Corporate entrepreneurship and rent creation: an integration of perspectives

1 Paper to the ESU-conference at University of Seville, Spain, 12 - 17 September 2011 Corporate entrepreneurship and rent creation: an integration of perspectives Jorunn Grande Contact information: Jorunn Grande Nord-Trøndelag University College Servicebox 2501 7729 Steinkjer Norway E-mail: [email protected] 2 ABSTRACT Firms engage in corporate entrepreneurship to increase competitiveness and sustain performance through rejuvenation, renewal, and redefinition of their organizations, markets, or industries. This is challenging to most firms, since it often involves new relations to customers, suppliers and contact with less familiar industries. The reward for successful CE engagement should be a more profitable firm. However, the potential to new value creation and competitive advantages may originate from different sources within the firm and is quite complex. Thus, even if the relationship between CE and performance has been well researched and documented, there seem to be less understanding of the reasons why CE may produce superior performance. CE may leverage several bases of competitive advantage. This conceptual study argues that these bases may be explored through the entrepreneurial orientation (EO), resource based (RBV) and dynamic capability (DC) perspectives. The study links the RBV, EO and DC perspectives respectively to Richardian, Entrepreneurial and Austrian rents. Each of these perspectives may thus provide their unique insight into how entrepreneurship may create new rent streams and improve performance in firms. In total the study contributes to further understanding of how and why CE may lead to superior performance in firms. 1 INTRODUCTION Firms engage in corporate entrepreneurship (CE) to increase competitiveness and sustain performance through rejuvenation, renewal, and redefinition of their organizations, markets, or industries (Covin and Miles, 1999). This is challenging to most firms, since it often involves new relations to customers, suppliers and contact with less familiar industries. The reward for successful CE engagement should be a more profitable firm. However, the potential to new value creation and competitive advantages may originate from different sources within the firm and is quite complex. Even if the relationship between CE and performance has been well researched and documented, there is according to Covin and Miles (1999) less understanding of the reasons why CE may produce superior performance. To extend knowledge on this issue this conceptual study perceive CE to be an overarching perspective and tool for analysing how new profit (rent) may be created and captured by firms engaging in entrepreneurial activities. Under the CE umbrella the entrepreneurial orientation (EO), resource based view (RBV) and dynamic capability (DC) perspectives are integrated since each of them may represent a unique source for sustaining competitive advantage and superior performance in firms. The paper proceeds as follows. First the content of CE and its link to performance is explained. Then the concept of rent and various types/sources of rent are explained and linked to theories of CE (EO, RBV and DC). This is followed by a brief view of the content EO, RBV and DC perspectives. The paper ends by discussing and concluding on how these perspectives each yield unique insight but together also complementing insight, on how and why CE may lead to superior performance in firms. 2 CORPORATE ENTREPRENEURSHIP (CE) Based on the expected positive influence on the renewal and performance in existing firms, entrepreneurial efforts in an organizational setting have received increased attention among scholars in the last decades (Miller, 1983; Covin and Slevin, 1989; Lumpkin and Dess, 1996; Wiklund, 1999; Wiklund and Shepherd, 2003; 2005). It should be noted that a range of terms and definitions are used to describe entrepreneurial efforts within an organizational context. 3 Terms often used are intrapreneurship (Antoncic and Hisrich, 2003), strategic renewal (Sharma and Chrisman, 1999), corporate entrepreneurship (Zahra, 1995) and entrepreneurial orientation (Lumpkin and Dess, 1996). This study has selected the term corporate entrepreneurship (CE) as an overarching perspective and label of entrepreneurial efforts inside existing firms. The definition of Sharma and Chrisman’s (1999, p. 18) is further adapted, which states that CE is “…the process whereby an individual or a group of individuals, in association with an existing organization, create a new organization or instigate renewal or innovation within that organization”. CE is thus considered a process where an individual or group of individuals, in the context of an existing firm, create innovative resource combinations (Elfring, 2005). CE thus recognises that the entrepreneurial initiative has emerged from or within an already existing organisation rather than appearing only as an independent individual act. In addition to requiring individuals with particular entrepreneurial behaviour within the firm, the firm must also possess an organisational environment that tolerates and supports these activities (Elfring, 2005). By browsing through the literature we find descriptions of the content like; organizational creation (Sharma and Chrisman, 1999), processes and activities that leads to new entry (Lumpkin and Dess, 1996), innovation and venturing (Zahra, 1993), departing from the customary (Antoncic and Hisrich, 2003), creation of new wealth through new combination of resources (Guth and Ginsberg, 1990), proactive innovations and risk taking (Miller, 1983). These all describe how entrepreneurship may be undertaken inside an existing firm. 2.1 CE and performance Firms engage in corporate entrepreneurship to increase competitiveness and sustain performance through rejuvenation, renewal, and redefinition of their organizations, markets, or industries (Covin and Miles, 1999). This is challenging to most firms, since it often involves new relations to customers, suppliers and contact with businesses in other industries. However, the reward for successful CE engagement should be a more profitable firm. The relationship between CE and performance has been well researched and documented, but according to Covin and Miles (1999) there is less understanding of the reasons why CE may produce superior performance. When expected returns are not obtained this might indicate a lack of understanding of what constitutes the potential origins for creating new competitive advantage in this sector. Covin and Miles (1999) argue that there are seeds of competitive advantage in each of their four typologies. They also suggest that these advantages are related to the organizational actions behind the CE phenomenon which again are often linked to recognized bases of competitive advantage. They further claim that all typologies of CE will represent appropriate, defensible, and value enhancing behavior to all firms in any given competitive context. The latter argument also suggests that more conservative firms should benefit from CE behavior and strategies, even if other scholars have had less confidence in this (Hart, 1992; Smart and Conant, 1994). Covin and Miles (1999) further explain that an organizational rejuvenation in general may improve the firm’s implementation of a new diversification strategy that already has led to some improvement in performance and thus further optimize benefits from this strategy. Hamel and Prahalad (1989) also argue that CE will leverage multiple bases for its advantage, since high performance often are the results of firms that are able to “layer” several bases of firm competitive advantage. Finally, Alvarez and Busenitz (2001) explain that through better entrepreneurial efforts and skills, firms may utilize their resources more efficiently by discovering alternative uses of possessed resources and increase their awareness towards new opportunities in the environment. In total this suggests that CE should have a 4 great potential for giving important insight on which are critical resources and capabilities for making farm entrepreneurship successful. This study builds on and extends above theory by discussing the concept of rent as the outcome of corporate entrepreneurship. Exploring the concept of rent may aid the understanding of different potential sources to new competitive advantages and thus indicate how new income streams and superior performance may be created in firms. This should contribute to a better understanding on how and why CE may lead to superior performance. 3 OUTCOMES OF CE – GENERATION OF RENTS In classical economics the ability to generate rent has early been considered one of the most important attribute to resources and the term rents has been used as a common denominator for profits to resource owners. As explained earlier, engagement in CE is expected to increase the firms’ potential to generate new rent and superior profits in firms. In general rent may be referred to as “excess returns to resources that are limited in supply” (Schoemaker, 1990, p. 1178) or as “return in excess of a resource owner’s opportunity cost above-normal rates of return” (Mahoney and Pandian, 1992, p. 364). Thus, it is the proportion of earnings in excess of the minimum cost needed to enter a specific industry. Rents may be generated from possessing scarce and unique resources in a static world, but might also arise from innovative efforts disrupting this static picture according to Schumpeter’s theory on creative destructions (Alvarez and Barney, 2004; Schumpeter, 1939). Thus the definition and description various type of rents may thus aid us in the process of understanding why some firms earn profit and some firms not (or a lot less). Profits that originate from unique resources may be related to economic rents. The nineteenth century British economist David Ricardo found that when resources are scarce, differ in quality and are more or less accessible they have a potential to generate rents to their resource owners (Galunic and Rondan, 1998; Knudsen, 2003). Ricardo developed his theory on rent based on examples from agriculture where he observed differences in profits to landowners related to different quality of land. This type of rent is commonly labelled Ricardian rent. Some resources are limited in supply and may also vary in quality such they are more expensive to extract or harvest compared to others. Ricardian rent may thus include value attached to ownership of valuable land, locational advantages, patents and copyrights (Mahoney and Pandian, 1992). Depending on the strength of the isolating mechanisms1 (barriers to imitation), the stability in supply or demand, resource owners (firms) may be able to sustain this rent. Another source to new value creation may rise from entrepreneurial efforts in firms. Previous advantages based on unique resources may be destroyed in long run, and to sustain profit and competitiveness firms need to find new ways of generating rent. Ricardian rent typically reflects a static picture and markets in equilibrium. However, when this static picture is disrupted, for instance by a Schumpeterian innovation, Ricardian rents may also change (Darroch et al., 2005). A new discovery of a resource (i.e. a metal substitute), innovations or change in consumer needs may leave previously valuable resources obsolete and useless such that previous Ricardian rents evaporate. To survive and sustain competitiveness the firm then need to find new sources to generate profit. In periods of turbulent and changing environments firms thus need to create new rent through exploration of new opportunities, risk taking, innovations and pro-active efforts in 1 For a comprehensive overview of isolating mechanisms se table 1 in Mahoney and Pandian and also Alvarez and Barney 2004. 5 order to survive. This rent is called entrepreneurial or Schumpeterian rent after the work of Schumpeter on disruptive innovations (Galunic and Rondan, 1998; Mahoney and Pandian, 1992). Alvarez (2007) explains that entrepreneurial rent is returns primarily to risk and uncertainty, and defines it to be “the value created when economic actors combine resources in new and different ways, and when these resource combinations are not known ex ante” (Alvarez, 2007, p. 431). The positive income effects related to entrepreneurial activities may therefore be related to the generation of rent accruing from new innovations and market disruptions. In this way new resources or new uses of resources may be discovered. When looking at the sustainability of the newly created entrepreneurial rent, parts of it are explained as inherently self-destructive due to diffusion of knowledge. Other parts of the entrepreneurial rent may however contain a new Ricardian rent and thus a more lasting rent, emerging from the discovery of new valuable resource combinations unique to the firm (Darroch et al., 2005; Alvarez and Barney, 2004). Entrepreneurial rents may thus be divided in two main parts; payment to arbitrage and to innovations (Ross and Westgren, 2005; Alvarez, 2007)2. Arbitrage occurs in a situation where ”an economic actor already controls all resources necessary to generate the rents associated with a market opportunity” (Alvarez and Barney, 2004, p. 624), while an innovation reflects shifts in either demand or supply curves. Rents from arbitrage are typically more vulnerable to competition and thus likely to dissipate as an innovation diffuses in the market. According to Alvarez (2007), it is not evident that firms are able to appropriate all rent that may be generated from discoveries and innovations. The reason is that the value of entrepreneurial rents may not be known when they are created, and depending on how easy the new inventions are to imitate, competitors might also capture part of this rent. This means that entrepreneurial alertness may create new rent streams to the firm, but it is not always obvious how firms should optimize the advantage of their new innovation. A critical issue is the firms’ ability to appropriate the rent that is generated through their entrepreneurial and innovative efforts (Alvarez, 2007). This vulnerable part of entrepreneurial rent may be called Austrian or Monopoly rent, which makes a connection to superior management and the ability to protect the firm from competition (Alvarez and Barney, 2004). For instance, the knowledge of and use of effective isolating mechanisms as well as the building of new strategic alliances might help the firm in protecting the rent from dilution to aggressive competitors (Teece et al., 1997). Optimal appropriation of rent may require effective integration of new resources and knowledge, and might demand significant changes in the operation of the firm. The firms’ ability to effectively initiate and effectuate changes is thus likely to be of critical importance in optimizing appropriation of rent. The above discussion of rent should yield further insight into the unique elements in CE that may create competitive advantage and superior profit to business enterprises. It shows that the potential to new value creation and competitive advantages may originate from different sources within the firm and is quite complex. To optimize benefits from business rejuvenation firms need knowledge of resources, entrepreneurial efforts and the appropriation of rent. Exploring these fundaments should thus have a great potential for adding further indepth insight into several distinguishable sources to profit when firms engage in new business models. When firms engage in corporate entrepreneurship several sources to profit may thus be activated as suggested by Table 1, which indicate a link between different types of rents and 2 Entrepreneurial rent is often called Schumpeterian or Austrian rent based on these two parts. These terms might thus have different content, but is often used interchangeably in literature and the precise meaning of rent might differ between authors (Schoemaker, 1990). For instance, Austrian rent is often related to the arbitrage part of entrepreneurial rent (Darroch et al., 2005), but sometimes the Entrepreneurial and Schumpeterian rent is also used in the labeling this part of rent. 6 theories of CE. First of all there is a rent that based on payment to unique resources. Second, there is rents that based on payment to innovation, risk and uncertainty. Finally additional rents may be gained from superior management and arbitrage strategies which optimize appropriation of rent that may dissipate to competitors. To get further insight into these different sources profit and rent this study has integrated the EO, RBV and DC perspectives to get a better understanding of how CE may leverage several sources of profit (as explained by Hammel and Prahalad, 1989). These perspectives all focus on explaining how firms may sustain their competitive advantage and gain superior profits, but they also give each their distinct piece of information towards increased knowledge and understanding into the complex issue of how new value is created, appropriated and sustained. Table 1 gives an overview of various types of rent and their relation the scientific perspectives of EO, RBV and DC. This illustrates that the three perspectives may each be related to their unique source of rent creation in firms. The EO, RBV and DC perspectives are presented and discussed in the next sections in this chapter. 7 Table 1 Rent creation and theories of CE Types of rent and their content Intelectual roots Theories of CE Ricardian rent (May include Marshallian or Paretian rents)  Rents earned from resources in fixed or limited supply  Payments to resources and capabilities that are unique to the firm and cannot be incrementally dissipated  Ricardian rents might be destroyed by a Schumpeterian innovation Ricardo, 1821 Marshall, 1920 Resources-based view (RBV) Explains returns to unique resources Entrepreneurial rent (Also called Schumpeterian rent and includes Austrian rent)  Is the ”value created when economic actors combine resources in new and different ways, and when these resource combinations are not known ex ante” (Rumelt, 1987)  Rents created when new resources or uses of resources (new resource combinations) is discovered  Are returns to risk and unceratinty (Alvarez, 2007)  Composed of Ricardian and Austrian rents; payments to innovations and arbitrage Schumpeter, 1934 Rumelt, 1987 Entrepreneurial orientation (EO) Explains returns to innovations, risk and uncertainty Austrian and/or monopoly rent (Entrepreneurial rent that is not Ricardian)  Enables appropriation of rent (Austrian rents) subject to dissipation by imitators and attracting entry by competitors (Alvarez and Barney, 2004)  DC protects Austrian rent from competitors by applying isolating mechanisms  Capture rent by developing arbitrage strategies (Ross and Westgren, 2006) Schumpeter, 1934 Teece et al., 1997 Dynamic capability (DC) Explains returns to superior management 8 4 PERSPECTIVES OF CE 4.1 Entrepreneurial orientation (EO) Due to the increased attention to entrepreneurship inside existing firms the concept entrepreneurial orientation (EO) has emerged as an important device for studying, describing and evaluating entrepreneurial efforts within existing firms the last two decades. Lumpkin and Dess (1996, p. 136) explain EO as “…the processes, practises, and decision-making activities that lead to new entry”, and further that it “… involves the intentions and actions of key players functioning in a dynamic generative process aimed at new-venture creation”. EO is therefore used to characterize a set of related processes in firms, including a variety of activities related to identification of new opportunities and subsequent investment in the resource base (Alvarez and Busenitz, 2001). In short, the literature defines EO as a firm level phenomenon (Lumpkin and Dess, 1996) and is also often described as the mind-set of firms involved in the pursuit of new ventures (Rauch, Wiklund, Frese and Lumpkin, 2004). The field seems to agree to conceptualize EO as having from three (Covin and Slevin, 1989; Wiklund, 1999; Madsen, 2007) to five dimensions (Lumpkin and Dess, 1996; Hughes and Morgan, 2007) that might vary independently of each other. These are 1) a propensity to act autonomously, 2) a willingness to innovate, 3) a willingness to take risks, 4) a tendency to act aggressively towards competitors and 5) a pro-activity towards market opportunities (Lumpkin and Dess, 1996). Here autonomy is understood as the independent actions undertaken by entrepreneurial leaders or teams to bring about a new venture and see it realized. The innovative dimension captures the tendency toward embracing and supporting creativity and experimentation, technological leadership, novelty and R&D in the development of products, services and processes. The autonomy and innovativeness dimensions also represent an alertness to profit opportunities and exercising of superior judgement and intuition in the firm (Ross and Westgreen, 2006). The risk-taking dimension reflects an acceptance of uncertainty and risk related activities and is typically characterized by resource commitment to uncertain outcomes and activities. This reflects that value is created from the ability to take risk and bear uncertainty (Ross and Westgreen, 2006). Competitive aggressiveness conveys the intensity with which a firm chooses to compete and its’ efforts to surpass competitors. Finally, pro-activeness is related to a forward-looking perspective where companies actively seek to anticipate opportunities to develop, and are eager to introduce new products in the market to obtain first mover advantages and shape the direction of the environment. It differs from the competitive aggressive dimension in that it is not directed towards competitors but relates more to market opportunities (Lumpkin and Dess, 1996). As shown in Table 1 this perspective may be linked to entrepreneurial rent which may provide a further understanding of why EO may lead to superior performance in firms. 4.1.1 EO and performance The main assumption behind the EO concept is that all firms fall along an action continuum that ranges from highly conservative to highly entrepreneurial (Barringer and Bluedorn, 1999). Entrepreneurial firms are explained as being risk taking, innovative and proactive, whereas more conservative firms are described as risk averse, less innovative and typically adopt a “wait and see posture” (Barringer and Bluedorn, 1999). It follows from this that firms with an entrepreneurial orientation are more likely to introduce as well as gain from innovations than more conservative firms. The predominant evidence in literature also shows that firms with a high score on entrepreneurial orientation perform better than firms with a lower score (Covin and Slevin, 1991; Wiklund, 1999; Wiklund and Shepherd, 2003; 2005; 9 Keh, Nguyen and Ng, 2007; Madsen, 2007). A study of business founders by Frank, Lueger and Korunka (2007) found a positive relationship between risk propensity and success. They attribute this positive effect of a greater risk propensity to be an indirect learning effect of facing risk, and explain that this is likely to increase both the “ability and willingness of the founder to handle risky situations” (Frank, Lueger and Korunka, 2007, p. 242). However, some scientists argue that a high EO also might lead to adverse effects to the firm in certain situations (Smart and Conant, 1994; Hart, 1992). It is easy to understand that the risk dimension might have both negative and positive effects on performance. A willingness to take on more risk means a greater chance for gains as well as losses, and it might take time to learn from it. Previous studies suggest that an extremely high EO also might have negative effects on performance, indicating that a moderately high EO, including moderate risk, moderate innovation and moderate pro-activity might be most profitable (Bhuian et al., 2005). Worth noting also is that when facing turbulent markets some resources such as access to financial capital, might indirectly influence the relationship between EO and performance and in this way limit the adverse effects of risk. 4.2 The resource based view (RBV) Entrepreneurship involves new resource combinations (Burgelman, 1983). Here the RBV focuses on the uniqueness of resources as critical for creating new rent streams to firms (Alvares, 2007; Alvarez and Barney, 2004). The resource based view (RBV) has emerged as an important perspective and instrument for understanding, finding and evaluating possible business opportunities and resource needs in firms (Penrose, 1959; Barney, 2002). The RBV builds on the foundation that the critical elements for strategic change and creation of long run competitive advantages often are found in the internal resource configuration of the firm (Rumelt, 1991; Borch, Huse and Senneseth, 1999). In her early work, Penrose (1959) argued that even if firms have similar factor endowments, there exist different mechanisms for resources combination and utilization that results in heterogeneity among firms. More recent strategy research also indicates that there are greater differences in profits between firms within an industry compared to the differences that exist between industries. By identifying and acquiring resources that are critical to the development of demanded products, firms may earn above normal earnings (Wernerfelt, 1984). Thus the RBV approach focuses on rents stemming from owners of scarce resources that are firm specific rather than the profits based on positioning in product markets (Teece et al., 1997). The seminal elements of the RBV approach are then found in Penrose’s “The Theory of the Growth of the Firm” (Penrose 1959), but the earliest attempts to describe and apply it as an independent perspective are found in Rumelt (1984), Teece (1984), Wernerfelt (1984) and Barney (1986). Since then, research within the RBV has received great attention from scholars both empirically and conceptually and is now perceived to be one of the most widely accepted theoretical perspectives within the field of strategic management (Priem and Butler, 2001; Newbert, 2007). According to the RBV the firm’s ability to build new competitive advantages and explore new markets depends on its available resources and its ability to develop both physical and human resources (Barney, 1991; 2002). The RBV conceptualizes the firm as a bundle of resources, where different resources vary in their importance for generating added value to the firm. The main message in the RBV is that firms with valuable, rare and inimitable (VRI) resources have the potential to achieve superior performance (Barney, 1991; 2002). This means that the resources must possess some kind of value or capacity that gives advantages to the firm compared to others. In this way some firms may be better fit than others to pursue 16 Covin, J.G. and Slevin, D.P. (1989). Strategic management of small firms in hostile and benign environments. Strategic Management Journal, 10, 75-87. Covin, J.G. and Slevin, D.P. (1991). A conceptual model of entrepreneurship as firm behavior. 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