Large Companies Are Worrying Less About Core Competencies, Should Nations Remain Stuck?

Business headlines around the world these days exhibit two trends. Firstly, there are a lot of announcements on business diversification. Firms are getting into new businesses, sometimes seemingly unrelated. Secondly, there is a big push for vertical integration. Firms are trying to control more and more of the value chains of their key product offerings.

This is actually similar to how early business magnates like Andrew Carnegie or Henry Ford built their businesses — they did everything concerning their businesses themselves. Till late 1960s, firms like Unilever and Universal Fruit Company became known for vertical integration across a range of business interests.

However, in the middle of the twentieth century, as firms became global or very big in their home markets, the talk about core competencies started getting entrenched. Analysing a business as a portfolio with constituents competing for limited resources gave rise to several theories which continued to focus on optimal structure of a firm.

Going back to 1937, the Nobel winning economist Ronald Coase wrote a seminal paper “The Nature Of The Firm”. He established that transaction costs, which go beyond the price of goods or services, should determine what the firms should produce internally. His work on understanding economic efficiencies of resource allocation in the presence of externalities formed the basis of how firms should be organised and which transactions should be outsourced.

In 1990, C K Prahlad and Gary Hamel wrote their famous Harvard Business Review article, “The Core Competence of the Corporation”. They explained that firms must identify, cultivate and exploit the core competencies that make business grow faster. Management consulting firms like BCG with the growth-share matrix and McKinsey with the product portfolio analysis further designed tools to address the question of what should a firm do.

On the balance, the second half of the last century established commonly accepted ground rules on how firms operated — they should not be doing everything, they should know what they are good at and they should know when to outsource parts of the business. The rising tide of globalisation further lifted the boats of these ruthless efficiency led management models.

But today, things seem to have come a full circle. A giant like Amazon is not just diversifying its business at a rapid pace, it is also vertically integrating each of these business lines. An innovator like Tesla is trying to control as much of the supply chain it possibly can. Elon Musk is also trying to buy Twitter, which would add social media to his repertoire of cars, batteries and spaceships. Apple, whose core competency decidedly was making beautiful consumer-facing hardware is making chips and revelling in deep content integration for its range of devices.

Closer home, Indian family-owned conglomerates were less influenced by the core competency theories, but even they had started to look at exiting some businesses based on portfolio analysis techniques. But in the last few years, the trend has stalled and even reversed.

This turn of fortune demonstrates how management theories that were once considered sacred can easily turn on their head. As the world saw more economic and social integration, transaction costs lowered which made it easier to think only in terms of allocative efficiency with no other consideration taking prominence. So perhaps, the management theories which looked unassailable were merely the aftereffects of globalisation rather than its foundational zeitgeist. As the world started decoupling post the global financial crisis, the ideas which ruled the roost for quarter of a century suddenly appeared to be planted on shaky grounds.

The list of firms which had a core competency-led deeply entrenched market position and yet went bust is a long one. This despite the fact that good private firms tend to be agile and operate flexibly through their professional management. To the contrary, the list of firms that did not care about core competencies in the classical definition and are today near-monopolies is also substantive. In this poor shelf life of once passionately-backed theories, there is a lesson — not just for firms, but also for nations.

National economic stereotypes have been built on much the same theories. China was the manufacturing behemoth, Bangladesh and Vietnam the clothes factories and India the back office to the world. There may not be a better time than now to revisit these assumptions and model national economies on dimensions which go beyond just economic efficiencies. Certainly for India, this is a good time to acquire new capabilities and new focus. The most obvious idea is to add manufacturing strength to the existing substantial service sector proficiency.

In a complex and uncertain world, perhaps the most volatile since the Second World War, every country is bound to deal with several externalities. The transaction costs imposed by these externalities are now considerable, which in the Ronald Coase worldview should be an opportunity to build local strengths. Industrial capabilities at strength, investments in research and development and India as the new, second or third home for marquee names in the manufacturing world can achieve this rebalancing.

Programmes like production linked incentives have already provided a jumpstart. As private capital expenditure responds to the emerging business opportunities, there is no reason why India cannot build deep manufacturing strengths and break the stereotype that the Indian economy has to stay wedded to services.

At the peak of theories backing core competencies, there was one notable dissenting voice. In a 1997 Harvard Business Review essay titled “Why Focused Strategies May Be Wrong For Emerging Markets”, Professors Tarun Khanna and Krishna G Palepu explained why Western efficiency-led dogma should not be applied to conglomerates of the developing world. Their voice was not ignored, but certainly their view did not emerge on top then. However, time, the best judge of them all, has proven Khanna and Palepu right.

The same context-specific, horses for courses thinking may well grant Indian economy the wherewithal to adapt and thrive.