Corporate advantage: exploitation vs. exploration

Exploration versus exploitation: Which works best? A lot depends on the nature of the business and the firm's initial strategic plans.

The field of corporate strategy looks out over the business landscape and tries to point out the best path toward corporate advantage, which gives one company an edge over another. But there are a lot of primrose paths lurking in the field.

Strategy generally works like this: A corporation proclaims its initial corporate strategy, which is the path it believes will take it toward earnings and profits. Some companies prefer a path of exploitation, meaning that they are strictly bound by their initial, deliberate corporate plan. Other companies favor exploration, which means that they are willing to explore different strategies as time goes by.

Adrián Atilio Caldart of Warwick Business School (U.K.) and Joan E. Ricart of IESE Business School (Spain) examine these two very different approaches - and a combination of the two - in the paper "Corporate Strategy: An Agent-Based Approach". Their paper aims to determine which approach produces the best results.

Caldart and Ricart examine the field of corporate strategy from an evolutionary perspective. They view corporate strategy as a process driven by three interlinked processes.

First, corporate managers develop a representation of how the firm will respond to challenges, which results in a corporate strategic plan. Then, the firm implements the plan by deciding whether to prioritize an exploitative development of the initial plan (the dynamics of continuity) or to engage in an opportunistic combination of exploitation and exploration (dynamics of change). Plans are based on the complexity theory, which states that the firm frames its corporate strategy by choosing among structural designs with varying degrees of differentiation and integration.

Exploitation vs. exploration

The conceptual distinction between exploration and exploitation has emerged as a widely used analytical construct to address issues related to continuity and change in organization studies. How do firms divide their attention and resources and develop competences?

The paper looks closely at the exploitation versus exploration dichotomy. Exploitation is about creating reliability from experience. It implies firm behavior characterized by refinement, efficiency, selection and implementation. It is associated with mechanistic structures, path dependence, routinization, bureaucracy and stability. Returns associated with exploitation are more certain and closer in time, and exploitative firms are more likely to generate a stable performance.

As for exploration, it is about creating variety in experience. A firm's behavior is characterized by discovery, risk taking, variation, experimentation and innovation. In general, it is associated with organic structures, loosely coupled systems, path breaking and emergence. By generating large variation, explorative firms can experience substantial success as well as failure. Exploration is riskier and returns are more distant in time.

Maintaining an appropriate balance between the two greatly impacts a firm's survival and prosperity.

Depends on environment

To see which dichotomy works best under which conditions, the authors developed a set of agent-based simulations of corporate strategies featuring different characteristics.

The simulations, based on Kauffman's NK model, make it possible to model exploitative and explorative corporate strategies by tuning the levels of environmental complexity faced by the firms and the quality of the strategic plans formulated by their top managers. The simulations allow the researchers to study how interactions between different parts affect a firm's performance.

The results indicate that the relative performances of exploitative strategies versus those characterized by an opportunistic combination of exploitation and exploration depend on the characteristics of the environment in which the firm operates, and also on the quality of the corporate strategic plans that determine the initial strategic positioning of the firm.

"Our findings are relevant for the debate on the tensions between exploration and exploitation as two opposed logics for strategic evolution," write Caldart and Ricart.

"Results show the contingent value of each of the exploitative and explorative corporate-level strategies. Strategies based on disciplined exploitation with the boundaries of a strategic plan work better when strategic plans have a high quality and when environments tend to be simple."

"However, in situations characterized by the combination of a complex environment and management's limited understanding of the strategic alternatives available for the firm, opportunistic strategies that shift from exploitation to exploration, in line with the punctuated equilibrium paradigm, are the best performers."

In other words, exploitation - disciplined behavior - works best for companies in a simple environment and that have a high-quality strategic plan. In a more complex environment, in which managers are uncertain of their strategic possibilities, exploration - opportunistic behavior - is more effective.

Loose, self-organized collaboration

The results speak to the long-lasting debate on the relative merits of self-restraint versus opportunistic adaptation as opposite strategic behaviors. They also support the argument that in times of intra-firm collaboration, in the search for corporate advantage, loose, self-organized collaboration between the business units works better than centrally imposed, tight collaborative initiatives.

"An architectural design that relies more strongly on self-organized independence at the business unit level allows firms to 'economize' on organizational interdependencies while still achieving the potential for synergy development resulting from interdivisional activity sharing and knowledge transfer."

The results also support Porter's 1996 advice to strategic leaders to resist "constant pressure to compromise, relax trade-offs and emulate rivals."

Disciplined firms that have a deep knowledge of their competitive landscape and are able to evolve incrementally in a simple environment outpace their rivals that engage in varying degrees of opportunistic behavior.

However, in more turbulent environments, in which it is difficult to develop sound strategic plans, it is also difficult to plan. In fact, the more complex the organization is, the more risky it will be to adhere rigidly to an established strategic plan.

In summary, the paper helps companies understand how the strategic posture they select will unfold over time. In a field with many thorns, the paper's results will help steer them toward the corporate advantage that will bloom.