Problems of Economic Transition, vol. 57, no. 9, 2015, pp. 119.

q 2015 Taylor & Francis Group, LLC

ISSN: 1061-1991 (print)/ISSN 1557-931X (online)
DOI: 10.1080/10611991.2014.1088357

MAKSIM A. STORCHEVOI

The Theory of the Firm and Strategic

Management
This article analyzes approaches to the theory of the firm that were
developed within the framework of strategic management: theory of
positioning, the resource-based approach, theory of dynamic capabilities, and the concept of knowledge, as well as the theory of open
innovation. The author shows how to interpret the basic ideas of these
approaches from the perspective of the economic theory of the firm, and
he identifies a number of concepts that allow for the expansion and
enrichment of the economic theory of the firm.
Keywords: theory of the firm, theory of positioning, strategic management, resource-based approach, dynamic capabilities, knowledge-based
theory, strategic theory of the firm, theory of open innovation

Several interesting concepts in the literature on management offer a

new and more accurate understanding of the firm in opposition to the
traditional economic approaches. What is new about these concepts and
are they really alternative theories in relation to the theory of the firm?
We will offer a short summary of ideas from the field of strategic

English translation q 2015 Taylor & Francis Group, LLC, from the Russian text
q 2013 Voprosy ekonomiki. Teoriia firmy i strategicheskii menedzhment,
Voprosy ekonomiki, 2013, no. 1, pp. 131 46. [Notes have been renumbered for this
edition.Ed.]
Maskim Anatolevich Storchevoi is a senior instructor in the Department of
Strategic and International Management at the Graduate School of Management at
St. Petersburg State University (St. Petersburg).
Translated by Brad Damare.
1

PROBLEMS OF ECONOMIC TRANSITION

management and we will attempt to answer what they represent:

alternative theories or a variation on the general economic theory of the
firm.1 This article will be especially useful for economists who study the
theory of the firm, but do not know how to study the firm in different
branches of management science.
First we must examine the general, methodological differences
between economic theory and management so that our subsequent
assessment of management theory itself will be more precise and better
understood.

Management and economic science: The interaction of two

disciplines
From a methodological perspective, management and economic theory
are not entirely identical to each other. First, economic theory is a
positive science that explains the behavior of economic agents, and
management is an applied science, the basic purpose of which is the
practical management of an organization for achieving stated objectives.
Second, unlike economic theory, which depends on ones own
methodological analysis of rational behavior and competition, management has no positive theory of organizational behavior. Moreover,
management borrows ideas and concepts from different social science
disciplineseconomic theory, organizational theory, sociology, psychology, and so forthand thus it cannot avoid being an
interdisciplinary science. Because there is no unified system of
borrowing and synthesis, it actually operates on the principle of well
take anything that works, and every author does this to some extent.
Consequently, the methodology of management contains many types of
rhetoric and logic that are often quite difficult to compare with one
another.
Third, management consists of different branches focused on solving
different problemsgeneral management, strategic management,
production management, personnel management, and so forthand
each branch of management is connected with its own economic theory.
Nearly all the branches of management have a certain connection with
the economic theory of the firm in the sense that it can be used for
solving specific problems in general management, personnel management, supply management, and so forth. Is it actually used in this way?

PROBLEMS OF ECONOMIC TRANSITION

As experience shows, this occurs in three circumstances: (1) the

authors export some concepts from economic science; (2) they invent
their own concepts that are essentially analogous to economic concepts
but more down to earth; or (3) they offer new concepts that are flawed
or erroneous from the perspective of economic theory. The second
circumstance is the most common, though not the most effective path,
because it is unwise not to use the tools already developed in other
sciences. However, new concepts in management sometimes (as we will
see below) involve the successful application of economic ideas, which
allows for the shaping of new knowledge that can be usefully reexported
back to economic theory.
Later we will examine several concepts that have been developed
in the area of strategic management that are connected with issues
addressed by the economic theory of the firm: the nature, scope, and
structure of the firm. We will attempt to define how to correlate these
concepts with the answers provided by the economic theory of the firm,
and whether we can extract new knowledge for the latter from these
concepts.

Ideas of the firm in the earliest concepts of strategic management

Strategic management involves the solving of key problems in a firms
activity: the choice of business in which the firm will engage itself, and
the choice of competitive strategy that will allow the firm to profit.
These problems touch directly on fundamental issues in the economic
theory of the firm: its scope and structure. Which concepts did strategic
management offer for analyzing this issue?
Strategic management as a science began to be developed in the
1950s in view of the long-range planning idea, and later strategic
planning, which reflected the desire to plan the direction of
development for already existing, large organizations for several years
ahead, independent of whatever economic conditions might arise.2 It is
no surprise that these theories barely examine the issue of scope or
structure of the firm. However, against the background of market
saturation and strengthening competition, companies are faced with the
problems of how and where they should compete in the future. Analysts
began to develop terminology and language for analyzing what
specifically should occupy an organization: what portfolio of products it

PROBLEMS OF ECONOMIC TRANSITION

should issue, what markets it should enter, and so forth. Igor Ansoff
(Ansoff, 1965; 1979) made a significant contribution to this analysis,
along with a few consulting companies. Ansoff discussed the internal
structure of companies with terms like accountability, profit center,
and economy of scale, however, his analysis was more general and
less in-depth than the approach later developed under the economic
theory of the firm. In addition, the early management theories began to
examine the internal structure of the organization, which is necessary for
implementing any productive strategy. Here the work of business
historian Alfred Chandler has played an important role (Chandler,
1962).

Porters theory of positioning

The next serious breakthrough in strategic management was the concept
of positioning, developed by Michael Porter in the 1980s (Porter, 1979,
1980). At first he explicitly applied terms and concepts from economic
theory, specifically theories of industrial organization, to strategic
management. To assess the goals of strategic management, Porter
suggested defining the firms position in the industry as the goal of
strategic management, which then allowed it to gain specific advantages
and increase its profit. This position was reduced to the choice of
product, its degrees of differentiation, its scale of production, and the
intended consumer: these variables are central to the theory of industrial
organization. The only principle difference between these two
approaches (along with different degrees of formalization) is that Porter
describes how to prevent a firm from losing profits (including in those
situations when some portion of the gains go to consumers), whereas
partisans of the theory of industrial organization show how to maximize
those gains for society (primarily for consumers). In both argument and
rhetoric, the two approaches are otherwise very similar (an economist
who begins reading Porters book will persistently catch himself
thinking he is reading a textbook on industrial organization).
Porter formulated his theory in its most straightforward and effective
form so it could be taught to people in business. First, he developed the
concept of the five forces of competition that reduce a firms profit:
active competitors, potential competitors, trade substitutes, suppliers,
and consumers. It is necessary to decide the firms position in the

PROBLEMS OF ECONOMIC TRANSITION

industry in such a way that the overall effect of those forces is

minimized. Second, he offered three types of strategies: absolute cost
advantage, differentiation, and focus on a specific type of consumer.
These strategy types depend on concepts from economics (especially
economies of scale and the theory of monopolistic competition), as well.
What kind of relationship does Porters theory have with the
economic theory of the firm? Although Porter did not, strictly speaking,
aim at defining the scope and structure of the firm, he nevertheless
touched on these issues in some form or another. For example, the
strategy of absolute cost advantage is directly connected with assessing
the horizontal scope of the firm, but Porter does not address these, and he
understands the sources of absolute cost advantage in a more
significantly narrow way than a simple economy of scale does (Porter,
1985, pp. 62 118). Later, when assessing the problems of diversification, Porter examines the corresponding changes in a firms internal
structure that give rise to different benefits (e.g., the shared use of
unified assets or divisions, which is again an economy of scale), as well
as to different losses (the costs of coordination, compromise, and
inflexibility) (Porter, 1985, pp. 31749). Here Porter comes closest to
the issues involved in the theory of the firm, and though he does not use
an understanding of opportunistic behavior or problems of agency,
he does assess factors associated with them. For Porter, the cost of
coordination is an additional cost associated with the necessity of
coordinating the use of one asset or department with other divisions, the
cost of compromise is the loss in efficiency in the activity of a joint
department due to the fact that this department can no longer consider
the needs of a specific division very deeply and needs to sacrifice some
of them, and the cost of inflexibility is a slowed reaction to the actions of
competitors and the possibility of rearranging divisions. Obviously,
these phenomena are closely related to the problem of opportunistic
behavior, but the latter represents a single factor that enhances the
magnitude of all these losses. In other words, Porter defines these
losses under the assumption that there is no opportunistic behavior. Like
Ansoff, Porter mentions in passing that individual responsibility is
needed, or profit sharing, but there is no sort of theory behind it. If Porter
introduced these concepts to his analysis, he would have to add yet
another chapter to his book (and possibly not just one).
Thus, although Porters theory represented a deep and multifaceted
analysis of the firm, it touched on only some of the dilemmas of

PROBLEMS OF ECONOMIC TRANSITION

integration and only some of the problems of internal structure, and it

lacked an analysis of opportunistic behavior. The latter is unsurprising,
since the basic ideas of theory of contracts have, by the beginning of the
1980s, only been discussed in individual articles and are still not
generally known in the academic community.
What could Porters theory offer to the science of economics? From a
strictly methodological perspective, practically nothing, because it was
just a brilliant application of economic theory to the problems of
competitive strategy of the firm, but only of economic theory in its
preopportunistic form.

The resource-based concept of the firm

The end of the 1980s saw a new approach to the study of stable
competitive advantages, focused not on the product market, but on the
market of a firms resources (Wernerfelt, 1984). It suggested that all
firms are heterogeneous in terms of their resources and, consequently,
when choosing a competitive strategy, they have to begin with the firms
specific resources. Moreover, only rare and valuable resources that
cannot be reproduced by competitors can be used for gaining aboveaverage profits over the long term. After a few years this theory became
famous as the resource-based view.
A number of authors took to clarifying and developing this concept
(Barney, 1986; Dierickx and Cool, 1989; and others). A more precise
description of resources that could be used as a source of competitive
advantages was derived in the concepts of valuable, rare, inimitable, and
nonsubstitutable (VRIN) resources (Barney, 1991). These could include
practically any of a companys resources: technology, employees,
location, brand, and so forth.
For example, the basic VRIN resources of the Coca-Cola Company
and PepsiCo, Inc. are their brands, since modern chemistry makes it not
particularly difficult to copy their drink formulas. A basic and unique
resource of many successful retail stores is their location, which
competitors cannot copy. A basic competitive advantage of Borjomi
[mineral water] is its unique natural spring. For technology companies,
the VRIN resources are the technology itself or the patents it maintains.
For example, Sharps unique capacity to produce flat-screen monitors
allowed it to be the leader in the high-definition-display market for a

PROBLEMS OF ECONOMIC TRANSITION

long time, while DuPonts business success came primarily through its
patents.
Another important element in the resource-based approach was the
idea of an organizations capability or competence. Unlike a resource,
which represents something concrete (a patent, equipment, location,
etc.), an organizations capability or competence consists of some
combination of resources, people, organizational structures, knowledge,
regulations, and so forth that allows this organization to do what other
organizations cannot. Different scholars have expressed this idea, but it
truly became popular after the publication of the article, The Core
Competence of the Corporation (Prahalad and Hamel, 1990), which
likewise focused on a critique of the product-based approach to
strategic management.
For example, Honda maintains the lead in production of powerful
engines, which creates its competitive capability on the market for
motorcycles, automobiles, and so forth. Sonys unique capability is the
production of compact products, that is, putting out a large number
of technological parts of a limited size. For Toshiba, which had consistently
maintained the lead in the laptop market during the 1990s, the core
capability was building laptops unexceptional by any single parameter, but
giving the user a reliable, quality product overall. Toyotas unique
capability is to produce quality automobiles very quickly and at a very low
cost (recall its Just in Time and Lean Manufacturing approaches).
The role of the resource-based approach for strategic management
and for theory of the firm was a topic of animated discussion. One
attempt to define this role was taken by Kathleen Conner (Conner,
1991). In her methodological work, she compared the research-based
approach with five settled concepts of the firm: the theory of perfect
competition, Joe Bains theory of industrial organization, the
Schumpeterian approach, the Chicago approach, and the theory of
transaction costs. Conner suggested that the resource-based approach
takes at least one proposition from each theory, but at the same time it
contradicts at least one proposition from each theory.
We can generally analyze the resource-based approached as a new
theory of the firm that represents an explanation for the existence of
firms outside of opportunistic factors: the firm can create a unique set
of resources that cannot otherwise be produced through market
transactions by other firms. To illustrate this, Conner uses a hypothetical
situation in which implicit knowledge can be used within an integrated

PROBLEMS OF ECONOMIC TRANSITION

firm, but disappears or fails to come together in contractual

relationships.3

A strategic theory of the firm?

The most resolute authors spoke in favor of developing a special strategic
theory of the firm that fundamentally differed from other theories. This
idea was first suggested by Richard Rumelt (1984). He took note of the
fact that strategic management had trouble applying the conclusions of
neoclassical theory, since that theory did not take into account existing
factors like heterogeneity of resources and causal ambiguity.
Heterogeneity of resources means that each firm needs to work with its
unique set of resources because it cannot simply repeat what other firms
do, and it must seek out its own optimal combination of those resources
and the means to manage them. Causal ambiguity significantly
complicates this task, since the firm does not know beforehand how
successful one or another combination of resources will be. Moreover,
even a successful firm cannot say for certain which specific activities led
to that success, and which had no effect or even a negative one.
To overcome these limitations, Rumelt suggested a formal
microeconomic model of industry equilibrium, in which the productive
function includes various forms of heterogeneity and the result of its
activity has a likely outcome. From this model Rumelt concluded that,
given ambiguity, a firm prefers not to enter industries that already have
established leaders and where it is unclear how and when it could
achieve costs and quality comparable to theirs. We should note,
however, that formalization in this case was hardly a productive goal,
since, on the one hand, the basic conclusion is clear even without
mathematical analysis, and on the other hand, variables like causal
ambiguity and uncertainty are very difficult to measure. This is
probably why this kind of model has not reached any significant
conclusions since the publication of Rumelts article.
A few authors later resurrected the term strategic theory of the firm,
but in a different sense than Rumelt had used it. Any theory of the firm
that appeared under the theory of strategic management came to be
included under the umbrella of strategic, from the resource-based
view to the concept of dynamic capability (see below) and nearly all of
strategic management in general. For example, Nicolai Foss believes

PROBLEMS OF ECONOMIC TRANSITION

that the strategic theory of the firm should address four issues: the
nature, scope, and structure of the firm and its competitive advantages
(Foss, 1999). Vitalii Tambovtsev followed a similar integrative
approach: from his point of view, the strategic theory of the firm
includes the whole multitude of theories (the transactional approach and
others) that arose after neoclassical theory (Tambovtsev, 2010; for
more, see; Bukhvalov, 2010; Bukhvalov and Katkalo, 2005).
However, this integrative approach is extremely questionable. Its
adherents main argument is that an economic theory of the firm fails to
consider some factor or another, while the strategic theory of the firm does
consider that factor and is therefore a more complete and self-contained
theory. This assertion is methodologically inaccurate, because, if we are
talking about a positive explanation for a firms behavior and outlining a
number of factors that this theory, at a given stage of its development, has
not yet successfully included in its analysis, then we have to draw
conclusions about the need for a prompt inclusion of those factors into the
positive theory, and not construct some new theory with an ambiguous
name. As the first section of this article noted, management uses the
achievements of various disciplines, including economic theory, but does
that requires us to say that the latter is only part of the former? It would be
more accurate to conclude that there should be a unified economic theory
of the firm that addresses the basic issues of the nature, size, and structure
of the firm, as well as a self-contained instrumental theory of strategic
management that can rely on the economic theory of the firm for
formulating practical strategies toward creating competitive advantages.4
However, we should avoid making a methodological mistake here and
proposing the creation of an independent strategic theory of the firm.
The features of the fields historical development do not undo the logical
principles of its methodology, where sooner or later we have to call
everything by its own name. A new theory of the firm developed by
authors who work on strategic management is methodologically just an
expansion or evolution of the economic theory of the firm.

The contribution of the resource-based concept to the economic

theory of the firm
We can understand this claim better by more clearly highlighting the
contribution of the resource-based concept to the development of the

10 PROBLEMS OF ECONOMIC TRANSITION

economic theory of the firm. In essence, the resource-based approach

represents some modification to the simple logic of expansion (see
Storchevoi, 2012, pp. 60 61): not every extension of a firms scope is
advantageous. It is ill-advised to expand a firm into sectors where the
firm enjoys no VRIN resources, since there will be no profits in that
sector in the long run.
This kind of development of the basic logic of the theory of the firm
becomes more substantial and interesting if we apply it individually to
each of the problems of integration.
If business tackles the problem of vertical integration, it needs to take
into account not only the potential opportunism of a supplier or a client,
but also the clients available VRIN resources. If the supplier or client
has a monopoly, then integration is necessary, and the resource-based
argument has no effect on the theory of the firm. But if there is
competition between suppliers or clients, then the opportunistic
argument gives no reason for integration, which is not the case with
the resource-based approach.
If certain suppliers or clients draw additional rent from more
productive resources, then the firm can appropriate that rent by
integrating with the given suppliers. Note that in this kind of situation
the decision to integrate is not about battling opportunism, but about
expanding: to integrate wherever a profit is possible in the long run.
If we examine the problem of horizontal integration, organizational
solutions are affected by heterogeneity of resources here, as well.
In horizontal integration, a firm obtains profit thanks to economies of
scale, but its profit will be higher when integrating with resources whose
VRIN attributes are greater. If antitrust regulations permit a company to
have a 30 percent share of the market, it should try to acquire production
capacities with the best VRIN characteristics to make up that 30 percent
in order to maximize its profit due to Ricardian rent. A similar argument
could be applied to the problem of combined integration: the presence of
VRIN resources in an absorbed sector strengthens the arguments in
favor of integration.
As for the problem of conglomerate integration, the arguments of
the resource-based approach are clearly most significant, since all the
remaining explanations generally do not work in this case. The resourcebased theory of conglomerates probably explains the existence of
successful conglomerates, which can be analyzed as a collection of
VRIN resources, most convincingly.

PROBLEMS OF ECONOMIC TRANSITION 11

The basic contribution of the resource-based approach to development of the theory of the firm also consists in a similar modification
to solving the dilemmas of integration. As we can see, accounting for
heterogeneity of resources and for various ambiguities represents a
beneficial contribution to the development of the general theory of the
firm, but at the same time we have to emphasize that the resource-based
approach is not self-contained and only supplements the economic
theory of the firm with new variables. Any decisions on integration will
always consider not only VRIN resources but also potential losses from
opportunistic behavior that can override any benefits from internalizing
VRIN resources.

The concept of dynamic capabilities

Theoretically, any firm can create a unique combination of resources
for the existing market situation and obtain an advantage over all its
competitors. But in the long run that advantage will be lost for two
reasons: competitors will try to exceed that advantage, and sooner or
later will do so; technology and demand eventually changes, and the
market will then demand a different type of product or service. This
raises the question of whether a given firm can repeat its success with
finding the best combination of resources and maintain (or reobtain) a
competitive advantage over other firms. A version of the resource-based
approach came about in the 1990s to reflect on this theoretical problem,
in which so-called dynamic capabilities, the ability to constantly create
new and effective material and nonmaterial resources, were considered
as a firms particular and most important resource (Teece, Pisano, and
Shuen, 1990). To the extent that any other competitive advantages, even
those based on VRIN resources, have a tendency to weaken due to the
natural forces of competition (Alfred Marshall), the ability to
constantly produce newer and newer effective combinations of
resources is the most important means of preserving competitive
advantages.
For example, Apple Inc. managed, almost continually over the course
of decades, to produce new combinations of resources and to offer
new products on the market (the Macintosh computer, the LaseWriter
tabletop laser printer, the family of laptops from Powerbook to
MacBook, the iPod, the iTunes online music store, the iPhone, the iPad

12 PROBLEMS OF ECONOMIC TRANSITION

tablet, etc.), which nearly always presented the market with

revolutionary concepts and ideas. However, the success of specific
Apple products was short-lived because competitors copied them. In the
beginning Microsoft copied Apples most user-friendly possible
graphics interface in its operating system and office applications, and
captured a large share of the market thanks to a more aggressive pricing
policy and network effect, leaving Apple with a small, niche segment of
fans. After the release of the revolutionary iPhone and iPad, other
companies were somewhat quickly able to release products inferior in
quality. The Korean company Samsung became the main competitor,
currently selling its smart phones and tablets twice as actively as Apple,
which is steadily losing its share of the market. This example clearly
shows that Apple can only maintain a steady competitive advantage if it
has particular dynamic capabilities allowing it to continually create new
combinations of resources giving it an advantage, albeit temporary, over
its competitors. However, the question of what, specifically, should be
included in these dynamic capabilitiesunique organizational routines
or the individual talents of leading managers like Steve Jobsremains
an open one.
The difference between a resource-based approach and the concept of
dynamic capabilities was well-formulated by Valerii Katkalo (2006).
The resource-based approach is more static, the value of resources for
the organization is created exogenously, and rents are defined by an
objective scarcity of resources (a` la Ricardo). The concept of dynamic
capabilities examines competition as a process, the value of resources is
created within the company, and rents are Schumpeterian (they are
temporary and disappear as competitors succeed in copying the firms
innovations). However, the concept of dynamic capabilities has come
under serious criticism from various authors who have pointed to the
impossibility of measuring this kind of resource and its very limited
prognostic capabilities.
What conclusions can the economic theory of the firm draw from the
concept of dynamic capabilities? One conclusion is that a firms most
valuable resource is its top manager because he represents the dynamic
capabilities of a higher order that are necessary for reconfiguring all the
remaining resources (Storchevoi, 2006). However, is it possible to draw
conclusions about the size or structure of the firm on the basis of the
concept of dynamic capabilities? How can we use this concept to solve
integrational dilemmas? The only overall conclusion we can reach here

PROBLEMS OF ECONOMIC TRANSITION 13

is that the more absolute dynamic capabilities a firm has, the more
effective conclusions to integrational dilemmas will be found.
Unfortunately, it is impossible to draw any specific additional
conclusions, and this fact reflects a general methodological problem
for the concept of dynamic capabilities: it depends on such a high level
of abstraction that it can be used for broad philosophical discourse, but it
is impossible to use it for nontautological explanations of integrations
real dilemmas.
Moreover, the concept of dynamic capabilities itself could gain from
using the economic theory of the firm. In particular, it completely fails
to take into account the factor of opportunism, and suggests that, if
personal or organizational limitations hinder a companys workers or
managers from being dynamic, these limitations must be overcome
through the creation of corresponding skills and competences. Why do
the authors of this theory believe that workers and managers with
a developed capability for changes will, in a majority of cases,
resourcefully and dynamically maximize the organizations profit rather
than their own utility, and not think up new ways of performing this
task? This could mean anything from a modest slacking off to a
complete blocking of changes associated with, for example, the firing of
staff. Designing ideal dynamic capabilities is clearly impossible
without using the tools of the economic theory of the firm.

The knowledge-based view

Some theoreticians have emphasized the importance of knowledge as
a key factor defining a firms competitive advantage. This direction of
analysis is often considered a development of the resource-based
approach in strategic management, though historically it emerged
somewhat earlier within economic theory. Adherents of this idea
understand the firm not only as a collection of definite resources but also
as the collective knowledge and know-how that forms during the firms
development and disappears in the event of the firms termination.
In economic theory, Edith Penrose expressed a similar view of the firm
as a pool of non-material resources (Penrose, 1959). Later, Richard
Nelson and Sidney Winter suggested a whole evolutionary theory built
on the concept of routine as a firms capabilities (Nelson and Winter,
1982). Unfortunately, this theory does not rely on methodological

14 PROBLEMS OF ECONOMIC TRANSITION

individualism, and it appears incompatible with the economic theory of

the firm. A knowledge-based view of the firm was explicitly suggested
in the early 1990s by a number of authors independently of one another
(Foss, 1993; Grant, 1996; Kogut and Zander, 1992; Nonaka, 1991).
Ikujiro Nonaka emphasized the firms role as a mechanism of preserving
and transmitting implicit knowledge that cannot be formalized. Bruce
Kogut and Udo Zander offered a new approach in which a firms
existence and decisions about its scope were explained not by the
influence of transactional costs, but by the problem of preserving and
transmitting implicit organizational knowledge. Nicolai Foss suggested
a competence theory of the firm as an alternative explanation for the
existence and size of firm in relation to contract theory. In this theory the
existence of a firm is explained by the presence of unique competence of
the businessman, who can sell his services by contract, or create a firm
(Foss, 1993, p. 136). The firms scope is defined by what its
competences allow for effectively producing more of the same or
more of something closely related, which leads to horizontal
integration and diversification.
Another version of the knowledge-based view was Robert Grants
approach (Grant, 2002). He proceeded from the assumption that a firms
basic purpose consists not in preserving knowledge, but in disclosing and
applying the individual knowledge of its workers. Grant later tried to show
that firms manage the organization of international innovative activity
better than alliances or market contracts (Almeida, Song, and Grant, 2002).
Can we consider this theory an alternative explanation of the firm?
Despite its undoubted originality, the answer is no, because its basic
arguments are fully embedded in the logic of the economic theory of the
firm. A firms knowledge and competence often present themselves as
indivisible capital goods, and the process of preserving, improving, and
transmitting them are an indivisible production process that in many
cases should be immersed in one firm because they require systematic
formal and informal interaction among the workers. However, we
should note that, although knowledge as a special resource gives rise to
special contractual problems that are worthy of individual analysis, this
analysis could be carried out most productively within the economic
theory of the firm, and not as an alternative. We should also note that
many actual firms are not at all constructed around the knowledge of
individual workers or around production based on that knowledge.
For example, hair salons and fast-food restaurants, transportation and

PROBLEMS OF ECONOMIC TRANSITION 15

warehousing companies do not require knowledge that cannot be found

in the market. Furthermore, not all of the dilemmas of a firms scope are
associated with issues of knowledge. For example, the dilemma of
horizontal integration has no relation to knowledge, nor do many
dilemmas of vertical integration (e.g., the merger of oil extracting
companies, pipelines, oil refineries, and gas stations, and many similar
situations). Consequently, the concept of knowledge can expand on the
economic theory of the firm, but it cannot be an alternative to it.
We should note that, in 1996, one of the founders of this concept,
Nicolai Foss, published an article that contained a critique of Conner
(see the section above on the resource-based concept) and Kogut and
Zander as alternative explanations to the existence of the firm and an
implicit repudiation of his own similar statements from a 1993 article.
Foss criticized these authors for technological determinism and
recognized that debates about the concept of knowledge were necessary
but insufficient for the existence of the firm: there must be a threat of
opportunistic behavior.5

Theory of open innovation

The concept of knowledge is concentrated on the problem of creating or
preserving knowledge as the most important implicit resource, which
is difficult to copy and which could be the basis for competitive
advantages. However, some types of knowledge (primarily technological secrets) really can be copied without difficulty, and this raises the
problem of protecting a firms knowledge. In many situations it is
impossible to protect know-how via contracts because the natural
response here was always maximum vertical integration that places the
whole innovation process within the firm and prevents knowledge from
getting out. Of course, loss of effectiveness in this model is possible due
to opportunism, but the benefits of protecting know-how compensate for
this. This is so-called closed innovation, which takes place within a
single large firm. This is how giants like IBM or Siemens, who
concentrate all their innovations within themselves, have always
behaved.
However, in the 1990s companies began more and more frequently to
open up their innovation processes and to invite independent partners
and developers to take part in them. In management this approach found

16 PROBLEMS OF ECONOMIC TRANSITION

a reflection in the theory of open innovation, formulated by Henry

Chesbrough (2003, 2006). According to this theory, when the ratio of
losses from vertical integration and gains from control of know-how are
not in favor of expanding a firms scope, it is necessary to switch over to
a system of open technology, where the primary innovator performs
some central function in the general process and is rewarded for that
work with a patent, license, some kind of service, or another means of
monetizing the value created. The remaining work is performed by
independent innovation firms that develop their own products and
services around that technology. Two situations are possible here: the
central firm develops a core technology and sends it on to independent
innovators, or the central firm acquires developments from independent
innovators and integrates them into its products.
For example, in the 1990s IBM concentrated the development of all
its techonologies internally. It operated under the not-invented-here
pattern: it did not even take into account any outside developments.
At the same time, only a small selection of IBMs patents were actually
needed in its business, while the remaining 90 percent sat on shelves.
In the early 1990s IBM began to fall behind in the personal computer
market and faced enormous losses, the consequences of which led the
company to change the nature of its innovations completely: the
majority of workers in research and development (R&D) were let go,
and the company began to direct itself toward using independent
innovators on the market of free software development. Similar changes
took place in other companies, as well. In the 1990s Procter & Gamble
(P&G) transitioned to maximal use of outside innovation. For example,
it found a confectionary factory in the Italian city of Bologna that owned
machines for drawing images on baked goods using an inkjet printer
method, and on that basis it released Pringles with images and text
printed on each individual chip. The costs to P&G for developing this
product represented only an insignificant fraction of the overall amount,
and it was able to release it on the market twice as quickly as it could
have if the firm itself had developed the product.
Some leading companies have even reflected this change in ideology
by changing the first word of the traditional R&D label with a different
term denoting cooperation with outside developers. For example, P&G
called its program C&D (cooperate and develop), and Cisco gave its
program the name A&D (acquire and develop).

PROBLEMS OF ECONOMIC TRANSITION 17

Of course, the concept of open innovation does not fully replace the
logic of vertical integration and the concept of knowledge. In different
integrational dilemmas these approaches will manifest themselves
differently. For example, if we are discussing the horizontal integration
of independent teams of developers, then the concept of knowledge is
hardly suitable for the development of convincing arguments for or
against integration, whereas the theory of open innovation unambiguously states that it is better to do without integration, since independent,
competing teams can work much more effectively. In particular,
innovation breakthroughs simply will not appear if there is only a single,
fully horizontally integrated firm.
If we examine the dilemma of vertical or functional integration, we
cannot a priori reach a universal conclusion for all situations because
knowledge as a resource can be completely different and it is necessary
to factor in its type (codifiability, the ability to sell intermediate products
of knowledge on the market, the ability to obtain patents, etc.). Thus, the
concepts of knowledge and open innovation add important arguments to
the analysis of the economic theory of the firm, helping it to analyze the
high-tech sectors.
***
We have examined the basic approaches to the study of the firm
within strategic management and knowledge management. In the
majority of cases the idea of one or another management approach is
quite organically embedded in the structure of the economic theory of
the firm, which allows it to expand and come closer to reality (e.g., to
take into account the heterogeneity of resources or to pay much closer
attention to the role of knowledge). However, the creation of certain
independent theoriesstrategic theory of the firm or the concept of
knowledgeis methodologically incorrect. If we are talking about a
positive theory of the firm, addressing issues related to the nature, scope,
and structure of the firm, then the most consistent and deepest approach
is the economic theory of the firm, in which it is easy to include
supplemental arguments like heterogeneity of resources or knowledge.
This allows us to clarify the conclusions of the economic theory of the
firm itself, and to give a more fundamental and systematic interpretation
of its arguments. If we are talking about the theory of strategic
management as an applied discipline, then it should not invent its own
homemade positive theory of the firm, but be guided by settled

18 PROBLEMS OF ECONOMIC TRANSITION

economic theory (adding the necessary arguments to it if needed) and

focusing on the development of practical tools for analysis and for
making decisions about the scope and structure of the firm.

Notes
1. For a description of the general economic theory of the firm, see Storchevoi
(2012).
2. For a further description of the evolution of strategic management theory, see
Katkalo (2006).
3. Strictly speaking, this example is extremely relevant but relates more closely
to the concept of knowledge discussed below; it is too narrow for a general
research-based approach.
4. Oliver Williamson expressed a similar opinion about the more fundamental
nature of economic theory (Williamson, 1991).
5. To justify this, Foss uses the very same thought experiment that had led him to
the opposite position in his 1993 article. Back then he had asked the reader to
imagine a society of absolutely moral individuals where, according to the contractbased approach, no firms at all should exist, but they nevertheless do exist because
of accumulated competence. In 1996, using the very same experiment, Foss reached
the conclusion that, without any opportunistic behavior, this kind of cooperation
could be organized via market contracts.

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