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Stages of Organizational Transformation in TransitionEconomies: A Dynamic Capabilities Approach

Sarah E. A. Dixon, Klaus E. Meyer and Marc DayUniversity of Bath; University of Bath; Henley Business School, University of Reading

abstract How do organizations previously dominated by the state develop dynamiccapabilities that would support their growth in a competitive market economy? We develop atheoretical framework of organizational transformation that explains the processes by whichorganizations learn and develop dynamic capabilities in transition economies. Specifically, theframework theorizes about the importance of, and inter-relationships between, leadership,organizational learning, dynamic capabilities, and performance over three stages oftransformation. Propositions derived from this framework explain the pre-conditions enablingorganizational learning, the linkages between types of learning and functions of dynamiccapabilities, and the feedback from dynamic capabilities to organizational learning thatallows firms in transition economies to regain their footing and build long-term competitiveadvantage. We focus on transition contexts, where these processes have been magnified andthus offer new insights into strategizing in radically altered environments.

INTRODUCTION

Enterprises in transition economies have faced unusually radical transformation pro-cesses, while lacking both the resources and capabilities to face competitive markets,and the internal routines and processes that would facilitate organizational change(Newman, 2000; Uhlenbruck et al., 2003). At the outset, firms were often constrainedby their socialist institutional imprinting (Kriauciunas and Kale, 2006). Their opera-tional capabilities were also geared towards a now defunct economic system. Thissystem had discouraged entrepreneurship, innovation and experimentation, such thatthe dynamic capabilities required for organizational change and adaptation in a vola-tile environment are largely absent. This setting thus provides a useful context toexplore how organizations develop dynamic capabilities and bring about organiza-tional change when radical external institutional changes render their organizational

Address for reprints: Sarah E. A. Dixon, University of Bath, School of Management, Bath BA2 7AY, UK([email protected]).

© 2009 Blackwell Publishing Ltd and Society for the Advancement of Management Studies. Published by BlackwellPublishing, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

Journal of Management Studies 47:3 May 2010doi: 10.1111/j.1467-6486.2009.00856.x

capabilities largely irrelevant. In particular this setting raises questions about how orga-nizations, facing radical external institutional change, develop the dynamic capabilitiesrequired to compete in a volatile market economy. How does this process interact withleadership and organizational learning, and how is it conditioned by and supportive toorganizational performance?

In the present paper, we explore these questions and develop a theoretical frame-work that explains how changing leadership styles and processes of organizationallearning lead to the development of different types of dynamic capabilities over sub-sequent stages of organizational change and adjustment to a new market economy. Wesynthesize and extend rather than elaborate existing theory on organizational trans-formation in transition economies which, to date, has been partial in applying trans-action cost theory, institutional theory or the resource-based view (Estrin et al., 2009;Meyer and Peng, 2005; Wright et al., 2005). An important gap in the literature thusremains with respect to the interdependencies of different aspects and levels of orga-nizational change processes. Theoretical frameworks have been proposed that inte-grate organizational learning and organizational change theory (Newman, 2000) orresource-based and organizational learning theories (Uhlenbruck et al., 2003). Relatedwork investigates the links between governance, firm capabilities and restructuring(Filatotchev et al., 2003), or the relationships between top management team and orga-nizational learning (Dixon et al., 2007). However, these frameworks are of a staticnature and do not distinguish stages of transformation that an organization in a tran-sition economy is likely to experience. In this respect, several studies have identifiedvery distinct stages of economic transition (Peng, 2003; Peng and Zhou, 2005; Pufferet al., 2000). Our theorizing therefore synthesizes prior research and in doing so is ableto develop a clearer elaboration of three stages of transformation that we analyse atfour conceptual levels – leadership, organizational learning, dynamic capabilities, andperformance. We demonstrate the interrelationships between these constructs atvarious stages of transition, thus presenting a more integrated understanding of theprocesses by which firms develop novel capabilities allowing them to thrive in a novelmarket economy context.

Firms in transition economies face particular challenges, because of the nature of theirembeddedness in an economic and social system that is quickly becoming obsolete. Yet,gradually their challenges become more similar to those of firms facing environmentalchange in mature market economies. Moreover, the underlying processes are similar,which makes our framework also relevant to mature organizations in other contextsfacing unanticipated radical change in their environment. As such, although we focus onthe specific context of transition economies, we argue that our framework may, byextension, offer insights to scholars interested in radical organizational change anddynamic capabilities. Specifically we highlight micro-processes involved in the develop-ment of dynamic capabilities in volatile environments, including operational and higherorder capabilities, and learning processes that are incremental versus those that involvenew knowledge trajectories (Easterby-Smith et al., 2009). This broader contribution addsto existing work on the micro-foundations of capabilities and their evolution over time inline with changes in the environment (Ambrosini et al., 2009; Teece, 2007; Teece et al.,1997).

Stages of Organizational Transformation in Transition Economies 417

© 2009 Blackwell Publishing Ltd and Society for the Advancement of Management Studies

THEORETICAL PERSPECTIVES ON ORGANIZATIONALTRANSFORMATION

Recent literature on organizational change in both transition and developed econo-mies provides key concepts as a theoretical foundation for our research (Tables I andII). Dynamic capabilities are an appropriate perspective for developing a theory oforganizational change in turbulent environments because they are focal to the orga-nizational processes that enable growth and adaptation in changing environments(Eisenhardt and Martin, 2000; Teece et al., 1997). They are grounded in managerialcapabilities and organizational learning: the former, because managers play crucialroles in developing organizational capabilities (Teece et al., 1997) and the latter, sinceorganizational learning both leads to dynamic capabilities and is a dynamic capability(Zollo and Winter, 2002). In contrast, operational capabilities are defined as ‘zero-level’ capabilities, being the ‘how we earn a living now’ capabilities (Winter, 2003,p. 992).

The concepts of operational and dynamic capabilities are of pivotal interest to orga-nization scholars as well as management practice (Eisenhardt and Martin, 2000; Helfatet al., 2007; Teece et al., 1997). Dynamic capabilities have been defined as ‘the firm’sability to integrate, build, and reconfigure internal and external competencies to addressrapidly changing environments’ (Teece et al., 1997, p. 516). They constitute the firm’ssystematic methods for modifying operating routines and are created by organizationallearning (Zollo and Winter, 2002). They enable both new resource creation via ‘recon-figuration, leverage, learning and integration’ (Bowman and Ambrosini, 2003, p. 293)and alteration of an existing resource base by creating, integrating, recombining andreleasing resources (Eisenhardt and Martin, 2000).

Dynamic capabilities are created by organizational learning (Eisenhardt and Martin,2000; Mahoney, 1995; Pisano, 2000) in a process of co-evolution of past experience,knowledge articulation and knowledge codification processes (Zollo and Winter, 2002).

Table I. Constructs used in frameworks for organizational transformation

Constructs References

TMT/leadership Barr et al. (1992); Clark and Soulsby (1995, 1999, 2007); Dixon and Day(2007); Dixon et al. (2007); Filatotchev et al. (2003); Pettigrew et al. (1992);Pettus et al. (2009); Uhlenbruck et al. (2003); Vera and Crossan (2004)

Institutional theory Clark and Soulsby (1995, 1999, 2007); Newman (2000); Peng and Zhou(2005); Peng et al. (2005); Pettigrew et al. (1992)

(Internal) administrativeheritage

Clark and Soulsby (1995, 1999); Dawson (2003); Dixon and Day (2007);Newman (2000); Pettigrew et al. (1992)

Organizational learning Dixon and Day (2007); Dixon et al. (2007); Newman (2000); Peng and Zhou(2005); Uhlenbruck et al. (2003); Vera and Crossan (2004)

Dynamic capabilities Pettus et al. (2009); Rindova and Kotha (2001)Operational capabilities Dixon et al. (2007); Filatotchev et al. (2003); Peng and Zhou (2005)Resources Barr et al. (1992); Filatotchev et al. (2003); Uhlenbruck et al. (2003)

S. E. A. Dixon et al.418


However a further explanation of the processes underlying these functions is required,linking specific functions of dynamic capabilities with specific processes of organizationallearning.

Our paper presents a more detailed understanding of the micro-foundations ofdynamic capabilities and how these are linked to organizational learning. Helfat et al.(2007) distinguish two functions of dynamic capabilities as (1) the ‘deployment’ ofresources in a firm and (2) the search, selection and creation of resources, both of whichserve ‘to purposefully create, extend or modify’ (p. 4) the firm’s resource base. Teece

Table II. Studies of organizational transformation

Authors Framework Context Type

Barr et al. (1992) Cognitive change, strategic actions, andorganizational renewal

Developedeconomies

Empirical

Clark and Soulsby (1995) Social, economic, and institutional change, andtransformation of former state enterprises

Transitioneconomies

Empirical

Clark and Soulsby (1999) Adoption of multi-divisional form in largeenterprises

Transitioneconomies

Empirical

Clark and Soulsby (2007) Processual analysis of top management andorganizational change

Transitioneconomies

Empirical

Dawson (2003) A processual framework for organizationalchange

Developedeconomies

Empirical

Dixon and Day (2007) TMT, administrative heritage, and absorptivecapacity

Transitioneconomies

Empirical

Dixon et al. (2007) Organizational learning Transitioneconomies

Empirical

Filatotchev et al. (2003) Corporate governance and learning capacity Transitioneconomies

Empirical

Newman (2000) Effect of institutional upheaval on second-orderorganizational learning

Transitioneconomies

Theoretical

Peng (2003) A two-phase model of institutional transitions Emergingeconomies

Theoretical

Peng and Zhou (2005) Evolution of network strategies and institutionaltransitions in Asia

Emergingeconomies

Theoretical

Peng et al. (2005) What determines the scope of the firm:institutional relatedness

Transition anddevelopedeconomies

Theoretical

Pettigrew (1987) Context and action in the transformation of thefirm

Developedeconomies

Empirical

Pettigrew et al. (1992) Contexts for change Public sector EmpiricalPettus et al. (2009) Sequential development of dynamic capabilities Deregulated

industriesEmpirical

Rindova and Kotha(2001)

Relationship between continuous morphing andcompetitive advantage

Developedeconomies

Empirical

Uhlenbruck et al. (2003) Resource development in privatized firms Transitioneconomies

Theoretical

Vera and Crossan (2004) Strategic leadership and organizational learning Developedeconomies

Theoretical



(2007) examines the micro-foundations of three disaggregated aspects of dynamic capa-bilities: sensing and seizing opportunities, and maintaining competitiveness throughreconfiguration. We build on both studies, adopting Helfat et al.’s terminology, in devel-oping our framework. The concept of dynamic capabilities has not yet been applied tofirms in transition economies, as research has focused on operational capabilities (forinstance, Hitt et al., 2000). Yet, as we shall demonstrate, even the operational capabili-ties, that are required for short-term survival, have to be generated by some form ofdynamic capabilities.

Transformational change represents an organizational metamorphosis (Meyer, 1982)or a change in organizing templates (Greenwood and Hinings, 2006). It can be triggeredby changes in the external environment (Meyer, 1982) or by a change in the topmanagement team (TMT) (Virany et al., 1992). Both triggers are manifest in transitioneconomies and we thus utilize both institutional theory and leadership theories. Institu-tional theory is important because the behaviour of firms cannot be separated from theirinstitutional environment – they are embedded in the broader socio-political environ-ment in which competition takes place (Granovetter, 1985; Peng et al., 2005; Spiceret al., 2000). The study of transformation in transition economies therefore needs tolook beyond the internal processes of the organization. The degree of institutionalembeddedness (Granovetter, 1985) in the old planned economy is likely to constrainorganizational change since organizational capabilities fit an obsolete economic andsocial system. Leadership theories suggest that top managers are an important resource.Their knowledge determines the organization’s ability to leverage and exploit otherresources and to adapt to changes in the environment (Barney, 1986; Mahoney, 1995;Penrose, 1959). This is especially true in transition economies, where firms face transfor-mation challenges of magnitudes rarely seen elsewhere.

Organizational transformation is constrained by organizational history, inherited rou-tines and managers’ bounded rationality. These represent the firm’s administrativeheritage, that is the internal configuration of assets, capabilities, managerial responsibili-ties and influence that continues even after structural change (Bartlett and Ghoshal,1989). In transition economies, these constraints are magnified, as not only are thehistorical resources of firms inefficient (Uhlenbruck et al., 2003), but also the inheritednorms, values, and assumptions underlying economic activity are completely different tothose of a market economy (Newman, 2000). This imprinting from the previous socialistinstitutional and economic system impacts firms’ awareness of the need to changeoperating capabilities that were fitted to a planned rather than a market economy(Kriauciunas and Kale, 2006). These historically grounded constraints have proven to behard to overcome (Dixon and Day, 2007; Michailova and Husted, 2003; Vlachoutsicosand Lawrence, 1996).

An important element of the transformation process is organizational learning – theprocess of improving actions through better knowledge and understanding (Fiol andLyles, 1985). In particular the concepts of exploitation and exploration (March, 1991) arerelevant in transition economies because they help to explain how a firm (1) acquiresknowledge that is required for survival in a market economy and (2) explores fornew possibilities of competitive advantage in a challenging and unstable institutionalenvironment. Three theoretical models of organizational transformation in transition



economies incorporate organizational learning: Uhlenbruck et al. (2003) combine theresource-based view and organizational learning; Newman (2000) integrates institu-tional, organizational learning, and organizational change theory; and our prior study(Dixon et al., 2007) links TMTs, learning, and capabilities. We advance this literature byelaborating the focal process of developing dynamic capabilities as part of a holistictheoretical framework to explain the link between different types of learning, dynamiccapabilities and effects on performance.

ORGANIZATIONAL TRANSFORMATION IN TRANSITION ECONOMIES

Managerial processes vary at different stages of organizational transformation in transi-tion contexts (Peng, 2003; Puffer et al., 2000). We distinguish three stages, which weanalyse at four interlocking conceptual levels: leadership, organizational learning,dynamic capabilities, and performance (Figure 1). In Stage I, Break with the Past, the mainchallenge is to bring about awareness of the need to change, in order to dislodgeoperational capabilities that are no longer of use. In Stage II, Exploitation and Deployment,exploitation learning leads to the development of dynamic capabilities in the deploymentmode that enable the organization to reconfigure, leverage, and integrate resources, andthus to develop the threshold operational capabilities for short-term survival in a market

Dynamic

Capabilities(Deployment)

ContingentLeadership Style

(Transformational/

Transactional)

P4

P5

P7P6

Transactional

Leadership Style

Stage IIExploitation and Deployment

Stage IIIExploration and Innovation

P3

Stage IBreak with the Past

Socialist

Institutional

Imprinting

Transformational

Leadership Style

P2a

P1

P2b

TMT

Heterogeneous

Entrepreneurial

Outsiders

Awareness of

Need to Change

Organizational

Learning

(Exploration)

DynamicCapabilities

(Search &

Innovation)

P8

Sustainable

Competitive Advantage

Organizational

Learning(Exploitation)

P9

P10

Leadership

OrganizationalLearning

DynamicCapabilities

Performance

P11

Short-term Survival

Figure 1. Stages of organizational transformation in transition economies



economy. In Stage III, Exploration and Innovation, exploration learning generates dynamiccapabilities in their search and innovation function that are important for the organiza-tion to acquire the strategic flexibility to adapt to changes in the environment, and thusto secure sustained competitive advantage in a market economy with an unstable insti-tutional context. Feedback loops lead from the dynamic capabilities of search andinnovation to exploitation and exploration learning, enabling the constant refreshing ofstrategic capability and thus ongoing survival and sustainable competitive advantage.

Stage I: Break with the Past

Organizations adapt their routines to their environment. When this environment under-goes radical change they may find themselves with a mismatch between their establishedcapabilities and routines, and the new environment. Members of the organization arewell adapted to the old routines which therefore tend to endure. Historical endowmentsare ‘sticky’ in the sense that in the short term firms are stuck with their existing resourcesand structures, and the resultant processes that drive firm operations (Teece et al., 1997).Their capabilities ‘fit’ an obsolete system. Organizational change is thus constrained bythis ‘administrative heritage’ (Bartlett and Ghoshal, 1989) or what Kriauciunas and Kale(2006) describe specifically as ‘socialist organizational imprinting’ in the case of transitioneconomies. Socialist imprinting refers to ‘the impact of the institutional and marketenvironment characterizing the socialist economy at the time of the firm’s founding onits knowledge sets’ (Kriauciunas and Kale, 2006, p. 660). Therefore the first requirementfor organizational transformation is to create an awareness in the organization of a needto change, such as to decouple members from their old routines. Whether an organiza-tion succeeds in this break with its past depends on its embeddedness in old institutionsand the characteristics of the leadership team.

Studies of organizational change in developed economies indicate that a firm mustmanage not only its internal but also its external contexts (Pettigrew, 1987). Indeed abasic tenet of institutional theory is that a set of values, norms, and organizationaltemplates exists outside of particular firms that influences the way a firm is managed(Meyer and Bowman, 1977). However, Newman (2000) maintains that this would notapply in transition economies where the institutional context itself is changing radically.The institutional context no longer provides organizing templates, models for action,and sources of legitimacy. In transition economies, markets are continuously changing,emerging, and disappearing while the rules of the game are not yet established. Thus,organizations are affected by fundamental and comprehensive changes in the formaland informal rules of the game (Peng, 2003). The radical change in the institutionalcontext also means that many existing capabilities of firms become defunct in that theyno longer secure survival.

Strategic choice is embedded in the institutional framework, which has a stronginfluence on a company’s ‘genetic coding’ (Peng, 2000). This explains why companies intransition economies differ radically from Western firms. For example, Whitley andCzaban (1998) maintain that in a setting where the state has no coherent set of policiesand oscillates under different pressure groups, short-term ad hoc adjustments to imme-diate pressure may be more rational than undertaking relatively large-scale and highly



risky changes in pursuit of long-run strategic objectives. When the rules of the game arehighly uncertain, organizations are not able to invest in new capabilities and skills andwill therefore, by default, continue in their old ways (Peng and Heath, 1996). Entrench-ment behaviour by incumbents may act as a barrier to the acquisition of requiredresources and contribute to the maintenance of core rigidities (Newman, 2000). Indeed,the better the incumbents’ capabilities fit with the pre-transition context, the moredifficult it may be for them to transform (Peng, 2003). Firms thus differ in the extent towhich they adapt to the environment (Meyer, 1982; Meyer et al., 1990). In transitioneconomies, many of the large state owned enterprises have become corporate dinosaurs,entrenched in old behaviours and unable to make the first steps of adapting to a radicallychanged environment.

The rapid mass privatization that took place in Central and Eastern Europe destroyedthe old system, but did not create the institutional foundations that would enable it toachieve the required transformation of capabilities post privatization (Spicer et al., 2000).Even after privatization, organizations often ‘stick’ to their institutional templates( Johnson, 2000). Their strategies thus depend on their institutional relatedness – ‘thedegree of informal embeddedness or interconnectedness with dominant institutions’(Peng et al., 2005, p. 623). Therefore we suggest that the firm’s awareness of the need tochange is limited by its socialist institutional imprinting, i.e. the degree of institutionalembeddedness of the firm in the old system of the planned economy:

Proposition 1: In organizations in a transition economy, socialist institutional imprint-ing has a negative effect on the awareness of the need to change.

Research in developed economies has shown that managerial cognition has an importantinfluence on the ability of organizations to adapt (Tripsas and Gavetti, 2000). Managershave bounded rationality and therefore often develop a system of beliefs or dominant logic

for the organization based on a shared history (Prahalad and Bettis, 1986). Managersmay thus have difficulty adapting their mental models (Barr et al., 1992; Brown andEisenhardt, 1998; Greenwood and Hinings, 2006; Teece et al., 1997).

In transition economies managerial cognition is bounded by the experience of workingin a planned economy. Managers who were brought up in the old system wouldbe incapable of conceiving how to adapt to the new one (Meyer and Møller, 1998;Newman, 2000). If top managers stay in power during the transition process, they arelikely to have limited ability to change themselves or their organizations as they wouldtend to reinforce past routines.

In developed economies Wiersema and Bantel (1992) suggest that strategic change is afunction of receptivity to change, willingness to take risk, diversity of information sourcesand perspectives, and innovative decision making. This enhances the firm’s ‘absorptivecapacity’ (Cohen and Levinthal, 1990) – its ability to assimilate useful external innova-tions – because of the broader set of experiences available for interpreting and inter-nalizing new knowledge (Hambrick and Mason, 1984; Wiersema and Bantel, 1992).Changes in the management team can result in the unlearning of old routines and anincreased probability of strategic reorientation and discontinuous organizational change(Tushman and Rosenkopf, 1996; Virany et al., 1992).



Research in transition economies suggests that post-socialist enterprises are more likely tochange and restructure with a younger, marketing-oriented, short-tenured, well-educated, and heterogeneous TMT (Clark and Soulsby, 2007). Studies have also shownthat outsider managers with an entrepreneurial approach have a positive effect onorganizational restructuring and absorptive capacity (Dixon et al., 2007; Filatotchevet al., 2003).

Heterogeneous, entrepreneurial TMTs, containing outsiders, are likely to have highabsorptive capacity, and thus understand that different capabilities are required for thenew economic conditions. They are thus more likely to create an awareness of the needto change within their organization, despite the stultifying effect of the socialist institu-tional imprinting. Hence:

Proposition 2a: In the initial stage of organizational transformation, a top managementteam that is heterogeneous, entrepreneurial, and contains outsiders has a positiveeffect on the organization’s awareness of the need to change.

Studies of management style in developed economies have focused on transformationaland transactional leadership (Bass, 1985, 1998). The transformational style increasesabsorptive capacity (Garcia-Morales et al., 2007) and is thus considered most appro-priate for radical organizational change (Vera and Crossan, 2004). This style involveschanging the basic values, beliefs, and attitudes of subordinates and is described ascharismatic, inspirational, intellectually stimulating, and individually considerate(Avolio et al., 1999).

In transition economies, Elenkov’s (2002) analysis of leadership in 350 companies inRussia, established that transformational leadership predicted organizational perfor-mance above and beyond the impact of transactional leadership. Russian organizationsare characterized by a command-and-control approach which is manifested in authori-tarianism, obedience to authority, the use of coercive power, and an emphasis onrank and status (Kets de Vries, 2001). Russian top managers have typically beenhighly directive, strong leaders, with centralized decision making and a rigid hierarchy(McCarthy et al., 2005). Our earlier work (Dixon et al., 2007) established that a top-down management style was the most appropriate for breaking with administrativeheritage. We extend this study by introducing the concepts of transformational and trans-actional leadership to allow sharper theorizing. Thus we consider that in the earlystages of organizational transformation a transformational management style may bemore effective in changing the basic values, beliefs, and attitudes of managers withinthe organization and thus increasing its awareness of the need to change:

Proposition 2b: In the initial stage of organizational transformation, a transformationalleadership style has a more positive effect on the organization’s awareness of the needto change than a transactional leadership style.

Organizational learning is vital for securing survival in a new institutional environ-ment. But it is inhibited by the tendency of managers to interpret information based onprior knowledge or frames of reference (Cohen and Levinthal, 1990). Learning requires



an organization to reconstruct and adapt its knowledge base (comprising skills, struc-tures, and values), and to creatively destroy outmoded practices and attitudes (Pettigrewand Whipp, 1991).

The organizational learning of companies in transition economies is limited by theirexperience in a different economic system. Their prior knowledge, accumulated in theplanned economy, is not relevant to survival and success in a market economy, thereforeorganizational transformation is inhibited by both the lack of related knowledge and alarge learning gap (Hitt et al., 2000; Newman, 2000). Notably, the cognitive ability ofmanagers and employees to envisage major change and to identify and implementradically different routines is limited. Organizations, constrained by socialist institutionalimprinting, have inherited capabilities, practices, and attitudes inappropriate for amarket economy. Managers brought up in a planned economy will have learned thebehaviours necessary for success in that environment. Therefore organizational learningcan only take place if the organization becomes aware of the need to change and istherefore open to new ways of thinking and new business practices. This puts it in aposition to exploit the knowledge that exists, for example in the West, about how tosurvive in a market economy.

Proposition 3: In the initial stage of organizational transformation, an increase in theorganization’s awareness of the need to change has a positive effect on exploitationlearning.

The initial stage of organizational transformation in transition economies differs mostfrom what might be expected to happen in developed economies, precisely because ofthe extent of the institutional imprinting and the ‘stickiness’ of the administrative heri-tage. These concepts might, however, have relevance for Western organizations that are,for instance, constrained by historic paradigms in their technology, by their businessmodels, or their methods of assessing the environment (e.g. risk management practices;Haldane, 2009).

Stage II: Exploitation and Deployment

In the second stage of transformation, organizations engage in exploitation, learning toenable the deployment function of dynamic capabilities that facilitates the reconfigura-tion of resources. This process may be enhanced by a contingent approach to leadership,adopting a transformational style for parts of the organization where learning is slowest,but moving to a transactional style to empower parts of the organization that aremore advanced in their understanding of the requirements for survival under marketconditions.

In the literature on developed economies two types of organizational change aredescribed: continuous, or first order change, which is incremental and convergent; anddiscontinuous, or second order change, which is transformational (Meyer et al., 1990).These two modes of change can be linked to two leadership styles: transactional andtransformational.



Transactional leaders set goals and develop agreements about what is expected fromthe organization, whereas transformational leadership is inspirational and helps theorganization to reframe the future (Bass, 1985, 1998). The transactional leadership styleserves to increase the robustness of the existing organization, whereas transformationalleadership seeks to change it. Thus, Vera and Crossan (2004) suggest a contingent viewof leadership. In times of change, when a firm’s institutionalized learning has to bealtered, transformational leadership is required. In times of stability, transactional lead-ership is appropriate for the process of refreshing, reinforcing, and refining currentlearning.

In the transition economy context, our previous study (Dixon et al., 2007) suggested thatdifferent stages of organizational learning are associated with different leadership styles:initially an authoritative top-down approach to facilitate exploitation learning; followedby a more democratic approach empowering the organization and encouraging explo-ration learning. Our deeper theorizing suggests that both leadership styles can coexist,addressing the contingent needs of organizations undergoing change. Thus, at theintermediate stage of organizational transformation, transformational management isstill evident in the parts of the organization that have been slower to break with theadministrative heritage and therefore slower to unlearn and change, for exampleregional subsidiaries. However, transactional leadership becomes appropriate for partsof the organization that have already started to understand what is required for short-term survival, for example head office.

We suggest that a contingent approach, applying the appropriate management stylefor the given situation, is most likely to advance organizational learning in the interme-diate stage of transformation. On the one hand a transformational approach continuesto increase the awareness of the need for change and the absorptive capacity of theorganization via the break with the socialist administrative heritage and unlearning of oldroutines. On the other hand, a transactional approach, empowering those parts of theorganization, that learn and adapt faster than others, is important for acceleratingexploitation learning.

Proposition 4: In the intermediate stage of organizational transformation, a contingentleadership style has a more positive effect on organizational learning than either atransformational or a transactional style alone.

Organizational learning in both its exploitation and exploration functions is a foun-dation for developing dynamic capabilities, and thus indirectly for securing the survivalof the organization in a market economy. In transition economies, exploitation learning isrequired to develop the operational capabilities required for survival in a marketeconomy, but missing in a centrally planned economy, for instance marketing, financeand HR capabilities, corporate governance, information sharing, and the fostering ofinnovation (Filatotchev et al., 2003; Hitt et al., 2000; Peng, 2000; Puffer, 1994). Exploi-tation learning involves selecting, implementing, and adapting systems and capabilitiesthat are already available in organizations operating in the Western market economies.By learning about, and then deploying, the new capabilities (via the deployment functionof dynamic capabilities), the organization is better adapted to a market economy and its



chances of survival are enhanced. Exploitation learning supports the development of newroutines – the dynamic deployment and/or redeployment of resources – which helps totransform the organization. Thus these dynamic capabilities are higher order capabilitiesthat manipulate resources and capabilities that directly engender rent (Zott, 2003). Thesedynamic capabilities are specifically involved with redesigning routines around newcapabilities. The dynamic capability routines co-evolve with exploitation learning, uti-lizing knowledge that already exists in developed economies to deploy, adapt, andreconfigure its processes and operations in order to create new operational capabilitiesthat are taken for granted the West. Exploitation learning thus contributes to thedeployment function of dynamic capabilities. Yet by its nature it cannot generate fun-damentally new capabilities because the knowledge being exploited, although new forthe organization in a transition context, already exists elsewhere. It is therefore devel-oping the threshold capabilities for short-term survival.

Proposition 5: In the intermediate stage of organizational transformation, the greaterthe level of exploitation learning, the greater the deployment function of dynamiccapabilities.

Proposition 6: In the intermediate stage of organizational transformation, an increase inthe deployment function of dynamic capabilities will increase the likelihood of short-term organizational survival.

This stage of organizational transformation is likely to differ between transition anddeveloped economies due to the radical nature, the extent and the significance of thechange required to reach threshold levels for survival in a transition context. Westerncompanies, even those most resistant to change and constrained by their history, wouldbe unlikely to need such a comprehensive overhaul of operational capabilities.

Stage III: Exploration and Innovation

In the advanced stage of organizational transformation the organization moves beyondmere survival to securing sustainable competitive advantage. March (1991) maintainsthat organizations need both exploitation and exploration to succeed. However,researchers dispute whether it is possible to simultaneously engage in both types oflearning (Gupta et al., 2006), since exploration and exploitation compete for scarceorganizational resources (March, 1991). Benner and Tushman (2003) and He and Wong(2004) suggest the possibility of an ambidextrous organization, balancing continuous anddiscontinuous change and the two types of learning. Burgelman (2002), on the otherhand, concludes from his longitudinal study of the Intel corporation that exploitation andexploration learning were temporally differentiated in a process of punctuated equili-brium. We argue that in transition economies the latter case is more likely since evenexploitation of threshold operational capabilities requires radical transformation neces-sitating the focus of the organization on the urgent task of survival.

Survival requires what Winter (2003) called zero-level capabilities, being the ‘how weearn a living now’ capabilities (p. 992). They represent the organization’s ability to



produce a desired output (tangible or intangible), which he distinguishes from dynamiccapabilities that are the higher-order capabilities to manipulate operational capabilities.These ‘substantive capabilities’ (Zahra et al., 2006) facilitate organizational efficiencyand effectiveness.

However, operational capabilities of the type in common use by companies in amarket economy are not in themselves sufficient to secure sustainable competitive advan-tage. For this, the organization needs to search for and create new business models thatadd value in the specific context of the transition economy (London and Hart, 2004;Prahalad, 2004). Firms that are still in crisis due to failure to adapt to a market economydo not have spare capacity for search and innovation – they are likely to focus onadaptation and acquisition of existing best practice. However, once firms have securedthe basic operational capabilities for survival, after the intermediate stage in our model,they are then likely to have greater potential to search, take risks, experiment, andinnovate – key characteristics of exploration (March, 1991). Thus we subscribe toBurgelman’s (2002) punctuated equilibrium model.

Proposition 7: In the advanced stage of organizational transformation, the stronger thecapabilities for short-term survival the stronger the likelihood of exploration learning.

In developed economies, Heller and Yukl (1969) classify leadership styles on a continuumfrom no subordinate influence to complete subordinate influence in relation to specificsituations. More recently, the balance has swung towards greater subordinate influenceand empowerment. Empowerment has been described as both a relational dynamic anda motivational construct (Conger and Kanungo, 1988). As a relational dynamic it is theprocess by which a leader shares power with subordinates and as a motivational con-struct it implies an enabling, rather than just a delegation (Conger and Kanungo, 1988).Recent empirical research (Mom et al., 2007) indicates that top-down knowledge flows ofmanagers positively relate to exploitation activities, whereas bottom-up and horizontalknowledge flows of managers positively relate to these managers’ exploration activities.

Given the complexity and unpredictability of change in the institutional environment,we maintain that in the advanced stage of organizational transformation the TMT canno longer be the main interface of the organization with the environment or the solearbiter of creativity and innovation. Transactional leadership within an empoweredorganization with delegated authority and motivation to act, encouraging bottom-upand horizontal knowledge flows, is more likely to foster exploration learning at that stage.

Proposition 8: In the advanced stage of organizational transformation, a transactionalleadership style has a more positive effect on exploration learning than a transforma-tional leadership style.

Exploration refers to learning gained through processes of concerted variation,planned experimentation, and play (Baum et al., 2000), and involves learning along anentirely new trajectory (Gupta et al., 2006). This may be necessitated by changes in theenvironment that require a continuous rethinking of current strategic actions, organiza-tion structure, communications systems, corporate culture, asset deployment, and



investment strategies. This requires flexibility and the ability to balance stable and fluidstates of the organization (Hitt et al., 1998). Hence exploration learning is necessary toensure the strategic flexibility to act in a volatile environment (Hitt et al., 1998; Teeceet al., 1997).

Specific functions of dynamic capabilities result from exploration learning, for instancethe ‘innovative’ factor (Wang and Ahmed, 2007), the search, select, and create function(Helfat et al., 2007), and the sensing and shaping of opportunities and threats and seizingopportunities (Teece, 2007). Easterby-Smith and Prieto (2007) also explicitly identifiedboth exploitation and exploration learning as antecedents to dynamic capabilities, explo-ration involving moving outside the boundaries of current practice.

In transition economies, organizations need to engage in exploration learning, because thechallenges of the environment may require new business models for that specific context(London and Hart, 2004; Prahalad, 2004). Market conditions are continuously changingin a transition economy and the institutional environment is unstable (Newman, 2000;Uhlenbruck et al., 2003). In other words, merely importing and exploiting Westernbusiness techniques may not suffice to secure sustainable competitive advantage. Firmslearn through experimentation and internal development of new routines and capabili-ties adapted to the specific context, rather than the imposition of imported routines fromothers (Kogut and Zander, 1996).

We therefore suggest that exploration learning enables the search and innovationfunction of dynamic capabilities – this is the function that goes beyond manipulating anddeploying capabilities already in existence (albeit in the West). Like the deploymentfunction described above, it is a higher order capability that does not merely useexploration learning in seeking new directions for development, but also manages thatexploration and implements its outcomes, such that routines are established to utilize thenew ideas and knowledge. This is essential in the final stage of organizational transforma-tion to enable the strategic flexibility to adapt to an unpredictable and volatile environ-ment. Key concepts in differentiating between the constructs of exploration learning andthe search and innovation function of dynamic capabilities are (a) that the learninginvolves routines around ‘how to’ do something differently, whereas (b) dynamic capabili-ties involve both enabling routines for exploration learning to take place and implemen-tation routines for ‘what’ the organization actually does with the new knowledge.However, without exploration learning there would be nothing to implement, therefore:

Proposition 9: In the advanced stage of organizational transformation, the greater theexploration learning the greater the search and innovation function of dynamiccapabilities.

Teece (2007) has disaggregated dynamic capabilities into ‘the capacity (1) to sense andshape opportunities and threats, (2) to seize opportunities and (3) to maintain competi-tiveness through enhancing, combining, protecting, and, when necessary, reconfiguringthe business enterprise’s intangible and tangible assets’ (p. 1319). These categoriesbroadly correspond to Helfat et al.’s (2007) functions of search, select, and creation (1and 2), and deployment (3). Categories (1) and (2) correspond to what Ng (2007) calls‘strong form’ dynamic capabilities. These involve the discovery of new resources and uses



that may be a source of competitive advantage (Newbert, 2008). They enable organiza-tions to develop the strategic flexibility that is necessary for long term competitiveadvantage in an uncertain and changing environment. Strategic flexibility thus providesa link between the capabilities of the firm, and what is going on in the environment(Kraatz and Zajac, 2001), and helps companies to respond to crises in their competitiveenvironment (Grewal and Tansuhaj, 2001; Hitt et al., 1998).

Being aware of, and adapting to the environment, is critical for newly privatized firmsin transition economies. Strategic flexibility is particularly important for firms facing signifi-cant political and economic changes, an uncertain institutional environment, and poorlydeveloped markets (Uhlenbruck et al., 2003). Firms, according to Newbert (2008), con-tinuously have to adapt or proactively develop strategic responses to external change intheir efforts to secure sustainable competitive advantage (defined by Barney (1991) as theimplementation of a value creating strategy not simultaneously being implemented bycompetitors and which cannot easily be imitated). The dynamic capabilities of searchand innovation underpin strategic flexibility and thus may contribute to sustainablecompetitive advantage. Although the latter is by no means guaranteed, due to the riskynature of search and innovation (Helfat et al., 2007), nevertheless we suggest that thesedynamic capabilities of search and innovation are necessary, even if not sufficient, forsustainable competitive advantage, thus:

Proposition 10: In the advanced stage of organizational transformation, an increase inthe search and innovation function of dynamic capabilities increases the likelihood ofsustainable competitive advantage.

This final stage of organizational transformation is likely to show less distinct differ-ences between transition and developed economies, though the transition context tendsto show more volatility in the competitive and institutional environment. An example ofWestern firms facing challenges that loosely resemble those of firms in transition econo-mies is given by Pettus et al. (2009). They explore organizational change followingindustry deregulation and, like our framework, focus on the dynamic capabilities ofmanagerial capabilities, organizational learning and strategic flexibility. The problemsassociated with industry deregulation are similar to those encountered in transitioneconomies – both have to cope with an administrative heritage that is inappropriate fora competitive market environment. Our framework of organizational transformationcomplements Pettus et al.’s sequential analysis of dynamic capabilities. Both frameworksemphasize the importance of a TMT with new mental models, and different types oflearning.

Teece (2007), in explicating dynamic capabilities, refers to ‘entrepreneurial manage-rial capitalism’ (p. 1346), which incorporates the recognition of problems and trends, thedirection of resources, and the reshaping of organizational structures to take advantageof opportunities. Similarly we maintain that the dynamic capabilities of search andinnovation are the drivers of entrepreneurial routines that constantly refresh the orga-nizational learning processes. In other words, for ongoing survival and long-term sus-tainable advantage there is a feedback loop from the search and innovation function ofdynamic capabilities to exploitation and exploration learning. This leads to the constant



refreshing of operational capabilities and maintains the strategic flexibility of the orga-nization, thereby avoiding the development of core rigidities, organizational inertia, andan administrative heritage that no longer fits the requirements for survival and success.

Proposition 11: Dynamic capabilities of search and innovation have a positive impacton both exploitation and exploration learning.

A challenge to dynamic capabilities theory is the apparent inconsistency betweenorganizational renewal and the routine nature of organizational capabilities (Schreyöggand Kliesch-Eberl, 2007). Our framework shows how dynamic capabilities theory canindeed embrace both change and routines, and how constant refreshing of this strategiccapability through organizational learning is vital for organizational success in radicallychanging environments. Our framework thus provides both a theory of organizationaltransformation and a theory of potential sustained competitive advantage in conditionsof environmental change.

CONCLUSIONS AND RECOMMENDATIONS FOR FURTHER RESEARCH

Our three-stage integrative framework of organizational transformation provides a basisto analyse complex organizational transformation processes in contexts of radical envi-ronmental change. It extends earlier theoretical frameworks on transition economies,notably Newman (2000) and Uhlenbruck et al. (2003). In explicating the framework wehave added to dynamic capabilities theory by explaining the linkages, at different stagesof the transformation process, first between exploitation learning and the deploymentfunction of dynamic capabilities, and second between exploration learning and thesearch and innovation function of dynamic capabilities. Furthermore we have engagedin deeper theorizing to elucidate the micro-foundations of types of organizational learn-ing and dynamic capabilities. In so doing we have contributed to the ongoing work toopen up the ‘black box’ of organizational capabilities and add clarity to the concept ofdynamic capabilities (for instance, Ambrosini and Bowman, 2009; Ambrosini et al.,2009; Easterby-Smith et al., 2009; Teece, 2007; Wang and Ahmed, 2007). The extentand speed of organizational transformation in transition economies has enabled us toseparate out more clearly the two functions of dynamic capabilities – deployment, andsearch and innovation, which perhaps would not have been quite so obvious in lessradical change contexts.

We further propose that different management styles are required over the process oforganizational transformation. At the initial stage, the focal process is building awarenessof the need to change, which is most positively associated with a transformationalleadership style. In the intermediate stage, the most important processes are exploitationlearning and the deployment function of dynamic capabilities. These are associated witha contingent approach (transformational or transactional leadership). In the final stagethe organization moves towards exploration learning, which is associated most positivelywith a transactional leadership style, and supports the search and innovation function ofdynamic capabilities. Finally we propose feedback loops from the dynamic capabilities ofsearch and innovation to exploitation and exploration learning, that serve to continually



refresh the strategic capability of the organization, enabling continuing survival andpotential sustainable competitive advantage.

In summary, we have met the four major criteria for theory building, developed byWeber (2003). First we have articulated constructs that were the focus of prior theoriesin a different way. In particular we have elucidated concepts of dynamic capabilities(deployment, and search and innovation) in the context of organizational learning andchange. We have also isolated the variables in the transformation process at four con-ceptual levels, namely leadership, organizational learning, dynamic capabilities, andperformance. Second we have articulated the relationships between constructs not pre-viously linked in one theoretical framework: specifically we linked exploitation learningwith the deployment function of dynamic capabilities leading to the development ofoperational capabilities and short-term survival; and exploration learning with the searchand innovation function of dynamic capabilities leading to strategic flexibility and sus-tainable competitive advantage. Third we have articulated the boundary conditions ofthe theory in the context of a transition economy with radical institutional change.Finally we articulated the event space of the theory, the set of changes of state of theconstructs for which the theory is expected to hold. This relates both specifically to theprocess of organizational transformation in a transition economy, but also more broadlyto any firms adapting their strategy to radical shifts in their environment.

The conceptualization of the process of organizational transformation in transitioneconomies has facilitated theorizing at four levels: leadership, organizational learning,dynamic capabilities, and performance. The extent, difficulty and speed of the changesin this context provide a clearer focus for theory development – the radical nature of thechanges serves to exaggerate their features, as if with a magnifying glass, permitting aclearer view of the change processes. On the one hand, Western-derived constructs oforganizational learning and dynamic capabilities helped us to explain organizationalprocesses in transition contexts. On the other hand, this study helps to enhance thesetheories and offers insights that may provide new ways to think about the processes oforganizational transformation in Western companies, particularly well-established ones,anchored in their administrative heritage, yet facing radical external change in thefundamental logic how business is done their industry. This suggests that our model mayprovide a starting point for theorizing on firms’ strategic shifts triggered by the globalcrisis unfolding in 2009 (Rumelt, 2009; Sull, 2009; Williamson and Zeng, 2009).

Despite the above contributions this framework has a number of limitations. Forexample, in attempting to clarify the key processes involved in organizational transfor-mation over time it portrays organizational transformation as a simple linear process. Infact there are many areas where constructs overlap and interact with each other, forinstance organizational learning and dynamic capabilities, dynamic capabilities, andstrategic flexibility. The three stages of organizational transformation are also likely tooverlap. Furthermore, although the importance of context is emphasized at the front endof the framework, for reasons of parsimony we did not attempt to show the constantinteractions between organization and context over time.

The theoretical framework would benefit from empirical testing in companies under-going radical organizational transformation both in transition and developed economies.This research could take the form of qualitative case studies, as well as a large-scale



survey. Most of the constructs in the framework could be operationalized on the basis ofprevious studies, however, some thought would need to be given to the operationaliza-tion of the different types of dynamic capabilities. Furthermore, the complexity of theframework may require that a quantitative study be broken up into the three stages of themodel.

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