Dynamic Capabilities Theory Of The Firm Essay

Nicolai J. FOSS

Department of Industrial Economics and Strategy


Mots-clés : Relations entre théories, Théorie des contrats, Compétences, Théorie de la Firm.

Key Words : Relations between theories, Contract theory, Capabilities, The Theory of the firm.

I. - Introduction

After decades of relative neglect, the theory of the firm has now become one of the most rapidly expanding research areas in economics, winning one of its pioneers, Ronald Coase (1937), the Nobel prize (1). Much of the frontier research in modern economics is conducted within areas that lie close to or directly within the domain of the theory of the firm, and new mathematical techniques and concepts (e.g., super-modularities, lattice theory) are brought to bear on organizational issues.

The general expansion in economics of interest in the firm and in economic organization in general is reflected in a broad menu of contemporary theories of economic organization. Thus, we have Oliver Williamson's (1985) brand of transaction cost economics, nexus of contracts theories (Alchian & Demsetz, 1972 ; Cheung, 1983), the more recent outgrowth of these theories, namely agency theory (Holmström, 1982), and the incomplete contract approach pioneered by Grossman and Hart (1986).

Although these contractual theories of the firm differ — sometimes rather substantially — they are all agreed on emphasizing the importance of property rights, asymmetric information, and some behavioral assumption that extends the usual self-interest assumption (such as 'opportunism' or 'moral hazard'). In lieu of such notions, it is not possible to tell much of a story of

(1) The real pioneer, of course, is Frank Knight, who has the best claim to have founded the theory of economic organization with his Risk, Uncertainty and Profit (1921) (see Foss, 1993; 1996b).

REVUE D'ÉCONOMIE INDUSTRIELLE — n° 77, 3e trimestre 1996 7

Dynamic Capabilities

Dynamic capability is “the firm’s ability to integrate, build, and reconfigure internal and external competences to address rapidly changing environments” (David J. Teece, Gary Pisano, and Amy Shuen).

Dynamic capabilities can be distinguished from operational capabilities, which pertain to the current operations of an organization. Dynamic capabilities, by contrast, refer to “the capacity of an organization to purposefully create, extend, or modify its resource base” (Helfat et al., 2007). The basic assumption of the dynamic capabilities framework is that core competencies should be used to modify short-term competitive positions that can be used to build longer-term competitive advantage.

Read about Berkeley Research Group’s Dynamic Capabilities Advisory Practice,andwatch Dr. Teece and others describe dynamic capabilities and strategy.


Three dynamic capabilities are necessary in order to meet new challenges. Organizations and their employees need the capability to learn quickly and to build strategic assets. New strategic assets such as capability, technology, and customer feedback have to be integrated within the company. Existing strategic assets have to be transformed or reconfigured.

Teece’s concept of dynamic capabilities essentially says that what matters for business is corporate agility: the capacity to (1) sense and shape opportunities and threats, (2) seize opportunities, and (3) maintain competitiveness through enhancing, combining, protecting, and, when necessary, reconfiguring the business enterprise’s intangible and tangible assets.


Learning requires common codes of communication and coordinated search procedures. The organizational knowledge generated resides in new patterns of activity, in “routines,” or a new logic of organization. Routines are patterns of interactions that represent successful solutions to particular problems. These patterns of interaction are resident in group behavior, and certain sub-routines may be resident in individual behavior. Collaborations and partnerships can be a source for new organizational learning, which helps firms to recognize dysfunctional routines and prevent strategic blind spots. Similar to learning, building strategic assets is another dynamic capability. For example, alliance and acquisition routines can enable firms to bring new strategic assets into the firm from external sources.

New assets

The effective and efficient internal coordination or integration of strategic assets may also determine a firm’s performance. According to Garvin (1988), quality performance is driven by special organizational routines for gathering and processing information, linking customer experiences with engineering design choices, and coordinating factories and component suppliers. Increasingly, competitive advantage also requires the integration of external activities and technologies: for example, in the form of alliances and the virtual corporation. Zahra and Nielsen (2002) show that internal and external human resources and technological resources are related to technology commercialization.

Transformation of existing assets

Fast-changing markets require the ability to reconfigure the firm’s asset structure and accomplish the necessary internal and external transformation (Amit and Schoemaker, 1993). Change is costly, and so firms must develop processes to find high-payoff changes at low costs. The capability to change depends on the ability to scan the environment, evaluate markets, and quickly accomplish reconfiguration and transformation ahead of the competition. This can be supported by decentralization, local autonomy, and strategic alliances.


Over time, a firm’s assets may become co-specialized, meaning that they are uniquely valuable in combination. An example is where the physical assets (e.g., plants), human resources (e.g., researchers), and intellectual property (e.g., patents and tacit knowledge) of a company provide a synergistic combination of complementary assets. Such co-specialized assets are therefore more valuable in combination than in isolation. The combination gives a firm a more sustainable competitive advantage (Teece, 2009; Douma and Schreuder, 2013).

Asset orchestration

If capabilities are dependent on co-specialized assets, it makes the coordination task of management particularly difficult. Managerial decisions should take the optimal configuration of assets into account. Asset orchestration refers to the managerial search, selection, and configuration of resources and capabilities. The term intends to convey that, in an optimal configuration of assets, the whole is more valuable than the sum of the parts.


Professor David Teece

Professor Teece is an authority on subjects including the theory of the firm and strategic management, the economics of technological change, knowledge management, technology transfer, and antitrust economics and innovation. He has a Ph.D. in economics from the University of Pennsylvania, has held teaching and research positions at Stanford University and Oxford University, and has received four honorary doctorates.

Dr. Teece has testified before Congress on regulatory policy and competition policy, has authored over 200 books and articles, and is the editor of Industrial & Corporate Change. According to Science Watch, he is the lead author on the most-cited article in economics and business worldwide from 1995 to 2005. He is also one of the top-10 most-cited scholars in economics and business for the decade and has been recognized by Accenture as one of the world’s top-50 business intellectuals.

Read more about Dr. Teece and his publications and activities at the UC Berkeley website, his Berkeley Research Group profile, and his Google Scholar page.

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