Adapting to Radical Change: Strategy and Environment in Piece-Rate Adoption During China's Transition

Adaptation to radical change is central to research in organization theory, and some of the most dramatic examples of environmental change have occurred recently in transition economies such as China. I take advantage of change during China’s economic reform to study the relative importance of organizational and environmental factors in producing innovative managerial response. I find that strategic choice predicted innovation in the early stages of reform, but environmental factors increased in salience over time. Intrafirm support, Communist Party connections, and a market orientation produced innovation early in reform. Simple imitation of others was also salient in early years. As reform progressed, managers increasingly imitated other profitable firms and drew on their own experience. My results inform an understanding of both the process by which innovation occurs and firm behavior in transition economies. (Chinese Firms; Chinese Transition; Environmental Change; Corporate Strategy) An ability to adapt to radical change is a key determinant of competitive advantage and organizational survival (D’Aveni 1994, Richardson 1996, Volberda 1996), and the changes taking place in transition economies offer a unique opportunity to study the adaptation process. Instead of long, relatively stable periods in which firms established and maintained competitive advantage, environments in many contexts are increasingly characterized by short periods of competitive dominance marred by frequent disruptions that hinder performance and survival capabilities (D’Aveni 1994, Ilinitch et al. 1998). While awareness of the importance of organizational adaptation has intensified, the factors that facilitate or hinder adaptation have attracted little attention. Some of the most dramatic political and economic changes in recent years have occurred in transition economies, and the early stages of transition may be particularly instructive in the understanding of the adaptation process. Early in reform, basic institutional arrangements governing economic behavior are dismantled, environmental uncertainty intensifies, and managerial response is particularly visible. This study takes advantage of China’s economic transition to explore the relative role of organizational and environmental influences in managerial innovation. I integrate ideas from strategic choice and institutional theory to propose that the dynamics of adoption change in relative salience over time and that different combinations of influences are salient at different stages in the spread of a new practice. I argue that in the early stages of change, strategic choice by managers will be relatively salient. Manager traits, connections, and orientations are likely to be particularly important at this stage of the change process. Over time, however, mimetic processes and firm experience are likely to become increasingly relevant. Moreover, because change seldom occurs instantaneously, the interaction between old and new practices influences both the adoption of the new practice and the nature of emergent organizational strategies. To study adaptation, I explore the process by which Chinese firms adopted piece-rate wages, a quintessential market-oriented labor practice. China’s transition is an ideal context for this study because it had a clear beginning and was radical relative to the changes explored in previous literature. Yet China’s reform was gradual compared to other transition economies, making it is possible to isolate and observe firm response. I focus on piece rates as an illustrative example of a widely adopted market practice that was a clear departure from socialist labor practices. Piece rates were abandoned during the socialist era, but Chinese reformers granted state-owned firms permission to use them in the first years of reform. State officials monitored and directed firm activities during LISA A. KEISTER Adapting to Radical Change 460 ORGANIZATION SCIENCE/Vol. 13, No. 5, September–October 2002 transition, but piece-rate use was left to manager discretion from early in reform. Piece rates accounted for a lower percentage of total employee compensation in China than in other transition economies, but more than 40% of formerly state-owned firms in China used them by 1989 (CASS/UCSD 1990). In the next sections, I provide additional background on China’s reform, propose a series of hypotheses to explain the adoption of piece rates, and use longitudinal (1980–1989) data on 769 formerly state-owned firms to test the hypotheses. The Adoption of Piece Rates During China’s Transition Prior to reform, organizations in China were all state owned and were part of a system of redistribution and central planning (Groves et al. 1994). The hierarchical planning system included multiple layers from central ministries, to provinces, municipalities, counties, and townships, with each level redistributing resources in its jurisdiction (Nee 1992, Guthrie 1997). All industrial profits in China were remitted to the state after fixed deductions were taken by the factory, and central planners redistributed these profits according to long-term state plans (Walder 1992, Jefferson and Rawski 1994). The state controlled the allocation of all resources, including labor. State agencies permanently assigned workers to factories, factories could not fire workers, and wages, promotions, and bonuses were dictated from above (Naughton 1995). In 1978, the state initiated large-scale industrial reform and began to reduce its role in firms to that of a shareholder with limited liability and authority (Dong and Hu 1995). State control was not eliminated immediately, but its role gradually began to loosen. Profit retention was introduced (Naughton 1995, p. 100), the “factory manager responsibility system” gave managers authority over the organization, and most organizations adopted longterm managerial contracts (Groves et al. 1995). Firms also began to hire temporary and contract workers, and labor migration began to increase (Korzec 1988, Howard 1991). Worker bonuses and welfare funds grew rapidly (Naughton 1995, p. 103), and managers started to make other decisions about hiring, promoting, and firing workers (Groves et al. 1994, 1995). Responding to these changes, firms also began to introduce wholly new strategies, such as piece wages. Linking pay to output was somewhat common in earlier historical periods, but the use of incentive-based compensation schemes was prohibited following China’s 1949 communist takeover (Naughton 1995). Beginning in 1978, firms were again allowed to use piece wages, and by the late 1980s, their use had become taken for granted. Their use was less common in China than in European transition economies, but piece wages were used widely in China even in the first years of reform (Naughton 1995, p. 343). As early as 1981, nearly 70% of firms used them, and up to 20% of some firms’ total wage bill was accounted for by piece wages in some regions and sectors (CASS/UCSD 1990). The use of piece wages varied regionally and by industry, and as with other strategic decisions in China (Naughton 1995), it is likely that social processes (such as diffusion) affected the adoption of this new strategy. At the same time, because firms continued to use socialist labor practices, the adoption of piece rates created a dual system of socialist and capitalist labor practices within firms (Keister 2000). Reformers pushed for the development of a socialist market economy, and organizations correspondingly began to adopt capitalist practices such as the use of piece rates while retaining socialist methods of hiring, firing, and compensating workers (often because the state required it). The state continued to regulate labor practices, but as managerial authority over the operation of firms expanded, reformers transferred responsibility for many of these practices to the firm (Naughton 1995). Most firms continued to employ permanent workers through the end of the 1980s, but in 1984, all new employees were considered contract workers (those who had been hired previously as permanent employees were still guaranteed lifetime employment). Likewise, most organizations continued to accept workers allocated by state agencies even while beginning to acquire workers from newly developing markets (Dong and Hu 1995). The continued use of socialist-oriented labor practices reflected coercion to some degree, but it was also a voluntary risk-reduction strategy on the part of organizational decision makers (Keister 1998). Perspectives on Managerial Innovation Under what conditions would a Chinese state-owned firm decide to adopt an innovative labor practice in the first decade of reform? Strategy research undertaken primarily in developed market economies suggests that two predominant explanations account for this type of behavior: a strategic choice explanation and an institutional explanation. The first set of factors, the strategic choice factors, are internal in nature. Penrose (1959), Nelson and Winter (1982), Barney (1986 and 1991), and a host of others (Tichy 1983, Dutton and Duncan 1987, Ginsberg 1988, Barnett 1993) have argued that factors internal to the firm determine the nature and timing of innovative actions. The relative factors include knowledge of the managers and firm, organizational routines, and related capabilities. LISA A. KEISTER Adapting to Radical Change ORGANIZATION SCIENCE/Vol. 13, No. 5, September–October 2002 461 From this perspective, firms’ unique knowledge and capabilities allow managers to undertake new activities that, under the right set of internal and external conditions, can improve performance and the firm’s long-term competitive position. A central concern is the nature of the capabilities that are relevant and how these develop and change over time (Ginsberg 1988). Managerial innovation occurs when the firm has the necessary internal resources and capabilities to change and the change appears to be in the firm’s advantage, given available information (Kelly and Amburgey 1991). Alternatively, external environmental factors may create an incentive for altering organizational structures and strategic orientations. Institutional theory, in particular, focuses on the relationship between a firm and external organizations and pressures. Institutional ideas are more commonly used to study similarities among organizations than as a lens for understanding structural change in organizations (Meyer and Rowan 1977, DiMaggio and Powell 1983, Buchko 1994). In some of the works that identify the basic ideas underlying the approach, however, institutionalization is both a process and a property variable that is usefully extended to discuss change (Zucker 1977, DiMaggio and Powell 1983). In these works, institutional theory distinguishes radical from incremental change (Dougherty 1994, Greenwood and Hinnings 1996), identifies the contextual conditions under which change occurs (Leblebici et al. 1991, Oliver 1991), and identifies the conditions under which ideas are diffused among organizations (Tolbert and Zucker 1983, Strang and Meyer 1993, Haunschild and Miner 1997). Managerial innovation may result, for example, from external normative pressure, a need for legitimacy, or simply exposure. In reality, the process by which organizations adapt to change is likely to be a function of multiple interacting influences including both organizational and environmental factors, and change is likely to be fueled by a different mix of influences at different stages of the process. Tolbert and Zucker (1996) propose that the adoption of new practices begins with innovation and flows through habituation, objectification, and sedimentation. While their model does not explicitly identify internal strategic factors as relevant in the early stages, the factors that lead to early experimentation are, indeed, internal and consistent with strategic choice arguments. Moreover, institutional arguments suggest that environmental factors become more salient over time and interact with internal factors to create a combination of influences on change. Incorporating organizational and environmental factors at different points in the change process suggests that a dual system is likely to develop within the organization as the old strategy is slowly abandoned and replaced by the new strategy. Organization Factors In the early stages of change, organizations largely act independently to generate new structural arrangements in response to specific problems (Kelly and Amburgey 1991). At this stage, manager and firm traits are particularly salient determinants of adoption of new practices (Tolbert and Zucker 1996). One internal factor that was important in Chinese firms in the early stages of reform, and that likely affected innovative behavior, was the degree to which workers supported management (Naughton 1994). While this would not be considered a firm capability in most western organizations, managers with internal support, or mobilizing advantage, were more likely to be able to effectively implement new ideas (Pettigrew 1973). The factory manager responsibility system gave managers control of many decisions, but for decades workers had participated in running enterprises and making critical decisions (Naughton 1995). This practice was unlikely to change immediately given the group orientation that was pervasive in Chinese firms (Child 1972). An important indicator of worker support for managers was being elected by the workers. Managers who had worker support were more able to adopt and implement innovative practices than those who were at odds with workers. Support was particularly important in the early stages of reform because prereform norms of the importance of workers were still recent, manager confidence was relatively low given the move to markets, and firm action was largely independent of the actions of other firms (Naughton 1994). Workers supported the use of piece rates, in particular, because such a pay scheme had the potential to dramatically increase their wages. The importance of worker support likely declined as boards of directors increasingly played a role in manager appointment, but it was an important indicator of managers’ abilities to institute change in the early stages of reform. For this reason, I expect that: HYPOTHESIS 1. Worker support will increase the use of piece rates in the early stages of reform but will have no effect on piece-rate use as reform progresses. Another managerial trait that was likely to influence innovative behavior during China’s reform was the manager’s orientation toward using market means of compensation rather than socialist means. The adoption of piece rates was more likely by managers who were market-oriented, given the meritocratic nature of the practice. Reforming the economic system forced managers to LISA A. KEISTER Adapting to Radical Change 462 ORGANIZATION SCIENCE/Vol. 13, No. 5, September–October 2002 begin relying less on strategies such as cultivating bargaining position with superiors and more on profit maximization and improving competitive advantage. Managers who were members of the Communist Party were likely to be less market oriented than those who were not party members. Likewise, managers who demonstrated a general openness to market practices were more likely to be early innovators. Unlike the importance of intrafirm support, however, party connections and a market orientation likely influenced the use of piece rates throughout the first decade of reform. During that decade, both political and economic forces shaped firm behavior as managers learned to balance and take advantage of their ties to both the existing politically dominated system and the new market-based system. Thus, I expect that: HYPOTHESIS 2. Communist Party connections will decrease the use of piece rates in the early stages of reform, but will become less important as reform progresses. HYPOTHESIS 3. A market orientation will increase the use of piece rates in the early stages of reform and will become more important as reform progresses. Labor Market Development Market conditions also likely affected the adoption of new strategies. Managers prefer certainty because predictable environments are high in munificence and stability (Pfeffer and Salancik 1978, Dess and Beard 1984, Keats and Hitt 1988). In times of high uncertainty, managers strive to reduce both the uncertainty itself and the perception of uncertainty (Aguilar 1967, Rumelt 1974, Fahey and Narayanan 1986). Managers are also likely to imitate others and to innovate when uncertainty is high (DiMaggio and Powell 1983, O’Neill et al. 1998). Uncertainty is particularly salient in transition economies where the revolutionary pace of change makes even the most basic transactions uncertain (Keister 2001). In the early stages of reform in China, markets were just beginning to develop. As a result, infrastructure was in poor condition, it was difficult to distribute goods outside the local area, and stock markets were not reliable sources of capital (Gong 1995, Karmel 1994, Li 1995, Spiegel 1994). Because labor markets were just forming, labor surpluses and shortages also plagued firms (Keister 2001). The degree to which labor markets were developed would likely affect the adoption of an innovative labor strategy, such as piece rates, as managers were more likely to innovate where the labor supply was uncertain. The use of piece rates, in particular, was likely greater where markets were poorly developed as it is a particularly innovative strategy that was perceived as necessary under highly uncertain conditions. The importance of market development declined over time, however, as markets developed and uncertainty declined. For these reasons, I expect that: HYPOTHESIS 4. Poorly developed labor markets will increase the use of piece rates in the early stages of reform but will have no effect on piece-rate use as reform progresses. Exposure Exposure to other firms using innovative labor practices also likely affected managerial innovation. The diffusion of practices results from a variety of pressures including regulatory agencies, government agencies, laws, courts, professions, interest groups, and public opinion (Meyer and Rowan 1977, Scott 1987, Zucker 1987). Uncertainty has also been shown to affect diffusion (Haunschild and Miner 1997, O’Neill et al. 1998). When a practice is new, it is likely that any imitation that does occur is frequency, or pure imitation, based (Tolbert and Zucker 1996). In general, organizations imitate the actions that have been taken by large numbers of other organizations because the legitimacy of the practice is enhanced (DiMaggio and Powell 1983, Tolbert and Zucker 1983). Imitative behavior occurs both actively (Meyer and Rowan 1977) and less deliberately as the practice becomes taken for granted (Zucker 1977, March 1981). There is also evidence that frequency of use of a practice by other organizations may serve as an indicator of the technical value of a practice (Abrahamson and Rosenkopf 1993). In the early stages of China’s reform, simple exposure to other firms using the practice was what was relevant for motivating change. The impetus for innovation was largely internal, as I have argued above, and simple exposure suggests little more than managers may have decided to use the innovative practice simply because they saw others using it. Reflecting a culture that still contained elements of a period in which anything associated with market economics was taboo, piece rates were an uncommon compensation practice in China before reform (Naughton 1995). As a result, managers may not have thought to try such a practice in the early stages unless they witnessed their colleagues using the strategy. Simply being exposed to others using the new strategy was likely sufficient to lead to use of the strategy in the focal firm. As time passed, however, simple imitation is likely to have been replaced by active imitation of successful (i.e., profitable) others and acquiescence to other external pressures. Researchers have shown that under such conditions, the exposure effect will be greatest when the focal organization is exposed to use by successful or large others (DiMaggio and Powell 1983, Ibarra 1992, Haunschild LISA A. KEISTER Adapting to Radical Change ORGANIZATION SCIENCE/Vol. 13, No. 5, September–October 2002 463 and Miner 1997). Specifically, organizations modeled themselves after others they perceived to be more legitimate or successful, such as those that were more profitable (DiMaggio and Powell 1983, p. 152). Such targeted mimetic behavior is more likely after a practice has been tried for some time and managers have recognized that others are using it. Moreover, if the use of the practice is responsible for the firm’s profits, imitation is even more likely. In China, managerial efforts to improve combined with exposure to the behavior and resulting success or failure of other firms likely increased the nature of mimetic processes. Time increased the likelihood that firms would have had contact with others using different practices, and labor reforms such as those that took effect in 1984 increasingly made firms aware of practices that had not been apparent before. Over time, managers became aware of the impact that early adoption appeared to have on the financial success of innovative firms, and pressure to adopt market-oriented practices used by successful firms to maintain or increase legitimacy also likely increased. Thus, I expect that: HYPOTHESIS 5. Simple exposure to other organizations using piece rates will increase piece-rate use in the early stages of reform. HYPOTHESIS 6. Exposure to other organizations using piece rates profitably will increase piece-rate use in the later stages of reform. Experience Literature on organizational learning suggests that past success influences an organization’s receptivity to change (Levinthal and March 1981, O’Neill, et al. 1998). Yet there is also evidence that organizations with a history of success are unlikely to adopt new strategies because they overinvest in past decisions and either stagnate or fail to innovate because inertia propels them in the same direction (O’Neill et al. 1998). It is most common to see success lead initially to more innovation and then later to stagnation. Because the use of piece rates was relatively new in China in the period under investigation, there was not sufficient time for past success to begin to have a negative effect. Thus, a firm’s successful past use of the practice during reform in China was likely to have a strictly increasing effect on use of the new strategy. Moreover, Chinese managers were accustomed to responding to bureaucratic incentives rather than internalizing and reacting to the financial performance of the firm. During reform, however, this is likely to have changed. Particularly as reform progressed, managers were likely to have begun internalizing and repeating behaviors that improved efficiency and financial performance. Likewise, the cost associated with using alternative strategies is likely to affect use of the innovative strategy. In the Chinese firms, the cost associated with using state-sanctioned labor practices, in particular, is likely to have impacted use of piece rates (Pfeffer and Salancik 1978, pp. 272– 273). As a result, firms developed pluralistic labor systems in which permanent state-assigned workers and workers hired on developing labor markets worked in the same factories, perhaps even in the same jobs. This suggests that both success with the new strategy and the costs of the old affected change. Thus, I expect that: HYPOTHESIS 7. The greater the benefit of using piece rates early in reform, the more likely a firm will be to use piece rates in the later stages of reform. HYPOTHESIS 8. The greater the cost of using alternative labor compensation strategies early in reform, the more likely a firm will be to use piece rates in the later stages of reform.