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nearly all relationships among competitors, are guided by the “invisible hand” of the market. Market-based interactions often are less freewheeling than one might expect. All firms are subject to regulatory oversight for environmental concerns, employment activities, new product development and testing, and potential anticompetitive interactions with competitors. Firms are subject to persistent power and dependence relationships with their trading partners. Managers at competing firms often acknowledge valuable industry norms and traditions, resulting in resistance to change on such matters as the adoption of new technologies and changes in work practices. The behavior of top managers in an industry sometimes appears oriented more toward winning peer approval and respect for themselves and their firms than toward maximizing shareholder wealth.
Sociologists study these aspects of firm behavior by focusing on institutions, which are relatively stable organizational arrangements, often possessing a distinct identity within the broader social context, that help bring order to sets of economic transactions. Institutions can involve the formal regulation of firms, whether by government agencies or other nongovernmental regulatory organizations. They can also be less formal and involve ongoing power–dependence relationships between firms that come to be taken for granted. Finally, similar to how we discussed a firm’s culture earlier in this chapter, institutional arrangements may embody general patterns of values, beliefs, and behavioral norms that motivate and stabilize affected firms.37
Firms not only react to the demands of the external environment; firms sometimes influence their external environment to their advantage. Large and successful firms such as Google, Hyundai, and Tata may be able to influence regulation, drive industry innovation, discipline their buyers and suppliers, and even modify industry culture on their own terms. Smaller firms, often in conjunction with competitors and media organizations, may jointly lobby regulators and cooperate with government agencies to bring about favorable regulatory or environmental changes or oppose the actions of strong competitors. In many U.S. communities, for example, local retailers have successfully lobbied their legislators to block the expansion of Wal-Mart and other superstores.
Institutions and Regulation
Government regulation imposes rules on firms and enforces them by imposing penalties for noncompliance. A variety of quasi-public and professional groups, such as professional and trade associations, may also set rules for membership. When those professional groups have public legitimacy, these rules are as binding as government regulations. For example, health insurers will not reimburse hospitals unless they are accredited by the private Joint Commission on the Accreditation of Healthcare Organizations (JCAHO). The coercive side of rules and regulations must generally be minor, however, since rules based largely on the threat of force are unlikely to be widely accepted and valued, and monitoring and enforcement are costly. Indeed, JCAHO accreditation requirements are fairly unrestrictive, and few hospitals are ever put on “probation,” let alone lose accreditation. Regulations must also be seen as legitimate to be effective. They constitute the “rules of the game” that provide a common basis for all participants in an industry.38
Regulatory activity has a huge influence on the strategic behavior of firms. The Sherman and Clayton Acts in the United States, and similar laws in the Treaty on the Functioning of the European Union, limit the size and scope of firms. There are laws governing how firms share information and whether they can “steal” information, for
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example, by hiring key employees from competitors. Interlocking corporate directorships are generally illegal in the United States and Europe but allowed in Asia. Tax regulations can alter the course of whole sets of corporate activities, ranging from charitable donations to the securing of advice on corporate control transactions. In certain industries, such as commercial aviation, regulations of the U.S. Department of Homeland Security have greatly increased the costs of doing business for all competitors while eliminating the competitive value of some capabilities (rapid gate turnaround) that some airlines, such as Southwest, had developed since the industry was deregulated in 1978.
Regulation imposes costs on firms. These include the direct costs of compliance, the increased business costs due to noncompliance (for example, the costs of borrowing with a poor rating from a rating agency), the costs of strategic options that must be forgone because of regulations, the higher prices for goods that consumers pay, along with other potential distortions to a market that may result from the imperfections of a given regulatory regime. If a firm, often jointly with others, pursues what David Baron calls a “nonmarket” strategy that attempts to shape legislation through lobbying, then the costs of such a strategy must also be considered.39 Such a strategy can be very successful, at least for a time, but it is also expensive and risky.
Some firms can gain a strategic advantage from regulation. Patents grant inventors up to 20 years exclusivity in which they may enjoy monopoly profits. Licensure laws restrict entry into professions. Governments subsidize some technologies while imposing regulatory costs on others. For example, farmers in the United States benefit from rules requiring ethanol in gasoline, while natural gas developers face steep environmental hurdles. These rules can be explained by simple political economy. Powerful incumbents may find that government regulators are receptive to their campaign contributions, while potential entrants are unable to assure the same level of support. Industry-specific regulatory agencies may actually protect incumbents and come to associate with their economic interests. In times of significant change, however, such as from technological innovations or increased global competition, protective regulations are more likely to impede the ability of incumbents to adapt. The strategic implications of regulations for firms are complicated by the fact that regulatory organizations are seldom neutral third parties but instead are pursuing their own strategies, using their regulatory power to do so.
Interfirm Resource Dependence Relationships
Firms develop relationships with other firms and organizations in their environment, whether competitors, buyers, suppliers, complementors, or nonbusiness organizations. Just as individuals can develop power/dependence relationships with other individuals, firms can develop power/dependence relationships with other firms. Asymmetries in information, resources, capabilities, and other factors often characterize these relationships and lead to the development of these relationships. For example, an importing firm can become dependent on its supplier, especially if the imported goods are of critical importance and not otherwise available.
The concept of power/dependence relationships between firms is closely related to the holdup problem that we discussed in Chapter 3, and the solutions are similar as well. Firms can reduce their dependence on trading partners through vertical integration, long-term contracting, or joint ventures and alliances. Several studies have documented such effects. Jeffrey Pfeffer documented how asymmetric power relations between buyers and sellers were associated with the motivation for vertical mergers.
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Menachem Brenner and Zur Shapira found that asymmetric trading was positively associated with vertical mergers, while mutual trading was inversely associated. Sydney Finkelstein replicated Pfeffer’s study, but only weakly, showing that, although resource dependence contributes to our understanding of vertical mergers, it is not the principal explanation.40
The discussion thus far centers on bilateral power/dependence relationships. In some situations, many firms become dependent on a key player in the vertical chain. For example, in developing economies, a shortage of capital along with profound market imperfections may discourage foreign investment. In these situations, we often see the emergence of business groups centered on either a trading family with a strong name or a large financial institution. These groups serve as intermediary structures between governments and markets, and are common in Japan, Korea, India, and other Asian nations. More recently, multinational firms have adopted approaches similar to those of business groups in their strategies for emerging markets. Tarun Khanna and Krishna Palepu develop this approach in terms of institutional voids, by which they refer to the absence of important market intermediaries that provide market participants with the requisite information, contract enforcement, and related services needed to consummate their transactions.41 Strategies in these markets require firms, either individually or collectively, to address institutional voids, in effect doing some of the work expected of government in providing infrastructure, such as assuming an intermediary role in a market. Failing this, firms in emerging markets need to determine how to adapt their business models to work around institutional voids and ensure that they can do business effectively. If adaptations are not possible, then firms must either postpone their entry to these markets or consider exiting them if they are already competing there.
Important industry resources can be tangible, such as money and raw materials, or intangible, such as status and reputation. A firm with a strong and positive reputation or high status can more easily establish a presence with customers, negotiate with suppliers, and secure cooperation within the vertical chain. Smaller and less established firms will want to associate with high-status firms to benefit from their superior standing and higher status. This interaction can provide a basis for associations among firms. For example, Joel Podolny studied the groupings that arose among investment banks around the issuance of new securities, based on evidence from “tombstone” announcements for a sample of financial transactions.42 Tombstone notices are plain advertisements printed in black and white that inform investors of the date when a security issue will become available, how many securities are being offered in the issue, and the names of the underwriters that have undersigned the securities. The Securities and Exchange Commission regulates what information can be included in these announcements. The lead firms in an issue, along with other participating highstatus firms, are listed prominently on these notices, and the placement of names on them is a matter of negotiation for the principal firms. The additional firms participating in an issue are listed on the announcement below the lead firms. The role of a bank in a given deal, and its compensation from the deal, were associated with its position in the status ordering suggested by the announcement.
There are many ways that a firm’s reputation can suffer. A product may fail or be recalled for safety reasons, such as Merck’s Vioxx drug. Disasters, both natural and man-made, can strike, such as Hurricane Katrina or the 2010 BP Deepwater Horizon oil spill in the Gulf of Mexico. While Hurricane Katrina clearly damaged the reputations of New Orleans and FEMA and BP is a clear loser from the spill, firms such as Wal-Mart, Home Depot, and Lowe’s actually saw their reputations enhanced as a result
