Introduction to (Sustainable) Enterprise Performance

Recent scholarship stresses that business enterprises consist of port- folios of idiosyncratic and difficult-to-trade assets and competencies (“resources”).1 Within this framework, competitive advantage can flow at a point in time from the ownership of scarce but relevant and difficult-to-imitate assets, especially know-how. However, in fast- moving business environments open to global competition, and characterized by dispersion in the geographical and organizational sources of innovation and manufacturing, sustainable advantage requires more than the ownership of difficult-to-replicate (knowl- edge) assets. It also requires unique and difficult-to-replicate dynamic capabilities. These capabilities can be harnessed to con- tinuously create, extend, upgrade, protect, and keep relevant the enterprise’s unique asset base. For analytical purposes, dynamic capabilities can be disaggregated into the capacity (1) to sense and shape opportunities and  threats,  (2)  to  seize  opportuni- ties, and (3) to maintain competitiveness through enhancing, combining, protecting, and when necessary, reconfiguring the business enterprise’s intangible and tangible assets. Dynamic capa- bilities include difficult-to-replicate enterprise capabilities required to adapt to changing  customer  and  technological  opportuni- ties. They also embrace the enterprise’s capacity to shape the ecosystem it occupies, develop new products and processes, and design and implement viable business models. It is hypothesized that excellence in these “orchestration”2 capacities undergirds an enterprise’s capacity to successfully innovate and capture sufficient value to deliver superior long-term financial performance. The thesis advanced is that while the long-run performance of the enterprise is determined in some measure by how the (exter- nal) business environment rewards its heritage, the development and exercise of (internal) dynamic capabilities lie at the core of enterprise success (and failure). This chapter first describes the nature of dynamic capabilities, and then explicates their microfoundations.

The ambition of the dynamic capabilities framework is noth- ing less than to explain the sources of enterprise-level competi- tive advantage over time, and provide guidance to managers for avoiding the zero-profit condition that results when homogeneous firms compete in perfectly competitive markets. A framework, like a model, abstracts from reality. It endeavors to identify classes of relevant variables and their interrelationships. A framework is less rigorous than a model as it is sometimes agnostic about the particular form of the theoretical relationships that may exist. Early statements of the dynamic capabilities framework can be found in Teece, Pisano, and Shuen (1990a, 1990b, 1997) and Teece and Pisano (1994). An extensive literature on dynamic capabilities now exists (e.g. Helfat et al., 2007) that can be organized and integrated into the general framework offered here.

As indicated, the possession of dynamic capabilities is espe- cially relevant to multinational enterprise performance in business environments that display certain characteristics. The first is that the environment is open to international commerce and fully exposed to the opportunities and threats associated with rapid technological change. The second is that technical change itself is systemic in that multiple inventions must be combined to create products and/or services that address customer needs. The third is that there are well-developed global markets for the exchange of (component) goods and services; and the fourth is that the business environment is characterized by poorly developed mar- kets in which to exchange technological and managerial know- how. These characteristics can be found in large sectors of the global economy and especially in high-technology sectors. In such sectors, the foundations of enterprise success today  depend very little on the enterprise’s ability to engage in (textbook) optimiza- tion against known constraints, or capturing scale economies in production. Rather, enterprise success depends  upon  the  discov- ery and development of  opportunities;  the  effective  combination of internally generated and externally generated inventions; effi- cient and effective technology transfer inside the enterprise and between and amongst enterprises; the protection of intellectual property; the upgrading of “best practice” business processes; the invention of new business models; making unbiased decisions; and achieving protection against imitation and other forms of replica- tion by rivals. It also involves shaping new “rules of the game” in the global marketplace. The traditional elements of business success—maintaining incentive alignment, owning tangible assets, controlling costs, maintaining quality, “optimizing” inventories— are necessary but they are unlikely to be sufficient for sustained superior enterprise performance.

Executives seem to recognize new challenges in today’s glob- ally competitive environments and understand how technologic- al innovation is necessary but not sufficient for success. A. J. Lafley, CEO of Proctor & Gamble, notes that “the name of the game is innovation. We work really hard to try to turn innova- tion into a strategy and a process . . . ”.3 Sam Pamisano, CEO of IBM, remarks that “innovation is about much more than new products. It is about reinventing business processes and building entirely new markets that meet untapped customer demand.”4 Put differently, there is an emerging recognition by managers them- selves that the foundations of enterprise success transcend simply being productive at R&D, achieving new product introductions, adopting best practice, and delivering quality products and services. Not only must the innovating enterprise spend heavily on R&D and assiduously develop and protect its intellectual property; it must also generate and implement the complementary organiza- tional and managerial innovations needed to achieve and sustain competitiveness.

As indicated, not all enterprise-level responses to opportunities and threats are manifestations of dynamic capabilities. As Sidney Winter (2003: 991) notes, “ad hoc problem solving” isn’t necessarily a capability. Nor is the adoption of a well-understood and replicable “best” practice likely to constitute a dynamic capability. Imple- menting best practice may help an enterprise become or remain viable, but best practices that are already widely adopted cannot by themselves in a competitive market situation enable an enterprise to earn more than its cost of capital, or outperform its competitors. Likewise, invention and innovation by themselves are insufficient to generate success (Teece, 1986a).

Two yardsticks can be proposed for calibrating capabilities: “tech- nical” fitness and “evolutionary” fitness (Helfat et al., 2007). Tech- nical fitness is defined by how effectively a capability performs its function, regardless of how well the capability enables a firm to make a living. Evolutionary or external fitness refers to how well the capability enables a firm to make a living. Evolutionary fitness references the selection environment. Helfat et al. (2007) further note that both technical and evolutionary fitness range from zero to some positive value. These yardsticks are consistent with the discussion here. Dynamic capabilities assist in achieving evolutionary fitness, in part by helping to shape the environment. The element of dynamic capabilities that involves shaping (and not just adapting to) the environment is entrepreneurial in nature. Arguably, entrepreneurial fitness ought to have equal standing with evolutionary fitness.

Dynamic capabilities have no doubt been relevant to achieving competitive advantage for some time. However, their importance is now amplified because the global economy has become more open and the sources of invention, innovation, and manufacturing are more diverse geographically and organizationally (Teece, 2000), and multiple inventions must be combined to achieve market- place success (Somaya and Teece, 2007). Achieving evolutionary fitness is harder today that it was before the millennium. Moreover, regulatory and institutional structures must often be reshaped for new markets to emerge; and as discussed later, the ubiquity of “platforms” must now be recognized (Evans et al., 2006).

While the development and astute management of intangible assets/intellectual capital is increasingly recognized as central to sustained enterprise competitiveness, the understanding of why and how intangibles are now so critical still remains opaque and is not addressed by orthodox frameworks. What is needed is a new framework for business and economic analysis. As former US Federal Reserve Chairman Alan Greenspan remarked, “we must begin the important work of developing a framework capable of analyzing the growth of an economy increasingly dominated by conceptual products”.5 The dynamic capabilities approach devel- oped here endeavors to be responsive to this challenge at the enterprise level.

In an earlier treatment (Teece et al., 1997: 530), it was noted that “we have merely sketched an outline for a dynamic capa- bilities approach”. In what follows, the nature of various classes of dynamic capabilities is identified, and an effort is made to separate the microfoundations of dynamic capabilities from the capability itself. Put differently, important distinctions are made between the organizational and managerial processes, procedures, systems, and structures that undergird each class of capability, and the capability itself. One should note that the identification of the microfoundations of dynamic capabilities must be necessarily incomplete, inchoate, and somewhat opaque and/or their imple- mentation must be rather difficult. Otherwise sustainable competi- tive advantage would erode with the effective communication and application of dynamic capability concepts.

Of course, the existence of processes, procedures, systems, and structures already ubiquitously adopted by competitors does not imply that these have not in the past been the source of com- petitive advantage, or might not still be a source of competitive advantage in certain contexts. For example, studies of the diffusion of organizational innovations (e.g. Armour and Teece, 1978; Teece, 1980b) indicate that diffusion is by no means instantaneous, and that profits can persist for many years before being competed away. Decade-long adoption cycles for new business structures and procedures (e.g. performance measurement systems) are not uncommon. Uncertain imitability (Lippman and Rumelt, 1982) may also serve to slow the diffusion process and support persistent differential performance.

Fortunately, the existing literature on strategy, innovation, and organization, and the new literature on  dynamic  capabilities have identified a panoply of processes and routines that can be recognized as providing certain microfoundations for dynamic capabilities. For instance, Eisenhardt and Martin (2000) identify cross-functional R&D teams, new product development routines, quality control routines, and technology transfer and/or knowl- edge transfer routines, and certain performance measurement sys- tems as important elements (microfoundations) of dynamic capa- bilities. The effort here is not designed to be comprehensive, but to integrate the strategy and innovation literature and provide an umbrella framework that highlights the most critical capabilities management needs to sustain the evolutionary and entrepreneur- ial fitness of the business enterprise.

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

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