Phase transitions and emergence of entrepreneurship: The transformation of Chinese SOEs over time

Journal of Business Venturing 22 (2007) 77 – 96

Phase transitions and emergence of entrepreneurship: The transformation of Chinese SOEs over time Justin Tan Schulich School of Business, York University, Toronto, Ontario Canada M3J 1P3 Received 1 June 2004; received in revised form 1 April 2005; accepted 1 September 2005

Abstract Configurational theory has been a key building block of organizational research. An understanding of how certain configurations evolve over time, especially during discontinuous changes such as economic transition, has been largely a missing link in the literature. Considering economic transition as a process rather than an outcome, this study examined strategic adaptations among Chinese SOEs in two phases, 1990 and 2002. Findings from two surveys and from interviews revealed that environmental characteristics changed significantly over time and that firms responded with more entrepreneurial strategies aimed at firm growth rather than at satisfying state planners. Such changes were related to improved performance. The study closes by offering implications for research and practice. D 2006 Published by Elsevier Inc. Keywords: Phase transition; Environment-strategy coevolution; Chinese enterprise reform

1. Executive summary Configurational theory has been a key building block of organizational research and holds profound implications for research and practice. Configurations between features in a firm’s environment and its strategic responses evolve over time. However, academic and practical understanding of this process is limited, especially in cases of discontinuous change such as the transition towards market economies. Since firms in these transitional economies E-mail address: [email protected]. 0883-9026/$ - see front matter D 2006 Published by Elsevier Inc. doi:10.1016/j.jbusvent.2005.09.002

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have emerged to be suppliers, customers, strategic alliance partners, and competitors of multinational corporations, an improved understanding of the changes these firms have undergone over time will have significant bearing for scholars as well as practitioners. In this study, I examine entrepreneurial transformation among Chinese SOEs in two phases, 1990 and 2002. Findings from two surveys and interviews reveal that environmental characteristics and the strategies that firms deploy in response have changed dramatically over time. The changes have been associated with firm performance. The results suggest that phase changes during the economic reform process call for firms to shift from one strategy to another in order to realign with their environments. This strategic reconfiguration is critical to performance. The issue presented here is particularly salient for emerging economies because the very term btransition economyQ suggests a time-related process encompassing a number of distinct phases. Although institutions evolve through relatively long periods of stability (quasi-equilibrium) during which incremental changes occur in the organizational environment, the process is likely to be punctuated by instances of discontinuous change that demarcate distinct evolutionary phases. By comparing and contrasting different approaches to economic reform, the study offers the following observations. In many former Soviet bloc and other centrally planned Eastern European economies, the dshock therapy model of reform overturned the basic underlying rules governing the behavior of economic actors, thereby leaving no basis on which the system could self-organize. The displacement of the old system by a single dominant new system in the absence of transitional institutional structure resulted in system and organizational level disorder. In China’s case, the duel commitments of maintaining political control while promoting economic freedom has led to a paradoxical yet robust system, one in which two opposing forces co-exist and compete. The hybrid system, while bringing unprecedented turbulence to the market place, has also maintained a certain level of stability and continuity at the system level. If organizations are able to survive in the period of phase transition, they have the potential to be creative and to change. Instead of realising prior intention, the long term outcome of a creative changeable system is emergent. It embodies administrative principles as well as implicit principles arising from ongoing interaction among firms. As a result, despite the turbulence in the environment, firms have gradually transformed themselves and adopted a new set of strategic orientations by learning from and enacting their environment. The co-existence, and co-adaptation between two competing systems have led to a transition process with unique bChinese characteristics.Q Over time, firms have transformed themselves and become future oriented, more proactive, and more willing to take risks. In sum, the study suggests that the Chinese economic transition exhibits two important qualities: it is locally turbulent but globally stable, a paradoxical phenomenon indicative of phase transition in a complex adaptive system. Implications for research and practice are discussed. Transition in China will continue to be a path-dependent process in which firms’ experiences of the reforms are highly contingent on the institutional structure of state administration and a firm’s position in this administrative hierarchy, but it will also be shaped by the networks of firms and the models of economic action and organizational structure to which Chinese firms are exposed. — Doug Guthrie, 1999.

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Some time ago, Meyer et al. (1990) pointed out that bfrom time to time, organizational environments undergo cataclysmic upheavals — changes so sudden and extensive that they alter the trajectories of entire industries, overwhelm the adaptive capacities of resilient organizations, and surpass the comprehension of seasoned managersQ (p. 93). Organizational scholars intimately involved in the study of centrally planned economies such as those in the former Soviet Union, Eastern Europe, and the People’s Republic of China registered little surprise when communism began to falter seriously in the mid-1980s. However, most were taken aback by the sheer speed of the collapse of the former communist bloc in 1989 and by the depth of the economic crises that afflicted virtually all of the centrally planned economies shortly thereafter. It has been more than a decade since the Russian Federation embraced Western political reform (Sachs, 1989), yet its economy still has not recovered from the bshock therapy.Q For most of these planned economies emerging from the former Soviet Union, the economic crisis has yet to bottom out, and it will be some years before the bulk of their respective populations will see any substantial economic benefits from the reform. Standing in sharp contrast to the Russian experience, however, is the Chinese evolutionary approach of economic transition. Ever since the late-1970s, the Chinese economy has also undergone a radical transformation and movement towards market economy, but this transition has not involved the degree of pain, upheaval, and economic dislocation associated with the reform in other transitional economies. On the contrary, the Chinese economy has boomed like no other economy in recent times. Moreover, the Chinese experience is noteworthy precisely because it has largely been constructed upon two crucial elements absent from other transitional economies. First, China was very successful in utilizing many of the efficient aspects and emerging positive trends of the old system. Second, China has been keen to learn from practical examples of transition shown to be successful elsewhere rather than from abstract theoretical models in constructing its own version of reform program. Despite a number of tumultuous events, the Chinese transition in the last two decades has been characterized by a relatively continuous process. As a result, organizational research on China has focused more upon the difficulties of managing an already successful process of change while other transitional economies continue to struggle over the tension between bBig BangQ and gradual reform (Bateman and Tan, 1998). One of the main difficulties faced by the reform-minded policy makers has been to improve the performance of the previously inefficient state-owned enterprises (SOEs). Whether SOEs can transform themselves and become competitive depends on whether the environment is moving from a rigid bureaucracy toward one that favors entrepreneurial initiative, on whether firms respond to such change by adopting strategies aimed at achieving growth rather than satisfying state planners, and on whether the newly transformed environment and firm strategies result in improved performance. Such issues present an unprecedented challenge as well as opportunity for organizational research, because theories explaining the process of such bquantum changesQ involving environmental changes and strategic adaptation are sparse in the literature (Meyer et al., 1990). It has been more than two decades since China started economic reform in 1978. Judging by the near absence of dramatic political reform, one may argue that China is hardly a success story of reform. However, in light of China’s sustained annual economic growth for more than two decades, few can ignore the significance of China experience

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(Boisot and Child, 1996). Rooted in a deep conviction that much insight can be gained by examining the Chinese transition process and understanding how individual firms have been influenced and transformed during such process, I undertake this study to trace the changes in organizational environment and firm strategies over the last two decades. The turbulent yet uninterrupted transition presents us with a unique opportunity to examine environmental changes, strategic adaptation, and organizational transformation in discrete phases (Peng, 2003). Such an experimental setting offers the opportunity to examine an important but often missed temporal dimension in our theorizing by tracking the changing environment–strategy interface as new configuration unfolds. bThese kinds of changes do not occur often; when they do, they provide us with an opportunity to examine the conditions under which actors can alter their social structureQ (Fligstein, 1991). Utilizing this natural experiment, I consider China’s economic transition and entrepreneurial transformation as a complex adaptive systems and devise a bstaged modelQ to examine how changes in organizational environment have impacted firm strategic adaptations and consequently firm performance. I bracket the Chinese transition process into two phases, 1978 to 1990 and 1990 to 2002 (see Fig. 1), and examine two points (1990 and 2002) of bconfigurational transitionsQ (Meyer et al., 1990). My motivation stems from the unique experimental setting provided by large-scale transition to extend the literature on how organizations respond to institutional changes and make strategic choices during the time of fundamental transitions. Such comparison between phases benables the explicit examination of how actions of one period lead to changes in the context that will affect action in subsequent periodsQ (Langley, 1999: 703; Zajac et al., 2001

1989

19

78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02

1978

Note 1. In 1978, Chinese Communist Party announced in its Third Plenary Session of the 11th Central Committee that it would shift its focus to economic development, marking the “Open Door” policy. 2. Following the 1989 “June 4th Incident,” economic embargo from the West has led to sharp decline of foreign direct investment and Chinese foreign trade. 3. In December 2001, China has joined World Trade Organization. 4. Chinese 2002 GDP was based on mid-year estimate. Fig. 1. Milestones of Chinese reform and GDP growth (1978–2002).

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2000). It is intended that such an effort will offer btheoretically grounded depiction of how organizations operateQ (Anderson et al., 1999) and extend the strategic choice perspective by focusing on how organizations strategically respond to a radically evolving, as opposed to existing, organizational environment. This allows us to make comparisons with binitial conditionsQ (Levinthal and Myatt, 1994) in order to study not only bcontinuous, or firstorder change,Q but also discontinuous, or second-order changeQ that transforms fundamental properties or states of the systemQ (Meyer et al., 1990). In the next section, I review literature on economic transition and entrepreneurial transformation. I then compare and contrast the current environment and firm strategic orientation with those of more than a decade ago. The discussion leads to a number of hypotheses that will be empirically tested.

2. Transition as a dynamic process: theory and hypotheses To start, we may consider economic transition and entrepreneurial transformation as complex adaptive systems; they are dynamic, bounded networks of diverse agents interacting nonlinearly. Dynamic refers to the continual interactions of multiple agents and resulting uncertainties, turbulence, and surprises. Bounded refers to the defining purpose or intent of the system. The bnetworkQ metaphor characterizes the multiple interconnections of the system. The multiple agents include various stakeholders with diverse goals. They have the capacity to exchange information, learn, and adjust behavior, yet no individual agent can ever know or understand everything that is occurring. The nonlinear relationship among the agents is the result of ongoing feedback loops which can amplify the magnitude and dramatically shift the direction of minor changes. If entrepreneurial transformation is a highly complex and turbulent process, the way that the above factors are manifested in such a particular transition process at any given time and over time may be understood through a number of complexity science principles: self-organization, emergence, and co-evolution. Self-organization refers to the spontaneous development of structures and forms of behavior in systems characterized by multiple feedback loops and nonlinear dynamics. These structures are a function of the patterns of locally defined relationships among agents rather than a globally specified master plan. The state of any given agent changes as a result of the states of other agents, with each agent seeking a better position, a niche, in its local fitness landscape where it can prosper and survive. As the agents of any complex system interact, novel circumstances continuously emerge in aperiodic ways (Miller et al., 2001). When a system is in the phase transition, minor perturbations in environmental parameters could force major changes in the system’s evolution, making its future unpredictable. But in the phase transition there is also a degree of dlock inT which makes the global behavior of the system remarkably robust to perturbations. This combination of sensitivity and lock in constitutes bounded instability, making the behavior of complex adaptive systems locally unpredictable but globally stable. As a system evolves there are archetypal patterns of behavior, patterns at a broad qualitative level, which are recognizable and predictable. The economic reform in China officially began in late 1970s, marked by the Third Plenary Session of the 11th Central Committee of the Communist Party of China. Held in

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December 1978, the session resulted in a decision to shift the focus of the Party’s work to socialist modernization: establishing a policy of reform and opening up to the outside world. Since then the reform in China has been a relatively controlled and incremental process. Unlike former Soviet and Eastern European countries that followed the bbig bangQ approach, Chinese policy makers orchestrated an evolutionary model, in which major policy changes were tested and introduced in stages. Major exogenous shocks such as the Tiananmen Square incident in 1989 punctuated the continuity of transition but did not sway its trajectory. The Tiananmen Square events led to a major embargo from the West, resulting in sharp declines in foreign direct investment (Table 1). Predictions circulated around the world that China’s Communist regime had lost its legitimacy and that the economy would soon collapse. Shortly afterwards , the Soviet Union dissolved, followed quickly by the rest of the communist bloc in Eastern Europe. Yet the Chinese reform model, characterized by rapid economic reform coupled with a near absence of political reform, allowed the political regime to survive the domino effect that brought down the socialist empire in Europe. Meanwhile, the level of growth has stunned even the most optimistic China watchers. The economy has sustained double-digit annual growth rates since 1991, while SOEs’ share of total industrial output continues to decline (Table 1). With the country’s entry into the World Trade Organization in December 2002, the SOEs stand at a crossroads between the opportunity to rise to economic prominence and the threat of economic extinction in the face of overwhelming competition from multinational corporations (Nolan, 2001). They have become an integral part of the global value chain for MNCs, as customers, suppliers, strategic alliance partners, and competitors, but their position is tenuous. To understand the dynamics of economic transition and entrepreneurial transformation, which involves the realignment of firm strategy with the environment as well as the realignment of internal organizational components, I start by viewing China’s transitional economy as a complex adaptive system. The transition process essentially has been the breakdown of old Table 1 Key economic indicators of Chinese economic transition since 1990

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Total GDP*

D%

Total FDI**

1690.92 1854.79 2161.78 2663.81 3463.44 4675.94 5847.81 6788.46 7446.26 7834.52 8191.09 8940.35 9593.00

9.69% 16.55% 23.22% 30.02% 35.01% 25.06% 16.09% 9.69% 5.21% 4.55% 9.15% 7.30%

5.60 6.60 11.98 58.12 111.44 82.68 91.28 73.28 51.00 52.10 41.22 62.38 69.20

D%

17.79% 81.58% 385.30% 91.72% 25.80% 10.40% 19.72% 30.40% 2.15% 20.88% 51.32% 10.92%

Source: Chinese State Statistics Bureau. Note: *In billion Yuan (RMB). **In billion US dollar.

Industrial* output (Total)

Industrial* output (SOE)

SOE share

2201.70 2392.40 2662.50 3459.90 4840.20 7017.60 9189.40 9959.50 11,373.30 11,904.80 12,611.10

1234.30 1306.40 1495.50 1782.40 2272.50 2620.10 3122.00 3617.30 3596.80 3362.10 3557.10

56.06% 54.61% 56.17% 51.52% 46.95% 37.34% 33.97% 36.32% 31.62% 28.24% 28.21%

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rules. Economic reforms have allowed the influx of previously nonexistent business forms and opportunities. This rich vitalization of a stagnant system has also dramatically heightened environmental uncertainty, due to the increased number of participants, greater market demand, and highly diverse markets. This uncertainty may in the general sense be deemed random, and certainly in the short run, evidence would indicate that this is so. These qualities would suggest that Chinese firms have operated in a sort of punctuated equilibrium (Brown and Eisenhardt, 1997; Haveman et al., 2001; Meyer et al., 1990), which describes a relatively newly discovered class of behavior found in highly complex and volatile systems. Such systems are intuitively deterministic. That is, they operate on a known set of simple rules, so holistic behavior ought to be readily predictable. They are also dissipative systems that need to be revitalized with energy over time. In the case of Chinese reform, over sufficient time, the transition appears surprisingly stable. The system, supported by a tight central authority – the kind that was dismantled in other transitional economies – has by and large maintained a high level of stability (Guthrie, 1999). The reform has been a continuously evolving process in which new measures are introduced on an incremental basis. The transition in a sense takes on an improvisational nature, best represented by Deng Xiaoping’s plan bto cross the river by feeling the stones underfoot.Q As a result the Chinese economy has avoided making catastrophic mistakes and sustained steady growth. More importantly, the rapidly changing environment, characterized by a combination of discontinuous phase transitions and incremental adaptations, offers a context for firms to learn and adapt (Guthrie, 1999). The dstonesT that Deng Xiaoping referred to are bthe ruinsQ of the old system where economic actors in China bwill find the materials with which to build a new order,Q and which will bshape the possibilities of transformation in the subsequent stageQ (Stark, 1992). To understand this process, I endeavor to model configurational transitions resulting from bframe-breakingQ events that define phases as well as the incremental changes between phases. 2.1. Strategic–environmental interactions over time The Chinese transition process is unique because of several key features: (1) history and initial conditions (the bstonesQ), as well as the explicit or implicit mission and underlying priorities for the transition; (2) particular agents and their unique styles and interests; (3) the pattern of nonlinear interactions within the network of agents; (4) the local fitness landscape (i.e. the specific niche of agents) and its particular competitive issues, and finally (5) regional and global influences, such as larger institutional systems. bChina’s reforms are highly path dependentQ (Walder, 1995). While the reform in Russia and other Eastern European countries has seen one new system almost entirely displace another, the Chinese model combines the socialist ideology with the capitalist market based system, even though it is an opposing force.1 As a result, the two competing 1 The pragmatic former paramount Chinese leader, who was widely regarded as the bChief ArchitectQ of Chinese reform model, Deng Xiaoping, once made a remark to justify introducing policies often labeled as bcapitalismQ in Chinese socialist system: bIt does not matter if the cat is black or white, so long as it catches the mouse.Q Essentially it means, bIt does not matter if it is capitalism or socialism, so long as it helps Chinese economic growth.Q

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ideologies co-exist, compete, and counterbalance. Like the meeting of hot and cold air, the convergence of socialism and capitalism creates tremendous energy and turbulence. Such a chaotic environment is particularly conducive to entrepreneurial activities. As time goes by, the scale and scope of the economy increases, giving way to more complex modes of transactions between parties. Organizations as adaptive systems have to match the increasing complexity of their environments (Ashby, 1956). Thus, it is imperative that managers recognize the strategic and organizational implications of and requirements for competing in changing environmental contexts (Slevin and Covin, 1997). A key step in studying environmental changes is to identify the most prevalent dimensions that cluster together (Meyer et al., 1993). Current literature suggests several environmental dimensions, including complexity, turbulence, and hostility, which can be interpreted as the impact of environment on the firm (Tan and Litschert, 1994). These dimensions provide a framework for examining the environmental challenges influencing strategic choice in transitional economies. The environmental landscape has undergone dramatic changes since the 1970s. After operating in a protected and stable environment for years, SOEs no longer enjoyed state sanctioned monopoly and had to learn new rules of the game. Facing a system that lacked codified information, these managers often found information regarding the environment to be too little, too late, and too inaccurate. The events of 1989 put the Chinese political regime in a paradoxical position. Motivated by fear for their own survival, Chinese policy makers tightened political control against any opposition. Meanwhile, the pressure to survive also prompted them to promote economic growth as the last resort to preserve legitimacy, since the legacy of the old system was responsible for the public opposition. Various measures of institutional reform were introduced in order to improve the clarity of the system and provide more protection for private property, especially foreign investments. Firms were given more autonomy and incentive to compete. For employees and especially managers, welfare became increasingly tied to performance. These sorts of changes are particularly salient for emerging economies, because the very term bemerging economiesQ suggests a time-related process (Peng, 2003). Comparing the changes between the two phases of transition, I propose the following: H1. Over the course of an economic transition, the organizational environment undergoes fundamental transformation. More specifically, compared with phase one (1990), the environment in phase two (2002) is characterized by reduced hostility (H1a), reduced turbulence (H1b), and reduced complexity (H1c). For organizational strategists, the ability to identify the changing bbig pictureQ during the turbulent time of transitions has a significant impact on the strategic choices they make. Since 1990, globalization and technological innovation have reshaped the competitive landscape SOEs face. Previously protected domestic markets have been under constant attack by nonstate domestic firms as well as foreign competition, while new opportunities emerge overseas for more proactive firms. Entry barriers have collapsed due to gradual reform, and customers have become increasingly demanding, as the seller’s market typical of a command economy became history. While the old SOEs struggled to sustain their advantages by building resources and capabilities, escalating competition and imitation constantly eroded every competitive advantage previously protected by the state government.

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A unique aspect of an economy in transition is that it constitutes the co-existence of opposing systems. For China, these are the command economy of the past and the freemarket economy of the future. In a state of transition, the two forces counterbalance each other, preventing either side from dominating completely. In fact, the success of a transition between two such extremes depends on the stability of the equilibrium in such as dynamic process. Qualitatively, the interaction of between the biron fistQ of the past and the binvisible handQ of the future reflects the fluctuation between the upper and lower bounds of a dynamic growth model. Growth in this case refers to progress towards a pure free market. The trajectory of the model is driven by a growth factor and an inhibiting factor. The growth factor is the new pressure on firms to perform and take risks. This pushes SOE firms to be more market-oriented. The inhibiting factor is the still-present political pressure and institutional order. Realistically an economy in transition is one that is still restrained from full free-market orientation. With these restraints, the system grows at a rate roughly proportional to the difference from the upper limit. Intuitively, a system that approaches the upper limit slows in growth or is pushed back towards the lower limit by the inhibiting factor. A system that approaches the lower limit is induced to grow towards the upper limit. The state of the system thereby fluctuates between these two bounds. For SOE managers, the dual-system transition process is represented by two opposing pressures. Pressure from political forces dominated decision-making before the reform and in the early phases of reform. Since managers were often political appointees and answered to the state, their highest priority was to avoid making mistakes (Tan and Litschert, 1994). As a result, SOE managers were highly risk-averse. As the reform progressed, they increasingly faced the weight of the emerging market. It thus stands to reason that strategic orientations would be contingent upon the interaction between the two competing forces, which varies at different phases of transition. In the early reform era, the pressure to perform fell far behind the pressure to avoid mistakes, contributing to managers’ risk-aversion. The privileged position inherited from the socialist legacy gave SOEs little incentive to increase performance and respond to market forces. Desperately trying to find a balance between two competing forces, SOEs managers searched for an optimal alignment of firm strategic orientation to firm environment. In the early phase of transition, most reform measures were implemented from the top, and the legacy of the old system retained an overwhelming impact on activity at lower administrative levels. As a result SOEs lacked managerial discretion and incentive and were likely to be particularly conservative and defensive. They tended to avoid more entrepreneurial-minded strategies such as proactiveness, innovativeness, and future oriented choices that involved more risk-taking. Following the strategic orientations first outlined by Miller and Friesen (1983) and Venkatraman (1989), I derive the following hypothesis: H2. In the early phase of economic transition (1990), the predominant strategic orientation of firms is characterized by defensiveness. As economic reform further intensifies, SOEs find themselves being thrown into the water of relentless competition from various non-state enterprises, ranging from township

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and village enterprises and privately owned startups, to foreign invested firms. Facing a sink or swim reality, they developed different adaptive responses to complex environments: complexity reduction and complexity absorption. Complexity reduction entails getting to understand the complexity and acting on it directly, including attempts at environmental enactment. Complexity absorption entails creating options and risk-hedging strategies, often through alliances (Boisot and Child, 1999). SOEs have been granted unprecedented autonomy as well as financial independence, and many of the traditional SOEs have also been transformed through joint stock holding or strategic alliances. Such newly acquired autonomy and flexibility have motivated the SOEs to build resources and capabilities to compete. As a result, they have become more willing to be innovative and proactive and assume more risks than their predecessors. As reform intensifies, SOEs face increasing pressure from new forms and sources of competition, and the pressure to perform has increased. Meanwhile, a new generation of SOE managers has emerged from the transition process. Since many new managers are no longer political appointees but are elected by employees or appointed by the board, they are more responsive to market demands than to state planners. In an environment like this, new comers are motivated to find new practices or conventions so that they can compete with established firms. As such, the industry evolves and changes over time (Zacharakisa et al., 2003). In sum, it is predicted that as a result of another phase of economic reform and environmental changes, firm strategic profiles are also likely to change significantly. I therefore derive the following hypothesis: H3. Firm strategic orientations in the later phase of transition (2002) are significantly different from strategic orientations in the early phase (1990). In this study I am interested in comparing and contrasting firm strategies characterized by several more fine-tuned dimensions, such as willingness to trade short-term gain for future growth potential, willingness to innovate, and willingness to take added risks in order to pursue opportunities. Thus, I would specifically expect that firms in the new era (2002) have become less conservative, more proactive, more innovative, and more willing to commit to future-oriented and risky strategies. To decompose the hypothesis on strategic changes, I restate H3 as follows: H3. Compared to their predecessors in the early phase of transition, SOEs in the later phase are more willing to commit to future growth (H3a), more willing to take proactive and innovative strategies (H3b) , more willing to take risks (H3c) , and less likely to take conservative and defensive strategies (H3d). 2.2. Performance implications of configurational transition From a managerial standpoint, organizational researchers are interested in entrepreneurial adaptation due to its implications for survival and prosperity (Meyer et al., 1990), since an appropriate alignment between environmental attributes and strategic orientations is likely to lead to improved performance. Following the environment–strategy– performance relationship, I expect the predominant strategies for each time period to be positively related to performance.

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H4. For firms in different phases of transition, the predominant strategies selected are positively related to performance. More specifically, since defensive strategy is hypothesized to be the preferred strategy in the early phase of reform, while in the later phase managers are expected to be more future oriented, proactive and innovative, more willing to take risks, and less likely to adopt defensive strategies, I expect these strategic orientations to be positively related to performance. In sum, the configurational transitions highlight two distinct and recurring phases as described by Haveman et al. (2001, 254): long periods of bquasiequilibrium,Q during which SOEs make incremental changes, and brief periods of bdisequilibriumQ, during which new originations appear and many existing ones are transmogrified (Gersick, 1991; Tushman and Anderson, 1986; Tushman and Romanelli, 1985). In the next section, I discuss specific procedures that were followed to examine such configurational transitions over time.

3. Research methodology Since large-sample firm-level data are difficult to collect in China, most existing studies have relied on case based methods. Although highly insightful for theory development, case studies are less useful when the objective of the research is theory testing. This study joins the handful of studies in China that rely on quantitative analysis of data from a relatively large sample to test theories. 3.1. Survey content This study is based on extensive archival research and interviews, which track the progress of firms over the period of time studied. Hypotheses testing is based on survey data in order to maintain consistency and comparability. To enable consistent comparisons over different time periods, the surveys employ the same questionnaire. The questionnaire covers three broad categories, namely organizational environment, firm strategic orientations, and performance. I view the environment as a perceptual and multidimensional construct. As Hambrick (1983) and Miller (1988) noted, the manner in which managers perceive their environment is more critical and relevant to those variables subject to managerial control than to archival measures of the environment. Previous studies set in transitional economies have conceptualized organizational environment in terms of three dimensions: complexity, turbulence, and hostility (e.g. Tan and Litschert, 1994). Environmental segments upon which each environment dimension is built include competitor, customer, supplier, and political-regulatory sectors. Each question is measured on a seven-point scale. Scores with multiple segments are averaged to form measures of each of the three environmental dimensions. In this research, the study of strategic orientation was primarily focused on the characteristics of decision-making concerned with matching internal capabilities and activities to the external environment in which firms compete. Strategic orientations included futurity, innovativeness, risk-taking, analysis, and defensiveness (Miller and Friesen, 1983; Venkatraman, 1989). Specifically, respondents were asked to rank

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characteristics of each of these strategic orientations based on relevance to their firms. These questions followed a seven-point scale response format and were used to operationalize five strategic dimensions: proactiveness, riskiness, futurity, analysis, and defensiveness. In assessing performance implications, I measured firm performance by profitability. The response format was a five-point scale (from bottom 20% to top 20%) in comparison to major competitors in the industry. For control purposes, I also included firm size, measured by the number of employees. The questionnaire was designed in English, incorporating feedback from scholars in strategic management, entrepreneurship, and research methodology. 3.2. Survey structure The controlled process of economic reform in China has attracted growing attention from around the world due to its significance for theory and practice. What has been missing in the literature is an understanding of bconfigurational transitionsQ between distinct bframe-breakingQ phases (Meyer et al., 1990). Taking a dynamic systems perspective, and following a staged model, I decompose the quarter-century of China’s transition into two phases, the first phase beginning in 1978 with the start of the reform and ending in 1990 with economic sanctions and the Tiananmen Square incident, and the second phase covering the economic transition in the following twelve years leading up to China’s entry into the World Trade Organization (WTO) in December of 2001. The two surveys were conducted in 1990 and 2002, respectively. The choice of bracketing is consistent with the perspective of leading China scholars who have studied the Chinese reform and transition process in phases. For instance, Qian (1999) examined China’s transition process in two phases and suggested that the first phase, from the beginning of reform to the early 1990s, was most characterized by an increase in the scope of markets in resource allocation and competition, while the second phase was most characterized by the creation of new institutions where old institutions still stood. To control for key confounding factors, I draw the samples from the same sampling space. The firms are all SOEs in the Chinese electronics industry in several major industrial cities in Northern China. In total, I collected 55 valid returned questionnaires for the 1990 sample and 104 for the 2002 sample. With sponsorship from several major government agencies and industry associations, I received considerable support from participants. In both surveys, I offered seminars to potential participants, as well as an executive summary of the study. The 2002 survey was in part aided by a leading survey organization that provides professional services to top management through a CEO club. Most of the respondents are members of this CEO club, and about 25% of those surveyed attended a seminar presented by the author. 3.3. Validity and reliability Since this study was conducted in a cross-national setting, I took certain steps to ensure measurement equivalence when the questionnaire was converted into another language. In this case I pretested the questionnaire in China, and subjected it to a back-translation

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procedure to ensure validity. Results of subsequent personal interviews also provided added validation to responses in the questionnaire. Previous research suggested that in the absence of archival data, self-reported measures are acceptable and are often equally reliable, provided that data reliability is examined (Dess and Robinson, 1984). In this study, I tested reliability by checking Cronbach’s a Coefficient. Generally a value around 0.7 is considered adequate to conclude internal consistency (Nunnally, 1978). Results met this suggested guideline. I also checked nonresponse bias by following the techniques reported by Roth and O’Donnell (1996). The results exhibited stability and reduced the possibility of systematic nonresponse bias. Based on substantial knowledge of the sponsoring organization about the firms I surveyed, I have sufficient reason to believe that there was no significant nonresponse bias. I do not contend that such bias was absent; I only contend that such errors would be randomly distributed if they did exist. In both samples I assume that the means are normally distributed since they were randomly drawn. In addition, I tested the validity of the normality assumption using the Shapiro–Wilk W test. I also applied Kendall and Stuart’s rule of thumb using skewness and kurtosis. Results indicated that the normality assumption appears to be valid when applied to the data at hand.

4. Statistical analyses and results Following the multidimensional approach of measuring environment and strategy, I generated three composite environmental variables and five strategic orientation variables. The three environmental variables are hostility, turbulence, and complexity. For strategic orientations, I included futurity, proactiveness, risk affinity, analysis, and defensiveness. These constructs were grounded in theory and have been validated. In addition, I included a control variable, firm size. I used a 5-point scale to capture the range of firm size based on the number of employees. These firms ranged from fewer than 100 employees to over 5000 employees. Table 2 presents the descriptive statistics and correlation coefficients. I performed statistical analyses using SPSS. I first performed analyses of variance (ANOVA) to test changes in organizational environment and firm strategies. Evidence Table 2 Descriptive statistics and correlation coefficients Mean S.D. N 1 2 3 4 5 6 7 8 9

Hostility Turbulence Complexity Futurity Proactiveness Risk-taking Analysis Defensiveness Performance

4.43 5.28 4.75 3.99 4.20 4.25 4.42 4.26 3.21

0.52 0.60 0.40 0.91 1.05 1.13 0.68 1.28 1.18

160 160 160 160 160 160 160 160 160

1

2 0.41** 0.35** 0.42** 0.23** 0.19* 0.21** 0.35** 0.39**

3

0.56** 0.40** 0.20* 0.17* 0.002 0.29** 0.26**

4

0.33** 0.18* 0.20** 0.149 0.16* 0.24**

Note: *Significant at 0.05 level. **Significant at 0.01 level.

5

0.68** 0.59** 0.080 0.61** 0.37*

6

0.87** 0.21** 0.72** 0.133

7

8

0.39** 0.73** 0.22** 0.090 0.089 0.37**

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supporting the hypotheses regarding changes in perceived environmental characteristics and strategic orientations can be found by comparing and contrasting Table 3. As can be seen from the table, there were decreases in perceived environmental hostility, turbulence, and complexity from 1990 to 2002. Results from ANOVA tests show that changes were rather consistent, thus lending support to the first set of hypotheses (H1a–H1c). Using the same approach, I found a similar pattern regarding the strategic orientations. Specifically, compared to respondents from the 1990 sample, who exhibited a strong preference for conservative and defensive postures as predicted in H2, the respondents from the 2002 group reported higher willingness to be future oriented, proactive, and take more risks. On the other hand, firms reported much lower willingness to be conservative and defensive. The only dimension that did not exhibit significant change was the analyses dimension, which reflects a hybrid strategy (Miles and Snow, 1978). Evidence was found to support the third set of hypotheses (H3a–H3d). Lower scores were reported on the two relatively conservative orientations, namely analyses and defensiveness. To test the performance implications, I employed an ordinary least square (OLS) regression model. Table 4 summarizes the results. To provide a frame of reference, I first tested the impact of strategy on firm performance for the first period (1990). As demonstrated in Model 1 (Table 4), the predominant strategy was conservative and Table 3 Subgroup descriptive statistics and analyses of variance (ANOVA) Descriptive statistics

Hostility

Turbulence

Complexity

Futurity

Proactiveness

Riskiness

Analyses

Defensiveness

1990 2002 Total 1990 2002 Total 1990 2002 Total 1990 2002 Total 1990 2002 Total 1990 2002 Total 1990 2002 Total 1990 2002 Total

ANOVA N

Mean

S.D.

Min

Max

56 104 160 56 104 160 56 104 160 56 104 160 56 104 160 56 104 160 56 104 160 56 104 160

4.77 4.25 4.43 5.61 5.11 5.28 4.87 4.68 4.75 3.44 4.29 3.99 3.58 4.54 4.20 3.74 4.53 4.25 4.51 4.37 4.42 5.23 3.74 4.26

0.45 0.46 0.52 0.30 0.65 0.60 0.35 0.41 0.40 0.88 0.78 0.91 0.98 0.94 1.05 0.88 1.15 1.13 0.52 0.75 0.68 0.99 1.11 1.28

3.50 2.94 2.94 4.00 3.44 3.44 3.38 3.38 3.38 2.00 2.00 2.00 1.67 2.67 1.67 2.67 2.33 2.33 3.33 3.00 3.00 3.00 2.00 2.00

5.50 5.21 5.50 6.00 6.00 6.00 5.50 5.50 5.50 6.00 5.67 6.00 6.33 6.00 6.33 6.33 6.67 6.67 5.67 6.00 6.00 6.67 6.00 6.67

Sum of sq Between groups Within groups Total Between groups Within groups Total Between groups Within groups Total Between groups Within groups Total Between groups Within groups Total Between groups Within groups Total Between groups Within groups Total Between groups Within groups Total

9.94 33.38 43.31 9.20 48.57 57.77 1.34 23.98 25.32 25.98 104.78 130.76 33.62 143.29 176.91 22.24 179.04 201.28 0.69 72.20 72.89 81.00 179.75 260.75

Note: *Significant at 0.05 level. **Significant at 0.01 level. ***Significant at 0.001 level.

Mean sq

F

9.94 0.21

47.04***

9.20 0.31

29.92***

1.34 0.15

8.82***

25.98 0.66

39.17***

33.62 0.91

37.07***

22.24 1.13

19.62***

0.69 0.46 81.00 1.14

1.50

71.20***

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Table 4 Impact of strategy on firm performance Model 1 (1990) Beta (Constant) Size Futurity Proactive Risk-taking Analysis Defensive N R2 F p

0.04 0.36 0.38 0.50 0.31* 0.38*

Model 2 (2002) T statistic 2.08 0.28 1.23 1.62 1.79 2.28 2.32 56 0.30 3.51** 0.006

Beta 0.15 0.43*** 0.01 0.70** 0.35*** 0.20

T statistic 0.49 1.63 4.31 0.05 2.99 3.33 1.59 104 0.33 7.87*** 0.000

Note: *Significant at 0.05 level. **Significant at 0.01 level. ***Significant at 0.001 level.

defensive oriented, as hypothesized in H2. Further, this strategic orientation was positively associated with firm performance, consistent with H4. I then included strategic orientation variables for firms in 2002 in Model 2. As can be seen from Table 4, I found mixed support for performance implications for the third set of hypotheses, as outlined in H4. The futurity dimension, which measures the willingness to sacrifice short-term gain and to commit resources for long-term growth, was negatively related to performance. The second strategic orientation, which was measured by willingness to make aggressive, proactive and innovative strategic moves, was negatively related to performance, although the result was not statistically significant. I did find clear evidence that risk-taking was positively related to performance. This was in sharp contrast to the previous phase (1990). Clearly firms in the late phase of reform, under different environmental characteristics, were more willing to take calculated risks. Through interviews, I discovered a consistent sentiment that due to increasing levels of complexity and turbulence in their environment as well as the speed and frequency of changes, executives have become increasingly reluctant to make long term resource commitments. Rather, they focus more on maintaining flexibility, making quick adaptations, and capturing immediate return. In other words, they improvise. It was particularly interesting to note that the analysis strategy, which is a hybrid strategy between the most entrepreneurial orientations and most conservative ones, was positively related to performance. This was in sharp contrast to the previous test based on the 1990 sample in which the strategy was negatively related to performance. Previous studies have found that the analysis strategy, which is rooted in Miles and Snow’s (1978) dAnalyzerT type, is an effective strategy for international joint ventures as well as township and village enterprises, which are both hybrid organizational forms (Tan, 2002). It is certainly interesting that the SOEs have been moving toward more dynamic and adaptive organizational types in terms of strategic positions and that such hybrid strategic postures, often the choice of firms facing highly complex environments and competing goals, may help firms to improvise and co-evolve with the environment.

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It should be noted that this study focuses on the perceived environment. Intuitively one may find evidence to suggest that the environment in Chinese transitional economy has become more turbulent than a decade ago, but the findings clearly show that managers have perceived the environment more favorably. While I acknowledge that there may be a difference between perceived and actual environment, I believe that perceptual measures make sense since only factors that participants perceive can enter into their strategy formulation behavior. Some researchers have argued (e.g., Miller, 1988) that the manner in which managers perceive their environment is more critical and relevant to variables subject to managerial control than archival measures of the environment. Perceptual measures thus enable the researcher to view a firm’s environment from the perspective of organizational members or key respondents. In sum, the results paint a dramatically different environmental and competitive landscape in that after a period of economic reform, the environment in China became more conducive to entrepreneurial activities. Furthermore, the innovative, proactive, and risk oriented strategies that emerged have led to improved performance.

5. Discussion and conclusion Following a staged perspective of transition, this study examines changes in organizational environment and strategic decision characteristics in China. The study reveals some profound transformations in environment–strategy configuration brought about by the economic transition. The study finds that different phases of the transition process call for firms’ ability to switch from one strategy to another in order to align with environmental changes. Specifically, the results suggest that, compared to the early phase of reform in 1990, the environment in the late phase (2002) is more conducive to entrepreneurial activities, and managers in SOEs have reacted favorably with more entrepreneurial oriented strategic choices aimed at future growth rather than at satisfying state planners. As one manager told us, bgrowing our business under an uncertain environment is like crossing a turbulent river. If I want to cross the river without getting my cloths wet, I have to feel for the stones under foot and position quickly, as taught by the great leader.Q2 Such adaptive behavior of the new generation of managers is consistent with the bimprovisationalQ mode of entrepreneurial adaptation that improves adaptive flexibility under complexity and turbulence (Brown and Eisenhardt, 1998; Meyer, 1988; Meyer et al., 1988). Essentially, these managers constantly probe the future, experiment with new ways to gain competitive advantage, align themselves quickly with the rapidly changing environment, and adopt any strategies so long as they work. The transformation in China has been a result of mutual influence between environmental forces and organizational actions (Guthrie, 1999), a reciprocal process that resembles a co-evolutionary model (Carney and Gedajlovic, 2002) that is path dependent. Strategies that at one point give firms competitive advantage may become obsolete or even liabilities when environmental conditions change. However, firms and environments are partly, but not exclusively, dependent upon historical patterns of firm– 2

He was referring to Deng Xiaoping’s famous bcross the river by touching the stonesQ model.

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environment interaction. Firms do not passively react to the environment; they proactively influence and benactQ their environment (Levinthal and March, 1993) and co-evolve with their environment along certain bpath-dependent trajectoriesQ (Carney and Gedajlovic, 2002). The issue presented here is particularly salient for emerging economies, because the very term btransition economyQ suggests a time-related process that may be viewed in different phases. Although institutions evolve through relatively long periods of relative stability (quasi-equilibrium) during which incremental changes occur in the organizational environment, such an evolutionary process is also likely to be punctuated by discontinuous transformations, often associated with phase transitions. On the boundary between phases, the system still operates on the same set of simple rules, and the system in transition organizes itself under a special sort of structure. If an organization is sustained at the edge of chaos, in the phase transition between stability and instability, it has the potential to be creative and to change. The future of such a system cannot be determined by some prior shared intention because the links between action and long term outcomes dissolve. Instead of realising prior intention, the long term outcomes of a creative changeable system are emergent (Mintzberg and Waters, 1985; Nonaka, 1988; Stacey, 1995). Following this line of reasoning, some insights may be added to the debate on radicalism versus incrementalism, an issue that concerns scholars, policy makers, consultants and practicing executives. In the case of transformed Communist regimes in Eastern and Central Europe, the basic underlying rules were overturned, leaving no basis on which the system could self-organize. The replacement of the old system by one dominant new system in the absence of appropriate institutional structure has led to disorder at the system level and at the business level. In China’s case, the duel pressure of maintaining political control while promoting economic freedom has led to a paradoxical yet practical system, one in which two opposing forces co-exist and compete. The hybrid system, which is locally chaotic and brings unprecedented turbulence to the market place, has also maintained a certain level of stability and continuity at the system level. This is because the co-existence of two opposing systems has led to another feature of self-organizing mechanism: global stability (Kauffman, 1995). What would seem to be random adaptive behavior at the individual firm level exhibits order at the system level due to basic underlying rules embedded in the system. At the dedge of chaosT (Brown and Eisenhardt, 1998), effective organizations have gradually transformed themselves and adopted new sets of entrepreneurial strategies by learning and enacting their environment (Levinthal and March, 1993). The co-existence and co-adaptation between two competing systems have made the transition process uniquely Chinese, ruled by neither the biron fistQ of central planning nor the binvisible handQ of the market, but by a hybrid bvisible hand.Q So far, the Chinese model of economic reform and transition has challenged the conventional wisdom of transition. In sum, it can be argued that the Chinese economic transition has exhibited two important qualities: it is locally turbulent but globally stable, a characteristic phenomenon of a complex adaptive system. For policy makers and executives in China and elsewhere in the world, the prospect that Chinese SOEs may shape the institutional environment and recreate themselves has

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profound practical implications. Compelling empirical evidence suggests that faced with unprecedented competition from multinationals following entry into the WTO, most Chinese SOEs may not be able to survive the massive restructuring and consolidation (e.g. Nolan, 2001). However, if the more proactive and entrepreneurial SOEs can co-evolve with the rapidly changing environment, reposition themselves, and develop new competitive advantage, they may very well survive the historical reform and perhaps grow into different forms (Boisot and Child, 1996). As Lehrer (2001) suggests, initial differences in strategy can lead to sustained differences in competitive advantage in later phases of transition. As the world enters the third millennium, we have just set out on the long road to achieving an understanding of the dynamic interaction between environment and firm entrepreneurial transformations in the context of transitional economies. Ongoing longitudinal research will not only create an analytical framework enabling us to better understand how strategic choices are made when confronting fundamental transitions; in the process, it will also enrich the debates over public policy and managerial practice on how to deal more effectively with the challenges associated with transition. Such efforts should bfocus not only on economic performance and productivity but also on the organization-level structures and practices that are reactions to broad institutional changesQ (Guthrie, 1999: 7). The changing face of environment–strategy configurations has made strategic adaptations inevitable for domestic and foreign firms that participate in transition economies. Historically, fundamental transitions in societies have led to major progress in social sciences. Thus, the unprecedented challenges in understanding and managing the transitional economies are likely to give rise to new ideas, theories, and paradigms. It is hoped that the evidence presented in this paper will inspire future interest and provoke validation or falsification of the ideas presented.

Acknowledgements This paper was completed while the author was a Fulbright Distinguished Professor at Nankai University in China, which provided institutional support. Research assistance from David Tan is much appreciated.

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