Vertical Integration, Innovation, and

Strategic Management Journal
Strat. Mgmt. J., 34: 10421064 (2013)

Published online EarlyView 4 June 2013 in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2045
Received 14 January 2011; Final revision received 19 January 2012
VERTICAL INTEGRATION, INNOVATION, AND
ALLIANCE PORTFOLIO SIZE: IMPLICATIONS FOR
FIRM PERFORMANCE
NANDINI LAHIRI
1
*
and SRIRAM NARAYANAN
2
1
Fox School of Business, Temple University, Philadelphia, U.S.A.
2
Eli Broad College of Business, Michigan State University, East Lansing, Michigan,
U.S.A.
We examine the consequences of alliance portfolio conguration by focusing on contingencies
that affect the impact of alliance portfolio size on innovation and nancial performance. While
increasing alliance portfolio size is expected to positively impact innovation and nancial
performance, we propose that, at high levels of innovation of the focal rm, increasing alliance
portfolio size dampens nancial performance. We also propose that rm boundaries moderate the
impact of alliance portfolio size on innovation and nancial performance differently. Specically,
vertically integrated rms benet less (more) than their vertically specialized counterparts in
leveraging higher innovation (nancial) performance with increasing alliance portfolio size. Our
analysis suggests that both vertical scope and innovation levels of the rm play an important role
in understanding how alliance portfolios impact performance. Copyright 2013 John Wiley
& Sons, Ltd.
INTRODUCTION
Competition among rms increasingly depends
on whether rms can create and utilize knowl-
edge in a timely and cost-efcient manner. This
is particularly true for industries that are charac-
terized by rapid technological development, short
product life cycles, and increasing capital expen-
diture. Hence, rms are increasingly relying on
alliances as strategic resources to gain capabilities
necessary for organizational success (Eisenhardt
and Schoonhoven, 1996; Harrigan, 1984; Zollo,
Reuer, and Singh, 2002). Alliances enable rms
Keywords: alliance portfolio; manufacturing alliances;
vertical integration; nancial performance; innovation
performance
*Correspondence to: Nandini Lahiri, Fox School of Business,
Temple University, 1801 Liacouras Walk, Philadelphia, PA
19122, U.S.A. E-mail: nlahiri@temple.edu
Copyright 2013 John Wiley & Sons, Ltd.
to access complementary assets and/or capabili-
ties that are required to create, store, and com-
mercialize knowledge to generate new products
(Rothaermel, Hitt, and Jobe, 2006). As a result, in
many industries, the number of alliances that rms
engage in has signicantly increased in the 1990s
and beyond (Kale and Singh, 2009; Lavie, 2007).
Firms management of multiple alliances simul-
taneously has been referred to in the literature
as alliance portfolio management (Kale and
Singh, 2009). Prior work asserts that alliances
are an important source of competitive advantage
for rms and serve as resources that may not
be easily imitated by others (Eisenhardt and
Schoonhoven, 1996). Alliance portfolio resources
can be exploited by rms in multiple ways. First,
increasing portfolio size increases the number of
alliances from which rms can draw resources.
External knowledge gained from alliances
can, in turn, be applied to improve innovation
Vertical Integration, Innovation and Alliance Portfolio Size 1043
performance (Hoffmann, 2007). Second, with
a portfolio of alliances, rms learn to attribute
outcomes to changes in inputs and processes
(Sampson, 2007), allowing better identication
of cause and effect. Third, engaging in a larger
portfolio of alliances enables rms to learn and
utilize diverse knowledge from partners better
over time (Deeds, Decarolis, and Coombs, 2000;
Grant, 1996). Finally, rms with larger alliance
portfolios are likely to see greater survival rates
of their alliances (ranging from 40 to 60 percent)
(Kale, Dyer, and Singh, 2002; Sampson, 2007).
Prior research on exploiting alliance portfolio
resources can be divided into three categories: (1)
alliance portfolio size (e.g., Ahuja, 2000; Deeds
and Hill, 1999; Hoffmann, 2007); (2) alliance
portfolio characteristics such as breadth, density,
level of redundancy (e.g., Ahuja, 2000; Gulati,
1998; Hoffmann, 2007), and strength of individual
alliances in a portfolio (Hoffmann, 2007; Rowley,
Behrens, and Krackhardt, 2000); and, nally, (3)
characteristics of partners in the alliance portfolio
(Lavie, 2007; Lavie, Kang, and Rosenkopf, 2011;
Stuart, 2000; Vasudeva and Anand, 2011).
In contrast to research at the level of an
individual alliance, research in alliance portfolios
is recent (Wassmer, 2008). Firms with similar
alliance portfolio size (hereinafter referred to as
APS) often experience considerable heterogeneity
in their performance outcomes (Lavie, 2007). Such
heterogeneity in performance can be attributed
to two factors. First, and one that has received
relatively greater attention in the literature, is
heterogeneity of resources that partner rms in the
alliance portfolio bring to the table, such as scope
of portfolio resources (Ahuja, 2000; Gulati, 1998;
Vasudeva and Anand, 2011), efciency (Baum,
Calabrese, and Silverman, 2000), and alliance
partner quality (Stuart, 2000). Second, and one that
has received limited attention in the literature, is
heterogeneity in focal rm capabilities to derive
benets from the alliance portfolio.
In the context of alliance portfolios, heterogene-
ity in rm capabilities to derive benets from
alliances is particularly important. From the focal
rms perspective, while individual alliances are
means to achieve specic objectives, or priorities,
the alliance portfolio conguration is often formu-
lated keeping broader rm strategy in mind (Duys-
ters, Man, and Wildeman, 1999; Wassmer, 2008).
An implicit assumption that drives prior research
is that alliance portfolio conguration is consistent
with key strategic priorities of the rm as they rein-
force each other in improving performance. In our
paper, we relax this assumption.
Strategic priorities manifest themselves in the
key choices and decisions that the rm makes. In
conceiving the rm as a bundle of choices, we
identify two important contingencies to improve
our understanding of how APS impacts the focal
rms performance. First is the focal rms choice
to vertically integrate or not (Teece and Pisano,
1994). Second is the choice to invest resources
in innovation that manifest in high levels of
innovation performance (OBrien, 2003). Both of
these choices are interrelated (Armour and Teece,
1980), more so in high technology industries,
which is the empirical context of our research.
The interrelated nature of vertical integration
and innovation makes these choices appropriate
for this study. By emphasizing these boundary
conditions, we contribute to the literature in the
following ways.
First, while nancial performance is a key
metric for the rm, in high clock speed indus-
tries, a rms response to rapid technological
change is a critical element of competition (Nad-
karni and Narayanan, 2007). In such industries,
innovation is an important strategic priority
(Teece and Pisano, 1994) and drives nancial
performance. Specically, when rms engage
in a portfolio of alliances, current innovation
capabilities of rms may have an important
bearing on their ability to exploit knowledge from
partners in order to improve nancial perfor-
mance. However, the nature of this impact is less
understood.
Second, an important theme in the alliance port-
folio research has been the scope and diversity
of resources that partners in the alliance portfo-
lio bring to the table. The focal rms ability to
utilize the diversity of knowledge that increasing
APS brings with it depends on the internal knowl-
edge resources of the rm (Cohen and Levinthal,
1990; Vasudeva and Anand, 2011). Vertically inte-
grated (hereinafter referred to as VI) rms, due
to technical dialog between upstream and down-
stream units, are more likely to have internal
access to a broader knowledge base of rm-specic
knowledge than vertically specialized (hereinafter
referred to as VS) rms (Monteverde, 1995; Teece,
1994; Teece et al ., 1994). Therefore, vertical inte-
gration is viewed as an important strategic priority
in the literature to exploit rm-specic knowledge
Copyright 2013 John Wiley & Sons, Ltd. Strat. Mgmt. J., 34: 10421064 (2013)
DOI: 10.1002/smj
1044 N. Lahiri and S. Narayanan
(e.g., Armour and Teece, 1980; Wernerfelt, 1984).
Recent work also suggests that VI rms engage
in a portfolio of alliances in activities that they
pursue in-house (e.g., Harrigan, 1984; Rothaer-
mel et al ., 2006). Accordingly, vertical scope is
an important choice that determines the extent to
which focal rms benet from alliance portfo-
lio conguration in both innovation and nancial
performance. However, current literature offers
limited understanding of how VI rms differ
from VS rms in their ability to utilize alliance
portfolios to increase innovation and nancial
performance.
Third, much of the prior work on the impact of
APS focuses on innovation performance as an out-
come. In comparison, relatively little attention has
been paid to a rms nancial performance (Lavie,
2007). Moreover, the existing evidence of the
impact of APS on nancial performance is mixed
(Lavie, 2007). Research indicates that partner-
specic experience may have limited inuence in
driving economic performance of the focal rm
(Goerzen, 2007; Hoang and Rothaermel, 2005).
For example, on one hand, Goerzen (2007) nds
that repeated equity-based partnerships result in
inferior economic performance for the focal rm.
Similarly, Hoang and Rothaermel (2005) nd a
diminishing effect of rms alliance experience
on R&D project performance. On the other hand,
prior studies that have identied rms ability to
manage alliance portfolios, and the relevant experi-
ence that alliance portfolios bring as a predictor of
alliance performance, have revealed mixed or lim-
ited empirical support (Anand and Khanna, 2000;
Merchant and Schendel, 2000). Anand and Khanna
(2000) nd signicant learning effects for focal
rms but only in managing a large number of
alliances of certain types, such as R&D alliances
and joint ventures. Our research contributes to the
understanding of the impact of APS by focusing
on boundary conditions.
Finally, the importance of our research needs to
be evaluated in the context of trade-offs that rms
face in using a portfolio of alliances as means to
gain capabilities. On one hand, engaging simul-
taneously in multiple alliances helps rms remain
exible in response to changes in technology,
demand uncertainty, and reducing product-market
cycle times by accessing partner capabilities
(DAveni and Ilinitch, 1992; Harrigan, 1984). On
the other hand, engaging in multiple alliances
simultaneously may also result in the depreciation
of existing capabilities and the failure to seize new
opportunities, leading to a drop in rm perfor-
mance (Bettis, Bradley, and Hamel, 1992; Quinn
and Hilmer, 1994). These have implications for
rms aspiring to utilize their internal knowledge
in combination with external knowledge from
multiple alliance partners to improve performance.
Our research attempts to investigate these trade-
offs by examining the contingencies that underpin
the impact of APS on innovation performance
and nancial performance of the focal rm.
1
We test our hypotheses using an unbalanced
panel of 282 publicly traded semiconductor rms
between 1991 and 2002. Our data comes from
multiple sources, including (1) SDC Thomson,
(2) Compustat and Global Vantage, (3) rm
boundary data collected from the semiconductor
industry association databases, and (4) patent data
from the United States Patents and Trademarks
Ofce (USPTO). Furthermore, in line with the
objective of comparing portfolios of alliances
whose activities are performed in-house by VI
rms and not by VS rms, we focus on alliances
where the scope of activity is manufacturing. In
our sample, VI rms engage in both design and
manufacturing activities in-house while VS rms
engage only in design activities in-house.
The remainder of the paper is structured as fol-
lows. In the next section, we develop theory and
hypotheses. Following, we describe our research
setting, data sources, measures, and the econo-
metric specication. We then describe the results.
Finally, we discuss the theoretical and managerial
implications of our work and conclude.
THEORY AND HYPOTHESES
We dene an alliance as any independently initi-
ated interrm link that involves exchange sharing
or codevelopment (Gulati, 1995). These include
joint ventures, R&D or production agreements,
marketing or distribution agreements, or technol-
ogy exchange. For the purpose of our analysis,
we consider only those alliances that have man-
ufacturing identied in their scope of activities.
The reasons for this are developed in detail in the
Measures section.
1
In this paper, we use the terms nancial performance and rm
performance interchangeably.
DOI: 10.1002/smj
Alliance portfolio size, innovation, and
nancial performance
In this section, we rst discuss existing research
on the relationship between innovation and nan-
cial performance of the focal rm. Next, given
prior work in this area, we formulate the base-
line hypothesis, relating APS to both innovation
performance and nancial performance. We then
hypothesize the interaction between boundary con-
ditions (levels of innovation and vertical scope)
and APS, and their impact on nancial and inno-
vation performance.
Innovation and nancial performance
Fast-paced industries are characterized by rapid
changes in product and process technologies, i.e.,
high clock speed (Fine, 1998). In such industries,
the ability to innovate is an important source of
competitive advantage for rms (Eisenhardt and
Bourgeois, 1988; Tung, 1979). Despite a broad
consensus that greater innovation leads to higher
nancial performance, empirical evidence of this
linkage is minimal (e.g., Damanpour and Evan,
1984; Damanpour, Szabat, and Evan, 1989) and is
relatively recent (Rothaermel et al ., 2006).
Alliance portfolio size and innovation
performance
Competitive advantage of a rm is determined by
its ability to exploit rm specic capabilities and to
develop new ones (Teece and Pisano, 1994; Teece,
1982; Wernerfelt, 1984). These capabilities enable
the rm to innovate. Alliances provide access to
critical complementary assets that reside outside
rm boundaries (Teece, 1982). The knowledge
elements that external partners provide allow the
focal rm to improve its innovation performance.
Drawing on Schumpeters (1934) view that inno-
vation involves combination and recombination of
existing and new resources available to the rm,
increasing APS will provide an increasing num-
ber of external knowledge elements available to
the focal rm. These external knowledge elements,
when combined with internal knowledge resources
of the rm, can have an impact on innovation
performance (Ahuja, 2000; Cohen and Levinthal,
1990). First, rms with a larger APS will have
access to a wider variety of knowledge resources
from different partners. Access to more diverse
external resources from alliance partners increases
the likelihood of being able to locate knowledge
elements, previously unknown to the rm, which
can be used in novel ways to aid problem solu-
tion. The likelihood of such instances increases
with an increase in size of the focal rms alliance
portfolio. Second, increased diversity of knowl-
edge elements from external sources increases the
opportunities for novel combinations (Ahuja and
Katila, 2001). Finally, a larger number of ongo-
ing alliances indicates higher centrality of the
focal rm in the network of industry peers, which
allows the focal rm access to greater variety in
types of information (Baum et al ., 2000; Stuart,
Hoang, and Hybels, 1999). Thus, increasing APS
is likely to enhance innovation performance of
the rm.
Simultaneously managing a large number of
alliances may, however, bring with it multi-
ple challenges for the focal rm. While part-
ners are useful for the additional resources that
focal rms can leverage (Levinthal and March,
1993), the challenges of utilizing external knowl-
edge increases with greater diversity of knowledge.
First, the challenges of search, identication, and
transfer of knowledge resources across a portfo-
lio of partners increases signicantly as the APS
increases (Duysters et al ., 1999). Second is the
importance of rms internal routines that are
required to develop products and processes (Nel-
son and Winter, 1982). Unlike working with indi-
vidual partner rms, utilizing resources across a
portfolio of partners requires rms to simultane-
ously adapt internal routines to multiple partners.
As APS increases beyond a point, it is possi-
ble that the challenge of searching for appropriate
knowledge elements that contribute to novel prob-
lem solutions becomes signicant. Specically, the
gains are offset by the challenges, and the focal
rm is less likely to depend on external resources
provided by yet another alliance partner. This
results in diminishing the impact of APS on inno-
vation performance.
Alliance portfolio size and nancial performance
Firms with larger APS are likely to experience
increased nancial performance for the follow-
ing reasons. First, rms in fast-paced industries
face increased uncertainty arising out of technol-
ogy volatility and demand uncertainty (Bourgeois
and Eisenhardt, 1988). While individual alliances
DOI: 10.1002/smj
may help overcome demand uncertainty (Gilley
and Rasheed, 2000), rms with larger alliance port-
folios cope better with environmental changes by
effectively responding to uncertainties (Dess et al .,
1995; Duysters et al ., 1999). Second, larger APS
enables the focal rm to lower costs through sev-
eral cost-effective technologies of partners (Bet-
tis et al ., 1992) and the potential for increased
economies of scale from multiple alliance partners
(Gilley and Rasheed, 2000).
As APS increases, its impact on rm perfor-
mance may be diminishing, or even negative.
This may be attributed to the following reasons.
First, rms pursue the most promising alliance
options and pursue those opportunities early
on. This leaves less productive alliance options
as rms engage in an increasing number of
alliances (Rothaermel et al ., 2006). Second, as
APS increases, the effectiveness of a managers
ability to exploit the alliances for their benet
will decrease given the increased demands on
managerial attention and bounded rationality
(Rothaermel, 2001b; Simon, 1991). Third, with
increasing APS, bureaucracy and transaction costs
of coordinating simultaneously across multiple
parties increases (Rothaermel, 2001b). Finally,
past research suggests that alliance experience has
a curvilinear impact on alliance success (Hoang
and Rothaermel, 2005). Combining our argu-
ments above on the impact of APS on nancial
performance and innovation performance, we
hypothesize the following:
Hypothesis 0: Alliance portfolio size has an
inverted U-shaped impact on both innovation
performance and nancial performance.
Alliance portfolio size, innovation and nancial
performance
Prior work suggests that innovation is character-
ized as novel problem-solving behavior that is
useful for rms (Dougherty and Hardy, 1996). Cre-
ation of knowledge involves repeated use of the
rms existing knowledge elements and increasing
the scope of search for new knowledge elements
(Katila and Ahuja, 2001). Firms that experience
success in innovation often search for problem
solutions by repeated use and/or novel combina-
tions and recombinations of existing knowledge.
They may also use knowledge from domains that
did not exist before in the particular industry
space (Ahuja and Lampert, 2001). In contrast,
rms that fall into the familiarity, maturity, and
propinquity trap are more likely to experience
low-impact innovations. Firms search for new
knowledge both within and outside their bound-
aries, i.e., their alliance partners, to solve inno-
vative problems (George et al ., 2001; Eisenhardt
and Schoonhoven, 1996). A larger portfolio of
alliances potentially enables access to higher diver-
sity of external knowledge that the focal rm
would otherwise not have access to (George et al .,
2001). However, organizations are heterogeneous
in their ability to search and integrate knowl-
edge resources from alliance partners. Drawing on
resource dependence theory (RDT) (Salancik and
Pfeffer, 1978), we propose that rms that have
higher levels of innovation gain less by increas-
ing APS in comparison to rms that have lower
levels of innovation.
The key premise of RDT is that when rm
survival hinges on critical procurement of exter-
nal resources (portfolio of alliance partners in
this context), rms may reduce uncertainty in the
ow of these needed resources by reducing their
dependency on these external resources (Casciaro
and Piskorski, 2005). Such reduction in depen-
dencies may also necessitate changes to internal
processes (Casciaro and Piskorski, 2005). In situ-
ations where rms engage in innovation through
search, transfer, combination, and recombina-
tion of knowledge resources (Ahuja and Katila,
2001; Katila and Ahuja, 2002), RDT suggests the
following:
First, rms with greater success in innovation
often engage in repeated use of their internal
knowledge. Repetition and familiarity of perform-
ing similar tasks, even with a different combina-
tion of knowledge elements, reduces search and
knowledge transfer costs (Katila and Ahuja, 2001).
While rms effort at problem solving via search-
ing for knowledge elements includes both local
and distant search (Levinthal and March, 1993),
rms tend to draw more from knowledge resources
that are similar and proximate (Rosenkopf and
Almeida, 2003). In addition, the need to bring
external knowledge at the appropriate location
for its utilization is critical (von Hippel, 1994).
Given the sticky nature of knowledge, transfer-
ring external knowledge from partners across rm
boundaries to the focal rm is costly (Hansen,
1999; von Hippel, 1994). Since resources are
more likely to be diverse in a larger portfolio of
DOI: 10.1002/smj
alliances, search and interrm knowledge transfer
costs may increase with portfolio size. Hence,
innovation-oriented rms may rely more on their
own knowledge, the use of which may be less
costly than expending effort on search and transfer
of external knowledge, the costs of which increase
with portfolio size.
Second, innovation in rms is a result of key
processes, shared languages, and routines that
organizations have established (Malerba and Ors-
enigo, 2000; Nelson and Winter, 1982). Speci-
cally, organizations that engage in high levels of
innovation then become experts in eliciting, using,
and applying knowledge to solve problems (Dyer
and Nobeoka, 2000; Nonaka and Takeuchi, 1995).
In such rms, routines and procedures could be
adapted to minimize coordination costs of innova-
tion. Engaging in increasing numbers of alliances
to leverage innovation can often require changes
to existing internal innovation routines and pro-
cesses. As organizations engage in larger numbers
of alliances, making changes may be costlier and
cause disturbances to the current set of established
routines.
Finally, for rms engaging in high-impact
innovation, search is often conducted in novel,
emerging, and pioneering technology domains. By
denition, emerging and pioneering technology
domains did not exist in the industry space or have
no precedence (Ahuja and Lampert, 2001). Engag-
ing in high-impact innovation requires signicant
resource outlay and may be riskier than engag-
ing in low-impact innovation (Sivadas and Dwyer,
2000). Further, high-impact innovation based on
external resources may require greater collabo-
ration, mutual learning, and unlearning between
partners (Nord and Tucker, 1987; Sivadas and
Dwyer, 2000), thus increasing costs for the focal
rm. Such effects are likely to be exacerbated
with increasing APS due to the need to manage
a large number of alliance partners simultaneously
(Duysters et al ., 1999). Thus, consistent with RDT,
with increasing innovation level, rms would rely
less on outside resources (Casciaro and Piskorski,
2005; Salancik and Pfeffer, 1978) to reduce search
costs. Therefore, we hypothesize:
Hypothesis 1: With increasing levels of innova-
tion, the positive impact of increasing alliance
portfolio size on nancial performance is
dampened.
Alliance portfolio size, vertical scope, and
nancial performance
The choice of vertical scope of a rm is a funda-
mental one (Williamson, 1971). Vertical integra-
tion is more likely to protect imitable resources
of the rm (Wernerfelt, 1984). In high technol-
ogy environments, the choice of vertical scope
is critical to rm protability due to high asset
specicity and the need for extensive coordination
across activities (Monteverde, 1995). With regard
to interrm collaboration, the choice to vertically
integrate allows rms to engage in activities that
are often also conducted in-house. This has been
noted in multiple studies (Parmigiani and Mitchell,
2009; Rothaermel et al ., 2006). Thus, the decisions
that VI/VS rms make can be categorized as make,
buy, or both make and buy. VI rms pursuing both
make and buy for an activity performed in-house
are said to pursue tapered strategic outsourcing
(Rothaermel et al ., 2006) or concurrent sourcing
(Parmigiani and Mitchell, 2009), while VS rms
that only buy are said to pursue quasi-strategic out-
sourcing (Rothaermel et al ., 2006). Our research
contrasts VI rms pursuing tapered strategic out-
sourcing with VS rms pursuing quasi-strategic
outsourcing.
Prior research has found that the impact of verti-
cal integration on nancial performance is positive.
For example, in the context of the airline indus-
try, vertical integration has been found to reduce
airline delay resulting in increased price yields
(Forbes and Lederman, 2010). Further, a meta-
analysis of the drivers of nancial performance
suggests a positive relationship between vertical
integration and nancial performance (Capon, Far-
ley, and Hoenig, 1990). Hence, VI rms may be
better positioned (than VS rms) to gain from
larger APS to enhance nancial performance for
the following reasons.
First, past literature in industrial organization
suggests that VI rms are more likely than VS
rms to possess higher bargaining power, higher
monitoring efciency, and lower cost in search for
suppliers by virtue of scale of operations (Stigler,
1951). As APS increases, the opportunities to
exploit bargaining power provide greater cost
savings (Porter, 1980).
Second, VI rms engage in more activities in
the overall value chain than do VS rms. For
activities that these VS rm do not engage in,
they have no option but to buy. On the other
DOI: 10.1002/smj
hand, for VI rms the alliance portfolio may
be congured to reduce cost and hedge against
market risk and demand uncertainty (Dess et al .,
1995). In particular, VI rms that have larger APS
will have greater exibility in accommodating
major changes in the external environment. This
allows them to recognize and act promptly when
it is time to pursue new courses of action on
resource commitments (Shimizu and Hitt, 2004).
Therefore, VI rms (compared to VS rms) can
benet more, as increasing APS acts as a safety
net against demand volatility to gain strategic
exibility.
Finally, in VI rms, synergies arising from
the relatedness of the upstream and downstream
businesses have a positive impact on nancial
performance by economizing on administrative,
selling, advertising, and other expenses (DAveni
and Ravenscraft, 1994). Increasing portfolio size
increases the opportunities to identify and leverage
synergies with upstream and/or downstream units
compared to that of VS rms (where, by denition,
no vertical synergies exist). Based on these
arguments, we hypothesize:
Hypothesis 2: Vertically integrated rms
(compared to vertically specialized rms) are
more likely to experience enhanced benets
of increasing alliance portfolio size on rm
performance.
Our arguments for hypotheses HI and H2 were
based on examining how innovation level and
vertical scope, two important strategic priorities
of the rm, moderate the impact of increasing
APS on nancial performance. We argued how
heterogeneity in search costs and operational
costs, drive nancial performance. The focus on
costs is appropriate given the outcome is nancial
performance. Next, we focus our attention on
the moderating inuence of vertical scope on
innovation performance. Our arguments for this
hypothesis are predicated on heterogeneity in a
rms ability to use external knowledge to arrive
at novel solutions to their problems.
Alliance portfolio size, vertical scope, and
innovation performance
Prior work suggests that VI rms, with the oppor-
tunity for technological dialog between upstream
and downstream units, are more likely to have
higher levels of innovation (Armour and Teece,
1980; Monteverde, 1995). Recent work in the
British building industry suggests that, while VS
rms build islands of knowledge, VI rms are
better able to protect their knowledge by draw-
ing from different domains (Cacciatori and Jaco-
bides, 2005). We argue that the benet for VI
rms from increasing APS is less than that
for VS rms. Building on the idea that inno-
vation results from search, transfer, combina-
tion, and recombination of knowledge elements
(Ahuja and Katila, 2001; Katila and Ahuja, 2002),
alliance portfolios may impact innovation per-
formance by (1) contributing novel knowledge
elements to the focal rm for conceptualizing
unique solutions to problems, and (2) increas-
ing diversity of knowledge elements from external
sources to increase the combinatorial possibilities
of potentially novel solutions. However, a rms
choice of vertical integration will inuence the
impact of APS on innovation performance in the
following ways.
First, for external knowledge sourced from
the alliance portfolio to be useful in problem
solving it must be novel to the focal rm. VI
rms, by virtue of their enhanced knowledge
base, arising from technological dialog between
upstream and downstream units (Monteverde,
1995), have a better understanding of the key
contextual contingencies surrounding the environ-
ment (Jacobides and Winter, 2005; Winter, 1988).
VS rms, on the other hand, possess a narrower
knowledge base by choosing not to pursue the
value chain activity. As APS increases, the range
of external knowledge available to the focal
rm increases. Since the diversity of existing
knowledge resources in VI (relative to VS) rms
is higher, the likelihood that the addition of yet
another alliance to the existing portfolio will pro-
vide novel knowledge to the rm is less likely for
VI rms.
Second, larger alliance portfolios allow
increased combinatorial possibilities to enhance
the likelihood of novel problem solutions. In
utilizing external knowledge from a wider variety
of alliance partners, the focal rm must be able to
relate the external knowledge to its own resources.
An important driver of heterogeneity in rms
utilization of external knowledge, to improve inno-
vation performance, is the ability to combine and
recombine external knowledge with the existing
DOI: 10.1002/smj
knowledge elements (Cohen and Levinthal, 1990).
Given the need to bring internal and external
knowledge together at the same location (von
Hippel, 1994), rms must conduct an internal
search to identify the appropriate internal knowl-
edge that can be combined with particular external
knowledge elements to gain the most benets. In
the context of individual alliances, it is well estab-
lished that rms face complexity in combining and
recombining knowledge from different sources
(Hoang and Rothaermel, 2010). With increasing
APS, the task becomes more complex. Thus, given
the higher diversity of knowledge base of the VI
rm, relating larger bases of external knowledge to
its own diverse knowledge base becomes particu-
larly more challenging for VI rms (relative to VS
rms). Given the challenges in combining internal
and external knowledge, the likelihood that an
additional alliance partner will increase the pos-
sibility of novel solutions to problems is less for
VI rms.
Finally, prior literature has established the
importance of resource slack to a rms success
in pursuing innovation. Search for problem solu-
tions is often driven by the availability of
slack resources (OBrien, 2003). VI rms are
more likely to expend slack resources in inter-
nal search and coordination (than VS rms)
because of the linkages between vertical units
and their broader knowledge base. Since slack
resources are limited, the more resources are used
up in internal search, the less is available to
search across external resources. Therefore, for
VI rms, searching, locating, and relating exter-
nal resources to the appropriate knowledge within
the rms own boundaries may be more challeng-
ing (Hansen, 1999), as compared to VS rms. The
larger the APS, the greater the amount of slack
resources required to search and create innova-
tive problem solutions. Based on these arguments,
we hypothesize:
Hypothesis 3. Vertically integrated rms
(compared to vertically specialized rms) are
more likely to experience reduced benets of
increasing alliance portfolio size on innovation
performance.
Overall, we summarize our hypotheses in
Figure 1.
Portfolio size
Innovation
performance
Firm
performance
Vertical
integration
H0: (+/-)
H0: (+/-)
(+)
H1: (-)
H2: (+) H3: (-)
Figure 1. Conceptual framework
METHODS AND MEASURES
Research setting
The empirical setting of our research is the semi-
conductor industry. This industry is characterized
by (1) short product life cycle, high competi-
tion, and high research and development inten-
sity (West, 2002); (2) an increase in patenting
activity since the early 1980s (Hall and Ziedo-
nis, 2001), attesting the importance of innovation
as a competitive priority; (3) a signicant shift
from vertical integration to vertical specialization
in the last 15 years (Macher, Mowery, and Minin,
2007), making both organizational forms equally
prevalent; and (4) evidence of a large number of
alliances that have manufacturing as the scope of
activity (Eisenhardt and Schoonhoven, 1996; Mon-
teverde, 1995). Manufacturing alliances are seen as
an important way to gain strategic competencies
(Macher et al ., 2007) and contribute signicantly
to innovativeness of focal rms in this industry
(Armour and Teece, 1980).
Data sources
Our sample of rms was obtained in the following
manner. First, we generated a list of all publicly
traded rms in the semiconductor industry that
identied either SIC code 3674 and/or NAICS
code 334413 as their main line of business.
However, this method of identication may result
in exclusion of rms that identied some other line
of business as their primary revenue earner, yet
were among the top semiconductor revenue earners
as indicated by Dataquest reports. To account for
these omissions, we use industry analyst reports
DOI: 10.1002/smj
to determine if SIC 3674/NAICS 334413 was a
major revenue earner, even if it was not stated
as the top one. Using this approach, we were left
with 282 rms in our sample over a time period
of 19912002.
Our primary objective was to compare VS rms
that sourced externally, as opposed to VI rms that
performed the activity in-house and also sourced
externally. Therefore, we chose manufacturing as
the scope of alliance activity in this research.
In addition, multiple additional factors make this
activity an ideal choice. First, de-integration within
the industry in the late 1990s, as noted by Macher,
Mowery, and Simcoe (2002), implies that we have
both publicly traded VI and VS rms in our sam-
ple. Second, the industry is characterized by a
high level of uncertainty surrounding fabrication.
Since the technology is not particularly well devel-
oped, problem solving efforts in fabrication often
draw from basic science (West, 2002). Thus, inno-
vation is a relevant performance metric even for
manufacturing activity. Finally, manufacturing is
a costly activity, and cost considerations signif-
icantly affect nancial performance (Macher and
Mowery, 2004).
The independent, dependent, and control vari-
ables are drawn from the following sources:
USPTO, Semiconductor Equipment and Materi-
als International (SEMI), 10-K reports, Global
Semiconductor Association (GSA), SDC database,
Compustat, and Global Vantage. Data on patenting
activity of semiconductor rms is drawn primarily
from the USPTO. Drawing only from the USPTO
data is appropriate as rms are more likely to
patent under the USPTO system, given the size
of the US market (Lim, 2004; Almeida, 1996).
Second, over half of the patents issued by the
USPTO have assignees with addresses outside the
United States, which indicates focusing on the
USPTO system might not create biases. Finally,
the effect of strong patent rights, as in the United
States, is important in determining patenting fre-
quency in the semiconductor industry (Hall and
Ziedonis, 2001). It also controls for variations in
innovation performance regimes that would oth-
erwise arise in comparing patents across different
systems.
Data on vertical integration was obtained from
a cross-sectional survey administered to all rms
in the semiconductor industry by the Global Semi-
conductor Alliance (GSA). Given the longitudinal
nature of our data, we supplemented the GSA
survey data with 10-K reports to account for
changes in rm boundaries, if any, over time.
Data on alliances was obtained from the
Thomson groups SDC Platinum database, which
provides information on alliance activity of rms
publicly traded in the United States.
Finally, data on rm level controls such as
size, R&D, and age were obtained from mul-
tiple databases such as Compustat for North
American organizations, and Global Vantage for
organizations located elsewhere. Data on prod-
uct market controls were obtained from company
annual reports and dataquest reports.
Dependent variables
Innovation performance
Patent data has been used to measure innovation
performance in the past literature and is consid-
ered a valid measure of innovation activity (Acs
and Audretsch, 1989). Patents are directly related
to innovation performance (e.g., Comanor and
Scherer, 1969; Mueller, 1966; Pakes and Griliches,
1984) and represent an externally validated mea-
sure of technological novelty (Griliches, 1990).
Patenting is an effective tool for appropriating
value, particularly in the semiconductor industry
(Hall and Ziedonis, 2001). To construct the patent
data, for each rm in the sample a list of all divi-
sions, subsidiaries, and joint ventures was prepared
using the Who Owns Whom database. Each rms
history was traced for the period of data in question
from trade journals, rm annual reports, the SDC
database, directory of corporate afliations, and
internet sources to account for any name and divi-
sion changes, divestments, acquisitions, and joint
ventures that may have been omitted by the Who
Owns Whom database. Following this, the patent
count was computed for each rm-year by assign-
ing all patents issued solely to the rm or all of its
subsidiaries.
Using number of patents as a direct measure of
the rms innovation performance assumes that all
innovations are equal. Hence, we use a weighted
measure of innovation that assigns an impact
factor to each patent in the rms portfolio of
granted patents for each year. Our measure of a
patents impact is the number of forward citations
that the focal rms patent receives from other
patents (Argyres and Silverman, 2004; Henderson,
Jaffe, and Trajtenberg, 1998). Weighting individual
DOI: 10.1002/smj
patents with the number of forward citations
allows for different values to be placed on patents
within the rms patent portfolio. A patent that
is cited by a larger number of future inventors
may be construed to have a greater impact than
patents that are cited by fewer inventors. Past
research suggests a close association between
patents weighted by the forward citations and
other social measures of innovation (Trajtenberg,
1990). To avoid truncation bias in measuring
forward citations, consistent with past research, we
chose a window of ve years from the patents
application date to measure the number of citations
the patent receives (e.g., Deng, Lev, and Narin,
1999). Research suggests that patents not cited
in a time frame of ve years are unlikely to be
remembered (Gittelman and Kogut, 2003; Jaffe,
Trajtenberg, and Henderson, 1993). Thus, our
measure of innovation performance is the number
of granted patents led by a rm in year t and is
weighted by ve-year forward citations.
Financial performance
We measure nancial performance using net
income. This is based on past accounting literature,
which suggests net income as a reliable indicator
of the performance of the rm (Dhaliwal, Subra-
manyam, and Trezevant, 1999).
Independent variables
Alliance portfolio size
We measure APS as the number of manufacturing
alliances in which the focal rm is involved
(Bae and Gargiulo, 2004). Since the impact of
an alliance may not be immediately felt on
performance measures (Stuart, 2000), we measure
alliance portfolio as the cumulative number of
manufacturing alliances that the focal rm has
entered into in three years prior to the year in
question (e.g., Koka and Prescott, 2002; Schilling
and Phelps, 2007).
Vertical integration
We measure vertical integration using a dummy
variable. Specically, the variable takes a value
of 0 if the rm engages in design only and a
value of 1 if the rm engages in both design and
manufacturing (referred to as fabrication in the
industry).
Innovation performance
In addition to being a dependent variable, innova-
tion performance is also an independent variable in
our model for nancial performance. Please refer
to the dependent variable section for a description
of this measure.
Control variables
We also control for multiple variables that may
inuence innovation and nancial performance.
Other non-manufacturing alliances (non-manu
alliances)
Our APS variable consists of alliances that have
manufacturing activity identied as their scope.
Therefore, we control for the possibility that
alliances other than manufacturing in the overall
alliance portfolio of a rm may have an effect on
both innovation and nancial performance (Ahuja,
2000; Gulati, 1998).
Activities other than manufacturing (other manu
activities)
Some manufacturing alliances have activities other
than manufacturing dened in the scope. To
control for this issue, we capture the average
number of activities, other than manufacturing, in
the rms alliance portfolio.
R&D intensity
Prior research suggests that R&D intensity of
the rm signicantly inuences the innovation
performance of the rm (Cohen and Levinthal,
1990). To allow for the possibility, we use R&D
investment scaled by sales of the focal rm as a
control variable.
Firm age
Older rms possess greater knowledge stock that
may be applied across innovations (Gittelman and
Kogut, 2003). Therefore, we control for the age of
the rm on innovation performance.
Firm size
Larger rms may have greater performance due to
scale effects. Therefore, we use total employees to
DOI: 10.1002/smj
control for the effect of rm size on innovation
and nancial performance.
Focal rm focus of technological resources (own
tech focus)
Past research on rms innovation performance
suggests that diversity of technological resources
positively impacts innovation performance
(Markides, 1995). Thus, we control for the impact
of a rms focus of technological resources
on innovation and nancial performance. This
measure is based on the Herndahl Index of pri-
mary three-digit technology classes under which
individual patents were led. Each technology
class was weighted by the percentage of the rms
total patents to arrive at the Herndahl Index.
Alliance portfolio focus of technological resources
(alliance portfolio tech focus)
The scope of resources that the alliance portfolio
offers to the focal rm might be important
in addition to the total number of alliances.
Following a methodology similar to the one used
for calculating the own tech focus variable,
we construct the cumulative Herndahl Index of
primary three-digit technology classes under which
partner rms led patents. Each technology class
was weighted by the percentage of the portfolios
total patents to arrive at the Herndahl Index.
Product markets (PM)
Product market areas the focal rm has a pres-
ence in might impact a rms performance and
innovation. Therefore, to control for nature of the
product market that individual rms participate in,
we introduce dummies for the main categories of
analog, digital memory, digital logic, and digital
microcomponents. This categorization is in line
with the major product markets in the semicon-
ductor industry for the time period under study. All
other product markets are coded under the other
category, which is the referent variable in our anal-
ysis.
Number of business segments (segments)
As stated earlier, some rms in our data did
not identify semiconductors as their main line of
business but were included in our sample based
on analyst reports. To control for the possibility
that such diversied rms may have characteristics
driving performance that our data is unable to
capture, we control for the number of business
segments for each focal rm, for a particular
year. This data was collated through multiple
sources including the Compustat segments and
Orbis databases, annual reports, and 10-K reports.
Technology transfer (tech transfer)
Given the importance of knowledge base for
overall success of rms in this industry, we
control for the number of alliances that mandate
technology transfer as the scope of their activity.
Assets
We control for the book value of assets of the focal
rms. This is particularly important since rms
with higher assets may have a strong inuence on
net income, the dependent variable in this study.
Year, technology class, and country effects
We include year dummies, 51 three-digit USPTO
technology class dummies (Gittelman and Kogut,
2003; Trajtenberg, Henderson, and Jaffe, 1992),
and country dummies in both rm performance
and innovation performance models to control for
idiosyncratic factors related to year, technology
class, and country of origin of the rm that our data
is not able to capture but could drive innovation
and/or nancial performance. Our referent dummy
variables are the year 1991, the technology class
438, which corresponds to the highest frequency
of patents, and the United States for country.
Econometric specication
We rst examine the impact of alliance portfolio
on innovation performance. Our dependent vari-
able, innovation performance, is a count measure
and takes only non-negative integer values. Given
over dispersion in our data, we use a negative
binomial specication (Hall and Ziedonis, 2001;
Hausman, Hall, and Griliches, 1984). The model
also accounts for the presence of unobserved het-
erogeneity by using a rm-specic error term
such that E(Y
it
/X
it
) =e
(*X
it
+
it
)
, where
it
rep-
resents the unobserved rm-specic heterogene-
ity (Hausman et al ., 1984). Further, the error
DOI: 10.1002/smj
term
it
is distributed gamma (Hausman et al .,
1984). We estimate the model using random effect
negative binomial specication. Innovation perfor-
mance was modeled as:
Y
it
= f

X
i ,t 1
, Z
i ,t 1
,
t
,
j
(1)
In Equation 1, Y
it
is the innovation performance
of rm i in year t ; X
i,t-1
is the vector of the key
independent variables of interest in year t1; Z
i,t-1
is the vector of control variables in year t1;
t
is the column vector of year dummies, and
j
is
the vector of time-invariant technology class and
country dummies. The analysis was done using
the panel negative binomial regression procedure
(xtnbreg) available in STATA 11.
Next, we examine the impact of alliance
portfolio on nancial performance. Our depen-
dent variable is measured using net income. We
accommodate rm-specic heterogeneity using
rm level random intercepts. Firm performance
was modeled as:
K
it
= f

i ,t 1
,
i ,t 1
,
t
(2)
In Equation 2, K
it
is nancial performance of
rm i in year t;
i ,t 1
is the vector of the key
independent variables of interest lagged by a year;
i ,t 1
is a vector of control variables;
t
is the
vector of year dummies and time-invariant country
dummies. We used the xtreg procedure in STATA
11 to estimate Equation 2.
RESULTS
Table 1 provides descriptive statistics and the
bivariate correlation of all the variables used in
the analyses. Tables 2 and 3 display the results
of models predicting innovation performance and
nancial performance, respectively. In Table 2,
Model 1 displays the results of only control
variables, Model 2 includes direct effects (both
linear and square term) of APS, and Model 3
displays the results of the full model with the
hypothesized interaction of alliance portfolio and
vertical integration (H3). Similarly, in Table 3,
Model 1 displays the results of the effect of control
variables, innovation performance, and APS on
performance. Model 2 displays the results of
the interaction term between APS and innovation
performance added to Model 1 (H1). Model 3
displays the results of the full model, where we
introduce the interaction term between vertical
integration/specialization and APS on performance
(H2). We discuss results displayed in Table 3,
Models 4 and 5, in the robustness section. We now
summarize our results.
First, we hypothesized an inverted U-shaped
relationship for the impact of APS on innova-
tion and nancial performance (H0). Our results
indicate a signicant positive linear effect of APS
on both innovation performance (Table 2, Models
2, 3) and nancial performance (Table 3, Models
14). The square term is not signicant in any
of the models. While we nd no support for the
inverted U-shaped effect of the baseline hypoth-
esis, we do nd a signicant linear positive rela-
tionship for the entire range of the data. This result
contributes to the debate on the role of APS in
increasing performance. Lavie (2007: 1128) notes
that while scholars and managers often assume
that the impact of APS is positive, it has received
limited support in research. Our results provide
support for a linear relationship in the impact of
manufacturing APS on rm and innovation perfor-
mance outcomes in the semiconductor industry.
Second, we hypothesized that, with increasing
innovation levels, the impact of APS on nancial
performance is dampened (H1). We nd support
for this hypothesis (see Table 3, Model 3). The
interaction of APS and innovation performance on
nancial performance is negative and signicant.
Figure 2 (drawn to scale) represents the attening
of the slope of the impact of APS on nancial
performance as innovation goes from mean to
(mean +1 SD). While the overall effect of APS on
nancial performance remains positive, its impact
on nancial performance is dampened at high
levels of innovation.
Third, we hypothesized that the impact of APS
on nancial performance is enhanced for VI rms
as compared to VS rms (H2). Our result indicates
that the interaction is positive and signicant on
nancial performance, supporting H2 (Table 3,
Model 3). Figure 3 (drawn to scale) demonstrates
that the slope of APS on nancial performance is
steeper for VI rms than the slope of APS for VS
rms.
Finally, we hypothesized that the impact of
APS on innovation performance is dampened in
VI rms relative to VS rms (H3). Our results
(Table 2, Model 3) indicate that the interaction is
negative and signicant. Figure 4 (drawn to scale)
DOI: 10.1002/smj
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DOI: 10.1002/smj
Table 2. Negative binomial results of innovation performance
Innovation performance Model 1 Model 2 Model 3
Portfolio size 0.077*(0.031) 0.114*** (0.033)
Portfolio size-square 0.001 (0.001) 0.000 (0.001)
Vertical integration 0.105 ( 0.156) 0.126 (0.157) 0.096 (0.157)
Vertical integration portfolio size 0.173* (0.072)
R&D intensity 0.004 (0.012) 0.004 (0.012) 0.004 (0.012)
Firm age 0.003 (0.004) 0.006 (0.005) 0.005 (0.005)
Firm size 0.002 (0.001) 0.003 (0.001) 0.003 (0.001)
Own tech focus 0.348* (0.172) 0.376* (0.173) 0.365* (0.173)
Alliance portfolio tech focus 1.007(0.672) 1.088 (0.702) 1.032 (0.701)
Non-manu alliances 0.022(0.018) 0.001 (0.018) 0.005 (0.019)
Other manu activities 0.013 (0.024) 0.008 (0.021) 0.000 (0.021)
PM-analog 0.279 (0.199) 0.259 (0.199) 0.275 (0.199)
PM-digital logic 0.258 (0.160) 0.253 (0.161) 0.264 (0.161)
PM-digital memory 0.303 (0.163) 0.200 (0.167) 0.219 (0.165)
PM-digital micro 0.222 (0.190) 0.274 ( 0.192) 0.242 (0.192)
Segments 0.110***(0.029) 0.099*** (0.029) 0.104*** (0.030)
Year dummies Included Included Included
Technology class dummies (3-digit) Included Included Included
Country dummies Included Included Included
Constant 1.775***(0.223) 1.671*** (0.228) 1.627*** (0.228)
Wald chi-square 751.611 791.237 790.171
Log likelihood 3,704.504 3,672.352 3,669.723
AIC 7,559.007 7,498.705 7,495.446
N =1,296.
*p <0.05; **p <0.01; ***p <0.001.
All IVs are lagged by a year. Numbers indicated in the cells pertain to estimates (s.e.).
Two-tailed tests for hypothesized and control variables.
demonstrates that the slope of APS on innovation
performance is steeper for VS rms than the slope
of APS on innovation performance for VI rms.
Robustness
Using our data, we ran multiple robustness checks.
First, given prior concerns about the quality of
alliance termination data in the SDC Thomson
database (Schilling 2009), we ran robustness
checks with a one-year APS measure. In addition,
we also ran a ve-year cumulative APS measure
(e.g., Stuart, 2000). Our results were robust to
these alternate measures.
Second, we ran robustness checks with a three-
year cut-off window for weighting the forward
citations of patents, instead of ve years. Once
again, our results were robust.
Third, we correct for the endogeneity issues
that arise from including innovation as a driver
of nancial performance. We observe innovation
of the rm contingent on the rm having patented
under the USPTO system for that particular year.
This calls for a Heckman correction for the
focal rms choice to patent under the USPTO
system (USPTO existence). We use a two-stage
procedure to account for this. In the rst stage,
we use a probit specication to examine the
drivers of USPTO existence. The results of this
model are displayed in Table 3, Model USPTO
existence. The variable rm age is used as an
instrumental variable in the rst-stage regression.
Our choice of instrumental variable is driven
by prior work that suggests that the impact
of age on nancial performance is inconclusive
(Coad, Segarra, and Teruel, 2013), while age
has a positive impact on innovation performance
(Srensen and Stuart, 2000). Using the predicted
values from the probit regression, we construct the
hazard for nonselection (Hamilton and Nickerson,
2003) that was used as a control variable in the
equation for nancial performance. We note that
the inverse Mills ratio was signicant in this
case justifying its inclusion to correct for the
choice of patenting under the USPTO system. The
coefcients of the second stage shown in Table 3,
Model 4 are similar to Table 3, Model 3. Since
innovative rms are more likely to patent under
DOI: 10.1002/smj
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DOI: 10.1002/smj
0
500
1000
1500
2000
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1 3 5 7 9 11 13 15 17 19 21 23
F
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(
$
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Innovation = mean
Innovation = mean + 1 s.d.
Figure 2. Interaction effect of alliance portfolio and
innovation performance on nancial performance
0
500
1000
1500
2000
2500
3000
3500
4000
0 5 10 15 20
F
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p
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(
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Vertically integrated
Vertically specialized
Figure 3. Interaction of alliance portfolio with vertical
integration/specialization on nancial performance
0.0
0.5
1.0
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2.0
2.5
0 2.5 5 7.5 10 12.5 15 17.5 20 22.5 25
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p
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Vertically specialized
Vertically integrated
Figure 4. Interaction of alliance portfolio with vertical
integration/specialization on innovation performance
the USPTO system than not, our nonselection
hazard also corrects for unobserved heterogeneity
between innovative and noninnovative rms that
might drive performance. Further, our results are
robust to endogeneity caused by simultaneity as
we use lagged independent variables, in line with
the recommendation of Judge (1985).
Fourth, we note that vertical integration is a
choice variable for rms and also raises concerns
of endogeneity. To correct for this, we ran a rst-
stage probit regression with vertical integration
as a dependent variable and demand uncertainty
as the instrumental variable. We measure demand
uncertainty, following Dess and Beard (1984), by
regressing annual sales of the rm on time over
the period 19912002 and used the standard error
of the estimate as an indicator of the volatility
in the demand. Following Williamson (1971), we
expect that high volatility in an industry with sig-
nicantly specialized assets would lead to vertical
integration. We then generate the predicted proba-
bility of vertical integration from this equation and
determine the hazard of nonselection (Hamilton
and Nickerson, 2003). Our data (Table 4) reveals
that the Mills ratio was insignicant, implying
that endogeneity was not a signicant concern in
affecting the results (Table 4, Panels B and C).
Therefore, we believe that our results are robust
to the effects of endogenous choice of vertical
integration.
Fifth, we used grand mean centered variables for
interaction terms to help alleviate multicollinearity
concerns (Kreft, Leeuw, and Aiken, 1995). In par-
ticular, the mean VIF (condition number) for inno-
vation equation was 2.33 (7.87) and the mean VIF
(condition number) for the performance equation
was 2.69 (8.77). Furthermore, the maximum VIF
was below ten for all variables and the condition
indices were below the prescribed number of 30,
suggesting that our estimates are stable (Cohen
et al ., 2003). Next, we examined our model for
AR(1) disturbances particularly for the nancial
performance equation. Our results did not change.
DISCUSSION
Despite recent attention to the impact of APS
on rm performance, our understanding of
the effect of APS on nancial performance of
rms remains incomplete (Lavie, 2007). In this
research, we develop a contingency view of
the impact of APS on different dimensions of
performance. Our contingencies are the rms
innovation level and vertical scope. Our work con-
tributes to theory and managerial practice in the
following ways.
First, we examine how contingencies of the
focal rm moderate the impact of APS on nancial
performance. Alliances are an important source of
competitive advantage and increase innovation via
gains from external technology (Kale and Singh,
2009). Our work extends past research in this area
DOI: 10.1002/smj
T
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DOI: 10.1002/smj
by nding that highly innovative rms benet less
from increasing APS than less innovative rms
with respect to nancial performance. Organi-
zational learning literature suggests that creation
of new knowledge is an evolutionary process
that arises from a combination of innovation
opportunity, technology appropriability, and the
overall knowledge base of the innovating rm
(Malerba and Orsenigo, 1993; Schumpeter, 1934).
Firms that engage in high levels of innovation
share internal knowledge within (Burns and
Stalker, 1961) and have high levels of internal
communication and collaboration (Blackler, 1995;
Hoegl and Proserpio, 2004). Our results suggest
that managers would benet from paying attention
to the interplay between innovation level and
the degree of benets that can be derived as
they pursue additional alliances as a means to
enhance nancial performance. This requires both
a deeper consideration of the rms innovation
processes and the degree to which larger numbers
of alliances are really useful.
Second, an important aspect of our research is
the choice of innovation as a performance out-
come of APS. Past research has examined the
impact of APS on market performance (Rothaer-
mel, 2001a, b). Recent research suggests that ver-
tical integration and APS complement each other
in their impact on market performance (Rothaer-
mel et al ., 2006). Given this stream, our focus
was on understanding how vertical integration
and APS interact to drive a different perfor-
mance outcome, i.e., innovation performance. Our
results indicate that vertical integration substitutes
the impact of APS in driving innovation perfor-
mance. This substitution effect on innovation pro-
vides a contrast to the complementary effect on
market outcome. By focusing on manufacturing
alliances in a cost and knowledge intensive indus-
try such as semiconductors (Macher et al ., 2002),
our research offers a new context in the study
of APS.
Third, our results indicate that, while increasing
portfolio size is useful for VI rms to enhance
nancial performance, it is more useful for VS
rms to improve innovation performance and,
consequently, nancial performance. That is,
our results indicate an asymmetry in the impact
of APS on nancial performance depending on
the rms vertical scope. In order to obtain a
better understanding, we performed additional
analysis to evaluate the total effect of APS on rm
performance for VI and VS rms. This additional
analysis helps us understand the extent and signif-
icance of the direct, indirect, and total effects of
portfolio size on rm performance for VI and VS
rms separately and relative to each other.
2
We
note that the total effect of APS on nancial perfor-
mance consists of two parts. First is a direct impact
of APS on nancial performance; the second is
an indirect effect (via innovation) on nancial
performance.
Our analysis suggests that, at mean levels of
innovation and APS, the direct effect of portfolio
size of VS (VI) rms on innovation performance is
2
The procedure of calculating the total net effect of APS
on rm performance for vertically integrated and vertically
specialized rms was as follows. For ease of exposition, we
do not add time subscripts, and focus our attention on the core
variables of VI, APS, innovation performance (IP), and rm
performance (FP).
IP (APS, VI ) = exp ( +
1
APS +
2
VI +
3
VI APS) (3)
FP (IP, APS, VI ) = +
1
IP +
2
APS +
3
APS
IP +
4
VI +
5
VI APS (4)
The net effect of alliance portfolio size (APS) on nancial
performance is given by the following rst order condition:
FP (.)
APS
=
1
IP (.)
APS
+
2
+
3
IP +
3
IP (.)
APS
APS +
5
VI
(5)
Equation 5 can be rewritten as:
FP
APS
= (
2
+
3
IP +
5
VI ) +
IP
APS

FP
IP
(6)
In general, Equation 6 can be rewritten as:
FP
APS
= (
2
+
3
IP +
5
VI )
+((
1
+
3
VI ) IP) (
1
+
3
APS) (7)
Since
IP
APS
= ((
1
+
3
VI ) IP), we use Equation 7 to
evaluate the net effect of APS on rm performance. In
Equation 7, let
(.) = ((
1
+
3
VI )IP) (
1
+
3
APS)
and
let (.) =
2
+
3
IP +
5
VI . As seen from Figure 1,
we interpret (.) as the conditional indirect effect of APS on
nancial performance via innovation performance (conditional
effect of portfolio size on innovation performance conditional
effect of innovation performance on rm performance). In
addition, (.) is akin to the conditional direct effect of APS on
nancial performance for any specic innovation performance.
We set VI =1 (VI =0) in Equation 7, (.) and (.), respectively,
in order to nd the total effect, indirect effect, and direct effect
respectively for VI (VS) rms. The standard errors for the
estimates are approximated using the Delta method (Wooldridge,
2001: 4445).
DOI: 10.1002/smj
26.04; p =0.126 (120.15; p =0.000). The indirect
effect of portfolio size on nancial performance
for VS (VI) rms is 7.73; p =0.001 (4.00;
p =0.382). Finally, the total effect of APS on
nancial performance for VS (VI) rms is 33.76;
p =0.053 (116.15; p =0.001). Our results imply
that, conditional on mean levels of innovation
and APS, the direct effect is signicant only for
VI rms, indirect effect signicant only for VS
rms, and the total effect signicant for both VI
and VS rms. It is important to note that for
VI rms, increasing APS causes a decline in
nancial performance, as seen in the negative
indirect effect on nancial performance. However,
this negative indirect effect of portfolio size is not
statistically signicant. In contrast, both direct and
indirect effects of APS on nancial performance
are positive for VS rms.
We performed additional analyses to understand
the difference in magnitude (and its statistical sig-
nicance) for the direct, indirect, and total effects
between VI and VS rms. It is important to note
that the difference in the direct effect of APS
on nancial performance for VI and VS rms
may be evaluated based on results corresponding
to H2. However, such information is not readily
available from our regression analyses for indirect
effects and total effects of APS on nancial perfor-
mance. Accordingly, the estimates for the indirect
and total effects of APS on nancial performance
were derived based on Equation 7 in Footnote 2.
Our results indicate that, conditional on mean lev-
els of innovation and APS, the indirect effect of
portfolio size on nancial performance is signi-
cantly higher for VS rms than for VI rms (differ-
ence =11.73; t -value =2.27 and p-value =0.023).
In addition, the total effect of portfolio size
on rm performance is signicantly higher for
VI rms than for VS rms (difference =82.38;
t -value =2.32 and p-value =0.020).
In addition to evaluating the difference in
indirect and total effects contingent on sample
mean levels of innovation and APS, we examined
these effects at various levels of innovation. Our
results indicate that the total effect of APS on
rm performance is signicantly different between
VI and VS rms at low to mean levels of
innovation. However, the total effect of APS
on rm performance is not signicantly different
between VI and VS rms at higher levels of
innovation (mean +1 SD).
Our results suggest that, while increasing APS
enhances rm performance, the vertical scope
of the rm is critical in better understanding
how APS impacts rm performance. Specically,
depending on vertical scope, how external
resources made available by increasing APS allow
rms to improve performance varies signicantly.
VI rms enjoy signicantly greater direct benets
(than VS rms) but signicantly less indirect
benets (than VS rms) in the overall utilization
of external partner resources. In addition, the
total effect of APS on rm performance is not
signicantly different between VI and VS rms at
high levels of innovation. It is possible that asym-
metries, in direct and indirect effects, are driven
by differences in managerial incentives. Specif-
ically, managers in VS rms may have greater
incentives to leverage alliance partner resources to
drive innovation, and consequently improve rm
performance. On the other hand, VI rms, given
their prior investments in the value chain and
shared internal knowledge, have fewer incentives
to rely on the portfolio of alliance partners as
a source of external knowledge for innovation.
For example, Robertson and Langlois (1995: 522)
note that managers in VI rms lack the high-
powered incentives of a nancially independent
relationship. Corroborating this observation, Hall
and Ziedonis (2001) suggest that VS rms in the
semiconductor industry need to show signicant
evidence of innovation potential and proprietary
knowledge to seek external funding, which is often
critical for survival. Managers in these rms might
have a greater motivation and incentive to rely on,
and exploit, alliance portfolios as key resources
to enhance innovation capabilities. These innova-
tion capabilities also relate signicantly to rm
performance, more so in VS rms than in VI rms.
Our nding of the asymmetry in how alliance
portfolios are leveraged differently by VI and VS
rms aspiring for enhanced innovation and nan-
cial performance has received little attention to
date. For theorists, our results suggest that consid-
ering multiple performance measures may provide
additional insights on the pathways through which
rms with differing vertical scope can leverage
alliance portfolios to improve rm performance.
For managers, our results imply that a careful
consideration of multiple performance attributes
may be important towards building an overall
understanding of the complex and inter-related
mechanisms.
DOI: 10.1002/smj
CONCLUSIONS
The primary insight from our analysis is that strate-
gic priorities of rms, innovation level and vertical
integration, interact with APS in improving nan-
cial performance. First, because innovation is a
strategic priority of the rm, we examine the role
of APS on nancial performance in the context
of varying levels of innovation of the rm. Con-
trary to popular belief, our results indicate that
highly innovative rms rely less on alliances to
enhance nancial performance. Second, because
vertical integration is yet another strategic prior-
ity of the rm, it is important to understand its
inuence in the impact of APS on rm perfor-
mance. Our results indicate that, while VI rms are
better in beneting from increased APS in nan-
cial performance, it is VS rms that can better
utilize increased APS in innovation performance.
Our results highlight the trade-offs that managers
in VI and VS rms face.
Our study is not without limitations, some of
which may form the basis for future research. First,
given the single industry setting of our study, it
suffers from generalizability of results. Second,
while we were constrained by the use of patents
as sole measures of innovation, other prior studies
have used alternate measures of innovation (e.g.,
Rothaermel et al ., 2006). Future studies could pro-
vide additional insight into this complex interplay
of various factors by considering other sources of
innovation along with other performance metrics.
Finally, our results point towards a need for
understanding managerial motivations and incen-
tives in exploiting the alliance portfolio. While
literature has suggested that VI and VS rms may
have differing incentives in exploiting external
knowledge to their benet (Robertson and Lan-
glois, 1995), studying the nature of incentives may
yield additional knowledge on heterogeneity in
performance outcomes between VI and VS rms.
ACKNOWLEDGEMENTS
We are grateful to Rich Bettis, Sridhar Balasubra-
manium, Hari Sridhar, Anne Parmigiani, associate
editor Tomi Laamanen, and three anonymous ref-
erees for helpful comments, and the Global Semi-
conductor Association for data support. Errors and
omissions remain our own. Authorship is in alpha-
betical order.
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DOI: 10.1002/smj

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