Conceptual Framework and Hypotheses

5.1.2 From Entry Barriers to Mobility Barriers

In the early 1970s, guided by Caves and Spence, a number of researchers including Hunt, Newman, and Porter, engaged in doctoral research investigating the existence of structural asymmetries within industries and modeling the competitive behavior of firms on the basis of these asymmetries. They also initiated theorizing about strategic groups and formalized the strategic grouping approach (Faulkner et al. 2003). Coined by Hunt in his doctoral dissertation in 1972, the strategic grouping idea caught on with two publications from Caves and Porter in the late 1970s (Caves et al. 1977; Porter 1979).

A strategic group can be seen as a set of firms within an industry that are similar to one another and different from firms outside the group on one or more key dimensions of their strategy. While in traditional IO view firms are assumed to be alike except for their size, strategic grouping view conceptualized the economic understanding of the heterogeneity of the firm (Porter 1979; Porter 1980).

One heterogeneity finding suggested that firms established in other markets were often the least disadvantaged entrants to an industry. Investigations implied that assets of established firms influenced their strategic position as entrants, notably ‘excess capacity’ of underutilized assets and ‘price discrimination’ due to capacity that can be put to use in various markets. This drove an extension of the ‘barriers to entry’ view. Recognizing that entry barriers are partly structural and partly endogenous, the view set forth as a general theory of the mobility of firms among industry spaces, encompassing exit and strategic shifts as well as entry intro new spaces. The generalization of ‘entry barriers’ into ‘mobility barriers’ provided the anchor of mobility barriers theory, rationalizing why some strategic groups can achieve persistent performance advantages over other strategic groups (Bain 1968; Caves et al. 1977;

Porter 1979).

It was argued that tacit collusion by strategic group members to establish group protection can contribute to superior performance of the group as a whole, as well as to that of the individual firm (Fiegenbaum et al. 1995). The intensity of inter-group competition was linked to three factors: number and size distribution of groups, strategic distance between groups, and market interdependence between groups (Porter 1979). Porter also suggested that variances in performance across strategic groups may be affected for three reasons:

differences in bargaining power, differences in exposure of strategic groups to substitute products, and differences in the degree to which firms within the group compete with each other.

5.1.3 Strategic Groups

The contribution of Hunt, Newman, and Porter, shaped the general thinking in suggesting that firms within the same industry are likely to differ on traits other than size. This paved the way for debates about whether the firm or the industry, or some intra-industry group stratification

is the appropriate unit for analysis (McGee et al. 1986; Faulkner et al. 2003). McGee and Thomas specified the definition for the firm within a strategic group: “A firm within a group makes strategic decisions that cannot readily be imitated by a firm outside the group without substantial cost, significant elapsed time, or uncertainty about the outcome of those decisions” (McGee et al., p. 150). The definition comprises the mobility barriers concept, formalizing barriers either as absolute cost of movement from one strategic position to another or as the cost penalty that the group entrant must face relative to group incumbents.

Figure 39 illustrates major sources of mobility barriers (McGee et al. 1986).

Market Related Strategies Market Related Strategies Product line

User technologies Market segmentation Distribution channels Brand names Geographic coverage Selling systems

Industry Supply Characteristics Industry Supply Characteristics Economies of scale

• Production

• Marketing

• Administration Manufacturing processes R&D capability

Marketing and distribution systems

Characteristics of Firms Characteristics of Firms Ownership

Organization structure Control systems Management skills Boundaries of firms

• Diversification

• Vertical integration Firm size

Relationships with influence groups Market Related Strategies

Market Related Strategies Product line

User technologies Market segmentation Distribution channels Brand names Geographic coverage Selling systems

Industry Supply Characteristics Industry Supply Characteristics Economies of scale

• Production

• Marketing

• Administration Manufacturing processes R&D capability

Marketing and distribution systems

Characteristics of Firms Characteristics of Firms Ownership

Organization structure Control systems Management skills Boundaries of firms

• Diversification

• Vertical integration Firm size

Relationships with influence groups

Figure 39: Sources of Mobility Barriers Creating Competitive Advantage

Source: McGee et al. (1986), p. 151

Mobility barriers view and strategic grouping approach enrich strategy analysis.³³

It became generally recognized that strategic grouping provides major benefits for strategic management research: rich interpretations of industry structures and firm asset structures with impact on competition, conceptual frames for analyzing change over time and across sectors, and a taxonomy for interpreting change of asset structures of firms with effects on competition in the long run (McGee et al. 1986; Faulkner et al. 2003). Therefore strategic grouping approach was chosen for this research endeavor.

Provided strategic groups exist, their demography can reflect competitive dynamics and their formation can reflect strategy innovations and risky decisions. Mobility barriers facilitate our thinking about strategic thrusts that underpin market position and competitive advantage. Related considerations naturally link to resources and core capabilities of the firm.

33 One example of a prominent strategic group framework is Porter’s two by two matrix, mapping cost advantages accruing to larger competitors due to effects of scale or experience on one axis, and advantages from specializing on customer groups or by developing unique specialist skills on the other axis. Another prominent example of the essence of strategic grouping is the BCG matrix, a model allowing for the investigation of the boundary of the firm. The BCG matrix maps relative market share on one axis and industry growth rate on the other axis. Although the BCG matrix prescribes the optimal intra-firm business portfolio mix of a multi-business firm, it is based on variables which apply the industry as unit of analysis.

Academic research based on strategic grouping approach often links group membership to performance, investigates industry and firm evolution, and also investigates dynamic strategic groups and hybrid strategic groups (McGee et al. 1986; Daems et al. 1994; DeSarbo et al.

2008; DeSarbo et al. 2009). Though research interest with respect to performance-related investigations has a long tradition, empirical evidence supporting a link between group membership and group profitability is rather weak.

It was argued that the overly narrow focus on performance leads to limited insights to be gained from strategic grouping research. Also the drive for quantification seemed to have overshadowed the need to adequately specify the business model and the strategic dimensions being addressed. In fact, a minority of strategic grouping studies emphasized a detailed understanding of the sector context in specifying strategic variables. It was criticized that often strategic grouping studies rely on broad indicators and that few researchers have chosen to build their own sector expertise from which variable identification and specifications could proceed (McGee et al. 1986; Daems et al. 1994). The overall research design of this study deliberately intends to mitigate these issues.

5.1.4 Hypotheses

Until now, most research on PE has by and large investigated the PE industry and its participants through a homogenous view. Academics and practitioners often use the term PE as a synonym for either VC or LBO activity, and firms with a footprint in traditional PE are generally being perceived as VC or LBO associations, even if traditional PE activity only constitutes a small share of their overall business.

Though academic thirst for quantifiable empirical results might facilitate an efficient utilization of research capacity, the marginal practical relevance of many findings must raise concerns about research effectiveness in PE. Often researchers rush into analyzing samples of firms which on the face are marked as PE firms. For example, PE firms who may have less than 50% in assets under management in PE get clubbed with monolithic PE firms.

In samples where data actually would allow for a richer understanding of contemporary PE firms, the prevailing monolithic view of PE triggers adjustments of non-traditional PE activities. Although this reduction in complexity can make research efforts less cumbersome, it also falsely reinforces the homogeneity view and monolithic view of the PE firm.

An analysis of PE strategy considerations based on evolutionist approach, empiricist approach, and essentialist approach, a broad synthesis of PE literature, and expert interviews, indicated that the prevailing homogeneity view of the PE firm might be myopic. This central thesis will be tested empirically by investigating whether hypothesis A1 can be accepted (by rejecting A0).

A1: The PE sector is heterogeneous and strategic groups exist

A0: The PE sector is homogeneous and firms do not differ on specific traits

It seems plausible that different PE firms can successfully pursue various competitive strategies, depending on their strategic group affiliation. Yet, what is success for the PE firm?

Most performance studies in the PE context used fund performance or portfolio company performance as an approximation for the success of the PE firm. Nevertheless, success of the PE firm on the corporate level can also be approximated by measuring other variables such as growth of assets under management, capital supply, reputation, or operational efficiency of the PE firm. Not all success variables of the PE firm must correlate with investment performance measures. Scale, for example, typically leads to lower investment performance suggesting less success of the PE firm. However, the same large PE firm can be considered very successful when looking at its high management fees (Lopez de Silanes et al. 2009;

Metrick et al. 2009).

Therefore the full success story of the PE firm is perhaps more multi-layered than might instantly appear. If the heterogeneity view holds, it is also possible that several successful competitive strategies exist for PE firms, a hypothesis (B1) which will also be tested.

B1: Several successful strategies exist in the PE sector B0: There is one best strategy in the PE sector

Empirical research in other strategic spaces showed that in contemplating strategic change, firms typically monitor the behavior of similar reference organizations in the same competitive environment in their search for new strategic options. It was observed that firms examine the recipes of competitive groups and focus initially on their own strategic group as a reference point (Huff 1982; McGee et al. 1986; Huff et al. 1992; Fiegenbaum et al. 1995).

Often PE firms are regionally concentrated around major financial hubs and many PE investment professionals belong to relatively tight relationship networks. So in spite of the sector’s secretiveness, the proximity between PE investment professionals and networks effect in general can allow for the diffusion of information across firm boundaries (Sorenson et al. 2001; Seppä et al. 2002; Hochberg et al. 2005; Loos 2005). In recent years PE firms also became increasingly transparent about themselves. This indicates that it is possible that successful firms in the PE sector monitor other firms in their strategic group as reference points, converging to each other over time (see hypothesis C1).

C1: Intra-group variances of successful strategic groups converge to the mean over time C0: Intra-group variances of successful strategic groups stay stable or increase over time

The notion of industry confines and boundaries of strategic spaces is fuzzy. Like arbitrary set borders between countries, there is often no natural separating element between strategic spaces. Strategic spaces investigated by traditional IO research typically had a natural separating element. In the financial services space it is difficult to find such separating elements, except for regulation. Without such natural frontiers, why should PE firms not

gradually expand into attractive adjacent strategic spaces? Therefore this study also tests whether PE firms are traversing the strategic space of the PE sector (see D1).

D1: One or more strategic groups traverse the boundaries of the PE sector D0: All PE firms are within the confines of the PE sector

Provided D0 can be rejected, two interpretations appear to be plausible. Either a strategic group is in the process of traversing the confined strategic space toward another strategic space, and typology, industry definitions, SIC codes, databases and regulation will be adjusted accordingly sometimes in the future. Alternatively, it could also be that a strategic group is shaping the boundaries of the strategic space, i.e. it is either expanding the pre-confined space or it is pioneering a completely new strategic space. The respective hypothesis (see E1) will also be tested.

E1: Traversing strategic groups shape the boundary of the strategic space of PE E0: Traversing strategic groups move on to other strategic spaces

A typical problem of research is that it often does not describe how crucial issues were addressed. It was recommended that underlying methodological decisions should be presented in sufficient detail to allow readers to make informed judgments about findings (Cummings et al. 1995). This is even more vital for studies using strategic grouping approach, given the relevance of researcher judgment (Ketchen et al. 1996). The following section presents the methodology, as well as the underlying data which was investigated during empirical testing.

The subsequent chapter will interpret the results and provide an outlook for future research.