A network-based model of exploration and exploitation

Abstract

We propose a new model of exploration and exploitation, in which firms rely on local search for exploitation and on imitation for exploration. We assume that firms imitate the knowledge base of successful competitors, with imitation errors taking place depending on the social distance between the imitating firm and imitated firm in the network. The key model outcome, consistent with earlier empirical findings, holds that successful imitation generally occurs at an intermediate level of cognitive proximity because imitation at high cognitive distance is too error-prone, while for imitation at low cognitive distance there are typically no firms to imitate. A second outcome holds that social and cognitive proximity are substitutes. The model further shows that exploration by imitation is more beneficial in highly complex industries than in less complex industries, and that small-world networks yield the highest benefits for collective learning.