Strategic organization in traditional industries:

Boundary architecture as a source of competitive advantage

Ana Abrunhosa Faculty of Economics

Universidade de Coimbra Av. Dias da Silva, 165, 3004-512 Coimbra, Portugal

ampa@fe.uc.pt

Filipe Santos

Assistant Professor of Entrepreneurship INSEAD

Boulevard de Constance 77305 Fontainebleau, France

Filipe.santos@insead.edu

Draft Version: 19/01/2006

ABSTRACT

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INTRODUCTION

The firm-level design of organizational boundaries has been a topic of recent attention in the

strategy and organizations literature {Santos, 2005 #970; Jacobides, 2006 #1124}. This stream of

work explores the architecture of organizational boundaries and its impact on the overall

performance of firms. It aims to address the gap created by the dominant focus of the

organizations literature over the last 30 years on the transaction as the unit of analysis

{Williamson, 1975 #185; Williamson, 1991 #808}. In fact, while this literature has given us

considerable understanding about the drivers of individual boundary decisions, its micro-

analytical focus has obscured the firm-level effects of organizational boundaries on issues like

innovation and competitive advantage. As Jacobides and Billinger argue {2006 #1124: p.2}:

“Surprisingly though, little, if any research has looked at how the overall boundaries of a given

firm are set, how they evolve, and how they affect that firm’s prospects”. This paper aims to

address this gap by exploring how the re-design of organizational boundaries can become a

source of firm-level innovation and competitive advantage.

This topic is important since a micro-analytical focus on the discrete boundary choices of

make versus buy versus ally has difficulties in explaining firm-level evolution. For example,

although the literature has confirmed that asset specificity is associated with internalization

{Shelanski, 1995 #855}, there are arguments that asset specificity may be a result of

internalization and not its cause {Kogut, 1996 #25}. In addition, although there are arguments

that firm level capabilities drive boundaries {Argyres, 1996 #34}, these capabilities may

originate from prior boundary decisions thus suggesting a co-evolution between boundaries and

capabilities {Poppo, 1998 #63}. Both these effects are impossible to disentangle with the

traditional focus on discrete decisions at a single point in time. Finally, although managers are

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supposed to align governance choices with transaction characteristics to minimize transaction

costs {Williamson, 1991 #808}, there is suggestive evidence that managers often decide to both

make and buy for the same transactions {Harrigan, 1985 #1127; Jacobides, 2006 #1124;He, 2006

#1135}, which seems inconsistent with current theories.

Some recent work has started to address these issues by exploring the architecture of

boundaries at a firm level. Santos and Eisenhardt {2005 #1033} look at how entrepreneurs in

five firms addressing nascent markets manage their boundaries over time. They find that a logic

of power drives boundary formation in these firms and shapes their market scope. The goal of

entrepreneurs is creating a monopoly position in distinct and viable new market that they define,

bound and defend. In a related paper, Santos {2005 #1064} finds that initial power-driven

boundary choices drives the development of organizational capabilities which in turn shape the

structure of transaction in the new market. Interestingly, capabilities then may drive boundaries

although in an unexpected way – stronger capabilities may increase the use of outsourcing in

order to allow scaling the organization faster. Asset specificity may play a lesser role than the

theory suggests in the choice of governance for activities in these markets, .

Another recent study focused on the boundary transformation of a large, established

European firm in the garment industry and suggested the concept of vertical architecture of

boundaries {Jacobides, 2006 #1124}. This research argues that shaping boundaries is not only a

decision about the scope of activities of the firm but also about the permeability of boundaries to

markets at different stages in the value system. The study suggests that a permeable boundary

architecture is important for the ability of firms in traditional sectors to survive an intensifying

competition from low-cost countries. Although this concept of boundary architecture is novel

and intriguing, the study is based on a single case study and the performance implications of the

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new boundary architecture are suggested but not tested. Thus, in order to further explore how the

firm-level design of firm boundaries affects firm-level outcomes we ask: How does the

architecture of firm boundaries impacts their ability to compete in traditional industries facing

global competition?

In particular, we track the evolution of the boundaries of three Portuguese footwear SMEs

over a 15 years period. The footwear industry is a good example of a traditional manufacturing-

based industry where the basis of competitive advantage has been shifting away from developed

economies, such as the US and Southern European countries, towards emerging economies, such

as China, India and Eastern European countries. These countries have joined the world economy

in the last decades of the 20th century and benefit from an abundance of low cost labor,

improved infrastructure and market access. How can established firms in developed countries

compete in such an environment when their source of competitive advantage is being slowly but

inexorably eroded? While some attention has been devoted to this topic by policy-makers at an

industry-level of analysis, little research has focused on how firm level strategies, such as the

architecture of organizational boundaries, affect competitive advantage {Jacobides, 2006

#1124}.

Our findings suggest that the architecture of organizational boundaries may be a particularly

powerful source of innovation and competitive advantage. The data suggest that exemplar firms,

that were pioneers in the co-development and introduction of new technologies and whose

leaders are centrally connected within the industry may be sideswiped by competition when their

executives don’t change the architecture of their firm boundaries. In contrast, firms in initial

weaker competitive positions, but whose executives re-design the architecture of the

organizational boundaries may thrive despite increasing competition. The boundary architecture

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adopted by the high-performing firms was surprising. Instead of a narrower specialization on

certain activity clusters to improve differentiation, managers tend to augment the firm vertica

scope within the value system. However, instead of a tight coupling of activities to serve a

particular market need, managers increase the permeability of different activity clusters by

frequently accessing markets in both the input and output sides. In addition, these activity

clusters are organized in increasingly modular ways, creating a more loosely-coupled activity

system. This combination of vertical integration, permeability and modularity allow firms to

become more responsive to market changes and thrive despite a challenging competitive

environment.

Our study contributes to the boundary literature by elaborating the novel concept of vertical

architecture of boundaries {Jacobides, 2006 #1124} as a combination of firm-level boundary

decisions about scope, permeability, and modularity of activities. In particular we explore the

links between scope, permeability and modularity and explain why these processes work and

what their limitations are. Given our longitudinal analysis, we also offer strong evidence of the

performance impact of boundary architecture. Methodologically, we contribute by proposing a

new analytical tool to study firm-level boundary change over time.

Discuss contributions at the interface of strategy and organization including implications for

the business model and innovation.

Discuss policy and management practice contributions about how to win despite threatening

conditions

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METHODS

The research design is an inductive, multiple case study. Multiple cases enable a replication

logic in which the set of cases is treated as a series of experiments, with each case serving to

confirm or disconfirm the inferences drawn from the others {Yin, 1994 #936}. A multiple case

study typically results in better-grounded and more general theory than single cases {Eisenhardt,

1989 #248}. Inductive research builds on the data to explore a phenomenon of interest for which

prior theory is lacking or does not seem to adhere to the phenomenon as observed. Thus, rather

than testing hypothesis, the goal is to develop new theoretical insights that can explain the

phenomenon of interest, in the case, boundary change at the firm-level over time.

The research employs an embedded design with three levels of analysis: organization,

industry and activity cluster. An embedded design enables richer, more accurate theory by

uncovering aspects of a phenomenon that occur at multiple levels. The organization is the central

unit of analysis and the research focus on tracking the evolution of organizational boundaries

over time and assessing their performance implications. Smaller units of analysis such as activity

clusters focus data collection by addressing well-defined organizational events, while larger units

of analysis, such as the industry, provide a longitudinal context (Yin 1994).

The research setting is the global footwear industry from 1990 to 2005 with a focus on how

Portuguese firms adapted to the transformations that occurred in this period. This was a period in

which a conjunction of supply and demand-based factors led to the erosion of the competitive

factors on which the competitive basis of the Portuguese industry had been established. The

research sample is drawn from Portuguese SMEs that were already in existence in 1990, a time

when the industry started to suffer the pressures of a changing competitive landscape, and had

survived until 2004, the time when the study started. We focused on SMEs since these constitute

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about 75% of the employment in this industry {APPICAPS, 2001 #1129}. It should be noted that

is weight is similar to the overall structure of European industry (Ana, confirm and present data).

SMEs are understudied in the Organizations and Strategy literature in relation to their economic

importance.

We selected three firms based on a theoretical logic. Given our goal of understanding how

firm boundaries may impact performance we selected firms that exhibited a strong variance in

performance. We chose a firm that was in an excellent strategic position in 1995 and, yet,

exhibited a very weak performance ten years after by 2004. We choose another firm which was

weakly positioned in 1995, and yet, had exhibited a much stronger performance by 2004. We

also selected the firm that was considered by industry experts as the best performer in the period

1995-2004. Our approach was to develop an in-depth study of the boundaries of these firms

throughout a 15 year period and theorize about their relations to the outcomes observed. A

description of the sample firms and their main characteristics is presented in table 1. The choice

of these firms was validated by experts at the Shoes Technology Center in Portugal, who have

worked alongside most of the footwear firms throughout the period under analysis. Table 1

presents an overview of the sample firms (Ana, complete table)

Basilius J.Sampaio&Irmão Investvar

Founding date 1973 1981 1985

1995

Sales (€) 15,4M

Profits (€) 508K

Employees 168 70

2004

Sales (€) 3,3M

Profits (€) (468K) *

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Employees 65

Given the goal of understanding how organizational boundaries are managed over time, we

necessarily employ a longitudinal design, collecting data that covers 15 years of the firms’

existence from 1990 to 2005. Although our firms may be longer-lived than some other firms,

having sufficient history for each firm was necessary to understand the temporal dynamics of

organizational boundaries and its impact on firm performance. This requirement outweighed the

implications of not having a random sample, especially in a descriptive and theory-building

study such as ours.

Analytical Tools

In order to study the architecture of organizational boundaries at the firm-level we needed to

develop a new analytical apparatus. We start by adopting the view of firms as activity systems

aimed at creating value in particular markets {Porter, 1991 #178;Siggelkow, 2001 #895} Thus,

we can track firm boundaries by looking at the scope of activities that firms engage in over time.

However, we should take into account that firm boundaries may exhibit a certain level of

permeability. In fact, in contrast to the canonical make-or-buy choice typically portrayed in the

boundaries literature, evidence has suggested that firms frequently make and buy for the same

activity {Jacobides, 2006 #1124}. We thus analyze the extent to which each activity is open to

markets in both the input and output sides. Thus, the market is not only represented by firm’s

end-client, but surrounds firms and can inter-penetrate them in different areas of activity.

In addition, we elaborate the concept of the value system to represent the set of

interconnected activities that are required to create value in a market. The value system thus

defines the established scope and structure of activities for a particular market. For the purpose

of this analysis we focus on the central activities that add value to customers and generally

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Not present in the activity

Subcontracts the activity

Internalizes the activity

Transfers internally the output of the activity Transfers externally the output of the activity

Internalizes and subcontracts the activity

ignore more generic support activities. We refer to the term value system and not value chain or

value network because we are agnostic about the structure that this set of activities and linkages

can take. In some occasions, particularly for tangible products, the set of value-creating activities

is better characterized as a sequence or chain {Porter, 1985 #179}. Other times it may be better

characterized by a network of activities with no clear sequence and where knowledge flows are

paramount {Allee, 2000 #1122}. Most frequently it will be a structure in-between a chain and a

network, which is why we prefer to use the more general term “value system”. While in nascent

markets the value system may be incipient and shaped over time by the actions of entrepreneurs

and managers {Santos, 2005 #1033}, in more mature markets, such as the leather footwear

industry that is the focus of this study, it is likely to be well established and stable over time. The

value system for the leather footwear industry, the particular focus of our study, is depicted in

figure 1, representing all the added value activities necessary for the creation of value for the

end-users of shoes.

Figure 1 – The value system for the footwear industry

Brand

Design Technical model

Marketing

Quality

Cut

ting

Sow

ing

Ass

embl

y

Distribution

International retail

National retail Leather Rubber

Soles prod. Tannary

MARKET

End user

Formatted: Font: 10 pt

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A new collection of shoes starts with a brand concept that informs the creative design of the

shoe. Then there is the need to transform that design into a technical model that can be mass-

produced, a process that is usually based on a CAD-CAM software system. The key components

for the shoe production process are the leather and the soles, both of which need to be processed.

The main stages of shoe production are the cutting of the leather, the sewing of the cut leather to

form the top of the shoe, and the assembly of the leather to the sole to complete the shoe. Then

there needs to occur the distribution of the shoe to retail stores, supported by marketing

activities. This value system, as depicted in figure 1, was developed after extensive consultation

with industry experts and firm directors.

The architecture of organizational boundaries is thus defined by the scope and permeability

of a firm’s activities in the context of the value system of the market. Scope is defined by the

extent to which the activities of the firm cover the required activities of the value system.

Permeability is defined by the extent to which each activity area is open to the market on the

input side (meaning it acquires input from other companies) and open to the market on the output

side (meaning that it sells the output of the activity to the market). By overlapping the activity

system of the firm with the value system of the industry one can visualize the architecture of

boundaries of a firm. Figure 2 shows the architecture of boundaries for the three firms in our

sample in 1990:

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Basílius

J.Sampaio & Irmão

Investvar

Figure 2 – Architecture of boundaries of sample firms, in 1990

By developing these figures for different periods over time we can track the changing

architecture of boundaries. In particular we chose the years of 1990, 1995, 1999, 2002 and 2005

since these represent important milestones in industry evolution.

The Portuguese Footwear Industry

Portugal is a country specialized in the production of leather footwear of medium and high

quality. It is in third place in Europe in exports ranking and in fourth place worldwide, which is

remarkable for a small country of 10 million inhabitants (APICCAPS, 2003). During the period

of 1986-1990, the Portuguese footwear industry grew at a fast rate due to Portugal joining the

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European Union while having lower than average labor costs. Portugal thus received important

manufacturing orders from European agents of global buyers (large retailers and brand-named

merchandisers) that used Portugal as a manufacturing base for large size orders of footwear.

However, in early 1990, the industry started to see signs of change in the global competitive

environment, due to both demand and supply-based changes.

The supply-side changes were caused by the emergence of low-cost countries which

threatened the traditional competitive basis of the Portuguese industry. A crescente concorrência

dos países emergentes com mais baixos custos salariais tem provocado a deslocalização desta

indústria, do sul da Europa para países asiáticos e do leste europeu, por parte das grandes

marcas e distribuidores americanos e europeus. Isto tem levado ao encerramento de grandes

empresas de capital estrangeiro e de elevado número de pequenas empresas que trabalhavam

como subcontratadas dessas grandes empresas.

In addition, demand-side changes transformed shoes from a product considered as a basic

consumption need to a lifestyle purchase. Esta alteração dos padrões de consumo tem como

consequência o decréscimo da procura de produtos estandardizados e o aparecimento de uma

procura mais exigente e diversificada. Isto trás importantes implicações ao nível da oferta. Por

um lado, os produtos têm que responder rapidamente às necessidades dos diferentes segmentos

da procura, implicando o abandono da produção em massa e a evolução para a produção por

encomenda de pequenas séries (encomendas compostas por reduzidas quantidades de uma

grande diversidade de modelos). Estando a maioria das empresas portuguesas especializadas

nas grandes séries, este factor vem contribuir para uma maior erosão da base competitiva do

sector.

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Recognizing the need to change, the sector started, after 1995, a movement of

technological modernization. In this process, the Footwear Technological Centre played an

important catalytic role. In 1999, the sector starts to suffer greatly from loss of its cost

competitive advantages when the global buyers present in Portugal started to relocate to lower

cost areas. In this period, many footwear firms had to close down and this tendency has

continued. After 1999, we considered in our analysis shorter periods (3 years) in order to better

capture constant and important changes that have been occurring in the sector. In addition, for

more recent periods we also have more detailed data that allow us to more accurately to capture

transformation of boundaries in the sample companies.

Data Collection and Analysis:

There are three main data sources: archival, interview and observations, collected over a two

year period in 2004 and 2005. The extensive archival data include both internal and external

sources. The internal sources include financial data, historical data, and press releases. The

external sources include media articles about each firm and industry studies.

The second main data source is semi-structured interviews with internal and external

informants. Internal informants include top and middle managers, and workers. We

complemented these informants with external informants: business partners, competitors, and

industry experts. The use of multiple informants serves two main purposes. First, multiple

informants mitigate the potential biases of any individual respondent by allowing information to

be confirmed across several sources (Golden 1992; Miller, Cardinal et al. 1997). Second,

multiple informants can lead to a richer and more elaborated model, since different individuals

typically focus on complementary aspects of a major decision (Schwenk 1985; Dougherty 1990).

The interviews ranged from 2 to 5 hours. We took detailed notes of the interviews, generating

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approximately 900 pages of notes. We followed up with clarifying emails and phone calls as

needed.

The third data source is direct observation of the different firms’ activities. We spent an

average of 30 hours in observation in each firm in the period of 2004-2005. These included

participation in business meetings with outside partners such as suppliers, distributors, retailers,

and designers. It also included internal management meetings regarding topics such as the

strategy of the company and production quality. In addition, two of the co-authors spent one day

in the production line of one of the studied firms, working along side the operators and learning

on how to produce a shoe. We also did observations in industry fairs, both national and

international, where the footwear companies promote and sell their products. Table 2 details the

data sources for each firm and also details the industry-level data gathered.

Basílius J.Sampaio&Irmão Investvar Industry-level Total

Number of visits

6 15 12 21 54

Number of informants

4 founder general manager

cutting unit supervisor sewing unit supervisor

8 General manager Administrative

manager Production director Marketing drector

Sales Director Modeling unit

supervisor sewing unit supervisor

9 General Manager,

Administrative manager Production director Marketing drector

Sales Director Communications

director Components engineer

Chemical engineer Business unit head

engenheiro de componentes,

20 industry experts representantives from APICCAPS representantives

from INESC other founder and general managers

41

Hours of observation

10 50 30 30 120

Hours of Interviews

30 85 50 120 285

Number of pages wth

notes

100 180 200 400 880

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Archival Sources

- Press News Press News

Press Releases

Jornal Interno

Revista da Empresa

Revista Sapato

Apiccaps publications

SATRA statistics

CTC statistics/studies

Ministério Economia

studies

INOFOR studies

Other authors studies

Participation in Industry fairs

3 (2 MOCAP e 1 DGS)

Using these extensive archival data, we developed chronological case histories for each firm.

Each case was about 40 pages in length. We organized the cases by year, detailing the boundary

changes that occurred in each period, including an analysis of their context, implementation and

impact on the company. Overall, this combination of extensive archival sources, interview data from

multiple internal and external informants, and direct observation enabled a rich, triangulated, and

accurate understanding of the phenomenon (Kumar, Stern et al. 1993). For example, media articles

and industry interviews clarified the industry context affecting the boundary changes, while

interviews with internal informants revealed the actions of managers, their drivers and the alternatives

not chosen.

As is typical in inductive research, we began with in-depth analysis of each case from the

perspective of our research question {Eisenhardt, 1989 #248}. The three researchers read the

cases independently in order to form their own view of each narrative. Tables and graphs were

used to facilitate the analysis {Miles, 1994 #998}. In particular we use the analytical tool

detailed above to track the scope and permeability of the firm boundaries over time. The goal of

this within-case analysis was to identify theoretical constructs, relationships, and longitudinal

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patterns within each case independently and in relation to the research question.

Consistent with multiple case research, we then turned to cross-case analysis in which the

insights that emerged from each case were compared with those from the other cases to identify

consistent patterns and themes across the cases {Eisenhardt, 1989 #248}. We first contrasted

Basilius to J.Sampaio&Irmão and to Investvar to understand the reasons for the performance

difference in these two firms. As patterns emerged, J.Sampaio&Irmão was also compared to

Investvar in detail to develop more robust and refined theoretical concepts. Significant

discrepancies and agreements in the emergent theory were noted and investigated further by

revisiting the data. We relied on an iterative process of cycling among theory, data, and literature

to induct a theoretical framework of how entrepreneurs organize their firm boundaries in

traditional industries facing increased competition..

FINDINGS

Our research goal is to explore how the architecture of organizational boundaries affects the

long-term performance of firms. In particular, we want to understand how firms may adapt to

highly competitive environments such as the one that characterizes the Portuguese footwear

industry during the period of analysis.

To study this process we started by analyzing the case of Basilius, a company widely

regarded by industry experts as the star of the industry throughout the 1990s. This family-based

company was founded in 1973 through the merger of three existing shoe manufacturing

companies. Its founder and general manager was a highly charismatic and well-connected

individual. He was the president of the Industry Association, and had a good reputation and

contacts with the main industry leaders and clients. At the start of the study in 1990 the company

had 176 employees, 5.8M euros in annual sales and exported about 90% of its production. It

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business model was centered on being a contract manufacturer for international clients. The

company fulfilled large batch orders for its clients (mostly agents for international companies). It

also had small modeling unit and often suggested some industrial design to its clients. The

company also supplied its own Basilius brand of man and women shoes for the domestic market

although these sales represented only about 5% of revenues.

In addition, the company was building a reputation for high quality production and

technological innovation. The company had implemented since 1988 an innovative software

CAD system acquired from a French company which also trained its employees. In early 1990,

Basilius was the first Portuguese company and the second in the world to acquire a water-jet

cutting system for leather from an Italian manufacturer. This provided the company with the

ability to fulfill smaller order batches. This led to the development, together with a Portuguese

software R&D center, of a custom-made CAD system that later became an industry standard. In

addition, a collaboration with a new venture led to the development of a more effective water-jet

cutting system than the Italian model initially acquired. This new system also became an industry

standard. Another research project with a Portuguese research center and an equipment firm led

to the development of a highly automated warehousing and transportation system that again

improved Basilius’s ability to respond to smaller order batches, which represented a growing

trend in the industry. This system also became an industry standard that was adopted by many

other firms. The company was recognized as the most prestigious Portuguese shoe

manufacturing company in 1994, 1995 and 1996. This period coincided with its production peak

with sales of 15.4M euros, profits of 508K euros and 168 employees. In 1997, Basilius won an

award for most successful manufacturing SME in Portugal.

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However, the company was not able to face the crisis that hit the industry in the late 1990s

and started a slow decay with lower revenues and capacity reduction. By end of 2004 the

company was unprofitable, it had substantially reduced its workforce to 105 employees and its

sales were 75% lower at 3.76M euros. It was in the process of further restructuring and

downsizing which occurred in 2005 when the company laid of almost half of its remaining

workforce, a process that was estimated to continue in 2006. What can explain such a weak

performance for a once so successful and innovative company?

We used the lens of boundary architecture to analyze the evolution of the company. We

analyzed the scope and permeability of the firm’s activities in the industry value system at

different points in time from 1990 to 2005, as depicted in figure 3.

Fig. 3 – The evolution of Basilius’ value system

1990

1995

1999

2002

2005

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The analysis reveals that despite all the technology investments and strong firm reputation,

the boundaries of Basilius remained remarkably stable throughout the period under analysis. The

company started in 1990 with activities in all manufacturing areas, together with technical

modeling and its own brand (with very small sales). By 1995 the major change in boundaries is

the beginning of subcontracting in production, mainly to deal with variability in demand. By

1999 there were no significant changes, other than having a smaller share of revenue generated

by its own brand compared to the manufacturing activities. There are no further changes in

boundaries at Basilius until 2005, other than the beginning of subcontracting work to India due to

lower labor costs and the cancellation of its own brand in 2005 due to low sales. Thus, Basilius, a

highly innovative and pro-active firm in many areas, exhibited a highly static approach to

managing its boundaries. It did not change the scope of its activities or how it interfaced with

markets. Its efforts were geared towards improving what the company traditionally did (serving

large international clients as a footwear manufacturer), a business model that was under pressure

due to a change in the basis of competition.

An alternative explanation for the weak performance of Basilius is that the footwear industry

in Portugal is condemned and that even the best companies in the industry will inevitable fail.

However, the case of the company J.Sampaio&rmão (Sampaio) suggests that firms may prosper

despite this competitive context if they transform the architecture of their organizational

boundaries.

Sampaio was founded in Felgueiras, Portugal, in 1981 by two brothers with the goal of

producing and commercializing shoes. It started operations with 3 employees. In 2005 the

company was thriving, with a sales growth of X since 1999, selling approximately 9M euros of

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shoes of which more than 90% were for the European export market. Given that this firm had a

similar origin as Basilius (founders originally from the shoe industry, family owned and family

run firm), served the same type of clients, and had a similar boundary scope in 1990, but had

much lower levels of innovation and reputation in the industry, what can explain the different

outcomes?

Figure 4 details the architecture of boundaries of the company in 1990. Similarly to most

companies in the industry, in the early 90s the company works essentially as a contract

manufacturer for international clients, with a focus on France and Belgium. Given the variability

of demand the company already outsources some of its manufacturing to other companies during

peak times. Although the company had its own brand, which was called Calafe, all of its sales

are branded with their client’s brand and the design offer is very incipient and based on imitation

and client suggestions. The commercial area is not well-developed and is assured by the CEO

who deals directly with the clients.

Figure 4 – Architecture of boundaries of J.Sampaio&Irmão, in 1990

The architecture of boundaries at Sampaio suffered some transformations by 1995. In 1994

the company hires an Italian designer to improve the creative design of its own branded products,

in close coordination with the company’s management. Sampaio then starts to develop its own

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designs in their shoe collections. Sampaio’s founder and director considered this change a very

important step since it meant that the company would be able to add more value for its clients by

suggesting new shoe designs. “The decisions taken in 1994 shaped our path of development…I

started to sell more of my own designs, although often not associated with the brand Calafe”.

Often these suggestions were fully accepted by the clients, other times they were accepted after

minor modifications that provided the company with a better sense of client requirements. The

decision to invest more on design had the goal of reducing the dependence of the company from

the large distributors who where their main clients. These clients were becoming very demanding

in terms of prices and often requested samples of shoes that did not result in orders. In fact, this

situation led to a crisis in 1996 when the company lost two very important clients, one who went

bankrupt and the other who moved the orders to China after Sampaio refused to keep supplying

small batches of sample shoes. These two clients represented 70% of annual sales. This crisis led

to a deep rethinking of the business model at Sampaio.

The company decides to stop targeting their traditional customer base of global agents and

address a new segment of clients who would be less price sensitive and operated at a smaller

scale. This segment was constituted by shoe retail chains which required smaller order sizes and

faster response times. These stores were trying to adapt to the transformation in demand patterns

that privileged higher diversity of models and colors to address fast changing tastes.

The new focus of the company required investment in brand and new technologies.

Specifically, the company undertakes significant investments between 1996 and 1999, including

implementing a new CAD shoe design, an enterprise management software system. It also

introduced a water-jet cut system for leather that reduced the cost of producing smaller batches

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of shoes. These investments amounted to 2.8M over three years and allowed the company to start

fulfilling the small sized, urgent orders that before were not economically viable.

These strategic changes are reflected in the 1999 architecture of boundaries. At the time, the

emphasis on the development of its own-design collection named Calafe made it necessary for

the company to improve its competencies. The company hires two salespeople to strengthen the

relation with its distributors, and reinforces its technical modeling area with new hires. During

this period the company director has a strong role in coordinating the relations between design,

technical modeling and production, together with the choice of soles and leather supplies. For

example, the company acquires raw leather and outsources the processing of the materials

according to their specific needs.

After 1999, the large clients continue to move their orders to lower costs countries, a trend

that hurts companies such as Basilius. However, Sampaio managers see this as a signal that they

should make a stronger bet in developing their own brand as opposed to the private label

business where they sell their Calafe brand and designs, which are then often re-branded by their

clients. However, Calafe was too connected in the minds of is private label business clients to

allow its transformation into a distinct brand. Thus, Sampaio managers decide to create a new

brand called Eject that aggregates its more innovative designs. The brand concept was defined as

“a brand for the young at heart from 8 to 88 years old”. Sampaio starts to produce small batches

of Eject shoes to sell directly to retail stores in late 2001. This shift was facilitated by all the

investments described above in the 1996-1999 period. The Director of Sampaio acknowledges:

“creating a brand requires time and a consistent strategy…If we had the traditional equipment

we would not be able to deliver the quick response times, production flexibility and small batches

required to create a branded collection of shoes for the retail market”. Thus, in 2002 the

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company is present in the activities of branding and distribution for the international retail

market, either directly or trough distributors. Given the specificities of the designs, materials and

colors required by the Eject shoes, Sampaio works closely with leather suppliers to guarantee the

required quality and colors and actually owns the inventory that is processed by their suppliers.

By 2005, there are significant changes in the architecture of boundaries. These include the

creation of a formal department of marketing to support the Eject brand and initiating the activity

of distributing directly to retail stores for the domestic market. However the greatest change is in

the design and modeling unit. While Sampaio traditionally had outside designers to support its

shoe design, it decides to internalize all design for the Eject brand since this was highly specific

to the company. Despite closing its boundaries on the input side, Sampaio manager decides to

open them on the output side. The company creates a more formal unit aggregating the activities

of creative design and technical modeling. This unit is provided with new machines that allow it

to produce new collection of shoes and develop small samples to show to prospective clients.

Thus, the company starts selling shoe collection services to clients that then produce those shoes

in low cost countries. This means that the company effectively modularizes some of its activities

and opens them to the market. This is an area where the company wants to invest further by

hiring new designers and modelers. In addition the company reinforces its activities in the area of

quality control of production in order to better foster its subcontracting activities.

Fig. 5 – The evolution of J.Sampaio&Irmão’s value system

1990

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Overall the company kept growing despite the tough industry context. Its sales grew xx% per

year in the period of 1999 to 2002. Its sales continue to grow and increased 30% in 2004 for a

total of 8.6M euros. Two thirds of this growth is due to the Eject branded shoes. The company

estimates 10M euros in sales for 2005, and again a strong growth of the Eject brand.

In contrast to Basilius which kept its boundaries static, Sampaio has transformed its boundary

architecture in the last 10 years by extending its scope in the industry value system, increasing its

permeability to markets in different activities, and starting to modularize certain activity clusters.

This boundary architecture allowed Sampaio managers to enter new areas of the value system,

gain more information about market opportunities in different areas of the value system and

1995

1999

2002

2005

24

understand better where their competencies lie compared to other organizations. It thus provided

more options for growth (private label, branded shoes, design services).

In order to check if this process of boundary change was replicated in other high-performing

companies and how it occurred, we studied Investvar, a company widely recognized as the

greatest success story in the Portuguese footwear industry throughout this period. From its

origins in 1987 as a small company with founders coming from the footwear components area,

the Investvar group reached 154 million euros in sales in 2004, most of it directed to

international markets. Investvar is currently responsible for 5% of Portugal’s footwear exports

and is one of the largest companies in the industry. What can explain this remarkable

performance?

We analysed the company throughout this period using the lens of boundary architecture. In

1990, the architecture of boundaries at Investvar was similar to Basilius and to Sampaio in terms

of scope and permeability of boundaries, as detailed in figure 6. Investvar produced shoes for a

major US client which owned the brand Aerosoles. However, Investvar also provided quality

control and logistic services to this client by monitoring the other Portuguese suppliers of

footwear. In 1990, all creative design, technical modeling and distribution were made by the

American client, in a very typical sub-contracting relation for the Portuguese footwear industry.

Fig 6 – Investvar’s value system in 1990

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In 1992, after five year manufacturing shoes for this American client, Investvar negotiated a

20 year license to become the exclusive commercial representative of the Aerosoles brand for the

EMEA regions (Europe, Middle-East and Africa). Investvar then starts to develop some of its

own designs and technical modeling of the shoes in an autonomous unit in Italy which also sells

modeling services to other clients. This unit is fully owned by one of the founders of Investvar

who owns 50% of company. Investvar then creates another autonomous unit to develop

distribution activities. Regarding its manufacturing unit, the European market starts to exhibit

strong growth and the company decides to open its boundaries on the input side by

subcontracting the production of shoes. It also opens its boundaries on the output side since it

also produces shoes for other than their own Aerosoles brand. This increased permeability of the

manufacturing unit allows dealing with capacity constraints and demand fluctuations.

Thus, by 1995 Investvar exhibits a strong difference in its boundary architecture, with

increased scope of activities, permeability in both the input and output sides and several

autonomous units along the value system as depicted in figure 7.

Fig. 7 – The evolution of Investvar’s value system

1990

1995 1995

1999

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As a result of its permeability of boundaries in the output side of manufacturing, Investvar

gained in 1996 a large contract from Marks & Spencer (M&S) for the exclusive production of

M&S’s FootGlove brand. In essence this agreement represented a branching out of the Aerosoles

brand to the UK market in exclusivity with M&S. The relationship between Investvar and M&S

led the group to improve its internal processes, add enterprise wide information systems, adopt

M&S’s “Ethical Code”, and make their subcontractors adopt the same level of standards. The

M&S contract came to represent 50% of the group’s revenues by 1999. In addition, the

commercial units keeps expanding its geographical scope to cover the EMEA region, either

finding new country distributors, or acquiring an equity stake in the distributors. In 1998 the

group launches a new retail unit with the goal of commercializing the Aerosoles brand directly to

end customers. New retail stores are created at a fast pace, some through direct ownership, while

others by franchising, in another evidence of increased permeability of boundaries. In addition,

the group increases its subcontracting in the manufacturing unit by developing relationships with

Chinese and Vietnamese suppliers. Thus, the boundary architecture in 1999 includes activities in

all areas of the value system, from design and branding to retail, with structure characterized by

autonomous units which are open to the market on both the input and output sides.

2002

2005

2002

2005

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Between 1999 and 2002, the major changes in the boundaries architecture are the creation of

marketing department to support the brand development and retail expansion activities. The

company also creates a JV with an Italian firm to produce a new type of flexible soles for the

Aerosoles shoes and for other clients, further expanding its scope into the components activities.

A high-quality, flexible sole is a key differentiatior for the Aerosoles brand whose main

attributes are “stylish and flexible”.

In 2003 Investvar leads a consortium called Frontshoes of six Portuguese footwear

companies together with two government-led private equity firms. Frontshoes then acquires a

retail chain in France with 64 stores, in order to develop additional retail channels for

Portuguese-branded shoes. Through this acquisition, Investvar starts providing retail services by

selling footwear from other companies to the end-customers. In addition, the company continues

to expand its own Aerosoles retail brand which comprises 90 retail units in 2004 with plans to

have 140 retail units by 2009. In addition the group creates a new design unit and starts

internalizing all Aerosoles designs and also selling design services for other companies. It also

starts to develop new brands of shoes to sell through the Frontshoes consortium and other retail

venues. At the end of 2004, M&S decides to end their exclusive agreement and use Investvar

manufacturing services in competition with other footwear manufacturers. As a response,

Investvar creates a company to sell the Aerosoles brand in the UK. In addition, the company

increases the modularity of its commercial and industrial units through a formal business unit

structure.

In 2005, the Investvar holding is involved in the production of 5 millions pairs of shoes per

year, 90% of which are exported to Europe. Subcontracting is responsible for about 60% of the

group’s total output. In 2004, Investvar accumulated a turnover in the industrial area of 53,7

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million euros and in the commercial area of 100,6 million euros. Investvar now accounts for 5%

of Portugal’s footwear exports.

Overall, Investvar exhibited a similar patter to Sampaio in terms of how it changed its

boundaries architecture. This pattern included an increasing scope of activities in the value

system of the industry, an increasing permeability of different areas of the value system to the

market, and a more refined modularity of internal activity clusters. However, these processes are

even more marked in Investvar than Sampaio. Investvar is present in the whole value system,

including areas such as retail and components. In addition, Investvar has a broader set of market

interfaces in both the inputs and outputs areas. Investvar sells components, design and industrial

modeling services, quality control services, production services, and retail services. It buys

components, production services, and distribution services. Finally, Investvar also exhibits a

more marked modularity of activities that includes organizing different units as independent

companies within a holding structure and adjusting the ownership of each company to guarantee

the right incentives and competencies.

DISCUSSION

We set out to explore how the architecture of firm boundaries impacts the long-term

performance of firms. We find that the low-performing company in our data had a static

approach to boundaries, while the two high performing companies had transformed their

boundaries through a pattern that included three main processes: scope extension, increased

permeability and more refined modularity. We describe each of these processes next,

highlighting their advantages and limitations, and how they are connected to form a very

effective way of organizing.

Scope extension

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Several researchers address the benefits of firms being specialized in a few activities and

using the markets for others (Jacobides, 2005). This concentration of resources and capabilities

in a few activities will allow them to be more efficient.

What can explain this move towards scope extension? This vertical integration was

essentially a response to changing demand conditions. First, it was a way of diminishing the

firms’ dependence from few large clients that would move away to emergent markets. Second, it

served as a mean to serve a new market segment -retailers and small distributors- that is

increasing. This emergent market is more demanding in terms of fashion, product diversity

(smaller batches) and short term deliveries. The nature of capabilities demanded is therefore

different. Contrary to the large clients, retailers and small distributors have no design and

industrial modeling activities. In order to serve this market, Portuguese firms developed

capabilities in these activities. Most of the times, this was strongly connected with the creation of

a brand. In a fashion market it is very important for firms to be in close contact with customers

because this allows them a better knowledge of fashion tendencies and demand patterns, which

are always changing. This can be only attained with a presence in distribution. The control of

distribution is also very important when firms want to develop their brands. Because Portuguese

firms have for a long time production capabilities, they orchestrate (they make in-house and

outsource) their production. By controlling the production activity, firms have control on the

products’ quality and response times.

Thus, we find that, contrary to the transaction cost economics argument (Williamson, 2000),

firms make and buy many of its inputs. They also transfer internally and sell many of its outputs

from different areas. The vertical integration also allows a better coordination of the different

activities, less dependence and quick response times.

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Disadvantages

However, scope extension can make firms more rigid since they need to increase the

investment of resources and develop new capabilities. In addition, the value creation potential of

an integrated, tightly coupled system of activities will be constrained by the capabilities of its

weaker link in the system. This can impose great costs and rigidity on companies since highly

specialized units can become more effective due to higher investment and increased learning. To

avoid the potential high cost of integration it is necessary that the different activity clusters in the

system be permeable to the market.

Permeability

As described by Jacobides (2005), vertical permeable architectures are partly integrated and

partly open to the market along a firm’s value chain. Independent of its vertical scope, the

company allows itself to open activities of its value system to the market, were each activity, or

business unit (single activity our group of activities), can engage in the acquisition of inputs and

selling of outputs to the market, besides the purchase of inputs from the firm’s upstream

activities and supply of firm’s activities downstream in the system

Evidences from the findings indicate that, despite variations in expansion of the boundaries

of each firm’s value system, each case presented a certain degree of permeability of its activities.

For instance, by looking at the production phase (see figures XXX), all of the firms studied

appear to develop the permeability of that activity, by the fact that they buy production capacities

from other companies (acquires inputs) and sell its production capacity to various clients (sells

outputs). Additionally, Sampaio and Investvar, as they expanded its boundaries over the years

and internalized activities, also presented an increased permeability in the design, industrial

modelation, distribution and retail. First, they began acquiring inputs for those activities from

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external sources (semi permeable to inputs) and later, in particular Investvar, added the selling of

outputs from those activities to the market (permeable).

Although this growth of permeability was more evident in Sampaio and Investvar, the

findings appear to reveal discontinuities in the permeability of the design activities. Initially, as

described, both Sampaio and Investvar acquired inputs for this activity from external sources, but

transferred their outputs internally. Later, they began transfer externally, or selling, these outputs

to the market.

However, from 2002 to 2005, Investvar ceased to acquire design inputs from external

sources, and developed them in-house instead. In the same manner, Sampaio decided to cease to

acquire design inputs for the EJECT brand, but remained acquiring inputs for the CALAFE

brand. However, both companies continued selling their design outputs to the market besides

transferring them downstream in the firms’ system. As such, the business unit composed of

design and industrial modelation became semi-permeable to outputs.

The permeability of the value system’s activities enables a more effective use of resources

and capacities, a better matching of capabilities with market needs and benchmarking with

competitors, thus improving efficiency. A vertical permeable architecture, combined with the

appropriate transfer prices and incentive design, facilitates resource allocation and guides a

firm’s growth process (Jacobides, 2005).

Opening firm’s activities to the market allows for the competences included in such activities

to be tested by it. As a consequence, the firm receives the information on how valuable those

competences are, if there is an opportunity in trading those competences and effectively

allocating resources for its further development. Thus, permeability also improves the learning

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capacity of the firm: by being opened to the market and being tested by it, the firm acknowledges

opportunities in selling the outputs of certain activities.

If, by engaging with the market, managers realize that they have weaker capabilities, the firm

will allocate less internal resources to these activities and will preferably buy those services from

the market. If the activity is overvalued, then the firm will allocate more resources for its

development and it will sell its outputs to the market, besides transferring them downstream

through the firm. This is what Jacobides {, 2005 #1084} describes as “having the market as a

safety valve”, which can almost serve as a “natural selection” mechanism for the firms activities,

fitting their capabilities with market opportunities.

However, there may be limits to permeability. As we observed in Sampaio and Investvar,

certain activities became semi-permeable, despite being permeable earlier. This is the case for

the design activities in both firms. Hence, what could justify such behavior? To what extent is it

worth for an activity to be permeable? To answer this question, we must look at two factors:

first, while the design activity was input-permeable to the market, the design capabilities became

increasingly valuable in comparison with the market offer. Thus, it became such a strategic asset,

that the transaction costs (Williamson, 2000) associated with the external purchase of this input

became too high, leading to the decision of ceasing the input acquisition. Also, we must look at

the ease of competitive imitation regarding such an asset (Birkinshaw, 2001). By purchasing the

design externally, there is a risk with this asset being transparent and more easily codified,

because competitors can obtain design from the same source. As the risk of imitation becomes

too high, firms will move to fully integrate that activity, therefore stopping its external

purchasing.

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In summary, contrasting to a strong, tightly-coupled vertical value system that is as strong as

its weakest link, an activity system, permeable to the market possesses a greater capacity of

adjustment to its supply and demand variations. Such system can become stronger than the

average of its capabilities, if it allows a differential growth in specific activities of the value

system. However, such a growth can only be realized if there is a modularization of the firms’

activities to allow for differential growth.

Modularity

The third element for an effective architecture of boundaries is modularity in activity

clusters. We have argued that scope expansion together with permeability enable firms to assess

their levels of competence relative to the market in different activity areas and also gain

awareness about market opportunities. This leads to improvements in the resource allocation

process through which firms will grow internally areas where they have comparative advantage

and rely on the market to supply the other activities. However this growth process will be

difficult to implement if there is a tight coupling between the different activity areas. Our data

suggest that an increasing modularity in activity clusters is important to fully take advantage of

scope expansion and permeability of boundaries. In fact, both J. Sampaio and Investvar were in

the process of modularizing their activity system. This modularization process consisted in

creating more autonomous units which became profit centers, and developing interfaces for the

transaction that were common across internal and external clients (and suppliers). These units

could lead to separate legal entities or co-exist within the same ownership structure.

In the case of J.Sampaio, the modularity was still incipient, perhaps due to their smaller scale

of operations {Puranam, 2005 #1128}. In fact the company has recently set up an autonomous

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unit that included creative design, technical modeling and a small production unit for samples

sample production equipment in order to grow the sales of new shoe collections to outside clients

who would then brand, manufacture and retail them. In order to further this modularization, the

company planned to set up a separate legal entity whenever the size of the market allowed it. In

addition, the company kept the productive activities as a separate unit that could either serve its

own branded collection or serve outside clients in the private label business.

Contributions to the Strategic Organization of Firms

The architecture of organizational boundaries is defined by the scope and permeability of a

firm’s activities in the context of the value system of the market. To the extent that we are

focusing on single business firms, this concept is consistent with the concept of vertical

architecture suggested by Jacobides and Billinger {Jacobides, 2006 #1124}. In addition, to the

extent that this architecture of boundaries explains how a firm is connected with partners to

create and appropriate value, it may be a representation of its business model {Amit, 2001

#1126}. A business model depicts the design of the content, structure, and governance of a

firm’s activities enabling the creation and appropriation of value through the exploitation of

business opportunities. We propose that a firm's business model has a direct impact on the

architecture of the firm boundaries and is an important locus of innovation and value creation

Innovation by itself is not relevant unless related to a transformation of the boundaries

architecture.

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CONCLUSION