Opportunities and Diversification - Expansion of Business by Analyzing the Structural Capital of Engineering Service Firms

TABLE OF CONTENT

ABSTRACT

TABLE OF FIGURES

LIST OF TABLES

LIST OF ABBREVIATIONS

1 INTRODUCTION AND PROBLEM STATEMENT
1.1 Description and Aims of the Research Project
1.2 Objectives and Contributions

2 PORTRAIT THE FIRM

3 THEORETICAL FRAMEWORK
3.1 Market-based View
3.1.1 External Analysis
3.2 Resource-based View
3.2.1 Capabilities as Organizational Routines
3.2.2 Dynamic Capabilities Approach and Competitive Advantage
3.2.2.1 Using Dynamic Capabilities to identify the Corporate-level Strategy
3.2.2.2 Sensing, Seizing and Reconfiguring: Driving Strategy into Action
3.2.2.3 Assessing Dynamic Capabilities
3.2.3 Capability Lifecycle and Evolution
3.2.3.1 Capability Branching and Transformation
3.2.3.2 Transferring Capabilities
3.3 Symbiosis of the market-based and resource-based perspective
3.4 A new Competitive Landscape: Knowledge-based view
3.4.1 Knowledge-Intensive Organizations
3.4.2 Performance Drivers under a Knowledge-based Perspective
3.4.3 Knowledge in Engineering Context

4 INTELLECTUAL CAPITAL
4.1 Classification of Intellectual Capital
4.2 State of the Art in Intangible Asset Research and Reporting

5 KNOWLEDGE MANAGEMENT
5.1 Recognizing Companies with different Knowledge Orientation
5.1.1 Company 1: people-centered
5.1.2 Company 2: process-oriented
5.2 Organizational Learning
5.2.1 Organizational Learning in Context
5.2.2 Clarifying the Nonaka and Takeuchi Model
5.2.2.1 First step: Socialization (tacit-to-tacit)
5.2.2.2 Second step: Externalization (tacit-to-explicit)
5.2.2.3 Third step: Combination (explicit-to-explicit)
5.2.2.4 Fourth step: Internalization (explicit-to-tacit)
5.2.3 The role of Organizational Learning in Dynamic Capabilities

6 PROPOSAL FOR SENSING CAPABILITIES
6.1 Why Structural Capital?
6.1.1 Antecedents
6.2 Methodology
6.3 Framework Design
6.3.1 Step 1: Assessment of the Business Environment
6.3.1.1 System Scope
6.3.1.2 Environment Analysis
6.3.1.3 Preliminary Business Results
6.3.1.4 Preliminary Business Processes Analysis
6.3.2 Step 2: Structural Capital Item analysis
6.3.3 Step 3: Clarification of Organizational Processes
6.3.3.1 Input: Definition of Processes and Cluster of SC Items
6.3.3.2 Input: Resource Configuration
6.3.3.3 Output: Synthesis of the CSF and Insight of Resource Configuration
6.3.4 Step 4: Assessment of Organizational Capabilities
6.3.4.1 Operationalization of the Structural Capital
6.3.4.2 Input 1: Assessment Criteria
6.3.4.3 Input 2: Assessment Scale Factor
6.3.4.4 Input 3: Evaluation Questions
6.3.4.5 Output: Structural Capital Evaluation
6.3.5 Step 5: Business Model Assessment
6.3.6 Step 6: Assessment and Ranking of the Market Segments

7 STRATEGIC PROCESS TO SEIZE CAPABILITIES
7.1 Strategy Insight
7.2 Strategy Execution
7.3 Mechanisms for Dynamic Capabilities
7.4 Knowledge Accumulation in Engineering Context
7.5 Development of a Corporate Knowledge Strategy
7.5.1 Barriers in Knowledge Management
7.5.2 Codification vs. Personalization

8 DISCUSSION

9 CONCLUSION

10 BIBLIOGRAPHY

APPENDIX A: STRUCTURAL CAPITAL BENCHMARK FRAMEWORK FOR SENSING CAPABILTIES

APPENDIX B: LEADERSHIP MODEL FOR THE ENGINEERING SERVICE FIRM

APPENDIX C: STRATEGIC INTERRELATION OF THE CONSTRUCTS

Erklärung

ABSTRACT

The master thesis describes a plan to build a framework for analyzing intangibles. In my experience, the engineering company were I worked as a project manager has the necessity to enhance the ‘know-how’ and ‘know-why’ in fields like ‘Intellectual Capital’ and ‘Knowledge Management’, since they have the most outstanding impact (Ordoñez de Pablos 2002, p.287).

Even if the thesis direction seems to be taken arbitrarily, the decision is justified with solid facts; the future of every ‘professional service company’, among others, lies in the understanding of new business paradigms. We are now in the middle of a knowledge era, where intangibles have to gain a new priority in the management agenda. As Lev (2001) exposes, ‘the importance of intangible assets is a characteristic feature of the new economy. As economies are becoming knowledge and technology-based, the intangible assets of companies are essential determinants of firm present and future competitiveness.’ In intangible assets lies the growth potential and value of a firm. Intellectual capital is now the value driver of an enterprise and most valuable assets. It currently constitutes between one-half and two-thirds of corporate market value, of both ‘old’ and ‘new economy’ enterprises.

Managers in the professional service industry have to re-think an ‘inside-out’ knowledge perspective of business development. Evaluating a new market segment, based on its attractiveness and leaving the internal dimension away from any consideration could be disastrous for a service company. Resources are heterogenic in nature and they cannot be acquired so easily; they have to be analyzed and systematically raised, especially if they are intangible.

An internal look to the resources of a company and its development, combined with the recognition of market trends can give a guideline to analyze what knowledge is needed to compete in exotic markets.

Therefore, this work proposes to build a strategic model, based on different fields of intangibles and strategic management. As a result, this thesis will show how to look into the internal dimension and work with intangibles, in case the firm decides to expands its horizons and enter new markets. This model and tool shall contribute actively to the business intelligence of the company.

TABLE OF FIGURES

Figure 1: Capabilities scope of the firm

Figure 2: Portfolio market share/growth rate from BCG

Figure 3: Five forces model on industry analysis in allusion to Porter

Figure 4: Relation resources capabilities

Figure 5: Process perspective

Figure 6: Branches of the capability lifecycle in allusion to Helfat and Peteraf 2003

Figure 7: Companies according to the customer adaptation

Figure 8: Performance drivers under the KBV

Figure 9: IC construct

Figure 10: Research construct

Figure 11: Knowledge management approach in allusion to Ordoñez de Pablos 2003

Figure 12: People-centric firm in allusion to Roos et al. 2001

Figure 13: Process-oriented firm

Figure 14: Knowledge dimensions, adapted from Nonaka 1995

Figure 15: Learning spiral from Nonaka and Takeuchi 2001

Figure 16: Organizational Learning mechanisms

Figure 17: 'Structural Capital Benchmark Framework' for sensing capabilities

Figure 18: ICP of the firm of the cost center 1022

Figure 19: System scope

Figure 20: Example of the first hierarchical level of the target system (the main user group)

Figure 21: Screenshot of the value-benefit analysis

Figure 22: Input and Output of the step 3

Figure 23: Identification of critical success factors

Figure 24: Portfolio analysis adapted from Bornemann and Reinhardt 2008

Figure 25: Knowledge approach in allusion to McMahon et al. 2004

Figure 26: Bar chart of a capability trend

Figure 27: Industry-capabilities typology

Figure 28: From black box to BM in allusion to Bornemann and Reinhardt 2008

Figure 29: Proposed scheme of a cross-impact matrix

Figure 30: Example of a cross-impact matrix

Figure 31: Cross-impact matrix with the IC

Figure 32: Output of the impact analysis - Illustration of the business model

Figure 33: Portfolio assessment of attractiveness/dynamic capabilities for market entry decisions

Figure 34: Strategic interrelations of the constructs

Figure 35: Dimensions of the competitive strategy

Figure 36: Proposition of a new leadership model for the firm

Figure 37: Knowledge evolution

Figure 38: Barriers in knowledge management according to Fraunhofer IESE 2003

Figure 39: Social context between dynamic capabilities and knowledge management

Figure 40: Innovation focus in allusion to Ellonen et al. 2009

LIST OF TABLES

Table 1: VRIN typology of resources

Table 2: Resource configuration strategies

Table 3: Capabilities hierarchy of two ESP in the aviation industry

Table 4: Capability lifecycle

Table 5: Organizational knowledge approach

Table 6: Company types according to knowledge-perspective

Table 7: Knowledge assets in allusion to Nonaka et al. 2001

Table 8: System scope questions

Table 9: Summary of system components in the cabin conversion segment

Table 10: Level of influencing factors according to Bornemann and Reinhardt 2008

Table 11: Example of identified factors derived from ‘influencing factors’

Table 12: Examples of possible critical success factors

Table 13: Proposed evaluation criteria

Table 14: Interpretations of the stair histogram

Table 15: Sensing and seizing activities

Table 16: Proposed management mechanisms for deploying dynamic capabilities

Table 17: Knowledge strategies according to Hansen et al. 1999 and McMahon et al. 2004

LIST OF ABBREVIATIONS

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1 INTRODUCTION AND PROBLEM STATEMENT

The future of many firms in the aerospace sector is uncertain. Factors like the financial crisis have made the industry unstable. Companies that are unable to adapt to different markets have difficulties to survive. Hence, engineering products nowadays demand to acquire a knowledge-based perspective of work like ‘peer production’ or ‘mass collaboration’, to promote open management standards (Tapscott and Williams 2008) and to focus on services with more value-added, which means that companies need to reeducate itself and to make constant investments in intangible resources.

Furthermore, the new competitive landscape [^[1] ] demands that companies are aware of emerging driving forces like globalization, more sophisticated customers and competitors, increased technological capabilities, shortening of product life cycles and diversification (Ordoñez de Pablos 2002). These issues emphasize the demand of flexibility and speed in responding to fast-changing environments (Menguc & Auh 2006).

In addition, one of the biggest problems that the firm where I worked for one and a half year, and to which this study is dedicated, are facing is the asymmetrical changes affecting service markets. This firm turned from being highly competitive, based in quality management and technical expertise to be unable to deploy its expertise in other segments. Many competitors acknowledged earlier that the market is changing and achieved to seize a better position. Consequently, the firm was prejudiced.

1.1 Description and Aims of the Research Project

This master thesis aims to build a framework for a systematic assess of professional service markets, using the engineering approach of Bornemann and Reinhardt (2008). It is based on the theory of the structural capital and a strategic process to appropriate required capabilities in the target markets. At the present, what this company lacks are not the physical resources or technical competences, but capabilities that enable the firm to leverage new competences to address new markets.

Service industries, including engineering services providers (hereafter ESP), have the particularity that the ‘core competences’ and the ‘critical success factors’ are based on intangible assets. Hence, this thesis shall contribute to a development of a strategic view of intangibles. Building this framework will help managers to understand the process of developing and formulating an effective strategy, which meets the industry demands, and consequently, it will show how to react to new business paradigms.

As a starting point it can be stated, that the managers of this firm have not been aware that every segment of an engineering service provider has its requirements in a context of knowledge management. This fact illustrates the first insight about the necessity of this thesis to research the structural capital because of its essential role in the engineering service industry. A knowledge strategy can only be deployed and articulated by developing an effective structural capital policy. Hence, in this study the structural capital is the main object of investigation.

The project ends with a concrete proposal about management mechanisms to execute the model, a discussion of the implications and important issues to consider, as well as a review of the developed ‘leadership model’. Finally, this project aims to show the emerging business paradigm that drives the current evolution of the strategic management disciplines.

1.2 Objectives and Contributions

The main objective of this work is to create a framework and tool that helps managers to enhance the understanding of how the intellectual capital impacts the ESP sector, and thus to assess the potentials of new markets. In order to achieve this, a research model has been developed based on the theoretical framework built in the chapter 3 and the performance drivers explained in chapters 4 and 5. In addition, the model can be used to clarify the core capabilities or competency areas, patterns of working structure, firm culture, platforms methods other assets of target companies. Analyzing the intellectual capital should be a major issue before entering a new market. By benchmarking the structural capital, managers will understand which capabilities have to be raised or improved before appointing a call for tender. Furthermore, having achieved this assessment of structural capital, and similar analysis of human and relational capital, the company will gain expertise in the following areas:

- Predictability of performance
- Systematic decision making
- Effective control of intangibles
- Connecting intangible assets reporting with financial reporting practices

2 PORTRAIT THE FIRM

The firm used as analysis object is a company specialized in engineering for all industries: automotive, railway and electronic. The firm is present worldwide in 17 countries and does represent a total of 33 production centers and 2300 employees.

The aeronautical activities, developed since 1989, are fully managed by the aerospace division. This company represents a labor force of 600 engineers, experienced in aeronautics, trained on all state-of-the-art tools and with the capability to operate worldwide. Its main locations for aeronautics are in Germany, France (Toulouse), Spain (Barcelona) and the Netherlands (Haarlem). All these offices are located close to major aeronautical actors. Companies like Lufthansa Technik AG, and EADS Airbus GmbH amongst others, are some of the references that this firm relies on. The activities of the company are focused in 7 different areas: Styling, engineering & design, calculation, development, project management, technical documentation and integration.

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Figure 1: Capabilities scope of the firm

3 THEORETICAL FRAMEWORK

3.1 Market-based View

A prevailing paradigm in the field of strategic management is the ‘Competitive forces Approach’ (Teece et al. 1997, p.510), also named market-based view (hereafter MBV). Derived from the Industry Structure-Conduct(=Strategy)-Performance paradigm of industrial organization (Porter, 1981), this model has the assumption that the structure of the industry determines the behavior of market participants, and emphasizes the actions that a firm can take to create defensible positions against competitive forces.

According to this approach, resources possess a high mobility. They are relatively easy to acquire and the market defines which resources are more valuable than others. Within the context of MBV, high performance of a firm is attributed to (1) the branch attractiveness ( Market growth rate), (2) the market positioning of the company (relative mark et share) and (3) the timing of market entry.[^[2] ] The focus of the market-based view of the strategic management approach is, as the name suggests, a market-oriented view of economic action, i.e. the development of a strategic plan is based on customer needs and behavior of competing companies. The market-oriented management perspective puts its emphasis on the external environment of a company, namely the industry or branch. The company itself is of little interest, instead, a proper assessment of the environment potential is more important.

3.1.1 External Analysis

To determine the attractiveness of an industry, Porter developed a model to analyze the industry structure. The following five factors determine the intensity of competition and profit opportunities in an industry: entry barriers, threat of substitution, bargaining power of buyers, bargaining power of suppliers, and rivalry among competitors. It also considers more general harbingers of environmental change: political, macro-economic, social and technological developments. By discerning the changing balance of these forces, it is assumed that managers can elicit insights into what their organization should do (Roos et al. 2001, p.22).

The ‘five-forces’ framework provides a systematic way of thinking about how competitive forces work at the industry level and how these forces determine the profitability of different industries and industry segments. The competitive forces framework also contains a number of underlying assumptions about the sources of competition and the nature of the strategy process (Teece et al. 1997, p.511). Finally, while there is some recognition given to firm-specific assets, differences among firms relate primarily to scale, scope and differentiation. This was later extended into generic strategies of cost leader, differentiator and niche player.

3.2 Resource-based View

In a global, knowledge-based economy the issue of why some firms are more competitive and perform better than others is probably the most important question. This is the focus of the analysis of many business disciplines and the subject of never-ending discussion. The Resource-based View (hereafter RBV) of the firm and subsequently the Dynamic Capabilities Approach and Capabilities Lifecycle are dominant paradigms explaining those issues.

The resource-based view of the firm rests upon the premise that close competitors differ in their resources and capabilities (Helfat and Peteraf 2003); what makes support on Helfat (2000) who suggests that some firms are more successful using their capabilities than others.

Identifying valuable resources in a firm implies that judgments about its value must be linked directly to the current profit streams of the firm, whereas the rarity of the resource can only be judged through a sound knowledge about competing firms. Moreover, as Bowman and Ambrosini (2003, p.292) suggest, judgments about inimitability and non-substitutability require foresight, combined with some understanding of how the particular resource was created (see Table 1).

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Table 1: VRIN typology of resources

Capabilities refer to a firm’s ability to deploy resources, usually in combination, and encapsulate both explicit processes and tacit elements [^[3] ] embedded in processes (Wang and Ahmed 2007, p.35). This means that capabilities are often firm-specific and are developed over time through complex interactions between the firm’s resources (Amit and Schoemaker 1993). For example, quality control is a process that can easily be adopted by firms, whereas total quality management (TQM) is not just a process, but requires the firm’s capability to develop an organization-wide vision, empowering employees and building a customer-orientation culture. Total quality management requires the firm to not only install a quality management process, but most importantly to tap into the tacit ‘energy’ of the firm.

RBV emphasizes firm-specific capabilities and assets, and the existence of isolating mechanisms as the fundamental determinants of firm performance, ‘but it does not attempt to explain the nature of the isolating mechanisms that enable the entrepreneurial rents’ (Teece et al. 1997, p.510), as well as mechanisms for integrating capabilities.

From this point the theory of the dynamic capabilities emerges: The ‘Dynamic Capabilities Approach’ does not involve the production of a good or provision of a marketable service, but the firm’s ‘ability’ to build, integrate and reconfigure internal and external competences (resources and capabilities) to address rapidly changing environments (Helfat and Peteraf 2003, p.998). Although dynamic capabilities are a set of high-level routines, they do not directly affect the output of the company in which the capability is deployed, but indirectly contribute to this output through an impact on operational capabilities (Helfat and Peteraf 2003, p.999). Firms have the ability to adapt and change over time by using ‘ learning mechanisms ’ or ‘ management mechanisms ’ that constitute these dynamic capabilities (Teece et al. 1997).

Heterogeneity across firms explains their comparative differences and competitive advantage.[^[4] ] But in absence of an understanding where this heterogeneity comes from, it is difficult to explain how this firm uses resources and capabilities to create competitive advantage (Helfat and Peteraf 2003, p.997). In addition, the following statement helps to understand the sources of heterogeneity: Since resources and capabilities may evolve and change sooner or later, the Capabilities Lifecycle gives the RBV a more dynamic perspective, contributing to the framework by explaining the evolution of these through the time (Helfat and Peteraf 2003, p.997).

This theory argues that if external environments are in a state of change or instability,[^[5] ] which is mainly the case in the engineering services industry, the firm’s own resources and capabilities are those which possess a more stable basis that address the firm’s direction. ‘Hence, a definition of a business in terms of what it is capable of doing may offer a more durable basis for strategy than a definition based upon the needs which the business seeks to satisfy’ (Grant 1991, p.116). If strategies are not resource-based, they are unlikely to succeed in a business environment (Wernerfelt 1995, p.173).

The superior task of this approach (RBV) to strategy formulation is maximizing rents over time (Grant 1991, p.119). According to this, management accounting has to act on an ‘ operative ’ level of business management to develop and maintain these resources and capabilities, so the firm assures its competitive advantage (Specker 2005). Due that the Dynamic Capabilities Approach (Teece et al. 1997, p.516) suggests that the firm must possess the ability to build and reconfigure internal and external competences, managers, practitioners and researchers have brought this perspective (RBV) to a business ‘ strategy ’ level to explore and analyze the relation between resources, organizational capabilities and firm performance (Helfat 2000), allocation, competition and profitability, the appropriability of returns and innovations, as well as the role of imperfect information between competitors regarding profitability, and most important the means by which the process of resource accumulation can sustain competitive advantage for a firm. (Grant 1991, p.115, Dierickx and Cool 1989, p.1504).[^[6] ]

The external environment plays an important role as well, because it determines the limits of the heterogeneity. The level of capability fulfillment is related to market conditions and industry structures, since it allows (for example) higher-cost or lower-quality firms to survive at lower levels of profitability than firms with superior capabilities.

3.2.1 Capabilities as Organizational Routines

To address the task of understanding the intangible assets of firms, there must be a clear definition of the association of firm capabilities and the organizational routines.

Organizational routines are conventional patterns of actions that are made up of a sequence, a routine, or a number of increasing routines, and a capability is a number of interacting routines. A firm consists of a big network of routines, coming from customer order invoice (supportive process), thru production processes (main process), to management routines (management process) such as the assessment of the business performance and the definition of actions to improve efficiency. The concept of organizational routines offers illuminating insights into the relations between resources, capabilities, and competitive advantage (Grant 1991, p.122)

Taking into account that companies, whether in the productive or in the service sector work with clear differentiated routines at a high-level, the following dimension is proposed to synthesize firm activities and be able to cluster them into three main categories. This dimension is called the Process-Based Business Perspective. [^[7] ]

3.2.2 Dynamic Capabilities Approach and Competitive Advantage

The essence of capabilities is embedded in different organizational processes. The content of these processes and the opportunities that come with it are shaped notably by the assets and resources that the firm possesses, and by the evolutionary path it has adopted.[^[8] ] The following categorization is proposed by Teece et al. (1997, p.518):

- Processes: refers to managerial routines encompassing 3 roles: coordination/integration (static concept), learning (dynamic concept using structural capital and learning mechanisms) and reconfiguration (a transformational concept).

- Market Positions: refers to the specific endowments of technology, intellectual property, complementary assets, customer base and external relations with suppliers and stakeholders.

- Paths: where a firm can go is a function of its current position and the paths ahead, and thus it refers to the strategic alternatives available to the firm.

3.2.2.1 Using Dynamic Capabilities to identify the Corporate-level Strategy

The value creation process of ESPs, which is mostly related to ‘knowledge management’ and ‘intellectual capital’, between the central office of a firm and its strategic business unit is enabled by choosing one of the six resource configurations proposed by Bowman and Ambrosini (2003). Their research results suggest that using a dynamic capabilities perspective, it is possible to gain insights about the role of a firm Headquarters regarding the resource creation process of a strategic business unit (SBU), and consequently the corporate strategy. The argument suggests that, where a multi-business corporation has a distinct headquarters, separated from SBU-level processes (which is mostly the case of ESP firms), the centre [headquarters] and its value-adding role can only be justified on one of two grounds:

- either the central office provides resources, or
- the central office has processes that create resources.

If the Headquarters provides support services for the SBUs, for example structural capital that can be delivered centrally at a lower cost or more effectively than they could be by the SBUs themselves, then these services are a resource coming from the headquarter for the SBUs. Otherwise, the headquarters performs processes that result in resource creation within the SBUs.

In order to create new resources the headquarters can basically adopt six configurational strategies, or modes of resource creation that are usually exclusive, because each strategy requires a particular combination of organizational structures and processes (see Table 2). This way, the corporate level can contribute by performing dynamic capabilities. This involves the processes of reconfiguration, leverage, learning and integration (Bowman and Ambrosini 2003, p.293 ff):

1. Reconfiguration processes A common form of resource creation through reconfiguration is consolidation. There are two forms: ‘consolidation of support activities’, and ‘reconfiguration to achieve scale economies in core processes’. They have different implications for the design of the corporate structure.
2. The headquarters leverage existing resources. This may be done by extending the scope of the resource into other SBUs or market. Extending the resource in this way may be done at lower cost than those required by an individual SBU. For example, culture as a resource can be leveraged unconsciously through the socialization of employees in particular ‘ways of doing things’.

3. Learning is the process using repetition and experimentation that enables tasks to be performed better and quicker (Teece et al. 1997, p.520). Learning obviously occurs at all levels in the structure, but the centre can indirectly influence the learning processes in SBUs by:

- encouraging SBUs to devote resources to innovation
- allowing SBUs time to explore new ideas
- introducing new perspectives and knowledge into SBUs
- encouraging experiments and tolerating failures
- establishing dialogue across SBUs
- funding R&D at SBU level

According to this, two learning strategies arise from the headquarters for the creation of new resources; one that operates through a supportive culture and another that provokes resource creation through tough controls (Bowman and Ambrosini 2003, p.293).

The Table 2 illustrates the six possible configuration strategies between the Headquarters and SBUs. They are potentially feasible strategy options that are coherent with regard to the relationships between the ‘ asset-creation aims of the strategy ’ and ‘ the required structures and processes ’. As for their management styles, each configuration will require different organizational processes, divisions of responsibilities, and SBU and Headquarters competences. Corporations have to choose between these modes of resource creation (Bowman and Ambrosini 2003, p.297).

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Table 2: Resource configuration strategies

3.2.2.2 Sensing, Seizing and Reconfiguring: Driving Strategy into Action

A strategy is by definition a bundle of selected tactics, where a tactic is a punctual action to be executed, or a task that can be operationalized. Furthermore it can be stated, that strategy is about understanding market and technology evolution and transformation as well as the ability to execute it in alignment with the plans.

To be successful, managers need to be able to (1) scan their environments, (2) identify relevant opportunities and threats, (3) to design a business that creates value to the customers in ways that competitors cannot easily imitate, and most important, (4) to ensure that these plans are implemented. Unfortunately, the uncertainty and complexity of competitors and particularly the fast-changing markets make this process a hard task to be effectively accomplished.

For this purpose, Teece (2007) grouped the main dynamic capabilities of the company into three dimensions. to help a company to comprehend the meaning and implications of the strategy process better, namely scanning the environment, capitalizing opportunities and deploying capabilities: ‘ sensing ’, ‘ seizing ’ and ‘ reconfiguring ’.

Sensing capabilities is about strategy insight, and represents the firm’s activities in scanning and monitoring changes in operating environments and identifying new opportunities. This is associated to management processes, structures, information systems and networks, through which external information and knowledge can be identified and imported across organizational boundaries (Liao et al. 2009, p.268).

Seizing capabilities is about strategic execution, and represents all attempts to capitalize and exploit potential opportunities. This is associated with activities like deploying service architecture and a business models, brand management, and building an organization that reinforces learning, creativity and innovativeness.

Reconfiguring capabilities are useful in asset ‘‘ orchestration’ ’, i.e. management mechanisms such as reallocating and redeployment of existing assets, and the management of complementary assets or reengineering processes (see KMO in chapter 7.3).

3.2.2.3 Assessing Dynamic Capabilities

In allusion to chapters 3.2.2.1 and 3.2.2.2, the dynamic capabilities approach will be used for two analytical purposes: (1) to sense the asset creation process of knowledge management of firms, and (2) to identify the underlying processes that firms use to reconfigure its own capabilities base in dynamic markets (2nd point explained below).[^[10] ]

Wang and Ahmed (2007, p.44) suggest that while recognizing the differential positions in resources and capabilities among firms and the different evolutionary paths, managers can chart the development of dynamic capabilities using common features identified, and benchmark them with other firms. Furthermore, according to Grant (1991, p.120), a firm capability can be identified and appraised using a standard functional classification of the firm’s activities.[^[11] ]

To contribute to this analysis, Wang and Ahmed (2007, p.36) differentiate capabilities in the following level of hierarchy:

- Zero-order capabilities are plain firm resources. In principle, these can be a source of competitive advantage when demonstrating VRIN traits, but do that markets are constantly changing, this assumption cannot be valid.
- First-order capabilities are operational firm-capabilities itself as stated in chapter 3.2. They are likely to result in improved performance to attain a desired goal.
- Second-order capabilities are Core capabilities; a bundle of a firm’s resources and capabilities that are strategically important.
- Third-order capabilities are dynamic capabilities and it emphasizes a firm’s constant pursuit of the renewal, reconfiguration and re-creation of resources, capabilities and core capabilities to address the environmental change.

The analysis of capabilities and its hierarchy gives insights of the type, or common feature of dynamic capabilities used in firms: adaptive, absorptive or innovative dynamic capabilities as the main transformational mechanism, and the key role of management in adapting, integrating and reconfiguring internal and external organizational skills.

There are firms that demonstrate fast responsiveness and flexible process innovation, coupled with management capability to effectively coordinate and redeploy competencies. For example, the success of Altran as an engineering consultant relies on its core capability to distribute information regarding, methods, project references, lessons-learnt and exchange of experiences to all the organization, as the firm keeps the control of knowledge in alignment with a central project management office (PMO) that provide the systematic and methodologies for executing consulting businesses. First-order capability is the flow of the knowledge-object supported by an innovative IT-tool and system solutions and the emphasis of core capability is the centralization of knowledge to make sure it flows across the organization.

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Table 3: Capabilities hierarchy of two ESP in the aviation industry

3.2.3 Capability Lifecycle and Evolution

The Capability Lifecycle is a concept developed by Helfat and Peteraf (2003), which depicts patterns and paths in the evolution of organizational capabilities. It gives insights of the business development of engineering firms in different areas. This concept is proposed in this analytical framework to assist the evaluation of capabilities of competing firms (see Figure 17). Many capabilities may pass through multiple stages of transformation before it faces an ultimate decline (Ibidem, p.998). Practical implications for this concept become relevant when managers have to sense capabilities, for example when performing investment appraisals, or deciding which capabilities are more relevant toward competitors.

In pursuing alternatives for capability development, a team may chose to imitate an existing capability or may develop it from scratch. Both situations demands that the organization looks into diverse possibilities of organizational learning. Furthermore, capability improvements in the development stage result from learning mechanisms, which result in the creation of dynamic capabilities (See chapter 5.2.3).

Once the capability reaches the maturity stage, or even before, various events may influence its future evolution. The capability then may branch into one of the six additional stages of the capability lifecycle: retirement, retrenchment, renewal, replication, redeployment, and recombination. The last two ‘evolutive’ paths reflect the existence of dynamic capabilities of service firms.

3.2.3.1 Capability Branching and Transformation

External or internal events can cause capability branching. For example external factors can be changes in demand, technology available, the strategy of the client and political environment among others, which has a strong impact to make managers take actions about the future of the capability. In addition, selection events can make a capability obsolete or provide it with a new opportunity to grow and change. In the case of internal decisions, capability branching can be enabled when managers see an opportunity of market diversification when a capability has reached certain level of high efficiency. According to this, capabilities turn into a specific direction; the branches in the Figure 6 represent the potential paths a capability can take.

For this reason, ESPs working as consultants tend to retain their know-how underneath their tacitness. In the one hand, replication and transfer are often impossible without transferring people, although this can be minimized if investments are made to convert tacit knowledge into codified knowledge; and on the other hand, many organizational routines are tacit in nature (Teece et al. 1997, p.525).[^[12] ]

3.2.3.2 Transferring Capabilities

‘Redeploying’ (transferring) a capability into other markets demands an extensive and methodical research of their attributes, the environments of deployment, as well as the constellation of resources embedded in these capabilities. ‘Replicating’ it demands that the capability has to be redeveloped (it can come from acquisition or internal growth).

A recombination of capabilities provide a better alternative to capabilities replication, because it enables the transfer of knowledge assets [^[13] ] (Kogut and Zander 2002) since dynamic capabilities can help to transform operational capabilities to perform in new markets. Based on this, an ESP firm can take advantage of items of its structural and relational capital to distribute (for example) new market intelligence across the organization.[^[14] ] Finally, performing an industry structure analysis as explained in chapter 3.1.1, without the reference of this approach is practically useless because substantial factors that help to appraise some issues like market entry and exit, the scale and scope of production or industry patterns of attractiveness can be missed (Helfat and Peteraf 2003, p.1008).

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Table 4: Capability lifecycle

3.3 Symbiosis of the market-based and resource-based perspective

Porter states that the success of a company depends on the following two aspects: First, the structure of the industry in which a company operates, and second, the actions of the company itself. Besides the attractiveness of the sector, it is important how a company achieves to position within the industry. For instance, should there be any change in the demand patterns of product markets, the value of the resource will change. On the contrary, considering a firm only as a ‘black box’, special business characteristics like organizational process are not evaluated (Teece et al. 1997 and Sirmon et al. 2007). Therefore, it is useful to see the market-based and resource-based theories of rivalry and performance as complementary rather than competing frames (Amit and Schoemaker 1993, p.35, Peteraf and Bergen 2003, p.1028).

The resource-based perspective promotes the implementation of managerial strategies for developing new capabilities. ‘If control over scarce resources is the source of economic profits, then it follows that such issues as skill acquisition, the management of knowledge and know-how […], and learning become fundamental strategic issues (Teece et al. 1997, p.514).

The perspective of the organizational-based view (hereafter OBV) is a theoretical construct that acts as a symbiosis of the MBV and RBV. Resources and Market conditions are interdependent, which means that there is a limited disponibility of resources and that they are to be acquired systematically according to market facts.

In essence, the OBV bundles all capabilities (operational and dynamic) and drives the process of ‘knowledge creation’ and ‘capability development and renewal’ in a constantly matching of external demands. In order to achieve this, management accounting has to evaluate strategies that are executed in synchronization with issues like market-phases, dynamic capabilities approach, capability and product-lifecycles.[^[18] ] Within an organizational-based approach, an ESP firm must be ‘designed’ in a form, that minor changes in its ‘modus operandi’ can achieve big changes in the organizational processes. It should be able to combine different learning mechanisms.[^[19] ] Furthermore, the decision process shall be as easy as possible, and thus coordination costs will not be too high when a new capability is still in the founding or development stage.[^[20] ] The further development of this approach, knowledge-based view (hereafter KBV), goes further to determine the optimal grade of articulation between the knowledge and organization, building for example what McMahon et al. (2004) denote as a ‘ knowledge community ’.

3.4 A new Competitive Landscape: Knowledge-based view

As the foundation of industrialized economies has shifted from physical resources to intellectual assets, the traditional bases of competitive advantage have begun to erode, because several driving forces emerged (Ordoñez de Pablos 2002, p.287). Knowledge-based sources are now the true source of this advantage. From the capture, codification, and dissemination of information, the success in competition will be based less on the strategic allocation of physical and financial resources and more on the strategic management of knowledge (Bontis 1998, p.63). Furthermore, the rise of networked computers has made it possible to codify, store, and share certain kinds of knowledge more easily and cheaply (Hansen et al. 1999, p.106).

The KBV goes forward by emphasizing that ‘knowledge’ and ‘learning’ must be in alignment with the corporate strategy. The following characteristics can be observed surrounding critical success factors (Ordoñez de Pablos 2002, p.287 ff):

- Focus on intangibles rather than tangible resources
- Hypercompetitive business environment
- Digitalization of activities
- Virtualization of activities
- Networking is a strength of building relations

3.4.1 Knowledge-Intensive Organizations

In knowledge-intensive organizations the "service" emerges as an ongoing problem-solving process between the customer and the producer. There is no standardized service package and the customers are treated individually. Customers often do not exactly know what they need. The service provider is an expert and the customer wants the problem solved by the expertise of the partner (Sveiby 1992). Often a system-solution is required. The "production" does not consist of goods or services but complex non-standardized problem-solving process. This process involves a lot of information processing (not necessarily computerized).

3.4.2 Performance Drivers under a Knowledge-based Perspective

The market value of a firm is the sum of its book value and ‘something else’. These other factors represent the intangible value of the firm (Villalonga 2004, p.510), which can only be attained with a systematic development of intangible assets. Moreover, every turn of a business cycle strengthens the core competences of the firm because it enhances its knowledge base.[^[21] ]

As the capacity to manage knowledge-based intellect is the critical skill of this era,[^[22] ] the KBV demands a new allocation of mechanisms in order for companies to be competitive. Even if some ESP firms have been innovative within their business orientation, industry participants in general are still not aware of relevant facts; the fast pace of technology, like information and communication technology (ICT), and the market dynamism, as explained in the dynamic capabilities approach (chapter 3.2.2).

To be more explicit, specific working mechanisms have to be set to achieve an effective deployment of intangible resources (e.g. knowledge and information) and its further development (e.g. know-how and expertise).[^[23] ] Two ‘higher-level’ performance drivers are proposed for this thesis, ‘intellectual capital’ (hereafter IC) and ‘knowledge management’ (hereafter KM). These value-creating drivers are interdependent; for example, skills, attitudes (HC) and customs (firm culture) of individuals are critical issues for KM if the company aims to transform the personal knowledge of employees into tangible, sharable information resources. On the contrary, KM is needed to articulate the performance driver of IC. Moreover, as proposed in chapter 7 Figure 36, an IC framework is proposed for sensing capabilities and a KM model to seize them, which leads to the view that an organization needs to make strategic decisions regarding which knowledge areas it wishes to enhance.

3.4.3 Knowledge in Engineering Context

The nature of engineering product development within modern organizations has changed to a great extent over the past few decades as products have become more complex. For example, within the aerospace industry, integrated product development processes based around multi-functional integrated product teams are becoming habitual.[^[24] ] Integrated product team members are not only multi-functional, but likely to work for different companies, have different nationalities and stem from different sites of one company or regions (McMahon et al. 2004, p.308).

An important task of knowledge management in engineering design is to create and foster skills and attitudes of the participants in the design process and to nurture the development of engineering communities, as well as collecting and organizing information and other resources associated with the encoded knowledge of those communities (McMahon et al. 2004, p.310).

4 INTELLECTUAL CAPITAL

Intangible assets are complex constructs that can be classified into human, structural and relational capital (Ordoñez de Pablos 2002, Bontis 2000). Intellectual capital (IC) is all the knowledge, information, intellectual property, structures, systems, company culture, experience and expertise that can be placed to create profit. A central point in succeeding in the engineering branch is the systematic development of already exposed resources and capabilities that flow across the intellectual capital of the firm.

Capabilities in terms of IC are the strategic grouping and balancing of these three assets (human, structural and relational) that generate profits (Union Fenosa 1999), as well as its deployment in a knowledge system. Furthermore, the IC perspective considers the organization's ability to transform one resource into another (Roos et al. 2001, p.23).[^[25] ] The presence of resources is not sufficient to create value. For example, Roos et al. (2001 p.23) explain that there is no correlation between the number of marketing experts in a firm and sales. The importance is in the way intangible resources are deployed, which implies the transformation from one resource into another. New structural capital can be created through formalizing knowledge into a process (For example by articulating or codifying it).

4.1 Classification of Intellectual Capital

The three elements of intellectual capital are classified as the following:

- Human capital comprises the competence, skills (especially tacit) and intellectual agility of the individual employees (Roos et al. 2001, p.23). This cannot be owned by the company (Bontis 2001, p.45). It is considered to be the most important intellectual asset as it is the source of innovation and renewal (Bontis 1998, p.65)
- Relational capital represents all the valuable relationships with customers, suppliers and other relevant stakeholders. The main content of relational capital is the knowledge of marketing channels and customer relationships (Bontis 1998, p.67)
- Structural capital is the value that derives from the human capital. That is the documented knowledge of the people who work in an organization, such as; processes, methods, models, and organizational and industry information (Penker 2008, p.3). Furthermore, it encompasses systems, structures, brands, intellectual property and other intangibles that are owned by the firm but do not appear on its balance-sheet. Examples of this are information systems, laboratories, competitive and market intelligence and management focus (Stewart 1997). Structural capital is ‘everything that gets left behind at the office when employees go home’ (Bontis 2001, p.45). On the contrary to human capital, structural capital belongs to organization as a whole and it can be reproduced and shared (Stewart 1997). Structural capital is a critical link that allows intellectual capital to be measured at the organizational level of analysis (Bontis, Keow, and Richardson 2000). The purpose of building structural capital within an organization is to create reusable knowledge and increase the sustainable value (Penker 2008, p.3)

The most relevant fact to be considered is that the ‘structural capital concerns all processes necessary for the fulfillment of services that are knowledge-based’ (Bornemann and Reinhardt 2008, p87). This will be the starting point for analyzing structural capital later in the chapter 6.3.2.

The pilot study of Nick Bontis (1998, p.71) has shown that intellectual capital has a significant and substantive impact on firm performance. However while all three dimensions are sources of firm competitive advantage and superior performance, they are not equally important. The theoretical considerations indicate that human capital is central to intangibles since it is the source of innovation and renewal (Stewart, 1997). However, the empirical research shows mixed results. For example, Bontis (1998, p.71) found that human capital without the support of structural capital is practically useless. On the other hand, the study of Wang and Chang (2005) found human capital to be the most crucial component.

For ESP firms that offer intangible solutions, performance is associated to the level of interrelation between the three IC constructs (human, structural and relational). Based on this assumption, a second dimension for building a research model is proposed. This dimension synthesizes the aspects related to the deployment of intangible capabilities embedded in the business processes (see Figure 5: Process perspective). This dimension is called the Intellectual-Capital Perspective (Figure 9: IC construct). The two dimensions are the base for developing a holistic model of intangible assessment engineering service companies (see Figure 10: Research construct).

4.2 State of the Art in Intangible Asset Research and Reporting

There are several approaches to manage intellectual capital actively (Bontis 2001). In addition, Bornemann and Alwert (2007, p.565) suggest that by integrating knowledge workers into the decision making process, an appropriate organizational structure that support an effective and efficient deployment of intangibles can be achieved. Established instruments encompass the following areas:

- Development of knowledge strategies (Hansen et al. 1999 and Shankar 2003)
- Intellectual capital reports (Ordoñez de Pablos, 2002, 2003 and 2004)
- Various others from knowledge management which improve internal communication as the main means of corporate integration as well as alignment

Regarding the last point, the German ‘ Wissensbilanz ’ method proposes the most pragmatic approach, encompassing following main areas: IC business model, IC process flow and IC potentials portfolio. Primarily, the German approach is used as a tool to improve the systematic process of an organization’s intellectual capital management. This gives a platform for management to prioritize activities from a cost/benefit approach for the firm’s future earnings potential. It visualizes systemic interrelationships as a process flow of contextually refined key IC components into an intelligence map (Edvinsson and Kivikas 2007, p.380).

Furthermore, recent research on components of intellectual capital has facilitated the understanding of the linkage between resources allocated into specific areas of intellectual capital and business performance. Increasing evidence has been revealed on the importance of investments in intellectual capital to sustain business growth (Ng 2006, p.492).

The challenge of most knowledge driven and knowledge intensive corporations are facing today is the transformation of the human capital into reusable structural capital (Penker 2008, p.3). System support is not the only challenge anymore; it’s the internal culture and leadership that separate the winners from the losers.[^[26] ] The impact of these transformations on value creation can be assessed and visualized through the intellectual capital approach with a ‘Navigator’, a model revealing all the value-creating resources (tangible and intangible), their transformations, and the relative importance of the resources and transformations for value creation.

In addition, different intellectual capital models developed try to articulate the link between knowledge assets and business performance. The majority of them provide an effective high-level taxonomy of intangibles, which primarily anchor around three components: human capital (HC), structural capital (SC) and customer capital (CC).[^[27] ][^[28] ]

For this purpose, Ordonez de Pablos (2004) developed a practical guideline to support the measurement and reporting of intellectual capital. In the report, the development of intellectual capital statements was proposed; these intellectual capital statements should be composed of an intellectual capital report, an intellectual capital flow report and an intellectual capital memo report in order to facilitate formal reporting to the stakeholders.

On one hand, IC reporting creates a holistic image of firm’s hidden value, contributes to the formation of a more detailed picture of the organization (Ordoñez de Pablos 2003, p.68), but on the other hand, an IC Report does not show the Business Model of company. Furthermore, a major drawback of all developed intellectual capital reports is their non-comparability due to the diversity of conceptions. Thus, it is not possible to compare and evaluate the results of different firms within an industry using diverse concepts of intellectual capital reports (Nemetz 2006, p.217).

Research and development expenditures demonstrate the amount of new resources allocated to generate new intellectual capital for technology-based companies. Such research and development expenditures would enable a firm to develop new products and patents as well as the technological know-how that could create competitive advantage for a company, as advocated in the resource-based view (Ng 2006, p.494). In the case of wireless application firms, the structural capital alone demonstrates a significant impact on revenues generated by these companies. Human capital, inclusive of resources for general and administrative activities, also demonstrated predictability for revenues generated in the respective years. However, its influence was found to be less than that of the structural capital (Ng 2006, p.503).

Infrastructure (structural) assets are those technologies, methodologies and processes that enable the organization to function.[^[29] ] Examples include methodologies for assessing risk, methods of managing a sales force, databases of information on the market or customers and communication systems such as e-mail and teleconferencing systems. Basically, all elements that make up the way the organization works. Such elements are peculiar to each business, and their value to the organization can only be attained by assessment within the target organization (Bontis 1999, p.448).

Research focusing on the architectural or integrative capabilities [^[30] ] of firms can offer ‘insights into the source of enduring differences in firm performance and highlights the importance of exploring the sources of structural capital’ (Bontis 1999, p.448).

In the case of Germany, a project was carried out at the Fraunhofer Institute in Berlin with the cooperation of small and medium-sized companies (SME). The aim of the project was to show how these SMEs utilize their intellectual capital (Wissenskapital), as their process-oriented perspective of business growth. The prime target was to raise systematic understanding of where the IC of those SMEs lies and how to evaluate it (Edvinsson and Kivikas 2007, p.377 ff.). The authors state that German companies need to better understand the internally ‘hidden’ assets, i.e. the competences that are not visible on the financial balance sheet (Edvinsson and Kivikas 2007, p.378). Competition in Germany is tough for ESP firms. They must develop a completely understanding of their intangible assets and capabilities (Edvinsson and Kivikas 2007, p.382)

‘Since investments in intangible assets in most of the attractive business sectors is now more than 50 per cent, they wish to have more transparency on what these investments bring to the company’s value and their impact on financial results.’

5 KNOWLEDGE MANAGEMENT

Knowledge management is a fast-moving field that has been created by the collision of several others: human resources, organizational development, change management, information technology, brand and reputation management, performance measurement and valuation (Ordoñez de Pablos 2003, p.62). It represents the process of capturing firm’s knowledge and using it to foster innovation (Nonaka and Takeuchi 1995).

The management of organizational knowledge (KM) encompasses two distinct but related phenomena: ‘intellectual capital stocks’ and ‘organizational learning flows’ (Bontis 1999a, and Easterby-Smith and Prieto 2008, p.238); It can be analyzed in two forms: static and dynamic (Ordoñez de Pablos 2002, p.62). The intellectual capital analysis represents the static approach towards organizational knowledge and knowledge management itself represents the dynamic analysis of organizational knowledge. Both approaches are complementary and contribute to the building of a holistic view of a firm. In addition, knowledge stocks and flows are interrelated because organizations that have a higher capacity to absorb knowledge will also have a higher predisposition to utilize and circulate it (Bontis 1999a, p.436).

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Table 5: Organizational knowledge approach

5.1 Recognizing Companies with different Knowledge Orientation

On the one hand, the main concern of operational knowledge management is to connect people to the system being used for the distribution and transfer of knowledge. On the other hand, strategic knowledge management is a process that links organizational knowledge with (Ordoñez de Pablos 2003, p.63):

- the design of organizational structures that promote knowledge [^[31] ]
- the development of knowledge workers, and [^[32] ]
- the business strategy

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Figure 11: Knowledge management approach in allusion to Ordoñez de Pablos 2003

As an example, one could consider two companies addressing the engineering service sector: They operate in similar markets, but the relative importance of their resources and the way they are deployed may be very different. Not less important is to consider, that these companies may change their ‘modus operandi’ (i.e. the way capabilities are deployed) repeatedly as a result of the implementation of a hybrid strategy. The following two sub-chapters clarify the statement (in allusion to Roos et al. 2001).

[...]

^[1] See chapter 3.4 A new Competitive Landscape: Knowledge-based view

^[2] The Boston Consulting Group is one of the main defender of this thesis

^[3] like know-how or leadership

^[4] See Wernerfelt 1984

^[5] Compare with Market-based view

^[6] See chapter 7.4 for a deeper clarification

^[7] Based on “Process-based Business Development”, Learning Script – Everth Larsson

^[8] Regarding the strategic evolution, see discussion about knowledge strategy in chapter 7.5

^[9] The green color shows where the resource is created.

^[10] Examples of how market dynamism drives dynamic capabilities can be found in Wang and Ahmed 2007, p.39 ff.

^[11] See chapter 3.2.1

^[12] See Hansen et al. 1999 for further discussion about codification vs. tacitness

^[13] See Table 7 for an insight of knowledge assets

^[14] See Table 3 example of Altran Consulting

^[15] Compare Hansen et al. 1999 and McMahon et al. 2004

^[16] Components of human capital are for example knowledge, skills and experience

^[17] Social ties within and outside the team

^[18] See Figure 34: Strategic interrelations of the constructs

^[19] See chapter 5.2.3: The role of Organizational Learning in Dynamic Capabilities

^[20] See Table 4: Capability lifecycle – “Trends”

^[21] Ordoñez de Pablos 2003, p.61 in allusion to Itami and Roehl 1987

^[22] Bontis 1999b, p392 in allusion to Quinn 1992

^[23] See Figure 37: Knowledge evolution

^[24] For example the development of the Airbus A380

^[25] Compare the contribution of Teece et al. 1997 to the Dynamic Capabilities Approach

^[26] In allusion to this, see chapter 7.5 Development of a Corporate Knowledge Strategy

^[27] Customer capital is another definition for relational capital

^[28] Compare Andreu and Bontis, 2007 p.346

^[29] Also seen as items of structural capital

^[30] Also transformational capabilities under the Dynamic Capabilities Approach

^[31] Compare with “structural capital”

^[32] Compare with “human capital“