Capturing Value From Investment Opportunities Under Product-Market Competition: When Do Internal Capital Markets Matter?

Abstract

The view that a business unit can better compete against product-market rivals if granted funding from its parent firm’s internal capital market (ICM) has lost traction within strategy, despite conflicting evidence. We develop a theory to explain when funding from a parent firm’s ICM should enable a business unit to more effectively capture value (i.e., profit) from its investment opportunities under product-market competition. We depart from prior theories by examining how opportunities relate to competition. Specifically, we propose a typology of opportunities along two strategic dimensions. The first dimension is firm-specificity, a concept derived from the resource-based view. It refers to whether an opportunity stems from unique firm resources and capabilities and is therefore exclusive to a business unit rather than shared with (and contestable by) its product-market rivals. The second dimension is uncertainty about the investment path, a concept derived from the literature on investment under uncertainty and real options. When present, it is impossible (and undesirable) to commit upfront to a fully predetermined set of investments in an opportunity. These dimensions imply that different opportunities may have distinct critical needs in terms of funding—such as secrecy, timeliness, and reliability—that must be satisfied for a business unit to capture value. Ultimately, our theory indicates that receiving funding from a parent firm’s ICM increases a business unit’s chances of capturing value when those critical needs are present, suggesting that units with ICM funding may prevail in some competitive environments.