The Effect of Firm Capabilities on the Relationship between Firm Level Strategy and Performance of Food and Beverage Manufacturing Companies in Kenya

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1 The Effect of Firm Capabilities on the Relationship between Firm Level Strategy and Performance of Food and Beverage Manufacturing Companies in Kenya Dominic C.Muteshi*, Zachary B.Awino**, Reginah K. Kitiabi*** and Ganesh P. Pokhariyal**** The effect of firm capabilities on development of strategy for performance improvement are becoming gradually prominent particularly in large scale manufacturing companies. No wonder, the main debate in strategic management is nowadays focused on the moderating effect of firm capabilities to the relationship between firm level strategy and performance. The paper is exploring this relationships in food and beverage manufacturing companies in Kenya. The results are based on an empirical survey of Chief Executive Officers (CEOs)/ Managing Directors (MDs) and their perception on firm capabilities utilization in strategy development of their firms. The study applied cross-sectional descriptive survey of the industry that provided data through a structured questionnaires. Study hypothesis was tested using regression analysis. Results of the independent effect of firm capabilities indicate statistical significant effect of human capital, manufacturing, marketing, and information technology on firm level strategy and performance. While research and development was not statistically essential to the connection. However, the combined effect of firm capabilities on the relationship between firm level strategy and performance was significant. Key Words: Firm Level Strategy, Capabilities and Firm Performance 1. Introduction Research in strategic management over the recent two decades has demonstrated that success in firm performance does not depend upon a one indicator but upon several factors. It is argued that firms with a clear and competitive strategy will outdo companies without similar strategy (Porter, 1996). Manufacturing organizations work in a dynamic environment and therefore they require to continuously develop strategies that will generate a greater performance and acquire a competitive edge (Mintzberg, Ahlstrand & Lampel, 2005). Strategy is involved with making choices (Porter, 1985). It is a process of ensuring a sustainable competitive edge by developing key capabilities leading to long-term performance (Lin, et al. 2014). Firm performance is directly affected by the strategies that are implemented within that organization so as to produce supernormal profits (Bowman & Toms, 2010). *Doctoral Student, School of Business, University of Nairobi, Kenya. **Associate Professor, School of Business, University of Nairobi, Kenya. ***Lecturer, School of Business, University of Nairobi, Kenya. ****Professor, School of Mathematics, University of Nairobi, Kenya 2

2 Firm capabilities is defined as firm s power to reconfigure, integrate, and build company and industry competencies to meet and adapt to the rapidly changing environment (Teece, et al., 1997). Capabilities are core competencies of a factory and are fundamental to the firm. In instances where these capabilities are lacking, the firm won t be the same (Hamel & Prahalad, 1990). Capability therefore, is the capacity or power of the resources to perform some tasks or activities (Robinson & Mital, 2012) for the purpose of achieving a particular end result. Firm capabilities are generally grouped as physical and intellectual assets. Tangible includes human, financial or physical capabilities while intangible include reputation, organization, know-how or patents (Aosa, Bagire & Awino, 2012). While Christensen (1997) and Grant (2003) classification of capabilities include financial resources, physical resources, human capital, technological resources, marketing, automation, research and development reputation and other firm resources. In brief, a detailed statistical evaluation of the performance records helps in identifying firm capabilities that influence a company sales, costs and profitability. Firm capabilities stem from resource based perspective which emphasizes on having specific capabilities, assets and presence of differentiating mechanism as the most important influencer of firm performance (Wernerfelt, 1984; Teece et al,, 1997). A firm improves on its performance by modifying its resource portfolio and affecting changes to internal strength with the external environment, hence the necessity for continuous analysis (Rothaermel, 2008). Therefore, capabilities are simply firm s abilities tocombine its resources for superior performance (Pearce et al., 2012). Occasionally, resources are configured, reconfigured, coevolved, coordinated and reorganized for proper exploitation in strategy execution (Teece et al., 1997). Firm capabilities are naturally limited and hence their prudential application is usually a goal focus of every firm. Firm s possession of strong capabilities enables it to readjust and adapt to volatile markets and environmental uncertainty and changes (Teece et al., 1997). Firm performance variations are subject to the effect of capabilities and firm level strategy (Kathleen and Martin, 2000). The main challenge for firms is the effective control of their current capabilities while concurrently developing new ones especially measuring firm capabilities in dimensions of human capital, marketing, manufacturing Automation, research and development and information technology. The research problem was the existing empirical contradictions on the constructs that determine firm performance within theorists and researchers for a period spanning for the recent three decades (Pearce & Robinson, 2003; Murgor, 2014). While Awino (2011) established that the independent effect of core competencies, capabilities, and strategy execution on firm performance in Kenya was weaker when contrasted to the combined effect of the same variables. Other studies focused on developed economies which are different context and their results and suggestions may not apply to the Kenyan context which is a developing economy (Pearce & Robinson, 2003; Karlsson & Tavassoli, 2015). Hence, this article tries to reduce the gap in the limited literature that have studied the relationships of the concepts of firm level strategy, capabilities and performance in Kenyan industries. 3

3 2. Literature Review The Dynamic Capabilities Theory (DCT) was developed by Teece et al (1997) anchored the current study. The theory is rooted in the Resource Based View (RBV) which posits that capabilities are company s capacity and abilities to assign resources (Wernerfelt, 1984). The exercise is usually in a concoction of firm s processes, procedures and demands. DCT viewpoint on performance often aims to understand a firm s development and survival (Teece et al., 1997; Pearce et al., 2012). According to Penrose (1995) value creation does not come from possession of resources but from their use and how much value is developed depends on how these resources are combined within the company and that firm s growth demands the continuous development and innovativeness of its managers. Teece et al (1997) extended RBV to formulate dynamic capabilities viewpoint that gives importance to organizational processes which employ firm resources. DCT approach to strategy evolved from resource approach need in generation of firm s core competency (Lopez, 2005). According to Rothaermel (2008), dynamic capabilities are intangible internal resources which are idiosyncratic: unique to every firm, inimitable and grounded in the firm history. Dynamic capabilities are strategic routines through which firms procure new resource arrangements as markets transpire, evolve, split, collide and die (Kathleen & Martin, 2000; Johnson & Scholes, 2005). It is observed that repeated practices donates to the gradual development of dynamic capabilities, the codification of that experience into technology. In addition, formal procedures reduce the difficulties to apply and accelerate in building routines and systems of effective dynamic capabilities depends upon market dynamism (Kathleen & Martin, 2000). DCT emphases that the important function of strategic management is firm s ability to appropriately adopt, integrate and rearrange internal skills, resources and operational competences to equal the needs of a dynamic surrounding (Teece et al., 1997). Thus, differentiation in company performance is dependent on how firms maximize on their critical capabilities and not mere ownership of the resources. The bottom-line argument of the DCT is that, firm performance is enhanced when firms are keen to recombine, coevolve, reconfigure, acquire and reallocate resources as their wants change (Aosa et al., 2012). Critics of the theory posits that dynamic capabilities are necessary but not enough circumstances for improvement of performance (Priem & Butler, 2000; Kathleen & Martin, 2000). In addition, the paper while acknowledging the theory contribution notes that by combining RBV on learned processes and activities, the theory has nothing new or different from RBV preposition. However, this theory guided the conceptualization of the mediation role of firm capabilities. Hamel and Prahalad (1990) posits that the critical role of management is to build a firm capable of developing products which customers demand, thus the firm s group of capabilities are arranged and reconfigured to be the firm s core and distinctive competences. For a business to exist and prosper in a dynamic environment, it needs to own guaranteed levels of firm capabilities. De Almeida et al (2013) established that there was a link between strategy execution, capabilities and 4

4 financial performance. The choice is determined by the compelling forces and opportunities/ threats in the forecasted business surrounding (Johannesson & Palona, 2010). For a company to maximize its performance and competitiveness, it has to balance strategy and core capabilities to external environment (Ansoff & Survillan, 1993). Empirical evidence shows that firms that select and afford to have compound or a conglomeration of strategies are at an advantage in relation of their projected performance when rated to those that chose not to or adopt a simple or one strategy (Karlie & Tavassoli, 2015). Conversely, Newbert (2008) argues that even if a firm owns capabilities that have the possibility to develop a competitive edge and high performance. Firm s full actualization will not be realised if it lacks the capacity for capabilities exploitation. This process involves development and execution of strategies for performance improvement. Even though Mintzberg et al (2005) argued that it s really hard to get strategy right as it s not possible to formulate strategy in unpredictable environment which springs over time as visions collide with and align to a turbulent truth. This highlights why scholars haven t found a common ground on what constitute key concepts for performance. The main foundation of RBV is that firms must base their strategic decisions on a strong set of resources that can generate complex capabilities and lead to superior performance (Amit & Schoemaker, 1993; Peteraf, 1993). According to Grant and Jordan (2012), firm s competitive edge and high performance are acquired based on assets and capabilities utilization is potential and sustainable than that based on product and demand portions. Capabilities assure sustainable competitive edge and indeed long-term performance because new capability configurations are always guaranteed as markets collide, emerge, marge, separate, and liquidate (Teece et al., 1997; Eisenhardt & Martin, 2000). Superior performance from resources can only be attained with proper integration, reconfigurations, combinations, evolutions, development and synergy of resources (Aosa et al., 2012). Capabilities allow the activation and redirection of the complex framework of economic and organizational factors. Thus, dynamic capabilities are important ingredients in maximizing future strategic direction of firm s(lopez, 2005). The process of aligning strategy, governance and values with firm performance involves understanding the wants of the market, devising a strategy to utilize available resources and setting the business distinct from competitors (Carlo, 2013). However, irrespective of how great the firm capabilities might be, they don t stir economic profits if a company doesn t succeed in acquiring resources whose production would be improved by capabilities (Makadok, 2001). Therefore, differences in firm performance may resonate from how differently organizations mix their resources in strategy development for high performance. Empirical proof shows that possession of valuable rare inimitable resources leads to superior performance (Barney, 1991; Zollo & Winter, 2003). Thus, creating a strategy based on unique capabilities provides a more long-term competitiveness and high performance. This notwithstanding presence of resources on its own does not lead to superior performance. Firm capabilities different from ordinary resources are 5

5 idiosyncratic, peculiar to each firm and grounded in the firm s history. They emerge because of firm s repeated processes and procedures captured in business frameworks with decades of history and that are hard to copy (Teece et al., 2008; Rugami, 2013). In some instances resource slack may lead to performance depending on how they are converted to active use, while in others they are a source of poor performance due to expenses apportioned to maintaining them (Tokuda, 2005). This explains as to why the research was necessary to validate the research and see if the same findings could be achieved with a focus on a food and beverage manufacturing companies (FBMC). Early writing on human capital flowed from economists of education such as (Schultz, 1971; Becker, 1976; Mincer, 1974) who were concentrating on the economic benefits from ploughing in both common and firm-specific training. This work is grounded on detailed empirical analysis, redresses the predominant assumption that the development of physical capital is paramount in economic success. In reality, physical capital explains only a comparatively small part of the rise of income in most countries (Becker, 1964). The connection between learning and economic growth (Hanuschek & Kimko, 2000; Psacharopoulos, 1973), productivity (Denison, 1967) and earnings growth (Becker, 1964; Schultz, 1971; Hewlett, 2002), all have powerful support in literature. To achieve this, the company has to create new products and should possess certain marketing capabilities. Its role in attaining company s market and financial success is massive and paramount (Ripolles, 2011; Kanibir et al., 2014, Nalcacia & Yagci, 2014). For example, firm s product development capability (PDC) influences the launch strategy for a long-lasting product that is consecutively improved over time (Banerjee, 2013). Marketing capabilities also accounts to the international expansion of global new businesses by impacting firm s decision to choose entry methods including higher resource employment in multinational markets (Ripolles, 2011). Grounded on these arguments, in this study, we suggest that exploitation and exploration positively arbitrate the positive correlation between marketing capability and new product innovations. Bharadwaj (2000) argued that information technology capability is the capacity of a company to mobilize and assign IT based assets in combination with other assets and capabilities. IT based assets consists of technical and governance IT skills, software IT-enabled resources like systems, knowledge, customer focus and synergy. Consequently, capabilities is the strength of a firm to mix resources to record impressive performance and acquire competitive advantage (Amit & Schoemaker, 1993). Hence, the joint effects of core competencies, capabilities, strategy, strategy operationalization is relatively stronger than their independent effect (Awino, 2011). This supports the preposition of Aosa et al (2012) who argued that firm performance is not affected by one variable but the power of the company to integrate, grow and rearrange capabilities and competencies. Some studies which looked on the independent effect on performance improvement established that deliberate investment in staff talent management may facilitate the development and modification of dynamic capabilities (Zolla & Winter, 2002). However, scholarly 6

6 scientific proof on which capabilities inform specific types of strategies are not well empirically grounded in literature. The literature on organization capabilities reports that firm capabilities are important factors in making firm strategic alternatives for improved performance (Teece et al, 1997) but empirical work undertaken to establish this relationship is still limited. With the above results in literature, the objective of this study was to establish the effect of firm capabilities on the relationship between strategy and firm performance of FBMC in Kenya. H 02. Firm capabilities have a significant effect on the relationship between firm level strategy and performance of food and beverage manufacturing companies in Kenya. 3. Methodology and Model To establish the effect of firm capabilities on the relationship between strategy and performance of FBMC, we analysed data from 178 large scale firms that were active members by Kenya Association of Manufacturers (KAM) by We chose registered firms registered firms because they account for 80% of the gross population of the sector under study. In Kenya FBMC are classified under the manufacturing sector which is an important sector of the economy contributing about 10% of Gross Domestic Product (GDP) (KIPPRA, 2014). Manufacturing sector employees nearly 300,000 people accounting for 13% of the Kenyan national employment. It is established that the industry s account to the GDP has been on decline trend from 13.9% in 2008, to 11% in 2010, to 9.6% in 2011, 9.2 % in The sectors proportion to the wage employment has also gradually declined from 13.9% in 2008 to 12.8 % in 2012 (KIPPRA, 2014). The decline in growth of this sector is attributed to a blend of factors, including high rising costs food ingredients, rising wage bills, increased establishment costs for new companies from COMESA nations and tightened bank loan requirements. The key respondents were the Chief Executive Officers/ Managing Directors of the FBMC. 125 representing a 70% response rate filled and returned the structured questionnaire. The response was deemed sufficient for our analysis. A 5 Likert type measure was used, ranging from 5 strongly agree to 1 strongly disagree, to indicate the extent to which the respondents agree with the statement that were given. Data was analysed through Statistical Package for Social Sciences (SPSS) software. Statistical tests were performed with 125 companies, respecting, for each factor, the total valid response. For data analysis we performed frequency tests, descriptive statistics (Mean and standard deviations), mean comparison t tests and hierarchical regression analysis. 4. The Findings These study aimed to establish the effect of firm capabilities on the relationship between strategy and firm performance. Before testing this relationship, the study sought to establish the manifestations of the various firm capabilities (using one sample t-tests). The firm capabilities that were considered for the study were human 7

7 resource capabilities, marketing capabilities, manufacturing automation, research and development and information technology. The hypothesis of the study was framed as H2. Firm capabilities have a significant effect on the relationship between strategy and performance of food and beverage manufacturing companies in Kenya. To test this hypothesis, the combined effect of firm capabilities was first determined on the firm level strategy and each performance indicator. For the overall test of the mediation effect of firm capabilities, composite indices for firm level strategy and capabilities were developed and regressed on the composite index of firm performance. The equation for the analysis using hierarchical regression; Y= f (Firm Level Strategy + Firm Capabilities). Y = βo2+β1x1 + β2x1 *X2 +ε2. The findings of the combined moderating effect of firm capabilities on the correlation between strategy and indicators of firm performance are depicted in Table1. Table 1: Regression Results of Firm Capabilities on Financial Performance Standardize Unstandardized Coefficients d Model B Std Error Beta T Sig. Tolerance V.I.F. 1 (Constant) Human Capital Marketing capabilities Manufacturing automation , Research and development capabilities Information technology capabilities a. Dependent variable financial performance The results in Table 1 which shows p values of less than 0.05 significance levels reveal that the five variables testing the mediation effect of firm capabilities on performance were statistically significant. The findings of the mediation effects of firm capabilities on firm level strategy and financial performance are presented in Table 2. 8

8 Table 2: Combined Effects of Firm Capabilities on Firm Level Strategy- Firm Performance Relationship Model Summary Model R R 2 Adjusted R 2 Std. Error of the estimate a Predictors: (Constant) Strategic Planning, Diversification, Business Process Outsourcing,Internal Restructuring, Product Development and Marketing development. ANOVA a Model Sum of Squares df Mean Square F Sig. 1 Regression b Residual Total Regression b Residual Total Dependent Variable- Financial Performance Predictors: Strategic planning, diversification, business process outsourcing, internal restructuring, product development and market development. Predictors: Strategic planning, diversification, business process outsourcing, internal restructuring, product development, market development, human resource capabilities, marketing capabilities, manufacturing automation, research and development and information technology. The results in Table 2 demonstrate that the three models testing the combined influence of independent variables on performance were statistically significant. The F statistics (F= 5.103) reveals that the effect of firm capabilities on firm level strategy is marginal. The statistical significance of the results in Table 2 supports the hypothesis. The results of the combined moderating effects of financial capabilities on the relationship between firm strategies and firm performance are presented in Table 3. Table 3: Summary of Combined Moderating Effects of Firm Capabilities on Firm Level Strategy Performance Relationship Model R R- Adjusted R- F df 1 Df2 Sig. F Durbin Squared R- squared Change Change Watson Squared change a b A. Predictors: (Constant) human capital, marketing capabilities, manufacturing automation, research and development capabilities, information technology capabilities. B. Dependent variable: (Firm Performance). From the model summary in Table 3 where the predictors: Human capital, marketing capabilities, manufacturing automation, research and development capabilities and information technology capabilities were added (F (1,409) = ; P<.05), the results indicated that these predictors contributed to the overall connection with the dependent variable, financial performance. The F-statistic of with a 9

9 probability ratio of.000 indicated that the model was significant and that all the independent variables were jointly significant in explaining the variation in the dependent variable (financial performance). The increase in R² after including the mediation variable (firm capabilities) in the analysis was.117. The findings failed to reject the alternative research hypothesis that firm capabilities have a significant effect on the connection of firm level strategy and performance of FBMC in Kenya was confirmed. Table 4 presents the regression analysis of firm capabilities on financial performance. Table 4: Regression Results of Firm Capabilities on Financial Performance Unstandardized Coefficients Standardized Model B Std Error Beta T Sig. Tolerance V.I.F. 1 (Constant) Human Capital Marketing capabilities Manufacturing automation -.136, , Research and development capabilities Information technology capabilities a. Dependent variable financial performance The overall regression model for this study was:y = X1+.187X2. Based on the statistical test of the beta coefficient (t = 4.045, p<0.05) for the mediation variable of firm capabilities, the null hypothesis that the slope or beta coefficient was equal to 0 (zero) was rejected. The research hypothesis that firm capabilities have a significant effect on the linkages between firm level strategy and performance of FBMC in Kenya was supported. The beta coefficient for the connectionoffirm level strategy and the mediation variable firm capabilities was.117 implying that the higher the firm capabilities the higher the financial performance of FBMC in Kenya. Therefore the alternative hypothesis that high firm capabilities are associated with high performance of FBMCs in Kenya in terms of financial performance was upheld. Human capital, marketing capabilities, manufacturing automation, research and development capabilities and information technology capabilities were found to be statistically significant at 5% level of confidence. The results of the combined moderating effect of firm capabilities on the firm level strategy-financial performance connections. The results indicated that firm capabilities have a significant influence on the correlation between firm level strategy and performance as supported by a significant value of

10 5. Summary and Conclusions The main objective of this research was to improve existing literature and present it in a current way regarding the effect of firm capabilities on the relationship between strategy and performance of food and beverages manufacturing companies in Kenya. The study confirmed the hypothesis that the combined effect of firm capabilities had a significant effect on the linkage between firm level strategy and performance. The results on the independent effect of human capital, marketing, manufacturing automation and information technology variables on correlation between firm level strategy and firm performance of FBMC in Kenya. However, research and development was not significant to the connection. In conclusion therefore, the study determined that firm capabilities fully moderates the relationship between firm level strategy and performance of FBMC in Kenya. The study supported previous research (Awino, 2011; De Almeida et al., 2013) which looked at the mediation effect of the concept on the independent and dependent variables with different conceptualization and contextualization frameworks. References Amit, R., & Schoemaker, P.J.H. (1993). Strategic assets and organizational rents. Strategic Management Journal, 14, Aosa, E., Bagire, V., & Awino, Z. (2012). The interaction of personal factors, structure and performance in NGOs. DBA Africa Management Review, 2 (3), Awino, Z.B. (2011). Strategic management: Am empirical investigation of selected strategy variables on firm performance: A study of supply chain management in large private manufacturing firms in Kenya. Prime Journals: Business Administration and Management (BAM), 1(1), Barney, J.B. (1991). Firm resources and sustainable competitive advantage. Journal of Management, 1(17), Bharadwaj, A. (2000). A resource based perspective on information technology capability and firm performance. An empirical investigation. MIS Quarterly, 24, Bowman, C., S. Toms, S. (2010). Accounting for competitive advantage: The resource based view of the firm and labour theory of value. Critical perspective on accounting. The Contours of Critical Accounting, 21(3), Carlo, T.E. (2013). Aligning strategy, leadership, and culture: Keys to competitive advantage. Pennsylvania: Penn State University in State College. De Almeida, F.E., Lisboa, J.V., Augusto, M.G., & Batista, P.C. (2013). Organizational capabilities, strategic orientation, strategy, strategy formulation quality, strategy implementation and organizational performance in Brazilian textile industries. XXXVII Encontro da ANPAD. Rio de Janeiro, Denison, D. R. (1967). Strategic assets and organizational rent.strategic Management Journal, 14:

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