Is there any way to distill the basic factors that lie behind busi- ness success? The answer, I believe, is in part context driven. Consider therefore competitive economies open to international trade, investment, and technology flows with legal structures that allow credible commitments. In such contexts, what are the foundations of business success? Does strategy and entrepreneur- ship matter? Do investment implementation processes and proto- cols matter? Does organizational structure matter? Does the choice of business model matter? The answer, of course, is that all of the above matter and that decisions on each involve managerial choices and action. Because so much matters, we need a frame- work that can integrate disparate but interdependent concepts.
The thesis advanced in this chapter is that a new kind of man- agement and organization is needed to compete in open economies generating and exposed to rapid innovation. The management required must be intensely entrepreneurial, while simultaneously being good at execution and the management of talented individ- uals. Failure to sense new opportunities, to seize upon them, and then restructure and reconfigure as new competition emerges will leave the enterprise extremely vulnerable. Employees’ jobs will be at risk if the management team does not have or is unable to develop requisite capabilities, which I label dynamic capabilities.
Early statements of the dynamic capabilities framework can be found in Teece, Pisano, and Shuen (1990a, 1990b), Teece and Pisano (1994), Teece (1996), and Teece, Pisano, and Shuen (1997). The definition of dynamic capabilities found in Teece, Pisano, and Shuen (1997) is slightly modified to read as follows:
The ability to sense and then seize new opportunities, and to reconfigure and protect knowledge assets, competencies and complementary assets so as to achieve sustained competitive advantage.
As shown in Chapter 1, it is possible to disaggregate dynamic capa- bilities into three classes: the capability to sense opportunities, the capacity to seize opportunities, and the capacity to manage threats through the combination, recombination, and reconfiguring of assets inside and outside of the firm’s boundaries. To avoid being too repetitive, each is described here in only a cursory manner. The microfoundations of these capabilities are outlined in Chapter 1.
1. Sensing
In fast-paced environments, consumer needs, technological oppor- tunities, and competitor activity are constantly in a state of flux. The profit streams earned by incumbent enterprises are almost always at risk. Opportunities constantly open up for both new- comers and incumbents. As discussed in Teece, Pisano, and Shuen (1997), some trajectories are easily recognized (e.g. miniaturiza- tion, compression, and digitization in information and communi- cation technology), most are not. Opportunities come from differ- ential access to existing information (Kirzner, 1973) or from new information and new knowledge (Schumpeter, 1911, 1934). The R&D process, of course, is one way to create such new knowledge and concomitant opportunity.
Kirzner stresses the alertness of the entrepreneur to recognize any disequilibrium by taking advantage of it; his entrepreneur provides the pressure to move the economy back towards equilib- rium. As Baumol (2006: 4) notes, “the job of Schumpeter’s entre- preneur is to destroy all equilibria, while Kirzner works to restore them. This is the mechanism underlying continuous industrial evo- lution and revolution.” Shane (2003) likewise notes that “Schum- peterian opportunities result from disequilibrating forces, making Schumpeterian entrepreneurship a disequilibrating activity. In con- trast, Kirznerian opportunities are the result of equilibrating forces” (p. 20).
When opportunities are first glimpsed, one must, of course, also figure out how and when competitors, suppliers, and customers will respond. Competitors may or may not see the opportunity or they may calibrate it differently. Their actions, along with those of customers, suppliers, the government, and standard-setting bodies can also change the nature of the opportunity and the rules of the game. There are no mandatory structures for the rules of the game, other than those imposed by regulators, public not-for-profit standard-setting bodies, intellectual property and antitrust laws, and social mores. The shape that the rules of the game take is thus the result of complex interactions between ecosystem participants. All managers can do is make informed conjectures about the way ahead. These conjectures become working hypotheses that need to be updated as evidence emerges. There are few “rules” upon which an early consensus will emerge; but once such rules emerge, quick action is likely to be needed.
In order to identify opportunities, enterprises must constantly engage in scanning, searching, and exploration across technolo- gies and markets, both “local” and “distant”. This activity not only involves investment in R&D and the probing and reprobing of customer needs and technological possibilities; it also involves understanding latent demand, the structural evolution of indus- tries and markets, and likely supplier and competitive responses. To the extent that business enterprises can open up technolog- ical opportunities through their own R&D and through tapping into the research output of others while simultaneously under- standing customer needs, they have a richer menu of investment opportunities.
Analysis of the search for information, knowledge, and oppor- tunity has a long history in management research and in practice (March and Simon, 1958; Nelson and Winter, 1982). The searching behavior of enterprises involves exploring on both market and technological fronts. It involves search inside the enterprise (e.g. for technological solutions) and search outside the boundaries of the enterprise too. Without exploration and search, an enterprise has limited opportunities. In essence, this capability is about invest- ment in R&D, scanning for new inventors and needs, and under- standing market evolution and transformation. Figuring out how to generate, select, filter, and comprehend relevant information is not a capability naturally resident in an enterprise or its manage- ment team.
2. Seizing
The skills that result in the identification and/or development of an opportunity are not the same as those required to profit from or “exploit” the opportunity. In theory, one could imagine a trans- action between entities that scout out and/or develop opportu- nities, and those that endeavor to execute upon them. In reality, some of both need to take place inside the enterprise and heavily involve the top management team. New insights about markets— particularly those that challenge the conventional wisdom—will always encounter negative responses; the promoters/visionaries must somehow defeat the naysayers and transform internal views. Some level of managerial consensus will be necessary to allow decisions to be made and implemented.
Investment decisions involve purchase of inputs and redeploy- ment of internal assets. To achieve returns in excess of the cost of capital, the ex post value of resources organized in new com- binations must be greater than the ex ante cost of securing their employment. The enterprise can earn returns in excess of its cost of capital if either:
- the enterprise has superior foresight with respect to the future market value of purchased inputs or
- the enterprise can purchase the inputs and use them ex post in unique combinations (such as in conjunction with its other complementary assets) in a manner which increases the cash flows attributable to the input.
Put differently, if the enterprise can redeploy purchased assets to a higher valued use or achieve scope and scale economics not available to the previous owner of the asset, then it can create value not available to others.
Sensing a business opportunity but failing to act is not uncommon2 because seizing opportunities involves both entrepre- neurial and managerial activity. At the most basic level, seizing is about making good decisions under uncertainty, and executing well on those decisions. It is not about optimizing on known prices and costs. Indecision, bias, and inaction are antithetical to this capability. In short, disciplined decision making and execution are both critical, although the latter has received more attention than the former in the management literature. Good decision making requires disciplined investment routines; information and data collection (both external and internal) and analyses, objec- tive reasoning, attention to history, and good governance. Indeed, decision-making routines provide part of the linkage between changes in the organizational environment and appropriate action inside the organization (Becker, 2004). Such routines may be incompletely specified and decisions will require further input and specification by management. Interpretation and judgment will be required to know what routines to employ in particular contexts. Routines will need to be modified as the environment itself changes.
The proficiency with which an opportunity is embraced is likely to depend importantly on the quality of the enterprise’s routines, decision rules, and strategies around investment in tangible and intangible assets. Business historians (e.g. Chandler, 1990a, 1990b; Lazonick, 2005 and others) have reminded us that over the long run, the ability of enterprises to arrange financing and invest astutely around new technologies is critical to enterprise perform- ance over the long run. Consider the development of civilian jet transport aircraft in the USA in the 1950s. As Phillips (1971) noted:
Any one of Boeing, Douglas, Lockheed, or Corvair might have been first … The technology was there to adapt to—not risklessly or costlessly to be sure, but it was there. Perhaps the biggest risk in 1953 was not technological in character. Instead, it was risk with respect to what sort of jet to build and when to build it. (p. 126)
In an environment of rapid technological change with increasing returns, there is considerable additional risk related to timing, product specification, and the selection of the particular technolo- gies that need to be accessed and combined to produce an offering to the market that will be appealing to customers. Boeing and Douglas succeeded with the 707 and DC-8, respectively. Both air- craft drew in part on certain technologies known at the time and pioneered by others, including de Havilland with its Comet series of civilian jet transports.
IBM likewise gained leadership in the computer industry not necessarily because of its technological prowess, but because it was willing and able to make the necessary investments in developing and commercializing the 360 family of mainframe computers.3 Technological pioneers who failed to make the decisions and gather the resources to invest behind their technological accomplish- ments (e.g. Ampex with the VCR, Xerox with the personal com- puter) let others profit from the innovation which they pioneered (Teece, 1986a). Consider also Intel’s decision in the 1980s to aban- don DRAMs, and focus on the microprocessor; or consider Rolls- Royce’s decision to persevere with the RB211 jet engine for four decades, eventually achieving success; or consider Motorola’s deci- sion to develop Iridium—a (failed) multibillion bet that involved deploying scores of low orbiting satellites to provide ubiquitous global mobile communications.4 History has been kind to some of these decisions, but not others.
Investment disciplines in a knowledge-based “new economy” enterprise are likely to involve special challenges. For instance, the ubiquity of interdependent systems and complementarities amongst technologies can lead to an n-sided market effect.5 Addressing opportunities may involve investing simultaneously in complementary technologies and complementary assets. Relatedly, the presence of increasing returns means that if one network gets ahead, it tends to stay ahead. Getting ahead is likely to require significant up-front investments. Customers will not want your products if there are strong network effects and your installed base is relatively small. Accordingly, one also needs to strategize around investment decisions, getting the timing right, building on increasing return advantages, and leveraging products and services from one application to another.
The organizational skill needed to make high quality unbiased, but interrelated, investment decisions under uncertainty is rare.6 Enterprises, like markets, do not behave in a frictionless fashion. Decisions languish, internal procedures get violated, projects get undermined, and goals get thwarted (Gibbons, 2003). Decision- making errors and biases are not uncommon. It is necessary to recognize that the investment decision context inside the enter- prise often involves irreversibilities, cannibalization, and/or asset coalignment issues. These issues are usually absent from capital allocation decisions made by pure financial investors. Because of concerns about cannibalization of existing product lines, inno- vations may get shelved. Because of significant irreversibilities, management’s asset selection and reinvestment decisions inside the enterprise7 often have long-lived implications for the business enterprise, transcending those made by a financial investor invest- ing in liquid assets.
The nature and priorities with respect to investment decision making have clearly changed. In the last century, financial capital was the scarce resource and internally generated cash was critical to an enterprise’s financial flexibility and capability. Capital bud- geting techniques were developed and applied to support project finance decisions. Top-down planning and control systems ensured that capital was properly allocated and malfeasance managed.
Today, financial capital is less of a constraint. The difficult resource to accumulate is knowledge. Knowledge is harder to mon- itor and manage than is financial capital. In an open economy with rapid technological change, the challenge is less about managing financial resources and more about managing, learning, knowledge accumulation and protection, and cospecialization. The environ- ment requires unique investment skills and different organizational structures and management systems. Conceptual approaches need to be modified and toolkits updated.
While project-financing criteria (e.g. discounted cash flow, pay- back periods, and the like) and techniques for decision making under uncertainty are well known, there is little recognition of how to value intangibles and take into account features such as cospecialization, irreversibilities, and opportunity costs.8 The latter are critical dimensions of strategic investment decisions. Indeed, the concept of a “strategic investment” is not recognized in the finance literature. Moreover, the field of finance provides almost no guidance with respect to how to estimate future cash flows. Making such estimates is as much, if not more, the foundation of good decision making as are the methodologies and procedures for analyzing cash flow.
As noted, the major investment choices made by executives (and the boards of directors) require special skills, not ubiqui- tously or evenly distributed amongst enterprises. Nor are they generally possessed by portfolio managers in the financial world.9 Resource/asset alignment and coalignment issues are important in many technology-based industries; they are quite different from portfolio balance issues. Investments inside the knowledge-based enterprise are often cospecialized10 to each other, and are fre- quently illiquid. Also, the nature of portfolio “balance” needed inside the knowledge-based enterprise is different from the port- folio balance sought by pure financial investors. The economics of cospecialization are not the economics of covariance with which investors are familiar. Indeed, the task of making astute project and enterprise-level investment decisions is quite daunting because of cospecialization and irreversibilities.
The project finance and related literatures provide tools and clear decision rules for project selection once cash flows are spe- cified, and uncertainty and/or risk are calibrated. However, the essence of the investment decision for the (strategic) manager in the knowledge-based enterprise is that it involves estimating future revenue streams and cost trajectories, as well as a panoply of continuous and interrelated cospecialized investment issues.11 The returns to particular cospecialized assets cannot generally be neatly apportioned or partitioned. As a result, the utility of traditional investment criteria outlined in finance textbooks is impaired.
In short, managers need to make judgments around not just future demand and competitive responses associated with multiple growth trajectories, but also around the payoffs from making inter- related investments in intangible assets. In the world of tangible assets, this can sometimes be precisely modeled. For instance, if one builds a new chemical plant or petroleum refinery, investment in various processing units can be modeled using linear programming tools. But in many circumstances, business investments are not in the form of clearly defined “projects” per se and future returns are uncertain.
Managerial judgment takes on great significance in such con- texts. This was also true during prior centuries as Alfred Chandler’s (1990a, 1990b) analysis of successful enterprises from the 1870s through the 1960s makes apparent. Tacit investment skills are of great importance, no matter how much analytical work is done to aid the decision. Chandler further argues that success in the late nineteenth and much of the twentieth century came to those enterprises that pursued his “three-pronged” strategy:
- early and large-scale investments behind new technologies;
- investment in product-specific marketing, distribution, and purchas- ing networks;
- recruiting and organizing the managers needed to supervise and coor- dinate functional activities.
The first and the second elements require commitment to invest- ments where irreversibilities and cospecialization are identified.12 While the nature of required investments may have changed, investment decision skills remain important.
Central to quality decisions in many industries today is the ability to gauge (or to shape) industry evolution and competi- tive responses, including the possible emergence of standards and dominant designs. Work in strategic management (Mitchell, 1991; Teece, 1986a) provides crude insights into decision factors and frameworks that recognize how the appropriability regime, stand- ards, market evolution, complementary assets, and the capabilities of competitors should be taken into account. These frameworks outline decision rules which can undergrid dynamic capabilities.
3. Reconfiguring
The establishment and subsequent growth of a successful enter- prise will lead to the augmentation of its resource and asset base. Success will lead to the accumulation of more resources and specific assets, as well as internal rules and procedures, and the enterprise will begin evolving in a path-dependent way. The key to sustained profitable growth is the ability to recombine and to reconfigure assets and organizational structures as markets and technologies change. Reconfiguration is needed to maintain eco- logical fitness and, if necessary, to try and escape from unfavorable path dependencies.
As the enterprise grows, it also has more assets to manage and to protect against malfeasance and mismanagement. Shirk- ing, free riding, the strategic manipulation of information, and internal complacency are all issues that established enterprises will confront continuously. In many cases, this leads to the establish- ment of rules and procedures (routines) that constrain interactions and behaviors. Except in very stable environments, such rules and procedures are likely to require modification from time to time, if superior performance is to be sustained. It is not uncom- mon to find that a routine subsequently becomes dysfunctional, providing inertia and other rigidities that stand in the way of improved performance (Leonard-Barton, 1995; Rumelt, 1995). As a result, less-well-resourced firms (sometimes rejuvenated estab- lished firms, sometimes new entrants) end up winning in the marketplace.
Sustained superior profitability involves a constant struggle to build, maintain, and adjust the complementarity of product offer- ings, systems, routines, and structures. Inside the enterprise, the old and the new must be complementary. If they are not, business units must be disposed of or placed in some type of separate struc- ture. Otherwise, work will not proceed efficiently, and conflicts of one kind or another will arise inside the enterprise.
Asset alignment and coalignment are necessary to minimize internal conflict and to maximize complementarities and product- ive exchange inside the enterprise. Teece et al. (1994) show across a large sample of establishments that surviving enterprises have a high degree of (product market) coherence. The persistence of this pattern across product categories suggests that coherence relates less to the particular technologies than to the processes and sequencing of expansion. The study suggested that diversifi- cation which eschews product relatedness is more likely to fail. Put differently, the markets addressed and the manner by which enterprises grow do appear to matter when it comes to long-term performance.
Also, as business enterprises grow, they face increasing complex- ity. This will require periodic internal restructuring and decom- position. Miles and Snow (1994) also highlight ecological fitness, although their focus is on the relationship between strategy, struc- ture, and processes. To them, “tight fit” organizations are those which have not become laden with bureaucratic processes and where “everyone can see clearly how and why things work as they do” (p. 20). With “tight fit”, there is an “appearance and feeling of simplicity, as well as the broad understanding of purpose and mechanisms in organizations” (pp. 20–1). Miles and Snow go on to note that in the absence of “tight fit”, managers have trou- ble articulating the strategy–structure–process package. Roles and responsibilities are not clear and the second-guessing of decisions is commonplace. Crises are frequent. They further note that “fit is both a state and a process—[it] is best conceptualized as a journey rather than a destination” (p. 11).
Redeployment and reconfiguration are important elements of what was referred to earlier as asset orchestration (see also Capron et al., 1998). Redeployment and reconfiguration may involve busi- ness model redesign and asset-realignment processes. Redeploy- ment could involve transfer of non-tradable assets to another organizational or geographic location. It may or may not involve mergers and acquisitions.13 Helfat and Peterof (2003) suggest that capability redeployment takes one of two forms:
The first involves the sharing of a capability between the old and the new market. Many instances of related diversifications fall into the category. A second form of redeployment involves inter-temporal transfers of capa- bility from one market to another. When demand for sperm (whale) oil plummeted after the first drilling of petroleum in Pennsylvania in 1859, the whaling teams shifted their activism. They adapted—from hunting sperm whales in tropical waters to hunting baleen whales in the Arctic. This involved a product market switch from whale oil to whale teeth used in products such as corsets, buggy coaches, and umbrellas. (pp. 20–1)
Other examples abound. Several major airlines have tried to create separate low cost “carriers within carriers”, partly in response to the success of Southwest Airlines in the USA. United Airlines has created Ted, KLM the Dutch airline created Buzz, British Airways created Go, and Delta Airways created Delta Express and then Song. Song had a lean management team, targeted women cus- tomers, had new boarding procedures, packed in more seats, and targeted higher aircraft utilization (Daniel, 2003: 8). Existing Delta aircraft and employees were redeployed into the new company to get it started. These restructurings involve both a modification of the business model, new or modified labor contracts, and a redeployment of assets. It is by no means clear that new business models that do not address fundamental labor cost and employee commitment issues in the airline industry will succeed—indeed some have already failed—but the necessity of adopting new business models has been recognized.
Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.