Dynamic Capabilities A Guide For Managers

About the Author

David J. Teece
David J. Teece is the Thomas W. Tusher Professor at the Haas School of Business at the
University of California, Berkeley. He is the author of over 200 books and articles on business
and economics
In the global economy, investing in technology and only technology is unlikely to pay off. As
this author writes wealth will flow to those that exhibit innovation in a dominant paradigm, own a
strong intellectual property position in critical technologies, and have high-performance business
models (Wal-Mart). Below, he describes how managers can achieve these ends.
Its sometimes said that theres nothing more practical than a good theory. Whether they realize
it or not, managers need a theoretical understanding of enterprise growth and development. In
this article, we propose the adoption of a conceptual framework that will help executives lead
their organizations in highly competitive global markets. For some, it will change frames of
reference and accepted priorities in terms of whats important to build, own, and manage.
To be useful, a theoretical framework must be general enough to provide guidance in a variety
of situations. This calls for judiciousness so that an overwhelming number of variables dont
render analysis an impossible task. It also calls for sufficient generality and flexibility, so that the
concepts can be applicable in a wide variety of circumstances. However, the theory must not be
so general and academic that it has little to do with practical management problems.
Management theory is young and fragmented, and generally not much of a guide for executives,
except on certain, narrow issues. The framework presented here can be helpful with the bigpicture issues.
This essay presents the Dynamic Capabilities Framework (Teece et al., 1990, 1997; Teece,
2007), which is increasingly providing the intellectual infrastructure for both theoretical and
applied analyses of strategic management and other issues facing business decision makers.
While originated by the author of this paper, a broad panoply of scholars and executives is now
contributing to its further development.2

The growing importance of intangible assets

The Dynamic Capabilities Framework is animated by the recognition of several global
megatrends that impact the contemporary business enterprise operating in hypercompetitive
environments. Perhaps the most critical of these trends is that access to global transportation
and information flows is so widespread that some say the world is flat (Friedman, 2007). In
particular, intermediate goods and services that might once have been hard to access are now

widely available, a reality which has created a system of global specialization. But on this flat
landscape, characterized by hyper-competition, the capabilities required to orchestrate and
deploy the available resources remain scarce and geographically isolated.
As a result of the greater ability to outsource almost anything and everything, the traditional
competitive sources of differentiation based on economies of scale and scope have been
eroded. If your market is too small to capture scale economies for an input or even a whole
product, then you should source from companies that have achieved them already. Textbooks
need to be rewritten to recognize the new reality.
Fortunately, there are other bases of competitive advantage unrelated to scale. The prime
example is the generation, ownership, and management of intangible assets, which have risen
to overshadow economies of scale in importance for enabling the enterprise to build and sustain
a successful position.
Perhaps the most important class of intangible assets not universally available is technological
know-how. Know-how and other intangibles are increasingly the bottleneck assets that allow
innovating firms to differentiate and establish some degree of competitive advantage. They
cause hillsand sometimes high mountainsto appear on otherwise flat competitive
landscapes. Value can flow to the enterprise from the astute creation, combination, transfer,
accumulation, and protection of intangible assets. Such assets are the new natural resources
of the global economy. But they are not naturally occurring and depend on managerial action
and, in part, on national systems of innovation (Nelson, 1993).
Intangible assets in general are a very economically interesting asset class, with powerful
implications for building and maintaining competitive advantage at the enterprise level.
Intangible assets are hard to build and difficult to manage. They are also unlikely to be traded
(i.e., markets, if they exist, will be thin) because their underlying value often derives from the
presence of complementary assets, which limits the number of buyers who will be willing and
able to pay the knowledge assets full potential strategic value. Furthermore, knowledge assets
are generally costly to transfer and can even be difficult to specify fully in a contract (Teece,
1981). As a result, these assets are harder to access than many other asset classes.
Ironically, even in natural resource industries, profits (for the business enterprise, but not
necessarily for the nation-state) flow fundamentally from the ownership and use of intangibles,
and only less so from ownership of the resource. The highest profits flow to those who develop
extraction technologies, deploy them effectively and safely, and build privileged relationships
with nation states and other constituencies. Accordingly, in the petroleum industry, oil in a
fundamental sense is found in the mind, not in the ground; locating new reserves in deep
water requires both (organizationally embedded) know-how and, in many jurisdictions,

relationships with nation-states to secure exploitation and production rights. Table 1 summarizes
the differences between intangible and physical assets along selected dimensions.

Table 1: Intangible Assets Compared With Physical Assets

Intangible Assets
Variety
Heterogeneous
Property rights
Often fuzzy
Market transactions
Infrequent
General awareness of transaction Low

Physical Assets
Homogeneous
Usually clear
Frequent
High

opportunity
Recognized on balance sheets
Possible strategic value

Yes
Low

No
High

Another intangible asset of central importance (besides knowhow) is a firms business model for
a given market, i.e., the structure of a firms value proposition for its customers (Chesbrough
and Rosenbloom, 2002; Teece, 2010a) and the design of the business that will deliver a solution
to the customer. Business-model innovations are critical to success in unsettled markets where
traditional revenue and pricing models are no longer applicable. The Internet allows and
requires business model innovation.
In particular, the Internet requires new pricing structures because users are accustomed to
getting information for free. Information providers are challenged to think of ways of charging
for ancillary or premium services (so-called fremium approaches) while not running afoul of
Internet users expectations of receiving free information.
The other main classes of intangible assets are technological know-how, business process
know-how, customer and business relationships, reputations, organizational culture and values,
as well as formally identified intellectual property. The ability to prevent (or punish) the imitation
of the key intangibles is necessary in order for the firm to capture value from its assets. Legal
barriers to imitation protect some knowledge assets, although these are of limited importance in
some industries due either to the pace of change or weak rights enforcement (e.g. digital
music).
Because knowledge assets by themselves will not yield value, they must almost always be
combined with other intangible and physical complements and bundled as a product to yield
value for a customer. Ownership and/or control of complementary assets are therefore also
necessary for competitive success (Teece, 1986). Textbooks are only now starting to recognize

the fundamental shifts that have taken place in the basis of competitive advantage. The
implications for business strategy, organization, and management education are monumental.
The growing importance of complements both inside and outside of the firm is a case in point.
The vital role of complementors changes the nature of the required technology management
approaches and business strategies because innovation in one product or service often
increases the value of their complement(s). For example, improvements in software help drive
demand for computing hardware, and vice-versa. Likewise, the development of high-octane
fuels in the 1940s by oil refiners enabled the creation of high-compression engines by auto
manufacturers.
It is also the case that intangible assets are rarely recorded on corporate balance sheets. As a
consequence, existing accounting-based frameworks have a hard time coming to grips with
them. Alan Greenspan, former chairman of the U.S. Federal Reserve Bank, once noted the
challenge of developing a framework capable of analyzing the growth of an economy
increasingly dominated by conceptual products (Greenspan, 2004). Conceptual products are
steeped in intangible assets.
These changes in the economy clearly call for a new theoretical framework for understanding
and guiding the growth of firms increasingly involved in creating and marketing conceptual,
rather than physical, products. The Dynamic Capabilities Framework recognizes these
considerations.

From knowledge assets to dynamic capabilities

As new bases of competitive advantage have gained in significance, old ways of looking at
competition have been supplanted. Porters Five Forces framework (Porter, 1980), which
applied the structure-performance paradigm of industrial organization economics to strategy,
focused on evaluating suppliers, customers, and the threat of new entrants and/or substitute
products. This framework is not without insight, but its not up to the task of revealing the
dominant logic of value capture in most new industries, as well as many of the old.
Hence, firms need to take a more comprehensive view of the environment in which they must
compete. Such a view needs to include not only buyers and suppliers but the local market for
skilled workers (since they are not entirely mobile internationally), universities (for access to
both highly educated talent and faculty research), financial institutions (especially venture
capital), the legal system (especially intellectual property law and employment law), and the
domestic political situation. Figure 1 displays these factors and their interaction.

Figure 1: The Business Ecosystem

In order to embrace these new elements of competition, the Dynamic Capabilities Framework
has emerged. It offers a comprehensive, multidisciplinary approach to managerial decisionmaking. No other framework offers, or purports to offer, a comprehensive and multidisciplinary,
research-based perspective on key strategic challenges. The Dynamic Capabilities Framework
helps identify the factors likely to impact enterprise performance. It is gradually developing into
a (interdisciplinary) theory of the modern corporation (Teece, 2010).
The Dynamic Capabilities perspective goes beyond a financial-statement view of assets to
emphasize the soft assets that management needs to orchestrate resources both inside and
outside the firm. This includes the external linkages that have gained in importance, as the
expansion of trade has led to greater specialization. It recognizes that to make the global
system of vertical specialization and co-specialization work, there is an enhanced need for the
business enterprise to develop and maintain asset alignment capabilities that enable
collaborating firms to develop and deliver a joint solution to business problems that customers
will value.
Dynamic capabilities can usefully be thought of as belonging to three clusters of activities and
adjustments: (1) identification and assessment of an opportunity (sensing); (2) mobilization of
resources to address an opportunity and to capture value from doing so (seizing); and (3)
continued renewal (transforming). These activities are required if the firm is to sustain itself as
markets and technologies change, although some firms will be stronger than others in

performing some or all of these tasks. Performance of these activities draws on all the skills and
disciplines used in the curriculum of business schools everywhere. The Dynamic Capabilities
Framework helps organize and harness (academic) disciplinary knowledge so as to apply it to
the task of building durable competitive advantage at the enterprise level.
Sensing is an inherently entrepreneurial set of capabilities that involves exploring technological
opportunities, probing markets, and listening to customers, along with scanning the other
elements of the business ecosystem. It requires management to build and test hypothesis
about market and technological evolution, including the recognition of latent demand. The
world wasnt clamoring for a coffeehouse on every corner, but Starbucks, under the guidance of
Howard Schultz, recognized and successfully exploited the potential market. As this example
implies, Sensing requires managerial insight and vision or an analytical process that can be a
proxy for it.
Seizing capabilities include designing business models to satisfy customers and capture value.
They also include securing access to capital and the necessary human resources. Employee
motivation is vital. Good incentive design is a necessary but not sufficient condition for superior
performance in this area. Strong relationships must also be forged externally with suppliers,
complementors, and customers.
Companies that successfully build and orchestrate assets within the ecosystem stand to profit
handsomely. Apple retained an estimated 40 percent of the gross profits from the entirety of the
value chain on its hard drive-based iPods, despite manufacturing no part of the product itself
(Linden et al., 2009). This is not counting the revenue from licensing makers of iPod
accessories or sales from the iTunes Music Store.
Transforming capabilities are needed most obviously when radical new opportunities are to be
addressed. But they are also needed periodically to soften the rigidities that develop over time
from asset accumulation, standard operating procedures, and insider misappropriation of rent
streams. A firms assets must also be kept in alignment to achieve the best strategic fit: firm
with ecosystem, structure with strategy, and assets with each other. Complementarities need to
be constantly managed (reconfigured as necessary) to achieve evolutionary fitness, avoiding
loss of value should market leverage shift to favor external complements.
Apple has proved to be a paradigmatic practitioner of dynamic capabilities as it has created and
transformed a series of markets. Table 2 shows how each of its major product introductions
reflected aspects of the major categories of dynamic capabilities. In particular, Apples strategy
implementation has created and shaped markets.

Table 2: Dynamic Capabilities at Apple

iPod

Sensing
existing mp3

Seizing
create an

Transforming
port iTunes

Result
domination of

players were too

aesthetically

software to rival

the portable

geeky

appealing portable Windows platform; digital music

device with a

expand into

player market;

simple interface

content distribution expansion to

over an

with the iTunes

video

accelerated

Music Store; shift

capabilities

product

company

(playback and

development

emphasis from

distribution).

cycle; later:

computers to

improve

consumer

appropriability with electronics

exclusive FairPlay
DRM in the iTunes

iPhone

existing smart

Music Store
create a

phones retained

multimedia phone capabilities; enter companies

an awkward

with a large screen the regulated

interface too close and an intuitive

to their cell phone interface; promote
roots.

complementary

develop telephony one of the only

telephony market

making money
with smart
phones

asset creation with

the App Store

iPad

infrastructure.
netbooks provide scale up the

extend the simple (too early to

an unsatisfying

iPhone interface to interface aesthetic know)

computing

provide a richer

experience and E- multimedia

readers provide

platform without

limited

phone functionality.

to a computing
platform.

functionality.
In addition to Apples ability to identify and orchestrate new asset combinations, wealth in the
global economy flows to innovation within a dominant paradigm (Intel), a strong intellectual
property position in critical technologies (Qualcomm), and high-performance business models
(Wal-Mart). The important lesson is that investing in technology by itself is unlikely to pay off.
Entrepreneurial managers and leaders building and deploying intangible assets are critical
success factors. Capturing value is never certain, but it can be managed.

References
Baranskaya, Anna, and Teece, David J. (forthcoming). Business Model Dashboards and
Design Algorithms: Lessons from Apples iPod, iPhone, and iPad.
Friedman, Thomas L. (2007). The World is Flat: A Brief History of the Twenty-First Century. New
York: Farrar, Straus and Giroux.
Linden, Greg, Kraemer, Kenneth L., and Dedrick, Jason (2009). Who Captures Value in a
Global Innovation System? The case of Apples iPod. Communications of the ACM. 52(3): 140144.
Nelson, Richard R. (ed.) (1993). National Systems of Innovation. New York: Oxford University
Press.
Porter, M. E. (1980). Competitive Strategy: Techniques for Analyzing Industries and
Competitors. New York: Free Press.

Teece, David J. (2007). Explicating Dynamic Capabilities: The Nature and Microfoundations of
(Sustainable) Enterprise Performance, Strategic Management Journal, 28(13): 1319-1350.
Teece, David J. (2010). Technological Innovation and the Theory of the Firm: The Role of
Enterprise-level Knowledge, Complementarities, and (Dynamic) Capabilities. In N. Rosenberg
and B. Hall (eds.) Handbook of the Economics of Innovation, Volume 1. Amsterdam: NorthHolland.
Teece, David J., Pisano, Gary, and Shuen, Amy (1990) Firm Capabilities, Resources, and the
Concept of Strategy. Center for Research in Management. University of California, Berkeley,
CCC Working Paper 90-8.