Theory of the firm: theortical perspectives from an innovation point of view

Journal of the Academy of Business and Economics, Jan, 2004 by Joseph B. Richards, Seung Bai Bach

ABSTRACT

This paper explores the nature of a firm from an innovation perspective. An organization may be thought of as a collection of networked resources. Developments in information technology enable increased interactions between these resources for information and knowledge generation. Because of these increased interactions, the value of each resource is likely enhanced. The possibility of generating new knowledge and information resources as a result of these interactions would affect the structure which organizations adopt to manage environmental uncertainty and to effect innovation. The basic question we explore is whether the need for innovation is the fundamental reason for firms coming into existence in this era of information economy.

1. INTRODUCTION

Many of the phenomena that we observe in economic and social organizational behavior might be well understood if we take into account that the actors involved have limited capability to understand fully the cause and effect of the phenomena. The behavior of the actors under this "limited rationality" would sensitize organizational behavior with respect to changes in actors' information processing capacity. This limitation in the information processing capability of human actors has been thought as the basis of the existence, structure, and functioning of economic organizations such as firms (e.g. Simon 1973). Literature in organization performance and behavior are closely linked to the view that an organization can be considered as an information processing system (Simon, 1973; Galbraith 1977; Tushman and Nadler, 1978).

This paper will focus on the effect of the advances in information technology on organizational resources and on the structure an organization adopts to facilitate a continuous process of innovation. We argue that organizational capabilities with respect to information processing and decision making are enhanced by information technology advances. The behavior of each member in an organization is likely to be influenced more by others because of the increased possibility of interactions for information and knowledge sharing. The increased capability of the members for interactions has implications on the evolution of structures which an organization adopts to manage environmental uncertainty and innovation.

Schumpeter's idea of innovation is essentially "carrying out new combinations" and in this respect, innovation is a broad concept (1934). The importance of firm's resources in carrying out these new combinations was pointed to by Penrose (1959). Her main point was that different combinations of existing resources and their deployments are ultimate issues of organization. The rapid advance of information technology has increased the possibilities of combining firm resources within and combining resources across firms and national boundaries. This is because IT advances have caused a dramatic increase and transportability of information (Sampler, 1998). Managing intangible resources like knowledge and information can have greater impetus for economic growth than tangible resources do, because intangible resources can be leveraged to add value to tangible input resources (Teece et al., 1997). Given the emerging and increasing concerns regarding advanced IT and its impacts on organizations, this theoretical study intends to explore the dynamics of the following research questions.

1. How do the advances in IT and communication technology affect the structure that an organization adopts to manage innovation?

2. What resources are critical for the organization for managing in an information economy? How do the characteristics of these resources affect the organization structure that best suits innovation?

3. What are the determinants of a firm level organization in contrast to a market level organization where the resources to be coordinated and organized are predominantly information and knowledge?

2. LITERATURE REVIEW

Organizational information processing is traditionally known under various characterizations as management information systems, intelligence systems, decision support systems, communication systems, and administrative control systems. We use the definition of organizational information processing according to Huber (1982) as "the carrying out of the ad hoc or prescribed activities through which organizational members assess, distribute, alter or use organizationally relevant information". The term "members" is intended to be defined broadly as an individual, a work group, a department or even a corporate division. The members may be called 'nodes' or 'units' in an information network or structure context.

Until the advent of modern information technology, an organization's structure was a relatively inflexible hierarchical channel for information flows (Norton and Lester, 1996). Multiple units organized in a hierarchical structure reduce complexity as well as simplify coordination of large systems with multiple heterogeneous tasks (Simon, 1981). Hierarchy primarily serves two functions; one it gives a pyramid of authority, and second, it decomposes an organization into departments or nodes that generally reflect the pattern of communication (Simon, 1983). The roles of individuals and groups are clearly delineated in traditional hierarchies. The formal and informal communication channels in an organization are subjected to the vagaries of the working relationships between the units in the hierarchy and this is instrumental in differing levels of communication effectiveness across organizations having identical hierarchical structure and environment. This problem of human hierarchy was pointed out by Simon (1981). "The real flesh and blood organization has many interpart relations other than the lines of formal authority and in many instances the formal hierarchy exists only on paper" (Simon 1981, p. 197).