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increase the scope of a firm’s capabilities (Karim and Mitchell, 2000; Hitt et al., 1998). Several factors assist a firm in increasing the scope of its capabilities through acquisition. First, firms that are able to recognize important capabilities that it lacks but needs in order to compete in the future will be more likely to increase the likelihood of increasing the scope of their capabilities

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by identifying potential targets with the necessary capabilities (Wernerfelt, 1984; Cohen and Levinthal, 1994). While the firm may increase the likelihood of increasing scope during the selection process, it may also increase its likelihood of increasing scope post-acquisition by effectively recognizing important capabilities possessed by the target during integration (Graebner, 2004). For example, research has revealed that in many situations the acquiring firm recognized important capabilities possessed by the target only after working to integrate the target into the acquirer (Haspeslagh and Jemison, 1991; Graebner, 2004). Additionally, this research has found that firms that effectively nurtured the target’s capabilities during integration were more likely to preserve the target’s unique capability and subsequently, increase the scope of the acquiring firm’s capabilities. It is proposed here that both externally- and internally- oriented absorptive capacity impact the acquirer’s ability to increase the scope of its capabilities through acquisition.

Externally-oriented Absorptive Capacity Effects on Scope

Externally-oriented absorptive capacity consists of a firm’s ability to acquire and assimilate valuable external knowledge. The capabilities that firms use to acquire and assimilate valuable external knowledge are likely to impact whether a firm increases the scope of its capabilities through acquisition for several reasons. First, as a firm actively increases their requisite variety by maintaining a broad network of external relationships, searching various sources of information, and continuously scanning the environment, the firm increases the likelihood that new capabilities offered by the target are related to the acquiring firm’s existing knowledge base (Cohen and Levinthal, 1990). Furthermore, the emphasis on searching external sources for information and the increase in requisite variety that result from acquisition and assimilation capabilities are likely to cultivate an organizational culture that is open to external knowledge (Zhara and George, 2002). This openness decreases the likelihood that the firm narrowly defines its domain and rejects the knowledge offered by the target because of a NIH sentiment (Katz and Allen, 1982). Furthermore, routines that help the firm acquire and assimilate external knowledge also expose the firm to potential trends and help the firm to predict future trends (Dollinger, 1984). As a result, the firm is more likely to have an understanding of the capabilities it needs for future success and more easily assimilate the

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knowledge associated with these capabilities. Consequently, the firm will be more open to the potential for the target’s unique capabilities to help enhance its current capabilities.

Second, as stated earlier, these capabilities often include collaboration routines. Collaboration routines help a firm manage their relationships with external partners (e.g. build social capital, developing interfaces) and provide firms with routines for sharing knowledge with external partners (Goes and Park, 1997; Zollo et al., 2002; Simonin, 1997). Acquisitions present a hybrid form of collaboration. The target unit is not considered external to the firm nor is it entirely internal to the firm. Differences in administrative heritage, culture, and operational practices create a barrier to fully assimilating the target unit as an internal unit (Greenwood et al., 1997). Thus, the firm must carefully manage the interactions between the acquirer and target to preserve the knowledge possessed by the target while also accessing its valuable capabilities. Routines for collaboration may help a firm manage their relationships with the newly acquired unit by providing experience and routines for sharing knowledge with external partners, thereby having a positive impact on a firm’s ability to increase its scope of capabilities through acquisition.

Finally, routines to acquire and assimilate external knowledge may also include practices to evaluate external knowledge (Huber, 1991; Almeida et al., 2003; Foote et al., 2002). After a firm has recognized valuable external knowledge, it must assess whether the benefits of acquiring the external knowledge outweigh the costs of acquiring the external knowledge. These routines are likely to help firms increase the scope of their capabilities through acquisition by helping the firm to more accurately assess the potential success of transferring the target’s unique capabilities. Additionally, capabilities associated with the acquisition and assimilation of external knowledge may also consist of routines for devising strategies to internalize the external knowledge. (Kale and Singh, 2007; Zollo and Singh, 2004). These routines help firms delegate responsibilities and execute the integration of new knowledge into the firm (Simonin, 1997). Consequently, these processes are likely to help a firm bring the knowledge offered by the target into the acquiring firm’s operations.

In summary, externally-oriented absorptive capacity capabilities are likely to assist a firm in renewing their capabilities from acquisition by creating a culture open to external knowledge, increasing the requisite variety needed to understand the knowledge offered by the target unit,

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providing the firm with routines to manage external relationships for knowledge sharing, and enhancing the acquiring firm’s ability to evaluate and internalize external knowledge.

H4a: Externally-oriented absorptive capacity has a positive effect on the change in scope of capabilities.

Internally-oriented Absorptive Capacity Effects on Scope

Internally-oriented absorptive capacity capabilities consist of a firm’s ability to transform and exploit new knowledge. Transformation and exploitation capabilities include socialization and knowledge sharing routines. Socialization capabilities provide a firm with routines to create and nurture social capital throughout the organization. Examples of these practices include the use of cross-functional teams and job rotation (Jansen et al., 2005; Gupta and Govindarajan, 2000; Campion et al., 1994). Knowledge sharing routines provide the firm with routines to facilitate knowledge sharing in the organization and include such practices as maintaining staff responsible for managing and disseminating internal knowledge throughout the organization (Foote, Matson, and Rudd, 2001; Pawlowski and Robey, 2004). These capabilities are likely to help a firm benefit from capabilities renewal by enhancing the firm’s ability to access and disseminate the target’s knowledge. Internally-oriented absorptive capacity is likely to influence a firm’s ability to increase the scope of its capabilities through acquisition for several reasons. First, knowledge sharing routines and socialization routines increase the likelihood that the acquiring firm may access the knowledge possessed by the target firm. Past research suggests that the transfer of knowledge, particularly tacit knowledge, is more likely when the teacher and student possess social capital and a shared understanding (Dyer and Singh, 1998). Firms with socialization and knowledge sharing routines are likely to utilize these routines in managing their relationship with the target firm. Over time these routines are likely to help the target overcome initial suspicions and resentments concerning the acquiring firm and develop social structures between the target and acquirer members (Graebner, 2004). Consequently, these routines may help the acquiring firm to develop the relationships necessary to understand where in the target important knowledge resides, the social capital necessary to facilitate the trust and motivation required to access the knowledge stored in the target firm, and the common understanding necessary to comprehend the knowledge stored in the target firm.

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Second, socialization capabilities facilitate dissemination of new knowledge to the acquirer by facilitating the development of social capital among the firm’s members. Social capital assists members in transferring and transforming knowledge by creating a shared understanding, shared language, and reciprocal trust (Nahapiet and Ghosal, 1998; Collins and Smith, 2006). These factors help foster not only the ability of firm members to share knowledge but also the motivation to do so. Routines to create social capital in the firm are likely to help the firm disseminate knowledge offered by the target firm by providing the acquiring firm members with the social networks and common understandings necessary to disseminate the new knowledge through the organization (Nahapiet and Ghoshal, 1998; Smith, Collins, and Clark, 2005). These social networks and shared understandings facilitate the dissemination of the target’s knowledge by increasing the likelihood that as members of the acquiring firm discover valuable practices in the target, they know where in the organization that knowledge may be best used, have social relationships with the individuals in units that may become the intended recipient, and have the ability and motivation to transfer the knowledge to the intended recipient because of their reciprocal understanding and trust. Furthermore, the presence of knowledge sharing routines such as knowledge management task forces may further facilitate the transfer of the valuable knowledge (Jansen et al., 2005; Gupta and Govindarajan, 2000). Thus, the socialization and knowledge sharing capabilities increase the flexibility with which a firm may disseminate the target firm’s knowledge resources.

Finally, the firm’s capabilities to transform and exploit knowledge increase the likelihood that the firm will utilize the new capabilities gained from the acquisition. Researchers have pointed to capabilities such as the ability to buffer units from initial market tests as an important transformation capability (Kogut and Zander, 1992). Buffering the unit responsible for transformation provides the unit with the necessary slack for experimentation or trial-and-error learning by shielding the unit from the financial and operational demands of day-to-day operations. Thus, acquirers that provide the necessary slack for experimentation are more likely to increase their scope of capabilities by allowing units to experiment with the new capabilities and by shielding the units from immediate market tests (Haspeslagh and Jemison, 1991). Furthermore, transformation and exploitation are associated with routines that allow the firm to retrieve knowledge from its organizational memory (Hargadon and Sutton, 1997). These routines may further increase the likelihood that the acquirer increases the scope of its

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capabilities through acquisition by helping the firm to make connections between apparently disparate experiences and integrate the new knowledge with past knowledge.

In summary, internally-oriented absorptive capacity capabilities impact the likelihood that the acquiring firm will increase the scope of its capabilities through acquisition by helping the firm to access the knowledge possessed by the target through the development of social capital between the acquiring and target firms, disseminate the knowledge possessed by the target through the utilization of existing social networks and knowledge sharing routines, and utilize the new capabilities possessed by the target through the creation of an organizational environment that facilitates trial-and-error learning.

H4b: Internally-oriented absorptive capacity has a positive effect on the change in scope of capabilities.

Complementary Role of Internally- and Externally-Oriented Absorptive Capacity on Capability Scope

While both externally-oriented absorptive capacity and internally-oriented absorptive capacity play unique roles in increasing the likelihood that the firm will increase the scope of its capabilities through acquisition, I suggest that it is their combined use that impacts the effect of acquisition on scope of capabilities. Specifically, the impact of externally-oriented absorptive capacity on the firm’s change in scope will depend on the firm’s level of internally-oriented absorptive capacity. Externally-oriented absorptive capacity provides firms with a culture that is open to external knowledge, the requisite variety needed to understand the knowledge possessed by the target, and the routines necessary to bring the external knowledge into the organization-- all of which may positively impact the change in scope of capabilities following an acquisition. However, the effect of externally-oriented absorptive capacity will be significantly lessened if the firm has a low level of internally-oriented absorptive capacity because of the difficulty the firm will likely encounter internalizing the knowledge possessed by the target, building the social capital to access the new capability, and nurturing the new capability possessed in the target. Furthermore, higher levels of internally-oriented absorptive capacity increase the likelihood that the firm will experience the positive effects of externally-oriented absorptive capacity by helping the firm to utilize the knowledge made available from the target by disseminating it across the

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organization and using the new capability in its existing operations. Consequently, it is proposed that internally-oriented absorptive capacity will moderate the strength of the positive relationship between the externally-oriented absorptive capacity and the change in scope of