Note: This article was originally published by Booz & Company.
Every great company is involved in building great capabilities: gaining competitive advantage from the things it does exceptionally well. In the last few years, the growing recognition of capabilities’ importance in management strategy and business innovation has made David Teece’s work particularly relevant. A professor at the Haas School of Business at the University of California at Berkeley, Teece originated the theory of “dynamic capabilities” to explain how companies fulfill two seemingly contradictory imperatives. They must be both stable enough to continue to deliver value in their own distinctive way and resilient and adaptive enough to shift on a dime when circumstances demand it.
The dynamic capabilities concept is noteworthy for its explicit repudiation of the economics mainstream, which required Teece to turn against his own academic heritage. Originally from New Zealand, he studied economics at the University of Pennsylvania, where one of his mentors was Nobel laureate Oliver Williamson. (Teece’s work, in turn, influenced management strategy theorist Gary Pisano and business innovation expert Henry Chesbrough, who were his students and collaborators.)
Teece sat down with us at the Berkeley Research Group in Emeryville, Calif.—a firm that he cofounded in 2010 and chairs—to talk about the origins of the theory, the relationship of economic value to capabilities-driven strategies, and the ever-challenging quest to define how companies can reliably develop dynamic capabilities of their own.
S+B: What is a dynamic capability?
TEECE: A capability is a set of learned processes and activities that enable a company to produce a particular outcome. Ordinary capabilities are like best practices. They typically start in one or two companies and spread to the entire industry. Every automobile company knows how to build an assembly plant, or how to get relatively quick equipment turns on the line. It took 25 years, but every company has now learned the Toyota production system. You can learn it by taking an engineering class here at U.C. Berkeley.
Dynamic capabilities, unlike ordinary capabilities, are idiosyncratic: unique to each company and rooted in the company’s history. They’re captured not just in routines, but in business models that go back decades and that are difficult to imitate. Lynda Gratton and the late Sumantra Ghoshal called them “signature processes.” They are “the way things are done around here.”
S+B: Where do these signature processes come from?
TEECE: Usually they’re based on things that the company has done in the past, going back to its origins. But I don’t buy into the deterministic view that once a company gets going, everything it does is locked in place. Instead, companies adapt, in a process much like evolutionary fitness. As the business niche changes, the capability changes accordingly.
Companies adapt, in a process much like evolutionary fitness.
That doesn’t just happen on its own. Three types of managerial activities can make a capability dynamic: sensing (which means identifying and assessing opportunities outside your company), seizing (mobilizing your resources to capture value from those opportunities), and transforming (continuous renewal). This framework, which I described in my paper “Explicating Dynamic Capabilities” [Strategic Management Journal, Dec. 2007] explains how to get the future right: how to position today’s resources properly for tomorrow.
For example, Nokia missed the smartphone revolution because the company was not well equipped for sensing—especially compared to Apple, which was embedded in the milieu that was breeding the next generation of smartphones. Based here in the San Francisco Bay Area, Steve Jobs sensed what customers wanted, and he knew what technologists were doing. Even more importantly, he built the capabilities that Apple needed, step by step. For example, to make the iPod work, Apple developed capabilities in digital rights management and handheld device design. Jobs and his team learned how to cut deals with studios and recording companies, and how to bring together user-friendly technology in a very appealing form factor.