1. Nature of the Capability
In fast-paced, globally competitive environments, consumer needs, technological opportunities, and competitor activity are constantly in a state of flux. Opportunities open up for both newcomers and incumbents, putting the profit streams of incumbent enterprises at risk. As discussed in Teece et al. (1997), some emerging marketplace trajectories are easily recognized. In microelectronics this might include miniaturization, greater chip density, and compression and digitization in information and communication technology. How- ever, most emerging trajectories are hard to discern. Sensing (and shaping) new opportunities is very much a scanning, creation, learning, and interpretive activity. Investment in research and related activities is usually a necessary complement to this activity. Opportunities get detected by the enterprise because of two classes of factors. First, as stressed by Kirzner (1973), entrepre- neurs can have differential access to existing information. Second, new information and new knowledge (exogenous or endogenous) can create opportunities, as emphasized by Schumpeter (1934).
Kirzner stressed how the entrepreneurial function recognizes any disequilibrium and takes advantage of it. The Kirznerian view is that entrepreneurship is the mechanism by which the economy moves back toward equilibrium. Schumpeter, on the other hand, stressed upsetting the equilibrium. As Baumol (2006: 4) notes, “the job of Schumpeter’s entrepreneur is to destroy all equilibria, while Kirzner’s works to restore them. This is the mechanism underlying continuous industrial evolution and revolution.” Equilibrium is rarely if ever achieved (Shane, 2003). Both forces are relevant in today’s economy.
To identify and shape opportunities, enterprises must constantly scan, search, and explore across technologies and markets, both “local” and “distant” (March and Simon, 1958; Nelson and Winter, 1982). This activity not only involves investment in research activ- ity and the probing and reprobing of customer needs and techno- logical possibilities; it also involves understanding latent demand, the structural evolution of industries and markets, and likely sup- plier and competitor responses. To the extent that business enter- prises can open up technological opportunities (through engaging in R&D and through tapping into the research output of others) while simultaneously learning about customer needs, they have a broad menu of commercialization opportunities. Overcoming a narrow search horizon is extremely difficult and costly for man- agement teams tied to established problem-solving competences. Henderson (1994) notes that General Motors (GM), IBM, and Dig- ital Equipment Corporation (DEC) encountered difficulties because they became prisoners of the deeply ingrained assumptions, infor- mation filters, and problem-solving strategies that made up their world views, turning the solutions that once made them great into strategic straitjackets.
When opportunities are first glimpsed, entrepreneurs and managers must figure out how to interpret new events and developments, which technologies to pursue, and which market segments to target. They must assess how technologies will evolve and how and when competitors, suppliers, and customers will respond. Competitors may or may not see the opportunity, and even if they do they may calibrate it differently. Their actions, along with those of customers, suppliers, standard-setting bodies, and governments, can also change the nature of the opportunity and the manner in which competition will unfold.
There are also constraints on the rules by which competitive forces will play out. These constraints are imposed by regulators, standard-setting bodies, laws, social mores, and business ethics. The shape of the “rules of the game” is thus the result of coevo- lution and complex interaction between what might be thought of as (business) ecosystem participants. Because of uncertainty, entrepreneurs/managers must make informed conjectures about the path ahead. These conjectures become working hypotheses that can be updated as evidence emerges. Once a new evolutionary path becomes apparent, quick action is needed.
Microfoundations
The literature on entrepreneurship emphasizes that opportunity discovery and creation can originate from the cognitive and cre- ative (“right brain”) capacities of individual(s). However, discov- ery can also be grounded in organizational processes, such as research and development activity. The ability to create and/or sense opportunities is clearly not uniformly distributed amongst individuals or enterprises. Opportunity creation and/or discovery by individuals require both access to information and the ability to recognize, sense, and shape developments. The ability to recognize opportunities depends in part on the individual’s capabilities and extant knowledge (or the knowledge and learning capacities of the organization to which the individual belongs) particularly about user needs in relationship to existing as well as novel solutions. This requires specific knowledge, creative activity, and the ability to understand user/customer decision making, and practical wisdom (Nonaka and Toyama, 2007). It involves interpreting available information in whatever form it appears—a chart, a picture, a conversation at a trade show, news of scientific and technological breakthroughs, or the angst expressed by a frustrated customer. One must accumulate and then filter information from professional and social contacts to create a conjecture or a hypothesis about the likely evolution of technologies, customer needs, and marketplace responses. This task involves scanning and monitoring internal and external technological developments and assessing customer needs, expressed and latent. It involves learning, interpretation, and creative activity.
While certain individuals in the enterprise may have the neces- sary cognitive and creative skills, the more desirable approach is to embed scanning, interpretative, and creative processes inside the enterprise itself. The enterprise will be vulnerable if the sensing, creative, and learning functions are left to the cognitive traits of a few individuals.6 Organizational processes can be put in place inside the enterprise to garner new technical information, tap developments in exogenous science, monitor customer needs and competitor activity, and shape new products and processes oppor- tunities. Information must be filtered, and must flow to those capa- ble of making sense of it. Internal argument and discussion about changing market and technological reality can be both inductive and deductive. Hypothesis development, hypothesis “testing”, and synthesis about the meaning of information obtained via search are critical functions, and must be performed by the top manage- ment team. The rigorous assembly of data, facts, and anecdotes can help test beliefs. Once a synthesis of the evidence is achieved, recurrent synthesis and updating can be embedded in business processes designed by middle management and/or the planning unit in the business organization (Casson, 1997). If enterprises fail to engage in such activities, they won’t be able to assess market and technological developments and spot opportunities. As a consequence, they will likely miss opportunities visible to others.
As noted in Teece et al. (1997), more decentralized organizations with greater local autonomy are less likely to be blindsided by market and technological developments. Because of the problem of information decay as information moves up (and down) a hier- archy, businesses must devise mechanisms and procedures to keep management informed. Bill Hewlett and David Packard developed “management by walking about” (Packard, 1995) as a mechanism to prevent top management at Hewlett-Packard from becoming isolated from what was going on at lower levels in the enterprise, and outside the enterprise as well. In other organizations (e.g. pro- fessional services) the management ranks can be filled by leading professionals who remain involved with professional work. This protects them from the hazards of managerial isolation.
The search activities that are relevant to “sensing” include infor- mation about what’s going on in the business ecosystem. With respect to technologies, R&D activity can itself be thought of as a form of “search” for new products and processes. However, R&D is too often usually a manifestation of “local” search. “Local” search is only one component of relevant search. In fast-paced envir- onments, with a large percentage of new product introductions coming from external sources, search/exploration activity should not just be local. Enterprises must search the core as well as to the periphery of their business ecosystem. Search must embrace poten- tial collaborators—customers, suppliers, complementors—that are active in innovative activity.
Customers are sometimes amongst the first to perceive the potential for applying new technology. Visionary members of cus- tomer organizations are often able to anticipate the potential for new technology and possibly even begin rudimentary development activities. Moreover, if the suppliers of new technology do not suc- ceed in properly understanding user/customer needs, it is unlikely that new products they might develop will be successful. Indeed, one of the most consistent findings from empirical research is that the probability that an innovation will be successful commer- cially is highly correlated with the developers’ understanding of user/customer needs (Freeman, 1974). Electronic computing and the Internet itself can rightly be viewed as having a significant com- ponent of user-led innovations. Business enterprises that are alert and sense the opportunity are often able to leverage customer-led efforts into new products and services, as the users themselves are frequently ill prepared to carry initial prototypes further forward.
Suppliers can also be drivers of innovation important in the final product. Innovation in microprocessor and DRAMs is a classic case.
This upstream or “component” innovation has impacted competi- tion and competitive outcomes in personal computers, cellular tele- phony, and consumer electronics more generally. Failure to “design in” new technology/components in a timely fashion will lead to failure; conversely, success can sometimes be achieved by continu- ous rapid “design in”. Indeed, continuous and rapid design around new technology/components developed elsewhere can itself be a source of durable competitive advantage. Put differently, with rapid innovation by component suppliers, downstream competitive success can flow from the ability of enterprises to continuously tap into such (external) innovation ahead of the competition. Exter- nal search and acquisition of technology have been going on for decades, but as Chesbrough (2003) explains, “Open Innovation” is now a mandate for enterprise success.
The concept and practice of open innovation underscore the importance of broad-based external search and subsequent integra- tion involving customers, suppliers, and complementors. Establish- ing linkages between corporations and universities assists broad- based search, as university programs are usually unshackled from the near at hand. Indeed, a recent study of patenting in the optic- al disk industry (Rosenkopf and Nerkar, 2001) seems to suggest that exploration that is more confined generates lower impacts, and that the impact of exploration is highest when exploration spans organizational (but not technological) boundaries. How- ever, it is not just a matter of searching for external inven- tions/innovations that represent new possibilities. Frequently it is a matter of combining complementary innovations so as to create a solution to a customer problem. The systemic nature (Teece, 2000) of many innovations compounds the need for external search.
Sensing opportunities and threats can also be facilitated if the enterprise and/or the entrepreneur explicitly or implicitly employs some kind of analytical framework, as this can help highlight what is important. The field of strategic management has been stranded for some time with a framework that implicitly assumes that industry structure (and product market share), mediated by enterprise behavior, determines enterprise performance. In Porter’s (1980) Five Forces framework, a good strategy involves somehow picking an attractive industry and positioning oneself to be shielded from competition. Porter’s approach mandates “industry” analysis7 and the calibration of five distinct industry-level forces: the role of potential entrants, suppliers, buyers, substitutes, and rivalry amongst competitors. Because of its rather static nature and the fact that it ignores many aspects of the competitive environment including the role of complementarities, path dependencies, and supporting institutions, its application in the contexts outlined in the Introduction to this chapter will limit the ability of the entrepreneur and/or the enterprise to properly sense opportu- nities and threats and properly calibrate strengths, weaknesses, and technological and market trajectories. If network effects, path dependencies, and the co-evolution of technologies and insti- tutions are significant, the Five Forces framework is of limited utility.
The Five Forces framework has inherent weaknesses in dynamic environments. Fundamental is that it implicitly views market structure as exogenous, when in fact market structure is the (endogenous) result of innovation and learning.8 Changes in sci- ence and technology create opportunities for innovation. Enter- prises can search amongst new possibilities and engage in devel- opment activities. If successful, such development impacts the relative fate of firms. This in turn determines market structure. Outcomes for individual enterprises are shaped in part by the selec- tion processes at work in the business ecosystem. Relevant factors ignored or underplayed by Five Forces include technological oppor- tunities, path dependencies, appropriability conditions, supporting institutions, installed base effects, learning, certain switching costs, and regulation. In short, in regimes of rapid technological change with well-developed markets for goods and services (and poorly developed markets for know-how), the Five Forces framework is compromised because it has insufficient appreciation (a) for the importance of and nature of innovation and other factors that change the “rules of the game”, (b) for factors inside the busi- ness enterprise that constrain choices, (c) for factors that impact imitation and appropriability issues, (d) for the role of supporting institutions, complementary assets, cospecialization, and network externalities, or (e) for the blurred nature of industry boundaries. Also, as discussed later, in many “platform” industries or where there is significant outsourcing, scale is an industry asset.
The dynamic capabilities framework represents a strong break with Five Forces. Within the dynamic capabilities framework, the “environmental” context recognized for analytical purposes is not that of the industry, but that of the business “ecosystem”—the community of organizations, institutions, and individuals that impact the enterprise and the enterprise’s customers and supplies. The relevant community therefore includes complementors, suppliers, regulatory authorities, standard-setting bodies, the judiciary, and educational and research institutions. It is a framework that recognizes that innovation and its supporting infrastructure have major impacts on competition. The dynamic capabilities framework is grounded in Kirznerian, Schumpeterian, and evolutionary theories of economic change, whereas Five Forces is grounded in the Mason-Bain paradigm of industrial economics.9 Also, whereas according to Porter the essence of strat- egy formulation is “coping with competition” (Porter, 1991: 11), in the dynamic capabilities tradition the essence of strategy involves selecting and developing technologies and business models that build competitive advantage through assembling and orchestrating difficult-to-replicate assets, thereby shaping competition itself.
Even when utilizing the ecosystem as the organizing paradigm for assessing developments in the business environment, the full import of particular facts, statistics, and developments is rarely obvious. Accordingly, the evaluative and inferential skill possessed by an organization and its management is important. Indeed, much of the information gathered and communicated inside the enter- prise has minimal decision relevance. Even if relevant, it often arrives too late. Management must find methods and procedures to peer through the fog of uncertainty and gain insight. This involves gathering and filtering technological, market, and compet- itive information from both inside and outside the enterprise, mak- ing sense of it, and figuring out implications for action. However, because attention is a scarce resource inside the enterprise (Cyert and March, 1963), management must carefully allocate resources to search and discovery. The enterprise’s articulated strategy can become a filter so that attention is not diverted to every opportu- nity and threat that “successful” search reveals. Likewise, scenario planning can collapse likely situations into a small number of scenarios that can facilitate cognition, and then action, once uncer- tainty is resolved. Figure 1.1 summarizes individual and enterprise traits that undergird sensing capabilities.
Fig. 1.1. Elements of ecosystem framework for “sensing” market and technological opportunities
Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.