Firm knowledge, stepping stones, and the evolution of capabilities

Theoretical developments in strategic management have emphasized the importance of the firm\u27s developmental pathway in the evolution of firm capabilities. New market entry is an important pathway for the growth of the firm and is thus a primary means for capability development. In a capabilities framework, however, market entry is a complex decision burdened with a number of important considerations. These include which market should be the next target; the mode of entry; the degree to which a firm\u27s current knowledge base may be leveraged for gain in the new market; and which market experience will contribute the most to new knowledge creation within the firm. In this dissertation we explore how the knowledge and capabilities of the firm influence market entry decisions and choice of entry mode and the influence that market experience has on firm capabilities and future market opportunities. We argue that since capabilities arise from and are enhanced by industry experience, the profit-maximizing, multi-unit firm finds it beneficial to ‘step through’ industry experiences in deliberate ways in order to exploit existing capabilities and to extend capabilities in order to prepare for distant target markets. We focus the conceptual discussion on the nature of knowledge, the direction of firm expansion, and capability dynamics of exploitation and extension. We develop the foundations for a theory of capability overlap and explore firm behavior under these conditions by means of an infinite-horizon dynamic program. The model captures the mechanisms involved in the evolution of capabilities and shows how stepping stone behavior arises from capabilities overlap. A featured aspect of the research is the development of a measure of inter-industry relatedness that explicitly identifies the knowledge overlap structure among industries. We employ the measure to answer several fundamental questions about the direction of firm expansion and the mode of entry. Empirical results show that firms tend to follow a knowledge-based logic as they expand, and that the relatedness of existing productive knowledge to an industry target strongly predicts the entry mode