Knowledge-intensive firms
Economies are measured by their output and outputs are measured using production functions. There are two ways to increase an economies’ output. First, try to increase the inputs (labour or capital) to the production cycle, thereby ascending up the same production function. Second, try to increase the productivity of the production process, changing the production function itself.
Up until the onset of the Industrial Revolution in the late 1700s, much of industry was characterized as labour intensive i.e labour costs were more of a concern than capital costs (think Agriculture). While capital intensity overtook labour intensity during the 1800s, as huge investments were needed for machinery and infrastructure (think Ironworks). During the late 1900s, another kind of input gained emphasis which targeted the production process rather than the inputs. This was the rise of knowledge-intensive firms (Professional services).
The following is a summary of observations made by William H. Starbuck in his paper ‘Learning by Knowledge-Intensive Firms’
It is not as straightforward to identify knowledge-intensive firms. Knowledge can’t be measured in monetary units such as market prices due to its context-specific value which can not be traded.
However, there are certain characteristics that provide a good signal:
- A knowledge-intensive firm need not be information intensive. Knowledge should be seen as a stock, not a flow.
- Esoteric expertise is valued more than widely shared knowledge.
Starbuck identifies Arthur D. Little, The Rand Corporation, and Wachtell Lipton as examples to further analyze the nature of knowledge-intensive firms.
Knowledge-intensive organizations try to convert individual expertise into organizational properties such as physical capital, routines, culture and social capital:
- Physical capital
Accounting firms often convert complex auditing procedures into checklists that novice clerical staff can complete. However, such assets are difficult to protect against imitation.
- Routines
Bureaucratic routines such as roles and responsibilities help set up personnel development programmes, while routines such as formalized documentation ease the transfer of people to meet the shifting needs of the organization.
- Culture
Formal structures are downplayed as experts demand autonomy. However, common values and norms are built by emphasizing shared backgrounds.
- Social Capital
Knowledge-intensive firms pay attention to symbolic outcomes and not just the substance of their outputs. Since many experts use jargon, clients often base their judgements on generic symbols such as confidence and presentation.
Knowledge-intensive firms manage their stock of knowledge. Knowledge flows in through hiring and training. Some knowledge gets built internally through research. While it flows out through departures and imitation. Some of the flow solidifies by means of conversion into physical capital and routines.
Typical strategies adopted by knowledge-intensive firms to deal with a dynamic environment include diversification and international expansion.
- Diversification
Firms try to enter a broad set of verticals and serve multiple clients to minimize the risk of redundancy and dependency. At the same time, they do not want to be seen as less than domain experts and lose clients.
- International expansion
Ease of transfer of knowledge provides an opportunity for international expansion. Since hierarchies are not present, firms have to depend on culture to ensure reliable quality. This homogeneity of culture arises from a shared education. At the same time, international expansion requires tailoring solutions to local contexts, which is ensured by hiring local talent.
In the end, Starbuck highlights that all expertise becomes less profitable as it becomes more prevalent and going forward physical assets like software will replace experts’ activities. However, there will always be a place for exceptional firms with rare experts.
