Innovate or Exploit? Achieving Balance Through Alliances or Acquisitions

A key managerial challenge concerns ensuring that a company is both innovative and efficient. A dilemma arises due to tradeoffs between exploring new knowledge and exploiting existing knowledge. Companies have limited resources to allocate to either activity and the practices associated with these activities differ.

Until recently, managers believed that companies should nurture ambidexterity, that is, simultaneously explore and exploit. However, a BCG survey revealed that 90% of companies fail to become ambidextrous. The ambidexterity, or organizational separation approach, suggests that companies can simultaneously explore and exploit by separating the exploring organizational unit from the exploiting unit. Then, managers are expected to integrate these activities and ensure that knowledge flows from the exploring unit to the exploiting unit. Most companies, however, have hard time implementing this solution.

Another approach is to balance exploration and exploitation within a single organizational unit by nurturing discipline, support, and trust. Under such conditions, employees can engage in both exploration and exploitation. The challenge here relates to cognitive constraints. There is no need for integration, but employees are assumed to be both motivated and capable of being innovative and productive, which is not always the case. Even the most talented employees have limited attention span and at any given moment can either explore or exploit. Organizing and coordinating their output is far from trivial.

A third approach calls for temporal separation by which a company transitions between exploration and exploitation over time. Here, the same unit engages in exploration and exploitation, but at any given moment it focuses only on one activity. The managerial challenge is to coordinate the transitions between exploration and exploitation, which are complex and time consuming. During the transition periods the company engages in both activities, for example, as it designs a new product while the previous one is still delivered to the market. The same team may be involved in both exploration and exploitation, which is common in software companies or in Japan, where the engineer that designed the product accompanies it in the marketing process.

In my research, I identified a new approach for balancing exploration and exploitation, which enables a company to specialize only in one activity, while pursuing the other activity via alliances or acquisitions. Most companies explore and exploit via multiple modes, including their internal organization, alliances, and acquisitions. I analyzed 190 software companies, tracking all their products, alliances, and acquisitions over 12 years. I found that companies that attempt to simultaneously explore and exploit in one mode such as their internal organization or acquisitions, suffer performance decline, mostly because these activities involve contradictory organizational routines. Exploitation facilitates consistency, stability and control, while exploration entails experimentation, flexibility, and risk-taking. Pursuing both activities in the same mode creates tension and coordination challenges. Also, managers cannot mobilize resources or reassign personnel across these activities. A case in point is Delta Airlines' decision to terminate its Song service which was supposed to compete with low-cost carriers offering point-to-point flights. Delta discovered that exploring with this new service conflicted with its traditional service and that it could gain more by avoiding exploration and using the Delta Song planes on its regular routes.

The recent evidence suggests that when a company explores in one mode while exploiting in another, it can enjoy the complementary benefits of exploration and exploitation, and improve its performance by decoupling exploration from exploitation. Such company can overcome the tension between conflicting routines, nurture a coherent learning environment, and promote specialization in either exploration or exploitation. In each mode the company can invest in one activity without sharing resources with the other activity, and follow consistent procedures. For instance, when Procter & Gamble (P&G) experienced performance decline in 2000, its CEO, Lafley, abandoned P&G's tradition of internal innovation, and opted for external innovation via acquisitions and alliances, while leveraging P&G's marketing and manufacturing infrastructure to exploit. P&G's "Connect and Develop" approach relied on its ability to recognize consumer trends while seeking external solutions to satisfy emerging customer needs. Instead of internalizing knowledge, P&G opted for acquisitions, such as SpinBrush, and for joint ventures, such as Precision Diagnostics. By 2006, many of P&G's products came from external contributions, which increased productivity, reduced costs, and doubled P&G's share price.

Indeed, my research shows that companies are better off leveraging alliances and acquisitions for exploration while focusing their internal organization on exploitation. This is so because exploration requires the company to move away from its core competence and prior knowledge, while internally, the company can effectively build on established solutions. In sum, maintaining innovation and efficiency is challenging, thus managers should consider alternative approaches for achieving both objectives.