Managers trying to gauge the impact of applying external knowledge sources to their firms’ innovations can draw on an existing body of research to help them in their task. However, there is very little research to help those same managers determine how that knowledge will impact their firm’s performance. The difficulty of measuring this impact represents a particular challenge for managers, as many today believe that the acquisition and application of knowledge from external sources will clearly have a positive impact on firm performance.
Our purpose in writing this article is to assess, in general terms, just what impact the use of external knowledge has on firm performance. In the article we address this central question: Does the use of external knowledge actually deliver the competitive advantage that many think it does? In the article we highlight the costs of acquiring external knowledge and the risks of assimilating that knowledge either improperly or inadequately. We suggest that the benefits of using external knowledge sources may not be consistently positive, but rather that the benefits are dependent on a firm’s strategies and capabilities. As we point out, the performance of firms that acquire a considerable amount of external knowledge without the ability to apply it effectively will decline when they enter multiple, new-product markets. On the other hand, firms with a well-developed capacity for assimilating knowledge acquired from external sources will likely improve their performance because they can manage the associated costs and risks and know how to deploy it effectively.
Using external sources in the process of creating knowledge
The ability of organizations to create, transfer, assemble, integrate and leverage knowledge is fundamental to achieving competitive advantage. Creating new knowledge, however, often involves combining internal and external knowledge in a unique way. From our perspective, internal knowledge is all the knowledge that a firm has created within its boundaries, while external knowledge is the knowledge that other firms have created and is thus stored within those other firms’ boundaries.
Firms rely on and acquire knowledge created by other firms for two primary reasons. First, creating knowledge typically involves enormous costs, costs that are often beyond the capacity of a single organization to incur. This is particularly true in knowledge-intensive industries, where standards and technologies change rapidly. Therefore, firms often form joint ventures, strategic alliances or networks so that they can pool their resources in their efforts to create new knowledge as a source of competitive advantage.
Second, the process of gathering or creating knowledge is never complete. Rather, it continues indefinitely through the continuing interactions between and among individuals and organizations. As a result, firms need to interact with and monitor the environment for sources of external knowledge to better understand and manage their knowledge-development process. In that spirit, firms often interact with suppliers, customers, competitors, industry associations and research communities.
It is definitely true that firms can benefit by using knowledge created by other firms to create new applications or new products. Often, such new applications and products tend to be novel and path breaking. However, novelty alone does not always guarantee commercial success. While firms may create better innovations by using external knowledge, those innovations may not necessarily result in improved firm performance because these firms may not be able to manage the costs and risks involved in acquiring and using external knowledge.How using external knowledge can impact firm performance
Acquiring external knowledge involves several costs. First, organizations need to scout the environment and search for appropriate knowledge that they can use. For this purpose, organizations need to create and maintain social networks, which take time and resources to build and maintain. Second, managers need to select the company that owns the required knowledge. This process involves bargaining and evaluating the pros and cons of each technology. Third, organizations need to monitor and enforce the agreements they made with other organizations that are related to acquiring the knowledge they find useful. It is not uncommon for these costs to exceed the potential benefits that external knowledge might deliver.
In addition to the costs of acquiring external knowledge, firms also run the risk of not fully absorbing external knowledge because of its tacit nature, something which makes it difficult to identify, understand and acquire. As well, external knowledge may reside in the private domains of other firms, which makes the acquisition process even more difficult. When a firm acquires external knowledge, it is more likely to acquire the explicit dimension that is typically easily accessible, the least complex and resides in public domains. It is more challenging to acquire the knowledge that is tacit, complex, and private. Given that the value of knowledge is often buried in the tacit core, efforts to acquire and absorb external knowledge are sometimes unsuccessful. Acquiring and using external knowledge does not guarantee a company that it will achieve competitive advantage because competitors can often acquire the same knowledge just as easily. Therefore, acquiring external knowledge might, at best, provide competitive parity but not competitive advantage. In the end, the firm that originally created the knowledge understands it better and is more likely to realize performance benefits than the firm that acquired it.
The intersection of external knowledge, firm strategy and performance
While all firms face the associated costs and risks of acquiring external knowledge, such costs are likely to be much higher for firms that are implementing new-product, market-entry strategies. This is mainly because firms that enter fewer new-product markets will need less external knowledge than those that enter more markets. Firms that are not pre-occupied with the issues of moving into new-product markets will have the time and resources to better deal with the challenges of acquiring and integrating new sources of external knowledge In contrast, firms that are engaged in the process of entering several new-product markets in a relatively short period of time might require more external knowledge to help manage the process, but they might not have the required time and resources to acquire and apply it.
In other words, using external knowledge will likely hurt the performance of firms that enter more new-product markets. This is because of the enhanced costs and risks of acquiring that knowledge, and the limited resources and time the companies have available to deal with each new-product market entry. Therefore, firms that rely on external knowledge to a high degree but are not pre-occupied with the implementation issues of entering new markets will perform better than those firms that use external knowledge extensively while implementing new-product market entry strategies.How the ability to “absorb” is related to external knowledge use and performance
The capacity to absorb, or absorptive capacity, is a fundamental learning processes related to a firm’s ability to acquire and apply knowledge. This ability is largely reflected in a firm’s R&D capabilities, though social interactions and power relationships within a firm are also important factors.
As a fundamental learning process, absorptive capacity influences the relationship between the use of external knowledge and performance in two primary ways. First, it reduces the costs of acquiring external knowledge by effectively identifying the most appropriate areas of external knowledge that the firm should acquire. Secondly, absorptive capacity enables firms to acquire external knowledge efficiently. A firm’s ability to absorb another firm’s knowledge is a relative concept, similar to two people who speak a common language and who are trying to exchange ideas. Just as two managers would be more likely to exchange ideas productively if they have same training and education, a firm can acquire knowledge from another firm more effectively if it uses a similar technology base.
Empirical evidence suggests that firms that are more absorptive will be more likely to acquire and assimilate knowledge effectively, whereas those less able to absorb knowledge will be more challenged in the process of knowledge transfer. Beyond the acquisition and integration issues, several areas of research suggest that firms with a higher ability to absorb knowledge will be more likely to develop new innovations with greater scale and quality. Therefore, firms that use external knowledge extensively and have a high absorptive capacity will perform better than firms that also use external knowledge extensively but have a low absorptive capacity. Research findings and implications
To validate our arguments, we conducted an empirical study of the 15 largest firms in the semiconductor industry. We examined almost 4,600 patents that these firms held, and determined how much external knowledge was used in developing those patents. We then analyzed the performance of firms by correlating it with their use of external knowledge, along with their product-market entry strategies and their capacity to absorb external knowledge.
Our results showed that the use of external knowledge could have a negative effect on firm performance if it occurred at the same relative time as implementing several new-product markets. We believe this effect reflects the difficulties in acquiring and applying external knowledge effectively during a time when a firm’s strategic capabilities are focused on the challenges of developing and marketing new product markets. This is because when firms enter new-product markets, they often face new technologies, new standards and new practices. Further, the knowledge that they currently possess might not be sufficient to meet the needs of the new markets. Consequently, firms may be forced to acquire external knowledge even though they may not know how to properly absorb the new external knowledge. As a result, firms that use external knowledge extensively while simultaneously implementing new-product market entries benefit much less from that external knowledge than firms that make fewer new-product market entries.
We found that firms with a higher absorptive capacity can likely mitigate the risks and costs associated with the extensive use of external knowledge. While firms can improve their absorptive capacity in many ways, we believe that having R&D facilities in multiple locations allows firms to better identify the knowledge they need from around the world and to access the tacit dimension of external knowledge by virtue of sharing the same context as the knowledge source. In addition, firms can also improve their absorptive capacities with the help of good communication, coordination and other similar mechanisms that help different parts of the organization know each other’s capacities and draw on them to make an effective use of the acquired external knowledge. Consequently, firms with a higher absorptive capacity can use external knowledge effectively and, hence, realize the expected performance benefits.
Overall, our study revealed that the use of external knowledge does not always have a positive effect on firm performance. It appears that the firms that do benefit from external knowledge use are those that are not pre-occupied with implementing new-product market entry strategies. Our findings magnify the need for managers to be careful about using external knowledge that their firm cannot absorb effectively, particularly when they are pursuing new product market entry strategies.
Our study highlights that using external knowledge is not always beneficial to firms. While this might contradict some existing thinking, managers can relate to the fact that even using internal knowledge for new applications is not easy and is fraught with the complexities of knowledge transfer. Therefore, the challenges of assimilating and applying external knowledge to realize performance benefits can be expected to be far greater. Our research has only confirmed this observation and underscored the need to weigh the benefits of using external knowledge against its associated costs and risks.
While firms can definitely benefit from using external knowledge, they must first recognize and manage the associated costs and risks in order to do so. This is imperative because costs and risks can become unmanageable and decrease the financial performance of firms, particularly when they enter new-product markets or do not have sufficient absorptive capacity. Managers who think about acquiring and using external knowledge from a strategic perspective will help themselves succeed in those two tasks and improve their ability to derive competitive advantage.
Reprint from Ivey Business Journal
[© Reprinted and used by permission of the Ivey Business School]