A Basic Theory of Inheritance: How Bad Practice Prevails

Received: 25 September 2014 Revised: 13 February 2017 Accepted: 25 February 2017 DOI: 10.1002/smj.2713 SPECIAL ISSUE ARTICLE A basic theory of inheritance: How bad practice prevails Freek Vermeulen Strategy and Entrepreneurship, London Business School, London, U.K. Research Summary: This paper develops an inheritance Correspondence theory explaining the diffusion and persistence of detri- Freek Vermeulen, London Business School, mental management practice. Received wisdom, in both Regent's Park, London NW1 4SA, U.K. management theory and practice, would suggest that a Email: [email protected] practice that lowers the life expectancy of adopting firms, over time, will vanish because it puts those firms at a competitive disadvantage. In this paper, I challenge this view. I develop a conceptual model that details how a practice that lowers the survival chances of adopting organizations may still spread and continue to exist across a population of firms. I propose that a combination of three basic conditions is sufficient to bring about this phe- nomenon: if the practice is somehow associated with success, if there exists causal ambiguity, and if the rate of its diffusion is high compared with the rate at which it accel- erates firms’ demise, the practice may continue to thrive and become a widespread and persistent feature in an industry. A pivotal conceptual insight is that the endur- ance of particular management practices and strategies is not merely a corollary of the competitiveness of the organizations that use them but that they have fitness levels of their own. Managerial Summary: All organizations have “best practices”: habits that they have picked up in the past or mimicked from others. Managers often believe that these must be the best ways of doing things, because otherwise market forces would have eliminated them. The theory in the paper explains why this belief may be wrong. Some enduring practices may be harmful without managers realizing it because it is not necessarily the most optimal practices that survive (just like harmful viruses persist in nature). As a corollary, the paper discusses how the iden- tification and cessation of detrimental practices can form a new source of and way to understand innovation. Strat Mgmt J. 2017;1–27. wileyonlinelibrary.com/journal/smj Copyright © 2017 John Wiley & Sons, Ltd. 1 2 VERMEULEN KEYWORDS evolutionary theory, inheritance theory, management practices 1 | INTRODUCTION The traditional view in economics and the social sciences in general has been that “efficient firms grow and survive; inefficient firms decline and fail” (Jovanovic, 1982, p. 649). Through competi- tion, market forces are thought to select out those firms with traits that make them less efficient (Alchian, 1950; Friedman, 1953). However, various observers of business have argued that inefficient practices seem to persist (e.g., M. W. Meyer & Zucker, 1989) and that they even appear to be widespread (Carroll, 1993). For example, detailing—face-to-face sales and promotion—is a key and very costly strategic practice in the pharmaceutical industry—it is estimated, for instance, that drug companies spend twice as much on detailing and free samples as they do on R&D (Gagnon & Lex- chin, 2008). Research by Mizik and Jacobson (2004, p. 1714), however, suggested that the practice is ineffective, which led the authors to wonder “why…firms persist at engaging in a practice that has negative returns.” Different explanations have been offered in our literature as to why inefficiencies do not always get weeded out. Some explanations have focused on conditions in the firms’ selection environment, arguing that if firms with lower fitness levels are able to survive, it is because of “light competitive pressure” (Leibenstein, 1966), “a loose selection environment” (Carroll, 1993), or an otherwise “munificent demand environment” (Van Witteloostuijn, 1998), possibly exacerbated by a weak reg- ulatory regime and ineffective institutions (Button & Weyman-Jones, 1992; Gomes & Jehiel, 2005). Others have sought to explain the persistence of inefficiencies through the notion that it is not just efficiency that drives the selection of firms; institutional theory, in particular, has argued that organizations may adopt strategies, structures, and also cultural elements for reasons of isomorphism (DiMaggio & Powell, 1983; J. Meyer & Rowan, 1977; Zucker, 1987). A practice may persist not because it increases efficiency but because it gives firms legitimacy and political influence and, along with these, access to valuable resources, such as customers, employees, or financial capital (see also Barnett, 1997; Carroll & Harrison, 1994; Chang & Wu, 2014; Nelson & Winter, 1982), which enhances its survival.1 In all of these studies, however, practices that lower an organization’s chances of survival are expected to gradually die out and disappear. This paper takes a different—and arguably more radical—perspective. I argue that inefficient practices that lower a firm’s chances of survival can still persist. The prime reason for this, I argue, is that many aspects of a firm’s strategy and organization are inherited, either from the firm’s own past or from others. Core strategic decisions, in terms of what formats to offer (Greve, 1996, 1998), what activities to perform (Haunschild, 1993; Stan & Vermeulen, 2013), and how to conduct opera- tions (Guler, Guillén, & Macpherson, 2002), have been shown to spread via a process of contagion. As a consequence, I contend, the survival of particular strategies and practices depends only 1Relatedly, the literature on slack has argued that, although perhaps in itself an inefficiency (Love & Nohria, 2005; Williamson, 1991), slack can indirectly aid a firm’s longevity because it enhances innovation (Nohria & Gulati, 1996; Singh, 1986). VERMEULEN 3 partially on the survival of the firms themselves. Characteristics of the practices and the process of their inheritance also matter. A key corollary of this conceptualization is that management practices and strategies have fitness levels that are related to but also distinct from the fitness levels of the practicing organizations. Following this line of argument, this paper outlines a basic theory describing the processes of inheritance and survival. The implication of the theory is that, in extremis, even universally harmful practices can spread and persist. To build a theory of inheritance, I begin my analysis with a hypo- thetical practice that is unambiguously detrimental, in the sense that it lowers the life expectancy of all adopting organization at all points in time. Of course, certain management practices may benefit some firms while being detrimental for others, under different circumstances, or at different points in time. Hence, an indiscriminately detrimental practice represents an extreme scenario. Yet, to build the theory, the central research question of this paper is whether even under such extreme circumstances a practice can still diffuse and persist. I identify three basic conditions under which this diffusion and persistence is feasible: first, the practice needs to have a spurious association with success, and I discuss several potential sources of this. Second, decision-makers have to experience causal ambiguity about the practice’s true long- term effects, which can be exogenous but also endogenous to the practice itself. Third, the rate of the practice’s diffusion across firms in the industry must be relatively high compared with the rate at which it terminates adopting organizations. Put differently, the practice spreads quicker than it kills. I elaborate on these three conditions to clarify the characteristics of persistent harmful management practices and the circumstances under which they are most likely to occur, and illustrate it with an example from prior research (of the practice of patient selection in in-vitro fertilization [IVF] clinics in the UK) and a simulation model. Finally, I discuss extensions and implications for organization theory and strategic management in particular. 2 | BACKGROUND 2.1 | Definitions In the theorizing, I adopt an “organizational practice” as the unit of analysis. I define a practice as a set of formal or informal rules of behavior, shared across people in an organization, that can be learned and passed on. Thus, under this definition, organizational practices include various types of strategic choices, including what activities to perform and what not to (e.g., Reitzig & Wagner, 2010; Stan & Vermeulen, 2013), issues of organizational design (e.g., Burns & Wholey, 1993), and strategic positioning (e.g., Greve, 1998). They also include formalized management tech- niques, such as quality circles (Abrahamson & Fairchild, 1999), and traits of organizational cul- ture, such as the practice of working long hours in many corporate-finance divisions in the banking industry (Chatman & Jehn, 1994). For the purpose of my argument, I define a bad practice as one that has a negative influence on the survival potential of an organization compared with a similar organization that does not adopt it. Thus, the life expectancy of the adopting organization would be higher if they had not implemented it.2 Hence, under this definition, a practice that 2The theory developed in this paper, regarding harmful management practices, relates to the literature on management fads (e.g., Abrahamson, 1996, 1997; Strang & Macy, 2001), but it represents a more extreme case. The literature on management fads and fashions

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