Relatedness and coherence: a theoretical framework

2. Relatedness and coherence: a theoretical framework

The theoretical and empirical literature has extensively investigated firms’ growth through diversification. The most recent studies observe that the world’s largest firms are not just multi-product, but typically and increasingly multi-technology too Oskarsson, 1993; Patel and Pavitt, 1994; von Tunzelmann, 1995; Granstrand et al., 1997. In both these contexts, a central issue is what determines the direction of firm diversification, and in particular whether they diversify into related or unrelated lines of business Teece, 1982. Nonetheless, much of the discussion on relatedness and coherence has been so far applied to the level of products, and to the possibility of expanding product ranges whilst maintaining coherence Dosi, 1982, 1988; Dosi et al., 1992; Teece et al., 1994. That a fundamental part of any firm’s corporate strategy is its choice of what portfolio of businesses to compete in, and that related diversification in product terms outperforms unrelated diversification Wernerfelt, 1984; Barney, 1991; Markides and Williamson, 1994; Robins and Wiersema, 1995, are well-established propositions. However, there is still disagreement about what the concept of relatedness does precisely include. According to Edith Penrose’s theory of diversified growth Penrose, 1959, unused productive services are a selective force in determining the direction of expansion. Excess resources are most often employed in similar settings, i.e. firms prefer to enter industries where the resource characteristics — the level of capital intensity, the level of sales intensity, the level of RD intensity — are similar to their own resource profiles. More specifically, firms seem to choose to enter industries that are close to their existing line of business, since the enterprise’s firm-specific resources help drive its diversification strategy. However, Penrose herself recently argued that ‘there is no reason why a firm should see its prospects of growth, its productive opportunities, in terms of its existing products only; there are many reasons why it should see them in terms of its productive resources and its knowledge, and should search for opportunities of using them more efficiently’ Penrose, 1995. Other studies, characterising corporations by boundaries which relate to their shared firm-specific assets Winter, 1987 and their multi-product scope Teece, 1982, have shown that firms do not diversify in a random way e.g. Teece et al., 1994. Nevertheless, despite the noteworthy amount of theoretical studies, the empirical measures of relatedness and coherence hitherto suggested provide only a partial picture of the scope of the firm to exploit interrelationships between sectors and technologies. The focus is predominantly on industry- and technology-specific characteristics of sectors Markides and Williamson, 1994. Pairs of sectors can be thought of as similar: 1. if they are vertically related or integrated; 2. if they have technology-based inter-sectoral linkages or technological spillovers; 3. if they serve similar types of markets. In other words, relatedness is considered as a concept exclusively associated with the inherent properties of the sectors. As such, firms can know a priori and exploit them in order to develop and maintain competitive advantages over their rivals. More recently, a wider concept of relatedness which also embodies firm-specific aspects capabilities and technological competencies has been suggested Dosi et al., 1992, 2000; Teece et al., 1994. It is based on the idea that a firm does not know what is related until trying it out. Relatedness and coherence are essentially cognitive and firm-specific concepts. Coherence is the result of a trial-and-error process, and what may be related diversification and coherent organisation for one firm, may not be so for another firm. The firm becomes an experimental device for selection: by exploring new combinations of capabilities, the firm incrementally and cumulatively learns which capabilities are related, and collects these together within its organisation as a coherent whole Cantwell, 1998. Consequently, coherence could then be seen in a dynamic context as the firm’s capacity to exploit and explore complementarities between a diversity of stocks of dispersed knowledge and localised learning processes Foss and Christensen, 1996. In this context, the present paper argues that: 1. the concept of relatedness amongst sectors must include all the dimensions separately suggested by the previous literature, as well as an additional firm-spe- cific dimension; and 2. the notion of coherence, as discussed with reference to product diversification, is applicable in the case of technological diversification too. Indeed, as in the case of product diversification where ‘coherence is exhibited when a firm’s lines of business are related in that there are certain technological and market character- istics common to each’ Teece et al., 1994, one would expect technological coherence to be exhibited when certain underlying scientific or engineering knowledge is common to each relevant technological area e.g. Breschi et al., 1998. Other authors e.g. Scott, 1993 have recently argued that the diversification of RD within the firm is not random, that is the firm diversifies its RD effort purposively to gain advantage of better appropriability, or because of cost advan- tages of common facilities or complementarities in the process of research across multiple industries 1 . Moreover, identifying and integrating competencies essential for the corporation almost inevitably requires investment in in-house learning and 1 It is worth observing that the coherence of the technology base has been recently associated with the degree of co-ordination and interrelatedness within the technology base as between the different technological and innovative capabilities Christensen, 1998a. Christensen 1998b highlights three dimension of coherence: i external coherence, which reflects the degree to which competencies constituting the technology base match the requirements of the competition; ii contextual coherence, which reflects correspondence between the technology base and the broader firm or corporate context the complementary assets, the operational and infrastructural firm context, the company’s strategy and culture; iii local coherence, which signifies the degree to which there are interdependencies and synergies between different parts of the technology base. patient experimentation, with the expectation of finding winning combinations of technologies, as where the technological relatedness lies may be unclear a priori 2 Granstrand et al., 1997.

3. The data