Strategic Renewal Over Time: The Enabling Role of Potential Absorptive Capacity in Aligning Internal and External Rates of Change

Top managers of multinational corporations are increasingly confronted with an accelerating rate of change in the external environment. Yet strategic renewal literature has devoted limited attention to the organizational mechanisms enabling firms to align internal with external rates of change, so as to achieve a dynamic firm-environment fit over time. This paper addresses that gap by taking a knowledge-based perspective. We develop a framework clarifying how a firm's potential absorptive capacity enables it to align internal with external rates of change. We illustrate the framework empirically by analyzing the rate of change in strategic renewal actions of Royal Dutch Shell as an indicator of the company's internal rate of change in the period 1980-2007, and by comparing it with external rates of change in the oil industry over the same period. The findings show that Shell's potential absorptive capacity was positively related to the alignment of internal and external rates of change. In addition, we find evidence that the degree of alignment was positively related to the company's performance during the observation period. Our study implies that managers who are aiming to align internal and external rates of change over time should: 1) monitor external rates of change through environmental scanning and boundary spanning, 2) create shared understanding of the long-term implications of change, 3) identify drivers of internal rates of change and understand how to pace the rate of strategic renewal actions, and finally, 4) maintain baseline levels of potential absorptive capacity, since increasing potential absorptive capacity takes time and requires a long-term perspective.

Introduction

An enduring perspective in strategy research is that to survive over time, organizations need to be aligned with their environment (Venkatraman and Camillus, 1984; Venkatraman and Prescott, 1990; Cohen and Levinthal, 1990; Zajac et al., 2000). This suggests that organizations may best match their internal strategic renewal to opportunities and threats arising in their external environment. Underlying this notion is a rich debate about whether organizations can self-renew in order to sustain such a dynamic fit over time. While one stream of research suggests that organizations are unable to change and become increasingly inert as they age and grow larger, another provides numerous examples of long-lived firms, indicating that organizations may well be able to sustain their competitive advantage in the face of change through strategic renewal (Lewin and Volberda, 1999).

Hannan and Freeman's seminal article suggests that a resolution of these seemingly opposing perspectives should be sought in a temporal context (Hannan and Freeman, 1984). Rather than assuming that organizations fail as a result of a general inability to change when faced with environmental change, they argue that failure results from a discrepancy between the pace of organizational change and the temporal pattern of change in key environments (i.e., relative inertia). In a similar vein, Volberda and Lewin (2003), among others, suggest that organizational survival involves managing internal rates of change so that they equal or exceed relevant external rates of change (e.g., competitors, technology, customers, et cetera) (See also: Gersick, 1994; Brown and Eisenhardt, 1997; Eisenhardt, 1989; Hoyt et al., 2007; Levinthal, 1992; Williams, 1994). This notion is closely related to the concept of (tempo) entrainment, referring to the adjustment of the pace of an (endogenous) activity to match or synchronize with that of another (exogenous) activity (Ancona and Chong, 1996, Pérez-Nordtvedt et al.,2008). Indeed, the realization that pacing rates of change is crucial for a firm's competitiveness and long-term survival is also apparent in practice. For instance, in General Electric's 2000 annual report, Jack Welch – CEO from 1981 to 2001 – writes that “…when the rate of change inside an institution becomes slower than the rate of change outside, the end is in sight.”

Yet while the importance of aligning internal and external rates of change over time seems to be recognized, academic and managerial understanding of how organizations manage this challenge remains limited (Flier et al., 2003; Kwee et al., 2008; Nadkarni and Narayanan, 2007; Pettigrew et al., 2001). For instance, a recent study by IBM – involving 1,130 CEOs and public sector leaders from forty countries across thirty-two industries – signals that, while practitioners are increasingly expecting substantial changes in their environment, their ability to cope with and effectively manage these changes lags behind considerably (IBM, 2008).

This study aims to contribute to understanding of firm-environment co-alignment from a knowledge-based perspective. In line with this perspective, we present a framework to suggest that a firm's potential absorptive capacity – that is, its ability to acquire and assimilate externally generated knowledge – plays an important role in aligning the rate of its strategic renewal actions (reflecting realized absorptive capacity) with external rates of change (Zahra and George, 2002). We empirically examine our framework through a quantitative analysis of the association between Royal Dutch plc's potential absorptive capacity and the alignment of its strategic renewal actions with external changes in the oil industry between 1980 and 2007. Consistent with our framework, our findings indicate that during the observation period, Shell's potential absorptive capacity was positively related to its ability to align the internal rate of change with the rate of change in the external environment. Furthermore, we provide evidence that the degree of alignment was positively related to the company's performance during the observation period. From these results, we suggest that to increase the chances of organizational survival, managers should focus on developing and maintaining the organization's potential absorptive capacity so as to enable internal rates of change to be aligned with the rate of change in the environment.

This paper is structured as follows: the next section starts with a brief review of relevant literature on firm-environment co-alignment and absorptive capacity. We subsequently develop the research framework, and present our analysis of Shell's strategic renewal actions and changes in the oil industry over the period 1980-2007. Finally, we discuss our findings as well as managerial implications and directions for future research.