Strategic Management Journal

Strat. Mgmt. J., 32: 15171523 (2011)

Published online EarlyView in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.963
Received 22 February 2010; Final revision received 18 March 2011

A BEHAVIORAL APPROACH TO
STRATEGYWHATS THE ALTERNATIVE?
DANIEL A. LEVINTHAL*
Wharton School of Business, University of Pennsylvania, Philadelphia, Pennsylvania,
U.S.A.

The strategy field has generally been viewed as somewhat fragmented with the primary fault line
stemming from the divide between economic and behavioral approaches. It is argued here that
this is a false divide as any but the most trivial problems require a behavioral act of representation
prior to invoking a deductive, rational approach. In this sense, all approaches are behavioral.
Once we recognize rationality as a process, then the pragmatic question becomes which among
the imperfect mechanisms to guide choice and behavior may be more or less preferred. Such a
viewpoint not only serves to help span the chasm of behavioral and economic approaches, but
it may also connect the applied normative frameworks and approaches within the field to more
theoretically grounded approaches. Copyright 2011 John Wiley & Sons, Ltd.

INTRODUCTION can be carried out, the playing field between so-

A number of scholars have noted the fragmented
nature of the strategy field (Mintzberg, 1987; Far-
journ, 2002; Gavetti and Levinthal, 2004). The
fundamental divide in this fragmentation is the
assumption scholars make regarding the choice
process of strategic actors and, in particular,
whether these choice processes are rational and
adhere to the axioms of expected utility theory
or whether choice processes are characterized by
some behavioral mechanisms. I argue that, in
general, this is a false dichotomy. Once one rec-
ognizes that a rational choice process requires an
a priori act of problem framing and representation
before the execution of a rational choice calculus
Keywords: cognition; rational choice; behavioral theories
of the firm
Correspondence to: Daniel A. Levinthal, Reginald H. Jones
Professor of Corporate Strategy, University of Pennsylvania,
Wharton School of Business, 3209 SH-DH, 3620 Locust Walk,
Philadelphia, PA 19104, U.S.A.
E-mail: dlev@wharton.upenn.edu
called rational choice characterizations of behav-
ior and behavioral accounts becomes considerably
more level.1 This false divide has been unhelpful
to the development of the field and has, arguably,
restricted the fields value to practice.
SMALL WORLD REPRESENTATIONS
Most problems of interest to strategists do not lend
themselves to well-posed problems for which an
optimum solution exists. Alternative actions are
typically not well specified and often need to be
discovered. Uncertainty over possible future states
may be difficult to express as explicit probabilities.
Further, the interdependencies among choices at a
1
Gavetti (forthcoming) offers a different line of argument linking
the economic and behavioral foundations of strategy, arguing
that strategic advantage ultimately stems from some market
failures and that these market failures, at their root, derive from
the limited rationality of strategic actors.

Copyright 2011 John Wiley & Sons, Ltd.

1518 D. A. Levinthal
point in time or across time (spatial and tempo-
ral interdependence) may make the specification
of an optimum infeasible. Indeed, while in the
management literature, the behavioralist tradition
is rooted in Simons (1955) observations regard-
ing the capacity of human cognition relative to the
demands of the problem environments in which
decision makers find themselves, the literature on
computation within engineering and computer sci-
ence recognizes an analogous constraint and notes
that a wide class of problems may exceed the
capacity of any computation device based on the
principles of a Turing machine (Casti, 1992).
Computational problems are termed NP com-
plete if the difficulty of finding a solution increases
at a rate faster than a polynomial expression of
the number of variables being considered. It is
important to note that such problems are, in many
respects, simpler than a typical strategy problem,
in that the set of alternative actions and the links
between actions and payoffs are well specified. A
classical example of such a problem is the trav-
eling salesman problem of minimizing the dis-
tance traveled if a salesman were to visit each
member of a set of cities without revisiting any
city. The particular engineering solutions to NP
complete problems vary, ranging from branch
and bound techniques (Garfinkel and Nernhauser,
1972) to algorithms of gradient search, but all
reflect some method of search over a set of pos-
sible solutions and, in that respect, some resem-
blance to satisficing (constraint satisfaction) and
processes of heuristic search central in discussions
of behavioral perspectives on the firm. Indeed,
Garey and Johnson (1979: 122), in writing on com-
putational approaches, note that the most widely
applied technique is that of neighborhood search,
in which a preselected set of local operations is
used to repeatedly improve an initial solution, con-
tinuing until no further local improvement can be
made and a locally optimum solution has been
obtained.
If an optimum solution cannot be defined for
a wide scope of problems, from relatively trivial
decision contexts such as chess, with well-posed
actions and payoffs but with complex temporal
interdependence across moves and countermoves,
or the traveling salesman problem, again a well-
specified problem but with a substantial degree
of spatial interdependence, than surely more com-
plex and less well posed problems such as how
a firm should enter a new market, in which new
Copyright 2011 John Wiley & Sons, Ltd.
emerging technologies should the firm invest, or
what constitutes a preferred incentive structure
do not lend themselves to a well-specified opti-
mum. If that is the case, then what is meant by
a contrast between a rational and a behavioral
approach?
The schemata provided in Figure 1 can help
frame an answer. There exists a problem space for
which there are well-specified alternatives, well-
defined probability measures on the link between
actions and outcomes, and sufficiently modest lev-
els of interdependence among the decision and
state variables that an optimum solution can be
derived.2 Such problems will be near the origin in
the alternative, uncertainty plane, as suggested
by the interior rectangle. Interestingly, much of
the discussion of behavioralism, particularly in
the vast literature on judgment and decision mak-
ing, is located in this subspace. Allais paradox
and Tverksy and Kahnemans classic work on
choice under uncertainty all reside in this space.
We know the rational choice solution to these
problems (that is choices, that are mutually con-
sistent and obey the axioms of expected utility
theory) and can readily contrast those choices
with actual behavior. This has been and contin-
ues to be a terribly important and vibrant line of
inquiry.
Figure 1. Space of representations and problems
2
To preserve this schemata in the set of representations that can
be visually rendered (i.e., not more than three dimensions), the
dimension of interdependency is not incorporated.
Strat. Mgmt. J., 32: 15171523 (2011)
DOI: 10.1002/smj

Rationality as a process
But what does rationality mean when we can-
not characterize an optimum solution to the prob-
lem setting? As March (1994) suggests, it may
be useful to view rationality as a process. From
that perspective rationality is a particular way to
approach action in a complex, untractable prob-
lem space. What operationally (behaviorally) does
rationality as a process mean in such circum-
stances? I argue that a central, though largely
under-recognized aspect, is the mapping of the
true underlying decision problem to a simple rep-
resentation that is, in turn, amendable to deductive
reasoning. While under the spell of the beauty and
power of this mechanism of deduction, we often
neglect the fact that the starting point for this pro-
cess was an act of cognitive representation.
This relative neglect has a number of poten-
tially problematic implications. First, of course,
we deprive ourselves of the opportunity to think
creatively about the space of alternative representa-
tions, as there is an implicit notion that the chosen
representation is, in fact, a characterization of the
true problem setting and not simply one, possibly
focal, option out of a vast sea of possible options.
Second, there is the risk of reifying the solution
that emerges out of the process of deduction. As
Einhorn and Horgath (1981) note, analytical efforts
to identify an optimal solution to a decision prob-
lem result in an optimum with reference to a model
of the underlying situation but need not corre-
spond to desired behavior in the actual decision
context. From the perspective of Figure 1, hav-
ing solved a rational representation (the expression
of the actual problem in a sufficiently parsimo-
nious manner such that an optimum solution can
be derived with respect to this representation), it
remains an open question as to the value of the
payoff to this solution in the actual problem envi-
ronment (the issue posed by the dashed curve in
the figure). For instance, the allocation of inputs
to a feedlot suggested by the solution of a linear
program of the feedlot problem may, in fact, be
suggestive of desired behavior in the actual con-
text of running a cattle ranch, but its superiority
over other possible solutions should not be taken
for granted or viewed as an axiomatic truth.
A failure to recognize the inherent loose cou-
pling between our models of the world and the
actual environment in which we act likely leads
to a dangerous degree of hubris on the part of
Copyright 2011 John Wiley & Sons, Ltd.
Commentary 1519
decision makers. To some degree, the recent finan-
cial collapse can be attributed to profit-seeking
individuals exploiting regulatory gaps, incomplete
information, and the divergent interests of vari-
ous parties. But such an account can be usefully
supplemented by a recognition that analysts misun-
derstood the loose coupling between the valuation
algorithms of their models and the actual financial
environment. For instance, as MacKenzie (2006)
notes, the Black-Scholes options model is not an
account of the fundamental physics of the financial
universe. Indeed, MacKenzie (2006) shows that
the quality of the fit of the model improved over
time with its adoption. Thus, there is an important
element of social constructionanalysts adopted
a particular valuation technique and, through that
process of adoption, the descriptive power of the
valuation technique improved. Similarly, analysts
can choose to value bundles of mortgages as if the
default risk of the individual underlying mortgages
are largely independent events. That, indeed, may
be a convenient modeling representation for many
purposes and for many times periods. However,
the actual problem environment clearly provides
for some measure of interdependent and correlated
risk, a property that may, in some circumstances,
reveal itself.
This recognition that the constraints of bounded
rationality are a function of the nature of the task
environment has a deep irony for the field of neo-
classical economics. Neoclassical accounts have
a clear and deep commitment to rational theo-
ries of choice. However, there is also a pervasive
and highly subordinated commitment to the nature
of the task environment in which choice takes
place. To be able to provide a simple character-
ization of the optimizing behavior of an agent, the
assumption that the second-order condition holds
is typically made early on in a typical neoclassical
analysis. That is, the agent is viewed as maxi-
mizing an objective function and to ensure, as a
modeling convenience, that this optimization prob-
lem has a well-specified unique solution that can be
characterized by setting the first derivative of the
payoff function with respect to each of the decision
variables to zero, a payoff function is specified,
or in some cases its properties simply assumed,
such that the payoff is concave. What this prop-
erty entails for a single choice variable is that, at
some point, decreasing returns set in; more subtly,
for settings of more than one choice variable, there
is the implied requirement that there is sufficiently
Strat. Mgmt. J., 32: 15171523 (2011)
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1520 D. A. Levinthal
little interdependence among the choice variables.3
Oftentimes this assumption is relegated to an early
footnote. In other cases, sufficient assumptions are
applied to the underling payoff functions of the
individual actors such that the desired property of
concavity is obtained.
This seemingly innocuous technical property has
exceedingly strong implications for the associated
task environment. The concavity of the payoff
function implies that there is a single local peak
in the payoff landscape. However, if the payoff is,
in fact, single peaked, essentially any choice pro-
cess will ultimately lead to the optimum (Levinthal
and Warglien, 1999). Indeed, there is an important
tradition, running from Beckers (1962) account of
the robustness of the property downward slopping
demand curves to assumptions about consumer
choice to Winters (1971) analysis that even simple
adaptive behavior on the part of individual firms
will reach a competitive equilibrium, that illus-
trates the robustness of classical economic proper-
ties to the assumptions about individual behavior.
Goode and Sundar (1993) offer one of the most
striking accounts of this sort. The double auction
game4 is one of the early hallmarks of experimen-
tal economics (Smith, 1962; Plott, 1982). Gener-
ations of undergraduate economics students have
gone through this experiment, and they and their
instructors have observed the reassuring outcome
that after many rounds of bids and asks, the auc-
tion price settles in and around the price suggested
by the competitive equilibrium. However, Goode
3
There are three technical issues regarding whether the first-
order conditions will characterize an optimum: (1) does an
interior optimum exist?; (2) if it exists, is it unique?; and
(3) are the first-order conditions characterizing a maximum or a
minimum point? The onset of diminishing returns ensures a finite
value of the optimum. The restriction on interdependence ensures
that any interior optimum will be unique. Nonunique optimum or
local, nonglobal, peaks (Levinthal, 1997) may arise when there
are strong complementarities among the choice variables.
Milgrom and Roberts (1990) develop an analytical approach
of lattices (Topkis, 1978) that allows for substantial interdepen-
dencies among an actors decision variables and does not require
the satisfaction of second-order conditions. However, in order
to characterize the comparative statics in this setting, the rather
strong condition of supermodularity is required, which holds that
if a policy choice is a complement of another choice for one set-
ting of the n parameters, it must be a complement for all other
possible settings of these parameters as well.
4
A double auction is a market mechanism whereby potential
buyers submit their bids and potential sellers simultaneously
submit their asking prices to an auctioneer. The auctioneer then
identifies a price p that clears the market: all the sellers who
asked for p or less and all buyers who bid p or more then buy
at this price p.
Copyright 2011 John Wiley & Sons, Ltd.
and Sunder (1993) show that the emergence of
the competitive equilibrium price need not provide
reassurance as to the microeconomics acumen of
the experiments participants. They demonstrate in
a simulation experiment that even simulated zero-
intelligence traders who offer up random bids and
asks, only constrained by their reservation utility
levels, also results in behavior corresponding to the
competitive equilibrium after multiple rounds. The
reason is that the basic double auction generates
a single-peaked performance landscape (Levinthal
and Warglien, 1999).
Small worlds and strategy frameworks
To act in a deductive, intentionally rational manner
in a complex world inevitably requires the explicit
or implicit creation of a small world representation
(Gavetti and Levinthal, 2000).5 This perspective
suggests that the simple low dimensional repre-
sentations put forth by strategy frameworks (typi-
cally 2x2), whether they be the BCG Growth/Share
Matrix or Porters Differentiation/Cost and
Focused/Mass market typology, may not be the
embarrassing contrivances of the MBA classroom,
but might better be viewed as inevitable efforts
at simplification that are a prerequisite for efforts
at deductive reasoning. The issue from the per-
spective of a normative effort is not whether one
engages in a gross simplification of the strategic
context, but what gross simplification will prove
more or less useful. In the context of Figure 1,
the suggestion is that strategy frameworks offer an
abstraction from the actual problem, an abstrac-
tion that is inevitably a fairly coarse-grained artic-
ulation of the actual problem, but one that may
preserve, to a fair degree, the sense of ambiguity
regarding action-outcome linkages and what con-
stitutes the set of possible actions.
The preservation of this ambiguity in this coarse-
grained representation need not be useful, but
5
The term small world is used here in the manner introduced
by Savage (1954) in his development of axiomatic-based theory
of rational choice and not in the sense of network ties per Watts
(1999). Savage (1954: 85) noted that the states of the world
denoted in his analytical apparatus were small worlds and that
they may form a partition of the grand world. That is, the idea
that the outcome states he was characterizing in his analytical
structure were informative, but incomplete, representations of a
more complex reality that stood outside the modelthe grand
world. In the context of the schema suggested by Figure 1,
this can be understood as the loose coupling between the actual
problem and the representation of the problem underlying a
rational approach.
Strat. Mgmt. J., 32: 15171523 (2011)
DOI: 10.1002/smj

at the same time we cannot say a priori that
a solution suggested by the strategy-framework
representation is inferior to that suggested by
the representation of the actual problem con-
text underlying a rational approach. Thus, rather
than putting scholars who provide characteriza-
tions of actors representations in one camp (cf.,
Porac, Thomas, Baden-Fuller, 1989; Huff, 1990)
and Porter (1996) and Brandenburger and Stuart
(1996), who offer frameworks grounded in eco-
nomic theory, in another, it may be more useful to
recognize the deep relationship between the two
sets of efforts.
As part of that nexus of a behavioral considera-
tion of representations and normative suggestions
regarding more or less preferred representations, a
grossly underexploited research opportunity lies in
examining how these normative frameworks play
out in practice. Consider the basic issue of organi-
zational goals. A substantial cottage industry has
developed around the idea of a balanced scorecard
(Kaplan and Norton, 1996), the idea that managers
should be given a wide array of operating mea-
sures from current sales, to rates of new product
development, and customer satisfaction levels to
guide their action. From a decision theoretic point
of view, it is hard to argue against the introduction
of additional measures; each additional measure
should provide an incremental signal regarding the
state of the system (i.e., firm). However, such an
approach implicitly assumes that actors can make
compensatory tradeoffs among outcomes, such as
balancing some increase/decrease in current sales
with a decreased/increased rate of new product
development effort. Yet, a long line of behav-
ioral research suggests that individuals tend to
treat objectives as independent constraints (Simon,
1955; Tversky, 1972) and find it quite difficult to
make compensatory tradeoffs even when all out-
comes are monetary ones (Thaler, 1985, 1999). As
Jensen (2001: 1112) notes, if distinct outcome
dimensions are not monotonic transformations of
one another, then telling a manager to maxi-
mize current profits, market share, future growth
in profits, and anything else one pleases will leave
that manager with no way to make a reasoned
decision.
Ethiraj and Levinthal (2009) show that provid-
ing less accurate and more limited goal structures
to actors who are boundedly rational and adap-
tive learners leads to superior performance, even
when evaluated on the basis of the true, full set
Copyright 2011 John Wiley & Sons, Ltd.
Commentary 1521
of goals. The simplified goal structure leads to
a clarity of action and opportunities for adap-
tive learning that the full goal structure inhibits.
Thus, there is a complementarity between con-
ceptions of the actors choice process and the
desired goal structure. If actors are capable of mak-
ing compensatory tradeoffs among all outcomes,
then providing them with the full goal struc-
ture would enhance performance. Alternatively, in
the absence of such a capacity, a simplified and
less accurate goal structure may lead to superior
performance.
CONCLUSION
The strategy field is arguably neglecting some of
the most important questions of an intentionally
rational approach to the problems of strategic man-
agement. Rather, one camp of scholars acts as if
its normative claims are axiomatic, and behav-
ioral scholars are often dismissive of the nor-
mative approach as being unrealistic. We would
be better served if the wisdom of an economic
approach was not presumed, but was taken seri-
ously. A small world solution may be a useful
guide to action in the grand world, but we need
to explore the boundary conditions around such
claims. While there is a high level of awareness
of the limitations and biases of decision heuris-
tics (cf., Tversky and Kahneman, 1986; Zajac and
Bazerman, 1991; Kahneman and Lovallo, 1993),
a related but distinct literature has emerged that
explores the efficacy of frugal (from a calcula-
tive standpoint) heuristics in empirical contexts
(Payne, Bettman, and Johnson, 1993; Gigerenzer,
2000).
The choice is not between whether we should act
in a God-like manner or like mortals. We are mor-
tals. Given this second-best setting, the question is
how to act with intelligence and efficacy in strate-
gic contexts. Business strategy is not a tic-tac-toe
environment in which explicit optimum of the real
strategic context can be derived. Further, one can
act with intelligence even in the absence of deliber-
ative reasoning. Adaptive learning, selection mech-
anisms and imitative processes are all alternative
bases of intelligence. Nonetheless, deliberative rea-
soning and analysis is an important mechanism.
But, such processes do not live wholly apart from
behavior mechanisms. As March (1994) notes, we
Strat. Mgmt. J., 32: 15171523 (2011)
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1522 D. A. Levinthal
should view rationality as a process, not as an out-
come. Doing so is respectful of both the power
and inherent limitations of such approaches. Fur-
ther, such a perspective acknowledges that there is
not a behavioral, rational choice divide in consid-
ering questions of business strategy. Rather, there
are merely different behavioral approaches and
mechanisms.
Writing down a small world representation of a
strategic context and deducing mathematically the
optimal behavior in this small world is a behav-
ioral process. When we fully recognize this as a
field, we will open up lines of inquiry that will
not only help connect currently disparate strands
of research, but also do so in a way that will
allow the field to more effectively speak to a prac-
titioner audience. The fact that strategy classes
consist largely of the unpacking and application
of rather simple strategy frameworks to particu-
lar case examples is indicative of the fact that
the reduction to practice from a small world rep-
resentation to even a parsimonious characteriza-
tion of the grand world is challenging. In this
respect, what separates a class in microeconomics
from a strategy class is that in the microeco-
nomics class students are presented with a fully
articulated small worldthe cost function of the
widget factory, rivals costs, the demand curve,
and the like. In the strategy case, there is the
imperative to use economic reasoning, but in a
setting with far less clarity regarding the linkage
between actions and outcomes. One can be more
or less skillful in the application of these frame-
works, but to the unending frustration of genera-
tions of students, that skill is not of the algorithmic
sort.
Behavioralists have, arguably, been too generous
or too self-effacing to their rational choice col-
leagues. There tends to be an implicit agreement
that the rational choice approach reflects norma-
tively desired behavior. While buying into that
supposition, behavioralists then go on to suggest
that such behavior is hard to achieve and that
their accounts may be more descriptively accu-
rate. I suggest that all approaches to strategic
decision making operate in the world of second
best. We should not privilege one approach as
having a universal a priori claim of superior-
ity. To do so creates false divides in the field
and obscures terribly important lines of future
inquiry.
Copyright 2011 John Wiley & Sons, Ltd.
ACKNOWLEDGEMENTS
This paper benefited from the thoughtful comments
of Special Issue Editor Thomas Powell and two
anonymous reviewers.
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