Foundations of the Knowledge-based theory of the firm

The foundation for any theory of the firm is a set of initial premises which form the basis for the logical development of propositions concerning the structure, behavior, performance and, indeed, the very existence of firms. Developing a knowledge-based theory of the firm raises the issue: What is knowledge? Since this question has intrigued some of the world’s greatest thinkers from Plato to Popper without the emergence of a clear consensus, this is not an arena in which I choose to compete. In terms of defining knowledge, all I offer beyond the simple tautology of ‘that which is known’ is the recognition that there are many types of knowledge relevant to the firm.1 For the purposes of developing a theory of the firm, my primary task is to establish those characteristics of knowledge which have critical implications for management. The literature on the analysis and management of knowledge points to the following characteristics as pertinent to the utilization of knowledge within the firm to create value.2

1. Transferability

The resource-based view of the firm recognizes the transferability of a firm’s resources and capabilities as a critical determinant of their capacity to confer sustainable competitive advantage (Barney, 1986). With regard to knowledge, the issue of transferability is important, not only between firms, but even more critically, within the firm. The management literature has clearly recognized the epistemological distinction between knowing how and knowing about which is captured by distinctions between subjective vs. objective knowledge, implicit or tacit vs. explicit knowledge, personal vs. prepositional knowledge, and procedural vs. declarative knowledge. My purpose here is not to make fine distinctions between different types of knowledge. I identify knowing how with tacit knowledge, and knowing about facts and theories with explicit knowledge. The critical distinction between the two lies in transferability and the mechanisms for transfer across individuals, across space, and across time. Explicit knowledge is revealed by its communi- cation. This ease of communication is its fundamental property. Indeed information has traditionally been viewed by economists as being a public good—once created it can be consumed by additional users at close to zero marginal cost. Tacit knowledge is revealed through its application. If tacit knowledge cannot be codified and can only be observed through its application and acquired through practice, its transfer between people is slow, costly, and uncertain (Kogut and Zander, 1992).

2. Capacity for aggregation

The efficiency with which knowledge can be transferred depends, in part, upon knowledge’s potential for aggregation. Knowledge transfer involves both transmission and receipt. Knowledge receipt has been analyzed in terms of the absorptive capacity of the recipient (Cohen and Levinthal, 1990). At both individual and organizational levels, knowledge absorption depends upon the recipient’s ability to add new knowledge to existing knowledge. This requires additivity between different elements of knowledge.

Efficiency of knowledge aggregation is greatly enhanced when knowledge can be expressed in terms of common language. Statistics is a particularly useful language for aggregating (and transferring) certain types of explicit knowledge—its efficiency in this role is greatly enhanced through advances in information technology. Thus, information on Ford Motor Com- pany’s cash balances, its foreign currency exposure, its inventories of spark plugs and crankshafts is readily transferred from multiple locations within the company and aggregated at a single location. Conversely information about the capabilities of Ford managers, or the quirks of individual machine tools, is idiosyncratic knowledge which cannot be aggregated at a single location. Hayek (1945: 521) refers to this as ‘knowledge of the particular circumstances of time and place,’ and Jensen and Meckling (1992) as ‘specific knowledge.’ As these authors have shown, and as we shall explore later in the paper, the ability to transfer and aggregate knowledge is a key determinant of the optimal location of decision-making authority within the firm.

3. Appropriability

Appropriability refers to the ability of the owner of a resource to receive a return equal to the value created by that resource (Teece, 1987; Levin et al., 1987). Knowledge is a resource which is subject to uniquely complex problems of appropriability. Tacit knowledge is not directly appropriable because it cannot be directly transferred: it can be appropriated only through its application to productive activity. Explicit knowledge suffers from two key problems of appropriability: first, as a public or nonrivalrous good, any one who acquires it can resell without losing it (Arrow, 1984); second, the mere act of marketing knowledge makes it available to potential buyers (Arrow, 1971: 152). Thus, except for patents and copyrights where knowledge owners are protected by legally established property rights, knowledge is generally inappropriable by means of market transactions. Lack of clear property rights results in ambiguity over the ownership of knowledge. While most explicit knowledge and all tacit knowledge is stored within individuals, much of this knowledge is created within the firm and is firm specific. This creates difficulties over the allocation of the returns to knowledge and achiev- ing optimal investment in new knowledge (Rosen, 1991).

4. Specialization in knowledge acquisition

Fundamental to Simon’s principle of bounded rationality is recognition that the human brain has limited capacity to acquire, store and process knowledge. The result is that efficiency in knowledge production (by which I mean the creation of new knowledge, the acquisition of existing knowledge, and storage of knowledge) requires that individuals specialize in particular areas of knowledge. This implies that experts are (almost) invariably specialists, while jacks-of-all-trades are masters-of-none.

5. The knowledge requirements of production

Production involves the transformation of inputs into outputs. Fundamental to a knowledge-based theory of the firm is the assumption that the critical input in production and primary source of value is knowledge. Indeed, if we were to resurrect a single-factor theory of value in the tradition of the classical economists’ labor theory of value or the French Physiocrats land- based theory of value, then the only defensible approach would be a knowledge-based theory of value, on the grounds that all human productivity is knowledge dependent, and machines are simply embodiments of knowledge.

Source: Grant Robert M. (1996), “Toward a Knowledge-Based Theory of the Firm”, Strategic Management Journal,

Vol. 17, Special Issue: Knowledge and the Firm (Winter, 1996), pp. 109-122.

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