Executive Summary — For many firms, the ability to create, organize, and disseminate know-how is a key factor in their ability to succeed. But should all companies engage in formal knowledge management? If not, which companies derive most value from a formal knowledge system? Conditional on implementing such a system, should the company focus more on learning from successes or learning from failures? Should such knowledge systems simply capture all experience, or should they be more selective? This paper develops and applies an economic framework to examine these questions. Key concepts include:
- Supporting firms' focus on best practice, information about successes is typically more useful than information about failures. Past successes can guide future successes, while past failures only point out certain pitfalls.
- Recording mediocre know-how can be counter-productive by inefficiently reducing employees' incentive to experiment.
- Larger firms with high turnover potentially gain the most from knowledge systems, but should also be the most selective when encoding information.
- The framework in this paper can be used to explore other questions on knowledge management. As knowledge management continues to grow in importance, a systematic economic perspective may shed important insights.
We use an economic model to study the optimal management of know-how, defined here as employee-generated information about the performance of specific solutions to problems that may or will recur in the future. We derive three main results. First, information about successes is typically more useful than information about failures, since successful methods can be replicated while failures can only be avoided. This supports firms' focus on 'best practice'. Second, recording mediocre know-how can actually be counter-productive, since such mediocre know-how may inefficiently reduce employees' incentives to experiment. This is a strong-form competency trap. Third, the firms that gain most from a formal knowledge system are also the ones that should be most selective when encoding information (i.e., the ones that are most at risk from the competency trap); namely, large firms that repeatedly face problems about which there is little general knowledge and that have high turnover among their employees. Beyond these main principles, we also show that it may be optimal to disseminate know-how on a plant-level but not on a firm-level, and that storing back-up solutions is most valuable at medium levels of environmental change.