The above analysis suggests that while the MNE theory has done quite well in an era of rapid globalization, there is nevertheless the need for a more robust theory of the MNE. As Peter Buckley put it, “the theory of the multinational ﬁrm therefore requires development in several directions—the general area of the eco- nomics of business strategy is in need of greater attention” (Buck- ley, 1985: 18).29 His admonition has merit, irrespective of the globalization that has taken place.
Largely missing from the theory of the MNE—either the Hymer version or the naked internalization versions—has been considera- tion of the importance of the ﬁrm’s organizational capabilities. This has been a signiﬁcant omission. Inasmuch as notions of organiza- tional capability have been around for decades, and have received much attention recently, efforts to embed capabilities into the the- ory of the MNE would appear to be overdue.
Developments in the ﬁeld of strategic management have high- lighted the importance of resources and (dynamic) capabilities to enterprise success. In this and following sections it is suggested that: (1) the capabilities perspective on the business enterprise has much to offer to the theory of MNE; (2) the capabilities perspec- tive is consistent with, and arguably implicit in, the Dunning and Teece treatments of the MNE. However, while prior work hinted at a capabilities approach, the MNE theory which referenced it was not developed sufﬁciently to illuminate the character of the MNE beyond what was provided by the internalization school; (3) Cantwell’s (1989) emphasis on technological accumulation can be seen as a useful jumping-off point for a more full-blown analysis of MNE capabilities.
Cantwell correctly recognizes that MNEs are frequently active generators of ﬁrm-speciﬁc competitive advantages. He sees the ﬁrm in evolutionary terms accumulating technology (and capabilities) over time. Moreover, technology transfer activities by MNEs create spillover beneﬁts. These external economies enhance the com- petitive capabilities of regions, thereby possibly stimulating more inward DFI.30 Hence, neither ﬁrm-speciﬁc (ownership) advantages or locational advantages are truly exogenous.
In short, Cantwell’s contributions add critical dynamic dimen- sions to Dunning’s framework as well as to internalization con- siderations. In my view, these are important extensions. The capabilities approach outlined below is yet a further extension, emphasizing the organizational as well as the technological capa- bilities of MNEs.
2. Resources/Capabilities Compared to the Internalization School
The internalization school saw the essence of MNE activity as being driven by market “failure”, that is, imperfection in mar- kets which caused managers to want to bring activities under common ownership, subject to internal rather than market coor- dination. Buckley and Casson (2002: 39) noted early on that “the strongest case of all concerns the markets for various types of knowledge”, Teece (1986a) put know-how at the core of the theory of the MNE. However, the elements of knowl- edge transfer that were emphasized in these early treatments did not necessarily draw out well the elements I now wish to emphasize.
In an early paper (Teece, 1977), capabilities were explicitly ﬂagged as being at the core of a ﬁrm’s technology. A distinction was made between embodied (embracing physical items such as tooling, equipment, and blueprints) and unembodied knowledge.
The second form of technology is the information that must be acquired if the physical equipment or “hardware” is to be utilized effectively. This information relates to methods of organization and operation, quality control, and various other manufacturing procedures. The effective con- veyance of such “peripheral” support constitutes the crux of the process of technology transfer. (Teece, 1977: 245)
This early statement was a crude attempt to recognize the import- ance of organization, procedures and tacit knowledge to business performance and technology transfer.31 These attributes of an orga- nization are what today we think of as elements of capability. If a ﬁrm possesses capabilities, it can create additional value by scaling them globally. In what follows I will identify the founda- tions of capabilities and discuss the manner in which such abilities are generated, and then replicated/transferred globally. I will ﬁrst outline the approach and identify some of the different sources of an MNE’s capabilities.
The capabilities approach represents the business enterprises as bundles or portfolios of difﬁcult-to-trade assets and (production) competencies (“resources”).32 Within this framework, competitive advantage can ﬂow at least for a period from the ownership of scarce and difﬁcult to imitate assets.33 However, sustainable com- petitive advantage can only ﬂow from whatever unique ability business enterprises have to continuously shape, reshape, con- ﬁgure and reconﬁgure, and align those assets to create new technology, to respond to competition, gain critical mass, and serve changing customer needs.34 The particular (nonimitable) “orchestration”35 capacity business enterprises have to shape, reshape, conﬁgure and reconﬁgure those assets so as to create and respond to changing technologies, competition, and market devel- opments is what has come to be known as the ﬁrm’s (dynamic) capabilities.
The dynamic capabilities framework is especially relevant to markets exposed to rapid technological change and strong inter- national competition. The framework suggests success factors for MNEs. With the continuous expansion of world trade and invest- ment, with factors of production being highly mobile, and with the sources of innovation becoming increasingly global, an increasingly larger share of the global economy is reasonably accurately charac- terized as “open”, that is, as being exposed to the forces of global competition, and to the international ﬂows of capital, technology, and skilled labor. The pay-off to ﬂexibility,36 entrepreneurship, learning, and astute investment choices and other factors that are central to the dynamic capabilities framework has increased since the 1960s when the global liberalization of trade and investment began gaining momentum (Teece, 2000). Moreover, intangible assets and intellectual capital are playing a greater role in eco- nomic activity. Subsequent sections of this chapter are an effort to analyze how MNEs—the global engines of the capitalist system— can be successful in this new environment where the “output” of the business enterprise is often “conceptual” products/intellectual capital.
3. Types of (Dynamic) Capabilities
In competitive global environments MNEs must proactively adjust their portfolio of assets and competencies in order to build and sustain competitive advantage. Many factors can trigger the need to reﬁne and sometimes reconﬁgure an MNE’s business model, and its assets and competences. Exogenous events (e.g. reces- sion, enhanced competition, exchange rate movements, regula- tion) will require responses. So will technological innovations, and the emergence of new competitors using different business models. However, not all enterprise-level responses to innovation and change are manifestations of dynamic capabilities. As Sidney Winter (2003) notes, “ad hoc problem solving” isn’t necessarily a capability.
The microfoundations of the MNE’s dynamic capabilities include difﬁcult to imitate organizational-level innovation, change, global sourcing and global marketing routines; the business intuition and insight needed to create new business models and rev- enue architectures that scale globally; the investment insights, protocols, and procedures which enable the business enterprise to identify and address new markets and technologies. Finally, dynamic capabilities include the capacity to calibrate uncer- tainty, and continuously effectuate the coalignment and efﬁcient governance of cospecialized assets domestically and internation- ally. Do note that dynamic capabilities are rooted in large part in the capabilities of management and in the design of the enterprise.
The typical MNE has assets at work in numerous jurisdictions. Orchestration skills are especially important when there is such a diversity of assets inside and outside the enterprise. Put differently, as a practical matter orchestration needs and opportunities expand as the ﬁrm globalizes, since the panoply of assets an MNE can access is, as a practical matter, likely to expand. Consider just the MNE’s own internal R&D resources. MNEs increasingly recognize that each of its R&D laboratories can be the source of new innovation, and it must organize itself appropriately to capture these potential beneﬁts (Almeida and Anupama, 2004).
Inasmuch as change requires continuous adjustments to business models and realignment of assets and competences to sustain value creation, an MNE’s dynamic capabilities require the continuous sensing of changing opportunities and needs on a global basis, and prompt execution. This ability to orchestrate assets globally and not just analyze changing needs is referred to here as managerial orchestration, and it is an essential element of dynamic capabilities whether an enterprise is domestic or multinational.
Various classes or sources of dynamic capabilities are now explored in more detail. A high performance MNE is likely to pos- sess several if not all of these difﬁcult-to-imitate attributes. While for analytical purposes several classes of dynamic capabilities are identiﬁed separately, they usually need to operate in unison (and be difﬁcult to imitate) for high performance to be achieved.
4. Dynamic Capabilities through the Selection and Implementation of Routinized Processes
In Teece and Pisano (1994) and Teece, Pisano, and Shuen (1997) certain routines37 (or “processes”) were an essential element of a ﬁrm’s (dynamic) capabilities. One can separate production routines to sustain current operations (not the basis of dynamic capabilities) from learning routines designed to achieve improvement (one basis of dynamic capabilities). Examples include new product develop- ment routines, quality control routines, and technology transfer and/or knowledge transfer routines.
Not all dynamic capabilities can undergird differential perform- ance. Cross-function R&D teams are now widely adopted and recognized as essential for superior product development perform- ance. However, the existence of common elements already ubi- quitously adopted by competitors does not imply that a partic- ular routine has not been the source of competitive advantage, at least for a considerable period of time. Studies of the diffu- sion of organizational innovations (e.g. Armour and Teece, 1978; Teece, 1980b) indicate that diffusion of organizational innovations is by no means instantaneous, particularly at the global level.
Accordingly, signiﬁcant economic proﬁts can be earned before diffusion competes away superior returns. Decade-long adoption cycles are not uncommon. Uncertain imitability (Lippman and Rumelt, 1982) is also likely to slow the diffusion process, domes- tically and internationally. Indeed, Helfat and Peteroff (2003) sug- gest that capabilities evolve in a life-cycle fashion, which includes several stages: founding, development, and maturity. Once matu- rity is attained, the capability can branch into additional stages, including renewal, replication, redeployment, and recombination. The expansion of international operations is a case in point.
5. Dynamic Capabilities through the Selection and Implementation of Improved Business “Models”
A business model deﬁnes the manner in which a business enter- prise delivers value to customers, entices customers to pay for value, and converts those payments to proﬁt. It is the hypoth- esis about what customers want and how an enterprise can go about getting paid and making a proﬁt for the value it delivers. It explains: (1) how the revenue and cost structure of business is to be “designed” to meet customer needs; (2) the way in which the resources are to be assembled; the identity of market segments to be targeted; and (3) the mechanisms and manner by which value is to be captured. The function of a business model is to “articulate” the value proposition, identify targeted market segments, deﬁne the structure of the value chain, and estimate the cost structure and proﬁt potential (Chesbrough and Rosenbloom, 2002: 533–4). In short, a business model is a plan for the ﬁnancial “architecture” of a business which makes valid assumptions about costs, scale, and customer and competitor behavior. It outlines the contours of the solution required to win in the marketplace.38 Once adopted it deﬁnes the way the ﬁrm “goes to market”. A good business model will scale globally.
Getting the business model right is critical to the success of a new business; adjusting and/or improving the model is likely to be crit- ical for continued success. The capacity an enterprise has to create, adjust, and hone globally scalable business models is a critical dynamic capability. There are some ﬁrms whose global expansion is built entirely on a business model. McDonald’s introduced fast- food franchising, and Dell introduced direct-to-consumer sales of personal computers and related computer equipment. Neither of these ﬁrms has spent substantial sums on R&D. Both have devel- oped systems and methods to ﬁgure out what products customers want; and both have developed new and different and cheaper ways of getting products to the consumer in a predictable fashion. The essence of their success depends importantly on the business models that they have employed.
6. Dynamic Capabilities through Investment Choices: The Special Role of Complementary and Cospecialized Assets39
In most analyses of competition and competitive advantage, it is common to stress that various innovations are substitutes, rather than complements that may be cospecialized to each other. Indeed, Schumpeter (1934) stressed that successful innovations/ﬁrms are threatened by swarms of imitators, all striving to produce “me- too” substitutes.40 Of equal if not greater signiﬁcance, particu- larly in industries in which innovation might be characterized as cumulative, is complementary innovation. For instance, in the enterprise software industry business applications can be especially valuable to users if they can somehow be integrated into a single program, or into a tightly integrated suite. The development of gyroscopic stabilizers made imaging devices such as video cameras and binoculars easier to use, and enhanced the product, especially when the new features are able to be introduced at low cost. Like- wise, better batteries enable personal computers and cell phones to run longer between charging. Situations of complementarities between technologies, and between technologies and other parts of the value chain, are extraordinarily common, yet infrequently featured in economic analysis and in strategy formulation. With the sources of technology being widely distributed internationally, there is a requirement to integrate globally distributed assets using the multinational enterprise as the fulcrum.
Complementary assets where the value of an asset is a function of its use in conjunction with other assets can be referred to as cospecialized assets.41 With cospecialization, joint use is value enhancing.42 Situations of cospecialization can emerge from R&D investments or from “thin” markets, that is, the assets in question are idiosyncratic and not readily bought and sold in a market. Capturing cospecialization beneﬁts frequently requires integrated operations. Cospecialization allows differentiated product offerings or unique cost savings. When markets are thin, competitors aren’t able to rapidly assemble the same assets by acquisition, and hence cannot offer the same products/services at competing price points. An enterprise’s ability to identify, develop, and utilize specialized43 and cospecialized assets built or bought is a core dynamic capability.
With cospecialization, special value can be created (and poten- tially appropriated by another party) when an asset owner is not cognizant of the value of its assets to another party with assets whose value will be enhanced through combination.44 This arises because the markets for cospecialized assets are necessarily thin, and are frequently global in nature. Because the cospecial- ized assets in question are unique, competitors cannot necessarily obtain these assets, and even if they could, the cospecialized asset is likely to have a different value in use if the competitor has a different portfolio of complementary assets.
In short, the dynamic capabilities framework suggests that cospe- cialized assets may need to be combined globally in order to enable (systemic) innovation45 to proceed. If they cannot be procured externally, they will need to be built internally. MNEs can create value by combining cospecialized assets. This may require the use of innovation routines to create the necessary cospecialized tech- nologies. Inasmuch as complementary technologies are frequently dispersed globally, such technologies will need to be pulled together on a global basis.
The computer, software, and electronics industries are riddled with cospecialization requirements and opportunities domestically and globally. A case in point was the development of NAND ﬂash memory for digital ﬁlm. Besides the capability to develop and man- ufacture ﬂash memory, one also needs NAND controller technol- ogy to access ﬂash memory quickly to enable the use of ﬂash mem- ory for digital photography. (Photographers didn’t want to wait more than a few seconds at most between photo shoots.) With- out NAND controller technology, NAND ﬂash couldn’t advance commercially. With it, an entire new application domain would open up. Since NAND ﬂash controller technology wasn’t ubiqui- tously available, the semiconductor ﬂash memory manufacturers had to (1) invest in R&D to develop their own (several tried and failed) or (2) try and acquire the technology externally—naturally difﬁcult as the technology was in only one set of hands, and wasn’t for sale via a naked license arrangement. Toshiba, for example, had the requisite NAND ﬂash memory chip technology, but lacked controllers. It turned to Lexar, and later to SanDisk to provide the controller technology. The global integration of these technologies by Toshiba (its dynamic capabilities) was important to its success in ﬂash memory devices.
Another example is the iPod pioneered by Apple. Steve Jobs and his colleagues at Apple combined known technology (digital music players had already been invented) with the iTunes music store (a cospecialized “asset” pioneered by Apple—CEO Steve Jobs himself persuaded key artists to provide content) and digital rights management (DRM) software developed by Apple to give the artists conﬁdence that their music would not be pirated. These key elements were combined in a superbly well-designed pack- age (the iPod player itself) which has obliterated Sony’s lead in the personal stereo market (the Sony “Walkman”). Nevertheless, the components that make up the iPod are almost all completely outsourced. As one observer noted: “take an iPod apart and 83% of the components are made by Japanese companies”.46 In short, it was Apple’s dynamic capabilities—the ability to sense a market need, and then to uniquely bring together all the necessary cospe- cialized assets—that undergirds Apple’s success with this product, which has been sold through Apple stores around the world.
Indeed, the example illustrates an increasingly common form of MNE, with the global sourcing of components and the bring- ing together by management of disparate assets from unexpected quarters.
7. Dynamic Capabilities through Asset Orchestration, Knowledge Sharing, and Coordination47
One of management’s core functions is to develop and implement a company’s unique strategy, and to forge a “ﬁt” globally amongst (and within) assets, structures, and processes. The ﬁrm’s manage- ment team must also decide which technological opportunities and customer needs the company will respond to, and then line up the resources/assets needed to effectuate the strategy. The ability to proactively adapt, redeploy, and reconﬁgure in an entrepreneurial fashion gives meaning to “orchestration”, and thus to dynamic capabilities.
Redeployment and reconﬁguration are business model redesign and asset-reshufﬂing processes that need to be ongoing in an orga- nization confronting change. Redeployment could involve trans- fer of nontradable assets to another organizational or geographic location (Teece, 1977). It may or may not involve mergers and acquisitions.48
Examples abound. Several major airlines are trying to create separate low cost “carriers within carriers”, partly in response to the success of Southwest airlines in the USA. United Airlines has cre- ated Ted, KLM the Dutch airline has created Buzz, British Airways has created Go, and Delta Airways ﬁrst Delta Express and more recently Song. Song has a lean management team, targets women customers, has new boarding procedures, packs in more seats, and targets 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, and a redeployment of assets—two elements of dynamic capabilities working together, hopefully in unison.
8. Dynamic Capabilities through Efﬁcient Learning, Technology Development, and Protection of Intellectual Property
It is well recognized that individuals develop knowledge inside the business enterprise.49 Failure to share such knowledge across divisions and geographies as needed may well lead to greater opportunity loss/untapped potential than any loss through the exercise of managerial discretion, for example, the consumption of managerial/worker perquisites. It is rather difﬁcult to monitor such behavior, however, as it is hard to calibrate what employees know, and what they are holding back. Good incentive design and the creation of a learning, knowledge-sharing, and knowledge- creating environment on a global basis is likely to be critical to business performance, and foundational to the dynamic capabilities of MNEs (Nonaka and Takeuchi, 1995).
Of equal importance is monitoring and controlling the transfer and “leakage” of trade secrets and intellectual property. Innovating business enterprises with limited experience have been known to inadvertently compromise or lose their intellectual property rights.50 Failure to proactively monitor and protect know-how and intellectual property is a common governance failure. The appropriation of shareholder capital for personal gain can occur with “spinouts” and the departure of key employees. Spinouts may be led by management, or by key employees.51 Monitoring know- how leakage and guarding against opportunistic exits is both a board and management-level responsibility.
The outsourcing of production and the proliferation of joint development activities likewise create requirements that ﬁrms develop governance procedures to monitor the transfer of tech- nology and intellectual property. Technology transfer activities which hitherto took place inside the ﬁrms increasingly take place across organizational boundaries. The development of governance mechanisms to assist the ﬂow of technology domestically and globally while protecting intellectual property rights from mis- appropriation is key to dynamic capabilities in many sectors today.
Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.