What are Dynamic Capabilities?

Concept of Dynamic Capabilities of a Firm

A dynamic capability refers to company’s ability to integrate, build and transform internal and external competencies. They can help an organization to achieve innovative forms of competitive advantage through integration, building and transformation of internal and external competencies, as to respond to changes in the environment. This management theory was defined by David Teece, Gary Pisano, and Amy Shuen in their 1997 paper Dynamic Capabilities and  Strategic Management. In the context of achieving organizational change, aligned to the external pressure: namely, these capabilities are perceived as business processes that use resources — specifically the processes of integration, restructuring, acquisition and release resources — to adapt or create market changes. Dynamic capabilities are especially helpful in explaining the sources of competitive advantage in extremely volatile markets.

Dynamic capabilities are determined by organizational and managerial processes, positions and paths. The organizational and managerial processes refer to the routines, i.e. current practices in an organization, such as coordination, integration, learning, transformation, etc. This is especially important, since most organizations engage in repetitive processes, such as production and/or service delivery, which require standardized performance of specialized tasks, in order to achieve adequate performance. Routines have developed over time and, at the moment of analyzing an organization, they represent successful solutions to common problems.

Organizational knowledge, accumulated through learning activities, results in new routines, which can, nevertheless, be shaped by future decisions and development directions. In the dynamic capability perspective, the strategic alternatives available to an organization are referred to as paths. The notion of path dependence indicates that future of an organization depends on its current position (which includes current resources, capabilities, routines, etc.) and potential development paths. Although the future behavior of an organization is shaped and limited by the current decisions and routines, there is no path that ‘must’ be followed, as to achieve a certain objective. There is a multitude of potential outcomes, which can be reached as a consequence of the same strategic decision, depending on a range of initial positions and the circumstances taking place in the environment. Once the development of a strategic situation in an organization takes place (by following a certain path), the social interactions are becoming ‘frozen’ in the form of “recurrent patterns”, representing the routines. They are collective social phenomena, which are very difficult to understand and replicate or transfer, which is in line with the fundamental Resource Based View (RBV) tenets, although its initial theoretical foundations were built upon the notion of strategic resources. Current competitive advantage can be achieved through routines, i.e. processes that are shaped by company’s positions and paths, but organizational innovation and change should be also explained in the same manner. Namely, by using the notion of an organizational process/routine, researchers are able to discuss the behavior of an organization in a profound manner, since routines encompass both internal and external drivers of change, as well as drivers leading to the stability.

Dynamic capabilities is that organizational ability to gain, integrate, transform, and release resources, in order to adapt or to create market changes. This, once again, emphasizes the role of dynamic capabilities in activating/coordinating strategic resources as ‘lower level’ constructs within the RBV theory of strategic management. In this framework, dynamic capabilities are believed to consist of specific strategic and organizational processes (new product development, creating strategic alliances, strategic decisions …), which can create value for an organization and that dynamic have greater equifinality, homogeneity and interchangeability than the traditional resource-based theory assumes. Equifinality means that similar competence can be reached in different ways and using different resources. Also, they state that the effective forms of dynamic abilities change depending on the degree of market volatility, i.e. when markets are moderately dynamic, dynamic capabilities resemble the traditional concept of routine, and when the markets are highly volatile, dynamic capabilities are simple, experimental, unstable processes that rely on new knowledge formed in the short term. Based on all previously said, it can be concluded that dynamic capabilities are necessary, but not a sufficient contrition for competitive advantage achievement.

In a relatively stable environment, dynamic capabilities are most likely to be unnecessary, while in the condition of rapid market changes, dynamic capabilities are necessary. If changes are not only fast, but also unpredictable, dynamic capabilities should be continually upgraded. They emphasize the structure and stability of dynamic capabilities, and state that dynamic capabilities do not include adjusting to the environment in a creative but unstructured way. Existence of dynamic capabilities is not necessary prerequisite for change adaptation, because the company can also react to changes ad-hoc.

The value and performance of operative and dynamic capabilities can be assessed through their ”technical” and ”evolutional” appropriateness. Technical appropriates measures how well capability performs its basic functions, while ”evolutionary” appropriateness measures the extent in which capability can assure the survival of the company. Operative capabilities have strong ”technical” appropriateness, while dynamic capabilities have a strong ”evolutionary” dimension which is entrepreneurial.

Elements of Dynamic Capabilities

Dynamic capabilities refer to the company’s orientation toward constant reshaping, renewing and re-creating resources and capabilities, and the improvement and reconstruction of key competencies in response to market changes in a constant effort to maintain a competitive advantage. The major components of dynamic capabilities are adaptive, absorptive and innovative capability. They support company’s ability to integrate, transform, renew and rebuild their competences and resources, and are common to all companies.

1. Adaptive capability

The role of the adaptive capability is to identify and exploit new market opportunities. It manifests through inherent resource possession and flexibility in the use of resources, i.e. strategic flexibility. Adaptive capability includes company’s ability to analyze the market, customers and competitors, allocate resources, and respond to changing market conditions. Sensing capability, which refers to the ability of understanding customer needs and market dynamics better than its competitors, could also be considered as a part of adaptive capabilities.

2. Absorptive Capability

Absorptive capability enables company to recognize the value of new, external information, absorb it and use it. It includes knowledge acquisition, knowledge assimilation, knowledge transformation, and knowledge exploitation. It is capability based on knowledge that supports the functioning of operational and dynamic capabilities. Absorptive capability is necessary for firm’s success. Absorptive capability depends upon company’s interface with external environment, and transfers of knowledge within organizational units. Absorptive capability has role in allocation resources for innovative capability.

3. Innovative Capability

Innovative capability refers to new products and markets development, and it manifests through development of new products and services, development of new production methods, risk-taking by key executives, market innovation, and firm’s innovative strategic orientation. Innovation capability is ability to continuously transform knowledge and ideas into new products, processes and systems for the benefit of the firm and its stakeholders. Innovative capability consists of new product development capability and new process development capability. The role of new product development capability includes new products and services development, quality of new products and services and the variety of new products and services in relation to company’s largest competitors, while new process development capability includes performance of innovation process and adaptation of new technology to existing processes. Innovative capabilities are very important for company’s evolution and survival, especially with respect to dynamic environment and constant change.

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