Environment-Strategy-Performance Linkages: A Study of Indian Firms during Economic Liberalization

Abstract

How firms from emerging economies transform themselves to adapt to the changing institutional environment during economic liberalization has generated a lot of interest among management scholars and practitioners alike. This paper presents an analysis of the corporate strategic behaviour of firms in India, a giant emerging economy undergoing economic reforms over the last one decade. Based on existing theories, a multivariate model has been developed to explore the contingency linkages of environment, corporate strategy, and performance. The model has been empirically verified in LISREL framework using primary and secondary data for 111 firms mainly belonging to the list of top 500 firms in India. The major observations emerging from the analysis are as follows: Environment played a significant role in shaping firm strategies and performance during reforms. Environmental munificence and competitive intensity influenced firm strategies and performance as hypothesized. Availability of high growth and profit opportunities across industries, easier access to resources in the international market, improvement in the supply situation, etc., had the greatest influence on the strategic behaviour of firms in the liberalized era. Firms facing intense competition and demanding customers reorganized the business portfolio by divesting some businesses and moving into more promising unrelated businesses, cut down the organization flab through downsizing, and promoted greater sharing of resources within. Firms having better environment-strategy ‘fit’ achieved superior performance. The effect of environment on firm performance was moderated by firm strategies. This conforms to the general principle of contingency theory derived based on the developed economy institutional framework. Among the corporate strategies, scale expansion strategy was found to be the most effective, as it yielded superior profit and market performance. Scale expansion benefited firms not only in gaining advantage due to economy of scale but also in using more modern technology and equipments. The strategy of product-market diversification did not have any significant effect on profitability. However, it resulted in poor market performance as observed from the significant negative influence of business scope on market return. This indicates that investors were generally wary of diversification moves by firms. Increased diversity in operation did not have any significant negative impact on performance. Therefore, unrelated diversification per se did not harm firms, at least, in the short run. The study does not support the earlier observations by researchers that firms with focused strategy and adopting defensive strategic orientation perform better during deregulation of industries in both developed and emerging economies. In fact, it can be observed that, during economic liberalization in India, firms that recognized the favourable and unfavourable changes in the environment early and increased their scale of business and diversified into deregulated industries selectively but aggressively achieved superior performance