Balancing exploration and exploitation: The moderating role of competitive intensity

Abstract

Drawing on Miles and Snow's classification of strategy type, this paper addresses the contingency role that competitive intensity plays in explaining the relationship between exploration/exploitation and firm performance. We further refine our firm performance measure into separate measures of effective and efficient firm performance. Our conceptual argument posits that for defenders, exploration will be positively related to effective firm performance while exploitation will be negatively related to efficient firm performance as competitive intensity increases. Conversely, for prospectors, we assert that exploration will be negatively related to effective firm performance, whereas exploitation will be positively associated with efficient firm performance as competition intensifies. Empirical results provide general support for our predictions. The implications for business theory and practice are discussed.

Introduction

Organizational learning is a necessary resource and capability for firms seeking to sustain a competitive advantage in today's marketplace (Barney, 1991). According to resource-based theory, resources include all the “assets, capabilities, organizational processes, firm attributes, information, knowledge, etc., controlled by a firm that enable the firm to conceive of and implement strategies that are efficient and effective” (Barney, 1991, p. 101). In this light, organizational learning, defined as the capability for organizations to create, disseminate, and act upon generated knowledge, can be regarded as a resource. Scholars have explored this capability using different types of learning: double loop vs. single loop learning (Argyris and Schon, 1978); generative vs. adaptive learning (Senge, 1990); and product innovation vs. production-oriented learning (McKee, 1992). Despite the diverse terminologies, commonalities can be readily observed and two distinct concepts of learning can be identified. One branch of research is chiefly concerned with revolutionary change; change that requires tasks to be accomplished under new organizational assumptions and frameworks (e.g., “S” curve; Foster, 1986). The other is more concerned with evolutionary, incremental changes; improvements based on existing platforms that benefit from repetition and routine (e.g., experience curve).

This distinction suggests that double loop, generative, and product-innovation learning are closely aligned with exploration while single loop, adaptive, and production oriented learning are aligned with exploitation approach to learning. Having asserted that exploration and exploitation are different modes of organizational learning, we further posit that these two types of learning represent organizational resources and capabilities that firms can use to develop and sustain their competitive advantage under changing environmental conditions.

Despite the apparent differences between the two types of learning, scholars and practitioners have long believed that a well-balanced combination of the two types of learning is essential for a healthy organization (Levinthal and March, 1993, March, 1991). Excessive exploration at the expense of exploitation can be costly, as the tangible outcomes of exploration will only be realized in the distant future and then only with considerable uncertainty. On the other hand, a concentration on exploitation without exploration discourages the organization from pursuing learning and development. This can direct firms to focus only on the near future and potentially miss out on long-term investments and opportunities that may prove valuable. Therefore, the recommendation of a well-balanced combination of the two should come as no surprise.

However, what is less understood and less well-documented in the literature is the contingency perspective of organizational learning that underscores the effectiveness of both types of learning under different contextual conditions. We draw on the strategy typology of Miles and Snow (1978) to examine how prospectors and defenders benefit by balancing exploration and exploitation when competition intensifies. We expect that the same exploratory or exploitative action will have different effects on performance depending on whether it is used by prospectors and defenders. The rationale for this belief rests on our assumption of prospectors' strong orientation towards exploration and defenders' strong orientation towards exploitation and the differential consequences of these actions under conditions of intensifying competition.

The goal of this paper is to develop a contingency model that tests the moderating role of competitive intensity on the relative effectiveness of exploration and exploitation on firm performance for prospectors and defenders. In addition, we provide a further refinement to existing measures of firm performance by looking at the categories of effective and efficient firm performance.

This study also explores the validity of Miles and Snow's (1978) construct of strategy type, using the concepts of exploration and exploitation. Despite the theoretical linkage between organizational learning (e.g., exploration and exploitation) and strategy type (e.g., prospectors and defenders), no research to date has empirically tested the validity of the models of exploration and exploitation and their differential effects on firm performance as a function of strategy type. Our study explicitly tests this assertion. Moreover, although prospectors and defenders, largely by assumption, are known to react differently to environmental change, no empirical results exist to confirm how the balance of exploration and exploitation alters for prospectors and defenders with intensified competitive pressure. In what is to follow, we provide the theoretical background four our argument along with testable hypotheses. This is followed by a presentation of empirical results and a discussion of the results. We end with a discussion of limitations and future research directions.