Knowledge specialization, organizational coupling, and the boundaries of the firm: Why do firms know more than they make?

Administrative Science Quarterly,  Dec, 2001  by Stefano Brusoni,  Andrea Prencipe,  Keith Pavitt

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More precisely, the knowledge boundaries of firms stretch beyond their production boundaries, and the evolution of their knowledge and product domains unfolds according to different principles. Prencipe (1997) found that aircraft engine manufacturers retain technological knowledge about components whose production is fully outsourced. Gambardella and Torrisi (1998) showed that in the electronics industry, firms are narrowing the range of products they offer, while extending the range of technologies on which they rely. Von Tunzelmann (1998) discussed similar findings in the food industry. Brusoni and Prencipe (2001) compared the case of the aircraft engine with mature chemical engineering design and construction activities and reached similar conclusions. More generally, Granstrand, Patel, and Pavitt (1997) found that large firms are more diversified in the technologies that they master than the products that they make and that their technological diversity has been increasing while they have typically been n arrowing their product range.

The gap between firms' production and knowledge boundaries may be the outcome of their efforts to reconcile apparently conflicting objectives. On the one hand, firms aim to exploit flexibility and to cut costs by outsourcing the production and detailed design of modular components and subsystems, i.e., they should buy. On the other hand, firms' competitive positions may depend on the capability to introduce radical product and component innovations by building on inhouse technological capabilities, i.e., they should make. Traditional explanations of firms' boundaries are ill equipped to explain the paradox pinpointed above: firms invest in broadening their knowledge bases while narrowing down their manufacturing bases.

Traditional Explanations of the Boundaries of the Firm: Transaction Costs and Modularity

In Williamson's (1975, 1985) transactions cost approach, knowledge appears as a production input, the characteristics of which are likely to lead to market failures. Empirical research consistently points to two key problems associated with knowledge-intensive activities. First, the partially tacit nature of knowledge, embodied in people and organizational routines, makes it highly specific and difficult to transfer (Nelson and Winter, 1982). Monteverde and Teece (1982: 209) argued that components that are specific to a company and that exhibit systemic effects are most likely to be manufactured in house, since their production process is built on specialized and non-patentable know-how. In addition, Mowery (1983) showed that although U.S. firms funded contract R&D for routine analytical tests, strategically important fundamental research and product development was kept in house. The nature of the output of R&D activity leads to another problem associated with knowledge-intensive activity, namely, appropriat ing its benefits. For instance, Pisano (1990) analyzed the evolving governance structures of biotechnology R&D and argued that, despite the advantages of collaboration, both specialized biotechnology firms and established pharmaceutical firms face transactional problems due to the weak conditions for appropriating knowledge resulting from their R&D. These problems led them toward increasing vertical integration.