Technologically oriented firms must allocate resources between exploration (research) and exploitation (development) activities. While scholars have emphasized the need for a mix between exploration and exploitation, some firms consciously choose to specialize only in either exploration or exploitation. The reasons for such a strategic posture could be many, including rigidities emanating from resources or routines. While previous studies suggest that an exploration/exploitation mix is necessary for success in an innovation strategy, focused strategies have recently come into research focus. In this research we adopt a methodological approach using case studies combined with an agent-based simulation model in order to learn about the effectiveness of specialization strategies. The results suggest that an exploration based specialization strategy can have a relative advantage over an exploitation based specialization strategy, and a balanced strategy is not absolutely necessary to ensure innovation success. We find that as competitive intensity increases, the relative advantage of exploration based specialization strategy diminishes.
Traditional innovation strategy planning has consistently suggested that firms need to excel in both exploitation as well as exploration, and in incremental as well as discontinuous innovations for competitive success. While both exploration and exploitation are essential for organizations, the resource commitment needed for these distinctly different endeavors requires a firm to make choices between the two based on current resource levels, organizational routines, alternatives and competitive strategies. Although a balance between exploration and exploitation delivers significant rewards, the complications to achieve this balance is enhanced by the the underlying organizational and system-based complexities. It is therefore reasonable to expect that some firms facing this situation may completely focus on either exploration or exploitation.
In our study, an agent-based model simulated an environment in which firms compete for different types of consumers based on a simplistic specialization strategy of exploitation or exploration. The firms in the model manufacture either incremental or innovative products as a part of their strategy. The results of this study suggest that, ceteris paribus, exploration based specialization strategy leads to higher profitability as compared to exploitation based specializations strategy. We do find support to the theoretical argument that emphasizing exploitation can compromise performance and, in turn, affect competitive position. We thus observe that macro-level market correction is possible for specialization strategies. We find this to be true for an exploration focus but not an exploitation focus. This finding supports the R&D strategy of companies like Proctor & Gamble who hire design houses such as IDEO, which focuses on providing ‘exploration’ services to innovating firms. Our findings also suggest that firms should not completely forgo exploration activities within their own organization. Leaving R&D to other firms becomes an issue of knowledge management. Further, within the notion of punctuated equilibrium where exploration and exploitation are temporally sequenced in a firm’s R&D strategy, the results of the study highlight that allocating a larger proportion of time for the strategy of exploration as compared to the strategy of exploitation would likely yield better firms performance.
In our model, competition also plays an important role in the profitability of a firm. Overall, we find that competitive intensity moderates the relationship between specialization strategy and average profits. We observe that competitive intensity negatively impacts the profits of a firm if it adopts non-adaptive specialization strategy of exploration. More competition obviously results in performance degradation within a set market size. However, as the competitive intensity increases, although the firm adopting exploration-only strategy display higher performance than the firm adopting exploitation-only strategy, the difference in their relative performance decreases. It can be argued that in the presence of large number of competitors, the resource commitment required for exploration puts them in a somewhat more disadvantageous position than the firm adopting an exploitation-only strategy. Beyond the immediate profit-based performance advantage, exploration strategy also enables a firm to reap first-mover advantage (such as creation of lock-in situations) and advantages pertaining to leading-edge knowledge. These aspects were not directly addressed in this study and provide directions for future research.
Since agent-based models can be useful as learning tools to guide intuition, the results of this model can be generalized for other similar types of innovating firms. The model showed that a firm can be profitable in highly competitive environments by not focusing solely on macro customer demands but instead finding a niche and building products for that niche. It is a strategy that Apple Inc. has been very successful at – starting with the niche market and later expanding into the general marketplace. For example, Apple’s iMac computer has only in the last few years entered mainstream business markets as opposed to being mainly targeted at the home, education, and creative professional markets. Our model shows how this can be a profitable strategy.
Our findings also provide additional support that theory regarding exploration and exploitation strategizing should be further developed for contingent environments. Firms that slowly evolve over time can do so without significantly hurting their performance outcomes. By taking a holistic approach to the exploration-exploitation dilemma, it was seen that adaptive firms tend to do better, but a firm that adopts a specialization strategy and intends to stick with it seem to do well when it chooses to invest its resources on exploration. As competitive intensity increases, the firm may evaluate its specialization posture and move its resource allocation towards exploitation strategy or assume a more ambidextrous form. We observe that firms that find a niche within which to operate can succeed in the marketplace.
Source: Garcia, R., Nair, A., Rummel, P. (2011). Specialization in exploration and exploitation: A systems approach. International Journal of Business and Systems Research, 5(1), 1-21.