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C. Theories That Deal With The Environment

Strategic theories of the firm (Andrews, 1980) examine the alignment between what the firm can do (organizational strengths and weaknesses) and the universe of what it might do (environmental opportunities and threats). Two streams of research have arisen here-both of which have Edith Penrose's theory of the growth of the firm as antecedent (Penrose, 1959).
One stream emphasizes the development of knowledge-related resources within the firm. Knowledge-related resources develop through a firm's experience in dealing with a particular competitive environment and exist as a combination of its assets and stakeholders (Rumelt, 1984). Concepts used to describe the manner in which a firm develops and stores its knowledge include (a) routines-path-dependent knowledge bases that help explain evolutionary change in an industry population through selection arguments such as those found in the theories of biological evolution (Nelson & Winter, 1982); (b) absorptive capacity-a concept that combines an evolutionary perspective with ideas from cognitive science and enables a firm to successfully incorporate new technologies into its strategy (Cohen & Levinthal, 1990). Other related concepts include organizational capabilities and core competencies.

The second stream of strategic theories uses an industry level perspective and is associated with concepts such as "market power" based on Bain's entry-barrier model (Bain, 1956) and imported into strategy by Porter (Porter, 1980). The idea of market power examines how markets are structured and how a particular firm can take advantage of that structure. These theories have been extended by game theorists mainly to incorporate standard formal theories of the firm into the industrial organization perspective.

A combination of the above two streams also exists: Organizational ecology theories focus on the inertia of firms in adopting new strategies. This inertia is attributed to the effort and time involved in implementing strategic changes. A fundamental strategic change involves the search and decision processes that lead to a new configuration of the firm's resources. The larger the proportion of the firm's resources that are up for grabs in implementing the changes, the more resistance the firm will have to face and overcome in order to make those changes (Freeman, 1995).

As mentioned previously, the literature review outlined above has been used to develop three definitions of the firm that are then used to identify the cut-off point between the pre-firm and the firm. These three definitions are operationalized as three constraints in the model presented in Section 4. Before moving from these definitions to the model, further details about the entrepreneurial process are described in Section 3.


The entrepreneurial process involves the selection or creation of a combination of resources, stakeholders and an environment that transforms the idea into a firm. This selection/creation occurs through a set of interconnected entrepreneurial decisions. Entrepreneurial decisions should not be confused with mundane decisions such as how many pencils to buy or what color telephones to install. Entrepreneurial decisions arise out of four interconnected decision domains, the first three of which correspond to the categories of theories of the firm discussed in the previous section:

1. Resources
This domain has to do with non-human resources. Decisions arising out of this domain typically lead to the selection/creation of a production function with relevant inputs, and technological constraints. Financing issues and issues of information systems and flows including accounting could also arise in the
context of this domain.
2. Stakeholders
This domain involves all stakeholders internal to the firm except the entrepreneur. Decisions arising out of this domain typically lead to the selection/creation of a set of feasible contracts between stakeholders within the firm. Issues of corporate culture and social responsibility are examples of other issues that arise in the context of this domain.

3. Environment
This domain forms the interface between the firm and its external environment including competitive (market/strategic) environment and macroeconomic environment. Decisions arising out this domain typically lead to the development of the firm's core competencies. Issues of market identification, positioning, and strategy development are some other areas that involve this domain.

4. Entrepreneur
This domain is particularly unique to the pre-firm and brings in issues of leadership, vision and the subjective theories of the entrepreneur who makes the selection/creation decisions arising out of all the domains. Decisions arising out of this domain typically lead to the overall identity of the firm in terms of its organizational structure, form, and purpose-i.e., they lead to either the creation of the firm or the premature demise of the pre-firm. Issues of firm diversity and differentiation, and the future trajectory of the firm including exit strategies for the entrepreneur and other stakeholders are some of the issues that arise in the context of this domain.

The four entrepreneurial decision domains have the following characteristic interconnections:

1. Every instance of an entrepreneurial process involves all four domains. Or in other words, every pre-firm is faced with decisions originating from all four domains.

2. While every entrepreneurial decision may originate in one or more of the four domains, each of those decisions involves elements of all four domains. Therefore, no entrepreneurial decision can be non-trivially studied or modeled without reference to all four domains.

3. There is no order or seriality to the four domains-that is, none of the four domains have primacy or priority over the other three. There is no pre-specified order in which the pre-firm may be faced with its entrepreneurial decisions.

Figure 2 illustrates the pre-firm as a set of entrepreneurial decisions arising out of the four interconnected decision domains. This figure is not a set of boxes connected by arrows as most process models are. Instead a topological object from Knot theory called a Brunnian 4-Link (Rolfsen, 1976) is used to capture the interconnectedness of the four domains as explained above.

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