Case Examples of RC

The following are case examples of relational capabilities.

D.3.4.1 Episode 4D: “Perpetuation Planning”

The manager of the insurer in case episode 4D; “Perpetuation Planning,” reflected on periods of significant change and noted, “one of the most important was the realization about four years ago that all businesses in our industries have perpetuation problems…”

and added “any CEO of any insurance company will tell you about 35% of their cumulative volume is at risk at any time, because the distribution vehicle (being agents) retire, die, fail in business, or become consolidated” in an industry that on an aggregate level has gone through substantial losses and a wave of consolidations.

The idea of perpetuation planning was something that was referred to many times and regarded to be of utmost importance. (This was further evident in that the manager profiled teaches courses on perpetuation planning to executives in the insurance, medical, and real estate industries.) The manager stressed the importance of anticipating

“the changing economic conditions by simply being observant for the leading economic indicators and the key operating ratios for some of our clients and where they were headed, how they were deteriorating—it prompted us to prioritize perpetuation planning.” The perpetuation planning process led to an acquisition. This involved bringing in a larger firm that purchased the partnership interest in the agency that was owned/managed from 1982 until 2008. The planning process leading up to this took 1½ years, with the recognition that when most acquisitions fail, “it’s almost never because fiscally they didn’t fit, it’s almost always because culturally they were incompatible.”

The need to establish philosophical and cultural compatibility prior to the acquisition was critical. If there was an imbalance in risk tolerance, the business could not grow according to the manager, because the business would be pulling against itself given the differing philosophies. The manager stressed that it was critical that the

acquiring firm “met philosophically and culturally with my values” and, “having found that to be true, we agreed to move forward.” The result is that “it’s turned out to be a very good marriage.” The acquisition allowed for the anticipating and taking care of the perpetuation issue, by providing not only for the manager, his family, and staff, but for those new people he wanted to bring on. And it afforded the “opportunity to share our vision of growth with the new firm and capitalize on their enhanced resources to bring to fruition some of our ideas within the scope of their larger organizations” and “so it’s just worked out well at every level.”

The manager of the insurer developed an RC in this episode, which is referred to as acquisition-based dynamic capability (ABDC) in the literature (Helfat et al., 2007, p.

121, emphasis original).

ABDC is a “form of relational capability that refers to the capacity to use business acquisitions to obtain new resources and capabilities” consisting of “acquisition identification capability, acquisition reconfiguration capability, and acquisition selection capability.” The selection capability involves

“the capacity to recognize when an acquisition is the appropriate mode for obtaining new resources and capabilities,” the identification capability is the capacity to “detect and negotiate with appropriate target firms” and the reconfiguration capability involves reshaping the resources of the two firms.

As a result of the ABDC, the manager noted that the sheer size of the organization he joined, coincidental with the economic downturn, created all kinds of opportunities, such as having in-house legal counsel, a dedicated HR professional at the disposal of clients (and/or prospective clients), and having loss control experts available at very little notice. It is these resources and capabilities that allow the insurer’s firm to capture business smaller insurance agencies are not able to, enabling it to survive and grow.

The ABDC (extended to ABDMC here) shows evolutionary fitness because by merging with a much larger firm, the insurer has access to greater resources and capabilities, and this new capacity has allowed the insurer to enter into markets previously unavailable, during periods of significant environmental change (i.e., the recent financial crisis and the recession of 2007-2009) and to achieve and sustain competitive advantage in so doing.

D.3.4.2 Episode 3C: “Joint Venture with a Community Bank”

The manager of the insurer established other RCs in addition to the example above. In case episode 3C, referred to as the “Joint Venture with a Community Bank,” the manager stated that, “I love innovative things where you can capture market share which was simply not identified,” although offered that banks and insurance agencies

typically to not “mix well” because joint ventures between them often do not work out.

The proposed venture needed to be planned thoroughly, therefore, and the strategy for sharing resources needed to consider ways in which the venture could be successful in order to avoid the pitfalls that other firms have experienced entering similar arrangements.

The venture made sense financially for the bank, given the current historically low interest rates banks were facing. The low interest rate environment meant generating income in other ways was necessary (aside from the spread between loan and deposit interest). The joint venture made sense financially for the insurer, too, in that it would capture valuable referral business through the bank branch network and generate growth.

Thus, the venture made sense fiscally for both parties, although finding an optimal way to share resources needed resolution. The solution involved creating what was referred to as a “virtual agency” for the bank. The “virtual agency” involved having the bank’s clientele access the insurer through the bank’s website. The platform was designed so the bank could generate client referrals and send them to the insurer to process. The insurer would write the business and then place it with one of its own companies. It was decided the bank would use its own brand name, as it had dedicated significant resources toward marketing and promoting name recognition in the community over the years. The insurer would take care of the underwriting, marketing, and placement, and cover the expenses in return for the referral business generated at the bank. The revenues generated would be shared, with the net income split evenly (the insurer has maintained net income in the 18 to 22% range historically, which is at the high end of the peer group for the industry).

The ability to execute this arrangement was based on a critical analysis of the relevant data and the appropriate due diligence required to agree to these terms. The firms developed pro forma financials with every line item regarding income and expenses examined in detail in order to determine where both firms needed to be to make a strong profit. The pro forma financial projections were for $10.5 million of new revenue over the first four years, and, as of this writing, the boards of both entities finished voting on approval of the joint venture, and the “virtual agency” is now up and running, and contributing to the ongoing need for organic growth for each of the entities.

The arrangement with the bank exemplifies use of DMCs. In the language of the DC literature, it involves a “relational capability” (RC) that leads to a “relational advantage”

(RA) (Helfat et al., 2007). The capability was developed with LBDMC and IBDMC (see Tables 4.6 and 4.7). The development of the “virtual agency” extends and modifies the resource base of both entities to create a new revenue-generating resource in the form of an RC. The “virtual agency” meets the tests of technical and evolutionary fitness. It is technically fit in that it is built with market-tested resources and capabilities. The “virtual agency” exemplifies evolutionary fitness too, in that it brings these resources and capabilities together in a new way to compete.

The RC is valuable in that it provides opportunity for the bank and the insurer to bring in new clients. It is rare and “unique,” and it is inimitable. The firms are also organized in such a way that they are benefitting from the capability. The competitive implication therefore is one in which the RC generates what is referred to as a relational advantage, defined as “a competitive advantage that derives from access to, or acquisition of, the resources and capabilities of other organizations” (Helfat et al., 2007, emphasis original).

D.4 Summary

The sections above in Appendix D provide an overview of the firms in the multi-case study, and data from the managers participating in the case study, which illustrated ways that their firms were able to achieve advantage during periods of significant change in the external environment (i.e., the recent financial crisis and Great Recession of 2007-2009). The data show managers used DMCs in order to do so, including transformational ones such as LBDMC, IBDMC used to generate an RC. In the following Appendix E, an audit trail is provided.