Ronald Coase in his classic (1937) article on the nature of the ﬁrm described ﬁrms and markets as alternative modes of governance, the choice between them made so as to minimize transaction costs. The boundaries of the ﬁrm were set by bringing transactions into the ﬁrms so that at the margin the internal costs of organizing equilibrated with the costs associated with transacting in the market.
Initiated by Coase’s (1937) seminal paper, a substantial literature has emerged on the relative efﬁciencies of ﬁrms and markets. This literature, greatly expanded by Oliver Williamson (1975, 1985) and others, has come to be known as transaction cost economics. It analyzes the relative efﬁciencies of markets and internal organiza- tion, as well as intermediate forms or organization such as strategic alliances.
Contractual difﬁculties associated with asset speciﬁcity are at the heart of the relative efﬁciency calculations in transaction cost economics. When speciﬁc assets are needed to support efﬁcient production, then the preferred organizational mode is internal organization. Vertical and other forms of integration are preferred over contractual arrangements when efﬁcient production requires investors to make irreversible investments in speciﬁc assets. The structures used to support transactions are referred to as govern- ance modes. Internal organization (doing things inside the ﬁrm) is one such governance mode.
The dynamic capabilities approach is very consistent with Coase in some ways but not others. It is accepted that it is useful to think of the ﬁrm and markets as alternative modes of governance. Relatedly, the selection of what to organize (manage) internally or via alliances or via the market depends on the nontradability of assets and what Langlois has termed “dynamic transactions costs”.
But it is not enough to convert the notion of nontradability entirely into the concept of “transaction costs”, deﬁned by Arrow (1969: 48) as the “costs of running the economic system”. Others have tried to operationalize the concept of transaction costs, with Alchian and Demsetz (1972) proposing technological nonsepara- bilities and Williamson (1985) focusing on speciﬁc assets. There is indeed a strong relationship between speciﬁc assets and nontraded or thinly traded assets.
However, there are reasons why assets are not traded (or are thinly traded) that do not relate to asset speciﬁcity. For instance, the land on the corner of Park Avenue and 59th Street in New York City rarely comes onto the market. The ability to write highly creative and efﬁcient software for computer operating systems is not widely distributed. Brands that signal particular values (e.g. Lexus) are likewise thinly traded. Uniqueness and asset speciﬁcity aren’t quite the same. In addition, the concept of cospecializa- tion is important (Teece, 1986a). Assets that are cospecialized to each other need to be employed in conjunction, often inside the ﬁrm.10 This isn’t the emphasis of Coase, Alchian and Demsetz, or of Williamson.
Assembling cospecialized assets inside the ﬁrm in the dynamic capabilities framework is not done primarily to guard against opportunism and recontracting hazards, although in some cases that may be important. Instead, because effective coordination and alignment of these assets/resources is difﬁcult to achieve through the price system, special value can accrue to achieving good align- ment within the ﬁrm. This is different from what Barnard (1938) has suggested with his emphasis on the functions of the executive as rooted in cooperative adaptation of a conscious and deliberate kind. Here the focus is on the “orchestration” of cospecialized assets by strategic managers. It is a proactive process designed to: (1) keep cospecialized assets in value-creating coalignment, (2) select new cospecialized assets to be developed through the investment process, and (3) divest or run down cospecialized assets that no longer help yield Rather than stressing opportunism (although opportunism surely exists and must be guarded against), the emphasis in dynamic capabilities is on change processes, inventing and reinventing the architecture of the business, asset selection, and asset orchestration.
One might reasonably ask the reasons for this signiﬁcant differ- ence in emphasis. Clearly, in dynamic capabilities, a comparative institutional framework is adopted. “Small numbers” bargaining is at the core, as in Williamson (1975). However, the emphasis on dynamic capabilities is not just on protecting value, but also on creating it. Barnard wouldn’t naturally see the importance of this emphasis, because his laboratory was the regulated Bell Telephone operating companies.
Alchian and Demsetz and Williamson have all emphasized opportunistic free riding. Indeed, their human actors are assumed to be boundedly rational, self-interest seeking, opportunistic, and full of guile. The dynamic capabilities framework adds other (arguably less ubiquitous) traits of human nature: (1) intrapre- neurship and entrepreneurship, and (2) foresight and acumen. Williamson appears to recognize that such skills ought to inﬂuence the theory of economic organization, when he quotes businessman Rolf Sprecket: “Whenever I see something badly done, or not done at all, I see an opportunity to make a fortune.” Williamson comments: “Those instincts, if widely operative, will inﬂuence the practice and ought to inﬂuence the theory of economic organi- zation” (1999: 1089). This statement opens the door to dynamic capabilities.
There are other differences as well. Williamson makes the trans- action the unit of analysis; in dynamic capabilities, the currency of interest includes complementary and cospecialized assets. The utility of transaction cost economics and related frameworks to make–buy–ally decisions and related governance decisions are not in dispute. But transaction cost economics leaves us with- out an understanding of the distinctive role of strategic manage- ment. Executives must not only choose governance models (as between market arrangements, alliances, and internal organiza- tion), but they must also understand how to design and implement different governance structures, and to coordinate investment activities.
Just as the governance of markets is not preordained by the economic system, nor is the selection of governance modes. Many elements of internal organization, business model design, and alliance structure require managers to select and design methods of governance. For example, as Chapter 5 explains in more detail, a relational capability for alliances includes selection and design of alliance governance. Again, dynamic capabilities come to the fore.
Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.