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JOMXXX10.1177/0149206316675929Journal of ManagementBower / Managing Resource Allocation

Journal of Management
Special Issue:
Vol. 43 No. 8, November 2017 2421­–2429
Resource Allocation and Strategy
DOI: 10.1177/0149206316675929
© The Author(s) 2016
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Commentary

Managing Resource Allocation: Personal

Reflections From a Managerial Perspective
Joseph L. Bower
Harvard Business School

The problem of resource allocation is central to economics. It is also central to the strategic
management of companies. Despite considerable research by management scholars describing
the process in firms first carried out in the 1960s and continuing since then, management theory
of the process remains wedded to a financial model of capital budgeting that poorly fits the
problem facing companies. Consulting firms stepped into the gap with models of business port-
folios that helped frame the resource allocation choices among business units. But over time,
changes in the capital markets, in the flows of technology, and in the patterns of global compe-
tition have meant that the dilemmas facing company managements are far more complex than
the models and concepts academic researchers use to describe them. This may well be because
the forces that must be taken into account are cognitive, organizational, and interpersonal as
well as economic and thus cross the lines of academic disciplines, while the time horizon of
these problems exceeds the scope of a typical academic research project. There is important
research to be done.

Keywords: resource allocation; capital budgeting; strategic management

In economics, the problem of resource allocation is central. In effect, macroeconomics

describes how the allocation of resources affects the behavior of a nation’s economy.
Microeconomics, sometimes called the theory of the firm, is supposed to describe how a
firm allocates resources and what the consequences will be. When I was a graduate student
in economics in the early 1960s, I was assured that macroeconomics was a robust theory,
but microeconomics was a very problematic field. At the time, I had no reason to consider

Acknowledgments: The author gratefully acknowledges assistance from Professor Catherine Maritan, Syracuse
University.

Corresponding author: Joseph L. Bower, Donald Kirk David Professor Emeritus, Harvard Business School,
Soldiers Field, Boston, MA 02163, USA.

E-mail: jbower@hbs.edu

2421
2422   Journal of Management / November 2017

seriously either of these propositions. But I knew that how firms allocated resources was
important, so I went on to study that process.
In management, the problem of resource allocation is the essence of strategy. Using
Mintzberg’s (1978) language, all the words on paper and analytics are empty intention unless
scientists, engineers, planners, marketers, sales people, and dollars—the resources of the
firm—are allocated to attempt to make that intention a reality. Realized strategy, what the
firm actually does, is the revealed consequence of a pattern of resource allocation (Mintzberg,
1978). This in fact is how Chandler (1962) discusses strategy in his seminal work, Strategy
and Structure. It is the idea captured in the title of my book with Clark Gilbert, From Resource
Allocation to Strategy, which summarizes 35 years of research following my initial study of
resource allocation (Bower & Gilbert, 2005).
From the perspective of more than 50 years, what is incredible to me is that very little has
changed in how resource allocation is discussed. Despite a great deal of work that describes
how the process of resource allocation actually works in firms, the established academic
canon has, if anything, become more distant from what actually happens. I should have
expected nothing different. Research in the fields of economics and financial economics
takes the firm and its shares to be the unit of analysis. Research that examines how firms
actually work takes place a level of aggregation below those fields.
My own work Managing the Resource Allocation Process (Bower, 1970), conducted in
the 1960s and published early in the 1970s, showed that in the large organizations that char-
acterized the economy, the resource allocation process was dispersed across the business
divisions and several levels of the hierarchical organizations used to manage companies. The
behavior of the executives in these corporations is governed by the organization design, the
planning and budgeting systems, the measurement and information systems, and the incen-
tive systems used to manage activity. The framing of business plans and capital budget pro-
posals reflect what executives believe they are being asked to achieve. Rather than the words
on paper that top executives issue in strategic plans or published in annual reports, operating
managers try to succeed in the jobs they have been given and for which they are paid, where,
as is often the case, they are paid for meeting short-term financial objectives, that is, how
they use the resources available to them. If instead they are rewarded for ambitious plans for
growth, they seek funding for projects that will generate fast growth if implementation is
successful (Bower, 1970; Bower & Gilbert, 2007). The use of the present tense in this sum-
mary is intentional since subsequent research has revealed this basic description to be accu-
rate (Bower & Gilbert, 2005).
After Managing the Resource Allocation Process was published in 1970, the review in the
Journal of Finance said that the work was interesting but did not seem to understand that
resources were allocated the way capital budgeting theory said they would be allocated. It
took me a long time to understand that when microeconomists were confronted with evi-
dence that the behavior about which they theorized did not conform to the accepted model,
the problem was not the model but that managers did not know how to behave.
Fortunately, management practice was often able to develop independent of microeco-
nomic theory. The management consultants were particularly useful in this respect. The
Boston Consulting Group (BCG) made two important contributions. In the 1960s, its work
on the experience curve demonstrated that long-run cost curves might continually decline in
a fixed relationship to cumulative unit production (Henderson, 1968). This work was of
 Bower / Managing Resource Allocation   2423

fundamental importance since capital budgeting theory relies on the idea that long-run cost
curves rise and therefore the marginal return on a capital investment will decline at some
point. This same body of work by BCG pointed out that investment in cost reduction projects
in a hypercompetitive industry might have positive accounting returns for a business in that
industry, but unless it fundamentally changed the competitive position of the business, it
would not change the prospects for negative returns in that business.
The idea that the investment in a project was somehow dependent on the success of the
business in which the project was imbedded was not contradictory to conventional capital
budgeting; it was simply a largely ignored idea. It was assumed that the “business case” for
a project would include appropriate analysis. One way to understand what had happened is
that the tools of marginal financial analysis used to examine which of two machines might be
the best investment to do a job, or whether a machine should be purchased or rented, were
regularly applied to the question of whether a company should invest in a particular business.
Should a company enter a business or should a company invest in a strategic expansion of a
business were treated in exactly the same fashion as a make-or-buy decision for a machine.
It may not be obvious why these decisions are so different and pose such a different ques-
tion for resource allocation in the firm or why the difference is so important. The first deci-
sion—let us say it is which of two machines a business should buy—is predicated on a
number of assumptions that are reasonable to make. To begin, the same machine will be used
in the same factory of the same business by the same people. The prospects of the business
may be uncertain, but that may affect the usefulness of the two machines more or less equally.
Technology is not at issue. Nor is demand. So it is merely a question of cost and availability
of capital measured against the likely return. The analytic work involved is well within the
purview of department or divisional operating executives responsible for using the
equipment.
Now consider the question of whether to enter a business. The attractiveness of the idea
depends on a number of future developments that will affect demand. Market structure is at
issue, especially the impact of new competitors and new technology. Whether to invest in
new technology in the same industry is an equally problematic choice. The way to assess
these decisions involves careful strategic analysis. The knowledge and understanding neces-
sary to make those assessments is distributed across the levels and functional lines of the
company. But traditional capital budgeting systems used to assess such proposals against the
use of capital in other needs make it easy to ignore the key questions that should be consid-
ered in making of a strategic decision. Indeed, the focus in most capital budgeting systems is
on quantitative summary ratios, such as return on investment, that when compared with the
weighted average cost of capital will in principle (in microeconomic theory) indicate which
proposals should be funded.
In fact, the range of uncertainties involved mean that it is typical for top managements to
look to the track record of the managers who endorse the proposals in order to determine
which projects to fund. In effect, with many questions to consider in a limited amount of
time, there is a kind of triage. While following formal processes, they review some proposals
in a cursory fashion and effectively delegate some of their decisions to the line managers that
they trust. Again, in a typical situation, since the list of acceptable proposals exceeds funds
available, funds are allocated in some version of a game of fair division in which the princi-
pal line executives all receive some funding for their projects. The critical factor here is that
2424   Journal of Management / November 2017

denying executives funding for their projects is effectively denying them the chance to grow
their businesses and thereby achieve the kind of record that would permit them to progress
further in the company.
Where the attraction of a new business or new technology is great, top managements often
turn to consultants for advice. When there is considerable uncertainty and executives in the
company have limited experience, top management may turn to acquisition as a way to buy
the knowledge and management skills their own organization lack. Research suggests that
acquisition as a route to entry in a new line of business brings its own special risks and
difficulties.
The forces described here are very powerful. Involved, for example, is the question of
what it means to give executives a job and then deny them the resources to do it. Obviously
if adequate resources are not available, one should not stay in a business. But where resources
are being allocated to projects, it is easy to spread them too widely. The essence of strategy
is focus. But if focus means denying resources to executives one admires and has high hopes
for, it is easy to diffuse resources instead. It is human to fudge such choices.
The documenting of experience curves that showed the existence of more or less perpetu-
ally declining long-term costs posed an important conceptual challenge for resource alloca-
tion in the firm, further complicating the challenge for top managements. Possession of the
low cost position in a market is a huge competitive advantage. But if total unit costs decline
with cumulative long-term volume, as shown in a wide range of experience curves, then a
firm has to keep investing to protect its position against an entrant willing to invest to gain
experience. The battle is unending. If a firm, say, a chemical company, enjoys strong posi-
tions in several markets—for example, polyethylene resin and film, polypropylene film and
fiber, vinyl plastics, and epoxies—how can it fund the investments needed to sustain position
in all of those businesses? And if it cannot, how can it choose which businesses to keep? A
more dramatic example might be GE, which in the 1960s had strong positions in computers,
nuclear power, and engines for supersonic aircraft as well as electric power generation, dis-
tribution, and use and emerging businesses in health care. Spreading resources to meet all
requests was impossible. But underfunding a business was suicide.
What was needed was a framework for comparing the strategic position of businesses as
opposed to projects that would relate to their long-term profitability. At GE, strategic plan-
ners began working on this problem in the 1960s. Using the history of GE’s hundreds of
individual businesses as data, they demonstrated the proposition that market share was an
important predictor of profitability. Indeed, they concluded that only the businesses with a
number 1 or 2 position in a market would earn profits above their cost of capital. This group
of analysts spun out of GE to form the Marketing Science Institute (MSI). MSI went on to
further elaborate the relationship of market position to profitability. Back at GE, these ideas
provided part of the foundation for Jack Welch’s restructuring of GE in the 1980s. Resources
were focused on a limited number of businesses. The rest were sold.
BCG’s second contribution to the management of the resource allocation process was
related to the same empirical observation (Henderson, 1970). It proposed an industry growth–
market share matrix that displayed the businesses of a company according to the growth rate
of the industry in which it was participating and its relative share of its market. Relative share
was a refinement of the number-1-or-2 idea. High relative share implied that one had more
cumulative experience and therefore lower total unit costs. Being number 1 with a dominant
 Bower / Managing Resource Allocation   2425

share was strategically stronger than a number 1 with a small margin over number 2 and
number 3.
Using the matrix, businesses could be characterized according to their strategic character-
istics. A business with a high relative share in a rapidly growing business would be profitable
and need capital. A business with high relative share in a slow-growth business would be
profitable but throw off cash. Low relative share in a high-growth business was a risky but
potentially high-return proposition requiring judicious funding. And unless something very
dramatic was done to change the circumstances, low relative share in a low-growth business
meant continual losses. Sale or exit was justified.
Several of the other major consulting groups developed their own matrices for categoriz-
ing and displaying the prospects of businesses. The importance to the management of busi-
nesses should not be underestimated. Instead of resource allocation focused on the cost and
return of individual projects, managers were now asked to consider the comparative strength
of businesses in their portfolio and make strategic choices rather than financial ones. In
effect, thinking about a portfolio of businesses enabled firms to break out of a resource allo-
cation paradigm that was effectively a mechanistic rationing of capital according to forecasts
of project returns.
This was a conceptual breakthrough. As shown by my research on resource allocation and
that of subsequent researchers, firms continued to invest in high-return cost reduction proj-
ects in slow-growth, hypercompetitive industries only to find that the businesses continued
to lose money even where the calculated return on the project might be high (see, for exam-
ple, Sull, 2005). A portfolio analysis of a company’s businesses would show that some busi-
nesses had to be divested, if resources were to be made available to the strong and promising
others.
An associated breakthrough was investment in executive education for subunit general
managers. The critical point was that the resource allocation process required as a critical
first step the submission of strategic business plans. These were the crucial input to the
matrix analysis. And of course, that was the next major challenge to be faced.
Just as project proposals reflected the relative skills and ambitions of the functional man-
agers who prepared them and the general managers who endorsed them, the strategic plans
were no better than the ability of those same managers to think strategically. A whole indus-
try of strategic consultants developed to aid middle managers in preparation of plans.
The stakes were high. A plan that resulted in a business being classified as low growth/low
relative share was a ticket to business sale. That prospect might be a correct conclusion from
the perspective of corporate resource allocation, but it was not one that unit managers flocked
to embrace. So companies developed large strategic staffs to “scrub” proposals for the accu-
racy of their analysis.
While intellectually the framing of the resource allocation process had improved, the
resource allocation was still largely a bottom-up affair that depended heavily on the quality
of the subunit planning. Because the stakes were so high for the individual managers involved,
if the bureaucracy of the company was allowed to run the process, it could readily be cor-
rupted in a way similar to the project-based system it was designed to replace.
What was desperately needed was an honest and open system of resource allocation that
reflected the realities of an increasingly complex and competitive global business environ-
ment. The 1980s and 1990s saw a series of individual corporate restructurings that served as
2426   Journal of Management / November 2017

models for that process. Perhaps most famous was Jack Welch’s restructuring of GE. He
dramatically pruned GE’s portfolio of businesses, for example, trading the businesses of
GE’s RCA subsidiary for the health care business of the French company Thompson.1 As
well, he laid off half of the middle management structure of GE—some 200,000 managers.
What was once a multilevel hierarchy of more than 100 strategic business units was now a
flat organization of 15 companies reporting to a much-reduced corporate office. Business
strategies were agreed upon in cross-level meetings that included operating and probable
capital budgets. Emphasis was on speed and quality.
With less fanfare, other companies made similar shifts, emerging as globally competitive
players. IBM, for example, went through two transformations. The first under Lou Gerstner
changed five regional companies into one IBM with five lines of business. Later, Sam
Palmisano changed that company into a global provider of digital platforms for the mature
and emerging markets. Ginni Rometty, his successor, is now working to transform IBM to
deal with the world of the digital cloud and the Internet of things.
It is hard to exaggerate how difficult it is to conceive and then implement the kinds of
restructurings that GE and IBM exemplify. Only some companies attempt the process, and
fewer succeed. The losers are dismantled, sold, or disappear. But in a world with fast-
changing technology and new global competitors, a firm’s strategy must be reframed and
the firm restructured, or it dies.
But still another challenge has emerged to thinking about and managing the resource allo-
cation process. The 1980s saw the emergence of new forms of finance that empowered new
corporate strategies. As well, technology proved much more mobile than researchers had
previously understood.
The basic microeconomic model of capital budgeting is based on the idea that a firm has
a list of project proposals for funding and limited availability of internal capital. The cost of
internal capital is calculated as a weighted average of the cost to the firm of equity and debt
(the WACC). Capital budgeting systems are still constructed to fund those projects whose
projected returns exceed the WACC. Portfolio strategic planning improves the process by
making sure that resources are committed only where strategic prospects are approved (which
improves the quality of the assumptions in the “business case” underlying proposed uses of
funds). But limited capital is a fundamental assumption.
What if capital were readily available? The 1980s saw the development of high-yield debt
as a tool to fund entrepreneurial businesses, such as MCI and Turner Broadcasting, but also
to fund leveraged buyouts of companies or the divisions of companies. If companies were
run with significant overhead and balance sheets with low debt relative to equity, an investor
could use debt with a lower cost than the company’s WACC to buy the company for a pre-
mium over the stock market price, reduce the overhead, and still make a profit on the invest-
ment. As this practice became widespread, firms found their portfolios faced new options in
the context of new pressures.
One important option was the spinoff. If a division had good prospects on its own, its
management might well want to pursue an independent course without the burden of corpo-
rate overhead. From the corporate parent’s perspective, if the division offered no strategic
benefits to the other businesses of the company, why not realize the market value of the divi-
sion, especially if the price offered by the investors who would fund the “management buy-
out” implied a higher price earnings multiple than the parent enjoyed?
 Bower / Managing Resource Allocation   2427

In effect, this new possibility, provided by the very large and liquid U.S. capital markets,
changed the strategic challenge to large, multibusiness corporations. A firm’s portfolio of
businesses ought to reflect its ability to enhance its prospects because of what some writers
call “a parenting advantage” (Goold & Campbell, 1991). A preeminent example of this kind
of thinking in practice is the Danaher Corporation. Its remarkable record of profitable organic
growth and successful acquisitions has been widely studied. It has devised a strong kit of
management tools for operations, planning, and management development that it assidu-
ously applies to its acquisitions and use for organic growth. The “Danaher system” is the
corporation’s parenting advantage.
In effect, Danaher thinks through and understands its unique corporate competence. It
then manages resource allocation so as to grow in businesses focused on the application of
that competence. Many readers will recognize this prescription as one made by Kenneth
Andrews (1971) in his foundational book, The Concept of Corporate Strategy. The stark dif-
ference is that Andrews could not imagine the life of corporate leaders in the context of
contemporary capital markets.
During the same post-1973 oil crisis decades, and reflecting the same liquid financial
markets, another force developed that added to the challenge of strategic resource allocation.
Starting with Jensen and Meckling’s (1976) development of agency theory, the idea that
holders of a company’s common shares actually own the company and that the board and
managers of a company are their agents has gained currency. This is not the place to discuss
at length what is wrong with this idea—the most important problem is that it does not cor-
respond with corporate law in Delaware and most states—but for boards and top managers,
the pressure from the capital market to produce current earnings has become intense. The
reason is that activist shareholders have leveraged small holdings—5% or 10% of a corpora-
tion’s shares—to impose changes in strategy that improve current share price. They justify
their action on the grounds that the objective of all firms is to maximize total shareholder
return and that they know how to do this better than self-serving managers.
We have seen important profitable and innovative corporations, such as DuPont, succumb
to activist pressures. Returning to the idea of a matrix, the activist seeks to have the low-
growth/low-share businesses divested, the high-growth/high-share businesses slow their
research and investment, and the risky high-prospect investments largely canceled. The
results are higher current earnings and higher share price.
For contemporary managements, the challenge of resource allocation is to fund their strat-
egy in the context of a stock market that seeks high current profitability and growth. Since
global growth is slow and overcapacity exists in many parts of the world—especially
China—it is hard in this context to think through a program of long-term resource allocation
with prospects for sustainable, profitable competiveness.
The reach of financial economics thinking into strategic management has been consider-
able, with ideas of agency theory and the importance of share price maximization infecting
much of the literature. With it has come the idea of delegated decision rights influenced by
an appropriate economy of incentives. For a period, it was even fashionable to teach courses
in organization using agency theory. All the remarkable progress in understanding the impor-
tance of teams and the usefulness of network organization was temporarily discarded as
students were taught the importance of aligning decision rights with incentives that paid for
performance defined in terms of contribution to total shareholder return.
2428   Journal of Management / November 2017

By way of contrast, work in the emerging field of entrepreneurial management has con-
tributed to our thinking. Ideas about lean start-ups and approaches to funding entrepreneurial
strategy have been useful in the context of established corporations thinking through how to
think about radical innovation.
Clayton Christensen’s concept of disruptive innovation has been useful (see, for example,
Christensen, 1997; Christensen & Bower, 1996). If we focus only on the core idea, the con-
cept helps us to understand how the resource allocation process in an established organiza-
tion interferes with a company’s ability to fund investment in those new products or business
concepts that have low margins in the initial years and product/service features that are infe-
rior using the measures of the incumbent business. The concept has helped companies think
through how to carve out such businesses from the ongoing core and allocate resources to
them in a separate fashion. Since web-based businesses often have those characteristics, the
idea has had a great deal of contemporary applicability.
What is missing is further work on the basic problem of resource allocation. A corpora-
tion’s strategy is an evolving target as global markets and technology shift. For example,
Olli-Pekka Kallasvuo, past CEO of Nokia and then a star of the strategic management com-
munity, noted in a rueful address to the Strategic Management Society that during its strate-
gic management process, Apple was not even on Nokia’s list of competitors 1 year before the
iPhone emerged and began to undermine Nokia’s market position. It is hard, but strategic
resource allocation requires the willingness to try to “see around corners.” Or as Andy Grove
(1996) put it in his book’s title, “only the paranoid survive.”
The reality of resource allocation is that it is a complex process involving technical, eco-
nomic and financial, organizational, cultural, and interpersonal forces that are fundamentally
interrelated. Knowledge about markets, competitors, and technology is dispersed across any
corporation. Strategic resource allocation requires conversations that cross functional and
divisional lines and levels. Perspectives at different points in the compass are different
according to geographic or divisional position. And each of those different perspectives may
well be correct.
I believe that it is this complexity that has deterred work on resource allocation. Ideas
from many disciplines are needed to describe the process. That means that good research is
not always easy to fit in the refereed journals of academia. The sort of descriptive work that
has enabled progress certainly does not fit in finance journals. It plays out over long periods
of time—generally longer than the time horizon of an academic seeking to publish on a fre-
quent basis. And the data usually defy simple quantification so that abstract modeling and
quantitative testing are seldom appropriate research tools. Even more problematic for an
academic, the challenge of the task facing corporate management changes significantly as
the environment changes. For example, as argued above, the contribution of the growth-share
matrix was considerably lessened once technology and capital moved freely in ways that
potentially erased the advantages of cumulative experience.
Resource allocation remains the fundamental economic task of a corporate management.
All the critical responsibilities of the top management—crafting strategy, building the orga-
nization, controlling operations, building and motivating the executive cohort, and managing
succession—are involved. What we need badly are new concepts that illuminate how these
basic activities influence resource allocation and how those relationships can be improved.
There is lots of work to do.
 Bower / Managing Resource Allocation   2429

Note
1. GE had purchased RCA in the 1970s.

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