Investments in Exploitation and Exploration Capabilities: Balance Versus Focus

Whether performance advantage accrues more to firms that balance exploitation (i.e., serving existing markets) and exploration (i.e., developing new products for future markets) or to those that focus on only one of these objectives is open to debate. To gain a better understanding of this dilemma, we employ longitudinal data from the pharmaceutical industry to examine how efficient firms are at utilizing resource investments to build exploitation and exploration capabilities. These capabilities are obtained using stochastic frontier estimation, which measures how efficiently firms use resource inputs to generate an output in a competitive landscape. We then link these capabilities to performance. We find that firms with superior exploitation capabilities have higher operating cash flow but lower firm value. In contrast, firms with superior exploration capabilities find the opposite effect. Importantly, firms that are superior in both capabilities enhance cash flow but not firm value.