Hazy ISCTM 2004 Proceedings

Strategic Resonance 1

Organizational Transformation as StrategicResonance Between Leadership Initiatives and

Dynamic Capabilities Development

Authors: J. K. Hazy

Abstract: To study how leadership interacts with exploration and exploitation(March, 1991) to enable adaptation, I model an organization with capabilities that co-evolve with the environment (Teece, Pisano, & Shuen, 1997; Van den Bosch, Volberda, & Boer, 1999). The organizational system’s capacity to generateexcess rents and to allocate them to exploit, build and reconfigure its capabilitiesis the core systemic process considered (Makadok, 2001). System dynamics techniques (Forrester, 1961) are used to model the rent producing system as two self-reinforcing and balancing feedback loop sub-systems. The exploitation valuecreation loop extracts rents from the environment by exploiting current resources and capabilities and, if possible, generating slack resources for future use (Barney, 1991). The exploration value creation loop invests slack resources inexploration creating the potential for the development of new capabilities. Based upon empirical results, two types of top-down leadership activity, transactional and transformational (Bass, 1985), are posited to operate by influencing the feedback loops at critical points. Transactional leadership activities increase exploitation and thus performance by identifying gaps between aspiration and current performance and implementing programs to close them (Winter, 2000). Transformational leadership activities identify gaps between current and desired organizational states and initiate programs that sustain and organize the effort to create new capabilities for future exploitation(Sashkin, 1995). The latter is done by initiating activity to sustain exploration and increase internal interaction complexity in order to lower structural barriers to change in the system (Marion, 1999). Transformational leadership activities thus enable the organization to test the performance value of a broader range oforganizational states, some of which may provide improved performance and thus form the basis for adaptation (McKelvey, 2003). A core assumption of the model is that, in contrast to bottom-up autonomous change (Burgelman, 1994), for strategic change to occur, that is change driven by top down strategic intent, there must be strategic resonance -- transformational leadership activities must resonate with the exploration value creation loop. In other words, transformational leadership and exploration activities must mutually reinforce


one another, an effect complicated by the delays inherent in both external markets and absorptive capacity development (Cohen & Levinthal, 1990).

To validate the leadership and capabilities model (LCM), system dynamics analysis is used to reconsider two well-known case studies. First, it is used to predict the transition of Intel, a major semiconductor company, from a dynamic memory manufacturer into a microprocessor company (Burgelman, 1994). Second, the model is used to consider the transition of NCR from a mechanical cash register vendor into a successful computer company (Rosenbloom, 2000).

Having predicted the stylized facts in these two case studies, the LCM is explored in general to identify critical points in the system where leadership activities stand the best chance of influencing the state of the system (March, 1981) to enable organizational transformation (Tushman & Romanelli, 1985).

Paper:

IntroductionDiscovery often follows the exploration of changingcircumstances. It is not surprising that since itsbeginnings, management and organizational research hassought to understand how organizations respond to change(Lewin, 1951). The question became particularly salient inthe early 1980’s when Japanese manufacturers began tothreaten US competitiveness (Halberstam, 1986) and continuesin importance today as organizations grapple with technologychange and ubiquitous globalization (Burgelman, 1994;Lichtenstein, 1995; March & Weissinger-Baylon, 1986;Romanelli & Tushman, 1994; Rosenbloom, 2000). March (1991)distills the problem of change to the balance betweenexploitation and exploration in pursuit of sustainability(March, 1991).

Leadership theory has likewise addressed the question ofchange and transformation but from a different vantage point-- the role and function of the executive or the leader aschange agent (Barnard, 1938; Conger, Spreitzer, & Lawler,1999; Drucker, 1995; Kanter, 1983; Kotter, 1990; McGregor,1954; Nadler, 1999; O'Toole, 1995). Although some recent


studies take the initial steps to bridge these twoperspectives (Christensen, 1997; Christensen & Raynor, 2003;Collins, 2001; Collins & Porras, 1994; Kotter & Heskett,1992; Sashkin, 2000; Schein, 1992; Schwandt & Marquardt,2000; Trice & Beyer, 1993; Tushman, Newman, & Romanelli,1986), there exists no cogent synthesis of how leadershipactivity relate to the transformation of organizations inthe face of change.

These perspectives, although different in many ways, share atheme articulated by March (1981): “the effectiveness ofleadership often depends on being able to time smallinterventions so that the force of natural organizationalprocesses amplifies the interventions” (p182).

To study how leadership relates to change, I explore howleadership activity, in interaction with the exploration andexploitation (March, 1991) activities of organizationalactors, serves the collective by enabling transformation. Imodel an organization that exploits and explores and thendevelops knowledge and capabilities that co-evolve with itsenvironment (Kauffman, 1993; Lewin, P., & Carroll, 1999;Teece et al., 1997; Van den Bosch et al., 1999). Theorganizational system’s capacity to generate excess rentsand to allocate them to exploit, build and reconfigure itscapabilities is the core systemic process considered. Theappropriate balance of exploitation and exploration asregulated by distinct leadership activities, enablessuccessful adaptation, and at times, transformation.

System dynamics techniques (Forrester, 1961; Sterman, 2000)are used to model the rent producing system as two self-reinforcing and balancing feedback loop sub-systems. Theexploitation value creation loop extracts rents from theenvironment by exploiting current resources and capabilitiesand, if possible, generating slack resources for future use(Barney, 1991). The exploration value creation loop investsslack resources in exploration creating the potential forthe development of new capabilities.


Leadership processes and activities emerge to systematicallybias the system and to guide the balance of exploitation andexploration with one eye on the environment and the otherfixed upon a grand plan that embodies collective aspirations(Gavetti & Levinthal, 2000). These bottom-up and top-downdynamic processes must be aligned, that is, be in what I amcalling strategic resonance, for successful transformationto occur. When strategic resonance occurs, as is describedby Collins (2001) in his book Good to Great, leadershiplooks easy and almost invisible.

Review of prior researchOrganizations in a changing environmentMarch (1981) described many of the complexities and apparentcontradictions inherent in the study of change at theorganizational level. He pointed out that change iscontinual and difficult to manage for organizational actors,that both what is stable and what changes are important, andthat theories of change are closely tied, and perhaps thesame as theories of action. He also pointed out thatresponse to the environment driven by prosaic internalprocesses can lead to unintended results and that changecomes both from rational planning and “organizationalfoolishness,” random acts that have long term consequences.These ideas have been developed and explored in case studiesdescribing the process of change in organizations andsynthesizing models of the change management process fromthe point of view of the actor (Burke & Litwin, 1992; Burke& Trahant, 2000; Christensen & Raynor, 2003; Kanter, 1983;Kanter, 1997; Kotter, 1990; Kotter, 1996).

An important area of study has been the idea thatorganizations and their routines and capabilities evolve(Nelson & Winter, 1982) and become competencies (Hamel &Prahalad, 1994). Although organizations adapt to changes inthe environment, in the process they can become constrainedby there histories building a “dominant logic” of success(Hamel & Prahalad, 1994). This very success can become


“structural inertia” that resists change (Hannan & Freeman,1984), a condition that is sometimes called the competencytrap (Stinchcombe, 1965), or the “myopia of learning”(Levinthal & March, 1993). In this context, Tushman andRomanelli (Romanelli & Tushman, 1994; Tushman et al., 1986;Tushman & Romanelli, 1985) developed a theory of punctuatedchange describing long periods of convergence toward aparticular strategy followed by relatively abrupt anddisruptive periods of strategic transformation.

Organizational change and choice has also been explored asan aspect of sensemaking (Weick, 1979; Weick, 1995; Weick &Quinn, 1999). Change for a collective, in this view, isabout making sense of an equivocal environment and sharingthat sense with others (Gioia & Chittipeddi, 1991; Gioia,Schultz, & Corley, 2000). This research begins to raise thequestion of how leadership relates to organizational change.

Leadership and changeEarly writing on leadership focused on the heroic or “greatman” hypothesis. This perspective assumed there wassomething unique about leaders (Carlyle, 1841/1907; James,1880). Weber (1958) codified this notion in social theoryand leadership in the concept of charisma in leadership, thedominating personality. Considering leadership in thismanner was discredited somewhat by the work of Stogdill(1948) in the 1940’s. In a meta-analysis of leadershipresearch he failed to identify any defining personalcharacteristics of leaders that would account for thespecial nature attributed to leaders. The focus of researchshifted to research on behaviors. In particular, behaviorsthat initiate structure for followers and those thatdemonstrate personal consideration for followers’ needs,were identified (Stogdill, 1974). These behavioral theoriesform the basis for much of our understanding of managementpractices (Bass, 1990; Drucker, 1954).


Transformational and Charismatic leadershipIn the late 1970’s, Burns (1978) proposed the notion thatleadership was more than sound, competent management, thatthere existed throughout history transforming leaders whocould inspire followers to be more and do more thanotherwise seemed possible. Independently, House (1977)reintroduced the notion of the charismatic leader, anindividual who advances greater influence than mightotherwise be possible due to his or her personal charm orother characteristics. Research in this area has identifiedfollower perceptions of leaders, rather than leadercharacteristics, as a key factors in distinguishing theperception of effective leadership. Two factors,transactional leadership and transformational leadership(Bass, 1985), have been identified as predictors ofleadership attribution. The persistence and independence ofthese factors was supported in a meta-analysis of numerousstudies (Tejeda, Scandura, & Pillai, 2001).

Transactional leadership activities involve behaviorspreviously associated with competent management. Assigningrewards, clarifying roles and effectively managingexceptions to process. Managing by objectives, contingentreward systems and project management processes are allexamples of organizational routines that followers wouldcall transactional leadership (if they knew the term) (Bass,1985). The perception of behaviors that promote theseactivities is consistently correlated with attribution ofleadership (Bass, 1985).

By contrast, transformational leadership is inspirational(Bass, 1985). Continuous communication interactionsintended to promote understanding of concerns ordissatisfaction about the present state of things and aimedat developing a shared, positive vision of the future, arekey aspects of transformational leadership activity (Kouzes& Posner, 1987). Visionary leaders are also cognizant ofthe organization’s culture and and appear to work toinfluence values as well as practice (Conger, 1989; Sashkin,


2000; Schein, 1992). Perception of behaviors that advancethese activities are also correlated with attributions ofleadership. Further, these two factors, transactional andtransformational, appear to be independent (Tejeda et al.,2001).

The Resource and Knowledge Based View (RKBV) of the firmThere is broad theoretical and empirical support forthinking about organizations in the context of their accessto and use of resources, capabilities and relevantknowledge. This emerging theory brings together theresource-based view (RBV) of the firm (Penrose, 1959), withits focus on differential access to critical resources, witha theory of the firm built upon the notion of capabilities,competences and knowledge and the dynamics of their creationand exploitation (Dosi, Nelson, & Winter, 2000; Hamel &Prahalad, 1994; Nelson & Winter, 1982; Teece, Pisano, &Shuen, 2000; Winter, 2000). Both of these theoreticalperspectives consider continued access to excess rentsderived from capabilities as the basis for sustainedcompetitive advantage. In a recent paper Makadok (2001;2002) presented a synthesized view called the Resource andKnowledge Based View of the Firm (RKBV). Critical to anyRKBV representation of the firm is the tension between thecontinued exploitation of existing capabilities, and theexploration for and creation of new capabilities, aspopularized by March (1991).

Also important in the study of how organizations change overtime is the notion that to grow capabilities, andorganization must invest in learning (Lundberg, 1989;Schwandt & Marquardt, 2000) and exploration. In doing thisthey build absorptive capacity, the ability to assimilatenew information effectively (Cohen & Levinthal, 1990). Theimportance of building absorptive capacity on the way tobuild new capabilities introduces a significant time delayin organizational change and transformation processes.


The Leadership and Capabilities ModelAdaptation and transformation The key premise of this analysis is that organizations andtheir leadership must be adept at rent producing processes(Makadok, 2001). This is accomplished through bothexploitation of existing capabilities and exploration fornew possible sources of rent. At times the explorationprocess may indicate, and potentially enable anorganizational transformation. The appropriate balance ofcapabilities to match the availability of rents dependscritically on the changing environment over time. This isa manifestation of the principle or requisite variety(Ashby, 1962).

Tushman and O’Reilly (1996) called organizations with thiscomplex and often contradictory set of skills ambidextrous.Others have characterized these internal processes in theneutral context of movement along a performance landscape,distinguishing adaptive walks up to the local performancepeak associated with the current configuration ofcapabilities, from long jump adaptations to a distant andpresumably very different configuration of capabilities(Kauffman, 1993; Levinthal, 1997). Cohen, March and Olsen(1988/1972) offered a less positive description of theorganizational process at work in organizations as theirleadership attempts to adapt and change in a complexenvironment. They describe the garbage can model oforganizational choice where problems and solutions aredeveloped independently and then randomly come together, asif in a “garbage can,” to determine future action.

Regardless of ones connotative inclination with respect toorganizational processes, it is well accepted that bothexploitation and exploration are important and thatmanagement and leadership processes need to orchestratethese dynamics to balance the short term and long-term needsof the collective.


The leadership and capabilities model (LCM) described hereaddresses these concerns. Leadership factors, transactionaland transformational (Bass, 1985), are associated withexploitation and exploration respectively. I definetransactional leadership as activities needed topersistently bias the system to improve performance andgenerate slack resources. Transformational leadership isdefined to be activities that enable an organization oraspects of an organization to create a vision of the future(Kouzes & Posner, 1987), to explore possibilities (Kotter &Heskett, 1992) and assemble new capabilities (Teece et al.,1997) to potentially sustain the organization in analternate configuration. In this context, transactionalleadership activities promote exploitation, that is,improvement in current capabilities (within an attractorbasin) for the purposes of short-term survival.Transformational leadership activities, on the other hand,continuously bias the system to look for alternative rentproducing opportunities. They do this by exploring,building alternative capabilities (Teece et al., 1997), andenabling the organization to shift into an alternative modeof operations (i.e., an alternative attractor basin) for thepurposes of longer-term adaptation.

The level of mutual re-enforcement between exploitation andtransactional leadership and between exploration andtransformational leadership, together with their balanceover time are predictors of organizational transformation.

For the purpose of this analysis, I define organizationaltransformation as a persistent shift in organizationalstructure, such that the level of performance rent garneredfrom new capabilities developed through exploration issufficient to sustain the organization over time. In otherwords, the organization has successfully entered newmarkets. When specific factors, described later in thecontext of the LCM, favor transformation, I say theorganization is in strategic resonance and thus has a higherthan normal likelihood of executing a successfultransformation.


Balancing Tension Between Exploitation and ExplorationI build upon a broad theoretical and empirical foundationwhere organizations are considered in the context of theiraccess to and use of resources, capabilities and relevantknowledge. Makadok (2001; 2002) presented a synthesizedview of this perspective and called it the Resource andKnowledge Based View of the Firm (RKBV). Critical to anyRKBV representation of the firm is the tension between thecontinued exploitation of existing capabilities, and theexploration for and creation of new capabilities, aspopularized by March (1991).

For this analysis, the RKBV is framed in system dynamicsterms as shown in Figure 1. Consider excess or slack rentsto be a stock managed by the system. These excess rentsderive from a system’s capabilities, both existing andpotentially brand new in processes discussed in detailbelow. The allocation of slack resources into eitherexploitation or exploration is a critical tension in thiscomplex system. Resources applied to exploration search fornew possibilities. Slack resources that remain can beaccumulated or returned for exploitation initiatives such asoutsourcing projects, quality programs or invested in otherefficiency improvements such as information technology (IT)or capital equipment.

Defining Dynamic Feedback Loops

Exploitation Value Creation LoopAs is shown in Figure 1, two self-reinforcing feedback loopsemanate from resource allocation choices. The lower leftpositive loop reflects the exploitation value creation loopdynamic: as more resources are allocated to exploitation,rents derived from existing capabilities increase. Absentmoderating external factors (described below), this wouldlead to increased available resources in a self-reinforcingexploitation value creation loop. Two external marketfactors moderate this effect. Firstly, the market carryingcapacity for existing markets changes over time and thus


limits the availability of rents. Secondly, the presence ofcompetitors also limits the amount and availability ofexcess rents. An organizational system in this situation isanalogous to an organism feeding at a known source ofnourishment, but where the source is both limited andsubject to competition.

In addition to the externalities, two internal dynamics actto balance the exploitation value creation loop: internalperformance aspirations and allocating some resources toexploration for alternative sources of rent. As aspirationsare achieved or satisfied, the drive toward continuousimprovement attenuates (Winter, 2000). Under this scenario,resources that might have been accumulated as slackresources and then channeled to improved exploitation mayinstead be consumed in departmental nest-featheringactivities, such as shorter work-days, increased perquisitesand larger offices, etc. As long as aspirations remainconstant and product satisfies those aspirations, the systemself-regulates to a constant level of performance rentgeneration. Available resources are consumed without regardto increased exploitation of capabilities. A secondinternal dynamic is the allocation of slack resources toexploration. Clearly, resources used for exploration arenot available for efforts to increased exploitationpotential. Exploration activities can thus be adistraction from exploitation efforts and therefore mayserve to reduce available rents generated by theexploitation of current capabilities in the short term.

One would expect that the capability to generate rent thatis in excess of market carrying capacity would be a waste ofresources, while inadequate capability limits access torent. An example of this capability/market-size matchingphenomenon is the management of inventory levels: too littleinventory leaves demand unsatisfied, too much must bewritten off as waste. In either case, rents are notmaximized. Thus, a critical measure of strategic resonancebetween internal processes and environmental conditions is


the gap between existing capabilities and market carryingcapacity.

PROPOSITION 1: The level of an organization’s current capability and the level ofmarket carrying capacity should resonate with one another over time; that is, thesmaller the on-going difference between capabilities and market carryingcapacity, the greater the potential for slack resources and thus the greater thelikelihood of successful transformation in future time steps.

Exploration Value Creation LoopThe upper left positive loop reflects the explorationdynamic: as resources are allocated to exploration, rentsderived from new capabilities increase. As in exploitation,the exploration value creation loop can be self-reinforcing.In this case, however, time delays are evident.Considerable research has shown that organizations mustfirst increase their absorptive capacity (Cohen & Levinthal,1990; Van den Bosch et al., 1999) before developing newcapabilities that have significant chance of success. Thisintroduces considerable time delay and in some cases makes aself-reinforcing exploration cycle difficult to sustain. Inaddition, new markets, even ones that become quite large,may take years to develop into sizes material to largesystems (Christensen, 1997; Christensen & Raynor, 2003;Mokyr, 1990). As such it may be necessary for the system tocontinually supply energy from internal sources to thissubsystem, in a kind of priming process. In this way, theexploration loop can be sustained absent positive rents forthe external environment. During this period, the systemmust respond to signals regarding future potential energysources and their interpretation (Daft & Weick, 1984),rather than positive energy in the form of rents, to makeinternal resource allocation choices (Christensen, 1997).

Even acknowledging this limitation, the importation of evenminimal rent associated with new capabilities remains animportant driver of sustained exploration. Rent from newcapabilities provides some energy for the system and thishelps provide positive reinforcement for the explorationfeedback loop. Many companies, for example, use internal


venturing models to nurture positive feedback loopsassociated with new capabilities development. These areways to help sustain exploration. Without external energy,internal processes alone must sustain exploration, adifficult condition to maintain over long periods.

Like the exploitation loop, rent from exploration isdependent upon two external factors, new market carryingcapacity and competition. In the case of new markets, thedynamics and timing are likely to be emergent and to somedegree enacted (Weick, 1979) by the organization, itspartners and competitors. As the volume of literature oninnovation attests, the above facts imply that that size andtiming of investment decisions in market developmentactivities can be a difficult challenge (Burgelman & Doz,2001; Christensen, 1997; Christensen & Raynor, 2003;Henderson & Clark, 1990).

Internally, the exploration value creation loop is balancedover time in two ways. Like in exploitation, anorganization’s “new capabilities” aspirations may beachieved by early success in the new market. As I describelater, the case of Intel’s entry into in microprocessors isan example of this. In Intel’s case, their aspirations innew markets were modest and the market itself was fastgrowing and easily accessible by them. Alternatively, ifresults are long in coming, or if “new capability”aspirations are not well articulated, the perception thataspirations are not consistent with a dominantinterpretation of market signals may cause the power of theaspirations to weaken over time. This is particularly trueif the amount of investment relative to the demonstratedopportunity is high. In the either case, without rent fromthe market to re-enforce the exploration feedback loop,continued exploration requires internal energy that maydrain the system’s slack resources, limit its ability toexploit current capabilities, and cause it to lower orchange its “new capabilities” aspirations as a means toshort term survival.


These effects combine to make change efforts difficult tosustain in the absence of either 1) rent from new marketsproportional to investment or 2) sustained transformationalleadership activities (as will be described in a latersection) that continually apply energy to the explorationsub-system by internally reinforcing aspirations. Acritical metric of the strategic resonance needed to sustainexploration is the difference between explorationcapabilities and new market carrying capacity, that is, theproportionate level of investment in new capabilities tocurrent, not future, new market opportunity levels.

PROPOSITION 2: The level of new capabilities developed through exploration andthe level of new market carrying capacity should resonate over time, that is thesmaller the difference between new capabilities and new market carryingcapacity, the greater the likelihood of sustained exploration and thus successfultransformation in future time steps.


TotalPerformance Rent Slack Resources

ExploitationAllocation

ExplorationAllocation

Rent FromExploitation ofCapabilities

Rent From NewCapabilitiesAbsorptive

Capacity ++++

+

+

+

+

Exploitation Value Creation

Exploration Value Creation

Old MarketsCarrying Capacity

New MarketsCarrying Capacity

+

+

Old MarketsCompetitive Dynamic

New MarketsCompetitive Dynamic

-

-

-

Distraction

Actual Performance vsAspiration Gap-

Complacency

Current State/AspirationState Gap

-

+New Market Success

Nest Feathering

+

AvailableResources+ +

-Consumed inoperations

-

Figure 1 – Value creation influence relationships absent leadership biasing

Bottom-up dynamicsAbsent overt top-down leadership activities, the tensionbetween exploitation and exploration is likely to bedetermined by external forces. Forces such as marketcarrying capacity in both new and old markets andcompetitive dynamics would thus determine the level of rentsthat can be achieved through either exploitation orexploration. These external and internal forces will alsodrive the complexity of the system. In the validationsection, I describe the case of Intel where bottom-updynamics overcame top-down biasing pressure away from newmarket exploration. Intel’s success is an illustration of


strategic resonance between exploration capabilities and newmarket carrying capacity.

Leadership impacts (biasing exploitation/exploration tension)Two types of overt top-down leadership activities areposited to operate in organizational systems by influencing(or biasing) each of the value creating feedback loopsdescribed earlier. This typology represents the empiricalresult that observed leadership behaviors factor into twocomponents: transactional and transformational leadership(Bass, 1985; Kouzes & Posner, 1987; Sashkin, 1995; Tejeda etal., 2001). In particular leadership activitiesinstitutionalize values and identify goals (Sashkin, 2000;Schein, 1992; Schwandt & Gorman, 2002; Trice & Beyer, 1993)and thus influence the perceived gaps between aspiration andperformance that characterize the balancing loops for bothexploitation and the exploration value creation.

Transactional leadership activities are posited to increaseexploitation capability and thus performance by identifyinggaps between performance aspirations and current performanceand by implementing programs to close them (Winter, 2000).Transformational leadership activities (Bass, 1985), on theother hand, orchestrate activities that identify gapsbetween the current and longer term desired organizationalstates and initiate programs that sustain and organize theeffort to explore for alternatives and create newcapabilities for future exploitation. In this way,transformational leadership activities enable theorganization to test a broader range of potentialorganizational states in interaction with the environmentand thus enable the organization’s configuration to co-evolve with the environment based upon performance successin new as well as old markets (Lewin et al., 1999; McKelvey,2003).

Transactional Leadership and ExploitationTransactional leadership activities, as described by Bass(1985), are associated with clarifying accountabilities and


links between action and reward. They are the leadershipactivities that show the organization’s members the way tosuccess. They are traditional management practices thatincrease the exploitation of current capabilities byimproving efficiency and effectiveness as well as handlingprocess disruptions quickly and effectively. Thusperformance is improved by identifying gaps between currentaspiration and current performance and implementing specificprograms to close the gaps. Disciplined process and roleclarity characterize this biasing process along withestablishing continually challenging aspirations andproviding the resources needed to address them.

PROPOSITION 3: A high level of transactional leadership activity implies increasedslack resources and thus increased potential for successful organizationtransformation in future periods.

In the language of complexity science, transactionalactivities enable the organization to approach a localperformance optimum by reducing complexity (Kauffman, 1995;Levinthal, 1997). Limiting interactions leads tounambiguous command and advice relationships and clear taskand resource assignments. These activities reducecomplexity and enable the organization to operate withgreater relative stability within a particular attractorbasin (McKelvey, 2003).

Risk of competency trapThe self-reinforcing dynamic of exploitation value creation,while increasing performance, has the perverse effect ofdeceasing the organization’s flexibility to change (Carley &Ren, 2001; Carley & Svoboda, 1996; Levinthal & March, 1993).As an organization becomes more finely tuned to succeedwithin a given set of capabilities, a random long-jumpadaptation to a different configuration becomes less andless likely to offer relative benefit, that is, to beaccretive to profits. As such, sweeping change is lesslikely to take hold against this type of structural inertia(Hannan & Freeman, 1984). Also called organizational myopia(Levinthal & March, 1993) this is particularly prevalent


with respect to exploration activities where time delaybetween project initiation and the realization of materialrents is significant, as is often the case, particularlywhen time to develop absorptive capacity is needed (Cohen &Levinthal, 1990).

To sustain exploration activity under these conditionsrequires a different kind of leadership, transformationalleadership.

TotalPerformance Rent Slack Resources

ExploitationAllocation

ExplorationAllocation

Rent FromExploitation ofCapabilities

Rent From NewCapabilitiesAbsorptive

Capacity ++++

+

+

+

+



Old MarketsCarrying Capacity

New MarketsCarrying Capacity

+

+

Old MarketsCompetitive Dynamic

New MarketsCompetitive Dynamic

-

-

TransactingLeadership Activity

Level

TransformationalLeadership Activity

Level

-

Distraction

Actual Performance vsAspiration Gap-

Complacency Performance Aspirations &Reduced Interaction Level

++

+

Pressure to Perform

Current State/AspirationState Gap Change Aspirations &

Interaction Level+

-

+New Market Success

+

+

Pressure to Change

Nest Feathering

+

-

Myopia

Consumed inoperations

AvailableResources+ +

--

Figure 2 - Influences in the leadership and capabilities model

Transformational Leadership and Exploration A different type of leadership, research has found,motivates change and transformation in organizations (Bass,1985; Bennis & Nanus, 1985; Burns, 1978; Conger, 1989;Kouzes & Posner, 1987; Sashkin, 1995; Sashkin, 2000; Yukl,1998). Transformational leadership activities (Bass, 1985)such as skip level town meetings and strategic visioning


sessions, are activities intended to motivate and inspirecollective action, establish a shared vision and ultimatelyfind an alternative future for the collective (Kouzes &Posner, 1987). These activities identify gaps between theunsatisfactory current state and a desired future state. Insum, transformational leadership activities establishcollective purpose and enable the collective resolve neededto sustain exploration in light of ambiguity and potentiallylong time delays (Conger, 1989).

These activities also increase the complexity of command,advice, task and resource interactions within theorganization so as to enable long jump adaptations. Insimple terms, new ideas meet less resistance. McKelvey(2003) has proposed that when internal complexity reaches acritical level, long jump adaptation, or significant change,becomes more likely. As such, transformational leadership,although perceived as motivational and inclusive, alsoincreases the interaction complexity within the organizationand thus enables the system to shift more easily to adifferent business model centering around a different basinof attraction.

For successful change to occur in an organization, theremust be an alternative business model that is sufficientlydeveloped so as to be available to the organization. Itmust also carry a likelihood of success that is comparableto the current state. In the transformation of IBM, a globalservice business had to be nurtured and developed to providea platform stable enough to support the weight of the newIBM once the total organization was shifted into it(Gerstner, 2002). In other words, the transformationalleadership effect must be accompanied by explorationactivities that build absorptive capacity (Cohen &Levinthal, 1990) and new capabilities that can form thebasis of a successful alternative configuration. When theseconditions exist, as they did at IBM under Gerstner, theorganization has strategic resonance.


Proposition 4: A high level of transformational leadership activity predictssuccessful transformation in later periods.

The existence of an acceptable alternative state is oftencomplicated by the time delays inherent in exploration, bothin terms of external markets and internal absorptivecapacity (Cohen & Levinthal, 1990). It takes time to buildcapabilities commensurate with new market opportunities. Thecase of Intel’s shift to microprocessors (Burgelman, 1994),described in the validation section, is an example of achange in state brought about by successful explorationprograms.

Proposition 5: Due to potentially long time delays, transformational leadershipactivity that sustains aspirations and exploration allocation over extendedperiods of time predicts successful transformation in later periods.

System Dynamics Implementation and ValidationTo consider the above propositions, many possible scenariosmust be observed if the researcher is to identifysignificant trends across many organizations. It is alsoimportant to look at scenarios that are comparable, or atleast at those in which differences can be adequatelymeasured. The nature of these questions would requirehundreds of samples—an impractical situation for fieldresearch. Further, my interest is in the cumulative,organization-level effects of exploitation, exploration andleadership activities over long periods of time. Also ofinterest was the influence of organizational histories onoutcomes. This makes computational modeling a logicalselection for research.

My interest is in understanding the build-up and/or declinein an organization’s size, revenue mix and value over timeas a function of strategic resonance variables describedabove. Because these factors are interrelated with complexfeedback loops , traditional linear modeling techniques areinappropriate.


These requirements led me to choose the system dynamicsmodeling technique (Forrester, 1961; Sterman, 2000). Ichose the Vensim software to design and build a systemdynamics model that reflects the conceptual frameworkdescribed above.

For validation I reconsidered the stylized facts from twowell-documented cases and compared the model results to theactual cases. These cases, described in detail later, are:Intel’s change to a microprocessor company in the 1970’s and1980’s (Burgelman, 1994) and NCR’s transformation frommechanical cash registers to electronic computers(Rosenbloom, 2000).

System dynamics modelBuilding upon the foundation of complexity science andorganization systems (Anderson, 1999) and using the resourceand knowledge based view (RKBV) of the firm (Barney, 1991;Makadok, 2001; Nelson & Winter, 1982) to frame theorganization’s systemic processes, I define feedback loopsthat enable the system to both sustain itself (exploitation)and change in response to the environment through adaptivesearch (exploration) (March, 1991).

Performance rents and the organizations resourcesConsistent with the Resource and Knowledge Based View of thefirm (RKBV), the organizational system gathers its resourcesfrom the environment through its various capabilities(Makadok, 2001). By interacting in various markets (assources of resources), some sources well known to thesystem, and some hidden, the organization aggregates a stockof excess rents. As is shown in Figure 3, this rent is taxedexogenously at a fixed rate by various stakeholders, e.g.,governments, investors, etc., but eventually, they becomethe resources available for consumption by the system.

Resources are dissipated in three ways: 1) Resourcesnecessary for continued operation are consumed at aparametrically defined rate; 2) other resources are consumedor dissipated through inefficient “nest-feathering”


activities, such as management perquisites and excesscompensation, at an endogenously determined rate (seesection on transactional leadership); and 3) the build-up ofa stock of slack resources available for discretionaryactivity. The importation and consumption of resources inthis way is the life-giving process of the organization ascomplex adaptive system.

Allocating resources to either exploitation and explorationSlack resources are consumed in the pursuit of eitherexploitation or exploration activities. Exploitationallocation is intended to improve the effectiveness in whichcurrent capabilities address known markets (i.e., resourcesin the environment) and extract performance rents thatbecame available to the organization for consumption. Build-up of current capability equates to an adaptive walk up alocal performance peak (Levinthal, 1997).

The risk, of course, is that the known resources accessed(i.e. markets addressed) by these capabilities dry up and ordeplete. Thus exploration for new resources, markets orsources of rent, is also a valid use of slack resources.


TotalPerformance

RentSlack

Resources

ExplorationResources

ExploitationResources

taxes, financingcosts

exploration resourceallocation

exploitation resourceallocation

exploration resourcesconsumption rate

exploitation resourcesconsumption rate

ResourcesAvailable to

Firm slack ratereturn rate

required foroperations nest feathering

Figure 3 - Stocks of resources and their consumption

The Exploitation value creation loopSlack resources allocated to exploitation accumulate and canbe used to increase the stock of current capabilities to beexploited. They are used to increase the rate at which thestock of capabilities addressing current markets are built-up and maintained. These capabilities, represented indollars of potential rent, would include capital goods,inventory and working capital, human assets, qualityprograms, intellectual property, software, processimprovements, etc. They are intended to improve the rate atwhich performance rent can be taken from markets currentlybeing addressed. The level of existing capabilities at aparticular time step represents the maximum potential amountof performance rent that the organizational system canextract from the environment at that time step. A simpleexample to consider is the available inventory on hand tomeet demand. More investment in more efficient production


processes could increase the level of inventory capabilityavailable for a given rate of resource consumption.

As is shown in Figure 4, in addition to adding to the stockof capabilities, the rate that performance rents areproduced by exploitation is also impacted by exogenousfactors. These include the stock level of market carryingcapacity and the nature of competition for the availableresources.

Market carrying capacity over time is input exogenously as afunction of time and represents the maximum rent that can beextracted from a given market by all industry players at aparticular time step. Thus, it is the aggregate demand forthe products or services produced by the relevantcapabilities. If the organizational system developscapabilities with the potential to generate rents in excessof the market carrying capacity, there is over capacity andno rent is produced on the excess. Clearly matchingcapability to market carrying capacity is a criticalorganizational task, and thus an important metric ofstrategic resonance.

Market competition for old or existing markets is also inputexogenously as a function over time. In this way theobserved marketplace characteristics can be modeled toreflect competitive dynamics. In this model, marketcompetition represents the market share won by competitors.Market carrying capacity multiplied times market competitiondetermines the maximum rent that could be extracted by theorganizational system should it have adequate capabilities.

The rate rent is produced from exploitation of currentcapabilities is the minimum between available marketcarrying capacity after competition (demand) and the levelof organizational capabilities available (supply) for eachtime step. Exploitation rent feeds into the organization’sstock of total performance rent.


TotalPerformance

RentSlack

Resources


CurrentCapabilitiesExploitation



exploitation capabilitiescreation rate


exploitationcapabilities rents

exploitation capabilitiesdissipation

OldMarketCarryingCapacity

disappearing oldmarkets

+

+


Firm slack ratereturn raterequired foroperations


Nest Featheringold market growth

Figure 4 - Exploitation value creation loop

The Exploration value creation loopAllocation of slack resources to exploration is intended tofind new markets and ways to nurture sources of futurerents. Exploration equates to long jump adaptation. Longjump adaptations have two complementary characteristics:they have a low probability of success in each individualcase, and they are necessary in the aggregate to identifynew of resource possibilities, that is, discover otherpossible markets. Allocation of resources to explorationincreases the rate at which the stock of explorationresources, such as R&D facilities and business developmentactivity, builds up.

It is not enough to find these alternative sources, however.Because random chance implies landing in the vicinity of adistant peak would most likely result in lower performanceinitially, the so-called competency trap (Levinthal & March,1993), exploration also requires building new capabilitiesin these areas (climbing the distant peaks through adaptivewalks) to determine if an attractive alternative source ofresources exists (Levinthal, 1997). The rate at which new


capabilities are dynamically assembled is influenced, inpart, by the level of exploration resources expended (Teeceet al., 1997).

The process of building knowledge before capabilities can beeffectively assembled, approximated by the concept ofabsorptive capacity (Cohen & Levinthal, 1990), adds timedelays between when exploration occurs, when capabilitiesare developed, and when rent (i.e., resources) can begathered from the markets based upon the capabilitiesdynamically assembled (Teece et al., 1997) to extract them.These time delay’s make the spontaneous development of aself re-enforcing feedback cycle less likely, although asthe Intel case described later shows, not impossible. Thepossibility, it turns out, is mediated by exogenous factors.

As shown in Figure 5, the exploration loop is influenced bytwo exogenous factors. New markets take time to develop andoften lag the identification of potential opportunities bymany years (Christensen, 1997; Mokyr, 1990). As such, thelevel of new market carrying capacity as a function of timeis an important regulator of the maximum explorationperformance rent that a stock of new capabilities canextract from the market at point in time, regardless of itslevel of capability. If significant rents are notrecoverable in the present environment, the exploration isnot self-sustaining and leadership biasing is needed (seetransformational leadership discussion later). If rents areimmediately available from exploration activities, even ifin small amounts, careful regulation of the explorationsubsystem can create self-sustaining re-enforcement loops.

Competition is also exogenous, although less a factor inthese new markets. If there is a limited market, there arelimited returns to investment. The relative match over timebetween new markets carrying capacity level and newcapabilities level is a key metric of strategic resonance.


TotalPerformance

RentSlack

Resources


New Capabilitiesfrom Exploration


exploration resourcesconsumption rateexploration capabilities

creation rate

explorationcapabilities rents

exploration capabilitiesdissipation

NewMarketCarryingCapacity

new markets

+ +

+

+


Firm slack ratereturn rate

required foroperations


Nest Feathering

Figure 5 - Exploration value creation loop

How transactional leadership intervenes in the system dynamicsIn the LCM, two aspects of the exploitation value creationloop are biased or influenced by interventions associatedwith transactional leadership activities: nest featheringactivities and resource allocation to improve theexploitation of current capabilities.

The level of transactional leadership activity, that is,actions such as frequent budget reviews, benchmarking,reward for performance compensation programs, etc, isreinforced by a continued perception that a gap existsbetween performance aspirations and actual performance.Likewise, a high level of transactional leadership activitygenerates increased performance aspiration which furtherhighlights a perceived performance gap. However, the


perception of actual performance is subject to reportingdelay, and thus the dynamics of the transactional leadershippositive feedback loop can overshoot the mark causingunintended consequences.

The perception of a performance gap leads to increasedpressure for transactional leadership. The level oftransactional leadership biases the exploitation loop in twoways: 1) it puts biasing pressure on the system to reducenest-feathering behaviors and thus increase the level ofslack resources returned to the system, and 2) biases theallocation of some slack resources to the exploitation ofcurrent capabilities.

TotalPerformance

RentSlack

Resources









Disappearing oldmarkets

old marketcompetition

-+


Firm

slack ratereturn rate


Complacency

Exploitation Value Creation actual performanceversus aspiration gap

pressure to perform

transactingaspirations

performance withreporting delay

TransactionalLeadershipActivitytransacting routine

creation rate

transactingdissipation rate

Nest Feathering

Figure 6 - Transactional leadership biases exploitation

How transformational leadership intervenes in the system dynamicsTwo aspects of the exploration value creation loop areinfluenced or biased by transformational leadershipactivities: resource allocation to exploration for new


capabilities, and focused investment in strategicinitiatives.

The level of transformational leadership activities, thatis, actions such as visioning sessions, town meetings, andcross-functional teams, etc, are reinforced by a continuedrecognition that a strategic gap exists between long termbusiness aspirations and the organization’s currentsituation. Perception of potential in new and growingmarkets is subject to interpretation and reporting delay andthus complicates the dynamics (Daft & Weick, 1984; Gavetti &Levinthal, 2000). Likewise, a high level oftransformational leadership activity contributes tocontinued high aspirations for the future. This furtherhighlights the gap between the organization’s current stateand its aspirations, that is, the strategic or vision gap.

A perceived strategic gap leads to increased pressure formore transformational leadership which in turn motivatescommitment to change. The level of transformationalleadership leads to the allocation of resources to generalexploration and to focused investment in strategicinitiatives to create new capabilities.


TotalPerformance

RentSlack

Resources





exploration resourcesconsumption rateexploration capabilities

creation rateexploration

capabilities rents



new markets

+

+

new marketcompetition

-

+


Firm slack ratereturn raterequired foroperations

Success or Fatigue


explore rents withreporting delay

project initiativeasset investment

sustained exploration"option" investment (+)

current state/desiredstate gap

pressure to change

transformingaspirations

TransformationalLeadershipActivity transforming

dissipation ratetransforming routine

creation rate

Nest Feathering

Figure 7 - Transformational leadership biases the system toward exploration and new capabilities creation

The leadership and Capabilities ModelTogether, the transformational/exploration subsystem whichenables change, when combined with thetransactional/exploitation subsystem that sustains theorganization in its current state, form the Leadership andCapabilities Model (LCM) shown in Figure 8.

Just as too much focus on exploitation can lead to myopiaand failure to see changes in the environment (Levinthal &March, 1993), too much attention ontransformation/exploration can be a distraction from thenecessary exploitation of capabilities and thus rentproduction. If inadequate attention is placed on currentcapabilities exploitation, rents might diminish and theavailability of slack resources might decline.

Thus balancing these two systems is both the problem ofleadership, transactional versus transformational (Bass,1985), and of organizations as systems, exploitation versusexploration (March 1991).


TotalPerformance

RentSlack

Resources








exploration resourcesconsumption rate

exploration capabilitiescreation rate



explorationcapabilities rents





new markets


Disappearing oldmarkets

+

+

new marketcompetition

old marketcompetition

-

-

+

+

-


Firm

slack ratereturn rate


Complacency

Success or Fatigue



explore rents withreporting delay

project initiativeasset investment

sustained exploration"option" investment (+)

current state/desiredstate gap

actual performanceversus aspiration gap

pressure to change

pressure to perform

transformingaspirations

transactingaspirations

performance withreporting delay

TransformationalLeadershipActivity

TransactionalLeadershipActivitytransacting routine

creation rate

transformingdissipation ratetransforming routine

creation rate

transactingdissipation rate

Nest Feathering

Figure 8 - The simplified Leadership and Capabilities Model (LCM)

Validation: two case studies compared to modelTo validate the above, the leadership and capabilities model(LCM) is used to reconsider two well-known case studies.Stylized facts from the case study are compared with themodel output. First, it is used to depict the transition ofIntel, a major semiconductor company, from a dynamic memorymanufacturer into a microprocessor company (Burgelman,1994). Second, the model is used to consider the transitionof NCR from a vendor of mechanical cash registers into asuccessful computer company (Rosenbloom, 2000).


The Case of Intel ReconsideredThe well-known case describing Intel’s strategic shift frommemory chips to microprocessors (Burgelman, 1991; Burgelman,1994) can be usefully explored using the system dynamicsmethods described above. This case illustrates the tensionbetween exploitation and exploration and the importance ofthe relative level and timing of rents. Although a topmanagement decision was taken in 1985 to exit memory infavor of microprocessors, it is clear from the case that therelative revenue trends of the two products actuallydeveloped rather smoothly over thirteen years, from 1972 to1985 (Burgelman, 1991). The crossover to dominance bymicroprocessors occurred in 1982. Still, it was threeyears, until 1985, before the decision to exit memorycompleted the transformation. Figure 9 shows the revenue mixbetween memory and logic in the case as reported byBurgelman (1991). Figure 10 shows how the LCM predicts thechange in sales mix as exploration and new capabilitiesdominates the exploitation of old capabilities in memory.In the LCM, this result occurs because rent from exploration(i.e., microprocessors) is sufficient to sustain thepositive feedback loop without transformational leadershipbiasing.

The data from the study also show that the process oftransformation relates directly to exploitation of corecapabilities in fabricating memory chips (dynamic randomaccess memory or DRAM) (Burgelman, 1991). The case states:”It was manufacturing prowess that made it possible forIntel to succeed in DRAM’s where other memory start-ups…hadfailed” (p. 243). This demonstrates the realization that itwas exploitation of current capabilities that sustained thefirm. It is also clear in the case that this capabilitytransferred readily to microprocessors, thus limiting thetime delay needed to establish new capabilities.

How was such sweeping change possible? The LCM systemdynamics model illustrates what happened at Intel and howsuccessful exploration transformed the company even in the


absence of a leadership change initiative. The exploitationvalue creation loop was sustaining the firm, even as,unbeknownst to management, competitive pressures werebeginning to limit the firm’s future prospects. Seniormanagement did not sanction allocating slack resources toexploration of microprocessor markets. As such, explorationwould not have been sustainable if it reduced availableexcess rents. In the case of microprocessors, however,margins were actually higher than memory thus enablingcontinued exploration and ultimately the domination of themicroprocessor positive feedback loop. Thus, the bottom-uptransformation at Intel occurred because rents fromexploration were immediate and sufficient to support thepositive feedback loop. This was because Intel’s fabricationcapabilities were immediately transferable tomicroprocessors making absorptive capacity (Cohen &Levinthal, 1990) high and because microprocessors were moreprofitable than memory from the start. Intel’s logicalproduction rule, that excess capacity be allocated to thehighest margin product, was the unimaginative routine thatcinched the transformation.

Importantly, at Intel there were no time delays associatedwith absorptive capacity or market demand. When the timedelay between exploration and reward is such thatexploration rents reinforce continued investment (i.e., theproject pays for itself) as was the case at Intel, gradualtransformation is possible. During this period, Intel’sexploitation/exploration dynamics never came into conflictwith Intel senior management’s stated aspiration, to be amemory company. Equally important, was that Intel’s cultureencouraged transformational leadership activities throughoutthe organization, even in defiance of top management. Insum, successful bottom-up transformations can succeed if thetime delay between exploration and reward is such thatembedded transformational leadership activities and theexploration that results are not in serious conflict withtop-down strategy making.


Figure 9 - Intel's Revenue mix as reported by Burgelman (1991)

Mix of Exploration and Exploitation1

0.75

0.5

0.25

00 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96 102 108 114 120

Time (Month)

Percent ExplorationPercent Exploitation


Figure 10 - LCM prediction of revenue mix between exploitation (memory) versus exploration (logic) when the rent from exploration is immediate and significant

The transformation of NCRThe history of NCR tells another important story about thebalance between exploration and exploitation. In this case,NCR exploited its capabilities in mechanical cash registers,and engaged in some exploration of the developing electronicprocessing market. Here, the biasing process associatedwith transformational leadership activities was needed toenable successful organizational change (Rosenbloom, 2000).

Since its founding in 1884, NCR was a leader in mechanicalcomputational devices, most notably cash registers. By the1949 it ranked second to IBM in the computing market and wastwice the size of fourth ranked Burroughs in computingindustry revenue (Rosenbloom, 2000). This success made itappear that NCR was a very likely platform for a successfultransformation into the electronic age of data processing.It didn’t quite work out that way. NCR’s history from the1950’s through the 1980’s illustrates the dynamics oforganizational transformation and the importance ofleadership in changing technology environments.

NCR was the last of the big four to make the strategicchoice to aggressively pursue the electronic age. Throughoutthe 1950’s and 1960’s many attempts were made to enter theelectronic age, but all were pursued as peripheral to thecore mechanical culture (Rosenbloom, 2000). For example,even though there were clear indications in the 1960’s andearly 1970’s that electronics were overtaking mechanicalparts in retail products, because customers continued to buymechanical, NCR continued to consider mechanical productsits core business. Throughout this period, NCR engaged inexploration experiments but continued to under invest in newcapabilities while at the same time failing to pressure the


current business to generate the slack resources that mighthave enabled greater investment.

Finally, in 1972 a new leader, Anderson, was named whoexhibited the attributes of both transactional andtransformational leadership as described in the literature(Bass, 1985). He responded to disappearing old markets withtransactional leadership actions and moved quickly toincrease efficiency in the core business, cutting employeesfrom a 1969 high of 103,000 to 90,000 by the end of 1973(Rosenbloom, 2000). He instituted transformationalleadership activities aimed at breaking up the headquartersmentality by reshuffling most of top management. He alsoinstituted symbolic changes such as formally renaming thecompany NCR Corporation and pronouncing to employees thatNCR would be primarily an electronics company within tenyears. In addition, he funded a new employee trainingprogram to develop the capabilities necessary to bothexploit current markets with incremental improvement andexplore for new opportunities.

Most significantly, Anderson invested heavily in electronicmarket opportunity allowing the new capabilities to achievemarket acceptance and eventually over take mechanicaldevices as the companies sustaining rent producing productline, the definition of transformation. Figure 11 shows howthe revenue grew over time even as the mix of mechanical andelectronic changed drastically from 1968 to 1977(Rosenbloom, 2000). Importantly, total revenue continued togrow during this period and into the 1980’s, effectivelysubstituting new product revenue for old.


Figure 11- NCR revenue as reported by Rosenbloom (2000)To validate the LCM, this change in revenue mix wasduplicated using the LCM. However, as Figure 12 shows, totalrevenue continues growing only when transformationalleadership biasing (to build new capabilities) is includedin the modeling. Thus the LCM implies that absenttransformational leadership biasing the system in the early1970’s, the decline in the mechanical device market wouldhave been disastrous for NCR. This result is implied in thecase study (Rosenbloom, 2000)


`Graph for Total Revenue (Rent)

4,000

3,000

2,000

1,000

00 18 36 54 72 90 108 126 144 162 180 198 216 234 252 270 288 306 324 342 360

Time (Month)

"Total Revenue (Rent)" : transformON dollars"Total Revenue (Rent)" : transformOFF dollars

Figure 12 - LCM total revenue with transformational leadership biasing ON and OFF

Observations and DiscussionAs the above cases show, the Leadership and CapabilitiesModel (LCM) can be used to illustrate how leadershipactivities interact with exploration and exploitation instrategic resonance to transform a company. Morepractically, it can be used to provide insight into thecritical points of intervention that may be leveraged byleadership for successful transformation projects (Kauffman,1995; March, 1981; McKelvey, 2003; Romanelli & Tushman,1994; Tushman & Romanelli, 1985).

Propositions explored

Exploitation effectivenessProposition 1 suggests that an organization’s capabilitiesshould be matched over time with the size of the marketsthey address. This may appear to be common sense, but it


implies a level of vigilance in matching the environment,rather than simply meeting demand, that has not beenadequately highlighted previously. It also provides apractical example of Ashby’s (1962) principle of requisitevariety. In sum, the LCM implies that all else being equal,closely matching capabilities to market carrying capacitygoes a long way to increasing stocks of slack resources.Although many intervening factors must be considered (asdescribed below), the availability of slack resourcesincreases the long term potential for organizationaltransformation when needed.

To test this proposition, the factors that were modeled mustbe measured. The difference between capabilities and marketcarrying capacity could be measured indirectly usingexisting metrics such as inventory levels and turns, revenueper employee, profit per employee, return on sales, returnon assets, etc. These metrics of operating efficiency havebeen around for years. However, the LCM provides anadditional context: operating efficiency is only half ofthe matching equation. Market carrying capacity must alsobe tracked, and because of timing delays, forecasted. Oncethe total market is served, improved efficiency implieshigher levels of slack resources. All else being equal,these metrics should predict successful transformation.

Exploration EffectivenessProposition 2 suggests that exploration also involvesmatching. Rents derived from new capabilities should bematched with the resources allocated to building them. Atfirst glance, this proposition appears to be at odds withconventional wisdom. It also appears to be in contradictionto research into absorptive capacity (Cohen & Levinthal,1989; Cohen & Levinthal, 1990). It is not, however. It iscomplementary.

The LCM recognizes the importance of time delays, inparticular the time it takes to build new capabilities thataddress market needs. This is the essence of absorptivecapacity (Cohen & Levinthal, 1990). As such, the LCM


explicitly recognizes the need for continuous baselineinvestment in exploration to reduce, somewhat, the timeneeded to build absorptive capacity. Too little investmentin exploration implies no new capabilities are developedwhich implies no rents are ever garnered from new markets.The LCM can be used to demonstrate the need for baselineexploration investment when old markets are in decline andnew markets must be addressed. Without investment inexploration, the organization can never garner new marketrents and eventually goes into decline.

This proposition does suggest that a disciplined approach toexploration and new capabilities development is predictiveof success in future transformation initiatives. This isbecause wasting resources reduces available slack, and thusthe opportunity for future exploration and exploitation.Although exploration is by definition, to some degreerandom, rather than suggesting a continuous process ofrandom exploration to build absorptive capacity, the LCMsuggests biasing otherwise random exploration towardspecific, existing or clearly developing marketopportunities identified as rent producing. The venturecapital industry approximates this approach. Investment islimited and tied to the achievement of milestones,operational hurdles that directly relate to marketplacevalidation. Failure to demonstrate market acceptance, byrevenue generation, for example means funding will notcontinue.

In contrast, budget based R&D spending more closelyapproximates a purely random process. This style drainsmore and more resources as the scale of explorationinvestment increases. In addition, truly random resourceallocation does not provide a mechanism for projectselection. Because projects not tied to current marketdynamics may be over-funded, and because there may besignificant time delays in market development, over builtcapabilities may lay fallow for years. These projectseventually draw management attention which may spark abacklash, wherein a lack of clear selection criteria leads


to the premature cancellation of promising projects(Christensen, 1997; Christensen and Raynor, 2003).

To test the implications of the LCM in this area in fieldresearch, we would need to look for metrics that determinethe rent producing approach used for exploration. Examplemeasurements would include level of investment compared tocurrent market opportunity, proven revenue (or profits)associated with exploration projects, how quickly projectsthat do not find a market are terminated. These are “realoption” related metrics: limiting losses, keeping optionsopen, but not exercising the option (investing heavily incapability development) until the market timing is right(Kogut & Kulatilaka, 2001).

Level of Transactional leadershipProposition 3 suggests that high levels of transactionalleadership activity such as goal setting, management byobjectives, reward for performance, and commitment/resultsreviews provides a consistent bias in two areas: 1) toreduce nest-feathering activities and thus increased slackresources, and 2) to increase allocation of slack resourcesto better exploitation of current capabilities.

The first of these two areas relates positively to slackresource production and thus implies greater potential forsuccessful transformation. The second acts to increase therate at which current capabilities are incrementallyimproved.

The situation in the second case is tricky, however, due toexternalities. If market carrying capacity is such thatincremental improvements in existing capabilities increaseperformance rents, then this activity has the desired effectand increases rent collected by the organization and thusslack resources. However, in declining markets, marketcarrying capacity limits rent potential. Thus we havediminishing (and perhaps even negative) returns as greatercapability translates into over supply. Thus, in situationswhere greater capability does not imply increased rents,


allocation of slack resources to exploitation is a waste ofresources. It increases the difference between existingcapabilities and current market carrying capacity, wastesslack resources, and thus reduces the potential forsuccessful transformation (by Proposition 1).

In declining markets, while transactional leadershipactivities are important for generating slack resources,their biasing effect can overshoot the mark and cause theorganization to miss its best path to the required futuretransformation. Once again, matching the environment iskey, and although obvious to some, this insight is oftenmissed in organizational settings. Lou Gerstner (2002)describes the situation in IBM in the early 1990’s:

Unfortunately, in IBM’s case the relationshipswere all wrong. Revenue was slowing because thecompany was so dependent on the mainframe, andmainframe sales were declining. Gross profit wassinking like a stone because we had to reducemainframe prices to compete. The only way tostabilize the ship was to ensure that expenseswere going down faster than the decline in grossprofit.

Expenses were a major problem. After months ofhard work, CFO Jerry York and his team determinedthat IBM’s expense to revenue ratio… was wildlyout of range with our competitors. On average ourcompetitors were spending 31 cents to produce $1of revenue, while we were spending 42 cents forthe same end. When we multiplied thisinefficiency times the total revenue of thecompany, we discovered we had a $7 billion expenseproblem! (pp 62-63)

As one would expect, Gerstner immediately initiatedtransactional leadership activities to address themarketplace/capabilities mismatch, as well as


transformational leadership activities in an effort totransform IBM.

Level and sustain time of Transformational LeadershipProposition 4 suggests that high levels of transformationalleadership activity lead to successful transformation.However, for strategic change, that is, change driven fromtop down strategic intent, to succeed, transformationalleadership activities must resonate with – mutuallyreinforce -- the appropriate exploration activities ongoingin the organization. This effect is often complicated by thesignificant and inconsistent time delays inherent in bothexternal market evolution and internal absorptive capacitydevelopment (Cohen & Levinthal, 1990).

Because of the inherent time delays in the exploration loop,it may be difficult to sustain without the application ofinternal energy to the system. As Proposition 5 describes,this internal energy comes in the form of sustained biasingpressure to change from high levels of transformationalleadership activity over time. Significant change takestime, often ten years or more (Collins, 2001).

To test this proposition in the field, metrics that indexthe level of transformational leadership activity at workwithin an organization would need to be developed. Examplesmight include the amount of time senior managers spend incross-functional activities, the clarity and consistentinterpretation of a vision of the future, etc. Thisproposition would imply that high marks on these metricsover a sustained period of time would predict successfultransformation.

The significance of strategic resonancePerhaps the most important implication of the LCM is thatall of the above factors are interrelated. There is no onesolution that drives organizational transformation. Ratherit is an effective, interacting combination of the abovefactors that is sufficient to 1) sustain the organization’sability to generate slack resources, 2) exploit, through its


current capabilities, known environmental resources, 3)explore the environment for new resource opportunities, and4) develop new capabilities to take advantage of these newopportunities, that enables and organization to persist overtime as a complex adaptive system. This is what I mean bystrategic resonance. As the preceding analysis has shown,the biasing function of leadership is a key component ofstrategic resonance.

LimitationsThis analysis is computational and is therefore limited inits application to real world organizational systems.Rather, areas for future field study can be indicated bythese results, as described above and in the next section.

Future researchFurther refinement of the LCM can be accomplished in twoways: additional computational modeling and field research.Computational modeling of the of agent interactions withinand external to the organization can be explicitly modeledusing agent-based modeling techniques that areorganizationally realistic (Carley & Ren, 2001; Hazy &Tivnan, 2003). Modeling of how boundary-spanning activitiesimpact organizational outcomes is an example of thisapproach (Hazy, Tivnan, & Schwandt, 2003).

Field research, some of which is described above, couldfurther validate this approach. Detailed case studies couldbe used to identify the metrics appropriate to quantify thepostulated relationships in the LCM. These metrics couldthen be used in broader quantitative studies to determinethe predictive power of the LCM in real world organizations.

________________________________________________________________

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