forced to recognize