Capacity-constrained capabilities, market maturity, and corporate diversification: Theory and evidence from the cardiovascular medical device industry, 1976--2004
While the contemporary literature on diversification from a resource perspective builds upon Penrose's (1959) idea of excess firm capabilities, the focus has been on the applicability of resources across domains. Making a clear analytical distinction between scale-free capabilities and those that are capacity-constrained and need to allocated to one use or another helps to shift the discourse back to some of Penrose's (1959) original interest in the stock of organizational capabilities. The existence of capacity-constrained capabilities implies that rational diversification decisions should be based upon the opportunity cost of their use in one domain or another. The core result is that the recognition that resources and capabilities must be allocated among alternative uses provides a rational explanation for the divergence between total profits and profit margins. Firms make rational decisions to increase total profit via diversification when the industries in which they are currently competing become relatively mature. Due to the spreading of capacity-constrained capabilities across more segments, we may observe that firms' rational diversification actions lead to total profit growth but lower average returns. The model provides an alternative explanation for empirical observations regarding the diversification discount. I suggest that the self-selection mechanism in the diversification process may be based upon superior capabilities in a low value (existing market) context. I find strong support for these propositions based on a unique data set that contains all the devices approved by the FDA and firms' entry into different product markets within the cardiovascular medical device industry from 1976-2004. These findings can help reconcile the conflict between the self-selection explanations in corporate finance for the observed diversification discount and the proposition well established in the strategy field that firms with more relevant capabilities are more likely to enter a new field. Since the current setting is a technology-intensive industry, these findings also provide insights regarding incumbents' economic incentives to enter new technical fields.
Year of publication: |
2007-01-01
|
---|---|
Authors: | Wu, Xun |
Publisher: |
ScholarlyCommons |
Saved in:
freely available
Saved in favorites
Similar items by person
-
Foreign direct investment in China's power sector : trends, benefits and barriers
Blackman, Allen, (1999)
-
Foreign Direct Investment in China's Power Sector: Trends, Benefits and Barriers
Blackman, Allen, (1998)
-
Access to utilities by the poor: A global perspective
Komives, Kristin, (2001)
- More ...