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Determinants of strategic change in the LTL motor carrier industry: a discrete choice analysis.

An important issue in deregulated transportation industries is to what extent firms change their strategies over time, particularly in response to a changing environment. A number of recent articles in the transportation and strategic management literature have examined strategy in a dynamic context.(1) However, there has been little systematic empirical investigation regarding the various determinants of strategic change.

More specifically, while much of the initial focus on strategy was in a static context, there has been of late a growing interest in the subject of strategic change. For example, Smith and Grimm(2) examined strategic change in response to the dramatic environmental shift of deregulation in the U.S. railroad industry. An important hypothesis of the study was that firms would need to change strategies following deregulation to remain aligned with their environment, and that firms changing strategies would out-perform those firms which did not change strategies. Based on data from customers serving as industry judges, this study classified firms into strategic groups at two points in time and found support for the primary hypotheses.

There have also been a number of studies exploring strategic change in industries other than transportation. Oster's study(3) uses Compustat data to draw information on strategic groups, based on product strategies using advertising data. Specifically, the advertising to sales ratios of firms were calculated in a number of industries and compared over time. Oster found that the incidence of strategic change over time was overall quite low, but noted variation across industries. One explanation was the degree to which advertising expenditures had a lasting effect over time; in such cases, there were greater mobility barriers or inertia working against strategic change.

Ginsberg(4) explored strategic change conceptually, examining such issues as the meaning of strategic change, how to model such change, and factors which may influence strategic change. In particular, Ginsberg posits that although changes in the external environment may well provide pressures for strategy change, a firm's internal capabilities, resources, and potential resistance to change are also significant factors. This work presents a useful framework on the subject and points to the need for further empirical investigation of strategic change.

Mascarenhas(5) and Zajac and Shortell(6) have provided additional empirical evidence regarding certain determinants of strategic change. Mascarenhas emphasizes the state of the economy, hypothesizing that firms will be more likely to change strategies during periods of economic decline, and also examined relative mobility rates between groups. These hypotheses were tested using data from firms providing off-shore drilling services.

Zajac and Shortell(7) also argue for the need for greater attention to strategy change, as opposed to static analyses of strategy, and offer empirical evidence based on health care providers' response to changes in Medicare regulations. Specifically, this study addresses the propensity of firms to change strategies and focuses attention on the role of previous firm strategy; the Miles and Snow topology of strategy is used, which classifies firms as prospectors, analyzers, defenders, or reactors.(8)

Most recently, Grimm and Smith(9) have provided evidence regarding the influence of management ability and experience in strategy change, as measured by education, age, years of service with the company, and functional background.

While these studies have focused much needed attention on the issue of strategic change, and have provided evidence regarding individual determinants of change, there is a need for a more comprehensive examination of the determinants of strategic change. This paper builds on a previous examination by Corsi, Grimm, Smith, and Smith (1991) of strategic change among less-than-truckload motor carriers.(10) In that effort, data on key strategic variables were gathered using archival methods at two points in time: 1977 and 1987. Following the methodology developed by Smith and Grimm,(11) cluster analysis on the combined sample was used to classify firms according to strategies and to assess which firms changed strategies over time. The performance of firms employing the various strategies in both the regulated and deregulated environments were compared to assess which strategies worked most effectively in a particular environment. Specific patterns of firm strategy change were examined to determine the frequency with which changes were made as well as the performance success associated with each pattern of strategy shifts.

While providing evidence regarding strategic change, the previous paper did not address the question of why some firms altered strategies over time while others did not. This paper develops a theory regarding strategic change, positing that the probability of change is a function of prior strategy, past performance, firm resources, and management ability and experience. A discrete choice model is used to investigate the determinants of strategic change in the less-than-truckload U.S. motor carrier industry, thereby testing the theory. This paper proceeds with the development of a model, followed by a section on data and methodology. The results are then presented and discussed.

THEORY: DETERMINANTS OF STRATEGIC CHANGE

Recent models of strategy change(12) highlight that two criteria must be met for a firm to alter its strategy: First, a firm must sense a need for strategic change, and key decision makers in the organization must be cognizant of this need. Second, a firm must have the ability to change strategies. Accordingly, we postulate a number of factors which will influence perceived need and ability to change, including financial performance, top management stock ownership, firm size, initial strategy, and characteristics of top managers. Each will be discussed in turn.

Financial Performance

The work of Nelson and Winter,(13) drawing on the earlier research by Cyert and March(14) and Simon,(15) argues that firms tend to satisfice rather than maximize profits. They will tend to continue past strategies and internal allocations of resources so long as performance is higher than some threshold level. However, when performance falls below this threshold, they will change strategies. Oster(16) provided support for this notion in finding that firms with high advertising strategies tended to reduce advertising when faced with a fall in profits. As discussed by Zajac and Shortell,(17) firms suffering low profits or anticipating low profits because their current strategy was out of alignment with the environment would be more likely to change strategies. Thus, Hypothesis 1:

Hypothesis 1: The poorer a firm's initial financial performance, the more likely is that firm to change strategies.

Management Stock Ownership

As pointed out by Ginsberg,(18) pressures for change brought about by poorer performance may well encounter inertia and resistance to change within a firm, with the result being no change in strategy. However, the degree to which managers will actually act in response to poor performance may well depend on the extent to which they are directly affected by adverse firm performance. For example, if compensation is tied to overall performance, managers may well be prompted to change strategies in the face of disappointing profits. Similarly, if managers are also to a large degree stockholders, they may well be more inclined to act. Hypotheses 2 follows from these arguments:

Hypothesis 2: The greater degree to which managers have ownership of a firm, the more likely is that firm to change strategies.

Firm Size

Firm size may influence the ability to change, in that larger firms might be more structurally complex. Structurally complex organizations may well have difficulty in transferring information from boundary spanners to decision makers and then to implementers. As structural complexity increases, so too does the probability that information transmitted through the organization will be blocked or modified.(19) Past policies may get entrenched, and any forces for change stifled by having to filter through complex layers of management. On the other hand, a smaller, entrepreneurial firm could quickly change strategies once a desire to change was established. Hypothesis 3 follows:

Hypothesis 3: The smaller a firm, the more likely is that firm to change strategies.

Initial Strategy

Zajac and Shortell(20) argued that initial strategy would influence both ability and desire to change. As discussed by Oster,(21) drawing on the earlier research of Bower,(22) past investments can often pose impediments to changing strategies. This is particularly true if a previous strategy hinged on large investments of fixed assets. For example, if a firm becomes very capital intensive in an effort to pursue a low-cost strategy, it will be very difficult to switch to an alternative course. On the other hand, a differentiation strategy will generally involve less commitment of fixed assets and will therefore be more easily altered. For example, Oster has argued that firms differentiating themselves on the basis of high advertising expenditures can easily shift out of advertising; high advertising expenditures in previous periods does not commit a firm in the future. The fourth hypothesis, then, is:

Hypothesis 4: The less a firm's strategy hinges on commitment of fixed assets, the more likely is that firm to change strategies.

Market Orientation of Managers

If strategic change is primarily motivated by environmental variation bringing about misalignment of strategy with environment, an important factor in building desire to change is the degree to which managers are in touch with market forces. Firms with more of an external orientation which concerns marketing, customer service, and boundary spanning functions, as opposed to internal functions such as finance or accounting, will be in a better position to sense and process relevant information in their environment and will gather a richer array of information.(23) Thus, such firms will be more likely to sense a need to alter strategies. This view is supported by Zajac and Shortell, who argue that from an "ability to change" point of view, defenders would be least likely to change because of an "inward-looking orientation." The following, then, is posited:

Hypothesis 5: The greater degree to which managers have an external, market orientation, the more likely is that firm to change strategies.

Change in Ownership Outside Company

The decision by firms to increase the share of their stock held by outsiders reflects a need to obtain additional sources of capital, perhaps as a means to finance expansion plans or service quality improvements mandated by a new deregulated environment. Along with the acceptance of these new capital sources is a management commitment to improve firm profitability. It is our hypothesis that this additional commitment to insure profitability will provide additional incentives to management to initiate strategic change in order to improve the fit with the new environment. Firms, increasingly beholden to outside financial interests, may have a more powerful need to change strategy to improve the firm's fit with the environment, thereby enhancing firm profitability and investor confidence. Hence, we hypothesize:

Hypothesis 6: The greater the change in outside company ownership, the more likely is that firm to change strategies.

Table 1. Summary of Hypotheses

Hypothesis 1: The poorer a firm's initial financial performance, the more likely is that firm to change strategies.

Hypothesis 2: The greater degree to which managers have ownership of a firm, the more likely is that firm to change strategies.

Hypothesis 3: The smaller a firm, the more likely is that firm to change strategies.

Hypothesis 4: The less a firm's strategy hinges on commitment of fixed assets, the more likely is that firm to change strategies.

Hypothesis 5: The greater degree to which managers have an external, market orientation, the more likely is that firm to change strategies.

Hypothesis 6: The greater the change in outside company ownership, the more likely is that firm to change strategies.

DATA AND METHODOLOGY

The measure of strategic change followed the methodology of Smith and Grimm.(24) More specifically, for a sample of less-than-truckload (LTL) motor carriers, archival data were obtained on six strategic dimensions over two time periods (1977 and 1987). These dimensions represented a broad range of strategic behavior, including cost and price position, traffic and customer focus, productivity, and service differentiation. The primary source of data was annual reports filed with the Interstate Commerce Commission (ICC). Specifically, carriers were included as defined by the ICC as "Instruction 27" carriers, those deriving more than 75 percent of their revenues from transportation of general freight. A cluster analysis was performed on the combined data, which consisted of observations across the two time periods.

The cluster analysis categorized the firms into six strategic groups. The six strategies were labeled: differentiation, product focus, regional focus, contingency, broad product/geographic scope, and low cost. Further details of the procedures and strategies can be found in Corsi, Grimm, Smith, and Smith.(25)

If a given firm's two observations across time were in the same cluster, it was designated as not having changed strategies; if the observations were in different clusters, the firm was designated as having changed strategy. Thus, a binary (0/1) variable was obtained for each firm, with 0 indicating no change in strategy and 1 indicating a change in strategy. This variable served as the dependent variable in the statistical analysis.

The independent variables are as follows: Firm size: The number of ICC geographic regions in which the firm operated was used as the measure of the size of the firm. These data were drawn from annual reports filed with the ICC.

Change in outside ownership: The change in outside company shares between 1987 and 1977 was used as a measure of the extent to which the company was increasingly controlled from the outside. For example, if 50 percent of the shares were owned by outside interests in 1977 and 70 percent of the shares were owned by outside interests in 1987, the change measure would in this case be 20 percent. These data were drawn from the American Trucking Association's (ATA's) Executive and Ownership Report (1977, 1987).

Type of strategy: A dummy variable was included, with a value of 1 if a firm pursued a differentiation strategy in the first time period, 0 for any other 1977 strategy.

Top management ownership: The percent of shares owned in 1977 by the top management team was used as a measure of to what degree the managers actually owned the company. These data were also drawn from the ATA's Executive and Ownership Report (1977, 1987). For the purposes of this study, executives listed in this report constituted the top management team.

Initial financial performance: 1977 operating ratio (operating expenses/operating revenues) was used to gauge initial financial performance. This is the most commonly used performance measure in the motor carrier industry and closely correlated with other financial indicators. The data were drawn from ICC annual reports. It should be noted that a smaller operating ratio indicates better financial performance.

Orientation of top managers: The ATA's Executive and Ownership Report (1977, 1987) provided information on each firm's top management team including job title. These job titles were initially grouped into and coded according to the following functional areas: finance/comptroller, rates/tariff, marketing operations, management, information systems, human resources/labor relations, international, safety, law, claims, and traffic management. For each firm, the presence or absence of a manager in each category was recorded. External-oriented functions, those most relevant in monitoring the competitive environment, included marketing, rates/tariffs, and finance/comptroller. The degree to which a company had representation in these three categories in the initial period was recorded.

The previous cluster analysis described above, which is used in this study to measure strategic change, employed a data set of 130 observations. The final data set for the present study consisted of 96 observations, based on data availability for all the independent variables. A discrete choice model is appropriate for testing the hypotheses given that the dependent variable (change/no change) is discrete. Specifically, the statistical package TSP was used to do a probit analysis, a discrete choice model which assumes a normal distribution in the error term.

RESULTS

The results are provided in Table 2. Regarding Hypothesis 1, the results are in the direction hypothesized but initial financial performance does not have a significant effect on change of strategy. Similarly, a greater degree of initial stock ownership on the part of the top management team corresponds with a higher propensity to change, but the coefficient is not statistically significant. The results support Hypothesis 3 in that smaller firms are more likely to change; the result is significant at a .05 level. Hypothesis 4 was also supported in that firms with a differentiation strategy were more likely to change, significant at a .05 level. The results were in the direction of Hypothesis 5, but insignificant. Finally, the coefficient testing Hypothesis 6 is marginally significant; a greater change in the degree of outside ownership leads to greater strategy change, significant at .10. It should be noted that the relatively low R-Squared is typical of discrete choice models and not problematic.(26)

DISCUSSION

The results indicate that firm size and prior strategy appear to be the most important determinants of change. The lack of findings regarding a firm's financial performance and, relatedly, the degree to which top managers are directly affected by poor performance is inconsistent with the satisficing literature but, as reported by Ginsberg,(27) is consistent with a number of previous studies finding no link between previous performance and change in strategy.

It is also instructive to examine the results in light of the special features of the motor carrier industry in its transition to a deregulated environment. For example, although the hypothesized relationship was that poorer financial performance in the base period would result in a greater firm proclivity to initiate strategic change, it must be emphasized that the performance of LTL motor carriers under regulation was quite strong across all firms. In the regulated environment, pricing, to a large extent, was accomplished through rate bureaus, which set uniform prices based on the costs of average firms. There was little deviation among LTL carriers from these rate bureau-established prices. (However, there were a growing number of independent actions in the late 1970s.) Previous research has shown that in the regulated environment firm performance was quite strong regardless of firm size or firm strategic orientation.(28)

The finding that small firms are significantly more likely to change strategy than are larger ones provides support for the hypothesis. However, it should be noted that previous research on these same LTL firms indicates that, while small firms have a greater propensity to change strategies to adopt to their new environment, their new strategic choices did not yield improved profitability. For example, while only ten small LTL firms in the sample pursued a low-cost strategy in a regulated environment, twenty-two pursued this strategy under deregulation. Unfortunately, the mean operating ratio for the small firms pursuing a low-cost strategy in the deregulated environment exceeded 100 percent--substantially above the overall mean operating ratio.(29) Thus, we might suggest that the small firms, while more able to change strategies as a result of the absence of bureaucratic inertia, may be less knowledgeable about the "correct" or "best" strategic fit.

The finding that the market orientation of the management team in the regulated environment did not impact upon the firm decision to make a strategic change in the deregulated environment can be explained with regard to the initial regulated environment of the LTL firms. ln that setting, firms placed very little emphasis on proactive marketing, the rate bureau system brought about price uniformity, and firms were restricted on their entry options and service additions. As a result, firms universally had only perfunctory commitments toward a market orientation under regulation. Perhaps over time the influence of market orientation in influencing strategic change will become stronger.
Table 2. Results of Probit Regression

Variable Estimate T-Statistic

Initial financial
performance 0.0016 0.05

Initial TMT
stock ownership 0.0037 0.98

Initial firm size -0.2627 -2.06(**)

Differentiation
strategy (initial) 0.9009 2.43(**)

Initial TMT market
orientation 0.0361 0.19

Change in
outside ownership 0.0076 1.84(*)

Constant 0.0471 0.02

Number of observations = 96

R-Squared = 0.16

* indicates significance at the .10 level.

** indicates significance at the .05 level.


Overall, the picture that emerges then is that firm propensity to make strategic changes is, indeed, influenced by a number of factors. For LTL motor carrier firms the most critical ones are firm size, strategy pursued in a regulated environment, and change in outside stock ownership during the transition to regulation. These results are instructive in developing a better understanding of firm strategy during a period of rapid environmental change. Certainly, they suggest that the likelihood that a given firm will change strategies is influenced by a number of firm-specific characteristics which may ultimately determine the degree to which firms adapt to their new environment.

ENDNOTES

1 Sharon Oster, "Intraindustry Structure and the Ease of Strategic Change," Review of Economics and Statistics, Vol. 64, 1982, pp. 376-383; Ken G. Smith and Curtis M. Grimm, "Environmental Variation, Strategic Change and Firm Performance: A Study of Railroad Deregulation," Strategic Management Journal, Vol. 8, 1987, pp. 363-376; Ari Ginsberg, "Measuring and Modelling Changes in Strategy: Theoretical Foundations and Empirical Directions," Strategic Management Journal, Vol. 9, 1988, pp. 559-575; Edward Zajac and Stephen Shortell, "Changing Generic Strategies: Likelihood, Direction and Performance Implication," Strategic Management Journal, Vol. 10, 1989, pp. 413-430; Briance Mascarenhas, "Strategic Group Dynamics," Academy of Management Journal, Vol. 32, No. 2, 1989, pp. 333-352; Curtis M. Grimm and Ken G. Smith, "Management and Organizational Change: A Note on the Railroad Industry," Strategic Management Journal, Vol. 12, 1991, pp. 557-562.

2 Ken G. Smith and Curtis M. Grimm, "Environmental Variation, Strategic Change and Firm Performance: A Study of Railroad Deregulation," Strategic Management Journal, Vol. 8, 1987, pp. 363-376.

3 Sharon Oster, "Intraindustry Structure and the Ease of Strategic Change," Review of Economics and Statistics, Vol. 64, 1982, pp. 376-383.

4 Ari Ginsberg, "Measuring and Modelling Changes in Strategy: Theoretical Foundations and Empirical Directions," Strategic Management Journal, Vol. 9, 1988, pp. 559-575.

5 Briance Mascarenhas, "Strategic Group Dynamics," Academy of Management Journal, Vol. 32. No. 2, 1989, pp. 333-352.

6 Edward Zajac and Stephen Shortell, "Changing Generic Strategies: Likelihood, Direction and Performance Implications," Strategic Management Journal, Vol. 10, 1989, pp. 413-430.

7 Edward Zajac and Stephen Shortell, "Changing Generic Strategies: Likelihood, Direction and Performance Implication," Strategic Management Journal, Vol. 10, 1989, pp. 413-430.

8 Robert Miles and Charles Snow, Organizational Strategy, Structure, and Process, McGraw-Hill New York, 1978. With regard to the Miles and Snow typology, defenders attempt to efficiently serve a limited and stable set of customers. Prospectors attempt to succeed through innovation, constantly striving to exploit new product and market opportunities. Analyzers are more selective about the markets and products served. Reactors do not follow any particular strategic orientation.

9 Curtis M. Grimm and Ken G. Smith, "Management and Organizational Change: A note on the Railroad Industry," Strategic Management Journal, Vol. 12, 1991, pp. 557-562.

10 Thomas M. Corsi, Curtis M. Grimm, Ken G. Smith, and Raymond D. Smith, "Deregulation, Strategic Change, and Firm Performance Among LTL Motor Carriers," Transportation Journal, Vol. 31, No. 1, Fall 1991, pp. 4-13.

11 Ken G. Smith and Curtis M. Grimm, "Environmental Variation, Strategic Change and Firm Performance: A Study of Railroad Deregulation," Strategic Management Journal, Vol. 8, 1987, pp. 363-376.

12 Ari Ginsberg, "Measuring and Modelling Changes in Strategy: Theoretical Foundations and Empirical Directions," Strategic Management Journal, Vol. 9, 1988, p. 559-575; Edward Zajac and Stephen Shortell, "Changing Generic Strategies: Likelihood, Direction and Performance Implication," Strategic Management Journal, Vol. 10, 1989. pp. 413-430.

13 Richard Nelson and Sydney Winter, An Evolutionary Theory of Economic Change, Harvard University Press, Cambridge, 1982.

14 Richard Cyert and James March, A Behavioral Theory of the Firm, Prentice Hall, Englewood Cliffs, NJ, 1963.

15 Herbert Simon, Models of Man, Wiley, New York, 1957.

16 Sharon Oster, "Intraindustry Structure and the Ease of Strategic Change," Review of Economics and Statistics, Vol. 64, 1982, pp. 376-383.

17 Edward Zajac and Stephen Shortell, "Changing Generic Strategies: Likelihood, Direction and Performance Implication," Strategic Management Journal, Vol. 10, 1989, pp. 413-430.

18 Ari Ginsberg, "Measuring and Modelling Changes in Strategy: Theoretical Foundations and Empirical Directions," Strategic Management Journal, Vol. 9, 1988, pp. 559-575.

19 J.R. Galbraith, Organization Design, Addison-Wesley, Reading, MA, 1977.

20 Edward Zajac and Stephen Shortell, "Changing Generic Strategies: Likelihood, Direction and Performance Implication," Strategic Management Journal, Vol. 10, 1989, pp. 413-430.

21 Sharon Oster, "Intraindustry Structure and the Ease of Strategic Change," Review of Economics and Statistics, Vol. 64, 1982, pp. 376-383.

22 Joseph Bower, Managing the Resource Allocation Process, Harvard Business School, Cambridge, 1970.

23 H.E. Aldrich, Organizations and Environments, Prentice Hall, Englewood Cliffs, NJ, 1979.

24 Ken G. Smith and Curtis M. Grimm, "Environmental Variation, Strategic Change and Firm Performance: A Study of Railroad Deregulation," Strategic Management Journal, Vol. 8, 1987, pp. 363-376.

25 Thomas M. Corsi. Curtis M. Grimm, Ken G. Smith, and Raymond D. Smith, "Deregulation, Strategic Change, and Firm Performance Among LTL Motor Carriers," op. cit. Briefly, the differentiation cluster emphasized service quality, with the highest rank among the clusters in operating expenses, employee compensation, and revenue per mile. The product focus cluster is characterized by a focus on LTL business. Firms following the regional focus strategy served the smallest number of ICC geographic regions. Firms following the contingency strategy ranked in the middle or near the bottom on all strategic dimensions. Firms in the broad product/geographic scope cluster served the most ICC geographic regions and had the highest percentage of TL traffic. Finally, firms in the low-cost cluster had the lowest operating expenses.

26 This issue is addressed in R. Pindyck and D. Rubinfeld, Econometric Models & Economic Forecasts, McGraw-Hill, New York, 1991, p. 268.

27 Ari Ginsberg, "Measuring and Modelling Changes in Strategy: Theoretical Foundations and Empirical Directions," Strategic Management Journal, Vol. 9, 1988, pp. 559-575.

28 Raymond D. Smith, Thomas M. Corsi, Curtis M. Grimm, and Ken G. Smith, "The Effects of LTL Motor Carrier Size on Strategy and Performance," forthcoming The Logistics and Transportation Review, 1992.

29 Smith, Corsi, Grimm, and Smith, op. cit. (1992).
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Title Annotation:less-than-truckload
Author:Grimm, Curtis M.; Corsi, Thomas M.; Smith, Raymond D.
Publication:Transportation Journal
Date:Jun 22, 1993
Words:4311
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