Knowledge, Strategy, and the Theory of the Firm Julia P. Liebeskind Knowledge, Strategy, and the Theory of the Firm Julia P. Liebeskind Strategic Management Journal (1996) Presentation By Group 3 Jason Franken Prasanna Karhade Hsiao-Ching Lee Hsiao-Ching Lee Jennifer Shen Marko Madunic

Strategy Research A firm’s main purpose is to generate economic rents by creating and sustaining sources of competitve advantage (Rumelt 1984) Concerns of Strategy Research Dynamic rent-seeking behavior Ownership and exploitation of unique assets, capabilities. Knowledge is arguably the most important asset that firms possess – a key source of both Ricardian and monopoly rents (Penrose 1959)

Knowledge Knowledge is defined as information whose validity has been established through tests of proof Knowledge, an intangible good, is unlikely to be uniformly distributed evenly across innovators; so its ownership can potentially earn both Ricardian and monopoly rents Ricardian rents are earned by firms when one firm possesses factors of production that are more productive (superior) that those of other firms carrying out the same activity As the degree to which the observability of products or processes is reduced, causal ambiguity increases, and the costs of imitation increase

Knowledge Protection Tangible assets can be efficiently protected by social institutions that enforce property ownership (i.e. courts) Property rights and market-based mechanisms for knowledge-assets are weak, costly to write and enforce In this paper, Liebeskind (1996) argues that TCE can be extended to accommodate the notion of knowledge

‘Isolating Mechanisms’ In The Firm TCE suggests that firms may have three advantages relative to markets for managing or ‘governing’ knowledge transactions:- 1. By unifying ownership of knowledge and other assets within a firm, the economic incentives of the contracting parties can be better aligned, thus attenuating incentives for opportunistic behavior 2. Firms can substitute an employment contract for a market contract for human capital services, increasing the scope of control over knowledge workers’ actions and/or reducing the costs of such control by replacing legal contracting with managerial fiat 3. A firm can alter the futurity of rewards relative to market contract, thereby reducing employee mobility

Costs Of ‘Isolating Mechanisms’ In The Firm All the protective capabilities discussed earlier have costs associated with them 1. Sunk costs –Administrative costs –Monitoring costs 2. Minimized communication –Knowledge protection occurs by impeding communication; since communication is critical to achieve coordination, productivity and speed-to-market can be expected to fall –Knowledge sharing and communication, in general, can be necessary for knowledge creation or innovation

Two Key Questions: Firms should carefully weigh the costs and benefits of knowledge protection. Firms also need to resolve the following key questions: 1.What knowledge should be protected and what should not? 2.What mechanism or combination of mechanisms should be used to protect its valuable knowledge?

Implications The managerial implications of firms can be understood as representing rent-seeking behavior, directed both at innovation – the discovery or creation of new processes and products – and ‘isolating mechanisms’ – the discovery and creation of mechanisms that serve to protect a firm’s innovations from imitation from rivals. Firms have generalized protective capabilities and that is why we observe so many different types of unique assets Firms can protect their knowledge and these generalized institutional capabilities can also promote strategic innovation

Concluding Comments Knowledge protection is likely to become an increasingly important issue In the modern global economy, the ability to protect knowledge will probably be as critical as the ability to create new knowledge – the ability to innovate Protective organizational arrangements can be vital to sustaining competitive advantage, especially in countries where legal protection against imitation are extremely weak