A Knowledge-based Theory of the FirmThe Problem-solving Perspective

Group-VII Abhinav Jha Anu Anupam Ram Kumar Umesh Kumar

Introduction
y Existing Literature:
y Boundaries of the firm encompass valuable competencies and core

knowledge y Organize to efficiently generate knowledge and capabilities y Knowledge: Input-output combinations achievable with all possible mixes and levels of activities known to the firm
y Problems:
y Lack of focus upon producing knowledge or capabilities in an efficient

manner. y Contradictory view on why hierarchies exist: to avoid knowledge transfers OR to facilitate knowledge transfers y Yet to provide a theory of alignment: When hierarchies are to be preferred to markets, or vice-versa

Proposed Knowledge-Based Theory

y Assumptions:
y Managers knowledge-based objective is to create valuable new

knowledge y Solutions to complex problems represent unique combinations or syntheses of existing knowledge
y Unit of Analysis: The problem and the profitable formation of new

knowledge y Proposed Mechanism:

y A manager chooses a problem, to which the firm seeks a solution and

in the process creates valuable new knowledge y Initial choice of the problem takes into account the cost of solution search, the presence of a high-value solution, and the ability of the firm to appropriate value from the discovery of such a solution.

y Modeling the problems:

y Problems are assumed to be complex (made up of large number of y y y y

parts interacting in a non-simple way) Complexity is modeled using NK modeling N: Number of parts K: Degree of interaction among the parts (ranges from 0 to 1) They combine to represent a range of landscapes from rugged (involving high degree of interaction) to smooth (involving low degree of interaction)

y Model for Solution Space:

y We have a solution landscape y The topology of such a landscape depends upon the value associated

with each combination of relevant existing knowledge, i.e. each solution y Peaks on solution landscapes represent valuable solutions, while valleys represent low-value solutions.

Types of Problems:
y Three categories proposed:
y Low Interaction/Decomposable Problems: Where the various

parts dont interact too much with each other, i.e. the value of K is low. The problem can be broken down into sub-parts and each sub-part can be individually solved to arrive at a solution y High Interaction Problems: The value of K is high resulting in a rugged solution landscape, where the global maximum is high, but the average height of the peaks is lower. The solution has to be looked for in a holistic manner. y Moderate Interaction Problems: They are nearly decomposable, i.e. they can be broken into sub-problems such that interactions among knowledge sets within sub-problems is much greater than between sub-problems.

Types of Solution Search Mechanisms

y Solutions to a problem may be arrived at in three ways:
y Random Trials: Almost useless in arriving at a valuable solution

to a complex problems y Directional/Local Search: A search guided solely by feedback or experience from prior trials. Well suited to low interaction problems, as trials are conducted by changing one design element at a time. y Heuristic/Cognitive Search: A search mechanism where individuals cognitively evaluate the probable consequences of design choices rather than relying solely on prior feedback. Well suited to high-interaction problems.

Relative Benefit of Trial Ordering and Selection by Problem Type

Hazards in Knowledge Formation

y Knowledge Appropriation
y The value of Knowledge can only be determined once it is

revealed at which point the acquirer doesnt need to pay for it anymore. Hence we require a strong set of property laws to ensure knowledge is revealed to the mutual benefit of all.
y Strategic Knowledge Accumulation
y Actors have incentives to strategically influence the pattern of

trials in a way that enhances their specialized knowledge or complements knowledge they already possess. This enhances their value within the organization and enables them to appropriate a greater share of the value of the solution.
y Hence the requirement for governance mechanisms

Comparative Analysis of Alternative Governance Mechanisms

Markets:
y Markets dispense with the need of conscious control y According to Hayek, markets provide inducements which make

y y y

y y

the individuals do the desirable things without anyone having to tell them what to do Individual participants need to know little about other actors Markets also offer powerful incentives for individual actors to make optimal use of their knowledge In markets, prices provide incentives and motivation to actors to search for the solutions that enhance their specialized knowledge or sale of products and services based on the knowledge Markets are suited to governing directional search Markets avoid knowledge exchange hazards by severely restricting knowledge exchange

Markets:
y Limitations:
y Markets discourage knowledge sharing and instead promote knowledge y y y y

hoarding Provide little protection against knowledge appropriation Provide no clear disincentives against strategic manipulation of search heuristics Provide weak incentives to invest in the formation of common language required for knowledge sharing and heuristic search Provide cumbersome and costly mechanism for searching complex solution landscapes

y Inferences:
y Markets are poorly suited to governing the process of solution search for

complex and non-decomposable problem y Necessary knowledge sharing is undermined because of appropriate incentive and the absence of shared language y Markets are efficient in finding directional search for solutions to decomposable problems y Markets fail in solving more complex problems and demand heuristic search

Authority-based hierarchy:
y In ABH centralization of decision making takes palce y Key figure A central figure who invests in understanding

critical knowledge interactions and composes suitable heuristics to guide search

y Advantages:
y Transfer of knowledge takes place y Economizes on the extensive and costly knowledge sharing and

education y Resolves knowledge based exchange hazards that arises in markets when problems are complex more efficiently y Supports heuristic search

Authority-based hierarchy:
y Limitations:
y Does not promote horizontal communication channels that would

support broad knowledge sharing among peers y Limited capacity, incentive and motivation to individuals actors to strategically manipulate the path of search y Authority does not imply expertise y When authority is exercised in the absence of knowledge search is contaminated rather than accelerated
y Inferences:
y ABH is superior to markets in heuristic search while inferior in

directional search due to incentive damage y More costly than markets due to costs of paying and supporting the central authority y The effectiveness of ABH relative to market-based control diminishes rapidly as problems become more disposable

Consensus-based hierarchy
y This form of hierarchy achieves extensive knowledge transfer

y y y

by enhancing the efficiency with which knowledge transfer occurs among actors within the boundaries of the firm. Extensive information sharing potentially permits actors within the firm to collectively agree on a path of search that is consensus reflection of the specialized knowledge sets housed within the firm. It is a potential solution to the failure of authority in governing heuristic search as problem increase in complexity. Each agent within the firm perceives the correct decision based on his/her knowledge and interests. Since interests and knowledge are commonly shared, consensus is spontaneous.

Consensus-based hierarchy (cont)

y Very low powered incentives are essential to consensus, because y y y

such incentives encourage knowledge sharing. Dispute resolution involves individual actors collectively deciding the path. Consensus fails in comparison to authority as problems diminish in complexity. The organizational cost of generating consensus are high. Hence, consensus based hierarchy should only be adopted when the benefits of consumers are high. Example: Sometimes for diagnosing and curing a complex disease, a panel consisting of 3-4 doctors is set-up. Thus the treatment of the patient is decided in a consensus based process.

Discriminating Alignment

y y y

Markets- High cost and low degree of knowledge set interaction ABH- Authority Based Hierarchy CBH- Consensus Based Hierarchy

Discriminating Alignment Between Governance Alternatives and Problem Complexity

Thanks