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Exploring the Performance Impact of High Performance Work Systems in Professional Service Firms: A practices-Resources-Uses Approach
In the present study, we develop a practices-resources-uses approach to systematically explain the indirect effect of high performance work systems (HPWS) on firm performance in professional service context. We argue that HPWS result in the creation of human capital, social capital and organizational capital resources. These resources in turn create value for firms when they are effectively explored and exploited. Our analysis of the indirect impact of HPWS on firm performance contributes to the understanding of how and why HPWS affect firm performance by identifying valuable resources and finding out the way to effectively use them in professional service firms (PSFs). We also provide theoretical support for the arguments of the resource-based view of firm (Barney, 1991), the knowledge-based theory of firm (Grant, 1996a, 1996b) and the dynamic capabilities (Teece, Pisano & Shuen, 1997) perspectives.
High Performance Work System; Professional Service Firms; Resource-Based View of Firm
Researchers on strategic human resource management (SHRM) argue for a focus on the bundle of HR practices rather than individual practices, as a primary unit of analysis when examining the impact of HR systems on individual and organizational performance (Huselid, 1995; MacDuffie, 1995). For example, high performance work systems (HPWS) (Datta, Guthrie, & Wright, 2005) have been found to positively relate to firms’ outcomes especially in manufacturing firms, such as financial performance (Guthrie, 2001; Huselid, 1995), employee turnover (Richard & Johnson, 2001), firm productivity (Guthrie, 2001), efficiency and flexibility (Evans & Davis, 2005), and organizational commitment (Youndt, Snell, Dean Jr, & Lepak, 1996).
However, the relationship between HPWS and firm performance is indirect and many scholars call for deeper and more theoretical approaches to understand how and why high performance work systems (HPWS) affect firm performance (Bowen & Ostroff, 2004; Combs, Liu, Hall, & Ketchen, 2006; Delery & Shaw, 2001), especially in service organizations (Combs et al., 2006). Based on the existing research, we argue that HPWS results in the creation of human capital (Wright, Dunford, & Snell, 2001), social capital (Leana & Van Buren III, 1999) and organizational capital resources (Koch & McGrath, 1996). Only when these resources are effectively managed and utilized, firms can generate superior profit above that which returns to competitors in perfectly competitive environment (Schultz, 1961), achieve sustainable competitive advantage and create value (Barney & Arikan, 2001; Sirmon, Hitt, & Ireland, 2007). The causal chain between resource endowment and firm performance is unclear and is in need of theoretical explication and empirical investigation (Leana & Van Buren III, 1999). Thus, we pursue two research questions: (1) How do HPWS affect firm performance in the professional services context? (2) What are valuable resources and how are they utilized by firms?
Guided by the contingency theory, the resource-based view of the firm (RBV) (Barney, 1991), the knowledge-based theory (Anand, Gardner, & Morris, 2007; Grant, 1996a, 1996b; Teece, 2003; Winch & Schneider, 1993) and dynamic capabilities theory (Teece et al., 1997; Eisenhardt & Martin, 2000), we propose a ‘practices-resources-uses’ performance approach to add insight to our understanding of the value creation-exploitation process in the professional service firm (PSF).
The paper is structured as follows. First, we briefly introduce the literature on PSFs and explain why we chose these organisations to conduct our research. We then propose a model that highlights how HPWS affect firm performance. We argue that HPWS affect firm performance through two steps. First, HPWS create firm resources, i.e., human capital, social capital, and organizational capital. And then these resources are exploited to improve firm performance in the short run or are explored to improve firm performance in the longer run.
Within the HPWS and firm performance relationship research, our model draws on the “practices-resources-uses” perspective, and provides important theoretical foundations for understanding how and why HR practices affect firm performance. We then discuss the further implications of the study for practitioners and explore the potential areas for future research.
Professional Service Firms (PSFs) are those whose primary assets are a highly educated (professional) workforce and whose outputs are intangible services encoded with complex knowledge (Greenwood, Li, Prakash, & Deephouse, 2005). Examples of professional services include accounting, engineering consulting, management consulting and legal services (De Brentani & Ragot, 1996). PSFs are knowledge-intensive (Morris, 2001; von Nordenflycht, 2007, 2010) with knowledge encoded in services as outputs (Empson, 2007; Morris & Empson, 1998; von Nordenflycht, 2007, 2010). PSFs are different from traditional firms. They primarily exploit intangible assets to produce customized solution for clients (Greenwood et al., 2005; Hitt, Shimizu, Uhlenbruck, & Bierman, 2006; Løwendahl, 2005; von Nordenflycht, 2007, 2010). Their human resources constitute the critical asset of the PSFs because they embody expertise and create firm-specific knowledge which can be translated into client solutions. Indeed clients may often follow professionals if they change firms (Groysberg & Lee, 2009). Because PSFs differ from other firms, to apply theories from other forms of organizations is “not only inapplicable … but may be dangerously wrong” (Maister, 1993: xvi). Our analysis will represent a good site to examine SHRM because human resources constitute the critical asset and therefore a strong test of the practices-uses-resources model – which is what we need to justify.
THERETICAL BACKGROUND AND PROPOSITONS
Strategic Human Resource Management (SHRM)
Strategic human resource management (SHRM) is defined as “the pattern of planned human resource deployments and activities intended to enable an organization to achieve its goals” (Wright, McMahan, & McWilliams, 1994: 298). Because firm performance stands out as a major organizational goal, many studies have been conducted that examine the linkage between human resources management practices and firm performance (Arthur, 1994; Becker & Gerhart, 1996; Datta et al., 2005; Delery & Doty, 1996; Guthrie, Flood, Liu, & MacCurtain, 2009; Huselid, 1995; MacDuffie, 1995; Richard & Johnson, 2001; Terpstra & Rozell, 1993; Youndt et al., 1996).
The researchers in this field argue that the bundle of HR practices rather than individual practices should be focused as a primary unit of analysis when examining the impact of HR systems on individual and organizational performance (Huselid, 1995; MacDuffie, 1995). Following the above argument, researchers have been encouraged to take a system perspective in examining the performance impact of HRM on relevant organizational outcomes (Wright & Boswell, 2002). For example, the study by Youndt et al. (1996) demonstrated that human capital-enhancing HR system was directly related to multiple dimensions of operational performance, i.e., employee productivity, machine efficiency, and customer alignment; the results of Collins and Clark (2003) indicates that the network-building HR practices positively related to the organizational performance, i.e., growth in sales and stock return; the research by Huselid (1995) illustrates a positive relationship between high performance work practices and organizational turnover, productivity and financial performance; the research on high performance work systems (HPWS) conducted by Datta et al. (2005), Guthrie et al. (2009) and Combs et al. (2006) finds that HPWS positively affected firm’s labour productivity, employee absenteeism and turnover. HPWS include HR practices that are designed to enhance employees’ skills, commitment, and productivity (Datta et al., 2005).
Most previous literature on the relationship between HRM practices and firm performance has looked at the direct relationship. However, many scholars agree that there are probably mediating variables through which HRM practices affect firm performance. As Wright and Gardner (2000:4) write, “One of the first issues that must be settled in the effort to understand how HR practices impact performance is to theorize the means through which this relationship occurs, in essence specifying the intervening variables between the measure of HR practices and the measure of firm performance.”
In the existing research, some scholars found human capital as one of mediators between SHRM and firm performance. Human capital refers to the stock of skills and knowledge embodied in individuals (Becker, 1964; O’Sullivan & Sheffrin, 1998). Guest (1997) argues that SHRM improve employees’ quality, i.e., skills and abilities. Snell and Dean (1992) also argue that HRM should ideally work to enhance the firm’s competitive position by creating superior human capital skills, experience and knowledge that contribute to firm economic value. Wright et al. (2001) assert that HPWS might have resulted in the creation of a high quality human capital pool that cannot be easily imitated because of time compression diseconomies (e.g., Merck’s R&D capability). Becker and Huselid (1996) state that human resource activities are thought to lead to the development of a skilled workforce and one that engages in functional behavior for the firm, thus forming a source of competitive advantage. This results in higher operating performance, which translates into increased profitability, and consequently results in higher stock prices (or market values).
There are also some scholars found that many human resource management practices have a significant role to play in creating social capital. Social capital is a resource which is embedded in the relationship among individuals (Loury, 1977; Coleman, 1988, 1990; Bourdieu; 1985; Burt, 1992; Putnam, 1993; Nahapiet & Ghoshal, 1998; Lin, 2001). For example, Wright et al. (2001) argue that HPWS may promote and maintain socially complex relationships characterized by trust, knowledge sharing, and teamwork (e.g., Southwest Airlines’ unique culture). Youndt, Subramaniam and Snell (2004) state that thoughtful selection of people who ‘fit’ with the organization’s culture, or intensive training programmes that not only socialize incoming employees but also indoctrinate common values among existing employees, may have a strong impact on the social capital of organizations. Leana and van Buren III (1999) introduce the construct of organizational social capital and develop a model that describes its components and consequences. They suggest that employment practices strongly affect the level of organizational social capital within a firm. They also describe the potential benefits and costs of organizational social capital for the firm and noted the contingent nature of organizational social capital’s relationship with performance. In other words, organizational social capital mediates the HR practices and organizational performance relationship. Evans and Davis (2005) provide a theoretical framework illustrating how the internal social structure of the organization can mediate the relationship between HPWS and organizational performance.
The third mediator between SHRM and firm performance is found as organizational capital. Subramaniam and Youndt (2005) and Youndt et al. (2004) define organizational capital as the institutionalized knowledge and codified experience residing within and utilized through databases, patents, manuals, structures, systems, and processes. Wright et al. (2001) argue that HPWS might play a role in creating cultures or mindsets that enable the maintenance of unique competencies. They mention that HR is not limited to its direct effects on employee skills and behavior. HR’s effects are more encompassing in that they help weave those skills and behaviors within the broader fabric of organizational processes, systems and, ultimately, competencies. Other strategists who embrace the RBV point out that competitive advantage (vis core competence) comes from aligning skills, motives, and so forth with organizational systems, structures, and processes that achieve capabilities at the organizational level (Hamel & Prahalad, 1994; Peteraf, 1993; Teece et al., 1997). Koch and McGrath (1996) take a similar logic in their study of the relationship between HR planning, recruitment, and staffing practices and labor productivity. They argue that “… a highly productive workforce is likely to have attributes that make it a particularly valuable strategic asset,” (p. 335). They suggest firms that develop effective routines for acquiring human assets develop a stock of talent that cannot be easily imitated.
The human capital, social capital and organizational capital are defined as three components of intellectual capital. One systematic research conducted by Youndt et al. (2004) find that a relatively small group of superior performing organizations exhibit high levels of human, social, and organizational capital. Most firms, however, tend to focus primarily on only one form of intellectual capital, and a small group of underperforming organizations have very low levels of all three types of intellectual capital. Another research by Subramaniam and Youndt (2005) suggest that an organization’s efforts at hiring, training, work design, and other human resource management activities may need to focus not only on shoring up their employees’ functional or specific technological skills/expertise, but also on developing their abilities to network, collaborate, and share information and knowledge.
To summarize, although the relationship between SHRM and firm performance has been found positive, it is indirect. Efficient SHRM could improve employees’ knowledge, skills, strength the relationships between employees, and also create superior databases, processes and then help firms achieve higher performance. In the following section, we analyse how HPWS create firm resources in PSFs.
HPWS and Firm Resources
There is a positive relationship between HPWS and firm performance. But how HPWS affect firm performance remains to be understood.
The resource-based view of firm (RBV) argues that a firm’s competitive advantages lie primarily on the application of valuable resources, skills and capabilities that the firm already control (Barney, 1991; Penrose, 1959; Wernerfelt, 1984).
The knowledge based theory of firm (Grant, 1996a, 1996b) considers knowledge as the most strategically significant resource of the firm. This knowledge is embedded and carried through multiple entities including individuals, relationships and organizational culture, identity, routines, documents, systems.
Guided by the resource-based view of firm (Barney, 1991) and the knowledge-based theory of firm (Grant, 1996a, 1996b), we argue that HPWS affect firm performance by creating valuable, rare, imperfectly imitable, and non-substitutable resources (Barney, 1991), i.e., human capital, social capital, and organizational capital. And these resources can also be understood as the places where knowledge is embedded.
Human capital. In PSFs, the human capital is defined as the knowledge and skills of their professionals that can be used to produce high quality professional services (Hitt, Bierman, Shimizu, & Kochhar, 2001; Hitt et al., 2006; Pennings, Lee, & Van Witteloostuijn, 1998). Human capital plays a strong role as the PSF’s key resource in solving client problems (Morris & Snell, 2008). Professionals possessing large amounts of experience, education, and training should be able to effectively create ideas on their own in response to the complexities of unique client needs. Their localized experience helps them to understand the needs of local clients and markets, which allows them to develop solutions that are unique to each contextual environment and hence heterogeneous across the firm. Professionals who draw the most upon human capital tend to rely on the experimentation, inspiration, and experience of individuals to solve a problem (Morris & Snell, 2008). To build high human capital, PSFs need to identify, attract and retain superior professionals, which can be achieved through HR practices such as selection, recruitment and training. HRM should ideally work to enhance the firm’s competitive position by creating superior human capital skills, experience and knowledge that contribute to firm economic value (Guest, 1997).
Thus we propose that HPWS result in the creation of a high quality human capital pool that cannot be easily imitated because of time compression diseconomies, e.g., Merck’s R&D capability (Wright et al., 2001). For example, the professionals in PSFs gain explicit knowledge through their formal education and tacit knowledge through learning on the job. HR practices are thought to lead to the development of a skilled workforce and one that results in functional behavior for the firm, thus potentially forming a source of competitive advantage (Becker & Huselid, 1998). These arguments lead to the following proposition.
The PSF’s human capital mediates the relationship between HPWS and firm performance.
Although human capital has many positive benefits, it represents costs to firms as well. For example, PSFs usually try to recruit the best graduates from top institutions. To attract them, firms need to provide compensation which is more than their marginal productivity early in their careers (Hitt et al., 2001). Furthermore, professionals’ new skills must be developed since they gain tacit knowledge through learning on the job (Bierman & Gely, 1994). Although they are learning new skills, they may be less effective at the beginning. The cost for them may exceed their capital (Hitt et al., 2001). These arguments lead to the following proposition.
There is a curvilinear relationship between the PSF’s human capital and firm performance. The relationship is negative early in the professionals’ tenure but becomes positive.
Social capital. Social capital is a resource which is embedded in the relationships among individuals (Loury, 1977; Coleman, 1988; Bourdieu; 1985; Burt, 1992; Putnam, 1993; Nahapiet & Ghoshal, 1998; Lin, 2001). It is different from human capital. Social capital is embedded within, available through, and derived from the network of relationships possessed by an individual or social unit (Nahapiet & Ghoshal, 1998) while human capital is embedded in individual’s head (Becker, 1964; O’Sullivan & Sheffrin, 2003).
Social capital plays an important role in PSFs. The firm’s ability to attract and retain clients depends not only on its competence to provide high quality services produced by the professionals’ human capital but also on their connections to potential clients (Maister, 1993; Smigel, 1969).
Pennings et al. (1998) analysed firm-level and individual-level social capital in PSFs. The firm-level social capital can help PSFs attract potential clients because the potential clients will choose a firm as a service provider on the basis of previous interpersonal relationship with the firm’s professionals when other things are equal. Within PSFs, the fact is that a set of clients are handled or looked after by an individual professional who is the key person. Their results show that social capital of owners (partners) contributed more to firm survival than those of employees (associates). Pennings et al. (1998)’s study produced major evidence for the contention that a firm’s human and social capital have important implications for performance.
The service delivered by PSFs suffers from an “opaque quality” because of PSFs’ knowledge intensity (von Nordenflycht, 2010). This refers to situations where the quality of an expert’s output is hard for non-experts (i.e., customers) to evaluate, even after the output is produced and delivered (Broschak, 2004; Empson, 2001; Levin & Tadelis, 2005; Løwendahl, 2000; cited in von Nordenflycht, 2010). In this situation, personal relationships and ambiguity reduction through personal contact take on extra significance. As clients and customers often have problems estimating the value of the product/service offered, establishing close social links between the PSFs and the customer/ client becomes vital (Alvesson, 2001). Other things equal, the potential clients will choose a firm as a service provider on the basis of previous interpersonal relationship with the firm’s professionals (Pennings et al., 1998). In addition, PSFs typically make investments in relationships with clients and make efforts to generate social attachment (Fichman & Levinthal, 1991).
Some research also demonstrates that social capital mediates the HR practices and firm performance relationship. For example, Youndt et al. (2004) state that thoughtful selection of people who ‘fit’ with the organization’s culture, or intensive training programmes that not only socialize incoming employees but also indoctrinate common values among existing employees, may have a strong impact on the social capital of organizations. Collins and Smith (2006)’s found that commitment-based HR practices were indirectly related to firm financial performance through their effects on organizational social climate and knowledge exchange and combination; Thus, HPWS improve the internal social structure within organizations, that facilitates communication and cooperation among employees (Evans & Davis, 2005) which in turn has been found to be linked to organizational performance. These arguments lead to the following proposition.
The PSF’s social capital mediates the relationship between HPWS and firm performance.
Organizational capital. Organizational capital is defined as the institutionalized knowledge and codified experience residing within an organization and utilized through databases, patents, manuals, structures, systems, and processes (Youndt et al., 2004; Subramaniam & Youndt 2005). The organizational routines and processes which embody organizational knowledge are a source of organizational competitive advantage (Teece, 2000)
In PSFs, organizational process of the typical professional service firm (PSF) is highly institutionalized because of the knowledge-based nature of the work and ultimately, in the historical evolution of relatively autonomous professions (Freidson, 1986; Greenwood, Hinings, & Brown, 1990; cited in Morris, Gardner, & Anand, 2007). The organizational routine of PSF is informal work understandings and practices built up by colleagues as they collaborate over time, like an accumulated short hand of work (Morris, 2000: 822). Morris and Snell (2008) emphasize the importance of organizational capital for PSFs. They state that organizations tend to draw on organizational capital for many aspects of learning, including knowledge creation, sharing, and integration, but this resource may provide more value for specific types of learning. Based on the basis of previous literature and their own experience with PSFs, organizational capital is most likely to create more value when individuals in the organization are trying to integrate knowledge. In terms of integration, then, organizational capital helps to create value through the implementation and reuse of knowledge across affiliates, which allows professionals to deliver solutions more efficiently to clients.
Besides facilitating knowledge integration, organizational capital also shapes professionals’ image and identity (Empson, 2001) which plays an important role in attracting new clients.
Many scholars have found that SHRM improve organizational capital. For example, Wright et al. (2001) argued that HPWS might play a role in creating cultures or mindsets that enable the maintenance of unique competencies (e.g., the safety record of DuPont). The HR is not limited to its direct effects on employee skills and behavior. HR’s effects are more encompassing in that they help weave those skills and behaviors within the broader fabric of organizational processes, systems and, ultimately, competencies. Other strategists who embrace the RBV point out that competitive advantage (vis core competence) comes from aligning skills, motives, and so forth with organizational systems, structures, and processes that achieve capabilities at the organizational level (Hamel & Prahalad, 1994; Peteraf, 1993; Teece et al., 1997). Koch and McGrath (1996) took a similar logic in their study of the relationship between HR planning, recruitment, and staffing practices and labor productivity. They argued that “… a highly productive workforce is likely to have attributes that make it a particularly valuable strategic asset,” (p. 335). They suggested that firms which developed effective routines for acquiring human assets develop a stock of talent that cannot be easily imitated. They also found that these HR practices were related to labor productivity in a sample of business units, and that this relationship was stronger in capital intensive organizations. These arguments lead to the following proposition.
The PSF’s organizational capital mediates the relationship between HPWS and firm performance.
The Uses of Firm Resources
The resource-based view of firm (RBV) and knowledge-based theory of firm contribute to identifying the existing resources that have the potential to constitute a source of sustainable competitive advantage (Hitt et al., 2006). However, merely possessing such resources does not guarantee the development of competitive advantages or the creation of value (Barney & Arikan, 2001; Priem & Butler, 2001; cited in Sirmon et al., 2007). These valuable resources must be effectively managed and utilized to achieve superior profit (Schultz, 1961) and a competitive advantage (Barney & Arikan, 2001; Sirmon et al., 2007).
The emphasis on the use of resources is consistent with the dynamic capabilities perspective (Teece et al., 1997) which includes considerations such as how resources are developed, how they are integrated within the firm and how they are released.
Using these resources is the same as using the knowledge which is embedded in the individuals, the relationships and the organizational processes, routines, databases, and systems. There are two streams or approaches of research on using these knowledge or resources (Hargadon & Fanelli, 2002). One focuses on how to reuse or replicate existing knowledge, i.e., exploitation (Levitt & March, 1988). The other one focuses on how to generate new knowledge, i.e., exploration (March, 1991; Kogut & Zander, 1992). The effective use of resources may help a PSF balance the effective exploitation of existing resources with exploration of knowledge to create new capabilities. The following matrix shows how PSFs create value by exploiting and exploring existing resources.
The matrix shows that the exploration of resources in PSFs is to deliver new products or service to new clients and to deliver new products or service to old clients. It also shows that the exploitation of resources in PSFs is to deliver existing services or products to the existing clients or new clients as there is no new knowledge/capability required. The exploration process needs to explore the human capital to invent new products or services and the social capital to attract new clients and new business and the organic organizational capital (Kang & Snell, 2009) that facilitate this delivery. The exploitation process needs to reuse or refine the existing products or services and existing clients, which requires the standardized organizational capital (Kang & Snell, 2009) to facilitate this delivery.
To illustrate exploration and exploitation more detail, four capabilities of PSFs are identified to effectively exploit existing resources with exploration of knowledge to create new capabilities. They are managing teams, leveraging knowledge, combining and exchanging knowledge, and sensing the changes in the external environment capabilities.
Managing teams. In professional service firms, most of work is project or program-oriented, serving the needs of the external customers. It requires several professionals work together, and frequently involves client contact, often through co-location at a client’s place of business. Then team forms the basic unit of work in the professional service firm. Generally, a team consists of partners and associates.
The dynamic global economic environment accelerates PSFs’ work speed. Usually the customers’ assignments are much more compressed in term of time (Morris, Gardner, & Anand, 2007). Therefore, to successful serving clients, the team management is vital. Teece (2003) provides a lot emphasis on the coordinating tasks, managing conflict, communicating and cooperating within the team in team management.
As with the traditional firm, coordination must be achieved, and conflict must be managed. In the professional services context, raw conflict can lead to mass defections and the destruction of enterprise value, even more assuredly than in an industrial company setting. So conflict management is likely to be especially significant with an expert services context because experts are likely to not only have strong preferences, but are also likely to be self-confident, possibly egotistical, and possibly lacking in good business sense while already having some degree of established financial success (Teece, 2003: 897). The most critical communication in a professional service context is frequently peer-to-peer. Partners (senior talent) frequently need to access other senior talent in order to meet client needs (Teece, 2003: 903).
Leveraging knowledge. Leveraging knowledge, that is the transfer of know-how from seniors to juniors in client assignments, sustains the basic division of labor in the professional firm and also underpins its profitability (Hitt et al., 2001; Malos & Campion, 2000).
All professional firms compete by leveraging knowledge and partners’ reputation (Greenwood et al., 2005). In PSFs, partners own the most human capital and social capital in a firm. To meet clients’ demands, partners need to select other professionals to form a team to possess the appropriate skills, experience and training. In this way, the partners’ knowledge and capabilities are leveraged. Meanwhile, the junior professionals, or associates also acquire intangible knowledge during the long apprenticeship they serve with their senior colleagues before being assessed for a partnership position.
Leverage ratios are measured by total number of associates divided by the total number of partners (Hitt, et al., 2001; Phillips, 2001). High leverage ratios are commensurate with highly codified knowledge packages and standardized tools and methodologies which can routinely be applied by junior associates. Lower leverage is associated with experience or expertise models in which knowledge is less routinized and the firm seeks more complex projects in which there is a premium on the experience or special expertise of more senior staff (Maister 1993; Hansen, Nohria, & Tierney, 1999).
Effective leveraging creates dynamic capabilities whereby the firm is able to renew, augment, and adapt its current capabilities to serve continuously changing and new client needs (Teece et al.. 1997; Tripsas, 1997; cited in Hitt et al., 2001). Hitt et al. (2001) also find the empirical support for the positive relationship between leveraging and firm performance in professional service context.
Combining and exchanging knowledge capability
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