WorkingPaperSeriesNo.20
ACapabilityTheoryoftheFirm:
AnEconomicsand(Strategic)ManagementPerspective
DavidJ.Teece1
24April2017
1
ThomasTusherProfessorofGlobalBusiness&Director,TusherCenteronIntellectualCapital,Haas
SchoolofBusiness,,UniversityofCalifornia,Berkeley;Chairman;BerkeleyResearchGroup,LLC.Email:
[email protected].
1
Abstract
Thebusinessenterpriseistheprimeinstitutionineconomicdevelopmentandgrowth;yet,until
recently,mainstreameconomicshasmostlytreatedfirmsashomogeneousandtherefore
interchangeableblackboxesmanagedbyuntrustworthy,opportunisticagents.Usingeconomic
principles,thefieldofstrategicmanagementhasdevelopedanuancedapproachtothe
understandingofhowfirmsarecreated,organized,andgrow,howtheyinnovateandcompete,
andhowmanagersmanage.Thatapproachhasyieldedatheoreticalframeworkknownas
“dynamiccapabilities.”Contrastsaredrawnbetweendynamiccapabilitiesandotherapproaches
tothetheoryofthefirm,includingtransactioncosteconomicsandagencytheory.Dynamic
capabilities,andcapabilitytheorymoregenerally,abandonthehomogeneityassumptionof
microeconomictheory.Thisallowsintellectualblinderstoberemovedandanunderstandingof
differentialfirm-levelperformancetoemerge.Capabilitytheoryrecognizesthatfirmsoften
havecapabilitygapsthatneedtoberemediedtobuildlong-termcompetitiveadvantage.A
richerconceptualunderstandingofthenatureofthebusinessenterpriseanditsmanagement
consistentwithevolutionaryandbehavioraleconomicsariseswhencapabilitiesarecenter
stage.Policyinsightsintogovernance,inequality,economicdevelopment,andthewealthof
nationsfollow.
Keywords:firmheterogeneity;dynamiccapabilities;transactioncosttheory;agencytheory;xinefficiency;d-ineffectiveness;strategy;entrepreneurship;evolutionaryeconomics;uncertainty;
inequality.
JELclassifications:B52,D21,L23
Acknowledgments:TheauthorismostgratefulforcommentsandexchangeswithGaryPisano
andDavidJohnston,particularlywithrespecttocapabilityaugmentation.Othercolleagues
includingGiovanniDosi,ConnieHelfat,NeilKay,RichardNelson,OliverWilliamson,andSidney
Winterhavehelpedguidemythinking.GregLindenprovidedhelpfulideasandassistance.
**Correspondence:D.J.Teece,BerkeleyResearchGroup,2200PowellStreet,Suite1200,
Emeryville,CA94608,USA.E-mail:[email protected]
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1.Introduction
Thepursuitofprofitiscoretocapitalism,asisthe
innovationthattakesplaceinthebusinessenterprise.
Theyarecoretocreatingvaluethatis,inturn,shared
betweensocietyandthevariousstakeholders
(includingbothshareholdersandemployees)
associatedwiththeenterprise.
Somefirmsprovetobefarmorecompetitivethan
others.Whilethisfactwillbeself-evidenttomost
observers,economictheoryhassurprisinglylittletosay
aboutwhythismightbeso.
Economistscannolongerclaimtoanalyzecertain
majoreconomicissueswhilerelyingonblack-box
modelsofthefirm.Agrowingbodyofempirical
researchonincomeinequality,forexample,has
establishedthatanunderstandingoffirm-level
differencesiscriticalbecausewagedifferencesare
largerbetweencompaniesthanwithinthem(e.g.,
Barthetal.,2016;Abowd,McKinneyandZhao,2017).
Songetal.(2016)foundthatovertwo-thirdsofthe
increaseinearningsinequalityfrom1981-2013canbe
accountedforbytherisingvarianceofearnings
betweenfirmsandonlyone-thirdwithinfirms.Oneof
theco-authorsofthatstudynotedinaseparatearticle
(Bloom,2017)thatinterfirminequalityhasbecome
greaterandmorepersistentasfirmsincreasinglysort
themselvesintoasmallnumberofknowledgeintensivecompaniesandalargerpoolofrelatively
labor-intensivefirms.Moreover,evidencesuggests
thatinterfirmdifferencesinprofitabilityarebecoming
morepersistent(FurmanandOrszag,2015).
Understandinghowsomeenterprisesbuildcapabilities,
grow,andcreatecompetitiveadvantage,leadingto
higherprofits(andhigherwages)aboveaperfectly
competitivelevel,isanessentialelementfor
understandingcapitalismandthemoderneconomy.
Indeed,asJohnSuttonoftheLondonSchoolof
EconomicsstatesinhisrecentbookCompetingin
Capabilities:“Theproximatecause[ofdifferencesin
thewealthofnations]lies,forthemostpart,inthe
capabilitiesoffirms”(Sutton,2012:8).
However,despitethesalienceofcapabilitiesto
businessperformanceandtoeconomicperformance
moregenerally,economists,untilquiterecently,have
notdevelopedtheconcept.Aboutallthateconomists
sinceAlfredMarshallhavetoofferwithrespecttothe
sourcesoffirm-levelcompetitiveadvantageare
theoriesofmonopolyandimperfectcompetition.
Unfortunately,theoriesofmonopoly,oligopoly,and
otherformsofimperfectcompetitionineconomicsare
ratherbarrenwhenitcomestoexplaininghow
innovativefirmslikeAmazonandAppleoutcompete
otherinnovativefirmslikeNokiaandMotorola,why
SingaporeAirlinesandEmiratesAirwayshavecometo
bemajorcarriersthatcanprovidesuperiorservice
whilegeneratingattractiveprofits,andwhyFonterra
needs“tobefarmoreagile”andstrugglestoadd
significantvalueforitsdairyfarmerowners(Fox,
2015).Perhapsthereasonisthatthereisnotheoryof
capabilitiesineconomics.
Surelyoneofthemostimportantquestionsinboth
economictheoryandeconomicrealityishow
individualfirmsbuildandmanagecapabilitiestocreate
andcapturevaluesoastoavoidthezero-profittrapof
competitiveequilibrium.Sadlythough,thisisnot
wheremoderntheoryhasgone.Theassumptionof
homogeneity(ornearhomogeneity)offirmshas
suffocatedthisinquiry.Partofthecollateraldamageis
thatthefieldofeconomicsisbereftofappreciative
frameworksthatcanprovideusefuladvicetofirms
makingresourceallocationdecisionsortopolicy
makersendeavoringtounderstandfirmsandshape
betteroutcomesforsociety.
Nevertheless,theRoyalSwedishAcademyofSciences
hasselectedseveralLaureatesinEconomicsin
recognitionofworkonefficiency-basedtheoriesofthe
firm.Efficiency-basedeconomicmodelsoutline
arrangementsthat,inpractice,arerelativelyeasyto
imitateandthatthereforecannotsupportdurable
3
firm-specificperformanceadvantageseventhough
theymightaidproductivity.Thus,notwithstanding
NobelprizestoCoase,Williamson,andHartfortheir
importantworkonhowfirmsorganizetheiractivities,
manyfundamentalquestionsaboutfirmshavebeen
leftunanswered,suchashowtheycreatevalueand
protectthatvaluesoastogrowandhavedurable
competitiveadvantagedomesticallyandglobally.The
buildingandmaintenanceofcompetitiveadvantage,to
theextentitisderivedfrominnovationratherthan
fromsometypeofmarketrestriction,isarguablymore
seminalthananinquiryinto(static)efficiencybecause
itfocusesonhowfirmsdevelop,learn,and,insome
cases,become“great”andbenefittheirstakeholders,
ratherthanmerelyselectboundariesorgovernance
structuressoastobecomeefficientenoughtojuststay
alive.Theapparatusofproduction,transactioncosts,
andagencytheorysimplydoesnotaddressthecritical
questionsthatmanagers,asresourceallocators(and
stewardstomultiplestakeholders),strugglewithevery
day.Despiteimportantadvances,mainstream
microeconomicstellsusnexttonothingaboutthe
dynamicallocationofresources,themaintenanceof
difficult-to-imitatepositivedifferentiation,andthe
sourcesoffirm-levelgrowthinemploymentand
profits.ToheterodoxeconomistslikeDosi,Nelson,
Winter,andmyself,thisisanembarrassinglacunain
economictheory;butitdoesnotseemtoperturbthe
mainstream.
Asnoted,themonopoly"problem"—withitsfocuson
welfareloss—isoneofafewplacesineconomictheory
wheresingle-firmissueshavebeenaddressed;butthe
answerssofarareoflimitedvalue.Whilescale,scope,
networkeffects,lock-in,andproductdifferentiation
areallpartofthemoderntoolkitthateconomists
reachintoforexplanationsofmarketpower,these
factorsdonotgonearlyfarenoughwhenitcomesto
understandinghowindividualfirmsestablishand
maintaincompetitiveadvantage.Indeed,the
professionhasbeenslowtoexplainwhyeventhese
structuralfactorscanproveinadequate,andhoweven
asmalldegreeof“monopoly”powercanbecontested
bydisruptiveinnovators.Marketandorganizational
evolutionarealsoexpresslyneglected.
Asnoted,someprogresshasbeenmade.However,in
textbooktheory,thereislittleefforttolookat
particularfirms,orgroupoffirms,theirhistories,and
organizationalandtechnologicalissuesinasystematic,
time-sensitivemanner.Thecontinuedsilenceof
mainstreameconomistsonthesematterscontributes
topolicymakershavingjaundicedandnaïveviewsof
theroleofmanagersandofthebusinessenterprisein
theeconomyandinsociety.Studentscomplain
bitterly,whilefacultiespushback.
Inshort,despitetheeffortsofMichaelPorterand
others,standardmonopolytheoryistoobluntan
instrumenttosupportameaningfulexplanationofthe
differentialfinancialperformanceoffirmsin
dynamicallychangingmarketslacedwithdeep
uncertainty.2Amoregranularviewofhowwealthis
createdandcapturedbyfirmsisneeded.Anewview
musthave,atitscore,atheoryofcapabilities.Sucha
theorymustexplainwhattheyare,howtheyarebuilt,
howtheyareemployed,andhowvalueiscaptured.
Theneglectof(single)firm-levelissuesbythe
mainstreammicro-theoristshasleftthedoorwide
openforstrategicmanagementscholarstoaddress
2
TeeceandColeman(1998)discussthreesourcesof
economicrents:Ricardian(scarcity)rentsaccruetothefirm
foritscontroloverscarceandvaluableinputs;
Schumpeterian(entrepreneurial)rentsaccruetoafirmfor
itsabilitytoexploituniqueknowledgeassetsintheperiod
beforerivalsareabletoimitateitsproductsorservices;and
Monopoly(Porterian)rentscanarisefrom“exclusionary
conductlackingefficiencyjustifications,frompredatory
conduct,orfromgovernmentallyconferredprivileges(e.g.,
licenses)”(TeeceandColeman,1998:822).Onlymonopoly
rentsshouldbeofconcerntoantitrustregulators.
4
importanteconomicissuessuchashowsuccessful
firmscreatedifficult-to-imitatecapabilitiesandother
pointsoftechnologicalandorganizationaldifference
thatenablethemtoinnovateandtoallocateresources
betterovertime.Suchanexplanationhasfailedto
emergeoutofstandardeconomicmodels.Noteven
modernCoase-WilliamsonandHart-Mooretheoriesof
thefirmareuptothetask,perhapsbecausethey
assumethatmarketsaremorecompletethantheyare.
WhileWilliamsonisexplicitthatcompletecontingent
claimsmarketsdon’texist,heandothers,including
Coase,goontoassumethatmanypricesexistwhen,in
reality,theyoftendonot(BoudreauxandHolcombe,
1989).Marketsaremoreoftenincomplete(Arrow,
1962,2012),propertyrightsareoftenindispute,
innovationregularlythrowstheeconomicsysteminto
disequilibrium,andKnightianuncertaintyisubiquitous.
AsNelson(1981)explains,theveryessenceof
capitalism—infact,theveryadvantageofaprivate
enterpriseeconomyoveraplannedone—isthat,with
privateenterprise,firmsinnovate,compete,
sometimesdisrupteachother,andsometimes
cooperate.Thisobservationwouldsuggestthatthe
abilityofacapitalisticsystemtoinnovate,morethan
thetwintheoremsofwelfareeconomics,oughttobe
thelynchpinofourunderstandingoftheadvantagesof
marketeconomies.Yetthisisnotthecase.Moreover,
thefieldofindustrialorganization,whichclaimsto
analyzecompetitionissues,hasnotfullyfacedupto
theimplicationsofworkingwithinamarketstructureperformanceparadigmthatsaysalmostnothingabout
thenatureoffirms’capabilitiesorabouthow
innovativefirmsandmarketsevolve.
Inthispaper,Iendeavortoaddresstheselacunaeby
developingaframeworkormeta-theoryoffirm
capabilitiesandinparticular,atheoryofhowfirms
innovateandchangesoastomaintainevolutionary
fitness.Anunderstandingofcapabilitiescanhelp
economistsbegintofillinimportantgaps.Thebasic
argumentisthatfirmsdifferentiatethemselves
throughlearning,entrepreneurship,innovation,and
astutedecisionmaking;inshort,firmsare
differentiatedbytheircapabilities,especiallytheir
capabilitiestodecide,toinnovate,andtochange.
Thepaperstartswithananalysisoftheshortcomings
ofthedominantmicroeconomictheoryofthefirm,
notingtheadmonitionsofCoase,Romer,Leontiefand
otherstobeloyaltothephenomenaathandandnot
merelyaccepttheoreticaleleganceandtheacclaimof
colleaguesasindicatorsofgoodscience.Ithen
introducethecapabilitiesviewofthefirm.Concepts
similartowhatIcall“ordinarycapabilities”are
beginningtogainrecognitionamongeconomists.The
dynamiccapabilitiesframework,whichencompasses
thefirm’sabilitytoactinanentrepreneurialfashion,
hasalsogainedsomeattention,buthasyettobefully
integratedintoeconomictheory.Thepaperthen
comparesthecapabilitiesframeworkwithmainstream
economicmodelsinanumberofareas,including
marketsandtheboundariesofthefirm.Special
attentionisgiventothecontrastingwaymanagersare
treatedintheeconomicsandcapabilitiesframeworks.
Next,afewareasareidentifiedwhereacapabilities
frameworkcouldbeusedtobetterinformpolicy,
includingantitrust,corporategovernance,and
economicdevelopment.Afinalsectionsummarizes
andconcludes.
2.FundamentalLacunaeinthe
TheoryoftheFirm
Thetheoryofthefirmhasreceivedconsiderable
attentionsinceRonaldCoase’sfamous1937article
“TheNatureoftheFirm.”Economistshavecertainly
beguntograpplewithquestionssuchas(1)whyfirms
existinamarketeconomy;(ii)whatdeterminesthe
boundariesofthefirm;(iii)howfirmsshouldbe
organizedtoalignincentivesformanagersandowners
and(iv)howtheyshouldbestructuredfinanciallyto
5
maximizeprofitsandminimizemanagerial
malfeasance.EconomistssuchasCoaseandWilliamson
havehelpedmassivelyonthefirstquestion.
WilliamsonandKlein,Crawford,andAlchianhave
contributedonthesecond,ashaveI.Apanoplyof
economistsincludingJensenandMecklingandAlchian
andDemsetzhaveputeffortintothethird,while
Jensenandothershavecontributedsignificantlytothe
fourth.However,asHaroldDemsetznoted:
“Neoclassicaltheory’sobjectiveistounderstandpriceguided,notmanagement-guided,resourceallocation”
(Demsetz,1997:426).Thisfocusisamajorlimitationas
itdeflectsattentionfromcriticalresourceallocation
decisions.
Inparticular,economistshavebeensilentfortoolong
oncriticalmanagerialissuessuchas:(i)howfirms
innovate(beyondjustspendingmoneyonR&D);(ii)
whyfirmshavecapabilitiesthattranscendthesumof
individualskillsoftheiremployeesandcontractors;(iii)
howindividualfirmsevolvesoastobuildandsustain
competitiveadvantageoverrivals.Asalreadynoted,
thethirdissueisarguablymorefundamentalthan
either(i)or(ii),andalsomanyoftheotherquestions
towhichtheprofessionhasalreadygivenitsattention.
Thethirdquestionhasimplicationsforthe
stakeholdersofthefirm(employees,shareholders,
customers,suppliers)andistalkedabouteverydayin
thebusinesspress.Ithas,toaninadequateextent,
beenaddressedinthestudyofmonopolyand
imperfectcompetition.Economistsusuallyappealto
somekindofstructuralcausesuchasentrybarriersor
scaleandscopeeconomiestoexplainwhysomefirms
getahead.Morerecently,first-moveradvantage,
networkeffects,multi-sidedplatforms,andswitching
costshavebeenaddedtothelist.3Theseanalyses
3
NicholasBloom’s(2017)explanationforinterfirm
heterogeneityastheresultofknowledge-intensivefirms
outsourcinglower-valuework,aggressivelyadoptingIT,and
benefitingfromsomeunspecifiedwinner-take-most
mechanismisarecentexample.
almostalwaysignorethehowandwhythatbrought
abouttheanalyzedcircumstances;yetthisiswhat
mattersforcompetitionpolicy,industrialpolicy,
innovationpolicy,andtheregulationofcorporate
governance.JudgeLearnedHandcameclosetothe
howandthewhyinhisinfluential1945opinionin
UnitedStatesvsAlcoawhenhenotedthata“producer
maybethesurvivoroutofactivecompetitors,merely
byvirtueofhissuperiorskill,foresightandindustry"
(148F.2d416(2dCir.1945)at571).AlineinHand’s
opinion4gaverisetothenotionofa“thrust-upon
monopoly,”whichwasusedbytheU.S.FederalTrade
Commissioninthe50sand60sasjustificationfornot
pursuingantitrustcasesagainstcompaniesmerely
becauseofmarketdominance.Ironically,Justice
Hand’sthinkingappears,atleastinsomesmallways,
tobeaheadofeconomists.Hisopinionswerean
invitationtoexplainthefoundationsofsuperior
managerialskill,foresight,andindustry.Behavioral
economistshaveinrecentyearsprovidedsignificant
insightsintodecisionmaking;butanyeffortto
establishlinksbetweentheseandtheperformanceof
individualfirmshasbeenhandicappedbytheabsence
ofacomprehensivefirm-levelframeworksuchasa
theoryoffirm-levelcapabilities.
Cluesastotheunderlyingreasonsforthelackof
progresscanbefoundinPaulRomer’s(forthcoming)
observationthattoomanyeconomistshaveshown
loyaltytotheirfriendsand,byimplication,theirown
(sunk)investmentinabodyofinadequatetheorythat
shouldhavebeenabandoneddecadesago.Romerhas
critiquedrationalexpectationsmacroeconomics,
pointingouthowthetheoryhasfailedtoexplainmuch
ofanything;buthismostfundamentalcritiqueisthat
thefielddisplaysgreaterloyaltytoitsmembersthanto
4
“[I]tmaynothaveachievedmonopoly;monopolymay
havebeenthrustuponit.”(148F.2d416(2dCir.1945)at
429).
6
thescientificprinciplesthatmustdrivehonestinquiry.
Hisconcernisthatmacroeconomicsissufferingfrom
“ageneralfailuremodeofascientificfieldthatrelies
onmathematicaltheory”,whichincludes“disregardfor
anddisinterestinideas,opinions,andworkofexperts
whoarenotpartofthegroup”(Romer,forthcoming:
7).5Hiscriticismofthepursuitof(false)rigorover
relevanceisjustasrelevanttomicro-asto
macroeconomics.
Critiquesofeconomicformalismarenotnew.More
thanthreedecadesago,NobellaureateWassily
Leontiefworriedpubliclyaboutthistendency:“Year
afteryeareconomictheoristscontinuetoproduce
scoresofmathematicalmodelsandtoexploreingreat
detailtheirformalproperties...withoutbeingableto
advance,inanyperceptiblewayasystematic
understandingofthestructureandtheoperationsofa
realeconomicsystem.”(Leontief,1982:107).Nobel
laureateRonaldCoase,shortlybeforehedied,
contributedacolumntotheHarvardBusinessReview
(CoaseandWang,2012).AccordingtoCoase:
“Economicsascurrentlypresentedintextbooksand
taughtintheclassroomdoesnothavemuchtodowith
businessmanagement”,whichhas“severelydamaged
boththebusinesscommunityandtheacademic
discipline...Itistimetoreengagetheseverely
impoverishedfieldofeconomicswiththeeconomy.”
Hisplea,however,remainslargelyignoredbythe
mainstream,evenastheyarequietlyendorsedby
economistsworkinginthefieldsofstrategic
managementandevolutionaryeconomics.Thepointis
notthatformal(dynamic)modelingisn’tuseful;itis.
Rather,itisthatthetoolsandmodelsneedtobe
embeddedinandconnectedtonarrativesofwhat
happensinsidefirms,industries,andecosystems.
Idon’twanttosuggestthatitisonlythepenchantfor
formalizationthathasdistractedourprofessionfrom
realissuesaboutbusinessfirmsandtheir
management,eventhoughIsuspectitisthelargest
cause.SidneyWinterandI(TeeceandWinter,1984)
sketchedoutdeficienciesanddeflections,andthe
appendixtothisarticleprovidesanupdatedbillof
particulars.Thereareatleasttwounderlyingculprits:
1. ReductionismandHomogeneity:
Economistsseetheindustrysupplycurve
asnothingotherthanthesumofindividual
firmsupplycurves.6Thisconstructis
convenient,especiallywhencoupledwith
anassumptionoffirm-levelhomogeneity,
whichenablesindustrysupplyfunctionsto
bespecified.However,itignores
interactioneffectsbetweenfirms,treats
themasoperatingon(andnotaboveor
below)anidentifiablesupplycurve,and
assumestheyareproducingtheright
product(s)givenmarketdemands.Noone
whoreadsevenamodicumofbusiness
newscouldpossiblybelievethisis
generallythecase.Theproblemhereis
5
Romersuggeststhatthisfailuremodeoccurs“whenafew
talentedresearcherscometoberespectedforgenuine
contributionsonthecuttingedgeofmathematicalmodeling.
Admirationevolvesintodeferencetotheseleaders.
Deferenceleadstoeffortalongthespecificlinesthatthe
leadersrecommend.Becauseguidancefromauthoritycan
coordinatetheeffortsofotherresearchers,conformityto
thefactsisnolongerneededasacoordinatingdevice.Asa
result,iffactsdisconfirmtheofficiallysanctionedtheoretical
vision,theyaresubordinated.Eventually,evidencestops
beingrelevant.Progressinthefieldisjudgedbythepurityof
itsmathematicaltheories,asdeterminedbytheauthorities”
(Romer,forthcoming:7-8).
6
WhileAlfredMarshall(1920)pioneeredtheconceptofthe
representativefirmasthebuildingblockfortheindustry
supplycurve,itisalsothecasethatheusedthisas
shorthandandthatfirmsare,infact,verydiverse.In
IndustryandTrade(Marshall,1919),hewasclearthatfirms
operateinadynamicenvironmentandthatfirms
themselveschange.Mathematicalanalysiswasrelegatedto
footnotesandappendices.
7
thateconomiststookastheirstartingpoint
themathematicalappendixtoAlfred
Marshall’s(1920)PrinciplesofEconomics
whereheconstructedthesupplycurve,
ratherthanthebodyofthebookandthe
restofhiswork,whichclearlyrecognized
firm-levelheterogeneityandthe
importanceofmanagement.Inadopting
thispath,economistsreadoutofthe
theoryofthefirmnotonlyanaffirmative
roleofthemanagerbutalsoanyrolefor
entrepreneurship(Baumol,1968,2010).
2. NeglectofInnovationandDeep
Uncertainty:Economistshavepreferredto
focusonriskandignoreKnightianand
Rosenbergian(technological)uncertainty,
despitetheobviousubiquityofdeep
uncertaintyduetotechnologicalchange,
politicalfactors,andunforeseeneconomic
interactions.Withrisk,rationaldecision
makerscanoperatebyapplyingtherules
ofprobability.Withdeepuncertainty(the
opensetofunknownunknownsabout
whichnoforecastcanbemade),rational
decisionmakersfreeze,andatleastone
economisthadtoappealtothe“animal
spirits”ofinvestorsandmanagerstodrive
hismacroeconomicmodel(Keynes,1936).
Economictheoryneedstosomehow
developatheoreticalstructurethatallows
entrepreneursandmanagerstoinvest,
operate,gaininsight,learn,andactinthe
presenceofthedeepuncertaintythatis
partofeverydaybusinesslife.
Onceeconomistsbegintoacceptthenecessityof
addressingtheselacunae,thetheoryofthefirm—and
microeconomicsmoregenerally—willbecomefar
morerelevantandcredibletoothersocialscientists,
managementscholars,andstudents.Itisthisvery
projecttowhichI’vedevotedmuchattentioninmy
ownworkbecauseitisnotenoughtosimplycriticize.
Onemustalsobuildanalternativetheoreticalstructure
thataffordskeenerinsightsandbetterexplanatory
power.Becausethetheoreticalframeworkoutlinedin
thispaperistheeffortofasinglescholar—assistedby
graduatestudents,post-doctoralfellows,and,on
occasion,colleagues—thiseffortisonlyastart,andis
verymodestrelativetothescaleoftheproblemat
hand.
Thereis,inmyview,toomuchtalentdissipatedon
developingformalagencymodelsofthefirmthat
ignoreitsmostfundamentalanddefiningelements:its
(unique)organizationalandmanagerialcapabilities,
andespeciallyitsabilitytoinnovateandtochange.
Demsetzinsightfullynotedthateconomictheoryhas
showna“neglectofinformationproblemsthatdonot
involveagencyrelationships.Theseareassociatedwith
planninginaworldinwhichtheworldishighly
uncertain,andtheyinvolveproblemsofproduct
choice,investmentandmarketingpolicies,andscope
ofoperations”(Demsetz,1997:428).Unfortunately,his
critiqueoftheexcessivefocusonagencyissuesdidnot
extendtosuggestingaremedyfortheproblem.Itismy
hopethatagreaterpercentageoftalentandtimein
theeconomicsfieldwillstart“doingtherightthings”
ratherthansimplydoingthings“right,”i.e.,creating
elegantbutlargelyirrelevantmathematicalmodelsof
firmsandtheirinteractions.Gametheory,when
appliedtomarkets,proveseverythingandnothingat
thesametimebecausemodelsdevelopedforone
settingareunlikelytoproverobustwhenapplied
elsewhere(Sutton,1990).
Clearly,behavioraleconomicshas,inrecentyears,
pointedoutissuesrelevanttomanagement:
irrationalityispossible,rulesofthumbareubiquitous,
andhubrisanddecisiontrapsarecommon.These
insights,whileimportant,stillleaveunexplainedkey
elementsofmanageriallyguidedresourceallocation
suchasstrategy,businessmodels,andthe
organizationalcapabilitiesthatimpacttheabilityto
transformthebusiness.
8
Intherestofthisarticle,Isummarizesomeofmy
recentworkonwhatI’mcallingacapability-based
theoryofthefirm.Iwillalsoreferencetheworkof
fellowtravelerslikeGiovanniDosi,ConnieHelfat,
RichardNelson,GaryPisano,andSidneyWinter.
Others,includingJayBarney,MichaelJacobides,Peter
Klein,RichardLanglois,SohviLeih,FrancoMalerba,
MargiePeteraf,andPaulSchoemaker,havejoinedthe
paradeofmanagementscholarstakingtheideasof
economists,challengingthemwherenecessary,and
applyingthemtomanagementandpolicyquestions.
3.TheCapabilitiesViewoftheFirm:
AnIntroduction
Whiletheprogressofscience,accordingtoKuhn
(1963),involvesperiodsinwhichamainstream
paradigmdominates,thesubsequentdiscoveryof
“anomalies”leadstotheemergenceofanew
paradigmthat,overtime,displacestheold.Such
anomaliesexistineconomicsforverylongperiods
withoutthemainstreambudgingmuchatall.Inthe
spiritofRomer’ssuggestionthat“aresearchprogram
oughttoinvolverisk”(Romer,forthcoming:7),Itake
heresomeriskandoutlinearadicalapproachtothe
theoryofthefirmthatputscapabilities,andnotthe
productionfunctionorproductionsets,centerstage.
Thisexerciseisanimatedbymyownconvictionandby
JohnSutton’s(andAlfredChandler’s)observationsthat
onecannotadequatelyexplainthewealthofeither
firmsornationswithoutatheoryofcapabilities.Ibegin
bypointingouttheratherwoodennatureofthe
approachtothefirmincontemporaryindustrial
organizationandineconomicsmoregenerally.
Resourceallocationineconomicsisprice-guidedor
government-guided;theroleoffirmsandtheir
managementinguidingresourceallocationislargely
ignored.
Thefieldofindustrialorganizationobservedalmosta
centuryagothatdifferentindustrieshaddifferent
levelsof(accounting)profits.Thisledtothestructureconduct-performance(S-C-P)paradigmthatsaw
concentratedmarketstructureasthefoundationfor
tacitorexplicitcollusion,andprofits(Mason,1949,and
Bain,1959).Althoughseverely(and,inmyview,
correctly)challengedbyPhillips(1971),Demsetz
(1973),andotherswhosawcausationasgoingfrom
(financial)performancetomarketstructure,the
structuralistviewhasnotlostmuchsway,7still
animatingtoday’santitrust/competitionpolicyand
evengivingrisetoPorter’sinfluentialFiveForces
frameworkofcompetitivestrategy(Porter,1980).The
FiveForcesmodelpossiblyhelpsexplainwhythe
pharmaceuticalindustryishistoricallymoreprofitable
thanairlines,andwhyairlineswithstronghubsare,on
average,moreprofitablethanrestaurants(although
thismaybechanging).Nonetheless,itleavesmany
questionsunanswered.Fundamentally,though,the
S-C-PparadigmandPorter’sFiveForcesvariantarenot
widelyapplicablebecauseanysupracompetitiveprofits
areduetoasmallnumberoffirmsandindustry-level
structuralfactors.
ItistruethatPorter’sFiveForcesframeworkfilleda
vacuuminbusinessschoolsandinmanagement
consulting,providingalaundrylistoffactorstoanalyze
soastoidentifyattractiveindustries.Itdidnothelpthe
analystfigureout,however,thecharacteristicsof
“good”firms.Moreover,ithasevolvedlittlesinceits
introductionandhasseriousshortcomings,having
importedmanyoftheweaknessesofthestructuralist
paradigmfromeconomicsuponwhichitwasbuilt.In
particular,FiveForcesdoesn’taccountforcapabilities
orforinnovation.Moreover,itfailstorecognizethata
7
Modernapproachestodisruption,e.g.,Abernathyand
Clark(1985),JordeandTeece(1991),Christensen(1997),all
sharethisview—implicitlyifnotexplicitly.
9
concentrated,marketstructureisoftenthe
consequence(ratherthanthecause)ofsuperior
profitability.Furthermore,itassumesthat“industry”is
ameaningfulcategory,andtheunderlyingtheorylacks
firm-levelexplanatorypower.Totakeoneexample,
entrybarriersaretreatedasanindustry-levelconstruct
andarethereforeuselessforexplainingintra-industry
performancedifferences.
Induecourse,theclearexistenceofintra-industry
performancedifferences(Rumelt,1991)was
sufficientlyembarrassingthatanalternative
perspectiveknownastheResource-BasedView
emergedtoexplainfirm-leveldifferences.Itgaineda
largefollowing(Teece,1982;Wernerfelt;1984;Barney,
1991;AmitandSchoemaker,1993),atleastinthefield
ofstrategicmanagement.Inthisparadigm,intraindustrydifferencesareexplainedbyfirm-level
ownershipofdifficult-to-imitateresources,especially
intangibleassets.Thesecanserveas“isolating
mechanisms”(Rumelt,1987).8Theapproachbuilton
Penrose(1959)andfoundearlyapplications(inthe
managementliterature)inresearchondiversification.
Buttressingtheresourcesapproach,meanwhile,was
importantworkonoperationsmanagement.This
revealedmeasurabledifferencesinperformanceand
technicalcapabilities(Abernathyetal.,1983;Hayes
andClark,1986;ClarkandFujimoto,1990)consistent
withLiebenstein’s(1966)notionofx-inefficiency.Both
ofthesenewerapproachesweresilent,however,on
importantquestionssuchaswhattechnicalcriteria
reallymatteredandwhatresourcesallowedsome
firmstoremaincompetitiveacrossnumerousturnsof
thetechnologycycle.Thiscreatedtheneedfor
evolutionaryeconomictheoryandsomethinglikea
dynamiccapabilitiesframework.
Thecapabilitiesviewofthefirmtobeoutlinedbelow
looksbeyond“factorsofproduction”andproduction
functionstorecognizetheimportanceofthechoices
managersmaketorenderresourcesmoreproductive
andtomeetcustomerdemand.Italsorecognizesthat
technologyandknow-howdonotfalllikemannafrom
heavenbutratherresultfromsearch,R&D,and
investment.Moreover,thecapturingofvalueby
innovatorsandimitatorsisafunctionofthestrengthof
competition,theappropriabilityregime,andthe
natureoftheindustrialknowledgethefirmcanbuildor
acquireovertime.Inthisway,thecapabilitiesview
endeavorstohelpexplaininterfirmheterogeneity,
enterpriseevolution,andorganizationallongevity.
I.
3.1Resources
versus
capabilities
Resourcesarethetangibleandintangibleassets,
broadlydefined,thatthefirmcandevelopand
effectivelycontrol.Resources,whichincludetheskills
ofthefirm’semployees,itsequipment,andthe
collectiveskillsoftheorganization,generatestreams
ofservicesthatthefirmcandeploy.Astheorizedby
Penrose(1959)afirmatanypointintimeislikelyto
haveunderemployedresources,including
managementskills.Afirmwithexcessresourcesmay
finditmoreprofitabletomonetizethoseservicesvia
productdiversificationintonewavenuesofgrowth
ratherthanthroughamarkettransactionthatleases
accesstothesurplusservicestoanindependent
party—assumingsuchatransactionwouldevenbe
feasible(Teece,1980a,1982).Thesedecisionsare
consistentwiththecapabilitiesapproachtothe
boundariesofthefirm,whichwillbediscussedbelow.
Themannerinwhichafirm’sresourcesare
coordinatedandmanagedisatleastasimportantto
competitivesuccessandsurvivalastheidentityofthe
resourcesthemselves.Capabilitiessuchasasset
8
Anintermediatestepwastheidentificationof“strategic
groups”consistingoffirmswithinanindustrythathave
adoptedsimilarstrategiesandbusinessmodelsandthatare
separatedfromothergroupsbymobilitybarriers(Hunt,
1972;Porter,1980).
10
orchestrationandmarketcreation(orco-creation)are
vitaltoprofitableresourcemanagement(Pitelisand
Teece,2010).Capabilitiesariseinpartfromlearning,
fromcombiningresources,andfromexploiting
complementaryassets.Manycapabilitiesbecome
embeddedinroutines,andsomeresidewiththetop
managementteam.Organizationalcapabilitiescan
usefullybethoughtofasfallingintooneoftwo
interconnected(butanalyticallyseparable)categories:
ordinarycapabilitiesanddynamiccapabilities.Ordinary
capabilitiesaretoalargeextentoperationalwhereas
dynamiccapabilitiesaregenerallystrategicinnature.
Capabilitiesarenotappropriatelysummarizedbya
productionfunctionbecausetheyareuntetheredfrom
particularproducts.Forexample,acapabilitytomake
machinespoweredbysmall,compactinternal
combustionenginescanmanifestitselfinthe
manufacturingofmotorcycles,outboard(boat)motors,
ortractorsandlawnmowers.Othercapabilities,such
astheabilitytoofferoutstandingcustomerservice,
maynotbetiedtoaparticularproductareaatall.
Ahigher-levelcategoryofcapabilitywaspositedby
Teece,Pisano,andShuenina1990workingpaper
(revisedandpublishedin1997).Inthisstreamof
researchinstrategicmanagement,“dynamic
capabilities”(Teeceetal.,1990)areintegralto
selecting,developing,andcoordinatingordinary
capabilities.Thedynamiccapabilitiesframework,
whichwillbeamplifiedbelow,hasalsobeenadvanced
byNelson(1991),Chandler(1992),andWinter(2003),
amongothers.Thedynamiccapabilitiesframeworkhas
becomeoneoftheleadingperspectivesonthefirmin
thefieldofstrategicmanagement(DiStefanoetal.,
2010).Itseekstoexplainfirmsurvival(orfailure)and
long-rungrowthandfirmsurvival(orfailure)by
detailinghowfirmscancreate,extend,integrate,
modify,anddeploytheirresourceswhile
simultaneouslymanagingcompetitivethreatsand
effectuatingnecessarytransformations(Teece,2010a).
Althoughitisnotyetfullyelaboratedasatheoryofthe
firm,thedynamiccapabilitiesframeworkbrings
Williamsoniantransactioncosts,Penroseanresources,
Knightianuncertainty,andSchumpeterian(knowledge)
combinationstogetherinawaythatcanpotentially
explainnotonlywhyfirmsexist,butalsotheirscope
andpotentialforgrowthandsustainedprofitabilityin
highlycompetitivemarkets.
II.
3.2Ordinary
anddynamic
capabilities
Thissectionprovidesfurtherspecificationofthetwo
typesofcapabilities.
a) Ordinarycapabilities
Ordinarycapabilities,whichencompassoperations,
administration,andgovernanceofthefirm’sactivities,
allowthefirmtoproduceandselladefined(andstatic)
setofproductsandservices.Ordinarycapabilitiesare
embeddedinsomecombinationof(1)skilled
personnel,including,undercertaincircumstances,
independentcontractors;(2)facilitiesandequipment;
(3)processesandroutines,includinganysupporting
technicalmanuals;and(4)theadministrative
coordinationneededtogetthejobdone.
Afirm’sordinarycapabilitiessupporttechnical
efficiency(andhenceproductivity)inperforminga
fixedgroupofproductiveactivities,regardlessofhow
well-orill-suitedtheoutputsaretothefirm’s
competitiveneeds(Teece,2007:1321).Qualitycontrol
methodologies,performancemeasurementandpayroll
executionareexamplesofordinarycapabilities.
Ordinarycapabilitiescanbemeasuredagainstthe
requirementsofspecifictasks,suchaslabor
productivity,inventoryturns,andtimetocompletion,
andcanthusbebenchmarkedinternallyorexternally
toindustrybestpractices.Bestoperationalpractices
arethosethatsupportspeed,quality,andefficiency.
11
Bestpracticesalone,however,aregenerally
insufficienttoensureafirmsuccessandsurvival,
exceptinweakcompetitiveenvironments(whichare
stillubiquitousinless-developedcountries).One
reasonisthatthereisnobenefitatbeingverygoodat
deliveringthe“wrong”productsaftermarketdemand
shifts.Furthermore,muchoftheknowledgebehind
ordinarycapabilitiescanbesecuredthrough
consultantsorthroughamodestinvestmentintraining
(Bloometal.,2013).Asaconsequence,goodandeven
“best”practicesdiffusemoreorlessquicklyatleast
amongstthosefirmsinenvironmentsexposedto
strongglobalcompetition.Suchfirmsarelikelytobe
awareofbenchmarkingdata,canacquireandabsorb
competitiveoff-the-shelftechnologies,andcan
implementbestpracticetraining.
Forexample,themultidivisional(M-form)
organizationalstructurediffusedacrosslarge-scale
corporationsinthemiddleofthe20thcentury.Inthe
petroleumindustry,themajorityofleadingfirms
adoptedanM-formstructureoveraperiodofabout15
years(Armour&Teece,1978;Teece,1980b).Oncethis
organizationalbestpracticebecamecommonplace,the
higherprofitsthathadaccruedtoitsearlyadoptersin
theU.S.petroleumindustrydissipated.
Eventhoughthediffusionofbestpracticesclearlyisn’t
rapidorcomplete,beingatopperformerin
productivityisunlikelytoleadtosupernormalprofits
becauseitonlytakesafewfirmsatthefrontiertodrive
pricesdowntocompetitivelevels,therebydissipating
anyeconomicrents.Putdifferently,evenifbest
practicesaren’tuniversallyadopted,theiradoptionis
unlikelytosupportreturnsabovecompetitivelevels.
Ingloballycompetitivefirmsfacingstrongcompetition
inadvancedeconomies,whereprofitshavethe
greatestpotentialtobesizable,arelativelyhighlevel
ofordinarycapabilitiesexists,andbestpracticesare
closetouniversal.BobLutz(2011),theformervice
chairmanatGeneralMotors,illustratesthispointfor
today’sautomotiveindustry9:
Theoperationsportionoftheautomobilebusinesshas
beenthoroughlyoptimizedovermanydecades,
doesn’tvarymuchfromoneautomobilecompanyto
another,andcanbemanagedwithafocuson
repetitiveprocess.It...requireslittleinthewayof
creativity,visionorimagination.Almostallcar
companiesdothisverywell,andthereislittleorno
competitiveadvantagetobegainedby“tryingeven
harder”inprocurement,manufacturingorwholesale.
Justbecauseoperationsarenotatpresenta
differentiatorintheindustrydoesnotmeanthatthey
arenotimportantatanaggregatelevel.Thereare
significantdifferencesinproductivityamongfirms
(Dosi,2007),andproductivitygapswidenedinthe
2000s(OECD,2015).Thistranslatesintoagreatdealof
unrealizedvalueforsociety.Doingordinarythingswell
cansupportthejobsassociatedwithsurvivingin“me
too”commoditycompetition.However,itcannotlead
tolevelsofexceptionalprofitabilitythatdrive
investment,employmentgrowth,wagegrowth,and
theeconomicexpansionassociatedwithbusiness
leadership.Thisisinpartbecause,asmentioned
above,thepresenceofwell-developed(best-practice)
ordinarycapabilitiesinafirmsaysnothingabout
whetheritscurrentproductionmixistherightpathfor
thepresentorthefuture.Infact,strongordinary
capabilitiescanleadafirmintocomplacency;atrapis
sprungwhenmarketconditionschangebecausea
single-mindedpursuitofefficiencyandproductivitycan
driveoutthecapacitytoeffectuatechangetowards
thenewsuiteofproductsandprocessesthemarket
9
Theadventofdriverlessandelectriccarsisturningthe
basicdesignparadigmofacaronitshead,andcertainnew
ordinarycapabilities(e.g.,buildingbatteries)arebeginning
tomatter.
12
requires.10Indeed,O’ReillyandTushman(2013)point
tohowthepursuitofefficiencycanstandinthewayof
innovation.
ongoingevolutionaryfitnessisthegoalofdynamic
capabilities.
Thefundamentalproblemisthat
efficiency/productivity,whichissomuchemphasized
in(static)economictheory,ignoresinnovationandthe
transformationofmarketsandorganizations.Inertiais
ofteninadvertentlyimposedonorganizationsby
effortstooptimizeprocessesandachievebestpractice.
Notsurprisingly,empiricalresearchontheeffectsof
processmanagementpracticesfailstoyieldconclusive
evidenceofbenefits.Powell(1995)andSamsonand
Terziovski(1999)didnotfindevidencethatthe
employmentofprocess(optimization)technologies
aidedenterpriseperformance.Indeed,someevidence
(e.g.,Garvin,1991)suggeststhecontrary.Thepayoffto
betterprocessmanagementisdoubtful,exceptinan
industry’speriodsoftechnologicalstability.AsBenner
andTushman(2003)noted:“Activitiesfocusedon
measurableefficiencyandvariancereductiondriveout
variance-increasingactivitiesand,thus,affectan
organization'sabilitytoinnovateandadaptoutsideof
existingtrajectories...Corecapabilitiesmaybecome
corerigidities”(BennerandTushman,2003:242).
Asnoted,dynamiccapabilitiesareaboutdoingthe
rightthings,attherighttime,basedonnewproduct
(andprocess)development,uniquemanagerial
orchestrationprocesses,achange-oriented
organizationalculture,andaprescientassessmentof
thebusinessenvironmentandtechnological
opportunities.Strongdynamiccapabilitiesare
possessedbythefew,notthemany.
Asapracticalmatter,theperceivedneedtomaintain
bestpracticeandhighproductivitycandistracttop
managementfromfocusingoninnovationsoasto
developtherightproducts.Doingthingsright
(technicalefficiency)isnotthesameasdoingtheright
things.Doingtherightthingssupportsevolutionary
fitness.Moreover,asJohnChambers,formerCEOof
CiscoSystems,hasobserved,companiesmustbe
willingandreadyto“changefromdoing‘therightthing
toolong’to‘thenextbigthing’”(Chambers,2017).This
b) Dynamiccapabilities
Strongdynamiccapabilitieshelpenableanenterprise
toprofitablybuildandrenewresources,reconfiguring
themasneededtoinnovateandrespondto(orbring
about)changesinthemarketandinthebusiness
environmentmoregenerally(PisanoandTeece,2007;
Teeceetal.,1997).Theyallowtheenterpriseandits
topmanagementtodevelopconjecturesaboutthe
evolutionofconsumerpreferences,businessproblems,
andtechnology;validateandfine-tunethem;andthen
actonthembyrealigningassetsandactivities.
Successfullybuildingstrongdynamiccapabilitiesallows
firmstochallengecompetitorsthatprioritizeefficiency
overinnovation,thatignore(orareignorantof)
changingcustomerneeds,orthatfailtoempower
internalentrepreneursandchangeagents.
Forappliedpurposes,dynamiccapabilitiescanusefully
bebrokendownintothreeprimaryclusters:(1)
identification,development,codevelopment,and
assessmentoftechnologicalopportunitiesin
relationshiptocustomerneeds(sensing);(2)
mobilizationofresourcestoaddressneedsand
opportunities,andtocapturevaluefromdoingso
(seizing);and(3)continuedrenewal(transforming).
Engagementincontinuousorsemi-continuoussensing,
10
HenryFordlearnedthisthehardway.TheFordMotor
Companyusedverticalintegrationtooptimizethe
productionprocessfortheModelT.Thisworkedwelluntil
themarketshifted.Bringingafollow-onproduct,theModel
A,tomarketwasalongandarduousprocessthatallowed
GeneralMotorstogetaheadofFord,aleadershipposition,
GMheldfordecades.
13
seizing,andtransformingisessentialifthefirmisto
sustainitselfascustomers,competitors,and
technologieschange(Teece,2007).
kindofdynamicoptimization,ratherthanthestatic
optimizationthatisnormallypracticed.LouGerstner,
IBM’sformer(turnaround)CEOputitthisway:
Dynamiccapabilitiesreside,inpart,withindividual
managersandespeciallythetopmanagementteam
whoarerequiredtotakeanentrepreneurialrolein
detectingandexploitingopportunities.Atcertain
criticaljunctures,theabilityofaCEOandthetop
managementteamtorecognizeakeydevelopmentor
trend,thendelineatearesponseandleadthefirmin
itspathforward,mightbethemostprominentfeature
ofthefirm’sdynamiccapabilities.Butthe
organization’svalues,culture,andcollectiveabilityto
quicklyimplementanewbusinessmodelorother
changesarealsointegraltothestrengthorweakness
ofthefirm’sdynamiccapabilities(Teece,2010b).
Inanythingotherthanaprotectedindustry,longevity
isthecapacitytochange...Rememberthatthe
enduringcompaniesweseearenotreallycompanies
thathavelastedfor100years.They’vechanged...and
theyaren’tthesamecompaniesastheywere.Ifthey
hadn’tchanged,theywouldn’thavesurvived.Ifyou
couldtakeasnapshotofthevaluesandprocessesof
mostcompanies50yearsago—anddidthesamewith
asurvivingcompanyin2014—youwouldsayit’sa
differentcompanyotherthan,perhaps,itsnameand
maybeitspurposeandmaybeitsindustry.The
leadershipthatreallycountsistheleadershipthat
keepsacompanychanginginanincremental,
continuousfashion.It’sconstantlyfocusingonthe
outside,onwhat’sgoingoninthemarketplace,what’s
changingthere,noticingwhatcompetitorsaredoing.
(DavisandDickson,2014:125).
Thedynamiccapabilitiesapproachhelpsexplainwhy
intangibleassets,includingafirm’scollective
knowledgeandcapabilities,havebecomethemost
valuableclassofassetsinawiderangeofindustries
(HultenandHao,2008).Thereasonisthatknowledge,
capabilities,andotherintangiblesarenotonlyscarce;
theyareoftendifficulttoimitate.
BobLutz(2011)ofGeneralMotors(echoingAbernathy,
1978)putthisaspectofdynamiccapabilitiesrather
succinctlyfortheautoindustry:
Wheretherealworkofmakingacarcompany
successfulsuddenlyturnscomplex,andwherethe
winnersareseparatedfromthelosers,isinthelongcycleproductdevelopmentprocess,whereshort-term
day-to-daymetricsandthetabulationofresultsare
meaningless.
Inotherwords,ordinarycapabilitiesdonotdetermine
whetherthecurrentproductionschedulewillbethe
right(orevenaprofitable)pathtofollowinthefuture.
Strongordinarycapabilitiesarevaluableonlyduringa
givenmarketwindow;theyareinsufficientto
undergirdsustainablecompetitiveadvantageasthe
businessenvironmentchanges.What’sneededissome
Dynamiccapabilitieshavetobe“built”througha
processofinvestmentindiscovery,knowledge
generation,andlearning.AsAppleCEOTimCooksaid
inFebruary2013withreferencetothecompany’s
abilitytointegratehardware,software,andservices:
“Applehastheabilitytoinnovateinallthreeofthese
spheresandcreatemagic.…Thisisn'tsomethingyou
canjustwriteacheckfor.Thisissomethingyoubuild
overdecades”(AFP,2013).
Table1summarizesimportantdistinctionsbetween
ordinaryanddynamiccapabilities,andTable2aligns
strategyanddynamiccapabilityconcepts.
<TABLE1ABOUTHERE>
<TABLE2ABOUTHERE>
14
III.
3.3Capability
development
a)Calibratingcapability“distance”
Lestdynamiccapabilitytheorybeimpugneditselffor
beinginsufficientlydynamic,theissueofhow
capabilitiesarebuiltneedsconsideration,too.Hereit
isusefultodistinguishbetweenthedemandside(i.e.,
whatconsumerswant)andthesupplyside(i.e.,how
firmsbuildcapabilitiesifwhatthemarketwantsand
whatthefirm’stechnologyandorganizationalloware
notsynchronized).
Inthedynamiccapabilitiesframework,sensingmay
leadtothediagnosisofamarketandcompetitive
situationthatrequirestransformingandthebuildingof
capabilitiesinsidethefirmthatdon’tcurrentlyexist.
Howcanthisbebroughtabout?Inessence,whatis
requiredislearninghowtodonewthings,possibly
utilizingquitedifferentbusinessmodels.Inthisregard,
thequestionof“distance”fromcurrentpracticesis
highlighted.Inourframework,capabilitydistancefor
anincumbentfirmcanbecalculatedonthree
dimensions(Figure1):
1. Technicaldistance:Atechnological
challengecanbeincremental(insidean
existingtechnologyparadigm)orradical
(outsidetheparadigm).Iftheformer,
kaizen(continuoussmallimprovementsto
existingtechnology)willoftengetthejob
donewiththeexistingresourcebase.Ifthe
challengeisradical,thenR&Dand/oropen
innovation(i.e.,technologyoutsourcing)
willberequired.Thechallengeis
particularlysevereincompetitivetermsif
itisradicalforthefocalfirmbut
incrementalforarival.Hence,“radical”is
tosomeextentarelativeconcept.
2. Marketdistance:Thetargetmarketcanbe
nearorfar.Marketdistanceincreasesas
thefirmreachesfornewpoolsof
customers,perhapsinanewgeography
withculturaland/orregulatorybarriers.
3. Businessmodeldistance:Distancealsohas
abusinessmodeldimension.Doesthenew
technologyrequirearadicallydifferent
revenuemechanism?Willtheexistingcost
structureremainprofitable?Doesthe
firm’scurrentmixofoutsourcingandinhouseactivitiesneedtochange?
Whenthecapabilitygoalliesclosertotheorigin(point
OinFigure1),itisrelativelyeasiertoachieve.The
furtheroutoneachaxis,theharder.Multipliereffects
forchangesinvolvingmorethanonedimensionmake
thechallengegreaterstill.
<FIGURE1ABOUTHERE>
b)Closing(ordinaryanddynamic)capability
“gaps”
Closingcapabilitiesgapsbetweenwhatcompanies
haveandwhattheyneedissomethingweknowalittle
moreabout.Capabilitygapsareofatleastthreekinds.
•
Closingtechnologygaps:Thecontemporary
literatureisrichwithrespecttohow
technologygapsgetclosed.Thediscussionhas
progressedfromstandardtechnologytransfer
issues(licensing,technologyassistance
agreements,etc.)tousingtheSECIprocess
(Nonaka,1991)andtousing“openinnovation”
(Chesbrough,2003),whilenotforgetting
traditionalinternaldevelopmentthrough
corporateR&D.ThecriticalityofR&Dandnew
productdevelopmenttothiseffortwillvary
withthemagnitudeofthegapthatmustbe
closed.Newtalentwilllikelyneedtobehiredif
thegapisconsiderablewhetherthe
technologyistobedevelopedin-houseor
absorbedfromanexternalsource.
15
Closingmarketgaps:Addressingnewmarket
segmentsrequiresadeepunderstandingof
customer“needs”,whichhasculturaland
economicdimensions.Themostvaluable
knowledgeaboutcustomerscomesfrom
interactingwiththeminmultiplemarket
segments.Dataanalysisisausefulsupplement
toexperientialknowledge.
• Closingbusinessmodelgaps:Theemergence
ofnewtechnologyandmarketneedscan
sometimesrequireadjustingthewaybusiness
isdone.Forinstance,theInternetisallowing
(andrequiring)onlinesales.Brick-and-mortar
storeshavetoimprovetheirtraditional
approaches,adoptthenew,orrunbothin
parallel.Evenmaturesectorssuchasoiland
gasarenotimmunefromtechnologyandother
shocks,astheindustryexperiencespolicy
uncertaintyaroundenvironmentalconcerns,
theemergenceofnewtechnologiessuchas
hydraulicfracturing,andnewassertiveness
amongstate-runoilandgascompanies(Shuen
etal.,2014).
Thereisaliteraturetohelpunderstandeachof
theabovegapsinisolation,butlittletohelp
understandhowtomanageallthreeatonce.Whenall
threemustbechanged,thefirmmustundergoa
radicaltransformation.Inasmuchasbusiness
organizationhassystemicdimensions,itisimportant
torecognizethatourunderstandingofsocialand
organizationalsystemsisoftenlimited.Suchan
admissionimpliesthatthebusinessriskassociated
withclosingcapabilitygapsislikelynon-linearwiththe
numberofgapstobeclosed.
•
Thereareatleasttwoclassesofphenomena
embeddedinunderstandinghowtoclosecapability
gaps:(1)learningand(2)transformation.Bothrequire
leadership.Organizationswon’tlearnunlesstheyare
encouraged—andgiventhemeans—todoso.Norwill
theytransformunlesstheleadersoftheorganization
areinthevanguard.Thisiswellknown,buta
systematicefforttoincorporatesuchnotionsinto
capabilitytheoryisjustbeginning(Teece,2016).
Whetherordinaryordynamic,therearecertain
systemicchallengesinclosingcapabilitygaps.Thefirst
challengeistoactuallyunderstandthelocationand
magnitudeofcapabilitiesdeficiencies.Oftenitisonly
afteranorganizationtriestodosomething(andfails)
thatthegapisapparent.Theearlyphaseofaproject
looksokaybecausetherearetypicallyfewoutcomes
metricstoevaluate;lateron,problembegintocropup,
theseniorteamgetsmoreandmoreinvolved,andthe
goalslipsfurtheraway.Adhoc“solutions”are
attemptedandfailed.Finally,thereisgeneral
recognitionofacapabilitygap.
Theremayormaynotbearesourcegap.
Resourcesarenotcapabilities.Theremaybebudgets
andpeopleassignedtoaproject;but,ifthepeopleare
notchosencorrectly,performancefailureismore
likely.Manyprojectsandprogramsfailbecauseofan
organization’sinabilitytodevelopandintegratethe
capabilitiesneededtodesign,develop,anddeliver.
Strong(ordinary)capabilities(andnotjustresources)
areneededtogetthingsdone.
Whatiscriticalareabilitiesto(1)recognize
whatcapabilitiesareneededand(2)developthem
quickly,efficientlyandeffectively.Thesecapabilities
themselvesarekeypartsofdynamiccapabilities(Feiler
andTeece,2014).
Dynamicallycapablefirmsareagile.Toooften,
though,agilityisdefinedastheabilitytodo
commonplacethingsfasterandcheaper.Ifthat’swhat
onemeansbyagility,itismoreakintoordinary(rather
thandynamic)capabilities.Whenagilityreferstoa
reductioninthetimerequiredtoreachbestpractices,
itissimplyanincantationforSixSigma,Value
Engineering,orotherefficiencyinitiatives.Thosemay
benecessaryfortheorganizationtobecomemore
efficient;buttheyareonlysecondarilyrelatedto
conferringevolutionaryfitness,i.e.,beingmore
16
effective,moreabletogetnewthingsdone,andmore
focusedontherightthings.
...Wereversetheratiooftalking-to-doingfrom80-20
to20-80.Thingshappen.(Johnston,2017)
Strategicagilityismoreabouteffectiveness
thanefficiency.Thetopmanagementteammust
identifyopportunitiesandrecognizegapsinthe
resourcesandcapabilitiesthattheorganizationneeds
toaddressopportunitiesandthreats.Theorganization
mustbeabletolearn,absorbandimprovethe
necessaryprocesses.Whileexistingbusinessesneed
bestpractices,new,materiallysignificantinitiatives
generallyrequirenewcapabilities.Afocusonthe
maintenanceoffinancialperformanceoverthe
creationofnewcapabilitiesactuallyimpairstheability
todeliverbetterresultsinthelongerrun.Ata
minimum,masteringacapabilityrequirescreatingthe
capacityforarepeatperformance.
Johnstongoesontonotethatexcellencein
buildingcapabilitiesoftencombinesinternaland
externalsourcesofknowledge.Inhiswords,it
requires:
Whiletherearewell-documentedpracticesfor
many,ifnotmost,ordinarycapabilities,therearefew
documentedprocessesforbringingnewcapabilities
online.Anorganizationhasfewornointernal
referencepointsforhowtodowhatithasneverdone
before.Theremaybeindividualswithsomeofthe
requisiteknowledge,butmanagementmaynotknow
whotheyare.Moreover,theorganizationmaynot
knowwhat“excellence”inthetargetcapabilitylooks
like.
Establishingnewcapabilitiesrequiresleadership
andteamwork.AsmanagementexpertDavidJohnston
describesit:
Itellteamsaswearegettingorganizedandpullingin
neededcapabilitiesthatweareaimingfor"crackle".It
ishardtodescribethephenomenon,excepttosaythat
westarttoworkmultiplestepsahead,making
decisionsnowthatdon'tsimplyservicethenext
milestone,buttherealendpoint...Thereislittle
debateoverhowtogoaboutsomething,andlittle
debateoverwhatisgoodenough—thisisareal
contrasttolower-capabilityteamswherenearly
everythingbecomesmatterfordiscussionanddebate
havingreadyaccesstogreathelpandactingonit.It
alsomeansthatifwedon'tknowexactlywheretoget
help,weknowsomeonewhodoes.Wedon'treinvent
wheels,wedon'tbeatourheadsagainstwalls,we
don'tpretendourwaythrough;wediscardhubrisand
ego,andwerecognizethatgreatnesscomesfrom
findingthesolution,notfromtryinghardortalking
smoothly.(ibid.)
Thesearchforcapabilitygapsbeginsby
examiningthematchbetweenaproposedbusiness
modelandthefirm’sexistingcapabilities.Ananalysis
ofexistingcapabilitiesneedsanobjectivepointofview
thatisdetailedandrealistic.Organizationalinstincts
tendtocompeltheexaggerationofcurrent
capabilities.
Thecapabilitiestobeassessedaretechnical,
market,andbusinessmodel-related.Theyare
undergirdedbybusinessprocessesthatsupport
making,storing,selling,shipping,delivering,andthe
handlingoftransactions,returns,andcomplaints.
Somecompaniesgointoanewlineofbusinessandare
slowtocometogripswithmanyofthesebusiness
processesuntilrequired.Lateinthegame,they
discoveranumberofbusinessprocessesthatreally
shouldhavebeenconsideredintheproduct
requirementsanddesign.Thereisthenquitea
scrambletodecidewhattodoandhowtodoit.
Marketentryisdelayedandcostssoar.Adrivefor
insightonsuchmattersispartofdynamiccapabilities.
Some(ordinary)capabilitieshavemultiple
optionsbywhichtheymaybeacquired.Seniorleaders
17
seekingtobuildordinarycapabilities,canexercisethe
followingthreeoptionsaloneorincombination:11
1. Make:choosetodevelopthenew
capabilityintheexistingorganizationby
selectinganddevelopingpeople,teams,
theirmethods,tools,processes,training
themandotherwiseexposingthemtonew
waysofdoingthings;
2. Buy:acquirethenewcapabilityby
purchasinganexistingorganizationorby
hiringkeyindividualswiththeknowhow
requiredtoimplementone;
3. Rent:addthenewcapabilitythroughmore
orlesstemporarycontractsand
consultants.
The“make”optiontakestime,effortandskill.A
robustcapabilitybuildingprocessrequiresthe
consciousattentionofmanagement.Topositionthe
organizationforexcellenceinanewcapabilityusing
theexistinginternalteamcanbeparticularly
challengingbecausein-houselearningprocessesare
difficulttoaccelerate.Successalsorequires
accountability,whichisaidedbytheuseofobjective
measuresagainstagreed-upongoals.
The“buy”optioncanbeproblematicasafirst
step,thoughitisoftentheonetaken—maybeeven
mostoftentaken.Buyingofteninvolveshiring;but
whomtohire?The“buy”optiontoaddorenhance
capabilitiesshouldprobablybelowerrankedunlessor
untilitisunderstoodwithreasonableprecisionwhatis
needed,includingwhatconstitutesexcellenceinthe
targetcapability.
The“rent”optioncanbeapowerfulaccelerator
forcapabilitydevelopment.Itinvolvesusing
consultantstojump-starttheestablishmentofa
capabilityatahigh(bestpractice)levelinorderto
producegoodresultsfairlyquickly.Abarriertothe
successofrentingcanberesistancefromtheexisting
organization.Theoptionrequiresaconsciousdirection
fromseniorleaderstoendorsethedirectionbeing
givenbytheoutsidefirmaspartofastrategicvision
andsetexpectationsforthebehaviorchange.
Gettingcapabilitiesintoplaceacrossallneeded
functionsandgeographiesisachallenge.Onecritical
requirementisalignment.Incommonpractice,
“alignment”isoftenusedtomeanacquiescenceona
particularissue.Itrarelymeanswhatitneedstomean,
namelymutualunderstanding,agreement,andaction
insupportofstrategicgoals.Acquiescenceisshallow
andeasilyabrogated.Strategicalignmentisdeep,
committedandaccountable.
Manycapabilities(anddynamiccapabilitiesin
particular)cannotbebought;theymustbebuilt.Inthe
caseoforganizationalcoherence,forexample,the
abilitytoknowhowprocessesandfunctionsneedtofit
togetherislargelyamatterofidiosyncraticexperience.
Anotherinappropriatecandidateforoutsourcingin
mostcasesisR&Dandothertechnologicalinnovation,
particularlywherethefirmneedsto“pace”the
technologysothatitdevelopsinlinewithotherparts
ofasystem(ChesbroughandTeece,1996).Managers
mustlearntosynchronizetheeffortsofmarketing,
R&D,operations,qualityassurance,etc.,tounderstand
theirperspectives,andtoeffectivelydrawthemintoa
coordinatedwholeinwaysspecifictoaparticular
companyataparticularstageinitstrajectory.Being
abletounderstandwhothestakeholdersare,toelicit
theirneeds,todevelopinteractivebusinessprocesses,
tocreateinternaldocumentationandcommunication
systemsaremoreexamplesofcapabilitiesthatare
difficultandprobablyinappropriatetooutsource.In
fact,theseintegrativecapabilitiesareofteninvisibleto
11
ChesbroughandTeece(1996)outlinesomeoftherelevant
elements(seebelow).
18
organizations,withmanagementbeingonlyvaguely
awareofthelearningthatneedstotakeplace.An
integrativecapabilitymayemergeinthecourseofa
project,butitmaynotpersistwithoutconscious
recognitionandnurturing.Ifconsciouslydeveloped,
suchacapabilitycangeneralizeandbecomeadynamic
capability.
Buildingcapabilitiesishard;thesilverliningis
that,oncebuilt,theyarethendifficultforothersto
imitate.Putdifferently,theabsenceofamarketfor
capabilitiesmeansthatbenefitscanflowfrom
entrepreneurialandmanagerialactivitythatbuildsand
honesvalue-creatingcapabilities.Oncesuch
capabilitiesexist,theastuteimplementationofvalue
capturestrategiescanfuelgrowthinprofits.
IV.
3.4Dynamic
capabilities
andstrategy
Strategy,whendevelopedsuccessfully,involvesdoing
therightthings—deployingthefirm’sscarceassetsin
calculatingwaysandaligningitsprocessesto
outmaneuvercompetitorsbytakingadvantageoftheir
mistakes,leveragingin-housestrengths,and
overcominganyconstraintsimposedbythefirm’s
legacy.Itisthusacriticaladjunctofdynamic
capabilities.
Putdifferently,themanagerialorchestrationthatis
coretoenhancingprocessesandexploitingpositions
mustbeguidedandinformedbystrategy—andviceversa.Strategyneedstobeconsistentandcoherent.
Althoughthefirmisconstrainedtosomeextentby
whatithasdoneinthepast,itcanstillshapethepath
ahead.Dynamiccapabilitiesguidedecisionssuchas
whichproductstomakeorwhichcustomerstotarget.
Strategyhelpstodeterminethetimingofmarketentry
andhowtokeepcompetitorsatbay.
Astrategycanbedefinedas“acoherentsetof
analyses,concepts,policies,arguments,andactions
thatrespondtoahigh-stakeschallenge”(Rumelt,
2011:6).AccordingtoRumelt(2011),agoodstrategy
has(1)prescientdiagnosesthatidentifyobstacles,(2)a
guidingpolicyspecifiesanapproachtoovercoming
them,and(3)coherentactionconsistsoffeasible
coordinatedactivitiesthatimplementthepolicy.A
goodstrategywilloftennotappearfullyformed,but
insteademergeoveraperiodoftrialanderror
(providedthebusinessenvironmentissufficiently
forgivingtoallowexperimentation).Whiletheactions
dictatedbythestrategymaybevisibletorivalsand
freelyimitable,rivalsmaynotperceiveitintheir
interesttodosountilitistoolatebecausethe
underlyingdiagnosisandpolicycanbekeptsecret.
Whiletheyareanalyticallydistinctconcepts,strategy
anddynamiccapabilitiesare,inpractice,closely
related.Forinstance,sensingisimportanttodynamic
capabilitiesbutalsocontainsastrongelementof
diagnosis,whichisimportanttostrategy;seizingneeds
tobeconnectedtobothaguidingpolicyandcoherent
action;andtransformingthatisvalueprotectingand
enhancingrequiresaguidingpolicyandcoherent
action.
Dynamiccapabilitiesandbusinessstrategies
codetermineperformance(Figure2).Strongdynamic
capabilitiesstillrequireasoundstrategy.Firmswith
weakercapabilitieswillrequiredifferentstrategies
fromfirmswithstrongercapabilities.Andthe
effectivenessofdynamiccapabilitieswillbe
compromisedbypoorstrategy.
<FIGURE2ABOUTHERE>
4.Capabilities:Antecedentsin
EconomicTheory
Theconceptofcapabilitiesoutlinedaboveisnot
completelyalientoeconomics.Organizational
capabilitieshaveappearedperiodicallyintheeconomic
19
literature,connectedmostoftenwithnotionsof
productivity.12Theirlineagecanbetracedatleastto
Marshall(1920:322)whorecognizedthatmanagerial
capabilitiesmatter.Despitehisuseofthe
representativefirmassumption,hesawfirmsasbeing
differentfromoneanother.Healsorecognizedthe
needforanevolutionary/capabilityapproachto
economics,noting
Weshallneedevermoretothinkofeconomicforces
asresemblingthosewhichmakeayoungmangrowin
strength,tillhereacheshisprime;afterwhichhe
graduallybecomesstiffandinactive,tillatlasthesinks
tomakeroomforotherandmorevigorouslife.
Asexplainedbelow,Marshall’sreferenceto“strength”
isalignedwithcapabilities,evolutionaryeconomics,
andnotionsoffirmheterogeneity.JoanRobinson
(1977:1324)notedthatMarshall“describedindustry
asaforestinwhicheachindividualtreegrowsonlytoa
certainheight.”
Afirststeptowardexplainingthisinterfirmvariation
wasmadebyPenrose(1959),whodescribedthe
relationbetweenafirm’sresourcesanditsproduction
offinalproducts.Richardson(1972:888)further
developedtheidea,positioningcapabilities,whichhe
definedasthefirm’s“knowledge,experienceand
skills,”asthedriverof,andconstrainton,theactivities
ofthefirm.Demsetz(1976:373)pointedtothe
“inherentcapabilitiesofproducers”asapossible
sociallybenignexplanationforlargemarketshares.
Thetermhascontinuedtobeusedinthiscontext(e.g.,
Bresnahan,1992).Morerecently,Matsusaka(2001)
developedadynamicmodelofcorporate
diversificationinwhichacquisitionanddivestmentare
drivenbyeffortstomatchafirm’sactivitiestoits
capabilities.Capabilitiesweredefinedas“the
combinedmarketing,distribution,anddevelopment
skillsoftopandmiddlemanagement”(Matsusaka,
2001:428).Thecapabilitiesmodelshowshow
diversifiedfirmscantradeatadiscountevenwhen
diversificationisvalue-maximizing,whichcontradicts
theresultsofagencymodelsofdiversification.
JohnSutton(2002)hasequated“capabilities”more
narrowlywiththeabilitytoenhanceproductquality
andreducecost.However,intheterminologylaidout
earlier,suchcapabilitiesareonlythe“ordinary”
capabilitiesrelevanttoanenterpriseremaining
competitiveinestablishedmarkets,notthedynamic
capabilitiesthatcanpotentiallyhelpthecorporatetree
togrowbeyondits“certainheight”.Nevertheless,in
writinglessformallyonthecapabilitiesrequiredfor
economicdevelopment,Suttonhashighlightedthe
ability(whatcanbeclassifiedasadynamiccapability)
ofmanagerstoselectpromisingmarkets(Sutton,
2012).
Althoughhedidnotusethelanguageofcapabilities,
Garicano(2000)introducedamodelofafirminwhich
workersareinvolvedeitherinproductionorinsolving
problems.Thismodelcapturesessentialfeaturesofthe
processbywhichfirmsharnessresourcestodevelop
newcapabilities.Thismodelofaknowledge-basedfirm
waslaterembeddedbyGaricanoandRossi-Hansberg
(2012)inageneralequilibriummodelinwhich
innovationsdisplaceoldproductsandleadtothe
foundingofnewfirmsthatlearnandbuildinternal
hierarchies.Anothermodelthatcaptureselementsof
thedynamiccapabilitiesframeworkwithoutdirectly
referringtoitwaspresentedbyDesseinandSantos
(2006).Intheirmodel,firmsmovetooneoftwo
equilibria:astrongdivisionoflaborresultingin
organizationalrigidityoraninternalsystemofflexible
coordinationthatpermitsbetteradaptationtolocal
12
Aneconomicconceptsimilartocapabilitiesis
“organizationcapital.”Thephrasewasintroducedby
PrescottandVisscher(1980)asaproxyforproprietary
informationthatafirmgathersaboutitsemployeesand
theirtasks.Ithassincebeenmademoregeneral,
encompassingafirm’s“operatingcapabilities...investment
capabilities....andinnovationcapabilities”(Levand
Radhakrishnan,2005:75).
20
changesincircumstance.Worksuchasthisshowsa
promisingavenuefortheincorporationof
organizationalcapabilitiesandrelatedconceptsinto
formalmodels.
Forthemostpart,however,theconceptofcapabilities
inmoderneconomicshasmigratedfromtherichand
dynamicenterprisegrowthfocusofMarshalland
Penrosetoanarrowerconceptionmoreconsistent
withastatic,production-functionmodelofthefirm.
Thisisdisappointingandhasdeeplyimpairedthe
abilityofeconomictheorytoinformmany
contemporaryissues.Somethingbetterisneeded.
5.Anew(capability)theoryofthe
firmcenteredaroundmanagingunder
deepuncertainty,innovation,and
building/deployingnon-pricedassets
Thedynamiccapabilitiesframeworksketchedabove
incorporatesanentrepreneurialtheoryofthefirmthat
startsfromamoreprimitiveinitialstatethantheone
assumedinmosteconomicmodels.IntheCoaseWilliamsonframework,forexample,manymarkets,
technologies,andpricesexistalready(Boudreauxand
Holcombe,1989).Inreality,entrepreneursmustfirst
cutthroughuncertaintyandcreateeachmarketbefore
therearepreferencesandpricesthatcanleadto
marketactivity,anobservationthatdatesbacktoat
leasttheworkofFrankKnight(1921).
V.
5.1Deep
uncertainty
Deepuncertaintyisubiquitousintoday’scomplex
interdependentbusinessworld.Majorunexpected
shocks,dubbed“BlackSwanevents”byfinancial
13
U.S.DepartmentofDefenseNewsBriefing,February12,
2002.Thephrase“unknown
unknowns”wasalreadyin
frequentuseatNASAandperhapsappearedfirstina1982
theoristNicholasTaleb(2007),occur“outsidethe
model.”Yet,asTalebargued,sucheventsoftendrive
changesinthefortunesofcountriesandcompanies.
Whilelarge-scaleshocksarerare,smallershocksare
fairlyfrequent.Small,frequent,andunanticipated
shocksareparticularlycommoninthetechnological
arena.Allindustriesarecompetinginaworldwhere
capabilitieshavespreadtomoregeographicregions
thaneverbeforeandinterconnectednesscan
propagateshockwavesfromonce-obscurecornersof
theglobetomajormarketsintheturnofanewscycle.
AsventurecapitalistWilliamJaneway(2012:105)
noted,“theInnovationEconomy...issaturatedin
unquantifiableuncertainty.”
Nearlyacenturyago,FrankKnightrecognizedthat:
Withuncertaintypresent,doingthings,theactual
executionofactivity,becomesinarealsensea
secondarypartoflife;theprimaryproblemorfunction
isdecidingwhattodoandhowtodoit.(Knight,1921:
268)
Practicallyallofthetraditionalapproachestothefirm
implicitlyassumerelativelypredictableenvironments.
Theseapproachesmayrecognizerisk,buttheyignore
deepuncertainty.Ineffect,theyassumethat
uncertaintycanbemanagedinthesamewayasrisk.
Accordingly,theyareoflittlehelptomanagersfiguring
outhowtocompeteinenvironmentscharacterizedby
technologicalferment,financialvolatility,andother
sourcesofdisruption.
Deepuncertaintyisthetypeofoperatingenvironment
then-U.S.SecretaryofDefenseDonaldRumsfeld
characterizedbytheterm“unknownunknowns.”13A
knownunknowniswhenoneismissingvital
knowledgethatcouldnonethelessbeknown,given
enoughtimeandresources.Forexample,intheBattle
NewYorkerarticlebyJohnNewhousecitingtheexampleof
metalfatiguecausingthecrashoftheBritishdeHavilland
Cometairlinerinthe1950s.
21
ofMidway,bothsidesknewtheenemyfleetexisted,
buttheydidnotknowwhere.Incontrast,anunknown
unknowniswhenwehaven’teventhoughtofthe
possibleevent.
Uncertaineventsdonotalwaysresultinnegative
outcomes.Alarge,unexpectedeventmightalsobe
positive,suchaswhenaconsumer-generatedonline
video“goesviral”andcreatesmassivedemandfora
toy.However,asanysmallcompanyunabletotake
advantageofasuddentemporarysurgeindemand
knows,positiveshocksrequireagilemanagementand
flexibleorganizations.Withuncertaintypresent,the
primaryproblemformanagersandinvestorsisfiguring
outwhattodo.Efficientexecution(howtodoitmost
costeffectively)isdecidedlysecondary.Thatiswhythe
dynamiccapabilitiesframeworkputsthemanagement
priorityaroundfiguringouthowtodotherightthings;
howtodothingsrightisofsecondaryimportance.
Formanagersintheinnovationeconomy,thegoal
shouldbetonavigateunexpectedeventswitha
minimumofdisruption—andpreferablywithout
resortingtocrisismanagement.Crisismanagementis
all-consuminganddeflectsmanagementfromengaging
withconcomitantopportunities.Whatisrequiredfor
sustainedprofitabilityisthatthebusinessenterprise
bebuilttorespondtotheunexpectedbyestablishing
andmaintainingflexiblesystems,whicharehallmarks
ofstrongdynamiccapabilities.
Thereislimitedshort-termfinancialprotection
availabletoguardagainstsuchuncertainty,orto
embraceunexpectedopportunity.Holdingcashisa
goodhedgeagainstunpleasantsurprises;itisaformof
self-insuranceagainstuninsurable(negative)
uncertaintiesthatabusiness(orindividual)mightface.
It’salsogoodtohaveifnewopportunitiessuddenly
emerge.
Managingunderdeepuncertaintycallsforartaswell
asscience.Reasonandanalysisareinthetoolkit,but
imaginationisalsorequired.Ineffect,navigatingthe
unknowninvolvesimaginingafutureandendeavoring
tobuildit.
Thereislimitedshort-termfinancialprotection
availabletoguardagainstuncertainty,ortoembrace
unexpectedopportunity.Holdingcashisagoodhedge
againstunpleasantsurprises;itisaformofselfinsuranceagainstuninsurable(negative)uncertainties
thatabusiness(orindividual)mightface.It’salsogood
tohaveifnewopportunitiessuddenlyemerge.
However,managinguncertaintyrequiresadifferent
kindofresourcethatisdeeplyentrepreneurialin
natureandenablesthefirmtodevelopanddeploy
non-pricedassets.
VI.
5.2The
centralityof
non-priced
assets
Mainstreampricetheoryholdsthatwith(perfect)
competitionitisimpossibletopurchasesomethingfor
lessthanit’sworthorforlessthanthelong-termcosts
ofproducingit.However,andwithoutappealingto
monopolytheory,itisoftenpossibletoacquire
somethingforlessthanit’sworthtothebuyerifthe
acquiringfirmhassuperiorinformationorowns
relatedspecificcomplementaryassetsforwhichthere
isnoestablishedmarket.
Infact,moststrategicassetshavenomarketpricein
isolationbecausethevalueofanassetiscontextdependent.Suchassetsgenerallyyieldtheirfullvalue
totheowneronlywhentheyarecombinedwithother
complementaryorcospecializedassets.Ifmarketsfor
isolatedstrategicassetsexistatall,theyaregenerally
thin.
Itiswellunderstoodthatthepricesystem’snormal
assetallocationroleisunlikelytooccurproperlywhen
assetvaluesdependonidiosyncraticcombinations.An
economicimplicationofthisisthatinputorfactor
marketsarenotfullyefficient,andthefactormarkets
22
willnotservetheircoordinatingfunction.The
entrepreneurialmanager,nottheWalrasian
arbitrageur,achievesthemicro-levelcoordinationon
whichtheeconomydepends.Andthemarket
inefficiencyopenstheway,iftheentrepreneurhas
correctlysensedandseizedthebusinessenvironment,
forsupernormalprofits—notfromarbitragebutfrom
innovationand/orsuperioracumen.
a)Coordination,integration,andinnovation
Asnotedearlier,technologicalandinnovational
complementaritiesimposecoordination,market
design,andcontrolchallenges.Alignmentofactivities
withinfirmsisrequired.Alignmentamongfirmsisalso
necessarywherecertaintypesofcomplementarities
exist.14Theseexternalalignmentswereraiseddecades
agoatthemostgenerallevelbyBoulding(1956),then
specificallybyMalmgren(1961)andRichardson(1972).
Thereafter,theywereechoedbyWilliamson(1975),
remarkeduponbyTeece(1984,1990),explored
empiricallytoalimiteddegreebyArmourandTeece
(1980)andHelfatandTeece(1987),emphasizedina
verticalrelationtogeneral-purposetechnologiesby
BresnahanandTrajtenberg(1995)andHelpman
(1998),butneverfullyexploredordevelopedby
economistsormanagementscholars.Theeconomics
literaturetendstoassumethat,inthemain,upstream
anddownstreaminvestmentexpectationswill
converge,whichseemsunlikelygiventheproprietary
(andhencesecret)natureofmuchoftherequired
innovationactivity.15
Intheeconomicallysignificantrealmofenablingand
general-purposetechnologies,thesealignment
problemsareparticularlysevere.Bresnahanand
Helpmanareamongstthefewpointingoutpotential
contractualandmarketfailureissuesthatmayleadto
under-investment.Withreferencetotheclassof
widelyapplicabletechnologies,Jones(2012:660)
notedthatthemainproblemforcapturingvalueby
exploitingtheapplicationofaninnovationinmany
downstreamsectorsis“thefactthatyoucannot
identifytherecombinantpossibilitiesexantemeans
thatyoucannoteasilysolvethebargainingproblemin
practice—youcannotintegrateyourwayaroundit.So
innovationfacesaseriousmarketfailureinthesense
thatsociallyprofitableinnovationdoesnotoccur.”In
short,thereisnomarketmechanism,perhapsnoteven
vertical(andhorizontal)integration,thatcanensure
sociallyoptimalinnovationandadoptionofgeneralpurposeandenablingtechnologiesthatpermitfurther
“addin”innovationbydownstreamimplementers.
Fromamanagerialperspective,thereisasimilar
lacunaregarding“alignment.”Someoftheseconcerns
areaddressedundertheheadingofbusinessmodel
issues(Teece,2010b),leavingittoentrepreneursto
designcreativeorganizationalarrangementstohelp
solvethecoordinationandassociatedappropriability
14
Technologicalcomplementaritiesarelargelyabsentfrom
economicanalysis.Infact,theycompletelyvitiatethe
conceptofaproductionfunction,whichassumesthatafixed
listofinputsisusedtopracticeatechnologyknowntoall
firms.Inreality,productionfunctions,evenintheabsenceof
amajorinnovation,areoftenfirm-specificandquite
proprietary.Schumpeter(1934)observednearlyacentury
agothattheveryessenceofinnovationistypically“new
combinations.”However,histheorybroughtnogranularity
totheanalysis.Nordidheconsidertheappropriabilityissues
aroundnewcombinationsbecausehismainfocuswason
theabilityofnewproductsandprocessestodisplace
existingones.Thisspoketosubstitution,not
complementarities.
15
Verticalintegrationcanpartiallymitigatecoordination
problems.ArmourandTeece(1980)establishedthatR&D
levelsinthepetroleumindustryweresensitivetotheextent
ofverticalintegrationinadirectionsuggestingthat
integrationcaneasethecoordinationissueswhennew
technologyisdevelopedanddeployed.HelfatandTeece
(1987)showedthatverticalintegrationreducedrisk,which
canincludetheuncertaintythataccompanies
commercializationofnewtechnology.
23
challenges.Whenthecoordination/integration
challengesareexternal,privateordering(contractual)
solutionsarepossibleinsome—butnotall—cases.
Intangiblesareaparticularlyimportantclassof
strategicassetsforwhichmarketsareunderdeveloped(Teece,1981,2015).Thisisonlyinpart
becauseofthelimitednatureofthepropertyrights
assignedtothem.Context-dependencyisparticularly
acuteforcertainknowledgeassetssuchas
technologicalcapabilitiesthatcannotbemeaningfully
securedwithoutacquiringacompanyorbusinessunit,
thenfindingawaytoretainkeypersonnel.Evenif
pricesdidreflectallinformation,thethin-market
phenomenonreferencedherewouldstillresultinwide
bandsfor“competitive”priceswhenfirmsare
heterogeneousandproductsaredifferentiated.Thisis
thesetupimplicitlyadoptedinthestrategic
managementliterature(Denrelletal.2003;Rumeltet
al.,1991;TeeceandWinter,1984).Modernauction
theory(e.g.,Klemperer,2002)likewiserecognizesthat
assetswillnotachievetheirfullvalueinanauctionif
thereisonlyonebuyer.
Economictheoryhasyettoaddressthesepervasive
marketimperfectionsinameaningfulway,particularly
asregardstheirimplicationsforthetheoryofthefirm,
theroleofthemanager,andthechallengesassociated
withinnovation.Hintsaboutthesematterscanbe
foundinRichardson(1972)andintheliteratureon
entrepreneurship(e.g.,Kirzner,1997)andthaton
general-purposetechnologicalinnovation(Bresnahan
andTrajtenberg,1995;Helpman,1998;andJones,
2012).Whatismissingisanefforttotiethese
disparatethreadsintoatheoryofthefirmthat
includesadistinctiveroleformanagers.Thedynamic
capabilitiesframeworkcanmovethetheoryofthefirm
inthatdirection.
b)Thecentralityofmanagerialasset
orchestration
Becausethevitalcoordinationandalignmentof
assets/resourcesisdifficulttoachievethroughthe
pricesystem,specialvaluecanaccruefromowningand
utilizingthecapabilityofachievinggoodinternaland
externalalignment.Thisismoreeasilyaccomplishedby
managersthanbymarkets.Achievingsuchalignment
throughinternalizationgoesbeyondwhatBarnard
(1938)hassuggestedasthefunctionsoftheexecutive.
Hiswasalimitedviewofmanagers,withtheirtask
whittleddowntooneof“cooperativeadaptation”
(Williamson,1993).Buildingandassemblingassets
insidethefirm(asopposedtoaccessingthemthrough
askeinofcontracts)isnotdoneprimarilytoguard
againstopportunismandrecontractinghazards,
althoughinsomecasesthatmaybeimportant.Rather,
itisdonetoachieveeconomiesofscopeand
appropriabilitybenefits,whichgoesfarbeyondthe
conventionaleconomiclogicofminimizing
Williamsoniantransactioncosts.Thisalignment
processhasincentiveandorganizationalculture
dimensions,too.Itismeaningfulthatthebasicunitof
analysisfordynamiccapabilitiesisnotthetransaction
(asintransactionscosteconomics)buttheentire
firm.16
Incapabilities-basedtheoriesofthefirm,theconcept
ofcospecializationbetweenoramongassetsis
particularlyimportant(Teece,1986).Assetsthatare
cospecializedneedtobeemployedinconjunctionwith
eachother,usuallyinsidethefirm(Teece,1980a).
Merelyputtingtwobusinessunitsordepartments
undercommonownershipandcommongovernance
neednotbringabout“integration”inthesenseof
achievingfullalignmentandcooperation.Williamson
identifiescommunicationdistortions,internal
procurementhazards,internalexpansionproclivities,
16
Totheextenttheemphasisindynamiccapabilitiesison
contracts(explicitorimplicit),itislessconcernedwith
avoidingopportunismandmoreconcernedwithembracing
opportunity.However,thereisalsoconsiderableemphasis
onproduction,learning,andinnovation.
24
andprogrampersistencebecause“shiftingthe
incrementaltransactionfromthemarkettothefirm
generallyresultsingreaterbudget-basedsupports,
whenceverticalintegrationgivesrisetopersistence
tendencies”(Williamson,1975:122).Hisconcluding
commentisthat:
althoughmarketfailureconstitutesapresumptive
basisforinternalizingtransactions,the“defects”
associatedwithmarketexchangemayneedtoexceed
anontrivialthresholdbeforeinternalorganization
offersaclearcostadvantage.(ibid.:130)
Onewayortheother,“integration”(whetherwithina
firmoramongstfirms)isnecessaryforlong-term
survival.Successfulfunctionalintegrationcanbe
tremendouslyhard,especiallyincontrastwith
disaggregation,whichisoftensimpletoaccomplish.
Growthwillalwaysinvolvemoreworkonintegration
(whichmaybeonereasonwhymanymanagersprefer
lowgrowth).Theentrepreneurialtaskofimplementing
value-enhancing“newcombinations”inherently
requiressomemeasureoffunctionalintegration.Itis
notjustacost-basedcalculus.Thesameistruefornew
businessmodelsandtheintroductionofnew
capabilities.Thechallengeoffunctionalintegrationis
lessinsmallercompanies.TheCEO/foundercanuse
personalinfluencetohelpbringitabout.As
organizationsbecomelarger,theCEOmustwork
throughotherstocommunicategoals,motivate
employees,andpropagatetheorganizationalculture
thatunderpinsgoodalignment.AsentrepreneurPeter
Thielhasnoted,thisishardtodo;buthecreditshis
fellowPayPalco-founder,ElonMusk,withthese
capabilities.WithreferencetoMusk’sTeslaandSpaceX
ventures,Thielhassaidthat“whatwasreally
impressivewasintegratingallthesepiecestogether,”
andthatthis“isactuallydonesurprisinglylittletoday
and...whenpeoplecanpullitoff,isveryvaluable”
(Thiel,2014).
distinctiveroleofthe(entrepreneurial)manageristhis
“orchestration”ofcospecializedassetsandofbusiness
activitytoachievevalue-creatingandvalue-capturing
alignment.Performedastutelyandproactively,such
orchestrationcan:(1)keepcospecializedassets(and
people)invalue-creatingalignment,(2)identifynew
cospecializedassetstobedevelopedthroughthe
investmentprocess,and(3)divestorrundown
cospecializedassetsthatnolongeryieldspecialvalue.
Thesegoalscannotbereadilyachievedthrough
contractingmechanismsinpartbecauseofdynamic
transactioncosts(thecostsofnegotiating,etc.)but
alsobecausetheremaynotbeacompetententityto
buildor“supply”theassetsthatareneeded.Inshort,
capabilitiesmustoftenbebuilt,theycannotbebought,
andthereislimitedutilityinlabelingthisconundrum
asatransactionscostproblem.
Ratherthanstressingopportunism(although
opportunismsurelyexistsandmustbeguarded
against),theemphasisindynamiccapabilitiesison
buildingspecializedassets(thatcannotbebought)and
onchangeprocesses(tokeeptheenterprisealigned
withitsbusinessenvironment).Theseprocesses
include,researchanddevelopment,remoldingthe
businessarchitecture,assetselection,andasset
orchestration.Indynamiccapabilities,“smallnumbers”
bargainingisatthecore,asinWilliamson(1975).
However,theemphasisindynamiccapabilitiesisnot
justonprotectingvaluefromrecontractinghazards;
it’salsooncreatingtheassetsthat,intransactioncost
economics,becometheobjectofrentappropriation
efforts.
Inthedynamiccapabilitiesframework,ratherthanthe
single-mindedpursuitofcostminimization,the
25
VII.
5.3Towarda
(capabilitybased)theory
of
heterogeneou
sfirms
a)Introduction
Intraindustryheterogeneityhasrootsinbothdemand-
andsupply-sidefactors.Differencesamongfirmsoften
reflectthefactthatfirmstargetdifferentcustomer
segmentswithdifferentneeds.Thus,inautos,
Volkswagencompetesfordifferentcustomersthan
Rolls-Royce,andthisrequiresdifferentproduction
technologiesanddifferentmarketingandsales
methods.Foranynumberofreasons,firmsmayoptfor
differenttechnologicalandorganizationalapproaches,
usedifferentbusinessmodels,andchoosedifferent
strategies—evenwhenthefirmsarepursuingthesame
orsimilarmarketsegments.Such(strategic)decisions
bymanagersestablishdifferentpathways,leadingto
interfirmheterogeneity.
Deepuncertaintyalsoimpactsdecisionmaking.
Technologicaluncertaintyrendersdecisionsrelatingto
innovationcomplex,anddifferentfirmsmakedifferent
decisionsbecauseofhoweachmanagementteam
readsthesituationdifferently(Rosenberg,1982;
Teece,Peteraf,Leih,2016).
Asfirmsinnovate,recombineassets,andcompete,
theycreateeconomicdynamismanddisequilibrium.17
Asopposedtomanyothertypesofinvestments,
innovationrequiresrobust“animalspirits”becausethe
bestpathisoftenunclear,outcomesareuncertain,and
payoffshardtocalibrate.
Thedynamiccapabilitiesframeworkthusrecognizes
thedistinctiveroleofmanagersinassetorchestration
andrecombination.Inendeavoringtobuildatheoryof
thefirmwithoutfullyacknowledgingtheeconomic
importanceofinternallymanagedcoordination,
Williamson,Jensen,andothershavedeflected
attentionawayfromtheimportantrolethebusiness
enterprise,ledbyentrepreneursandmanagers,plays
inallocatingresourcestoexpandtheexistingsetof
economicpossibilities.Coordinationisalsocrucialfor
theinitialidentificationoftheseopportunities.Because
themarketforinformation/knowledgeaboutnew
opportunities(Aroraetal.,2001,GansandStern,2010;
Teece,1981)isn’twelldeveloped,entrepreneursand
managersmustbuildorganizationalcapabilitiesinside
businessesfirmstoassistinknowledgecreationand
knowledgecapture.Theyoftendosoindistinctways,
generatingheterogeneity(Nelson,1991).
b)Sensing,seizing,andtransforming
Thesensing,seizing,andtransformingcapabilitiesof
managersandtheirorganizationsbringlearningand
leadershipontothestage.Mostimportantlyfora
completetheoryofthefirm,theyarethecritical
factorsthatdistinguishbetweenwhatcanbedone
insidethefirmasopposedtowhatispossibleundera
systemofpurecontracts.
‘Sensing’isaninherentlyentrepreneurialsetof
capabilitiesthatinvolvesexploringtechnological
opportunities,probingmarketsandlisteningto
customers,alongwithscanningtheotherelementsof
17
Thecapabilitiesframework,whileantitheticalto
traditionalproduction-functionviewsofthefirm,isnottobe
placedinstrongoppositiontoallmainstreameconomic
theoriesofthefirm.Theframeworkincorporates,butisnot
animated,bytransactioncostorcontractualconcerns.While
itisnotblindtoagencycosts,theseareseenasofsecondary
importancebecausethedynamiccapabilitiesframeworkis
focusedmoreonopportunitythanonopportunism.
Managerialdiscretion,harnessedastutely,isseenmoreasa
desirablecomplementtofirminnovationandgrowthrather
thanasasignificantriskfactorthatoughttodrive
organizationaldesignandfinancialstructure.Itenablesasset
orchestration,whichsolvesfundamentalmarketfailure
problems.
26
thebusinessecosystem.Itrequiresmanagementto
buildandtesthypothesesaboutmarketand
technologicalevolution,includingtherecognitionof
latentdemand.Theworldwasn’tclamoringfora
coffeehouseoneverycorner,butStarbucks,underthe
guidanceofHowardSchultz,recognizedandthen
successfullydevelopedandexploitedthepotentialnew
market.Asthisexampleimplies,sensingrequires
managerialinsightandvision—orananalyticalprocess
embeddedintheenterprisethatcanserveasaproxy
forit.Sensingbenefitsfromtheapplicationofdata
analyticstoreal-timemarketdatatospottrends,
anomaliesandpatterns.Theabilitytosensedifferent
waysofdoingthingsistheprecursortochoosing
amongthem.
Onceopportunitiesaresensed,choicesmustbemade,
andinvestmentfollows.Thestructureandassetsofthe
organizationhelpshapethechoicesmade.‘Seizing’
includesimplementingthechoiceofbusinessmodelto
satisfycustomers,shapemarketsandmarket
outcomes,andcapturevalue.Largecashbalances
providethefinancialflexibilitythataidsdynamic
capabilities.Readyaccesstoexternalcapitalandtop
talenthelps.Employeemotivationandcultural
alignmentisvital.Goodincentivedesignisanecessary
butnotsufficientconditionforsuperiorperformancein
thisarea.Strongrelationshipsmustalsobeforged
externallywithsuppliers,complementorsand
customers,withtheboundariesofthefirmdrawnto
avoid(oratleastlimit)thelossofprofitstotheowner
ofanexternal‘bottleneck’asset(Teece,1986).
Cooperationisoftenpartoftheecosystemoccupiedby
firmswithstrongdynamiccapabilities.
Sensingandseizingaresimilartoexplorationand
exploitation,twoactivitiesdiscussedinthe
organizationalbehaviorliteratureaspotentially
incompatibleinsideasingleorganization(March,
1991).Exploration(e.g.,researchonapotentially
disruptivetechnology)hasalongertimehorizonand
greateruncertaintythanexploitation(e.g.,selling
matureproducts).Thetwotypesofactivitiesrequire
differentmanagementstyles;onesolutionisan
"ambidextrousorganization"wheretwoseparate
subunitswithdifferentculturesarelinkedbyshared
company-widevaluesandseniormanagerswitha
broadview(O'ReillyandTushman,2004,2016).But
thetensionsbetweensubunitsmuststillbeastutely
managedsothattheintegratedstructurereapsthefull
learningbenefits.
The‘Transforming’capabilitiesthatrealignthe
enterprise’sresourcesareneededmostobviously
whenradicalnewopportunitiesaretobeaddressed.
Buttheyarealsoneededperiodicallytosoftenthe
rigiditiesthatdevelopovertimefromasset
accumulation,standardoperatingproceduresand
insidermisappropriationofrentstreams.Afirm’s
assetsmustalsobekeptinstrategicalignmentvis-à-vis
itsecosystem.Complementaritiesneedtobe
constantlymanagedandreconfiguredasnecessaryto
achieveevolutionaryfitness,limitinglossofvaluein
theeventthatdemandshiftsinawaythatfavors
externalcomplements.
c)Theeconomicsoforganizationalagility:
normativeelements18
Thedynamiccapabilitiesframeworkindicatesaset
ofprinciplesthatentrepreneurialmanagersshould
andusuallydounderstand.Inparticular,managers
mustrecognizethatthepursuitofagilityrequires
sensing,seizing,andtransformingandoftenputs
ordinaryanddynamiccapabilitiesinconflict.
Observersnotethat“thecrueljokeisthatin
attemptingtopreservetheirsourceofadvantage,
organizationscanovercommitto
institutionalization,makingthemmoreinertand
vulnerabletoenvironmentalshifts”(Worley,
Williams,andLawler,2014).Itisofgreat
18
ThissectionisbasedonTeece,Peteraf,andLeih(2016).
27
importancetounderstandwhencompanies
(inadvertentlyordeliberately)overcommitto
woodenstructures,andwheremaintainingand
enhancingagilityoughttobeamanagerialpriority.
Achievingorganizationalagilityofteninvolves
sacrificingtechnicalefficiencies.Ifnotforthis
tradeoff,organizationalagilitywouldnotbesohard
toachieve,andordinaryanddynamiccapabilities
wouldalwaysbeadditive.Becauseofthesecosts
andtradeoffs,itisgenerallybesttoshieldthe
organizationthroughinsurance/hedgingwhenthe
challengeismerelytomanagerisk.Thisisbecause
insurance/hedgingandtheinstallationofrisk
managementproceduresandprotocolsareless
disruptiveofoperations,andcanreducethe
amountofadjustmentsandadaptationthe
organizationneedstomaketoremaincompetitive.
Thetradeoffbetweenagilityandefficiencyisonly
sometimesrecognizedinthefieldofeconomics
(e.g.,Stigler,1939).Ithaslikewisereceived
insufficientattentioninthefieldofstrategic
managementandisalmostnevermentionedin
organizationaltheory,withthenotableexceptionof
theworkonorganizationalambidexterity,
mentionedearlier,byMichaelTushmanand
colleaguesO’ReillyandBenner(e.g.,Tushmanand
O’Reilly,1996;BennerandTushman,2003).
Ambidexterityisadynamiccapability(O’Reillyand
Tushman,2008).
Outsidetheambidexterityliterature,which
capturessome,butnotall,aspectsofagility,only
verylimitedattemptshavebeenmadetooffer
prescriptiveadvicetomanagersregardinghowto
negotiatetheagility-efficiencytradeoff.Evenwhen
observersdefineagilityas“ahigher-orderdynamic
capabilitythatisbuiltovertime”(DozandKosonen,
2008),theydonotusuallyconsidertradeoffs.The
followingaresomerelevantprinciplesthatare
derivedfromand/orareconsistentwiththe
dynamiccapabilitiesframework:
1) Riskcanandshouldbemanaged
differentlyfromuncertainty.
2) Thefirsttaskinmanagingthosebusiness
enterprisescompetinginenvironments
exposedtoperturbationanddisruptionis
todeterminewhetherthesourceof
changeisprimarilyriskorprimarily
uncertainty.
3) Uncertaintyinthebusinessenvironment
manifestsitselfinunpredictable
turbulence,disruption,and
hypercompetition.
4) Moreflexibleplantsandequipmentcan
enablethefirmtodealwithfrequent
changesintherateofproduction.
5) Notallbusinessenvironmentsfacestrong
dynamiccompetitiongeneratingdeep
uncertaintyatalltimes.
6) Relativecalmallowsforformsof“business
asusual,”eventhoughtheorganization
mustremainvigilantandbereadyforrapid
changewhenneeded.
7) Thenetbenefits(i.e.,benefitsminuscosts)
oforganizationalagilityincreasewiththe
degreeofuncertaintyintheorganization’s
competitiveenvironment.19
8) Tobettermanagedeepuncertainty,
businessfirmsneedtoquicklygenerate
and“test”a(novel)hypothesisaboutwhat
isgoingoninthebusinessenvironment.
9) Strongdynamiccapabilitiescanyield
organizationalagilitywhileminimizingthe
costofachievingaparticularlevelof
organizationalagility,therebyallowing
managementtoachieveamorefavorable
19
Theconceptofhigh-velocitymarketsissimilar(Bourgeois
andEisenhardt,1988).Theseideasarealsocapturedinone
oftheconceptsofnext-generationcompetition(Teece,
2012).
28
tradeoffbetweenagilityandefficiency.
10) Transformationishardforestablished
enterprisesbutrelativelyeasyforstartups.
Theaboveprinciplesarederivedfrom(orareat
leastconsistentwith)dynamiccapabilitiesthinking.
Webelievethatimplementationoftheseprinciples
canbestbedoneunderthesensing,seizing,and
transformingrubrics.Analysisundereachclusterof
microfoundationscanbenefitfromconsiderationof
these(derived)principles.Putdifferently,sensing,
seizing,andtransformingarethreeclustersof
dynamiccapabilitiesthatmustbebuilttoachieve
evolutionaryfitness.Whencoupledwithstrategy,
eachhelpsachievejudiciouslevelsofagility.
d.Agilityandstrategy
Nomatterhowastutelyentrepreneurial
managementcopeswithriskanduncertainty,how
effectivelyitdiagnoseswhat’shappeninginthe
marketplace,orhowwellitmanagesthe
flexibility/efficiencytradeoff,allisfornaughtif
theseactivitiesarenotalignedwithagoodstrategy.
Strongdynamiccapabilitiesallowacompanyto“roll
withthepunches”andtapintonewopportunities.
However,underlyingagilityhasopportunitycosts
andshouldonlybebuiltforworthwhilepurposes.
Theseissuesimplicatestrategy.
Theeffectivenessofevenstrongdynamic
capabilitiescanbecompromisedbypoorstrategy
andpoorstrategicleadership.Asnotedelsewhere,
thegreatertheuncertaintyanddynamisminthe
businessenvironmentandthegreatertheneedfor
organizationalagility,themorecriticalgood
strategy,entrepreneurialmanagement,andstrong
dynamiccapabilitiesbecomeforthefirm’sgrowth
andfinancialperformance(Teece,2014).
Analogiesoutsideofbusinessmakethisapparent.
Inboxing,theprizefightermuststayagileand“keep
uponhistoes,”readytododgethenextblowfrom
anadversary,orbetterstill,tostrategicallyplace
one.Agilityandstrategyworkintandem.Insome
cases,agilitywillbesacrificedtoaidstrategy,asin
thecaseofcommitmentstoproductioncapacity.
Thefactthatreducingagilityissometimesdesirable
speakstotheimportanceofbuildingstrategyinto
agilityframeworks,whichthedynamiccapabilities
frameworkrequires.Agilitydoesnotalwayscreate
orpreservevalue.Forexample,adecisionimplies
(orsignals)commitmentwhensignificant
irreversibilitiesoccur(i.e.,thereisnolow-costway
ofgoingback).Clearly,strategicchoicesand
organizationaldesignsneedtobemanaged
together,andmoreagility,evenputtingcosttoone
side,isnotalwaysbetter.
Inthecontextofwarfare,agilityisavaluableforce
characteristic.Hencethejustificationforthe
significantinvestmentsmadeintheUnitedStatesin
SpecialForcesandrapiddeploymentforces.20Such
forcestypicallyconsistofelitemilitaryunitsthatare
usuallybettertrainedandhaveprioritywithrespect
tonewequipment.
Anexcellentexampleoftheinterdependenceof
agility(acapability)andstrategyistheBattleof
Trafalgar(offCapeTrafalgar,Spain)in1805.This
wasanavalengagementfoughtbytheBritishRoyal
NavyagainstthecombinedFrenchandSpanish
fleetsduringtheNapoleonicWars.Historiansnever
failtogivecredittotheBritishAdmiralLord
Nelson’sstrategy:engagingtheenemyfleetby
dividinghissmallerforceintotwocolumnsdirected
perpendiculartothelargerenemyfleet—a
completebreakfromprevailingtacticalorthodoxy
(whichwastoengageparallel,inasingleline).Less
20
The82ndAirborneand75thRangerregimentarethebest
examplesofrapiddeployment
forces.
29
frequentlymentionedisthatinpursuingthis
strategy,AdmiralNelsonhopedtoisolatethe
enemy’sflagship(leadingtoalackofcoordination)
andcreatechaosonthewater.Intheensuing
chaos,therewouldnecessarilybeship-to-ship
actions,inwhichAdmiralNelson’smoreagileships
andcrewswouldhaveabetterchance.LordNelson
knewthatthebetterseaman-shipandfaster
reloadingspeedsoftheRoyalNavygunnerswould
playakeyrole.Thestrategywouldfavorhisships’
andhiscrew’scapabilitiesovertheirSpanishand
Frenchadversaries.Inshort,AdmiralNelson’s
strategyleveragedthemoreagilecapabilityofhis
navalforce.Despiteasmallernumberofships,he
wasabletopulloffadecisivevictory.
deepuncertaintyandassociatedthreatsand
opportunitiescharacteristicoftoday’sinnovation
economy.
Thetypeofagilitythat(entrepreneurial)managers
choosetobuildintotheirorganizationsand
maintainshoulddependontheirstrategyand
positioninginthemarketandthedesiretoprepare
forbothdownsideandupside.Thatsaid,iffirms
havestrongdynamiccapabilities,theywillbebetter
atsensingemergingdevelopments;moreover,they
willachieveagilitywithlesssacrificeofefficiency,
alongwithmakingbetteruseofwhateveragility
theypossess.Thisisbecausetheywill,bydefinition,
bebetteratsensing,seizing,andtransforming.
LordNelson’svictoryatTrafalgarwasnotthrough
strategyalone,whichisoftenassumed,butby
marryingcapabilities(andinparticularagility)and
strategy.Putdifferently,thevalue(andtheneed
for)agilitycannotbecalibratedproperlyabsent
considerationsofstrategy.Thatistheplaceto
whichthedynamiccapabilitiesframeworkleadsthe
analyst(andthemanagers).Whenavailable,
flexibility/agilitycanbecostlyandwillnotyield
commensuratebenefitsunlessmarriedtoagood
strategy.
However,oneshouldnotconflateagilityand
dynamiccapabilities.Thelatterhasfarmore
elementsand,whenpracticedwell,providesthe
enterprisegreaterrobustness.Whilefirmswith
strongdynamiccapabilitiesarelikely(iffacingdeep
uncertainty)tobeagile,firmsmayperformwellin
stableorevenpredictablyvolatile(i.e.,risky)
environmentswithouthavingmadecostly
investmentsinagility.Thedynamiccapabilities
frameworkhelpsoneunderstandthecostsand
payoffstoagility,whentobuildagilityinandwhen
notto,andwhentosacrificeit.
e.Epilogueonagility
Organizationalagilityisamuch-toutedattributeand
usuallyconsideredvirtuous.However,thereare
associatedcosts,andtheexistingstrategic
managementliteraturedoesnotexplainwhen
agilityisdesirable,thenatureofitsfoundations,
andhow,ifatall,itrelatestostrategy.Byviewing
agilitywithinthedynamiccapabilitiesframework,
weadvancethenotionthatagilityshouldbesought
onlyinharmonywiththerequirementsofthe
businessenvironmentandwiththefirm’sstrategy.
Fortunately,agilityisusuallyunnecessaryin
businessenvironmentsexposedmerelytorisk.On
theotherhand,itisessentialwhenconfrontingthe
Thedynamiccapabilitiesframeworkcanhelpguide
managerswithrespecttowhenandhowtomanage
underdeepuncertainty.Aswehavediscussed,the
frameworkisinformedbysystemstheoryand
assemblestheelementsneededtodecidewhento
investinagilityandwhentorelyonthestandard
toolsofriskmanagement.Traditionalstrategy
frameworksarenotonlysilentonsuchmatters,but
alsodeflectmanagementfromfocusingonthem.
Dynamiccapabilitiespropoundsthat,inregimesof
deepuncertaintysuchasthosewhichcharacterize
sectorsoftheeconomyexperiencingrapidchange,
managementmustprimetheorganizationfor
30
sensing,seizing,andtransforming,andmarrythe
rightstrategytothefirm’scapacitytobeagile.
Congruencebetweenstrategyandcapabilitiesis
particularlyimportant.Whenthebusiness
environmentissaturatedwithdeepuncertainty,
dynamiccapabilitiesoughttobetheCEO’s
leitmotif,asitdelineatespathwaysthatallow
escapefromtheagility/efficiencytradeoff.
Abductivereasoningandimaginativehypothesis
buildingneedtokickintogearquicklywhenthereis
deepuncertaintyaboutthefuture.Second,when
needed,agilitycanbeachievedbymultiple
organizationalmodalities.
Finally,whilenotdevelopeddirectly,wenotethat
agilitymaysometimesbeafool’serrand;enterprise
deathmayinfactbethebestsolutionif
squanderingresourcestotransformwouldleave
stakeholdersworseoff.Becausedynamic
capabilitiesrequirestrategytobecoupledtoagility,
onlywheneverythingiscongruentcanvaluebe
createdandcapturedanddurablecompetitive
advantagerealized.
Thedynamiccapabilitiesframeworkhighlights
interrelationshipsthatneedtobeunderstoodif
managersaretobuildandmaintaincompetitive
advantage.Ithelpssetprioritiesandenables
coherenceandcongruencebetweenstrategy,
structure,andthebusinessenvironment.21
VIII.
5.4The
foundationsof
firm-level
heterogeneity
Atopmanagementteamdeterminesthepathand
characterofanorganization.Atanygivendate,thetop
managementteamofaparticularenterpriseisunique
toitalone.Whiletheorganizationanditscapabilities
providemanagerswiththerawmaterialrequiredto
perpetuatetheenterprise,itisincumbentontop
managementtomakethekeydecisionsastowhether
theenterpriseiscurrentlymakingtherightproducts
andaddressingtherightmarketsegmentandwhether
itsfutureplansareappropriatelymatchedtoconsumer
needsandtechnologicalandcompetitive
opportunities.Topmanagementmustdevelop
conjectures,validatethem,andrealignassetsand
competencesfornewrequirements,aswellasshaping
theinternalcultureinwhichthegenerationand
sharingofknowledgearetotakeplace.Thecombined
dynamiccapabilitiesofthemanagersandthe
organizationenabletheenterprisetoprofitably
orchestrateitsresources,competences,andother
assets.
Withthedynamiccapabilitiesframework,Iwouldlike
tobelievethatweareindeedafewstepsclosertoa
trulyfundamentalunderstandingoftheoriginsoffirmlevelheterogeneityandthesourcesofenterprise-level
valuecreation,capture,anddurablegrowth.Noother
frameworkisasambitiousinitsreach.Understanding
theoriginsoflong-termcashflowgenerationisthe
deepestunansweredquestioninmicroeconomicand
financialtheory.Itisthequestionthatdirectlyand
indirectlyanimatesmanagementtheoryand
21
Inthisregard,theframeworkendeavorstorevitalizethe
applicationofgeneralsystemstheoryinmanagement.One
needs,asBouldingremindsus,to“notseek...toestablisha
single,self-contained‘generaltheoryofpractically
everything’...Suchatheorywouldbealmostwithout
content,forwealwayspayforgeneralitybysacrificing
content,andallwecansayaboutpracticallyeverythingis
almostnothing”(Boulding,1956:197).Onemust
neverthelessalwaysremainmindfulofAristotle’sclaimthat
knowledgeisderivedfromtheunderstandingofthewhole
andnotthatofthesingleparts.
31
investmentchoicesandmotivatesthequestfor
understandingthewaysthatenterprisesarefarfrom
beinginterchangeableblackboxes.
Asnotedearlier,heterogeneityisalsoimpactedby
marketdemandandtheneedsoftheparticular
customersegmentsthatabusinessenterprisechooses
totarget.Thebusinessprocessesattheheartof
capabilitiescanbeuniqueandfirm-specific.These
uniqueprocessesaresometimescalled“signature
processes”(Gratton&Ghoshal,2005).22Theyresult
frompastactivities,irreversibleinvestments,and
embeddedvaluesthatshapeadistinctorganizational
heritage.Theirbasisinpastmanagerialdecisionstends
tomakethemdifficultforcompetitorstoimitate.
Soonerorlater,though,iftheyaregood,theywillbe
copied.TheToyotaSystemofProduction,whichwas
eventuallymatchedbyU.S.automotivefirms,isone
suchexample.However,thereplicabilityofany
complexprocessissometimesconfoundedbywhat
LippmanandRumelt(1982)call“uncertainimitability.”
This,alongwithahightacitcomponenttothe
underlyingknowledge,maykeepasignatureprocess
effectivelyproprietaryforquitesometime,providing
atleastatemporarysourceofinterfirm
heterogeneity.23
6.ImplicationsofCapabilityTheory
forResourceAllocation:x-inefficiency
andd-ineffectiveness
as:“thestudyoftheallocationofscarcemeansto
satisfycompetingends.”24Itissometimesformulated
asanissueof“what,how,andforwhom.”Economists
oftenassumethat,iffirmsmaximizeprofits,theywill,
absentexternalities,driveeconomy-wideefficiency
throughAdamSmith’sinvisiblehand.AlfredChandler
(1977)remindsusthatthevisiblehandofthemanager
alsosupportedthepricesystem,althoughhedidn’t
explainitinamannerconsistentwitheconomictheory.
Thatiswhathasbeenattemptedabovewiththe
conceptsofthinmarketsand(managerial)asset
orchestration.Themorefundamentaleconomic
problem,perhaps,isabouthowtocreateandsustain
businessenterprisesthatcaninnovateandchange,
therebyaugmentingwhattheeconomycandowithits
availableresources.Thisisadynamicproblem.
AfterAlfredMarshallandtheAustrianSchool,
Leibenstein(1966),asnotedabove,wasoneofthefew
economiststoexplicitlyrecognizethatmanyfirmsmay
not,infact,achievetechnologicalefficiency,andthat
theproductionfunctionmaythereforebedifferentfor
differentfirmsinthesameindustry,evenwhenthere
iscompetition.Heproposedtheconceptofxinefficiency,whichoccurswhenafirmoperatesabove
itscostcurve.X-inefficiencymaderoomforthe
possibilitythatmanagers(asopposedto
entrepreneurs)mightmatterineconomictheoryafter
all.However,Leibenstein’sx-inefficiencytheory,
despitebeingcitedoccasionally,hasnotreallybeen
embracedbyeconomists.Ithasarrivedatanenigmatic
deadendintheeconomicsliterature.
Tomanyeconomists,thecentralproblemineconomic
theoryandinthefieldofeconomicsmoregenerallyis
theachievementofefficientresourceallocation.Many
textbooksstillframetheprobleminstatictermssuch
Averyrecent,welcomeexceptionisBloometal.
(2013),whointerestinglydeclared(consistentwith
Marshall)that“managementmatters”(p.40)basedon
acontrolledstudyinwhich14Indiantextileplants
Tobeclear,signatureprocessesarejustoneelementof
ordinaryanddynamiccapabilities.
23
Overlongerperiodsoftime,signatureprocessesmay
becomesomewhatimitablebyothers.AsGrattonand
Ghoshalpointout,suchatransformationoccurred,
eventually,intheautomotiveindustrywithToyota’slean
manufacturingmodel,knownastheToyotaSystemof
Production.
24
ThisdefinitioncanbefoundinBecker(1976)andissimilar
totreatmentsbyRobbins(1932)andmanyothers.
22
32
weretaughtasetof38well-known(indeveloped
countries)managementpractices,resultingina17%
increaseinproductivityinthefirstyear.Theapparent
reasonforthefirms’initial(avoidable)inefficiencywas
thattheIndianmanagershadeithernotknownabout
thesuperiorpracticesorhadbeenskepticalofwhat
theyhadheard.ThisconfirmsbasicAustrianSchool
notionsaboutimperfectinformation(andinaction)
beingubiquitousintheeconomicsystem.
Bloometal.focusonquiteordinaryorganizational
capabilities,whichareamenabletotransferand
testinginanexperimentalsetting.Inthedynamic
capabilitiesframework,thatismerelythetipofthe
icebergintermsofthewaysthatmanagement
matters.
Whilenotcouchedinthelanguageofx-inefficiency,
thedynamiccapabilitiesframeworkimplicitlyaccepts
elementsofthat50-year-oldconcept.Leibensteinand
othersattributedx-inefficiencytothelackofadequate
competition,butjustasimportantispoor
management,limitedinformation,andweakordinary
capabilities.Strongercompetitorsalonemaynotsolve
theseproblems.
Thedynamiccapabilitiesframeworksuggestsatheory
ofthefirmthatnotonlyrecognizesfirmswithxinefficiency(i.e.,firmswithweakordinarycapabilities,
asevidencedbycostsabovethetechnicallyefficient
level).Italsorecognizesfirmsthatsufferfromwhat
mightbecalled“d-ineffectiveness”(i.e.,weakdynamic
capabilities).Infact,Ipositthatmostfirmsaredineffective,because,atanypointintime,manyare
likelytoproduceaportfolioofproductsnotideally
suitedtocustomerneeds.Moreover,effortsto
eliminatex-inefficiencycancaused-ineffectiveness
throughtheefficiency-innovationtradeoffmentioned
earlier.
Strategicmanagementscholarshavelongrecognized
theproblemofsub-optimalmanagementpractices
thateconomictheoryforthemostpartassumesaway.
Asnoted,akeytenetofthefieldofstrategic
managementisthatnotallfirmswillfollowbest
practice,letalonegenerateandadaptnewpractices
whichoutclassallothers.Ifafirmisd-effective,itmay
notneedtofollowbestpracticetoremaincompetitive.
Inthedynamiccapabilitiesframework,onlyd-effective
firmsaredestinedtolast.Developmentsintradeand
technologyhaveplacedapremiumontheabilityof
companiestobecomeentrepreneurialandagileat
homeandabroad,requiringinturnthatmanagement
senseemergingopportunitiesandthreatsandorganize
toallowandpromoteflexibility,learning,and,of
course,innovation.Ordinarycapabilitiesareless
salientandcanoftenbeoutsourcedtoexpertsuppliers
thatachieveeconomiesofscalebyservingmultiple
customers.Internaloperationalefficiencyisnot
enoughforsurvivalandgrowthintoday’sglobal
economy.Indeed,afocusonefficiencywilllikely
dampeninnovation,unlessfirmsareambidextrous
(O’ReillyandTushman,2004).
Capabilitytheoryisthustheportmanteauthatallows
(strategic)managementtheorytoinformbotha
deeperunderstandingofdurablefirm-level
competitivenessandtheproperfunctioningofthe
economicsystem.Itprovideseconomicsubstanceto
Chandler’sconceptofthevisiblehandwhilehelpingto
highlightinvisiblehand“failures”associatedwith
incompletemarkets.25Thisinturnwillleadtobetter
understandingbypolicymakersofhowthefirms
actuallyoperate,notasmerebundlesofcapital,labor,
andtechnology,butratherascomplexorganizations
25
Afterbrieflyadoptingtransactioncostsasoneofhis
theoreticalframeworks,Chandlerswitchedtocapabilities
(Chandler,1992).
33
thatthriveandwitherbasedinsomemeasureonthe
(visiblehand)activitiesofmanagement.
IX.
7.PublicPolicyImplications
Differencesbetweenparadigmsoffirmbehaviorcan
haveimportantpublicpolicyramifications.Policy
makersmuststrivetocarrymultiplemodelsof
organizationalbehaviorinmindastheymake
judgmentsaboutpossibleemergingavenuesof
intervention.
Althoughthereissometruthtotheagencytheoryview
thatmanagersstealorwasteshareholderdollarsin
variousways,itcompletelyfailstoprovideany
understandingofhowfirmsfirstcreatethevaluethat
waywardmanagers(andboards)thensupposedly
dissipateorsteal.Whileithasbeenshownthat
contractingissuesandfearofopportunistic
recontractingbypartiesoutsidethefirmhelpshape
theboundariesofthefirm,transactioncosteconomics
ignoresdifferencesinproductioncostsandthevalueof
integratingdiversepoolsoftechnologyandknow-how.
Whiletheneoclassicalviewofthefirmasaproduction
functioncanilluminatecertainissuessurroundingthe
supplyanddemandforinputs,itassumesthatmarkets
existratherthanthattheymustfirstbecreated.
Badtheoryproducesbadpolicy;andbad,poorly
informedpublicpoliciescanweakenaneconomy.
Withoutaddingthecapabilitiesapproachtothepolicy
maker’stoolkit,government’smayimpedeinnovative
changesintheeconomythatoffermajorgrowth
opportunities.Inthissection,Iconsiderthreeareas
whereacapabilitiesapproachcanleadtonon-standard
policyprescriptions.
7.1Corporate
governance
andoversight
Regulatoryandlegalframeworksthatrelyoneconomic
analysis,particularlyagencytheory,havesteered
corporategovernanceawayfromafocusonthefuture
healthoftheorganizationtowardmoreshort-term
concerns.AsGaricano(2000:874)notes,“withafew
recentexceptions,mostpreviouseconomicsliterature
hasequatedthestudyoforganizationswiththestudy
ofincentiveproblems.”Accordingly,policyframeworks
haveover-emphasizedatleasttwopotentiallymajor
setsof“problems”forcorporatelongevityandgrowth.
Oneistheissuesarisingbetweenmanagementandthe
boardofdirectors.Theothersetofissuesisbetween
managementandshareholders.The“solutions”that
havebeenadoptedconstrainthescopeof
managementtofullyleveragethecapabilitiesofthe
firm,riskinglong-rungrowthinemploymentand
output.
a) Agencytheory
Themainstream(agency)theoryofthefirmtakesa
contraryapproachtothatofthecapabilities
framework.Inmostlarge,publiclytradedcorporations,
ownershipbelongstoamoreorlessfragmentedgroup
ofshareholders,whileday-to-daycontrolisexercised
byprofessionalmanagerswhomayormaynotowna
significantnumberofsharesinthefirm.Thisraisesthe
possibilitythatmanagerscouldchoosetooperatethe
firminwaysthatbenefitthemselvesratherthanthe
shareholders.
Concernsaboutthepotentialformisallocationof
resourcesbynon-ownermanagersdatesbacktoat
leasttheworkofBerleandMeans(1932).Inthe1960s,
aflurryofbooksbyeconomists,suchasWilliamson
(1964),Marris(1964),andBaumol(1967),expandedon
theBerleandMeansthesisthatincentive
misalignmentbetweenmanagersandshareholders
wasinimicaltoeconomicperformance.
34
Inthefinanceliterature,JensenandMeckling(1976)
offeredaninfluentialsolutionbasedonthefinancial
structureofthefirm,i.e.,thebalancebetweenthe
firm’suseofequity(stock)anddebt(bonds).They
arguedthatmisalignmentsintheobjectivesand
informationsetsoftheprincipal(owners)andthe
agent(managers)imposeagencycostssuchas
contractingandmonitoringexpenses.Theirsolution
reliedonatrade-offbetweentheagencycostsof
equityfinancing(whichweakenstheincentivesfor
managersbyreducingtheirownership)andtheagency
costsofdebt(whichstrengthensincentivesfor
managersbutcanleadthemtopursueoverlyrisky
strategies).Totalagencycostsareminimizedwhenthe
marginalagencycostofadditionaldebtequalsthe
marginalagencycostofadditionalequity.Thelogic
behindallsuchagencymodelsisthatmanagement
discretionmustbelimitedandshareholdervalue
maximized.
Inthedynamiccapabilitiesapproach,theriskofselfinterestedbehaviorbymanagersisnotignored,butit
isofsecondaryconcernrelativetothefutureprospects
ofthefirm.Appropriateincentivesystemsandboard
oversightarerecognizedasdesirable.However,the
mostimportantjoboforganizationaldesignisto
empowercreativecontributionsfrommanagersandto
coordinateandalign“experttalent”(Teece,2011).26
Long-termshareholderinterestsareservedbystrong
dynamiccapabilities.Thetaskoftheboardin
competitivemarketsistohelpmanagerskeepdynamic
considerationsprioritizedovertechnicalefficiency,as
thepursuitofthelattercannotleadto(andcan
undermine)long-runcompetitiveadvantageintight
selectionenvironments.
Boththeagencyandcapabilityperspectiveshavetheir
roletoplay.Owners(i.e.,shareholdersandtheir
representativesontheboard)mustfindwaysto
preventmanagerialexcessandfraudwhileharnessing
theskillofmanagerstobuildcapabilitiesandguidethe
firminhypercompetitiveglobalmarkets.
b) Boardoversight
Oneplacewherepolicymakershaverunafoulofthe
imperativesofenterprisecapabilitiesisinthedesignof
corporategovernancemechanisms,specificallythe
compositionoftheboardofdirectors.Inthe
Capabilitiesperspective,whatmattersmostisthe
board’sroleinverifyingthattopmanagementis
pursuingacoherentstrategicvisionanddeveloping
strongdynamiccapabilities.Inadditiontothestandard
financialmonitoringfunction,theboardshouldalsobe
responsibleforrespondingtoevidenceofstrategic
malfeasancebymanagement,i.e.,caseswheretop
managementismakingpoordecisionswithrespectto
thefirm’slong-terminvestments.Positioningforthe
future,notoptimizingforthepresent,oughttobethe
focusofattention.
Recentregulatorychanges,suchastheU.S.Sarbanes
OxleyActof2002,havecreatedgreaterfinancial
transparencyandrequireextremelytightfinancial
controlsandrigorous—somemightsaypedantic—
applicationofaccountingrules.However,thistypeof
rigorandoversight,whileconsistentwiththeproblems
asdefinedbyagencytheory,provideslittleprotection
againststrategicblundersbymanagement.Indeed,by
focusingsomuchboardattentionelsewhere,Sarbanes
Oxleyislikelytoamplifythelikelihoodofsuch
blunders.Thenewtechnicalrequirementsofgood
governancenowprioritizedinU.S.lawmaybeofonly
second-orthird-orderimportancerelativetothelarger
issuesthattrulygoodgovernancerequires,namely,
26
Topmanagementholdsthekeytounlockingthefirm’s
innovationcapabilities.Hittetal.(1996)showedthat
companiesinwhichmanagersarerewardedprimarilyon
periodicfinancialmeasuresratherthanonanevaluationof
theirlong-termstrategicinitiativesarelesslikelytoinvestin
R&D(andmorelikelytoacquireotherfirms)evenafter
controllingforindustry-specificR&Dintensity.
35
relentlessfocusoncapabilitydevelopment,innovation,
andtransformation.
Complicatingthepictureisthatwhatconstitutes“good
governance”may,infact,becontext-dependent.For
example,insomecircumstances,theseparationofthe
CEOandchairmanrolesmaybecounter-productiveto
therapidtransformationrequiredtomeeta
competitivethreat,ortodevelopandcommercializea
newtechnologythatismeetingresistancefromcertain
partsofthecompany.Bifurcatedresponsibilitiesand
decisionrightsmightwellcomplicateleadershipissues
andsloworganizationaltransformation.
Manyboardsmaytodayhaveinsufficientstrengthto
helpmanagementproperlyevaluatestrategic
alternatives.Boardmemberstypicallylackstaffto
conducttheirownanalyses,whichleavesthemreliant
onthemselvesandonmanagementfortheir
understandingofcomplexissues.
Inthecontemporarygovernanceenvironmentinthe
UnitedStatesandEurope(and,toalesserextent,
Asia),greaterweighthasbeenputontheneedfor
boardmemberswhoareindependentofmanagement,
butnotonmemberswhounderstandtheindustry
environmentinwhichthecompanymustcompete.
c) Shareholdervalue
Inlargepartduetothecurrencyofagencytheory,a
“shareholder-centeredideology”hascometo
dominatethelegal,economic,andbusinessfieldsof
mostmajoreconomies—andespeciallyintheUnited
StatesandtheUnitedKingdom(Hansmannand
Kraakman,2001:439;Deakin,2004).Asa
consequence,thereisatrendtowardconvergenceof
legalpractices,boardstructure,securitiesregulation,
andaccountingmethodologiesthatgovernmajor
eventssuchastakeoversdespitenationalvariations
suchastheUnitedKingdom’slegalrequirementfor
boardstoconsider“employeeinterests”(Conard,
1991)andothermanifestationsof“stakeholdervalue”
approaches(Kay1998).Theproblem,fromadynamic
capabilitiesperspective,isthatshareholderturnoveris
high,soasingle-mindedfocusonmaximizing
shareholdervaluetoooftenleadstoashort-runfocus
bybothmanagementandboards.
Corporationsgovernedaccordingtothetenetsof
agencytheorymaybe(atleasttheoretically)moreor
lessimmunefromself-aggrandizementbymanagers.
Buttheconstraintsimposedbyexistingregulationsand
developmentsincorporatelawhavealmostcertainly
restrictedtheabilityofmanagementtoinvestin
existingandnewbusinessestoensurethe
developmentofcapabilitiesandinnovationtodrivethe
long-termhealthofthecompanyandtheeconomy.27
Shareholderprimacybegantoemergeasaguiding
principleofcorporategovernanceinthe1980s.Itwas
manifestedinmultipleways,includinghostile
takeoversandanincreaseintheroleofstockoptions
inexecutivecompensation(Haberstroh,2002:93).One
fairlyrecentmanifestationfromtheperspectiveofthe
long-rungrowthoftheenterpriseisthedriveto
increasedividendsandbuybacks,bothofwhichraise
thevaluetoexisting,butnotnecessarilyfuture,
shareholders.Inthe1980s,thelargestcorporations
beganallocatingalargeshareoftheirincometo
dividendsandstockrepurchases(Lazonick,2014).In
manyyears,thecombinedtotalofdividendsand
repurchasesbythelargestcompaniesexceeded75%—
andsometimesexceeded100%—oftheirnetincome,
27
Intheory,agencymodelsarecompatiblewiththelongterm,sociallyefficientmaximizationofenterprisevalue.In
practice,thelogicofthesemodelshasbeendistortedto
rewardshort-termstockmarketactivistswhocajole
managementtosqueezelargepayoutsthatraisetheshort-
termvalueoftheirshares.Theseactivistsareoftennot
investorsbutrathertraders,despitethefactthattheycloak
themselvesinthemantleofshareholders.Theyoftenhave
littleifanyinterestinthelong-termhealthofthecompany.
36
leavingrelativelylittlemoneyforinvestinginthe
company’sfuture(Lazonick,2014).
Anotheroutgrowthoftheshareholderprimacyviewis
theroleofactivistinvestorsinbreakingupcompanies
toreleaseshort-termvaluewhilepotentiallyreducing
long-termpotential.Between2003and2013,the
amountundermanagementbyactivisthedgefunds
grewfromlessthan$12billionto$65.5billion(Das
andTerlep,2013).Thephenomenonisevenimpacting
therelativelyclosedmarketforcorporatecontrolin
Japan(Hamaoetal.,2011).
Companyperformanceinthewakeofshareholder
activismisdifficulttoevaluatebecausealargeshareof
targetcompaniesmergeordelistandothersdivest
activities,leavingareducedassetbaseonwhichto
judgeperformance.Studiesofhedgefundactivism
generallyfindaanincreaseinearnings(EBITDA/assets)
amongtheremainingcompaniesintheyearortwo
followingtheintervention(e.g.Bravetal.,2008).A
studyofmorethan300activistcampaignsbyalltypes
ofblockholdersthatoccurredbetween2003and2005
atU.S.listedfirmsfoundthat,whilethecampaigns
wereprofitablefortheinvestors,earnings(EBITDA
overassets)generallydeclinedrelativetothoseofa
matchedcontrolsampleoffirmsintheyearfollowing
theblockholder’sinitialinvestment(KleinandZur,
2011).Thestudyfoundthathedgefundsgenerally
pursuedstrategiesofparingcashbalancesbyraising
dividendsorincreasingleverage,whileothertypesof
“entrepreneurialactivists”pursuedstrategiesof
reducinginvestmentinR&Dand/ornewcapital.28
Morethan13%ofthesamplefirmsweremergedor
acquiredwithinayearoftheintervention(Kleinand
Zur,2011:219).
Shareholderactivismrisksreplacingtheknowledgeable
judgmentofthefirm’smanagersandboardwiththe
less-informedanalysisofinvestorswithaninterestin
makingaquickprofit.Astudyofhedgefundactivismin
theearly2000sfoundthatthefundsheldthesharesof
targetcompaniesforabout20months,whichislongrunfortaxpurposesbutnotintermsofthelifeofa
company(Bravetal.,2008:1732).Itseemshighlylikely
thatactivistsareleavingatrailoflostopportunities
frominvestmentsskippedforlackofcapitalor
executivesdistractedbyafocusonreturningcashto
shareholders.Reformsthatwouldbelikelytoimprove
theabilityofmanagementtofocusondeveloping
organizationalcapabilities(whichrequiresa
stakeholderapproach)ratherthanpayingoffor
panderingtoactivistshareholdersincludereducing
(short-term)stock-basedpay,limitingtheabilityof
firmstoexecuteopen-marketbuybacks,andrestoring
limitsontheabilityofshareholderstoshapeboards.
X.
7.2
Development
policy
Thedynamiccapabilitiesframeworkcouldalsobeused
toinformpolicywithrespecttoeconomic
development.Consider,forexample,thesuccessesof
theAsian“tiger”economiesandthelackluster
outcomesinmanyothercountries.Whereastraditional
economicdevelopmenttheoristsstressresource
accumulation(propelledbyhighratesofinvestment),
thedynamiccapabilitiesframeworkstressesthe
importanceofenterprise-levelentrepreneurship,
innovation,learning,andgoodstrategy.
Thisresonateswithemergingtheoriesofdevelopment
(LallandTeubal,1998).NelsonandPack(1999)
distinguishedbetweenaccumulationandassimilation
28
Astudythatlookedonlyathedgefundcampaigns,but
coveringafarlongerperiod(1994-2007)foundthatreturn
onassetsgenerallyimprovedinthefollowingfiveyears
(Bebchuketal.,2015).Thepaperdoesnotmakedirect
comparisonswithotherstudiesorlookatwhetherthe
recentperiodisdifferentfromtheearlieryearsofthe
sample.
37
theoriesofdevelopment.Theassimilationapproach
alignswithdynamiccapabilitiestheoriesofthe
developmentandgrowthofthebusinessenterprise.
Theaccumulationapproachismoreakintothe
resource-basedviewofthefirm(Barney,1991).When
NelsonandPack(1999:434)notedthat“if…one
marshals[inputs]butdoesnotinnovateandlearn,
developmentdoesnotfollow,”theyimplicitly
endorsedtheimportanceofcapabilitiesfornational
economicdevelopment.
Firmsarethe"engines"ofeconomicdevelopment.
Furthermore,asnotedintheintroduction,thereis
emergingevidencefromdevelopedeconomiesthat
better-managedfirmssupporthigherwages.Economic
developmentpolicymakersmustthereforeunderstand
thedevelopmentalprocessesinsidefirms.Itisupto
governmenttoprovidethefundamentaleconomicand
politicalconditionsfavorabletoenterpriseandnational
growthincludingafunctionalelectricaland
transportationinfrastructure,macroeconomicstability,
non-predatorytaxation,incentivesforsaving,internal
andexternalpeace,andrelativelyhighlevelsof
literacy.
Aconsensus,summarizedinaWorldBank(1993)study
ofthehigh-growtheconomiesofEastAsia,emergedon
theidealinstitutionalbasesforeconomicgrowth:(1)a
mechanismforbroaddistributionofthebenefitsof
growth;(2)apowerful,meritocraticbureaucracy
insulatedfromfactionalizedpoliticalandbusiness
influences;and(3)channelsforsharinginformation
betweenthebureaucracyandtheprivatesector.
Althoughsubsequenteventsandlaterreassessments
(summarizedinYusuf,2001)havecalledintoquestion
severalaspectsofthe“EastAsianMiracle”and
underlyingpolicies,itisclearthatpublicpolicycanplay
amorepositiveornegativeroleinacountry’s
economicdevelopment.
Thescarcityoffirm-specificidiosyncraticassetsandthe
complexityofintegrationandcoordinationprocesses
constrainsthegrowthoffirms.Thesupporting
infrastructureintheeconomyatlargealsomatters,
becausethisislikelytoaffectthelocalsupplyof
appropriatelyeducatedandtrainedmanagerialand
technologicalhumanresources.Thegrowthoffirm
capabilitiesiscloselycoupledtotheavailabilityin
factormarketsoftrainedpersonnel.
Itisworthnotingfromtheeconomichistoryofthe
UnitedStatesthatitwasonlywiththeemergenceof
therailroad,thetelegraph,andtheprofessional
managersrequiredtorunthemthatlarge,innovative,
industry-dominatingcompaniessuchasStandardOil
andGeneralMotorsemerged.Chandler(1977)labeled
thedynamismhechronicledinhisstudyofthelongrundevelopmentoftheindustrialbusinessenterprise
asaperiodof“managerialcapitalism”(Mason,1958).
Theentrepreneurialfunctionsinthedynamic
capabilitiesframeworkarenotconfinedtostart-ups
andtoindividualactors.Theyareassociatedwitha
newhybrid:entrepreneurialmanagerialcapitalism.
Publicpolicycanhelptoencouragetheimprovement
ofthelocalpoolofmanagementtalent.Forexample,
programsthatsupporteducationinadvanced
countries,periodsofoverseasemployment,and
eventualreturntoworkatlocalfirmscan,overtime,
raisethequalitylevelofthetalentpool.Incountries
thatalreadyhaveanumberofforeignsubsidiaries,
establishingprogramswiththosewhoarewillingto
providemanagementtrainingtolocalemployeesis
anotherpotentialavenuetoincreasethestockof
humancapital.
Evenwithcompetentmanagement,thepositionsof
firmsinindustrializingeconomiesmaynotinitiallybe
competitiveintheglobalsupplysystem.Nevertheless,
asdiscussedinthedynamiccapabilitiesframework
thesefirmscancatchupbybeingbetteratprocesses
andbycarefullychoosingthemarketsinwhichto
compete.ThusmanyfirmsinAsiahavefounda
promisingpathbyactinginitiallyascomplementorsto
firmsinadvancedcountries.Thiscouldbeasimple
supplyrelationship,butmultinationalenterprises
38
(MNEs)haveanincentivetoinvestresourcesin
spurringtheimprovementofcapabilitiesatlocal
suppliersinlow-wagecountriesinordertoreducethe
MNE’sowncostswhilemaintainingquality.Most
notably,localfirmsbecamestrategiccomplementors
toMNEsinmanufacturing(EastAsia)andinsoftware
andservices(India).Theserelationshipsbringhigher
employmentandexportearningstothedeveloping
country,buttheymaynotinvolvemuchvalueadded
becauseofthelimitedpowerofthelocalfirmsin
globalsupplychains,wheretheMNE,asownerofthe
valuablebottleneckassets,isabletoextractthemajor
shareofvalue(Dedricketal.,2010).
Manylocalfirmsinglobalvaluechainsneverdevelop
thecapabilitiestocompeteontheirown.Inafew
cases,however,localcompaniessuchasAcerin
TaiwanandSamsunginKoreasuccessfullygraduated
fromsuppliertocompetitor.Thisrequiredestablishing
managerialprocessestofacilitatetheabsorptionand
integrationoftechnicalandindustrialknowledgefrom
partnerfirmsandothersourceswhiledeveloping
capabilitiestoacquireandapplymarketknowledge,to
builddistributionandservicenetworks,andtocreatea
valuablebrandimage.Strongdynamiccapabilitiesare
requiredtocompeteinglobalindustries.
Inothercases,suppliersinglobalvaluechainscanuse
theircapabilitiestoexpandhorizontallytopursuelocal
marketopportunities(HumphreyandSchmitz,2002).
Developingcountrieshavearelativelylargeshareof
inefficient,poorlymanagedfirms(Bloometal.,2012).
Onceaparticularfirmdevelopsexcellencein
manufacturinginoneindustry,itcanoftenapplyits
operationalknow-howtoother,import-substituting
industrieswhereglobalcompetitionislessstrong
(AmsdenandHikino,1994).Forthisreason,
conglomeratesremainmuchmorecommonin
developingthaninadvancedeconomies.Large
businessgroupscanbeasourceofnationaladvantage
providedthatlocalinstitutionsarestrongenoughto
preventthecorruptionthatoftencomeswith
concentratedwealth.
Acapabilitiesperspectivecanalsobehelpfulin
developingregionalclusters.Aclusterisageographic
concentrationoffirms,suppliers,andassociated
institutionsinaparticularindustry(seePitelisetal.,
2006,foranoverview).Suchgroupingscanrealize
agglomerationeconomiesfromphenomenasuchas
specialization,laborpooling,andsharedservices.
Policyinterventionscanassistthedevelopmentof
existingclustersortheemergenceofnewones.A
capabilityinventory,forexample,canrevealgapsin
localactivities,suchaslegalservicesorIT
management,thatareraisingcostsorhampering
development.Promotingtieswithalocaluniversityor
othereducationalandtraininginstitutionsinthearea
canimproveinnovationorenhancethesupplyof
skilledlabor.Reducingadministrativeburdens
associatedwithstartingnewcompaniesandinvesting
innewfacilitiesisalsovital.
8.Conclusion
Economistsrecognizethatthefundamentaleconomic
problemsareabout“what,how,andforwhom.”
Textbookeconomicsseesresourceallocationdecisions
asguidedonlybythepricesystem,butmanagerial
decisionsbasedonmorethanjustrelativepricesplaya
keyrole,too.Facedwithpervasivedeepuncertainty,
differentmanagementteamsseetheworlddifferently,
pursuedifferentstrategies,allocateresources
accordingly,andbuilddistinctorganizational
capabilitiesinsidefirms.Somewilldobetterthan
others(Lovalloetal.,2017).Iftheymakemissteps,
theycansometimescatchup—particularlyifit’sabout
doingthingsright(the“how”),sincetherewill
generallybeawaytoachievebest-practiceefficiency.
However,itisnotaseasyforabusinesstosolvethe
“what”problem—amatterfordynamiccapabilities—
39
asthe“how”,whereordinarycapabilitiesare
sufficient.
Thecapabilitiesapproachisonlystartingtoreceive
attentionfromscholarsinthefieldofeconomics,
despitetheavailabilityofalargeandgrowing
theoreticalandempiricalliteratureinthefieldof
strategicmanagement.Totheextenteconomistshave
examinedtheconceptinrecentyears,theemphasis
hasbeenontheordinarycapabilitiesrelevantto
maintainingandimprovingproductivity.Dynamic
considerationsarelargelyabsentfromthisdiscourse.
Mainstreameconomicshasyettofullyembracethe
realityofheterogeneous,entrepreneurialfirms
creatingmarkets,developinguniqueand
differentiatingknowledge,pursuinguniquestrategies,
andtransforminginternalstructureandbusiness
modelstomanagedisruptivecompetition.
Coretothecapabilitiesapproachistherecognitionof
thebusinessenterpriseasanorganizationwith
capabilitiesandstrategies.Capabilitiesliebehind
distinct,firm-specificproductionactivities.Innovation
capabilitiescreatenewproducts,newprocesses,and
newproductionfunctions.Entrepreneursand
managersplaycriticalrolesindevelopingand
sustainingcapabilities.Ordinarycapabilitiesareabout
bestpractices,canoftenbeboughtor“rented”,and
diffuserelativelyquickly.Dynamiccapabilitiesare
hardertodevelop.Theymustbebuiltastheycannot
bebought.Whilestrongdynamiccapabilitiesenable
theeffectiveselectionanddeploymentofordinary
capabilities,thestrengtheningofordinarycapabilities,
suchasadriveforefficiency,canactuallyundermine
dynamiccapabilitiesbyreducingorganizationalagility,
unlessskillfullymanaged.
Thedynamiccapabilitiesframeworkcarvesouta
uniqueplaceineconomictheoryforthe
entrepreneurialmanager,whohashithertohadno
productiverole.Managersidentifyneededcapabilities
andhelpbuildorbuythosethataremissing,then
integrateandorchestratethem.Theyalsochoose
strategiesandmakedecisions—oftenunderdeep
uncertainty.Maintainingevolutionaryfitnessrequires
theirpresenceinthetheorybecausethepricesystem
alone,evenwhenforwardmarketsarereasonably
complete,cannotaccountforit.
Becauseofthedominanceofmainstreameconomicsin
publicpolicyanalysis,theabsenceofacapabilities
perspectivehasledtopolicymyopia.Thecapabilities
perspectivemaintainsthateconomicgrowthhasmore
todowithtechnologicalandbusinessinnovationthan
witheliminatingadditionalinefficiencies,asimportant
asthatisforboostingshort-termprofits.National
economicgrowthcanbehamstrungifshort-term
earnings-per-sharemetricsarecenterstage.What’s
criticalforgrowthisforfirmstoinvestinlonger-term,
value-enhancingprojects.Ifcorporateboardsare
forcedtoworryaboutaudittrailsandaredistracted
fromstrategizing,orifCEOswhoinvestforthelongrun
arechallengedbyshareholderactivistswithshorttime
horizons,thenthemajorityofshareholdersandother
stakeholderswillsuffer,evenifshort-termtraders
gain.
Likewise,iflessdevelopedcountriesfocuson
investmentfortechnicalefficiencywithout
considerationofmarketneedsandthebuildingof
(dynamic)managerialcompetences,successwillbe
limited.Thereareendlessimplicationsofacapabilities
approach,includingthepromiseofanewgenreof
microeconomicanalysisthatincorporatesamore
completemodelofthefactorsthatunderliefirm
heterogeneity,theinnovativeperformanceoffirms,
andproductivitygrowthintheeconomymore
generally.
Appendix:Deficienciesofthe
EstablishedModelsoftheFirm
Thisappendixcomparesthecapabilitiesviewofthe
firmwiththeleadingmodelsofthefirmthatare
40
currentlyprominentineconomics.Thethree
consideredherearetheneoclassicalmodelofthefirm,
transactionscosteconomics,andagencytheoretic
approaches.
Neoclassicaleconomicsviewsthefirmasaprofit
maximizingmachine.Somehavecalleditablackbox.
Mainstreameconomistshavebeenreluctanttolook
toodeeplyinside.Intheirheavilystylizedmodels,the
mainroleofmanagementistochooseinputssoasto
minimizecostswhileproducingthelevelofoutputthat
equatesmarginalrevenuewithmarginalcost.Markets
aregenerallyassumedtoexist,althoughdemandmay
beuncertain.Marketpowercanexistandisalmost
alwaysseenasdeleterious,evenifithasresultedfrom
innovationand/orsuperiorforesight.
Transactioncosteconomics(TCE),closelyassociated
withtheworkofRonaldCoaseandOliverWilliamson
(1975,1985),implicitlyassumesthatproductioncosts
arethesamenomatterthegovernancearrangements.
Thereislittleefforttolinkthetwo,ortobringin
innovation.Coase(1937)wentsofarastoignorethe
revenuesideentirely,modelinginternalizationof
transactionsuptothepointwherethemarginalcostof
internalizinganactivityisequaltothemarginalcostof
usingthemarketinstead.TCEfocusesinsteadonthe
relativecostsofintegratingtransactionsinsidethefirm
andcontractingfortheminamarket.Internalization
imposescostsbecauseofbureaucraticoverhead,while
marketcontractscarrycostsrelatedtoassetspecificity,
whichraisesthepossibilityofopportunistic
recontracting.
TCEisavariantoftheneoclassicalviewinthat
management’sgoalistominimizethesumof
productionandgovernance(transaction)costs.Ifthe
organizationallocusofafirm’stransactionscanbe
arrangedintheorderofthecostdifferencebetween
internalizationandcontracting,thentransactions
shouldbeinternalizeduptothepointwherethe
bureaucraticdeadweightofinternalizingthemarginal
transactionisjustequalwiththecostofconductingit
viathemarket.Thislogichasbeenacceptedwithout
seriouscritiquefromwithinthedisciplineforalmosta
century,despitethefactthatitfliesinthefaceof
conventionaleconomicanalysisbecause,asnoted,
Coasianboundarychoicesaremadestrictlyintermsof
costswithoutconsideringrevenuesorbenefits.Itis
unlikely,forexample,thatthedynamiceffectof
organizingknowledge-intensiveactivitieswithinthe
firmandacrossamarketinterfaceyieldthesame
benefits.
Theagencytheoryview,whichalsoassumesthat
agentswillactopportunisticallyifallowedtodoso,
looksatconflictsofinterestwithinandaroundthe
firm.Relevantprincipal-agentpairsinclude
shareholdersandmanagers,debtholdersand
shareholders,andmanagersandemployees.Oneof
themainapplicationsofagencytheoryistocapital
structure.Inparticular,JensenandMeckling(1976)
arguedthattheownershipstructureofthecorporation
(insidershareholders,externalshareholders,and
bondholders)shouldbeoptimizedbyconsideringthe
relatedagencycosts,whichincludemonitoring,
bonding,andthelossthatisassumedtoresultfrom
theseparationofownershipandmanagementcontrol.
Thekeyassumptionthroughoutthisgenreofmodelsis
thatmanagerswillmisusecorporatecashby
undertakingnegative-valueprojects,failingto
downsize,orspendingonwastefulR&Dunlessthecash
issiphonedofftoservicecorporatedebt.
Anotherclassofagencymodelspushestheproblem
downalevel,withoverspendingarisingfromthe
excessiverequestsofdivisionheadswhoarebetter
informedthanexecutivesaboutthevalueoftheir
projectsandwillchoosethosethatyieldthehighest
personal(asopposedtoorganizational)benefit
(Rumelt,1987;AghionandTirole,1997).Thus,
divisionalmanagersaremodeledaslikelytoprovide
inadequateormisleadinginformation,whichleadsto
inefficientinvestment(e.g.Stein,2002;Inderstand
Klein,2007;FriebelandRaith,2010).
41
Thesemodelsoffirmbehaviorhavemyriad
shortcomingsintermsofexplaininghowinnovation
andgrowth,therootsofwealthcreation,takeplace.
Thedynamiccapabilitiesframeworkmakesastartat
addressingthegaps.
XI.
A.1Markets
toooften
assumedtobe
complete,and
externalities
toooften
ignored
Atleasttwoofthethreeeconomicmodelsdiscussed
abovetendtoassumethatmarketsarerelatively
complete,eveniftheydon’tnecessarilyfunctionwell.29
Theseassumptionsreducetheeconomicproblemto
oneofcontract,wheninfactitmaybeamoresevere
problemofmarketexistenceormarketexpansion.
Theproblemstemsinpartfromwhatwasreferredto
earlierasthehyper-rationalequilibriumassumption
(TeeceandWinter,1984).Ina“perfect”worldof
markets(spot,term,future,etc.),thefirmhasfull
informationaboutcompetitors,aboutcomplementors
ininvestmentdecisions,andaboutwhatconsumers
reallywant.But,inreality,muchofthisinformationis
proprietary,tacit,ordiffuse,andthusinaccessible.The
decisiontoinvestdependsoncapabilitiesforsensing
andcalibratingopportunities,developingstrategiesto
exploitthemostpromising,andforeseeinghow
potentialcompetitorsandcomplementorswill
respond.Thesearenotcapabilitiesrequiredina
neoclassicalworldofperfectcompetition.Ofcourse,
gametheorymodelsofinformationasymmetryexist,
buttheyarenotrobust,andafarcryfromthecomplex
realitythatthecapabilitiesapproachendeavorsto
address.
Oneareawherethisisespeciallyproblematicisthatof
complementaryinvestment,aproblemflaggedby
Malmgren(1961)andRichardson(1972),remarked
uponbyTeece(1984),exploredmorerecentlyinthe
verticalcontextbyBresnahanandTrajtenberg(1995),
andcommentedonbyJones(2012).
XII.
A.2.Existence
offirms
assumed,
entrepreneurs
sidelined,and
managers
implicitly
vilified
Theneoclassicalmodelusuallyassumesthatmarkets
simplyexistandleadtospontaneousproduction.
Agencytheoryalsotakestheexistenceoffirmsas
given.IntheCoase-Williamsonformulation,firmsarise
frommarketfailure.Itcontraststhecostsformarketbasedarrangementswiththecontrolaffordedbya
hierarchicalfirm.Butitisfarfrombeingafull
explanationofwhyfirmsaremorethanthesumof
29
Thecapabilitiesapproachmakesnosuchassumption.
Indeed,marketsmayhavetobecreated,asinthecaseof
newproductsandservicesthattapintolatentdemand(e.g.
theiPadandAppStore)andwhichrequireafter-sales
supportandproducttraining.Thisrequiresthattop
managementhavethecapabilitiestoidentifyunmet
demand,conceivewaystomeetitprofitably,andcommit
resourcestodosowithnocertaintyofacompetitivereturn.
Fornewproductcategories,buildinguserawarenessand
knowledgeiscritical.ThisiswhatSingerdidgloballytoallow
marketdevelopmentofthesewingmachine.Gillettehas
likewisepromotedtheaestheticbenefitsofremovingmen’s
beardsandofacleanshaveinordertobroadenthemarket
foritssafetyrazors.Theneedforsuchcreationand
expansionactivitiesisassumedawayintransaction-based
approaches,wherethereisalmostalwaysaparty(or
customer)totransactwithandaknown,existingdemandto
satisfy.
42
theirparts.30Andtheassumptionthatfirmsexist
allowstheroleofentrepreneursinbuildingfirmstobe
ignored.
Managersarealsoslighted,eventhoughdifferencesin
management(pastandpresent)—andinmanagement
decisions—lieattherootofmostinterfirm
heterogeneity.31Inmicroeconomictheory,managers
havebeenvirtuallydeniedapositiveroleineconomic
performance,despiteclearevidenceoftheir
importance(AdnerandHelfat,2003).Itisamazingthat
thetheoryofthefirmwouldgoforsolongwithscant
attentiontotheroleofmanagement.Inthetheories
discussedabove,managersarealmostalwaystreated
(ifatall)asboundedly(ifnothyper-)rational
automatonswithdeepproclivitiestostealfrom
shareholders.
Inneoclassicaltheory,therolesofentrepreneursand
managersareoftenstrippedoutbytheassumptionof
fullinformationandtheexistenceofacompletesetof
markets,evenforcontingentclaims.32Agencytheory
recognizesmanagersonlyinsofarastheywillmisuse
30
Thecapabilitiesapproachrecognizesfirmsasrepositories
oftheproductiveknowledgethatdrivestheeconomy.Ina
knowledge-basedtheoryofthefirm,transactions(internal
orcontracted)donotjustentailcosts;theyalsodetermine
“howtheparties'startingknowledgeendowmentsare
blendedandused...[and]howlearningordevelopments
occurringduringthecourseoftheworkaretakeninto
account”(ConnerandPrahalad,1996:484).Because
knowledgeismorelikelytobefreelysharedandexploited
withinfirmsthanbetweenthem,theconductofactivities
withinafirmoftenhasadvantagesoverthemarketthata
transactioncosttheoryignores(Teece,1980a,1982).In
somecases,knowledgeconsiderationswillbemore
prominentthantherisksassociatedwithopportunism,and
inothercases,theoppositewillholdtrue.Evenif
transactioncostswerezero,learningandorchestration
functionswouldstillneedtobecarriedout.Thefirmisa
vehicledesignedtodoso.
ormisappropriatecorporatecashifgivenhalfa
chance.Thisraisesthequestionofwherethewealth
insidefirmscomesfrominthefirstplace,something
thatagencytheorydoesnot—andcannot—address.33
Economistshavealonghistoryoffailingtoconsider
howmuchorganizationisnecessarybeforethereare
goodsandservicestoexchangeinmarkets.Adam
Smith,inhisfamouspin-makingexample(Smith,1776,
I.1.3),didnotexplainhowthepingotinventedand
howtheintegrationandcoordinationofnon-traded
pinsections(e.g.thewire,thehead)tookplaceinside
theworkshopinordertorealizethefruitsof
specialization.Yetmanagementfunctionshadtobe
performedinSmith’spinfactorybecausespecialization
willnotproduceitsbenefitswithoutacoordinating
agent.
Somewhatsurprisingly,economistshavenotdone
muchaboutthislacunainthelasttwohundredyears
evenastheworkcarriedoutbymanagershasbecome
exponentiallymorecomplex.34Thereisoccasional
referenceto“superiorforesight”bymanagement(e.g.
31
Foramorecompletestatementabouthowmanagement
functionsareobscuredineconomictheory,seeTeeceand
Winter(1984).
32
“Wemaydefinethemanagertobetheindividualwho
overseestheongoingefficiencyofcontinuingprocesses...
Theentrepreneur(whetherornotheinfactalsodoublesas
amanager)hasadifferentfunction.Itishisjobtolocate
newideasandtoputthemintoeffect....Heistheindividual
whoexerciseswhatinthebusinessliteratureiscalled
‘leadership.’Anditishewhoisvirtuallyabsentfromthe
receivedtheoryofthefirm.”(Baumol,1968:64–65)
33
Inthedynamiccapabilitiesframework,managersare
expectedtofulfillentrepreneurialaswellasoperational
roles.WhiletheAustrianSchoolfindsroomforthe
entrepreneur,itdoesn’thavemuchroomforthemanager.
Incapabilityeconomics,thereisacomplementaryplacefor
theentrepreneurandthemanager.Hence,capabilitytheory
takesAustrianeconomicstothenextlogicalstep.
34
OnenoteworthyexceptionisWalker(1887),whoplaced
differencesinmanagerialabilityfirmlyatthecenterofhis
43
GilbertandNewbery,1982:525),butlittleexplanation
ofwhatthatmightentail.
andpotentiallyvaluablecharacteristicstothefirms
theymanage.
ThemanagerisscarcelypresenteveninJohnRoberts’
(2004)“modernfirm.”Andevenwhenmanagersare
presentineconomictheory,thefocusofmodern
economicsandfinanceisonthedistribution,andless
sothecreation,ofthevalue(Jensen,2000).Thisis
despitethefactthattheefficacyofthemarket
economyflowslessfromthetwintheoremsofwelfare
economicsandmorefrommanagerialorganizational
capability,enterprisemanagementresponsiveness,
entrepreneurship,andinnovation(Nelson,1981).
BloomandVanReenen(2007)lookedattheeconomic
impactofmanagementpracticessuchasprocess
documentationandperformancetrackinginhundreds
ofmedium-sizefirmsandshowedthattheywere
correlatedwithproductivitybutfoundawide
dispersionofadoptionamongthesamplefirms.Bloom
etal.(2013)followedthisupwithacontrolledstudyin
which14Indiantextileplantsweretaughtasetof38
well-known(indevelopedcountries)management
practices,resultingina17%increaseinproductivityin
thefirstyear.Theapparentreasonforthefirms’initial
(avoidable)inefficiencywasthattheIndianmanagers
hadeithernotknownaboutthesuperiorpracticesor
hadbeenskepticalofwhattheyhadheard.This
confirmsbasicAustrianSchoolnotionsaboutimperfect
information(andinaction)beingubiquitousinthe
economicsystem.
Managementisnotjustaboutspecializationandthe
divisionoflabor.It’salsoaboutthemore
entrepreneurialtasksofideation,co-creation,and
coordination(assetorchestration).Theintegrationof
ideasandtaskstocreateorco-createinnovative
productsandservicesisattheheartofhowfirms
compete.Thisisnotarecentdevelopment,butitisnot
yetadequatelyreflectedinmainstreameconomic
theory.
However,anempiricaleconomicsliteratureonthe
effectsofmanagersandmanagementpracticeson
firm-leveloutcomesisfinallyemerging.Bertrandand
Schoar(2003)carefullyanalyzedahostoffirm-level
variablesforasampleofabout500C-levelexecutives
whohadmovedfromonemajorU.S.companyto
anotherbetween1969and1999.Theyfound
significantmanagerialfixedeffectsinreturnonassets.
Theoperatingvariablesmostassociatedwiththe
identityofanexecutivewereacquisitionand
diversificationdecisions,dividendpolicy,interest
coverage(ameasureofdebtservicerelativeto
earnings),andcost-cutting.Mostimportantly,the
resultsconfirmcasualobservation—andinvestor
belief—thatcertainindividualexecutivesbringunique
Notonlythesestudiesbutalsologicandsimple
observationshowthatgoodmanagersplayavitalrole
invaluecreationforshareholdersandother
constituencies,suchasemployees.Yetagencytheory
hassoblottedoutappreciationofthesecritical
managementfunctionsthatthepositiverolesof
managementareeffectivelyforgotteninmodern
treatmentsofcorporategovernanceandpublicpolicy.
explanationfortheprofitdifferentialbetweencompanies.
Unfortunately,hisinsightsseemtohavefoundnopurchase
inthesubsequentliterature.
44
XIII.
A.3
Managerial
(non-price)
resource
allocation
substantially
ignored
Someeconomistswouldhaveusbelievethatmarket
exchangeactivityisthelinchpin,ifnotthesolebasis,of
efficientresourceallocationandwealthcreationinthe
economy.Economists(e.g.Hayek,1945)waxeloquent
abouthowwellthemarketdoesthiskindofallocation,
andappropriatelyso.35Thefirmisalsosignificant
becauseitisoneplacewheremarketsareparticularly
incomplete.Insidethefirm,thepricesystemmaynot
holdsway.
However,wheninnovationandchangearepartofthe
economy,morethanthepricesystemisneededto
allocatescarceresourcesamongunlimitedwants.
Managersandmanagementareneeded,too,inpart
becausekeyassetmarketsaretoothin—or
nonexistent.The(neoclassical)economicmodelof
marketexchangetakesforgrantedthatsomehow,
somewhere,newgoodsandservicesarebeing
designed,developed,andproducedbysomemethod
thatwillbetechnicallyefficient,conditionalonfactor
costs.
Thepricesystemhaslittlerelevancetotheinternal
allocationofresourceswithinfirms.Asexplainedin
Teece(1980a,1982,1986)andinHelfatetal.(2007,
Chapter2),managers,entrepreneurs,andinnovators
cannotjustleaveituptoahypotheticalmarkettoline
upspecificassets,developnewones,andintegrate
themintoawell-functioninginnovation,production,
andmarketingsystembecausemarketsforhigh-
specificity(idiosyncratic)assetsgenerallydon’texist,
andiftheydoexisttheyareinvariably“thin.”To
overcomethisproblem,managersbecomethe
instrumentsthathelpachievetheshrewd,andoften
highlycomplex,allocationofcompanyresources.They
gatherinformation,makeassessments,andgive
directivessothatnon-pricedassetsaredevelopedand
deployedinvalue-enhancingways.Thisisthe
orchestrationfunctionthatthedynamiccapabilities
frameworkassignstomanagers.
Asbothatheoreticalandpracticalmatter,howfirms
allocateresourcessothattheyareintheirfirstbest
useisafundamentalquestion.Howfirmsbuild,
augment,andmodifytheirresourcebaseand
productivecapabilitiesovertimeisalsoofcritical
importance.Theseareimportantresourceallocation
functionsthat(neoclassical)economictheoryignores.
Givenitshistoryofsuccessesinthefaceofuncertainty,
managedcoordinationwithinfirmscertainlyseemsjust
asremarkableanallocationprocessasthatwhich
Hayek(1945)observedintheworkingsoftheprice
system.Thus,marketsandintra-firmresource
allocationarenotonlysubstitutes,asCoase(1937)
implicitlyclaimed;theyarealsocomplements.
Williamson(1999:1106)seemstohaveagreed,noting
that“therelationbetweencompetenceand
governance[is]bothrivalandcomplementary—more
thelatterthantheformer”.
XIV.
A.4
Intraindustry
heterogeneity
ignored
Aconsequenceoffirms’departurefromcoordination
viathepricesystemisthattheydifferfromeachother
innumerousways,includingefficiencyand
35
HayekandotherAustrianSchooleconomistssuchasvon
MisesandKirzneralsomaintainthatpeopledonotallocate
meanstoends;rather,theyconsistentlyseektodiscover
andcreatenewendsandmeans.Inthisregard,Austrian
economicsiscompatiblewithdynamiccapabilities;
neoclassicaleconomicsisfarlessso.
45
innovativeness(Nelson,1991).Mainstreameconomics,
includingthethreemodelsofthefirmconsideredin
thispaper,shedslittlelightonthesourcesof
intraindustryheterogeneity.
Therehavebeenperiodicattemptstoembedfirm
heterogeneityinmodelsofeconomicactivity.Iwai
(1984),forexample,includedfirmswithdifferent
productioncostsinaSchumpeterianmodelofindustry
dynamics.Morerecently,Melitz(2003)introduceda
contract-based,heterogeneousfirmsmodelof
internationaltrade.Theheterogeneitywasintroduced
bydrawingeachfirm’sproductivityfromaprobability
distribution.Firmsstilloptimize,subjecttothelevelof
theirproductivity,andcompeteinexistingmarkets
withknowncharacteristics.Firmsmayenterorexita
market,buttheseevents(particularlyentry)are
generallyunexplained,apartfromrulethat,atleastin
theshort-run,productionisnotworthwhileifpriceis
lessthanaveragevariablecost.36
Thereisampleempiricalevidencethatprofitmaximizingfirmswillnotnecessarilyachievetechnical
efficiency(Syverson,2011).Asnoted,Leibenstein
(1966)introducedtheconceptofx-inefficiency,which
occurswhenafirmoperatesaboveitscostcurve.
EconomistsoftheAustrianSchoolrecognizedthat
firmsmaynotevenachievetechnologicalefficiency.
Leibenstein’sx-inefficiencytheorymadeclearthata
fullunderstandingoftheeconomyneededtolook
morecloselyatwhyfirmsdiffer.Althoughthe
challengewasn’ttakenupatthetime,recentresearch
hasstartedtofillintheblank.
ThestudiesofmanagementpracticesbyBloomand
VanReenen(2007)andBloometal.(2013)confirmed
thatmanyfirmsfailtooptimizetheiroperationsfor
anyofanumberofreasons.Theyshowedthat
competitionmatters,butsodoesmanagementwith
respecttodevelopingandusingquiteordinary
capabilities.
XV.
A.5Firm
boundaries
setby
incomplete
frameworks
Anotheraspectofinterfirmheterogeneityisthatfirms
choosedifferentbusinessmodelsanddifferent
boundaries.Inagivenindustry,somemaychoose
strongverticalintegrationwhileotherschooseto
contractoutmostofthenecessaryactivities.The
differencescanariseforanynumberofreasons,
includingdistinctfirmhistories,disparitiesin
coordinationcapabilities,anddifferentappropriability
strategies.
Oftheeconomicmodelsunderconsideration,
transactioncosteconomicsistheonemostassociated
withdelineatingtheboundariesofthefirm.As
describedabove,transactionsaretobeallocated
betweenthefirmandthemarketsoastoequatethe
marginalcostsofeachmodality.
Theproblemwiththisis,ashintedearlier,that
marginalbenefitsareignored.Inanycredible
economicmodel,firmboundariesneedtobeselected
36
Inthedynamiccapabilitiesframework,bycontrast,
interfirmheterogeneityisanaturaloutcome,notan
assumption.Becausemanycapabilitiesareidiosyncraticand
builtonauniqueorganizationalhistoryanduniquebusiness
modeldesigns,theyarenoteasilyimitatedbyotherfirms
thathavedifferenthistoriesandcorporatecultures.
Dynamiccapabilitiesareparticularlydistinctivebecausethey
areembeddedtosomeextentinthepersonalitiesandlevel
ofintegrationofthetopmanagementteam(Lindenand
Teece,2014).Moreover,theimitationofcapabilitiesisoften
confoundedbywhat“uncertainimitability”(Lippmanand
Rumelt,1982)becauseeventhepeopleinvolvedmaynot
fullyunderstandthecomplementaritiesunderlyingaspecific
capability.Hence,capabilities,especiallydynamic
capabilities,arehardtoimitate,allowinginterfirm
heterogeneitytopersist(JacobidesandWinter,2012).
46
basednotjustonthebasisoftransactioncostsbutalso
ontheneedtocapturevalue(Teece,1986,2006).In
thedynamiccapabilitiesframework,firmboundary
choicesaredefinednotjustbyasetofmake-or-buy
decisions.Theyalsorepresentabusinessmodelchoice.
Businessmodelstakeintoaccountappropriabilityas
wellascostissues.Controloverbottleneckassetsisa
keydriver(Teece2006,2010b).Forexample,afirm
withacertaintypeofunpatentableknow-howmaynot
beabletolicenseittopotentialuserswithout
revealingsomuchthattheusercanemploytheknowhowwithouttakingalicense(Arrow,1962).Thisand
othertypesof“marketfailures”candrivefirmstouse
businessmodelsthatemploythetechnologyinternally
ratherthanlicensingittoothers.Thisinturnrequires
thattheydeveloporacquirethenecessarycapabilities.
Furthermore,transactioncostanalysisoverlooks
product-specifictechnologicalconcernsbecausesome
complementaryactivitieshavemoreneedtobe
integratedthanothers.Forexample,(vertical)
integrationismorelikelytobepreferredwhen
unstructured(non-modular)technicaldialogueis
neededbetweentwostagesofproduction
(Monteverde,1995).
Anotherweaknessofthetransaction-focusedtheoryof
firmboundariesisits(implicit)assumptionthatfirms
are(oroughttobe)designedwith(static)efficiencyin
mind.Inthedynamiccapabilitiesframework,boundary
choicesneednotbeefficientinatransaction-cost
sensebecausefirmsdifferintheiruniquehistories,in
thequalityoftheirmanagement,intheirinternal
organizationalstructureandflexibility,andintheir
readinesstopursueopportunities.
Inotherwords,firmsneedtochangecontinuallyto
maintainevolutionaryfitnessforcompetitioninthe
market.Yetorganizationalchangeisalsolargely
missingfromtheeconomictheoryofthefirm.37While
thereisarecognitionamongorganizationaleconomists
thatchangecanbedifficultduetothepresenceof
complementaritiesoremployeemindsets(Brynjolfsson
andMilgrom,2013),thereisvirtuallynoexplorationof
theprocessesthatleadtotheneedforregular
transformationsofinternalstructuresandscopeof
activities.
XVI.
A.6Thetheory
of
complements
isconfused
Complementsarepervasivethroughouttheeconomic
system,andparticularlyintechnologydevelopment
andbusinesstransformation.Itiscommonfortwoor
moretechnologiestoproducemuchmorewhen
practicedtogether.Thefirststeamtrainsemerged
whenhigh-pressuresteamengineswereyokedtocoal
carsrunningoncoal-mininghandcartrails.Thelaser
andthecomputertogetherenabledCDsandDVDsand
alsoopticalfiber-basedtelecommunications.
Nevertheless,thesecomplementaritiesarenot
capturedadequatelybymostmainstreameconomic
models.
Absentcomplementarytechnologies,manyproducts
simplywon’tgetdevelopedandlaunched.Thiswasthe
case,forexample,intheU.S.electricalsupplyindustry
attheendofthe19thcentury.Theindustryhadakiller
app—lighting—butwasmiredina“warofthe
currents”betweenalternatinganddirectcurrent,each
ofwhichhadcertaindeficiencies.Itwasonlywiththe
developmentofrotaryconvertersthatonesystem
(alternatingcurrent)wasabletodevelopadominant
positionandspurrapiddeployment(David,1992).
Attheheartofeconomicnotionsofcomplementarityis
theidea,duetoEdgeworth(1897),thatthemarginal
valueofavariableincreaseswithanothervariable.
37
Williamson(1985)identifieswhathecallsthe
“fundamentaltransformation,”butaclosereadingshows
thatitisnotaboutorganizationaltransformation,butrather
transformationinacontractingparty’scompetitiveposition.
47
Despitethissimplebasis,thereismuchcomplexityto
theconceptofcomplementarity,whichprompted
NobelLaureatePaulSamuelsontosayin1974that:
Thetimeisripeforafresh,modernlookattheconcept
ofcomplementarity…thelastwordhasnotyetbeen
saidonthisancientpreoccupationofliteraryand
mathematicaleconomists.Thesimplestthingsare
oftenthemostcomplicatedtounderstandfully.
(Samuelson,1974:1255)
Theliteratureoncomplementsremains
underdevelopedandratherconfused.38Economists
tendtothinkofcomplementarityintermsofitseffect
onfactorpricesoronvaluefromuse(Carlawand
Lipsey,2002).Innovationstudies(e.g.,Rosenbergand
Frischtak,1983)lookinsteadattechnological
relatednessandtheimpactofnewcombinationsof
existingtechnologies.Economicsneedsastructurethat
canencompassanddifferentiateamongtheseand
othervariantsofcomplementarity.
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Table 1: Some Differences Between Ordinary and Dynamic Capabilities
Ordinary(“necessary”)capabilities
Dynamiccapabilities
Technicalefficiencyinbusiness
functions
Achievingcongruencewithcustomer
needsandtechnological
opportunities
Buyorbuild(learning)
Build(learning)
Operate,administrate,andgovern
Sense,seize,andtransform
Keyroutines
Bestpractices
Signature(beyondbestpractice)
processes
Managerial
emphasis
Staticoptimization
Entrepreneurialassetorchestration
andleadership
Priority
Doingthingsright
Doingtherightthings
Imitability
Relativelyimitable
Relativelyinimitable
Technicalfitness(efficiency)
Evolutionaryfitness(continuous
innovation)
Purpose
Modeof
attainability
Tripartite
schema
Result
Source:basedonTeece(2014),Table1
59
Table 2: The Interrelation of Dynamic Capabilities and Strategy
Strategykernel
Relateddynamic
capabilitiesschema
Natureofmanagerial
orchestration
Diagnosis
Guidingpolicy
Coherentaction
Sensing
Seizing/transformation
Seizing/transformation
Entrepreneurial
Administrative
Leadership
Source:Teece(2014).
Figure1:TheDimensionsofDistanceforTransformation
60
Figure2:TheLogicalStructureoftheDynamicCapabilitiesFramework
Source:Teece(2014).
61