After revisiting the research results on over 200 small and medium size companies I thought it useful to provide a presentation of the central focus of the research.—the Dynamic System Model (DSM)—and how the model and the research results relate to other work in strategic management and entrepreneurship.
This presentation, due to its length, will be published in 4 Parts in two week intervals each.
This first part deals with Strategic Actions and Organization Theory, etc.
Which Strategic Actions Determine Continued Growth and Profitability in the Small-to-Medium-Sized Firm?
Once a company is in operation, which factors determine its growth and profitability? Entrepreneurship researchers have taken four main directions in answering this question. Some adopt a Population Ecology approach—a Social Darwinian view seeking to identify external environmental factors influencing the birth and growth of a cluster of organizations—either sharing common industry or geographic characteristics.1 Others seek to identify owner-founder characteristics to predict the birth or success of enterprises. A third cluster of researchers employ a corporate life cycle approach—a developmental view suggesting that firms go through inevitable stages from birth to maturity and eventual death, analogous to the human being. A fourth group, taking a strategic adaptation perspective, focuses primarily on internal actions taken by the founder and other managers after a company has been established. This last group attempts to identify which strategies might be associated with growth and profitability (strategic adaptation perspective).2
Although all four approaches have merit, our research primarily reflects the fourth perspective. Our book provides a theoretical framework, strongly grounded in decades of open-system based organization theory research that helps to identify the categories of strategies you must consider in directing your company. These categories of strategies form the essence of the Dynamic System Model (DSM) and our book. Our book further emphasizes the open-system theory perspective that multi-tiered social systems (at individual, company and larger social levels) all interact dynamically to impact organizational outcomes. This perspective is quite consistent with recent research in the field of entrepreneurship and strategic management of growing firms, showing that interactions among individual, environmental and strategy variables provide more accurate predictions of sales growth than any one set of variables alone.3 We provide an update and interpretation of this research in the last section of this chapter.
Strategic management and Organization Theory : A Merging of Disciplines
Apart from its roots in the field of entrepreneurship, our research straddles two other disciplines: strategic management and organization theory. Until the late 1980’s, the field of strategic management and organization theory appeared quite distinct. Though both are interdisciplinary outgrowths of other disciplines, strategic management was more heavily influenced by the fields of marketing and finance, whereas organization theory was an outgrowth of social psychology and sociology. But it is logical and inevitable that researchers from each field would begin to pay attention to one another while searching for common truths. Both attempt to predict a common set of dependent variables—organizational success and effectiveness.
Strategic management has shifted since the 1950s from a focus on long-term corporate resource planning toward a focus on competitive advantage.4 Through the 1980s, much of strategic management research looks outward from the organization for competitive advantage: A company’s success depends upon its choice of industry, markets, and products. The three generic competitive strategies —cost leadership, differentiation, and focus— outlined by Michael Porter in his seminal work, Competitive Strategy each define an aspect of a company’s product advantage vis-a-vis its competitors.5 Led by Prahalad and Hamel, in the late 1980s and early 1990s, strategic management shifts again to look beyond the product/market mix toward the underlying core competencies, sets of skills, or capabilities that make new product development and process improvements possible.6 Rather than build strategy exclusively around products or customers, Prahalad and Hamel urge companies to build around a central set of corporate skills. Although their essays focus primarily on technical capabilities underlying a stream of products or services in large manufacturing corporations, other authors have subsequently picked up on the core competency theme, identifying an ever-broadening set of underlying capabilities thought to provide competitive advantage. Ulrich and Lake identify four sets of capabilities—financial, marketing, technological and organizational learning—the last referring to an organization’s ability to engage employees in problem-solving that helps it change.7 In 1994, Pfeffer identifies a trend in strategic orientation away from product and process technology, protected and regulated markets, and access to financial resources, toward organizational capabilities—in particular, how the work force is managed.8
As a sub-discipline of sociology, the field of organization theory evolved in a fairly isolated manner from the field of strategic management, with little crossover between the two fields until the late 1980s or early 1990s. To illustrate the subtle shift taking place at the time, consider the changes made to the popular organization-theory text, Daft’s Organization Theory and Design, between its 1992 and 1995 edition. In the 1992 edition, the chapter on organization effectiveness makes no mention of strategy. In the 1995 edition, Daft combines strategic management and organization effectiveness in a newly titled chapter reflecting this change, and includes a new chapter on organizational learning, that further expands on strategic management themes.9 Our book, Managing the Growing Firm, originally published in 1992, is also representative of an effort to integrate organization theory and strategic management.
Open-systems theory is one of the most important theories to cross over from organization theory into the general management literature. Though open-systems theory has long been a part of the body of knowledge in organization theory, popular interest in it has only recently reemerged.10 Apart from our book, several widely-read management books published in the early 1990s brought renewed attention to that perspective. Senge’s book, The Fifth Discipline, based extensively on open-systems theory principles, highlights the importance to managers of mental models such as open-systems theory to foster more creative problem-solving. He points out that by breaking problems into smaller parts, we often lose sight of the whole organization, advocating instead a total-system view of the organization.11 The books, including The Boundary-less Organizationand The Death of Competition both emphasize the importance of viewing an organization as a social system, that, in turn, is part of a larger business ecosystem.12 Another popular book, A Simpler Way, takes a somewhat more anthropomorphic view of organizations as living systems.13 Explaining system dynamics in more physical terms, Goldstein’s The Unshackled Organization elaborates on the internal qualities of the organization as a nonlinear system: Its capacity for synergy—the whole being greater than the sum of the parts; its capacity for self–organization—spontaneous and radical transformation of the system; the multidirectional and mutual interaction among elements; and the growth potential of the system as a result of a far-from-equilibrium process—the tendency of nonlinear systems to change, rather than to seek equilibrium.14
In sum, our work is influenced by a convergence between strategic management and organization theory. We adopt the view from strategic management that visioning, direction-setting, and the identification of core competencies and competitive advantage are useful in building the effective organization. We also benefit from the long-standing body of research on open-systems theory, helping us to identify more clearly what some of those internal core capabilities ought to be. We identify these core capabilities as part of the DSP model, described in the next section.
A Schematic Representation of the Dynamic System Model
Several readers of our first edition suggested we provide an introductory schematic presentation of the DSM, even though we discuss these points later in the text. To this end, we organize this section into four parts. The first three describe the underlying assumptions of the DSM:
- The organization is humankind’s “ultimate” tool
- The organization needs to combat entropy to survive
- The organization is a dynamic, social system
The fourth part outlines the Seven DSM issues we derive from these three assumptions.
The Organization is Humankind’s “Ultimate” Tool
Think of those people who have accomplished great things in history. In many cases, great individuals probably would not have reached such greatness without organizations to back them. Could President Abraham Lincoln have freed American slaves without the enthusiastic support of his government? How many people would John Wesley have reached, then and now, with his new view of Protestantism, without founding the Methodist Church? Consider Bill Gates. He might have designed a few software packages alone, but could he have dominated the global software industry in the 1990s without his software company, Microsoft Corporation? We think not.
The organization is humankind’s ultimate tool, because it is the means by which two or more people, working together in cooperation, can accomplish what a single person cannot. Just as a hammer adds physical leverage to the human arm, the organization extends the mental leverage of the human brain, and in many cases, the collective spirit. Do not assume that just because the organization is a powerful tool, that a CEO can or should be a dictator or ruler. But it does mean that in truly effective organizations, dozens, hundreds or even thousands of individuals can network together to accomplish a vision and shared objectives provided by its leadership. In the entrepreneurial firm, founders have a picture or vision of what they want to accomplish. The organization is their primary tool to help realize that vision. And as with any tool, the more clearly the organization’s purpose and its workings are understood, the more likely that purpose or vision will be realized.
The Organization Needs to Combat Entropy to Survive
Open-systems theory leads us to the second key principle of the DSM—the concept of entropy. Every organization needs to combat entropy or disorder to survive. The natural course of the universe is toward further disorder, according to the Second Law of Thermodynamics. But on a local level, order can be restored. You can counter entropy within your own company by understanding how all open systems fight chaos: Inputs are brought into the system, transformed in some manner, and then exit as outputs. These outputs (your products or services)—are then exchanged for new inputs. To counter entropy, this input-transformation-output (I-T-O) cycle must continually repeat itself during the life of the enterprise. The more efficient the transformation process, the more resources are left over for future use.
Consider the for-profit enterprise as a system: inputs of money, people, information and materials enter the system, and are transformed in a way that adds value to the inputs. When the finished products or services are sold, output is returned to the environment in exchange for more inputs (usually capital). The inputs used in the transformation process might be viewed as “costs” in operating the system. To operate efficiently, the ratio of outputs to inputs must be greater or equal to one. The system must operate efficiently over time, or it will eventually run out of resources. To operate effectively, the system must also add value to the inputs as they are being transformed or no one will desire the product. Adding value may take many forms: The manufacturer takes raw materials and converts them to finished goods; the distributor transports goods to a more central location; the retailer helps to build awareness of various product lines through advertising and by bringing product close to the end-user. In the service business, employee skills and information are combined to provide a service. Usually the biggest challenge at start-up is to get this cycle going—to determine a need to fill, to locate the resources to get started, to produce goods or services of adequate quality, and to build up a reliable customer base so that fresh inputs (typically money generated from sales) enter the system on a predictable basis. In most start-ups, this simplified model provides a sufficient explanation of the key challenges faced by the new business.
At first glance, the I-T-O cycle may not seem to apply to nonprofit firms. But the recipient of the output does not have to be the same as the provider of new input. Trade associations, a form of nonprofit organization, do indeed provide direct services to their paying members. But many charity organizations follow a less direct path in the I-T-O cycle. Consider for instance the American Red Cross. Though disaster victims sometimes join future ranks of volunteers, many key supporters of the American Red Cross never directly benefit from its activity. Nevertheless they contribute, valuing the services it provides to society—the larger social system. Most philanthropic organizations can be viewed this way. But make no mistake: A nonprofit group not perceived to provide a valuable service eventually ceases operations.
The Organization is a Dynamic, Social System
Once created, your company begins to take on a dynamic of its own. In spite of your best efforts, you eventually discover that you cannot control every action or outcome within your company, much less those actions impinging on it from outside. Why? According to open-systems theory, your company is part of a multi-tiered set of social systems. At one tier, your company is made up of individuals with freedom to choose and act, creating their own dynamic situation within the organization. In turn, your company interacts with individuals and organizations at higher levels of social systems beyond the organization’s own boundaries, further adding to its dynamic qualities.
Some interactions with the larger environment are a result of the I-T-O cycle. For instance, at the input stage, your company interacts with individuals (to recruit as employees), a bank (to apply for a loan); investors (to pressure for equity), suppliers (to buy raw materials), or a library (to obtain information). At the output stage, customers buy your products. But not all interactions are intentional or a direct result of the I-T-O cycle. Your company may be buffeted by higher interest rates, new government regulations or a spate of nasty weather. Your company may benefit from an unexpected new technological discovery or be threatened with extinction by the introduction of a substitute product. Paying attention to these interactions from the larger social system is also essential to your company’s survival and growth as a dynamic, social system.
In short, even though you create your own firm, once set in motion, many consequences are beyond your control. Consider the following image created in a training film to demonstrate chain reactions. A room is filled with ping pong balls set on mouse-traps. Someone (from off-camera) tosses a ball into the room. First, two other balls are released, then four, then eight. Before long, bouncing ping pong balls fill the room. Fortunately in the real world, chain reactions usually occur less randomly and more slowly. But the multiple interactions among individuals, groups and organizations in multi-tiered levels of social systems can result in a scene that appears almost as chaotic. When you create your company, you toss the first ball. After that, don’t expect to control all the dynamics you (and others) set in motion. But do pay close attention to the dynamics that result from your actions and those around you, both within and outside the company.
References and Footnotes-Part 1:
1. Zoltan J.Acs and David B. Audretsch, “The Determinants of Small-Firm Growth in US Manufacturing,” Applied Economics, 22 (1990), pp. 143-53. This article provides a good example of testing for industry effects on companies, although companies are aggregated by industry type.
2. Murray B. Low and Ian C. MacMillan, “Entrepreneurship: Past Research and Future Challenges,” Journal of Management, 14, no. 2 (1988), pp. 139-61. Low and MacMillan identify these four directions.
3. Richard Barkham, Graham Gudgin, Mark Hart and Eric Hanvey, The Determinants of Small Firm Growth: An Inter-Regional Study in the United Kingdom 1986-90, Regional Policy and Development Series 12 (London, England: Jessica Kingsley Publishers and Regional Studies Association, 1996), p. 47. In Barkham’s study, strategy aims and methods explain 28% of sales growth variation, compared with 14% explained by company characteristics and only 5% explained by entrepreneur characteristics. As a group, variables together explain 46% of the variation in sales growth. In William R. Sandberg and Charles W. Hofer, “Improving New Venture Performance: The Role of Strategy, Industry Structure, and the Entrepreneur,” Journal of Business Venturing, 2 (1987), pp.5-28, Sandberg and Hofer predict profitability, rather than sales growth. They find several statistically significant interactions among these three sets of variables, concluding that interactive effects have a far greater effect than any of these variables alone.
4. Robert M. Grant, Contemporary Strategic Analysis: Concepts, Techniques, Applications (Cambridge, MA: Blackwell Publishers, 1995). For a history of the field of Strategic Management, Refer to Chapter 1: The Concept of Strategy for discussion of the evolution of Strategic Management.
5. For his classic presentation of generic competitive strategies, refer to Michael Porter, Competitive Strategies (New York, NY: The Free Press, 1980), pp. 34-46.
6. C.K. Prahalad and Gary Hamel, “The Core Competence of the Corporation,” Harvard Business Review 68, no. 3 (1990), 79-91. See also, Gary Hamel and C.K. Prahalad, Competing for the Future (Boston, MA: Harvard Business School Press, 1994).
7. Dave Ulrich and Dale Lake, “Organizational Capability: Creating Competitive Advantage,” Academy of Management Executive, 5, no. 1 (1991) pp. 77-92.
8. Jeffrey Pfeffer, Competitive Advantage Through People: Unleashing the Power of the Work Force (Boston, MA: Harvard Business School Press, 1994), pp. 6-26.
9. See “Chapter 2: Strategic Management, and Organizational Effectiveness” and “Chapter 14: Toward the Learning Organization,” in Richard L. Daft, Organization Theory and Design, 5thed. (Minneapolis/St. Paul: MN: West Publishing Co., 1995); For comparison, see Richard L. Daft, Organization Theory and Design, 4th ed. (Minneapolis/St. Paul, MN: West Publishing Co., 1992).
10. Open-systems theory applications to organizations can be traced to two streams of applications in the early 1960s—a “subsystems” approach defined by Daniel Katz and Robert L. Kahn, The Social Psychology of Organizations, 1st ed. (New York: John Wiley & Sons, 1966) and an organization problem-solving model developed by Basil Georgopoulos and colleagues See Basil Georgopoulos and F. C. Mann, The Community General Hospital (New York: Macmillan, 1962); and for more recent discussion and research application, see Basil S. Georgopoulos, Organization Structure, Problem Solving and Effectiveness: A Comparative Study of Hospital Services (San Francisco: Jossey-Bass, 1986). For a more detailed presentation of our perspective, see Chapter 4 and also Lorraine U. Hendrickson, “Bridging the Gap between Organization Theory and the Practice of Managing Growth: The Dynamic System Planning Model,” Journal of Organizational Change Management, 5, no. 3 (1992), pp. 18-37.
11. Peter Senge, The Fifth Discipline: The Art and Practice of the Learning Organization (New York, NY: Doubleday/Currency, 1990).
12. Ron Ashkenas, David Ulrich, Todd Jick, and Steven Kerr, The Boundaryless Organization: Breaking the Chains of Organizational Structure (San Francisco: Jossey-Bass Publishers, 1995); James F. Moore, The Death of Competition: Leadership and Strategy in the Age of Business Ecosystems (New York: HarperCollins Publishers, 1996).
13. Margaret J. Wheatley and Myron Kellner-Rogers, A Simpler Way (San Francisco, CA: Berrett-Koehler Publishers, 1996).
14. Jeffrey Goldstein, The Unshackled Organization: Facing the Challenge of Unpredictability Through Spontaneous Reorganization (Portland, OR: Productivity Press, 1994).
The research was conducted by Dr. Lorraine Uhlaner with guidance from Dr. John Psarouthakis in the College of Business, Eastern Michigan University. An outcome of the research was the book “Dynamic Management of Growing Firms”, by Lorraine (Hendrickson) Uhlaner and John Psarouthakis, published by the University of Michigan Press in 1998. Upon reviewing recent literature, John Psarouthakis, given his experience in entrepreneurial management on how such companies are managed he thought it useful also to make the research results and analysis available through this magazine after we concluded that the management model described is still valid.
Lorraine Uhlaner is Professor of Entrepreneurship at EDHEC Business School, France and
Visiting Professor of Entrepreneurship at Nyenrode Business University, The Netherlands
She was a member of the faculty at the College of Business, EMU prior to her engagements above.
An academic researcher and teacher. In research, Prof. Uhlaner currently focuses on ownership and governance issues in the privately-held firm, especially responsibilities of ownership in firms with multiple ownership. Extensive research on SMEs as well as larger family-owned firms.
Extensive teaching experience in entrepreneurship, family business and organization behavior. She specializes in Family governance, responsibilities of ownership, knowledge management and structure in SMEs, Business transfer in the privately held firm.
Prof. Uhlaner received her PhD in Organization Psychology from the University of Michigan.
Her prior studies were at Harvard University, and at the University of Leiden, The Netherlands.