Open or Closed? - Local Action and Efficient Alliance Strategies in the Telecommunications Industry

What type of network is best? A loose, open one made up of disparate clusters, or a tightly knit ‘closed’ one? The debate between competing network theories in this area is far from resolved, and in this Working Paper Professor Martin Gargiulo and PhD candidate Jonghoon Bae tackle the question from a new angle. Examining the formation of new ties in interorganizational networks in the US telecommunications industry, they find that while in certain circumstances both theories hold true, creating the ideal network is both costly and sometimes, just beyond an organization’s control.

by Martin Gargiulo, Jonghoon Bae
Last Updated: 23 Jul 2013

By facilitating access to information, resources and opportunities, and by helping to overcome coordination difficulties, interorganizational networks can improve firm performance and help make it more innovative and perform better. While this is accepted, fundamental disagreement remains about what type of network structure facilitates these effects, or indeed, how an organization should go about building it. Coleman’s (1988) network closure theory vindicates the benefits of a network where partners are closely linked to one another. On the contrary, Burt’s (1992) “structural hole” theory stresses the benefits coming from forming alliance networks with otherwise unconnected partners, which creates opportunities for “brokerage” between those partners.

Martin Gargiulo, Associate Professor of Organizational Behavior and Jonghoon Bae, PhD candidate at INSEAD, attempt to redress this imbalance in network theory by studying the effects of 68 alliances conducted by 54 telecommunications firms in the US between 1991 and 1998. Looking at revenue growth and profitability, they focus on the endogenous micro-dynamics of these networks, empirically testing the opposing network theories. Direct and indirect ties linking a principal firm to its network partners are identified. Among these, a distinction is made between the value of forming new (non-redundant) direct ties that link a firm to new partners unconnected to the firm’s existing network and cohesive-enhancing indirect ties between two partners.

Consistent with the predictions of structural hole theory, the authors find that new direct ties that bring non-redundant links into an organization’s alliance network have a positive effect on that organization’s performance, whereas new indirect ties bridging across previously separate groups in the network had a negative effect on the principal organization’s performance. Yet they also find that new indirect ties that solely increased the cohesiveness of an already existing group in the network also enhanced the principal organization’s growth rate and profitability, a prediction that is consistent with network closure theory..

In being partially consistent with both theories, these results identified the dynamic conditions under which each theory holds. They also identified a new and unexpected phenomenon, namely, that while the formation of indirect ties around an organization initially negatively affected its performance, further additions of indirect ties within an already formed group could actually enhance performance. The authors extrapolate from this suggesting that the optimal network strategy for an organization is <i>selective</i> expansion to separate groups to gain from brokerage benefits, while taking advantage of, or even stimulating, close collaboration within those clusters.

These recommendations are framed with the warning that efficient partnership strategies must take into account the endogenous dynamics of the network. Network structures are ultimately the product of strategic interactions between players and thus the outcomes of an organization’s intended action are contingent on the actions taken by other players in the network. As each firm seeks to occupy the most central position in the network from which it brokers relationships between disparate partners, a competition takes place. With each actor in the network pursuing its own best interests, a firm’s attempts to better its position can be thwarted by others. Thus, while central brokerage positions in a network are advantageous, they are typically short-lived. The authors suggest that once undermined, an organization would do best to actively promote further indirect ties to cement the cohesion, rather than seeking to reestablish a new brokerage position at any cost.

INSEAD 2003

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