Strategic Management and Economics

Author(s): Richard P. Rumelt, Dan Schendel and David J. Teece

Source: Strategic Management Journal, Vol. 12, Special Issue: Fundamental Research Issues
in Strategy and Economics (Winter, 1991), pp. 5-29
Published by: Wiley
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 Strategic Management Jouiai sll, Vol. 12, 5-29 (1991)

STRATEGIC MANAGEMENT AND ECONOMICS

RICHARD P. RUMELT
Anderson Graduate School of Management, University of California, Los Angeles,
California, U.S.A.

DAN SCHENDEL
Krannert Graduate School of Management, Purdue University, West Lafayette,
Indiana, U.S.A.

DAVID J. TEECE
Haas School of Business, University of California, Berkeley, California, U.S.A.

This essaoy examines the relationslip ibetiveen strategic mtianiagemtienit anid economics. It
introdhces the special isslse oni this samtie top3ic by providing a guidle to tihe eighit papers
ontainedl in tihe special isslse, andt it offers tihe gluest edlitors viewpoints on t(ie ontribultions
of each d-i.sciplinze to tihe otilier. The essay, niotes tie mai0jor contribution fromti ecionomics hias
ibeen primi1arily' fromt tdie inldustrial organiZation literatlure, witii pirom iises of im-tiporttant gainis
to be mtiadie ftromt the 'nzew' economics as it breaks away firom1 t(ie neoclassi(al tlieory of tile
firm7*. Contribultions fromt strategic mtianiagemtienit to ecionomi(s are niotedi. Areas for fiurttier
resear(ci lutiliZing tie relationsiliip betw'een strategic m7ianiagem7ienit and1b e(onomics aore also
ildicated.

INTRODUCTION relevaint to generail mainaigers, Is in Jeinsein's

The last decaide hais witnessed a minor revolution
in straitegic mainaigemeint reseairch aind writiing.
As never before, aicaidemics haive aidopted the
Iianguaige aIInd logic of economiiics. This chainge is
owed to the increaised use of economics by
strategy scholairs aIInd to the increaised aibility of
economists, airmed with new tools aIInd richer
theories, to aittaick problems of centrail interest
to straitegic imanaiiiigemeint. Thus, duriing this paist
decaide we haive seen straitegy scholairs reaiching
out to use or reformulaite econoimiic theory, as
in Porter's (1980) influentiail treaitmeint of industry
structure. In the other direction, we haive
seen some economists positioning their work aIs
Key1 words: Editor's connmeit, strategic nmanagenmeint
econonmics, research issues
(1989) views oIn corporaite cointrol IInd Williaiim-
soi1's (1975, 1985) ainallysis of the efficieincy
properties of the institutioins of caipitailism.
Although there caIIn be little doubt that
ecoinomic thiinkiing is reshaipiing straitegic mainalge-
meint, opiInioIn is divided as to the usefulness of
this trend. Within straitegic maniasigeimieint, there
is a growing group who cross over between the
fields, but imiintaiin an uinderstanIidiing of their
distiinct strengths aind weaiknesses. However,
there aire ailso some who see ecoinomiiics aIs the
Isolution' to the straitegy problem (or, perhaips,
to the 'tenure' problemi), rejecting the field's
traiditioinail preoccupaitioin with situtioiil coIIm-
plexity aIId mainaigeriail processes. Finially, there
are some who stroingly oppose the conflueince,
seeing economiiics as 'imperialistic,' as takinig
undue credit for formailiziing thait which was
ailreaidy kinowin by others, aIInd as iinseinsitive to

0 143-2095/91/1 00005-25$ 12.50

? 1991 bY John WileY & Sons, Ltd.

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6 R. P. Rumzelt, D. Schenclel antid D. J. Teece
aispects of the humain situaitioin other thain the
raitionail pursuit of gaiin. Within economiiics, the
situaitioin is simpler: there aire those who follow
aIInd appreciate the contributionIs of straitegic
maniasigemiieint reseairch, but there is ai much lalrger
group who are unalwaire of traiditions outside of
economiiics aniid apprehend business management
oinly through their owIn coinstructs (aIInd an
occaisionall reaiding of the Wall Str-ect Jolurntial).
Our purpose for this speciail issue of the
Strategic Maniagettietit Jolurnlal is to examiine the
staite of the current coninectioin between straitegic
imanaiiiigemiieint aniid ecoinomiiics. T"his examiiiinaltioin
will be done in two waiys. The first waiy will be
in preseintiing paipers froiim a lalrger collection of
coiimimlissioined paipers aIInd coiimimeintairies thait
aippeair elsewhere' aId which provide pairticulairly
sailient exaimples of the intersectioin of the two
fields. The second waiy is through this editorial
essaiy which, in aidditioin to providing our
interpretaitioins of the paipers selected for this
speciail issue, is extended to provide our owIn
views about the conniectioin betweein straitegy aind
ecoinoiimics. These views aire intenided to chaillenge
both ecoinomiiists aind straitegists to recoginize
eaich others' coitributioins, liiimitaitioins, aIId the
opportuinities ealch falces in coininectiing theory aIId
aipplicaition. Along the waiy we hope thait new
directions aind priorities for reseairch will be
surfaiced for our reaiders, whether their primairy
interest is straitegy or economiiics. Some commilenit
will ailso be provided oIn the issue: Whait (aIInd
who) should guide the intellectuail developmenit
of the strategic maniasigemiieint field: strategic
thiinkiing aIId straitegists, or ecoinomiiic theory aIId
econoiiiists?
Our essaiy is orgainized in this waiy: the next
section briefly reviews the evolution of the
conlniectioin betweein ecoinoiimics aIInd strategic
maniasigemiieint. The third section aiddresses
imiiportaint forces thait haive iinduced this coininec-
tion. The fourth section examinies the future of
straitegic imanaiiiigemileint aIId ecoinomiiics, high-
I'IThe lairger collection of papers appears in Flwidme(ttietittil
Issues in Sti'ategy, Richard P. Rurmelt, Dan Schendlcl. and
David .1. Teece, (Edls.), Hairvatrdl Business School Prcss, 1992.
This book contaiins the papers in this special iSSLe, in some
caises in extendled form. This companion volumle extendls the
liscussion of strategic management and economics presentcd
in this special iSSLIe. broadens the scope to inciLlde other
social science dlisciplines. and providles a widlcr dliscuIsSion of
research issues fatcing the fieldl.
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lighting sailient research issues. The fifth section
provides a guide to the paipers in this issue. Our
summairy commilenits close the essaiy.
A BRIEF HISTORY OF ECONOMICS
WITHIN STrRATEGIC MANAGEMENT
Straitegic maniasigemiieint, oftein cailled 'policy' or
nowaidaiys simply 'strategy,' is aibout the direction
of orgainizaitioins, aniid miiost ofteni, busiiness firmiis.2
It includes those subjects which aire of primairy
concerni to senior management, or to ainyoine
seeking reasons for the success aind faiilure aimoing
orgainizaitioins. Firmis, if Inot all organizations, aire
in comilpetitioin. competitioni for faictor inputs,
competitioni for customers, IInd ultimiaitely, coIml-
petition for revenues thait cover the costs of their
chosen mannliier of surviving. Firms haive choices
to maike if they aire to survive. Those which aire
strategic include: the selection of goails, the choice
of products aIId services to offer; the design aIId
configuraitioni of policies determiniing how the
firm positioIns itself to compete in product-
mairkets (e.g. competitive straitegy); the choice
of an aippropriaite level of scope aIId diversity;
aIId the desigin of orgainizaitioin structure, aldminiiiis-
traitive systemils aIId policies used to defiine aIId
coordinalte work. It is a baisic proposition of the
straitegy field that these choices haive critical
iniflueince oIn the success or faiilure of the
eniterprise, aIInd, thait they must be integraited. It
is the integraitioni (or reinforciing paittern) aimong
these choices thait maikes the set a straitegy.
Straitegic Imanaiiiigemilenit aIs a field of inquiry is
firimily grouinded in pralctice aIId exists becaiuse
of the importance of its subject. The straitegic
directioin of busiiness organizations is ait the heairt
of weailth creaition inI moderin industrial society.
T"he field has Iot, like politicail scieince, grown
fromii ancient roots in philosophy, inor does it,
like pairts of ecoinoimiics, attract scholairs becaIuse
of the elegaince of its theoreticail underpiiniiings.
Raither, like mediciine or engiineeriing, it exists
2 W will LISe a vairiety ot terrms interchangeably aindl aIssuLIle
throughout the reader will interchainge them ieasily ais well.
Such alternatives as firmn/orgatnizattion/enterprise; proutict/ser-
vice; policy/strategy/strategic management; administrative
structUrc/organization structure/mianagtemnent process aIre
examples of terms and conccpts we use more or less
interchangeably for sake of vairiety and convenience, and wc
trLIst, with no loss ol gencratlity.

becaiuse it is worthwhile to codify, teach, aIId
expaind what is knowin aibout the skilled perform-
ance of roles aIId talsks that aIre a inecessaIry palrt
of our civilizaition. While its origins lie in pralctice
aIId codificaitioin, its aIdvaIIncemileint aIs a field
increalsingly depeinds upoIn buildiing theory thalt
helps explain aIId predict organizational success
aIInd failure. In the seinse of expainsioin, codifi-
caitioin, aIId tealchiing theory is necessary, tested
theory caipaible of prediction desirable, aIId the
sealrch and creaitioin of both to better practice,
absolutely at the heart of the field. Society is
served by efficient, well-adaipted orgainizaitionis
and straitegic management is concerinedl withl
delivering them through the study of their
creation, SUCCeSS, aInI SUrvival, as well as with
understanding their failure, its costs, and its
lessoIns.
Strategic management has a rich tradition and
long history as a teaching area in busilless schools,
a history virtuilly aIS loIng zIs that of busiiness
schools themselves. Prior to the 1960s, the
unldlerlyiing metaphor of the (teaching) fieldl
was that of functional integration. Uinder this
metaiphor, the value-added by what was thiein
cailledl 'busiiness policy' came from integration of
specialized knowledlge within broader perspec-
tives. The perspectives were dLuall: that of the
firimi as a whole, ilnCI ngilIg its performance, and
that of the role of the general manager. Together
with an intellectual style that stresses pragmatic
realism over abstraction, these perspectives
remaiin ait the center of the field andicl dlistinguish
it fr-om other fields with dlifferenit perspectives,
but with similar interests in tlle same core issues.
A new metaphor was inltrodLuced in the 1960s,
that of 'strategy.' Strategy was seeni as milore than
jLiSt coordination or integration of tfLllCtiOlnS-it
emiibodied the joiint sclection of the product-
market arenas in which tlhe firm would comlpete.
and the key policies defininig how it WOUld
comlpete. Strategy was not necessarily a single
decision or a primial action. but was a collection of
related, reinfor-cinig, resource-allocating decisionls
and implementing actions. Dependillg UpOIn
whether- one read Selznick's Leadershilp in Admsiiin-
istration ( 1957), C(handler's Strategy( (111(1 Structure
(1962), Andr-ew's matcrial in Blisi;iess Policyv:
Text andlS Cases ( 1965). or1 Ansoff's Corporate
Strategyt (1965), a company'S miiissioni or strategy
bulilt LIpOIn 'distinlctive competence,* constituited
the firimi's method of expansion, involved a
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Strategic Maiiagem-lenlt (a1i(1 Economics 7
balainced coinsideraitioin of the firmii's 'streingths
aId weakness: Iad defined its use of 'synergy
anid competitive advaintage' to develop new
miiarkets aId new products. Ever since the sixties,
the strategy metaphor has survived as a ceIntral
construct of the field, even without the careful
defiinitioin necessary for researclh purposes.
Where the sixties gave rise to basic coIncepts,
the decade of the 1 970s brought their developmileint
and application to practice, and in turn gave rise
to research in the fieldi as we Inow know it. The
seventies were marked by the rapid expainsioil3
of coinsultiing firmiis specializing in strategy, the
establishment of professional societies, and the
advent of journals PuLblishing material oIn strat-
egy.4 Three forces helpedl strategy flouri-sh in the
1970s. First, the hostility and instability of
the envir-onmiiienit of the sevenities ledl to a
disenchantment with 'planiniiig' and the search
for- miiethodls of adapting to and taking advantage
of the uIlexpectedl. Ihe strategy dloctrines of the
sevenities offeredl an alternative: building and
protectiing specialized streingths that weather
change aiid expressing those streingths inl Inew
produCtS and services as markets shift. The secoind
important force was the con1tiILued expainsion
and further developmiien-t of strategy consulting
practices based onI analytical tools and concepts.
The Bostoni Consultinlg Group pioneered in this
regard, creating the 'experience curve anId
deIiviing the 'growth-share matrix.' The third
key force at work was the maturation and
predomiiniance of the dliversified firmll. Top1 man-
agemient beganIi to see their corporations as
portfolios of busiiness unIits and their primary
respoinsibility a1S capital aIllocation among bLUSilleSS
Unlits. Tlle nlew systemils that evolved, duLbbed
Istrategic manamenient,' foiced b usinless managers
to definle their plans anId goals in coimlpetitive
terimIIls and generated a birisk demand for strategic
tools and strategy analysis.
It ShouIldl be niotled that 'I' lostoll (ConSUlIting" ( Group., thle
first otf the lirmlls specializing ill strategv. andic. the firill thalt
spun ot'f' man' simiiilaLr lirims, wais started by' BruLice I-l.litelnson
inl thle earlxl' sixties.
Fechnll'.';C,1I j(o)urna,;ls speCCializinlg ill stlra1teg'y suchCI aIS thlis
onle, beg,an1 pIuLblication in the eiolities. I-lowever., the
aeemIC enlt to k,lauCh1 tle SNMJ was made in 1978. 'I'lhe Strateioic
NiV111,aage1n'let SOCiCtV' starlted ill 1'981X butt OtIlhle grouIp)s su1Ch'
as thle Nortlh Amiler'icanii Society of' Corporate Planners,
Division ol' Btusiniess Policv and Planning of' the Acadeniv of'
malilaue.'ll.'lit, 'I'l1.e
ianacernent.IlkPlanning P'lailills((1.t'o'lt1
College ll can
of, TIN;IS. and ohr ()tile.lS c.ni
bie traced to thle sevenities.
8 R. P. Rium1elt, D. Sclhendel anid D. J. Teece
Until the sevenities, academic strategy research
consisted chiefly of clinical case stuLdies of actUal
sitUations, with generaliz,ations souLght throuLgh
induLctiol. AlthouLgh this style of research coIn-
tinules to play an important role, the seventies
saw the rise of ai new research style, one based
in deduLctive methods, the falsification philosophy
of Iopper, and the mnUltivariate statistical methods
characteristic of econometrics. Almost simull-
taneouLsly, three different streams of work were
changing the face of the field. Two of these
streams were conduLcted at Harvard, the third at
PuLrduLe University. At the Harvard BuLsiness
School, stuLdents of BruLce Scott bulilt on Chand-
ler's (1962) pioneerinig work and inllUgUrated a
stream of research on diversification and firm
performance. At the Harvard Department of
Ecoinomics, Richard Caves' stuLdents began to
modify traditional Mason/Bain stUdies of struLctuLre
and performance to incluLde differing positions of
firms within industries, inllUgUrating the stuLdy of
'strategic grouLps' within induLstries. Meanwhile,
at PuLrduLe University, Dan Schendel, together
with his and Arnold Cooper's stuLdents, began
the so-called 'brcwinig' stuLdies which explored the
empirical links between organizational resouLrce
choices, interpreted as 'strategy,' and firm per-
formance.5 This work demonstrated for the first
time the existence of struLctUral heterogeneity
within induLstries, and led to the first hard
empirical eviclence of the 'strategic grouLps' ulnder
discuLssion and development at alrvard. More
important than the contenit of the PuLrduLe and
Harvard stuLdies, however, was the different
empirical nlatUre of the work. In addition to cases
ulsed for induLctioll, this new work ulsed difficuLlt
data collection, and the rapidly growing power
of the compulter and muLltivariate statistical
methods capable of handling large data bases, to
test hypotheses in a deduLctive style of research.
This shift in research style ultimately led to
quLestions that case research and simple hypothesis
testing couLld not illUminate. ResuLlts were difficuLlt
to interpret, lacking any theory in which to
em bed them. CuLmulation of quLestions occuLrred,
buLt not of resuLlts that led to advice for
practitioners, or to tests of theory UsefUl for
practice. Hence, the work of the seveinties was
instrUmental in motivatinig the work of the
5 See -ltten and Scheldel (1977), Hatten, Schelndel, and
Cooper (1978), anid Scheldel and Pattton (1978).
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eighties and its search for linkages to theory. As
importantly, this work and style led to (A new
generation of researchers better equlipped to
handle the new style of research and its intellec-
tUal demands.
DuLring the 1980s, owinig to the changes noted,
the pace of change accelerated; economic thinkiing
moved closer to ceinter stage in strategic manage-
mileint as disciplines were examined for theoretical
motivation for the empirical work then bulilding.
The most inflUential contribuLtion of the decade
from economics WIS ulndouLbtedly Porter's Comn-
pe)titiv'(e Strcategv! (1980). In a remarkably short
timle, Porter's applications of moobility barriers,
induLstry analysis, and generic strategies became
broadly accepted and ulsed in teaching, COISul-
tation, and many research projects.
Whereas Porter's approach to strategy bulilt
on the struLctuLre-conduLct-performanice tradition,
which stuLdied market power, there was another
tradition, associated with the University of
Chicago, which saw inidLustry struLCtuire as
reflecting efficiency outtcomes rather than market
power. In this tradition differences in perform-
ance tend to signal differenices in reSOLurce
endowmenits. In addition, another new stream of
thouLght began to emphasize the importance of
ulniquLe, difficuLlt-to-imitate resouLrces in suLstinilng
performance. Within strategic management, these
approaches have flowed together and have been
duLbbed the r-esour'ce-basedl jeiiw! of the firm.'
In addition to these broad perspectives
developed within the field, duLring the 1980s
strategy scholars dramatically increased their ulse
of economic theory and their sophistication in
doinig so as the examples that follow indicate.
The event-stuLdy methods of financial economics
were ulsed to investigate strategic and organi-
zational change as well as the strategic fit of
acqUisitions. New security-market performance
measuLres were applied to old quLestions of
diversification and performance, market share
and performance, as well as new areas of
inquliry. Transaction-cost viewpoints on scope and
integration were adopted and new theories of
the efficiency of social bondinig advainced. Studies
"This view was named and defined by Wernerielt (1984a).
Additional contribtutionis were made by Teece (1982),
Lippman and RumLielt (1982), RumLielt (1984, 1987), Barney
(1986), and Ieece, PiSano, alnld ShluLeni (1990). Granlt
(1991) reviews the suibject and Coinner (1991) provides a
comprehensive evaluation.

of innovation lbegain to ulse the laIngUage anid
logic of r ents and appropriability, atnd research
in veniture capital responcded to the agency and
adverse selectioni problems characteristic of that
activity. Agency theory perspectives have been
tised in the study of firm size, diversification,
top-management compensation, and g,rowth. The
new giame-thleoretic approach to industrial organ-
izationi has inforined stucdies of prodLicer repLl-
tations, enitry and exit, technological chainge, and
the adoptioi of standard s.
In looking backwarcl over these three decadles,
what comes into focus is the search for theoretical
explanations of very complex plheionoienia. A
linking occur-red for the first time betweeni basic
discipliines of the social sciences,7 especially
economics, annd practical issuLes involvedl in
managing the firm. What had begun in the sixties
as rather simple concepts that gave insight into
phenomena described in cases, einlded in the
eighties motivatiing a search for theory withl caLusal
and predictive power able to be uLsed in practice.
WHY ECONOMICS IN STRATEGIC
MANAGEMENT?
Whv has the 'content' side of strategic mainage-
meint come to draw so heavily on economiiics'?
The trenid cannot have beeni drivcie by practice;
very few, if any, of the unregulated firms in
the U.S. emplov microeconomists to analyze
strategies or help chalrt strategic clirection. It
cannot have been driven by teaching; Imlost
stritegic manaigement courses; contilnue to rely
on cases that are more integrative thain analytic.
We contend that the infusioni of economic
thinking has been dcriven by five forces or events,
all connlected with the research program of
strategic management. They are: (1) the need to
interpret performance data, (2) the experience
curve, (3) the problem of persistenit profit,
(4) the chaniginig natture of economics, and (5) the
changing climate within business schools. Each
of the forces or events has shaped the conniectioni
7 It shouli be understood thait this special issule of' the
SMJ focuses on economics and strategy. but theoretical
contributions were ailso forthcoming from other basic disci-
plines suclh as psychology, sociology, political science, atid
anthropology. Indeed, the theoretical linkage seairch was
conidlucted oni a broad scale anld was by nio micans limiiited to
economiiics alone.
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Strategic Managemiientt anid Economics 9
between ecoifloics and strategic imiaInalgement
and each continues to pose practical and intellec-
tUal challenges that will shape fututre dlevelop-
meints.
The need to interpret performance data
In the early 1970s strategy researchers began to
look systematically at corporate performance
data, particUlarly retuLrin oni inivestimient, in
attempts to link results to mianagerial action.
FrUllhans (1972) study of the airline iniduLstry.
Rulmiielt's ( 1974) stuLdy of diveisificatioin strategy,
liattei, Scheindlel aiid Cooper's (1978) brewinig
industrx stuLdyV Biggadike's (1979) studCy of enitirv
and diversificatioi, aind the PIMS studies were
the early examples of this inew style of reseairch.
IThe problem im)plicit in each of these studies
was that of interpretiing the observed performance
differentials. What meaning shouLld be ascribed
to perforImaiince differenices between groups, or
to vatriables that correlate with performance? The
needl to find an adeqUate answer to these
(qLlestiols wais one of the forces engenderiing
econoimlic thiinkiing aimloing straltegy researchers.
The story of the market-share effect provides
ai goocl illustration of this dynamic. The empirical
association tbetween mailrket shalre aind profitability
was first discernedl in 10 ecoinomics research8
where the relatioIslhip was intepretedl as evidence
of 'minarket poNwer.' Why? I3ecatuse using the
structuLre-coniduLct-performaince paradigm as the
dlriver, market share representedl structUre
('conduct' was imiiplicit) and supernormal returins
wZere interpretedl ais poor social 'performance.'
Within the strategic mianagemnent comImunity, the
market-share isstue was raised by the Boston
Consultiing Group (BCG) aind sharpeniedl by the
PINIS studies. carried out onl the first business-
level data base available for ecoilomilic r-eseairch.
The leading role both BCG aindl PIMS gave to
market share helped shape thought about strategic
nImainageni ent in the late 1970s. The viewpoint
they espoused saw imarket-share ais an aIsset
that could be 'btought' anid 'sold' for strategic
I Imiiel and I-Ileliiberger (1971). Shepherd (1972), andci Gaile
(1972) all address this phenloeilenai. In the miarketine literaiture
therc were also models proposed aind studied that linked
market share to profitability. h-ut without Ilmuch attention
paid to the underlyinig theoretical issues involved.
 I() R. P. Ritinelt, D. Sclhendel at,id D. 1. Teece
purposes." BCG adlvisedl its clients to Winvest' in
share ill gIowinlg indCIustries (wlerIe competitivc
reaction wvas eithler absent or dlulledl) and 'hiarvest'
shaire in declinina indlustries. PIMS reseai-chiers
Andl Con1Suiltatits venlt furthier ianid told milanagers
they cOuld inicrease share. I1and thUS profit, by
re(lefininc tiheir mairkets (i.e. re(lefinie their
comipetitors (and preSLllumably their shaire positioin).
In 1979. Rulmiielt and Wernslev (1981) began an
empirical stuLdlx Using PI MS dlatai thiat was (lesigined
to estimate the 'cost' of g-aining market slhare.
T'heir motivation was dliscoimfort with the con1Suilt-
ants' a(ivice to gain shla-e in growing markets (or
new induILsItries. etc.). Thlie advice seemiledi to be
too mucIL of ta 'free lUnch.' Were there really
simiiple ruIleS of strategv that coull (lalway,s 1)e
expected to paiy oft"? Expecting to Iindcl the cost
of share-gains to be at least thleii worth in each
conitext, thex were quite Sut-prisecd to findl nio cost
to share-glails. C.'hangles in shaire and ch ianes in
profitability were p)ositively related in evCerv
coiltext examined. It was not p)Ossible to inlerpi-et
this r-esullt t'iiiholit extensive fora vs iuto (econotInic
theI-Ov (/11(1 advltinced (coomett'i(.'S. In the encl.
thev adopted the aSSmTIlptiOnl that share chainges
Nwere properly 'priced' and interprreted their
resuLlts aIs implying that the share-profit associ-
ati()n was causally Sp)uriouS. InSteald, all ullOb-
servedt stoclhastic process (i.c. Iuck, goodt
mianaglement) wvas jointly drivingy bothi. share aIndi
profitlbility. SubseqUent empirical research has
genierally sLIpported their vliew. 'Tlhe imiarket
share issue ailSO Stilal'.lKlted efforts to i.lodel
competitive equililbria in whiclh shlarc acind profCit-
ability are associated. Note that imiost of this
wvork hals been carried ouIt Withlin strategic
anagemleit rather than by econiomiiists.
'I'he market share story exemiplifies an argu-
menit over dlata analysis and equlilibriulll Whichl
qI'theirvicws wre allso eclioed hyv soifle ecoiiotists Sheperdi
(1979: 1) I81 ciiini1c thi t present mr k t shr . .t ill vi1ld
ai gYiveli PIoOit i-ite 'ith' fiiiii cinii mainitain thliLt profit rite.
O)r- it can r aise it niow, ws hile xideliii up sonie of' its imreii t
share to othi I Timi-is ()r it ici 'invest' presenit pirofits in
buildiiig u al hiiglei tfutuie maU irkct shae c'
See Jacob1son (1990)3 1 oi in ut. itdi intte t i Sec
Bouldin' '11d(1 Stiaclit (1990). SctlhetiidelI Iiltton (197(S) is
part of' theC PUI diie breVilln StLidliCs Ji1OX ()I iC i si iiult in.Li)LIs
vicw ot' the sctrcl f'or to -market share. profitability aii ii girowth.
'ipplialil ailldinLieIlt'S ( 1982) thleor-y ol' ilicer-talill iuiiitabtilitv
geiCl'irtCs tiS SOrt Of eqLiibri.ni. aIs does tilC differeitiated
oli(op()1oly! modeleICd lIh Karnani ( 198I5) Eleeaiit 111Oels ill
whliic mar ii-ket share milaitter-s' have beeii developed by
\Wcrnerfelt ( 1984Th. 1991)
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continuiies in new formi-s todlaiy. Siimply stated,
eCquilibriumlI meains that all actors have exploited
the oppiortutnlities they face. '1ThuS. comnpet'itive
eqiuilibriumn ruiles ouIt. (bVy asSUImption ). th-1e
possibility that clifferenices in firm wealth cani be
attribLuted to dlitferenices in freely variable strategy
chloices, or easily reversible dcecisiolis. lnstea(l,
observed differences in wealthl must be attributed
to phenomena that atre unconitrollaible or ullpre-
lictable. for example ordler of enltry. nonimiiitable
liffer-enices in quality or efficienicy, and of course.
luck. By making the aISSUImIption. the widlely-Lsedl
Studly of pierforinciice vs. some parameter or
other loses much of its value. For example. if
the worldl is in eqluiliblrtium,1 the fact that .rowving
indusitries lre more profitable dloes not mean
that oneC shouild inivest in growinlg ind(IuStl-ies.
Inisteadc, the assUMption of e(qUilibrl-ium.11 leadcs
the r-esearchler to pr-CSLIsume that the observed
profitability is balanced by the expectation of
futuitre losses, risk. or iS suIstined by imilpedlimlleints
to enitry, or is a reputation-base(l premniUm, or
is othierwise balanced by ulnseeni scaircity and
cost.
EquLIilibriumn aIssUmp)tions are the cornerstonie
ot niost econiomiaic thinking and are the most
straightforward way of modeling competition.
Researchers wlho esclhew equilibriumlI aSSIul)tiOnlS
Iisk cgross erro-rs in the caLusal intcrpretation otf
clata. Oni the other haliil, the risk in adloptingc
an equli riuLImI assUMPtion is that it may be
unwarranted. Observedl dlifferences in perform-
anCe Illmay aCtUally reflect xwidespread ignorance
about the phenomena bCillg stuLdliCed. Wlicih risk
is beeillg undertaken is not just ai matter of
preferenice bLut more likelx onie of condlitionis.
especially in the pI esenlce ol( innovation ani1d
change. Thlie general approaich to making this
judlgCeileiit is to ruIle in fx0vor of equilibriuim whell
the uln(derlyinig assets oI positions aire frequcitly
tradcledi or conitestel. wxvheln the level of aggrecgation
aind the ty,pe of cdata is farmiliar to actors in the
indLStrvy. wlheil the dhata is widely available andici
freqluently ireviewdcl, and wxhien tile coniniectionis
between tihe dlata il dprofits are widiely Lliunder-
stood.
\WlilC equlilibriLium aiSSuLmIlptiolls ofteil drive
out conisiderIa(ltioni of innovation, change, and
hletelrocenlleity. this dloes niot nlecd to be tile case.
In the neoclassical world, equilibriumn meant that
profits wvere everywhlere zero. or more grenerally,
thlaIt all oppor tUnities had beci exploited. But

miore sophisticated view's now Permit mior-e
sophisticatecd eqlUilibria. The basic idea of' Nash
eCquI1I)iluml .\21 wherein each a1CtOr d1oes the bcst hie
or) sIhe canl With Whatt theC\y illd indIv1id llN know and
cont rot. especially when COLed(.l w'ith LuInCetainty.
asymmlllletric informtatl.tionan Lluneq uLtll re LSOuLrl'CeC
enlldowm1lents. pIermitS a1 broa r'ag Of illtriguinlg
OLutCoImeCS. For example, onc CouIIld mIIOdeCl thlC
CduaL.I ill'italtiO ofa inoVation aIS aI proCeSS
iln \w\h;I1 chl coml.petitors observe its operation and
market rCesLlItS. anldl then } zRILuaIV ln wh11aIt
the leCalder aI]'Cilrdy kIlOWS. Inl SuCh'1 a m11od0el laree
p)IOfitS WOUld be earned. ftiIrms mighi;rt centerI and
tl)en exit. ad I d C() compeC t i t i g )a1 LI l ly C I f1 I I V
increase. Alth1oU(yIh thlC Product miarket \woldt
no0t be in n.OClSSI11 Ca etuilibriuL111m1 the be1haViorI
dCSCril.eCd iS Still equilibrliLlIll bha}VioI ill thlalt nI0
011on hS passSedC Lup') MIV OppOrtnllitiCS f0or prIOtil
that are I kio fO to tlhin. TIhSu it iS P}OSSih-e to
describei mal-v aspects of inno1vat ionl anIldl the
profit-creatililt transient respnISCS theCy inducLIeC
With UiIibI iLl 111 1110( ( I t }10(.111!} im JplOt ()rIaI
ofl nonnLoclassiid it S a5sumLpltio0S Wil brequired.
Anl CXMimpl.C oa equ MI CilifblrIIll aISSuIMPtiOll of
LISe ill StrIteg'iC I1anaieeme(_'Indlt iS thlalt Of '110n ILIIC
for rih s' th}it there' can be n'o 110geral rulles
for lcen ratin'y wealth. Thlerlc is nIo SUbStitultCe fOr
udIgeCM. C 11nt in C ICC decid1in WheC th1erI 01o n1ot th1iS
CXCluSiOnl Sh1olIC1d be appliedC to ia prj)tiCLlaIr CoIntCXt
(that is . dtuding how gene1(m. (ye1iral is 'Yeeneral)
IInteret stiniI I thlis equl Ibrium I all '1lSSumLlption1
1ai'toi(lliiCS tlilditil t CaS-bs)eC Situla.tiotnl
canalysis th}it hs been the hialimark of' stratecic
Management in1StlrulCtiOn. If thle'rCe arC eI0 n Co geell
Irles fol IcihIeS, thenI aI StlratV baISed OIn 0 enera
avastilableld in1t01ilfomtioi1 atnC LunSpeiaClizecd IreSoulirCeS
Shoul(11d be icj'ected. Opporitluities \w(orth under-
taking1 musLlst bie rooted in1 thle prN11 ti CularI si Of
theC Situaionl.
I} TI ItIi(l Cl Ill' 11LiStThyms o r
t'l(O fl- 1(I11 tll seIa
Sj) 'iII
ilnbomalatioln possessed by the tirm or its mnalielr's.
firm11 thle special reslourcS. Skills, andICI m11 market
Positions thlait the tirm possesses. V iedcCl ill tIhis
ligt, traditional case analysis is a leaeitililnlte
search for tOIpp)otulnIity!. What is \\worth} Irect'Oenizilit
is that the acceptance of this level of econiomIiic
eCj li1 5Ll 11t I 1 OCS 110 ILl l Ii V S t I c tC(_ i C 1.I'lI l1 clTC
mlent. no ( toioes it 1i1m) th1 t oInC ShIOldCI teiac
econ1omiiic thleor-eImis rather than manaaemient.
Whatt it dOes iOlvS iS thIt p)rofeCsiOnal CedLut'OrS
ailrC Iritglt in th1eir FOCUS onI developing skills in
the analysis of' the parItiCular- Irather tthilll theC
gIeneral. In addition4 it Suzetts a framewOrk Ifor
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vStr(ateJ(ic .'\I'lal1(we'i1(ent' {E(Il 1 ('.(col(olics.% i I
wvhere to look f'oi r oP)or't'I'ities aid. olicC
idlentif-ied,. a b,asis fbr)i jUdging their' relative merciits.
Theory alone1 is, inISufIficienit absent intimate.
uni(]uCIC knowledchc of technical coniditionis and
thle abil itv to position assets and skills to Create
favo)rable Competitive positions.
Th'le experien~ce cu-I!,ve
Durnng the 1970s the experienlCe CurIve doctrinle.
deCVclopedCC by theC BOStonl (ion01SUltinjz Gr-Oup1.\V
a1 poANverfUl *forIce wVithinl stratec!ic managemenC11C11t.
A\tlthouch theC idea' tha-t. SOMe Costs followved a
C-learingIM-bV-dIoing1 pa)'ttern1 hadlC beenI around Sinice
thec 1920s. it w'as laryeel inre by economists
beCauI1Se it wa~S a1 theIOretical1 nuisanSMCe; it decst roved
the ability of' stan(ldard miodels to reachII eCIuilib-
riumLI. f13CG II.CItOL 'C addd ou crt I Cal I inirediInt s:
()theIaC ue tha,'t the paIttern1 appied)HC no1t JUSt
to diriect klabor. butt to allI deflated Cost elemencits
Of va~ILue added: this expandcd version o)f the
learnine1t CurIVe Wa'S Called thle exper'ienCe curIVe:
2 -, c the provided convincine, dataI showine experi--
en-ce effe'cts In a broaIdvait of indu.IStrieS:
()theyV argued( tha,'t eXpeincI-CIe-ba.sed Cost
redcC LCtIonI was not restricted to thle early sta(yes
0)1 roductionl. but conitinue inenitly and
(4) they explored the competitive implicati'Ons o)f
the experienlce effe'ct. Anl example of thle latter
is 13( 'G>; SLutrcestimn that .1 there iS no naturLly~11
Stable reaI It IonIIshI IIp\.I wthI I cmptI tor)1s on anIIy
prOdUCt. unltil SOmeI oneC Competitor has a coml-
mandingk mar111ket Share of, thle normnal mlarket tor
tha1c't prIOdCICt an11d unltil the p)rodCLCt'S 17I growt
slows. Furthermore,1-C underICI Stable ConditiOn S, theC
profita.bility of each Compet itoi- SholMd be a
funlICtionl Of hliS a1ccuIMulLdMC LXp1I-eriece With that
product . (1970: 29)
TheII idea~ that1 CuIMuLktiV L prolu-Iiction eXperi-
eceICC not SCaleC, COUldI be pi imar IVdIve OF unit
COStS impl)1CIe aI VadLuI InI doing1 bUSineCSS aparflt
froml the immlediate proohts c urned. InI thle second-
half' Of theC SeVenltieS. Vi tillxKII ccry aticle, book.
See' ['PeypccHvlconil' o i'Axpericiawc. T'heJ Boston ( nsnl ti ii
(mop(11) 1 (),
i h '} j s eritic'.I iseL Shcrier-' s [I0 t )74 contempornlle-
MI ii iItIdnUt iAl orea niz/iotniiin text dlisilli"ssdl the Importanice of
IL. nuni h\- ---tloiII i pN P ri(MIldCtionll idLiLstHiS ieCbCauSe tilh
at.' ot cost rediLuctioll evidentiv dechlilnle aIs cuImlulative output
isexs hCvond several tIhousand Lillits. I ntcrestillvk. the Sec(olnd
IrvSised editionl. pUblished in II . aand(Ioed tile liSeC
and Im .'d l Ictlear in --lbv-dorili as a u iaan 1Pol tIl ut p he no mc1'ia.
eitillne, BC((i almone others.
12 R. P. Rumiiielt, D. Schenidel anid D. J. Teece
and pIresentation on stratetly IrefeIrIred in somlle
way to the experience culrve. The idea's power
was that it pIrovided aii explanation foI the
sustained domiinance of leaders, and br'oiI lheterIo-
geneity, despite competitioin. There was also the
simlple fact that it supported miany managers'
tastes for pursuinig dominance and growth at the
expense of current profit.
The impact of the experience curve on the
strategic mianagemient coIlmlmuIity extenided
beyond the overt conteint or correctness of the
doctriine. The experience curve was the first
wedge drivein in the split that wideined between
the study of mianagemient process and the study
of comlpetitive action and miarket outcomiles. In
a field which had traditionally seen the firm as
emilbedded within an 'environmient,' the experi-
ence curve focused attention oIn the actions of
alert rivals. Most importantly, the logic of the
experience curve engeindered a taste for a
microecoinoilmic style of explanation: For the first
timle there was a similple, parsimionious account
of what coilmpetitive advantage was, how it was
gained, and where it should be sought. Adding
piquancy was the fact that the logic of experience-
based coilmpetitioin was not imported from eco-
inomIlics, but was instead developed within strategic
mianagemient anid thein exported to econioilmics.
Finally, amiong those who sought mlore precisioni,
there was the need to clarify assumptions
about competitive behavior, to more exactly
characterize the resulting equilibria,'4 and to
empirically estimate the relative importance of
scale, industry-experieince, and firm-experieince
effects.'5 Thus, the very act of developinig and
grappling with the logic of experience-based
coinpetitioin enicouraged ecoinomIlic thinikinig withini
strategic mia na gemi e nt.
The problem of persistent profit
One of the key empirical observations made by
traditional strategy case research was that firImis
withini the samie inidustry differ fromil onie another,
aind that there seems to be an inertia associated
Experience-bised equiilibriai aire ainialytically intriactable.
Spence's [1974] work remaiins the best ainalysis, iccomplished
by ignoring discounting.
Liebermain [1984]. studying 37 chemical products. found
leairning effects much lalrger thain scaile economies aind showed
that they were aissociated with cumiiulative output raither than
cailendair time.
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with tllese differIences. Somne fiIrIms simply do
betteI tlhani others, and they! do SO consistently!.
Inideed, it is the fact of these differences that
wvas tlle origin of( tlle strategy con cept. In standard
neoclassical economlics, competitioni should erode
the extra profits earned by successful firms,
leaving each firm just enough to pay factor costs.
Yet empirical studies show that if you do well
today, you tend to do well tomorrow; good
results persist.
One of the factors in the 1970s that drove
strategy researchers to search for theoretical
explanations for persistent performance differ-
enices was the enormlous success and legitimlcy
of the capital asset pricing model (CAPM).
Developed by financial economlists, the CAPM
not only had practical usefulness, it gave great
strength to the idea that markets were efficient.
Consequenitly, an intellectual climlte developed
in the academy which tended to presume
efficiency in all markets, even product-markets,
and aggressively challenged assertions to the
contrary. The experience curve doctrine provided
a partial response to this challenge, but it clearly
was not the whole story.
In searching for explanations for endurinig
success it was natural to reach for relevant
economlic theory. The most obvious theory was
that of industrial organization economlics and
its various explanations for abnormial returns.
Traditional entry-barrier theory yielded the con-
cepts of scale economilies and sunk costs; moblility
barrier theory stressed the importance of learning
and first-mover advantages in making specialized
investmilenits in positions within indiustries. The
'Chicago' tradition supported the notioni that high
profits were returns to specialized, high-quality
resources. Game theory provided models of firms
which use preemptioni, brand crowdingi, dynamalic
limit-pricing, signaling, and reputations for tough-
ness to strategically protect market positionls.
The economlics of innovation brought a focus on
Schumpeterian competitioni, intellectual prop-
erty, and the costs of technology transfer. Andi
evolutionary economlics yielded the idea that
skills, emlbedded in organiizationial routines,
resisted imitation and had to be developed anew
by each firm.
Within strategic management there has been
a great deal of work aimed at synthesizinig
these ideas into coherent frameworks. The most
prominenit effort is Porter's (1980, 1985). Takinig

the basic ideas of the Mason/Blain structure-
conduct-performiance paradigm, Porter changed
the perspectivc from that of the industry to that
of the firmi. and formulated what had been
learned froimi this perspective inlto a theoiry of
competitive strategy. Porter catalogued,
descr-ibed, and discussed a wNide range of pheniom-
ena w-hich initerfered with frec conipetitioni, thus
allowing abnormal returns, and suggested hiow
their interaction and irelative importance varied
across contexts. Porter's (1985) later approach,
delineated in C'omIetitive AdMvatage extenidedt
the earlier analysis of competitive strategy to
encompass positioniilg withini an inidustry (or
strategic g roup) so as to achieve sustained
comilpetitive advantage. Positinig two basic types
of firn-specific advantage (cost-based or differenl-
tiation-based), Porter argued that advantage
could be sustained fi-om ia prioduct-miairket positioIn
and a configuration of internal activities that
were mutullly reiniforcinig (i.e. stronig comlplemileni-
tarities anmongst activities and the conditionis of
demrand).'"
A second effort at synthesis is the resource-
based view of strategy. This view shifts attention
away from product-mnarket barriers to coIlmpe-
tition, and towiards factor-market impedimiienits
to resotuce flows. Identifinga abnormal returnis
as rents to uniqlue resource combinations, rather
than market pover, this perspective emphasizes
the importaince of specialized, difficult-to-imitate
resources. The creationi of such resources is
seeni as entreprenleurship: strategic management
conisists of properly idenitityinig the existence and
quality of resources, and in building product-
market positioins and contractual arrangements
that monst effectively utilize, maintain, aind extend
these resources. This perspective finids its greatest
use in examining heterogeneity withini industries,
and in the dliscussioni of 'relatedness' aIIlmoig
diversified businesses. Nelsoni (this issue) dis-
cusses a recenit versioni of this viewpoint, incorpo-
Irating(, learnincg, that is called the 'dyarnmic
capabilities' approach. Prahalad and Hamel's
[1990] recent discussion of core competenices is
an expressioni of the resource-based view.
Ghemawat [1 991] provides a new attempt at
svnthlesis around the idea of comnnitment. His
T5 l his airgument can be couched in strict equilibrium terms
by introducillg straitegy-specific assets or other sources of
first-mover advantage.
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Strat gic ainaiagement (anld Economics 13
view is that the persistenice of strategies and of
performance both stem from mechanisms which
link and binid actions over time. l-ie idenitifies
lock-ini, lock-out, lags, and inertia as the key
irreversibilities at work and reinterprets a great
deal of strategic doctrinie in terms of the selection
and managyemnent of commiiitimietits.
In suimmiry, the single most significant impact
of econlomilics in strategic management has been
to radically alter explanations of success. Where
the traditional frameworks haid success tollow
leadership. clarity of purpose, anid a general
niotioIl of 'fit' betweeni the enterprise and its
enivironimlenlt, the niew framework focusecd onl the
impedimiienits to the elimination o.f abnormli
r-eturnis. Dependiinig upoIn the frarmework
emilployed, success is nlow seen as sustained
by mobility barriers, entry barriers, market
preemiiptioni, asset specificity, leariniiig, ambiguity.
tacit knowledge, nonimitable resources ailnd skills.
the shar-inig of core colimpetenices, and coimmit-
menit. That 'fit' was correlated with success can
be argued. that it is cauSaIl cannot be. The fit
argument lies in the long linie of work that Plorter
(this issue) describes as a continluinig search for
causal explaniation. TFeaching frameworks that
suggest the importanince of fit are correct so far
as they go, but it is the new economilic frameworks
which estalblish the causal linkages. That has
been learined from the pressure of askinag ques-
tioIns from an econ omiiics perspective.
TFhe changing nattire of economics
The econoimist's neoclassical moodel of the firm.
enshrinied in textbooks, was a smoothly runninilg
machinie in a world without secrets, without
frictions or uncertainty, and without a temporal
dimenisioni. That such a theory. so obviously
divorced from the mlost elementarv conditionis of
real firms, should continue to be taught in most
businiess schools as the theory of the firm' is a
truly! amiazing victorv of doctrine over reality.
Thiis erai miy. however, finallv be comliling to an
end(i as the cumulltive impact of new insights
take their toll. During the past 3() years, and
especially during the last 2() years. at least five
substantial monkev wrenches have been throwin
into what was a smoothly runiniiig maichinie. They
are cal led uncertain tx', itnforination asymmnietry,
bouniided rationazlity. opportunisni, and asset speci-
ficity. Each ot these phenoimenaii, takeni alone,
14 R. 1'. Ri?uuelt, D. Sclhene l (anld D. J. Teece
violate crucial axioms in the neoclassical model.
In various com biniatiolns they arie the essential
ingr-edienits of new subfields withini economiiics.
TIrailsactioil cost ecoilomiiics Irests pIrimailvy oI
the coiljuilctioil of boulilded rationality, asset
specificityv aild OppOItUllism. Ageilcy theoIy
iests oIn the coimibiniatioil of opportUnism aild
information asymmetry. The Ilew game-theoretic
inldustirial orIgailizatioIn deriives Imch of its pulilch
firoimi asviSymmietiries in information aild/or in
the timinlg of iIrIreversible expeildituires (asset
specificity). The eVOILutioilariy theoIry of the fiIrm11
aild of- techinological chailge Irests chietly oIn
Uilcertainlty aild bouinded; irationiality. Each olf
these ilew suLbfields has geileiated inisights anid
Iresearich theimies that are imiiporitanit to stIrategic
imianlageimient. Each is birieflv treated inl tuln11.
T-rallsaction cOSt CUOllOlIlICS
Of all the Ilew SuLbfields of economiiics, the
transactions cost birailnch of organizational cco-
inomiiics hias the grieatest aIffiinitY witlh stIrategic
imiiianageimenilt. Thle Iniiks deirive, In part, frmill
comimoiln initeirests in organizational formi i, iluCLid-
ilng a shared conicenii withi the Chanldler-Williamsoin
Ni-form hypothesis. They Ie also deirive fr-oimi a
coImm111Oni inltellectual style whichi legitimizes
ilnUiry into the ireasoins for specific institUtionlal
details. Th11e clinIical stuLdies condluLcted by strategy
iresearclieris and buISiiness historians are grist for
the transaction cost mill. A thieoiry wlichi seeks
to explain wh-ly on1e partiCUlar Clause appears in
a contract is clearly olf great initeirest to strategic
management scholars, whio have a dtefinite taste
f'or disaggregation. 1
FoIr manvy ecoinomiiists the aSSLIIulmptiOnI of
Ulnllimiitecly rational actors is the defiiiilnn charac-
teiristic of thieir fieldl. CoinseLuienitlvy transaction
cost ecoinomiiics whiichi follows Siiimon Inl positing
bo)uLliidecd rationality ha s had a diflicuIlt uplhill
Str-uggle foI IrCcogIlitionI and acceptance. rhe
suifield aot its staIt in the mid-1i970s as somle
CCOInom1iStS, bUilding oni Coase's (1937) seminal
work, becan to sstcmatically probe ql Liestioins
of firmii boUndarieis and internal organization.
Williamson ( 197)) Was the chlief architect of a
framework that explored the limlits 01 bOLIrnolnaries
of both markets and bUIiness filirms as anraniae-
- See, for exaimplc Joskow's 1191 tr] tIlmenlt of pr-i.cc-
d! CLkSt ILI men IiSCs inI 1)Ill-tICl'll CM 1 Contracts.
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menlts for coniductinlg economiiic activity. 1-is basic
poilnt was that transactions shoLuld take place in
that iegimiie which best economiiizes on the costs
imiiposedby bo dLlilded Irationlality aild oppoIrtunlisim.
T his framework was explicitly coimipariative (thie
relative efficieilcies of Imlarikets aild hieirarichies
weie exposed) aild eniabled ecoiloiiists forI the
fiIst timiie to say soimiething aboUt the efficiency
pIropeIrties of diffeireIlt organizational foIrIls.
(PIrevioLuSly econiomiiists had coimmoilnly sought
aild f'ounidc imioilopoly explanations foIr comlplex
foIrIms of bLusiniess organization; efficienicy expla-
niatioils weire ignoired oI deInigirate(l.) In additionI
to comparing markets aild hierarchies, tIraiisactioin
cost researchers also begail to look at qluestioils
of inlteirinal strIuLCtulire aild the manner in which
specific decisioils aild actioins weire takein. In
particular, the Chanldler-Williamsonl N-foirimi
hypothesis Irised important issues Irelatinlg to
coipoiate cointiol. These ideas begaln to acchieve
widei acceptance afteri beillg SuIppoited in a
Ilnliumber of empirical stUdies.
Withlini stirategic management, transaction cost
ecoiloimiics is the gr OLnld whleie ecoiloimiic thlink-
ing. strategy, aild organizational thieoiry imieet.
Because of its focuLs On1 illStitutioilal detaii, irathei
than mathematical display. it hias a biroaderi
aludctieilce amiong ioleconoIlotllists than other
branches of organizational ecoiloimiics. DLuInIlg
the 1980s, a coilsideriable aIllOLlIlt of woik was
doile in applying the transaction cost firamiieworik
to isSuLes in ortyailizatiOnll StrICtUre. Inl palrticularlI
research has been carried OLut Onl vertical SulyJ)1V
arrangements in a Illli uberi of- ilndulStries,I) thle
StrlLuCtulIre of IllUltillatiOllal fiirims (BLuckley and
Casson, 1976;- 'eece, 1981; KOgut, 1.988), sales
force organizatin(nesnadShiten
1-)ICCO ^.1.tioii (Aildlei-si and II Sciliiliittleiii,
1984), joint venltuIes (Hleniniart. 1988; Pisanio,
1990). anld franchising (KIlein, 1980). Williamson
[tIlis issLcI] provides a ulsefuIl Irieview of additional
applications of inlteriest to strategic management.
2 Armiour and ; leece 1978j demonimstrated reCtUrns to the
ado1)ti( I ol' the NI-f'orm as w\ell as showing evelitUal diissipationl
of excess rettiuirs throuih iiiiitzation: MIonteverdic aniid 'l'ccce
[1)821 established that specific aissets aift'I'fcte the erttical
S1t net ure ( orfan i/at ilS
Fark' cotihiulitions wereClo N-Ionteverdle aindci 'l'cccc's 11 9821
stuLdyx of aLuito Comp1lronenIts aId lNIaIstM's 1 9.881 stuldl\ Of
aer'os()pa)clc'.

Agency theory
Agency theorvy coiceris5 the desigin of incenitive
agreements and the allocation of decisioni riglits
aimong inclividluals with conflictinig preferenices or
inter-ests. Although it deals with the employmicint
tranisaction,. agency theory is not comiipatible with
traniisactioni cost theory. Wlher-eas trans,action cost
econiomnics begins withl the assertion that one
caninot write en forceable conltr'acts that cover all.
conitingenicies. aLgenicy theor-ists maike no such
presump)tion. and(i isiiteadi seek the optimal form
of siuch a contract.
Agelcy tlheoiy has developedl in two branches.
The principal-agenit literature is chieftly coincerined
with the design of optimal incentive contracts
between plrincipals ancd their emiployees or1 a(yents.
Principal-agent econlomics is largely mathematical
in form andi relatively inalccessible to those
who have not made investimenits in its special
techniology. 'I'he standard problem has the ag(,eint
shirking ulinless rewards Cai be properly coIn-
ditioned on informative signals about effort. T'he
inter-estinig aspect of' the problem is that hoth
pairties suffer if (oocl measures aire niot available.
A versioIn of the problem that links with strategic
management concerns project selection and the
design of incentives so that agenits will not distort
the capital buLdgetinig priocess.
'I'he second (corporalte control branch of the
aigency literature is less technilcal and is concerlned
witlh the dlesigin of the fillailcial claims and overall
governance structuIre of the firm. It is this branch
whichl is imlost sinilicicatnt to strategic management.
The coIrpora ste control hvpothesis most familiar
to strategic management is JTeinse's (198() 'fr'ee
cash flow' theor-y of leveratTe aindl taLkeovers.
Accoirding to Jenisen. in imialny tirimis, managers
have inappropriately ciriectecl frece caslih flow0
towards wasteful ilveStmllelltS 01o uses. iwo CuIes
to this problem hiave beeni piroposed: Luse of high
levels ot dcebt to conmimlit managements to paVyOutS
iaindl hostile takeovers, which p)Ut neCW Imallnag0elmleClt
teamis in place. What should str-ike strategic
management schlolar-s is that BC'G offered prie-
ciselv this diagnosis ftOr man1lily diverIsifieCi tirimls ill
the earlyv 1970s. According to BCG, mosit firms
mismanaaed their portfolios, misuLsilln the funLds
gellerated by mature cash-rich buSinesses ('co\\vs')
uLSUaIllNY b contiluing to r-eilnvest long alfter growth
opportunllities had evaporated.
The corporate conltr'ol perspective piovides a
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Strategic Mianagenient anid Economics 15
valuable framework for str-ategic management
reseairch. By r-ecognizitig the existence of 'bad
miiaagemeit. identifvinig remiedlial instruments.
andc emphasizing the impor-talce of proper
incentive airr-iangenments, it takes ai more ntor-mnative
stantdc thalni most other subfields of econiomics.
However, scholars woiking in this area also have
the tenidency to see all mainagerial problems as
due to illCorrect iicentives-a talutOlOgy fo r a
per-spective which aSSuLlmes away any other souir-ces
of dVSfuiaction (e.g. capital miarkets problems
like those (liscuisse(d by Shleifer- aindl Vishny in
this issuLe, miianiager-ial beliefs abotut caiuse and
effect, manigemiienit skills in coordination, a cnd
the priesenice or laick of character and self-
control).
Ga,nec-teorx catndi the niew , IO
Three of the papers in this special isstue dleal
with implications of game theory bor strategic
mnLtagemilenit. So oul remiairks here will be brief.
Mathematical game tleory' was invenitecd by vonl
NeUmlalnlnit1 and Morgenisterin ( 1944) and Nashi
('1950). However. little progress was made in
developing economiiic application1s unltil the late
1 970s. It was probably Spenice's (1974) work on
market signalling that sparked the miodernii interest
of econiomiiists aL'nd it was Stanford's 'galng of foir,'
Kreps, Milgrom, Roberts and Wilsonl (1982).
wlho codified the treatment of sequeltial gLames
with iiperifect infor-milationi.
Modlerni g(ame theoIry raises dele qLuestioins
atbout the nature of rational behavior. The idea
th,at a rational individual is one who maximizes
utility in the tface of' available information
is simply' 1ot sufficienit to generate 'sensible'
e(luilibria in many' nonicoopeirative gamiies with
asyillmetric in tf'ormation. Jo obtain 'senisible'
equilibria, aCtOrS muSt l)e assiginedt beliefs about
what others' beliefs will be in the eveent of
irrational alcts. Research inito tihe techinical and
hDilOSOPhliCal fOLundC1atiOnlS ot galmleC thlCOIrV lhlS, at
p)relent, littlc t(o do. directly' wvith stratcgic
manaiiagmenet, bu-it much to do with the future of
e'COnlomilics as thle scienlce of 'rational' behavior.
Game theor\y as aipplied to inidLustrial organi-
zation hals two basic themlles of imlost inlter-est to
stratecric manaaement: comimiitimldenlt stratecries
20 NuTlch of thte techniCul titdtion thle' LL(Sd llhad bCeen kid
byx Selten[I) andI larsanyi ' 19071.
 16 R. P. Rtwnelt, D. Sclie,itdel au-it D. .I. Teece
andct r-epuitationis. Commitment, as Ghiematlwat
(1991) emphiasizes, can be seen as cenitr al to
strategy. Aniong the commiiilitmiienit games that have
beeni anialyzed aire those involving investmenit in
specific assets and excess capacity. research
and dlevelopimniet with aindl withouit spillovers,
lorizontal iIeirgeri, and finiancial structure. Repru-
tatioIns arise in gamilies whele a firmii or actori can
have various 'tVpes ad tltier-s ImLust forimi beliefs
about which type is the truie one. Fhths for
example, a cuLstomer's belief (probability) that a
seller is of the hoinest' type constitutes the seller's
repLutatioIn anid that reputation can be lost if the
seller behlaves so ats to chliange the customiler's
beliefs. RepuItations cani also (lescriibe re'lationi-
ships within the firm, and the collection of
emiiployee beliefs atndc reputaitions cain be called
its 'cultulre.' Giveni the competitive imporitaiice
of external reputations, the efficienicy properties
of internal repuItationis, and the relative silence
of gaime theor-ists aibout how vari-ious equilibria
are actually- aichieved, there iS ClclIly much Iroom
foIr conitributioIns, iluCLidinlg those from striategic
anacement resear-clh.
Et'olutionzarv ecCO1OnloiSs
TheIe has beeni a long-standing analogy drawn
between biological comipetitioni (and resultillg
evolutioin) anid ecoinomiiic comilpetitioin. with bothi
fields ofteni poinltinlg towards the othier to grOuLld
ideas. Making the analogy conicirete, lhowevei,
has largely beeni the work ot Nelsoni anid Wiinter
(1982), who mairied the coincepts of tacit
knowledge and r outines to the dynamics of
Schumiipeter-iani comipetitioni. In theiI framework.
firmlils comilpete priminarilvy thlrough a str-uggle to
imiprove oI ininiovate. In this struggle, firis grope
towards better methiods with oinly a paItial
unLldeistandinig of the Caulsal StlrUCtuIre of theiI
owvn capabilities and of the technological oppor-
tuinitv set. Key to their view is the idea that
organizational. capacities are based oni routines
which are Inot explicitly comprehendcled, but whichi
arIe developed ancd bettered with repetitioni and
practice. This miciro-linik to leaIriniig-by-doinlg
means that the culi-reint capability of tihe fiIrimi is
a f uInctionl of histor y, making it imilpossible to
simply copy best priactice even when it is
obsiervedt.
Because evolutioniary econlomiics posits a firm
which cannot chang,e its strategy or itS structure
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easily or quickly, the field hlas a very close affinity
to population ecology views in organization
theory. Researchers interested in the evolutiion
of populations tened to woirk in the sociology
tradition, while those mor-e inter-ested in the
evolutioll ot firnm caipabilities anid techilical
progress tenCId to woIk in the ecoInomilics tradition.
Both fraimeworks challenge the nlive view that
firm s can changre strategyies easily, or that Such
changaes will eveni imlatteir wheni attempted and
i-nade.
Tbie cli(chaginig clitmnate it'ithinlisiiess schools
B3usilless schools haiive transformed themselves
profouidly over the past 3() years. BuLSilleSS
schools aIInd their facLulty hlave moved froimi
collectinlg anldl transmitting best CUrrellt practice
to developing and Comllmunllicatinig thieoiretical
ullnlerstaiidinigs of pheniomiienia coninectedt with
mianagement, principally, the iimanagemeniIet of
complcx businiess fimiiis. This transformation,
which OCCUrred toi larger reasons, has illflueniced
the straitegy field aiid its connection to econlomiiics
in impoitainit walVs. Theire aIe several Ireasonls
whiv thait transformationIl ils OCCurir -ecd: the impetus
of the Ford Founidation and Carnegie Founldatioin;
Ulliversity- hirinlg and pIoimotioin prIactices, the
rise of COInSultillg firins as repositories of best
prIactice aiind the relative prioxiiimity of econiomics
departmiienits. Without these chainges collectively,
the field ats we kinow it would be diffeIenit, aind
economics involvemeniit in strategy would have
been less.
In the late fitties, the so-called Gordon anid
Howell ( 1959), and the 1'iersoii (1959)) r eports
were published, both ciritiqluinig the business
sclhools of theiI day. The cIriticisimis were many
and the chanlges they prompted were extenisive,
but one of the Imlost far-reaching Irecomiimenl-
dations was that business schools nieeded to be
infused with IigoI, methods, and conitent o f basic
disciplinies: matlhematics, economnics, sociology,
and psychology. Thlis recommendation was avidly
followed, with the result that a good many
econiomists, psychologists, aLnd other-s trainied
solev in the basic social science disciplines
t'ound employment in business schools alongside
tIadlitional. professionally-orientedl faculty IIIemII-
hers. The traditional factulty fotund its scholarship
in stuLdyinig btusiniess firms, identifyinig the best
pIractice they coLuld fiind, andld transmitting what

they learned in the classiroomn, typically thl-rugl
a case, anid the occasionial puiblislhed ariticle.
Along the way suLch faculties were frequenitly
cast in the Irole of consultants to piracticiing
businiess mianaiagei-s and mn.laiy founid greater
financial Ireward in suclh work thlani they did tfr-om
their scholarliship alone. The new, discipline-based
faculty oni the othieri hand fouind theiI- schlolasIship
inside the acadein-. in the writingys of othei-s
similarly placed, aind in advaincinig the theory of
tleii- field, ofteni without Iresor-t to priactice and
apllication of what they learned. TheiI minids
anid rewards were concentrated on what thev
prIodLuced iniside the academin. Set in inotioni wIaIS
a priocess that retir-ed practice-based scholars in
favor of discipline-based ones.
In time, probably longer than anticipated,
the disciplinie batsed prefeienIce in hIingi(I and
pIomotioii led to a stionilgIe aind stroinger pIresenice
otf disciplinie based scholars, iluCiding economists.
Indeed, some newer business schools anid soime
olderI onles as well, weire oIrgaiiized withi the
ecoinomiiics depai-tmiienits as part of theiIr facultyt.
As businiess schools became ImloIre disciplinie
basedl, tlheir- standards foi hiringy anid priomiiotion
came into alignmiiienit with the social scien1ces.
The pr-imaiy meeasui-e of excellenice became
publication ill disciplinle-based jouIrnials aind
acceptance by the commiilluniity of discipline-based
scholars, Iratleri than relevance to priactice oI
conltIributioins to pIrofessionial educationi. Disci-
plinle-based scholars nlot oinly earnIIed internal
rewN-ards imore easilv. they also typically lacked
the cushioni of consultationi that would otherwise
allow a greateIr adaptation to the special circum-
stainces of professional schools. This self reinfor-c-
ing cycle is still presenit today.
ThIroughlout most of this pei-iod very high growtth
rIates chaIracterized business sclhools, as they Imloved
fiom granltinlg about 12,000 to ovei 70,000 MBA
degr-ees per yeai, and to imanvy mlloIre schools offteringC
the MBA. Well-trained faculties in specialty areas
sUchi as maiketing, finanice, accouLn1ting. an1d other
funlctiolns were in shoit supply, especially in the
earlier yeais of greatest growtlh. To fuel expiansioin
it was a short step to hire disciplined based faculties
directly, and worr y about their adaptatioll to
applicationis in business firms later. Sonme made
the tranisitioni, some did not, but maniy who did
retainied ani allegialnce to their base disciplinies that
included seekiing publicatioin reputations, not in
the field in which they were to profess, but in the
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Strategic Managetnenzt an.-d Ec0onom0nics 17
basic disciplinle in whiclh the fa1CUlty member hiad
beeni trcainied.
In the world ol' business, more aind more large
firms began to create their own managemiieint
developmlleInt programs, aimileCi at fillintg the
gaip between the incr-easinigly theoretical MBA
education anid the needs of practice. In addition,
COlSItilng firmns gIew in scope aiind sophistication.
In manv*' functional areas, inicltudinig management
anid strategy, specialist conslltinig firmils re placed
businiess schools as repositories of best practice.
These factors led to an increased piopoitioni
of businiess school faculties cither traiined in
economics diirectly. or illmportanllItly illfluLenced
by the stanidaids commnoni to discipline baised
scholars. Unfoieseen by Gordon, 1lowell. and
Pier-soni was the changing character of economlics,
aiid other social scienices. Less anid less conccrined
\Nwith emilpiriicismi. econiomilics became inicreasinigly
concernied with workinig out the inteniial logic of
its theoretical structur-e anid less aind less con-
cernicd with descrilbing real illStitUtionls. This tIrenld
contilnues today, \vith 'advanced' deparitmenits of
ecoInoImiics offering Ph. D. programs in w\hich
price-thieoiry is considered applied anid nlot eveni
cover-ed duriniig the fiIrst yeair of study.
These changes in business sclhools forced those
inlterIested in stIrate(Tic management to 'take sides.'
and adopt a discipline. Early on, the typical
faculty memiibei in stiategic management (then
called businless policy) was recruited fromii those
with expeirience and high ri-ank in a functional
area (e.g. marketinig). The switch required was
to that of the total enteriprise anid its genierial
management funlctioin. The inicreased disciplinie
base of business schools made this switch imiore
difficult. and many schools began to hire young
faculties and expect them to mlove up through
the ranks oni the mllerIit of woIrk donie in straiitegy.
To move through the system in this 'new' field
was especially difficult, as it tended to lack
the infrastructuie peculiar to proiriotioni needs:
patrons, senior faiculties wlho had beeni throglth
the system; jouiriials. veniues for exchanige of
views. Additionally, it had a case-based tradition
of research increasingly shuinined by the acadeimly.
Consequentlyx gI oups initerested in gelneral mIanl-
agemnenit anid strategyy begani to take either
organization theory or economics as their base
discipline.
Throughout the 1970s it appeared that organi-
zation theory was the discipline of choice for
18 R. P. Rulitielt, D. Sclienlrel anid D. J. TFeece
stirategy grioups. 1ioweveri, this balance was
Ireveirsed in the 1980s, larigely dcue to the success
of PoIrtei's approach to stirategy. Wlhile soImie
sclhools aiId theii striategy faculty Iretainied aii
essenitiallvy bealvioially focuLsed gioup, mainliy
otlheIs imioved to ecoInoimiics -based views. Like
ecoinoImiics itself, economnic-based striategy giroups
Inow also differenitiate thieimiselves oni thieiI coIml-
mitmient to imiatlhemiatical modeliing vs. veribal
reasoning anid thiCiIr inlteriest in thieoIr' vs. emipiri-
cisim. Withlini the behiaviorial giroups, the split is
chliefly betweeni those followinlg oirgaizatioin
thieoIry anid those takinlg a miainiageriial pirocess
view of striategic milaniagemig enit.
WhliChl gr'oupI lias the betteri idea'? Wlho will
dominiiate'? That ireimlainis to be seeii but if
wliat the top research-oriented i.e. Staiiford,
NoIrtlhwesteirni. Clhicago. Berkeley, etc.) sclhools
arce cdoinig Inow is aniy guide you lhave to bet oIn
those emphasizing coiitributioIn of econiomics, if
inot total irelianice oIn ecoinoImiists. If. oi the otlhei
lhanid, the top European sclhools oIr piractice is
youi guicle if wli at imcaniageirs listeni to miCakes a
difference, those wlho coIm binle a imiodicumii of
ecoinoImiics withi a focus oin niailageriiail pirocess
arce clear- winners. No miMatteri wlait you believe
will be the outcome of this cointest, ecoinomics
lhas clearly inlfused aiid inlforimied strategic ImlanI-
cgeimeit, nlot oinly by the poweir of its thieoIry to
yield inlsighits, but bv the tranisfoirimlatioin ot the
b usiiness schiool lhost, and the evolutioni of
sti'ategic mikaniagemIlenit as a field.
However, froml the viewpoinlt of strategic
miainiagemienieit we see a daiiger in these trenids.
We advocate a balanced view of the field, perhaps
tipped slighitly in favor of tests of theoretical
constructs by practice and application. If the
balaiice, as it hias at somc sclhools, goes too far
towaird thieoIry oIr towaird a sinigle disciplinCe base
Suchi as ecoionoiics, thieieC is Ino couniteriweighit
firomi piractice aiid applicatioin likely in Cithier
iresearclh oIr teachlinig. Likewise, if the balaiice
tips too fair toward imIaniageriial pIrocess oIr evenI
best priactice, as it lias at othieCI sclhools, there
are Ino theoretical COIlStr'UCtiOnIS to aCCUmla11tC
aind build for the good of the field. Either
unbalanced outcomile is bad. In our view, balance
requires both theory aiid application, in their
fullest aiId finlest ieprescietatioins, in our research.
in our teaching, aiId in our facuLlty. That suLICh
balanced vieCWs ieprescieteCl by portfolios of
scholars, some at the discipliine eind, others at
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the piractice ceid, do nlot exist, especially at ouI
best sclools, is a sad comimIilenlt onl the lack of
administriative leadershlip aind faculty ulnderstaind-
inlg that exists aboIt str-ategic miainiagemieinet, its
conltenit, and its chliallenges. Simon's (1967)
descriiptioni of the prioblemii of ruLllllling a piro-
fessioaiil schiool lias special irclevaiice to striategic
maniiiagemilenlt:
()rganiz ing a professional school. . .is ver'y iuiLiclh
like mixing oil with water. . Left to themselves,
oil and water will separate again [p. 1.6]. . A
professional sclhool aidministraition the clein and
seniior facuilty have in unceasing task of iightinig
the naturial incr ease of eintiopvy of pieventing
the svsteim fioii moving toward the e quilibrium
it wouldc otherwise seek. Whlen the school is no
loniger- able. v conitinual activitv' to maintain
the gradients thait differenitiate it fiomii the
environment, it deiclhes that ecqLiilibriuimii witl
the wol-Icd wlhicll is cleith. In the piofessionial
schlool 'dceth means 11 medioci itv acn ina bilitv
to fuilill its special fuLnctionis [p. 12].
Unlfor-tuniately, strategic management is too oftein
inhliabited (inhiibited?) by those who see n1o need
for (fear?) the balance we advocate.
THE FUTURE OF T'HE CONNECTION
BETWEEN ECONOMICS AND
STRATEGIC MANAGEMENT
We believe that striategic mniiiaagemilellt lias clearily
profited from the infusioni of economiic thinikinig.
There is no question that the presumptioni of
equilibrium aindl the specification of alert rivals,
raither thaini ain aimorplhous 'environnment,' hias
generated valuable iIew fraimieworks, nlew inlsights,
ianid greatly shairpenied thinikinig aimonig strategy
scholars. Nevertieless, it is vital also to iecoginize
that thils inlfusioin lias comec onily after the
weakening of orthodoxy withini econlomilics. For
decades ecoionomics imiipecded researclh inlto strategy
by comniiittinlg its initellectual capital aind inlfluCence
to static analysis, ain alimlost CXCluSiVC focus on
price comilpetition, the suppressioni of centrepre-
nleurslhip, a too stylized treatmeint of markets,
hyper-rationality assumptionis, aind the cavalier
treatment of know-lhow. 1-lad orthodoxy weak-
ened sooieri, strategy would have hiad the beenefits
from useful economic thinkinig earlier. That
orthioldoxy weakened was perhaps partially a
result of researchi in strategic management.

Econlomilics has been chietly conicerined with
the performance of miarkets in the allocation and
coordination of r esources. By contrast, strategic
manageiment is allbout coordination acind resouLrce
allocatioin insidc the firm. This distinictioni is
crucial aind explains why so much of econlomics
is niot readily applicable to thlC studyl of str-ategy,
anld why strategy can inlorm ecooiCS as mlllch
as econ1omi1ics can in forimi strate Ty. TIwenity-five
years ago economists. askedl how a firm should
be maiageda wouldl have (and (lid) artue that
subUllits should be meeasured on profit, they
ShtOuld tranlsfer prodUCtS. seI-rvices. anld capital to
one anothier- at marginal cost andl the more
internial comlpetition the better. lToday, we kniowv
that this advice. to runll a firm as if it w-vere a set
of imarkets, is ill-founded. Firm-ls replace markets
wNvhen iionmitiket iieanls of coordination and
commiiiitmiienit are superior. Splendid progress lhas
beeni miade in definiiit the efficienlt bounldaries
of firms-where mai-kets fail and hie rarchies are
sulerior--bLut there are limits to bIlilCdily' a thCor-y
of iiaageienelt ald st rateTvy arlounld market
failur-es. It is uIp to strategy scholars to flesh out
the inivet-se 'approach. supplying a cohci-eret theory
of' effectivc inter-nial coordiniationi anid resouLr-cC
allocaltioIn. of celtreprelleL uShip andI teChnclill
prot erss, so that markets ciani Ie idleltified as
beginnincg wlher-e oro-anizations fail.
The imost interestin(T issue regards the futuLre
of the comlpetitive strategy portiOll of strateg,ic
managTement. It is this SUbfield whlichi lhas tUrnled
imiost whl-oleheartedlx towards thie uLsC of CconIomIIic
reasonlingT anld models. If the trendlcl con1tillues
does the competitive strategy subject matter haec
ain independent ftutLre, or will it becomile juSt a
branchi of applied economics?,) Thlere are two
reasonis for concern about this. The first is
parochial: Tlhe field's miost elementary wisdom
suggests that competing head on withl economics
departmenits in their own diom11aini is at losing
strateav. The secolnd has to (lo with the internal
intearity of the field. To split off part of a
problemii for separate inquliry is to presuLmeIC
its inledpenidenlce fr-omii otlier clemencilts of the
plrob)lem. Yet, the siources of success and flilure
in firms. and thierefore the proper concerins of
genieral maniagemenlt, remlain anl issue o0f debate
(see. for example, Williamson's argument in this
issue). It would be a great loss if the stutdy of
coniipetitive strateg,y became dlivorced fromn the
other elemiienlts of strattegic manaaemnent.
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Strategic MU(nlgene;lit and EcoolOnics 19
We believe that competitive strategy will
remain ani initegrial paxirt of strategic imanalelellellt
an(ld that its coninectioni with eCoinomics will evolve
aiInd take on niew foirms in the future. We believe
that fears of 'ibsorption' will nlot be realized
for these reasonls: (1) strategy is nlot 'applied'
CC()onomics; (2) eCcoilonoists will nlot leaI-in about
business: (3) microeconiomiiics is Ca collage andci
apl)paretly cainot provide a coherenit inltecrated
theory of the firm or of mainagemeint; (4) that
whichi is strategTically critical changtes over time;
andci (5.) OrgranlizatiOnlal capability, llot imlarket
exchan ce. max iIlcieasin clv assumlle center stace
ini stratetic maniatcemiient reseairch.
Strategy is not applied rnicroecoIioiliics
Wc assert this because it is patently clear that
skillet pralctitioners do nlot dlevelop or imlplement
bluSiniess ol corporate str-atetrics lv yapplyingy
ecionoiics orI any? otlher dliscipline. There are
ecolloilmists w\vho arcue that this onlv pi-oves that
practitionlers are not verxv skillcd aftet all, but
suchI a respolnsc is nleithei Social scicncc, which
stuLdies naturatl order, inor (oocl professionalisml.,
whicih seeks to solvc riather thaii inolnore, the
expressed problems of practitioniers. We do niot
denly that economilic anialysis miav ble uLseful to a
strateCTist but so may demography, law, social
psvchologvy aild aln unliderstanlding of political
treinds, as well as ain appreciatioil for plroluct
design, process technologv, anld the physical
sciences Unllderlivhin the buLsineCss. Part of anyv
comlpetitive stratecgy can be tested against knowix
economlic theor- anld models of competitive reac-
tiOlln but most blusiniess strateTies also conitain
imlplicit hypotheses conicernintg org,anizatiolnal
behavior, political behavior, techliological relationi-
ships anid trendcs. aild reIv on1 ju'Lideienits about
the plercelptions, feelilas, anid beliefs of ciustomers,
suppliers, cemployees, andi competitors. Competitive
strategy is 1intearativxe-not juLst because it inte crates
bLusinesS funlctions andl helps create patterns of
consistenit reiniforcinc dlecisions, but also because
cre,atiny anild evxaluatiniC buSiness strategies requires
insights anld jLicdgemeilnts based oni a broad vxariety
of kno\wledte bases.
Economilists will not learin about business
Econlomiiics has a stronlg doctrinall coml)ponenlt that
resists displacement. Strategic mailagemenlt. by
20 R. P. Riun7elt, D. Sclhenidel and1) D. J. Teece
its nature and auclience, is pragmatic. If certaini
approaches do not shed light on blusiness praic-
tices. or if practitioners deny their validity, the
pioclivity of the strategy field will be, ancd should
be, to reject them. In addition, we believe that
ecoinomiiics will not delve very deeply into btusiness
practices to genierate new theory. This belief is
based on judg2ements ablout longy-term trenids in
academiia. As Simon (1969: 56) commentecd on
academic tastes, 'why woulcl anlyone in a uLniver-
sity stoop to teach or learni ablout desitgning
machines or planning market strategies wheln he
Could concern himself with solid-state phvsics?
The aniswer has been clear: he Usually \Vouldlnt.
Havini becoIm1e as mathemiiatical as physics, and
more axiomatic, mainstreamii economiiics will not
learn enough about business and management to
challeinee strateuic managemenet in its clomiain.
ThLs, for example, as induLstrial organization
increasingly becomiies infatuiated with formal
moclelina (it dicln't until the mid-1970s), it may
lose the rich emiipir-ical base that made it possible
for the Mason/Bain tradition to undergird Porter's
work. Put differenitly, industrial organization may
hiave already mialde its importaniit contriblutions to
strategy.
An example miiaV help illtustrate the very real
gap between theory, economic or otherwise, andl
the need to internalize a vast amouLnt of
in formation pertaining to buLsiness practice. A
case instructor used to ask 'What are this
comiipainy's strengths?' Econiomiiic reasoninig has
now helped us understanid that what we may
mean to ask is 'What firm-specific, nonimllitable
resouLrces or Sustainable market positionis are
presently Under-Utilized?' The restatemenit helps:
it is more precise, it proviies a definition of
'strength,' and it defends againist critics who insist
on ac discipline base behind uLniversity educaltion.
But are economists better equLiipped to aniswer
the questioni? We suspect not. It is probably
mu1tch easier to teach these economic coincepts to
a generalist thani it is to teach economists about
blusiniess.
Microeconomics is a collage
The upshot of all the ferment in economics is
that with regard to issues of most concern to
strategic managemnent, the neoclassical theory of
the firm is no longer a contender. However,
there is no new tlieory of the firm' to replace
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it. Instead, there are areas of iinquliry character-ized
by the assumLlptiolns that are acceptable in bluilding
models and by the phenomena to be explained.
Ther-C is excitemenit and vitality in the new
economics becaulse the range of phenomena that
can be explainecd has been dramiiatically enlar-ged.
However, there is also confuLsion over the loss
of the old determinism. With the old theory of
the firm, everyone knew how to price-youL just
set marceinal revenule equal to martinal cost. But
now price can signal quality to() customiiers anid
price may tell at potential entrant something
aboult the profits to be made. With the old theory
of the firm, a topic like 'corporate culture' was
outside the realm o.f consideration, and classified
with faith healing and voodoo. But now it is
clear that there can be many types of social
equilibi-ia amnon the actois within a firm, with
the equilibria depending upon sets of beliefs and
history, and that these equilibria have raadically
differ-ent efficiency properties. More generally,
it used to be that given a technology, the
neoclassical theor-y delivered a predictioin abOUt
the allocation of resources. But now oine hals to
specify the techniology, the inlforimlation sets of
the actors, includinig their beliefs, and the order
of play and one still usuallv obta ins many possible
equLilibria. The dlescriptive po\ver of the new
economiiics has been paid for by the loss of
determiiinismii.
lhe linmitationi of the new microeconomics is
that it exrplains rather than predicts. That is, it
tends to consist of a series of models, eachl of
whichi has beeni purposefuLlly engineered to
capture and illustrate a particular phenomiiena.
Modiels have been constructCed to examinie mar-
kets with consumer lovaltv, experience effects,
prodlucer reputations. conmplex signaling gamnes,
the strategic use of debt, muLltimarket deterrenice,
and causal amlbigUity. In addition, models have
been used to explore joint ventuLres, venture
capital, vertical integration, the appropriability
of intellectual capital, governanice structures, and
many other pheniomena. All of this has been
informative and provides strategic management
with at panoplv of useful insiglhts. However, these
phenlomena have not been dedulced from these
models or from some general theory. Rather,
each of these mainy models has been carefully
engineered to deliver the phenomena being
studied. The contribution of a good modeler is
in fincding the least aggressive assumptioins that

enable the phenomena in question. Consequently,
the new microeconomiiics is essentially a formal
language for expressing knowledge elsewhere
obtained. Camerer (this issue) calls this the
'collage problem.
The 'collage problem is simiiply that formal
theorizing has collapsed to examples. Conse-
quently, part of the intellectual structure of the
new microeconomics is evolving to look more
like strategic managemiient. Any scholar working
in strategic managemilent must be aware of the
traditional economist's normal reaction to most
of the work in our field: 'The subject is
interesting, but there is no tight theory-it looks
like a bunch of lists. But the new economics,
taken as a whole, is a 'bunch of lists. More
precisely, it delivers a large numllber of tightly
reasoned submodels, but no strong guidance as
to which will be important in a particular
situation.
The new microeconomiiics is still a developing
field and in the future we will see further
elaboration of existing frameworks. But we can
also confidently expect to hear the clangs of new
monkey wrenches being thrown. One already in
the air is the strong evidence for persistent
biases in human judgement and decision-making.
Another which can be anticipated is the fact that
managers not only have different information
sets, they also differ in their beliefs" and in their
understandings of the causal mechanisms they
face. A third, emphasized by Nelson (this issue),
is that firms do not apprehend complete sets of
alternatives, but grope forward with but limited
understanding of their own capabilities and the
opportunities they face.
The implications of this research style for
strategic management are several. First, it should
be clear that knowledge about what phenomena
need be studied is outside its scope. Henlce, there
remiiains a central and importanlt role for scholars
who identify phenomenla worth studyinig. For
example, it is up to strategy and managemiient
scholars to convince financial economists that
most firms really do bludget as if they were equity
constrained-only then will useful models of this
phenomena appear. Similarly, it is LIp to stratety
researchers to reveal the patterns of g,lobal
21 A belief is a prior probability assignmenit to an uLnolbservable
variable. Interestinig beliefs are those which afffect decisions
yet which are not significaiitly uipdated by events.
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Strategic MAIanagement (anid Econiomnics 21
interdependence and competition-economic
modeling will come after the fact. Second, the
economist's approach to these phenomena is to
show their existence; yet this is rarely sufficient
to help in practical strategy work. Yes, it is
useful to know that reputational equilibria are
enabled when product quality cannot be deter-
mined by inspection and warranties are unavail-
able, but this is of little help to a firm that wants
to know whether or not its reputation in the
U.S. for workshirts will help it in Eastern Europe.
It is LIp to strategy (or marketing, or other
functional fields) to develop the measures, tools,
and methods to help in specific situations. Third,
each of the economist"s models tends to be
minimal and independent of the others-they do
not integrate into any cohesive theory of the
firm. For examiiple, gamiie theorists can model
entry deterrence as based on reputations for
toughness, as flowing from asset specificity,
as responsive to uncertainty about post entry
performance, and find that entry is encouraged
by opportunities for learning, by the presence of
technology options, and by economics of scope
involving related products. However, these sepa-
rate models provide little or no information
about which of these phenomiiena, if any, will
predominate in a specific situation, nor do they
help much in determining even the rough
magnitudes of the wealth impacts each of these
phenomiiena can induce. This lack of specificity
not only hinders empirical testing, it renders the
professional utility of these concepts dramatically
smaller than model builders imagine.
What is strategic changes over time
What is strategic changes as time and discovery
alter the basis of comiipetition. These changes
arise, in part, because of technological, legal,
social, and political chanlges. They also arise
because educationl and research dissemiiinate
knowledge, reducillg the degree to which a
particular isSuC can be a source of advantage.
The rise of Japanese competition, for example,
has substantially altered the research agenda for
strateg,y scholars. By contrast, little or no
accommiiodation to such chang,es is seen in
microeconomiiics. Business school deans like to
argue that their research programs, though
abstract, constitute the practices of tomorrow.
The opposite is closer to the truth. Yesterday's
22 R. P. Ruiinelt, D. Sclietlidel (andt1 D. .1. Teece
bLUSiiiess strategies are the subject of todavys
research in strategic imailagem'renlt (e.g. takeovers
aind ILBOs, Kaizeni), and econlomics is just
beginniniig to theor-ize about phenomnena that
developed half a century ago (e.g. separation of
owneslhip and control, the diversified firm.
national advantages). Today's strategic issues
(e.g. the growthi of new 'networ-k' empires in
Eur ope and Asia. time--based competition ) are
only diimly perceived by anyone withini the
academny.
Advantage may be internal
Both theoretical and empirical research inlto the
sour ces of advantage has beguni to poinit to
organizational capabilities, rather than prodtiuct-
market positions or tactics, as the endiurinig
sources of advantage. If this is so, our investi-
gations will increasingly take us into doomains
whelre economiiics is presently at its weakest-
iniside the firii. Tlhere are bids by transaction
cost ecofoloiics and agency theor-y to become
6organization science,' and we can expect new
and imiportant inisighits fromii these fields. How-
ever, their comparative advantage is the analysis
of individual iresponses to incentives. If behalvior
turns on interacting expections, beliefs and
routinies, and if diagnosis, problem solving, and
the coordination of kinowledge rather than effort
are central, theni economiiic views of organization
will continue to be useful, bIut also will be only
one part of the story.
For this set of reasons we believe the boundaries
between strategic mianagemnent and econiomiiics
will remrain distinct, bIut proximiate and somtimiies
fuzzy. But the applied nature of strategic mianage-
ment and its extensive scope will require intersec-
tioIn with theoiry fro0m other social scienlce
disciplines as well.
A GUIDE TO THE PAPERS
The eight papers in this special issue each raise
or address issues whicih lie in the terrain betweeni
economiiics and strategic mnanagemnent. The
authors are leaders in their fields: Colin Camerer
in competitive strategy and the experimental
economiiics of games, Alfred Chandler in blIusiness
history as well ats corporate strategy and structure,
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Richard Nelsonl in the econlomics of tecihilological
change, Michael Porter in competitive strategy,
Garth Saloner in gcamne-theoretic industrial orgtral-
ization economiiics, Andrei Slileiferi and Robert
Vislhniy in financial economiiics and corporate
contr-ol, and Oliver Williamson in organizational
economiiics. The commentator on1 Camerer's and
Saloner's papers, Steven Postrel, is a conitriibutor
to bothi garme-theory and competitive strategy.
It is worthi emphasizing that each author was
assigned the topic for hiis paper by the editors.
The topics were selected to reveal the state-of-
the-art in the coinnectioni between economics and
strategic management. The happy consequenice
of having thils uniiquely talented groUp r-espond
to ou reqtiuests is that we obtain an uniobstiucted
view of our subject. Because each author has
been involved in the developimienit of the concepts
and thieories thiey use and descriibe, thiere are no
problems of misinterpretation, lack of compre-
hension, or' misinformation.
The very heartening aspect of these papers,
especially those written bvy discipline-based econ-
omists, is that flo one qtiuestiolis the importance of
the isstues that are raised in strategic management.
Twenty five years ago thiere would have beeni n1o
suchI agreement. Furthermore, thieire is general
agreement that neoclassical microecoiionoics is
woefully inadequate to deal withi important issues
of strategy. The frlctulre lines begin to appear
over whlichi of the newer economilc sutbfields supply
the greatest insighits inlto strategic advantage. Not
suiprisiigly, garme theorists tend to bet oIn garme
thieory. . . and so oI.
The alert reader will discern tiriee basic
frameworks in these papers (some papers utse
more than one). The fiist stresses the centrality
of avoiding direct competitioin and has nIo
great probleimi withi fairly strong rationality
and eqLuilibriulIl ISSUImnptiOns (e.g. Saloner and
Carmerer, as well as Porter's treatment of the
structure of advantage). The seconsd framework
stresses the importance of governance and of
getting the match iighit between the tecihinologies
to be mana ged and the system of ownershiip,
administration, planning, and conitrol. The writers
LISillg this framework (Chandler, Shlleifeir and
Vislhiny, and Williamson) imiix a static Imiodel of
efficieint arrangement withi the willinginess to see
real firms as making mistakes and learning froim
them. The thirid framework stresses the centrality
of innovation, learning, and discovery in shaping

advantage (e.g. Nelsoni as well as Porter s
treatment of the origini of advantage).
The papers
The developmenit and proper scope and structure
of the diversified firimi is one of the central issues
in oui field. Alfred Chandler's original study of
this sutbject was a key stimulus for the develop-
ment of a scholarly research tradition in strategic
management. In this paper he revisits the
question, using the events of the last 25 years to
inform aI new view of the administrative limits
of corporate headquarters units. In particular, he
examines how continiued growth forced the
standard M-forimi organizations of the immediate
post-WWII era to a three-tiered structure, and
how prosperity (and hiubris) led to diversification
strategies that overtaxed these structures.
The basic conceptual schemie Chandler brinlgs
to this paper is that developed in Scaile and1b Scole.
(Chandler. 1990). Heavy and technologically
complex inidustr-ies are characterized 1w inexhlust-
ible technical economiiies of scale and scope bIut
the ability of fir ns to exploit these economies is
limited bry their entreprenleulrill skill in guidinig
complementary investmiienits and theiri adminis-
trative skill in coordination of the resultaiit
operations. Thus, it is the managerial capabilities
of the corporate office that ultimately deteriniiies
the size, scope, and success of the enterprise. In
this paper, Chandler uses Goold and Campbell's
[1987] topology of headquarters styles, identifying
those usinig purely financial controls as essentially
administrative and those using strategic planning
or1 strategic control methods as perform-inig some
entrepreneurial funictiois. He analyzes the recent
histories of British and U.S. firms and concludes
that multibtusiniess companies employinig financial
controls have been successful only wheni they
have restricted their ownershiip to firms in services
and in simliply mature indtiustries. Where indtiustries
are mature, btut complex and require substantial
investments, headquarters Unlits must engage in
strategic control. And where complexity is
combinied with techniological advance, head-
quarters offices must supply entrepreneurially
oriented strategic planning.
As in Chandler's other works, many of his
COnCIluSiOlnS fit easily within an 'economilizinig
institutionial economiiics framework. Thus, for
example, the fact that advancing techinology
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Strategic ManIagemi1en1t anid Economics 23
increases the need for headqu arters strategic
planning can be seen as iniduced by the costs of
haggling and hiold-up that WOuld bie borne were
the divisioins to plan on a decentralized basis.
However. Chandler's essential contribLutiolns go
far beeyond this statiC picture. In reaching his
COnCluSiOIS, Chandler uses the methods he has
perfected: the historical analysis of challenge and
managerial responise. In this paper we do not
see firms 'applying' concepts or somehow driven
to the efficient responise by selection pressure.
Instead, we see management getting it wrong,
suffer-ing consequenices, strugglilng to understand
the nature of their dilemmas, and thenl, perhaps,
creating new structures, policies, and methods to
cope with, and perhaps transcend, the problem.
Chandler's real message is not that one must get
the headquarters design just righit, but that those
firm-is whichi dominate their industries are those
whichi have shown the most resilienice and insiglht
in respon ding to the challenges that their own
growth and expansion have generated.
Andrei Shleifer and Roblert Vishlny investigate
some of the sarme terrain as Chandler-the wave
of unrelated diversification followed by a wave
of restructurling and retrenchmiienit. Shleiferi and
Vishlny review the available evidence and coIn-
clude that Unrelated diversificationi did inot
improve economiiic efficiency. Unrelated diversi-
fication was carried too far in the 1960s, they
argue, because of antitrust enforcemiienit as well as
agency problems connected with multildivisional
structures: 'The M-form b egot the monster of
the conglomerate.'
What makes Shleifer and Vishniy's paper
especially interestinig is their treatment of the
efficient market hypotlhesis. Since the stock
market responded to conglomerate acquisitions
in the 1960s, many researchers have conclutded
that they created value. This paper argues that
the stock market was merely reflecting the
mistaken beliefs of ai majority of investors.
Drawing on1 their research on1 arbitrage and
market fads, Shleifer and Vishlny contend that
fads persist because it is too costly for the best-
informiied investors to bet against them.
The boom anid btust of conglomerates is a
conveniienit vehicle for this argument, but its
implications extend well beyond the issue of
conglomeration. Evenlt studiies, usinig stock mar-
ket residuals, have become a staindard way of
investigating the 'value' of various policies and
2-4 R. P. Riwnelt, D. Schendel andt D. 1. Teece
strategies. If these studies do not really measure
value, bIut only what investors thiniik is value,
theni this whole methodology may be significantly
weakened.
Richarid Nelson's paper addiresses the questioni
of how andi why firms differ, an extremely deep
questioni in strategic management. If different
firms display differenit levels of perforimianice or
competitive advantage, despite competitioni, then
the r easons for these persistent differences r eveal
the basis of competitive advantage. In this paper
Nelson tackles the especially difficult versioni of
this question: how discretionary consider-ations-
sucih as the strategies andi structures adopted by
management-lhelp uniider-pin suchi differences.
Althougih the existence of discretionar-y differ-
ences is comfortable for many studenits of
strategy, it is at odds with neoclassical microeconi-
omic theory, whicih Nelson sees as 'badly limited'
and hence unihielpful to the field of strategy. It
is badly limited because it is often too abstract
andi r arely deals with economiiic aggregates smaller
thani the industry, and because economists see
the economic problem as basically about getting
private incenitives rigit, not about identifyinig the
best things to do, and how to do them. In this
regard, Nelson andi Williamson see eye-to-eye.
Neither has much time (nor- do the editors of
this special issue) for the long, but gradcually
erodinig traditioni in economics which treats firms
as black boxes.
Nelson stresses that if economics is to infoirn
fundamenital questions in strategy, economists
must break away from the assumptioni of clear
and obvious choice sets and corir ect understanding
of consequenices of making various choices. He
offers a Schumpeteriani perspective, one which
stresses the importance of fundiamental uncer-
tainty, perceptions about feasible paths, andi trial
and erir or learning, as a better way to come
to grips with firms andi firnm behavior. More
particularly, he argues that it is the differenices
among firms in their abilities to gener-ate and
profit from ininovation, not differenices in com-
mand over particular techniologies, that are the
basis of dtuirable, difficult-to-imitate differences
in firnm performaice. It is the issue of firms'
caIpmlilities to inno tate whicih the strategy and
competitiveness literatur e oughit to be more
forthiright in tackling.
Oliver Williamson's paper is a call to arms.
The war is against the idea that strategizinig is a
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source of competitive advantage, and in favor of
stressing the importance of economiziig. It argues
that whereas the field of strategy shoulld be
concernied with first-order economizing
(4rectangles'), it has impor-ted doctrinies from
idiustr-ial or1ganizationi economics whichi are
focused Onl secondi-or-der economizing
('triangles'). Williamson conteidis that if strategic
maniagement is to unilock the souices of long-runl
competitive advantage, and if it is going to rely
on economic thinikinig to assist it, theni it
oughit not to r ely so uniciritically on economic
perspectives whicih appeal to market power
(strategies that restrict product competition) as
the souice of advantage. Rather, the field shouldi
develop more of an efficiency perspective-that
being good at what you do andi avoidiing waste
is more importanit thani exploiting switchinig costs
or1 playing oligopoly games.
Note that Williamsoni's economizing firm is
miles away from Porter's lowv-cost pirodlicer;
the economiiizer is not necessar ily efficient at
productioni, but in the broad ranige of businiess
funictiois. For example, the economiiizer may be
very efficient at managinig the transitioni from
design to productioni, or at tailoring produicts to
local tastes. Williamson's positioin on this issue
is at variance with the traditional (economic)
assumption that firms are 'on their cost curves.'
If firms are assumedi to be technically efficient,
the problem is simply to determine the level
of oUtpUt. Williamson, by contrast, sees the
fundamenital challenge as organizing and govern-
ing activities so as to eliminate waste.
Because tr-ansaction cost economics, which
Williamson pioneer-ed, is concer-ned with first-
or-der economizing, he suggests that it has much
to offer the field of strategy. (Of couise, there
are other approaches which focus on economizing
too.) His paper goes on to identify several
importanit insights from transactioni cost theory
whicih are r elevant to strategy. Transactioni costs
are the costs of organiizinig the economic system.
Inrnteial structures, managerial contiol systems,
and the positioninig of the boundaries of the firm
all impact tranisactioni costs. Williamson outlinies
a framewor-k which helps explain why these costs
differ across organiizationi forms andc theni shows
how the framewor-k applies to several issues in
strategic managemenit.
Michael Porter has played the key r ole in
shapinig the currenitly doominant perspective on1

comrpetitive strategy. That per-spective attempts
to explainl how a particular configuration of
activities, riesources, and indLustry characteristics
combine to shield a firmns profits from rapid
competitive erosionl. In this paper- Porter mnakes
the point that the dominant per-spective explains
competitive success at a given point in time,
solving what he labels the cross-sectional ptrobleln,
but that the dynamic process by which firms
perceive or attain supenior market position, what
he labels the time series or lonigitiudinatil prolleml,
is much less developed. His paper attemipts to
suggest whalt we know and what we need to
know to develop a theory of firm performance
linke(d to managerial choice, initial conlitions,
ancl environmental circumstance.
Porter begins with what he labels the chain of
causality (Figure 2 in his paper). In his cross-
sectional explanationi, success flows fromii advan-
tage inher-ent in indlustry structule ancd relative
position. Advanitiage, in turin, is dlue to the
configuration of activities. The activities provide
support to the configuration, in turn, becaslLlse of
drivers (i.e. activity-level souices of advantage).
Backing up longitudinally, activity configuLr-tions
and (driver-s arise from 'initial conditions' and
managerial choices. In the paper he then moves
even fLurther back, noting that initial conditionis
a(re the result of past managerial choices, luck,
and the nature and(l quality of the local (business)
environlment. One can, of cour-se, theni step
back again, seeinig the character of the local
environimlent as dlue to the policy choices miacle
by a variety of institutional leaders and natural
physical endowmlenlts. This chalin of causality map
not only helps unify Porter's own theorizing on
competitive strategy, it also clarifies the differenit
levels at which explanation can be attemptedl or
equilibr ium assumptions appliedl.
Wly do soImie milanagemienlts make the r-ight
choices in selectinlg products, industries, ancd
activity confiurlations? Porter reviews the degree
to which game theory, commitment views
(Gheniawat, 199 1), ancd the resource-basedl theory
of strategy can provide answers. Not surprisinigly,
none (loes the job, but we obtain insights aibout
each wapproach alonig the w\ay. Where, then, to
turnl'? Porter's (1990) OWIn CuIienit answer is Iluck
andl local environmiiienit. Drawing on his researcl
in Thle Cotnpetitive Advc,antage of Nations, he
argues that managerial insight dloes not spring
up ranclonmly, buLt is concentrated, in each
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Strategic Managemenlt andl L conomics 25
industry, in certaini locales. In those loca-ttions,
cluster-s of competing and supporting firms have
growni up which collectively embody a grea-It (leal
of specialized know-how. One of the most
intriguing ideas a(lvanced here, one drawn fr-om
Th,e (Coinpetitive Advisantage o( Ntdtionis, is that
strenigtlh is frequenitly the fruit of adversity.
Whait seems to keep us fromii making better
progr-ess on undlerstanding managerial choice?
Po rter suggests that a key missing elemenit is a
theory of action that is not rooted in chcoice, but
whiclh deals with creating new optioins aind
discovering new aipproaches. In this sense, he
joinis forces with Nelson wvho also calls for a
mlo(el of search aind discovery to help inform
the discussion of innovation and change.
Thl-ee papers in this special issue addiress the
connections between modern garme theo ry and
str-ategic management. Garth Saloner providles a
viewpoint on the usefulness of game theor-etic
mcodcelinig in strategic managemienit. His basically
positive view is conditioned by two imajor
cautions: there is no evidenice of any real-wvorld
use of game theory by companies, anld game
theoretic approaches are 'too hard' to be applied
to ainything but very simple 'boiled down' mlodels
of reality. The secondcl issue mayV Of Coulrse, be
the reason for the first ancd it is interesting to
speculate on wlhat consequences wotuld flow tfrom
the invention of a game theor-y 'engine' thalt
quickly and clearly yielded the equilibrria of very
complex models.
Saloner's enthusiasm for game theoretic modlels
survives these two considerationls and is based
on their necessity, the 'audit trail they provide,
their metaphoiricatl value, and their growing
impor-tanice in empirical research. Once you begin
to considler the reactionis of rivals to one another's
moves, he argues, you are doinig game analysis,
and the cuiirrent theory is simply the cdistilled
wis(lom about the most sensible way to (1o it.
The great value of explicit modeliing is the clear
record of assumiiptions and logic-the audit trail-
that permits others to verify aniid miodify one's
analysis. Saloner (dismisses the use of game theory
to cialculalte actual behavior, stressing insteaid the
value of understainding why certain results obtain
in certaini situations anid thie possibility of novel
insights. As work pr-ogresses, lie argues, researi-ch
will build up a mosaic of m ciels, each providinig
insights about a particular aspect of striategic
inlteractioin. Gamile thieorrV's coiltribLution to stra-
26 R. P. Ruinielt, D. Schendel andt D. 1. 7Teece
tegic management will be the sum total of the
insights this mosaic provides.
One of the niost challenging qtiuestionis Saloner
tackles is the reasonableness of the rationality
imputed to players in game theory. He points
out that in many games sucIh aIS COurinot
competitioni the rationality reqluired is not very
great. However, in many moderni game models,
equilibria are based on quite complex consider-
ations, straining the credulity of the rationality
assumption. Ther-e is no escape, he suggests,
froIm usinig judgemenit on this matter and notes
that youi owIn play in a game might be affected
bvy whether your oppoinenit was David Kreps, a
fourtlh grader, an average undergraduate, or the
CEO of a typical U. S. firm.
Colin Camerer also addresses the utility of
game theory to strategic management. Like
Saloner, Carmerer is concernied with the sparse-
ness of moder-n analysis, termed 'no fat' modelinig,
and with the fact thit game analysis is hard. If
neoclassical analysis is like eating with a fork, he
analogizes, game theory is like usilng chiopsticks.
Game theory is not only hard, Camerer stresses,
it is also too easy. That is, it is too easy to
generate explanationis for all sorts of behavior.
This happenis because behavior is not just
determined by preferences, but also by the
presence of hidden information.
The heart of Camerer's essay addresses the
rationality assumptioll-is it too demandinig to
be reasonable? His owIn laboratory work on
gamiies shows that people do not arrive at
strategies uSillg the cognitive methods of the
theorist. Consequenitly, theoretical equilibria are
usually approached only after repeated play.
Nonetheless, through processes of adaptation
anid/or evolutioll, theoretical equilibria are
approached. Camiierer also pOIlntS out that the
strict rationiality assumptiolIs of the theorist are
sometimes only ani anialytical conveniienice: the
samile equilibria cani often be justified with weaker
assumptiolIs, though the anialysis is more difficult.
Despite these anid other difficulties in living
with game theory, Camerer favors welcoming it
into the strategic maniagemenit faimily. Like
Salonier, he feels that it is the best way to look
at interactionis amonig alert rivals. In additioni,
Camnerer sees opportullities to inform areas of
interest to strategic mainagemenit such as the
properties of collective resourlces (reputationis
anid capabilities). Finally, he argues that the
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problem of too many explanations and too
many equilibria provides opportunities for good
empirical worlk to point the way.
Steven Postrel's paper is a comment on
Saloiier-'s anid Canier-er-'s discussioins of game
theor-y and strategy, especially the 'Pandora's
Box' problem that the theory has too few
constr-aints on gener-ating explanations of
behavior. Usiing a humor-ous setting, Postrel
shows how a game-theorist could build aI model
to rationalize unreasonable behavior. His point
is that game theory is not really a theor-y of
strategy but is only aI methodology for analyzing
games. Other than rationality, the sutbstantive
theory presenit in a model is in the assumptions,
not in the mechaimcs.
These theni are the papers offered in the special
issue. All offer infor-med and inter-estinig views,
and we hope will in their owIn right inifoirn the
reader on boundary conditiois, futurie challenges,
and research opportuniities that lie in considerinig
economic reasoning oni strategic management
issues.
SUMMARY AND CONCLUSIONS
We have tried to show the relationiship between
economics anid strategic maniagemerit in this
essay. It is more thani some admit, anid less thani
some would hope. We have tried to show that
economics anid strategic maniagemenit are not the
same thing, in research or in practice. We have
tried to indicate that it is the new economics that
offers the most promise bIut it is old economics
in the form of industrial orgainizationi that, thus
far, has miade the greatest contriblutiOl. There
cani be little questioni that the development of
the strategic mainaigemilenit field has blenefited
from the influenice of economilics, I ut the influenice
is not unlidirectionial either.
Where do we go from here"? One trend that
has recently emerged aind deserves mentioni is
the new attentioni to interinal orgainization.
Strategic malnaigemenit is incr-easinigly concernied
with uliderstaiidinig the addministrative processes
that select aind coordinaite the firm's activities.
The capabilities of the firiml, aind the asset
structures that accuLImulalte, appear central to
advaintage aind success. The assets that miatter do
not appear purely physical or separable. The
COnljulnlCtiOnl of physical and intaingible assets

results from inniovative milaniagerial choice aind
actioin not easily duplicated. About such miatters
the new economics cited aind discussed here,
both in the papers, aind this essay, are just
beginniniig to have somethinig to say. However.
in this new aind complex realm, economilics will
be only one of the logical systemlls ill use. Where
organizational relationships turni oni exchainge
and oni individuLal incenitives, various economic
approaches will have much to say. Where the
coordiniationi aind accumulaltioni of knowledge is
key, aind where patterns of belief aind attitude
are importanit, other disciplines will have more
to say.
Along with the interinal turin taken by research,
comes increasing concerin over dyniamic expla-
niationi. Gaime-theory brinigs a fanaitical attentioni
to sequenices of action aind reaction, histor-y
provides stories of chalilenige aind riesponse,
ininovationi is inherenitly dynaimiic, aind so aire the
processes whereby skillful mainaigers make sense
of anid respond to ain evolving environimenit. In
the more practice-oriented side of the field there
is great interest in time-based competition aind
in the interplay betweeni product-miairket striategy
anid the developmenit of organizational capabili-
ties.
More importanit thain these trends in subject
miatter is the graduLal enlairgement of striategic
mainaigemilenit to include disciplinie-based scholar-s
who shaire OuIr interest in ulider-standing the
direction of enterprises. CaLutioll in this regaird
is only reasoniable. Striategic malnaigemenit scholars
are smoall ill nulimiber- anid stlrLlggle to maiaitaini
integrationi aimonigst fr-ami-iewor-ks aind between
theory aiid piractice; imlost disciplinles ar-e populouS
aind tend to compete, riather thain cooperiate, with
other disciplines. Nonetheless, initellectual and
social mechlianisms must be foulid to miake the
very best of the discipline-based scholars welcome
in strategic manaiagemenit. Their participation aind
va-iety are key to the long-rull SuIVival of our
field.
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