Dynamics Capabilities as a Theory of Entrepreneurial Management

We now return to the dynamic capabilities perspective which builds on ideas from all of the above traditions. In addition to syn- thesizing ideas from different theoretical traditions, the dynamic capabilities approach seeks to provide a coherent framework which can both integrate existing conceptual and empirical knowledge, and facilitate prescription. First published in Teece and Pisano (1994) and elaborated in Teece et al. (1997),10 a paper which had circulated for seven years as a working paper (Teece, 1990),11 the dynamic capabilities approach builds, in particular, upon the theoretical foundations provided by Schumpeter (1934), Penrose ([1959] 1995), Williamson (1975, 1985), Cyert and March (1963), Rumelt (1984), Nelson and Winter (1982), and Teece (1982). In particular, it is consistent with the view that the emergence of new products and processes results from new combinations of knowl- edge and that processes of organizational and strategic renewal are essential for the long-term survival of the business firm. Enterprises must also match the exploration of new opportunities with the exploitation of existing ones.

In the dynamic capabilities approach, competitive success arises from the continuous development and reconfiguration of firm- specific assets (Teece and Pisano, 1994; Teece et al., 1997; Teece, 2007). Whereas Penrose and the resource-based scholars recognize the competitive importance of firm-specific capabilities, researchers within the dynamic capabilities paradigm attempt to outline specif- ically how organizations develop, sustain, and renew internal com- petencies. The dynamic capabilities approach is concerned with how firms identify opportunities, create new knowledge, dissem- inate it internally, embed it in new business models and/or new goods and services, and launch new products and services in the market. The framework by its very nature involves understanding both technological and organizational change. Processes are shaped by environmental evolution as well as organizational design—what we might call “Evolution with Design”.

The dynamic capability perspective follows Hayek (1945) (and the behavioral and evolutionary theorists) in emphasizing that coordination is an economic problem primarily because of change. In a static environment a short period of “set up” would be required to organize economic activity; but absent change in consumer tastes or technology, economic agents (both traders and managers) would permanently sort out the optimal flows of goods and services (together with methods of production). Thereafter, there would be no need for their services, as matters would be taken care of, once and for all.

Now introduce change. If there were a complete set of forward and contingent claims markets, adjustments in the economic sys- tem would occur weekly and risks would be allocated efficiently; even if there were a complete set of futures and contingent claims markets, there is still the need for managers/entrepreneurs to “integrate, build, and reconfigure internal and external compe- tences to address rapidly changing environments” (Teece et al., 1997). Coordinating and adapting effectively to changing environ- ments (Cyert and March, 1963) is an element of a firm’s dynamic capabilities. Barnard (1938) and Richardson (1960) were early to hint at these themes, but they did not embellish them far enough, and make innovation and entrepreneurship sufficiently central to their frameworks.

Indeed, Chester Barnard’s view of the firm was that it was funda- mentally a structure to achieve coordination and adaptation. There is no mention of opportunity identification, or entrepreneurship, or orchestrating new asset combinations. As Williamson (1990) observes, Barnard did not compare the firm to markets in terms of their coordinative or adaptive capabilities. One key difference is that the firm achieves coordination and adaptation with respect to non-traded or thinly traded assets; the market on the other hand enables rapid adaptation with respect to assets which are actively traded in thick markets.

However, dynamic capabilities views the business enterprise as providing much more than “coordination” and “adaptation”; as discussed in Chapter 2, the functions of the (strategic) manager go beyond what Barnard and Williamson have identified. In particu- lar, coordination and adaptation do not convey very well notions such as proactive search, selection, and subsequent implementa- tion of particular courses of action critical to the firm’s business strategies. Nor do they convey the importance of asset alignment, opportunity identification, access to critical cospecialized assets, and the interrelationship amongst the various elements of enter- prise strategy. These are all critical elements of management’s dynamic capabilities, and are important to value creation.

Put another way, in the theory of a private enterprise economy, firms with dynamic capabilities help patch up market “failures”.12 The market “failures” at issue are not only those due to high transaction costs and contractual incompleteness.13 Rather, they are associated with the nonexistence of certain markets and the need to identify, align, adapt, and coordinate activities and assets (especially complementary assets) in order to create value.

Complementarities frequently exist amongst activities and investments inside the firm, and frequently exist with activities and investments outside the firm. These complementarities are easy to manage when markets are “thick”,14 as standard pur- chase and sale agreements or term contracts ought to suffice. But when markets are thin, or nonexistent, alignment cannot necessarily be achieved by market activity. It’s the job of the (strategic) manager to decide what investments are to be made and what assets are to be purchased and how complementari- ties are to be managed and to design the business model that will make all of this work in a value-enhancing way for the customer.

G.B. Richardson (1960) has hinted at many issues that animate the dynamic capabilities framework. He has remarked upon the information problems associated with achieving coordination with investment decisions. However, his focus is on the industry-level coordination of investment. He identified situations where limited information about competitors’ investment decisions may impede efficient investment. However, this is not quite the focus with dynamic capabilities. The essential coordination task identified in the dynamic capabilities framework is internal to the firm, though it may well involve strategic alliances with other firms too. A fundamental challenge for management is to figure out how best to employ the firm’s existing assets, and how to reconfigure and augment those assets and tie them together in a viable business model to help augment the value proposition being brought to customers.

Needless to say, the proficient achievement of the necessary coordination is by no means assured. Decision-makers need infor- mation on changing consumer needs and technology. Such infor- mation is not always available; or if it is available, is likely to be incomplete, or highly subjective (Casson, 2000: 119; Simon, 1993a, 1993b). Managers are of course decision-makers and they must collect information, analyze it, synthesize it, and act upon it inside the firm. Situations are dealt with in many ways, sometimes by creating rules which specify how the organization will respond to the observations made (March and Simon, 1958). If this path is chosen, then rules may become codified and routinely applied (Casson, 2000: 129) whenever certain changes are detected.15

However, such rules are likely to be periodically revised for the firm to maintain its dynamic capabilities.

In some circumstances, new information and new situations may be best dealt with by forming a new firm (Knight, 1921).16 Those who discover the new information, and can figure out the appro- priate response, need not in theory be the same individual(s) who start a new enterprise; but given the absence of a well-functioning market for information about new market opportunities, the dis- coverer and the enterprise founder may need to be one and the same.

The coordinating and resource-allocating capabilities performed by management and featured in dynamic capabilities can shape markets, as much as markets shape the enterprise (Chandler, 1990a, 1990b; Teece, 1993; Simon, 1991). Put simply, firms and markets coevolve. Hence, while the need  for  asset  coordina- tion and orchestration and associated investment choices may be the fundamental problem, the firm’s dynamic capabilities— particularly its ability to introduce new products and services into the market—not only shape markets; they also require firm-level responses by competitors, suppliers, and sometimes customers.

The emergence/development of new markets for new asset types is thus important for strategic management. Elsewhere (Teece, 1998a, 2000) the emergence of an expanded (and global) set of “thick” intermediate product markets was identified as a major leveler in competition, enabling more specialist firms to compete and provide a limited kind of innovation, called autonomous inno- vation. There are parts of the value chain which ought to be outsourced when well-functioning intermediate (product) markets exist.

Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.

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