Review: “Knowledge of the Firm, Combinative Capabilities, and the Replication of Technology” – by Kogut and Zander (1992))

This review focuses on summarizing the main contents of the article published by Kogut and Zander in 1992 on the Organization Science. In the literature, this article is considered as fundamental one for the knowledge-based view – a branch of Resource-Based Theory of the Firm approach, that explains why firms exist and differ in performance in knowledge-based view.

Firstly, Kogut and Zander define organizations as “[…] social communities in which individual and social expertise is transformed into economically useful products and services by the application of a set of higher-order organizing principles” (p.384). What is central to this argument is that knowledge is held by individuals, but is also expressed in regularities by which members cooperate in a social community (i.e., group, organization, or network)” (p.383). As a fundamental puzzle of Michael Polanyi (1966) “is that individuals appear to know more than they can explain”; according to Kogut and Zander, “organizations know more than what their contracts can say” (p.383).

In knowledge-based view, Kogut and Zander state that: “Firms exist because they provide a social community of voluntaristic action structured by organizing principles that are not reduceable to individuals” (p.384). “What firms do better than markets is the sharing and transfer of the knowledge of individuals and groups within an organization” (p.383). And “Firms differ in their information and know-how and these differences, when they are economically interesting, have persisting effects on relative performance. Thus, a central characteristic to be explained is the persisting difference in capabilities, that is, the difficulty in their transfer and imitation. The persistence of differentials in firm performance lies in the joint problem of the difficulty of transferring and imitating knowledge” (p.387).

Information and Know-How

As the core contents of the article, Kogut and Zander develop a model of growth of knowledge of the firm, in which they categorize organizational knowledge into information and know-how; that are the basis of the growth of knowledge of the firm.

So, We begin by analyzing the knowledge of the firm by distinguishing between information regarding prices and the know-how, say, to divisionalize. “By information, [they] mean knowledge which can be transmitted without loss of integrity once the syntactical rules required for deciphering it are known. Information includes facts, axiomatic propositions, and symbols” (p.386). “Know-how is the accumulated practical skill or expertise that allows one to do something smoothly and efficiently” (von Hippel 1988). “Knowledge as information implies knowing what something means. Know-how is, as the compound words state, a description of knowing how to do something” (p.386). “The information is contained in the original listing of ingredients, but the know-how is only imperfectly represented in the description” (p.386-387).

Figure 1: Growth of Knowledge of the Firm

Source: Kogut and Zander (1992, p.385)

This distinction of information and know-how corresponds closely to that used in artificial intelligence of declarative and procedural knowledge. “Declarative knowledge consists of a statement that provides a state description, such as the information that inventory is equal to 100 books. Procedural knowledge consists of statements that describe a process, such as a method by which inventory is minimized”. “Know-how, like procedural knowledge, is a description of what defines current practice inside a firm. These practices may consist of how to organize factories, set transfer prices, or establish divisional and functional lines of authority and account-ability”. “The know-how is the understanding of how to organize a firm along these formal (and informal) lines. It is in the regularity of the structuring of work and of the interactions of employees conforming to explicit or implicit recipes, that one finds the content of the firm’s know-how” (p.387).

The Inertness of Knowledge

There is a need to go beyond the classification of information and know-how, and consider why knowledge is not easily transmitted and replicated. The transferability and imitability of a firm’s knowledge, whether it is in the form of information or know-how, are influenced by several characteristics.

“Consider the two dimensions of codifiability and complexity [of knowledge]. Codifiability refers to the ability of the firm to structure knowledge into a set of identifiable rules and relationships that can be easily communicated. Coded knowledge is alienable from the individual who wrote the code. Not all kinds of knowledge are amenable to codification” (p.387). Complexity, from a computer science perspective, “can be defined as the number of operations (or CPU time) required to solve a task” (p.388).

“Codifiability and complexity are related, though not identical. […] It is obvious that the number of parameters required to define […] a production system is dependent upon the choice of mathematical approaches or programming languages. For a particular code, the costs of transferring a technology will vary with its complexity. A change of code changes the degree of complexity” (p.388).

So, “it is important to underline the presumption that the knowledge of the firm must be understood as socially constructed, or, more simply stated, as resting in the organizing of human resources” (p.385). And, “the capabilities of the firm […] are argued to rest in the organizing principles by which relationships among individuals, within and between groups, and among organizations are structured” (p.384). “The issue of the organizing principles underlying the creation, replication, and imitation of technology opens a window on understanding the capabilities of the firm as a set of “inert” resources that are difficult to imitate and redeploy” (p.385).

Combinative Capabilities of the firm

In reality, “firms invest in new knowledge that correspond to a combination of current capabilities and expectations regarding future opportunities. Or, in other words, the knowledge of a firm can be considered as owning a portfolio of options, or platforms, on future developments” (p.385).

Bur how does firm learn and develop their organizational knowledge? For explaining this phenomenon, Kogut and Zander introduce the concept of combinative capability, that means “the intersection of the capability of the firm to exploit its knowledge and the unexplored potential of the technology” (p.391). They develop a dynamic perspective by suggesting that: “Creating new knowledge does not occur in abstraction from current abilities. Rather, new learning, such as innovations, are products of a firm’s combinative capabilities to generate new applications from existing knowledge” (p.391). In other words, firms learn new skills by recombining their current capabilities. “Knowledge advances by re-combinations, because a firm’s capabilities cannot be separated from how it is currently organized” (p.392). As Schumpeter (1968) argued that, in general, innovations are new combinations of existing knowledge and incremental learning. He writes: “to produce other things, or the same things by a different method, means to combine these materials and forces differently… Development in our sense is then defined by the carrying out of new combinations” (Schumpeter 1934, pp. 65-66).

“As widely recognized, firms learn in areas closely related to their existing practice. As the firm moves away from its knowledge base, its probability of success converges to that for a start-up operation” (p.392). “The abstract explanation for this claim is that the growth of knowledge is experiential, that is, it is the product of localized search as guided by a stable set of heuristics, or, in our terminology, know-how and information (Cyert and March 1963, Nelson and Winter 1982). It is this local search that generates a condition commonly called “path dependence,” that is, the tendency for what a firm is currently doing to persist in the future” (p.392). Because new ways of cooperating cannot be easily acquired, growth occurs by building on the social relationships that currently exist in a firm. What a firm has done before tends to predict what it can do in the future” (p.383).

So, the firm serves more than mechanisms by which initial social knowledge is transferred, but also by which new knowledge, or learning, is created through its “combinative capability” (p.384). This combinative capability is grounded “as localized learning to path dependence by developing a micro-behavioral foundation of social knowledge, while also stipulating the effects of the degree of environmental selection on the evolution of this knowledge” (p.384).

Transformation of Personal to Social Knowledge

“If knowledge is only held at the individual level, then firms could change simply by employee turnover. Because we know that hiring new workers is not equivalent to changing the skills of a firm, an analysis of what firms can do must understand knowledge as embedded in the organizing principles by which people cooperate within organizations” (p.383).

The following Figure 2 discusses the distinction between the knowledge of an individual and that of the organization; and the transformation of personal to social knowledge.

Figure 2: Transformation of Personal to Social Knowledge

Source: Kogut and Zander (1992, p.388)

“Nelson and Winter (1982) have provided an important contribution by separating skills from routines. Individuals can be skilled in certain activities, such as driving a car or playing tennis. These skills may indeed be difficult to pass on” (p.388). “It is, in fact, the problem of communicating personal skills that underlies Polanyi’s (1966) well-known idea of tacit knowledge, an idea similar to the dimensions of non-codifiable and complex knowledge. As noted earlier, to Polanyi, the central puzzle is the following: why do individuals know more than they can express” (p.389).

“The teaching of know-how and information requires frequently, interaction within small groups, often through the development of a unique language or code. Part of the knowledge of a group is simply knowing the information who knows what. But it also consists of how activities are to be organized, e.g., by Taylorist principles”.

“It is the sharing of a common stock of knowledge, both technical and organizational, that facilitates the transfer of knowledge within groups”. “By shared coding schemes, personal knowledge can be transmitted effectively within close-knit groups (Katz and Kahn 1966). Personal knowledge can be transmitted because a set of values are learned, permitting a shared language by which to communicate (Berger and Luckman 1967). It is this language which provides a normative sanction of how activities are to be organized, or what information is to be collected and evaluated” (p.389).

“But whereas the accumulation of small group interactions facilitate the creation of shared coding schemes within functions, a fundamental problem arises in the shifting of technologies from research groups to manufacturing and marketing. At this point, the identification with a professional orientation conflicts with the need to integrate within the organization. The problems of different professional languages are attenuated when technology transfer is horizontal […]. To facilitate this communication, certain individuals play pivotal roles as boundary spanners, both within the firm as well as between firms (Allen and Cohen 1969; Tushman 1977)” (p.398).

“The vertical transfer of technology, as when a product is moved from development to production, poses additional problems insofar that the shared codes of functional groups differ. To facilitate this transfer, a set of higher-order organizing principles act as mechanisms by which to codify technologies into a language accessible to a wider circle of individuals. These principles establish how the innovation is transferred to other groups, the responsibility of engineers to respond to complaints, and the allocation of incentives to establish authority over decisions. These organizing principles, which we call higher-order as they facilitate the integration of the entire organization, are also supported by data regarding profitability, costs, or task responsibility (as represented in an organizational chart)” (p.398-399).

“Complex organizations exist as communities within which varieties of functional expertise can be communicated and combined by a common language and organizing principles. To the extent that close integration within a supplier or buyer network is required, long-term relationships embed future transactions within a learned and shared code”. “In this wider perspective, a firm’s knowledge consists also of the information of other actors in the network, as well as the procedures by which resources are gained and transactions and cooperation are conducted” (p.398).

The Paradox of Replication

“For a firm to grow, it must develop organizing principles and a widely-held and shared code by which to orchestrate large numbers of people and, potentially, varied functions”. “The speed of replication of knowledge determines the rate of growth; control over its diffusion deters competitive erosion of the market position” (p.390).

And “there is an important implication for the growth of the firm in the transformation of technical knowledge into a code understood by a wide set of users”. “Because personal and small group knowledge is expensive to re-create, firms may desire to codify and simplify such knowledge as to be accessible to the wider organization, as well as to external users” (p.390).

“The problems of the growth of the firm are directly related to the issues of technology transfer and imitation. Once organizing principles replace individual skills of the entrepreneur, they serve as organizational instructions for future growth. Technology transfer is, from this perspective, the replication of existing activities. The goal of the firm is to reduce the costs of this transfer while preserving the quality and value of the technology” (p.390). “Whereas the advantages of reducing the costs of intra- or inter-firm technology transfer encourage codification of knowledge, such codification runs the risk of encouraging imitation. It is in this paradox that the firm faces a fundamental dilemma” (p.390).

“Imitation differs from technology transfer in a fundamental sense. Whereas technology transfer is concerned with adapting the technology to the least capable user, the threat of imitation is posed by the most capable competitors” (p.393). On the market, when the entry-deterring benefits (such as these ones of reputation among consumers, patent protection, or the exercise of monopoly restrictions) are absent, competition switches from traditional elements of market structure to the comparative capabilities of firms to replicate and generate new knowledge. “The nature of this competition is frequently characterized as a race between an innovator and the ability of the imitating firm either to reverse engineer and to decode the substantive technology. The growth of the firm is determined by a combination of the speed of technology transfer and of the imitative efforts of rivals” (p.393).

Selection Environment

Up to now, Kogut and Zander have explained the role of organizing principles to facilitate the transfer of technology and ideas within the organization of the firm. The distinction between the ability to produce a product and the capability to generate is fundamental to broadening the perspective to the competitive conditions of imitation.

“Short-term competitive pressures can […] draw from the investments required to build new capabilities. The direct effect of selection is on the acceptance and rejection of new products, but indirectly it is operating to reward or to penalize the economic merits of the underlying stock of knowledge. Knowledge, no matter how resistant to imitation, is of little value if it results in products that do not correspond competitively to consumers’ wants. Selection on product types acts to develop and retard the capabilities of firms” (p.393).

“The ability to indulge in a forward-looking development of knowledge is strongly contingent on the selection environment. Long-term survival involves a complex tradeoff between current profitability and investing in future capability. Future capabilities are of little value if the firm does not survive” (p.393). So, “an important question […] is the critical balancing between short-term survival and the long-term development of capabilities. A too strong reliance on current profitability can deflect from the wider development of capabilities (Stiglitz 1987)” (p.393). Also, “a too rigid competitive environment, especially in the early years of a firm’s development, may impede subsequent performance by retarding a firm’s ability to invest in new learning” (p.394). “By their ability to buffer internal ventures from an immediate market test, organizations have the possibility to create new capabilities by a process of trial-and-error learning” (p.393).

The Make Decision and Firm Capabilities

The merits of the above argument can be better evaluated by considering an example. An interesting application is the make-buy question, that is, whether a firm should source a component from the outside or make it internally.

“In fact, the costliness of [technology] transfer has often been reconstrued as market failure (Teece 1980). Because a buyer cannot ascertain its value by observation, technology cannot be priced out. Thus, markets fail for the selling of technology since it is costly to transact” (p.394).

“The problem of this market failure argument is not only that markets for technology do exist, but also that it is over-determined”. “Opportunism is not a necessary condition to explain why technology is transferred within a firm instead of the market. Rather, the issue becomes why and when are the costs of transfer of technology lower inside the firm than alternatives in the market, independent of contractual hazards” (p.394). Here, in fact, the firm do better than markets in sharing and transferring the technology, or in general, the knowledge of individuals and groups within the firm. The relevant market comparison, in this sense, are the efficiencies of other firms.

“While the boundaries of the firm are, unquestionably, influenced by transactional dilemmas, the question of capabilities points the analysis to understanding why organizations differ in their performance. The decision which capabilities to maintain and develop is influenced by the current knowledge of the firm and the expectation of the economic gain from exploring the opportunities in new technologies and organizing principles as platforms into future market developments. We propose that firms maintain those capabilities in-house that are expected to lead to recombinations of economic value” (p.394-395).

“The evaluation of this economic gain rests critically upon a firm’s ability to create and transfer technology more quickly than it is imitated in the market. Many investment decisions inside a firm do not include a make-buy calculation, for the presumption is that the new assets are extensions, or combinations, of the existing knowledge base” (p.395).

“The decision to make or buy is, thus, dependent upon three elements: how good a firm is currently at doing something, how good it is at learning specific capabilities, and the value of these capabilities as platforms into new markets”. “Similar propositions could be made in reference to other applications, such as acquisitions, the composition of a technology portfolio, and the sequence by which a firm invests in a foreign market” (p.395).

Conclusion

In this article, Kogut and Zander adopted “the view that firms are a repository of capabilities, as determined by the social knowledge embedded in enduring individual relationships structured by organizing principles. Switching to new capabilities is difficult, as neither the knowledge embedded in the current relationships and principles is well understood, nor the social fabric required to support the new learning known. It is the stability of these relationships that generates the characteristics of inertia in a firm’s capabilities” (p.396).

Source: Kogut Bruce, Zander Udo (1992), “Knowledge of the Firm, Combinative Capabilities, and the Replication of Technology”, Organization Science, Vol. 3, No. 3, Pages 301-441. https://doi.org/10.1287/orsc.3.3.383