Dynamic Capabilities

Garnering competitive advantage; shielding against disruption

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David J. Teece

The US military coined the acronym VUCA (volatility, uncertainty, complexity and ambiguity) in the late 1990s. It has since migrated to the business world, becoming a useful term to describe what companies are up against in the age of disruption. Disruption happens most frequently when firms are surprised. It’s not risk that is the enemy, as risk can often be hedged. It’s the deep uncertainty created by unknown unknowns that cause firms to flounder. Unknown unknowns are the hallmarks of business environments characterized by deep uncertainty.

To gain an edge in VUCA worlds, business leaders should embrace the power of dynamic capabilities: what a business uses to innovate, to sense both latent and present shifts in the marketplace and move quickly to respond to and capitalize on them with whatever is required. The ability to do this is what separates companies that crumble and fade from those that thrive because they are able to transform, possibly launching new products, adopting new business models and shaping the market so that they disrupt the disrupters.

Before you can build dynamic capabilities, however, you have to understand what separates them from ordinary capabilities.

Ordinary capabilities underpin the production and sale of a defined set of products and services: efficient manufacturing, effective marketing, strong partnerships and capable operations. Even at “best practice” levels, these capabilities don’t allow you to differentiate from the leaders. It is important for organizations to have ordinary capabilities, although they don’t need to own them. They are “ordinary” only in the sense that they are not proprietary. Not everyone has them, but leading firms do; or if they don’t, they can set about to build them. Consultants often help in this process. Sometimes it’s just a matter of reaching out for partners. For example, in the energy sector, large offshore drilling firms rely on established networks of highly specialized contractors. That’s an efficiently outsourced ordinary capability, and firms aren’t necessarily competitively handicapped by outsourcing. If there are plenty of providers, you can play one against the other. Ordinary capabilities enable firms to get work done. They are about doing things right. 

Dynamic capabilities are about doing the right things: developing new products and services, potentially opening markets where rivals have yet to arrive. They are also about doing things at the right time, based on new product (and process) developments, co-creating and co-innovating with partners and users and developing unique managerial orchestration processes. 

Strong ordinary capabilities require good management; strong dynamic capabilities require great leadership. A change-oriented entrepreneurial organizational culture that is open to partnerships inside and outside the firm is required for dynamic capabilities to find their footing.

To sum up, it is no longer sufficient to adopt best practices and then sit on your laurels. Ordinary capabilities alone will rarely suffice to support long-term competitive advantage, and they can even distract from preparing for the future. Indeed, achieving best practices can bring a false sense of comfort in a VUCA world. Ordinary capabilities can make companies good for now; strong dynamic capabilities make them great now and good for the long run.

Before it’s too late
Dynamic capabilities need to be prioritized over ordinary capabilities. You don’t want to follow the example of Henry Ford, who perfected manufacturing efficiency with the Model T but didn’t detect a change in consumer preferences and failed to innovate. By offering more models, more powerful engines, more gears, higher speeds and more colors, and allowing customers to customize their interiors, General Motors caught and eventually surpassed Ford’s position as the top-selling automaker. Similarly, Nokia dominated worldwide cellphone sales but didn’t see a content-laden, ecosystem-enabled smartphone coming. Its sales began to plummet when Apple introduced the internet-enabled iPhone in 2007, and Nokia no longer ranks among the top five handset brands. Put differently, Apple’s entry and business model seemingly came as a surprise to Nokia, and it lost its leadership position almost overnight.

Strong dynamic capabilities protect against that kind of disruption. They drive business leaders to innovate and monitor their external environments to sense and make sense of developments and to assess the sustainability and durability of their business models. Firms with dynamic capabilities are more prepared to build, integrate and reconfigure internal and external competencies when they detect conditions that could undermine their market positions or enable them to undermine their competitors. Dynamic capabilities also govern how ordinary capabilities should be combined, how to determine which capabilities must be added or retrenched and how to align capabilities and strategy. 

In short, dynamic capabilities serve as the bridge between the present and future. Without them, an organization is almost certain to be deeply disrupted by external forces. Firms with strong ordinary capabilities and weak dynamic capabilities run faster and further to stand still. Corporate burnout is a hallmark. When firms have strong dynamic capabilities, they can shape the business environment, disrupt competitors, attend to core stakeholders, earn high profit margins and ensure long-term growth and prosperity. 

Firms with strong dynamic capabilities sense and seize opportunities before rivals do. They can grow new business lines, although they must be willing to cannibalize their traditional revenue streams. Strong dynamic capabilities can enable firms to shape the surrounding business ecosystem in their favor by influencing the development of new standards and regulations. These benefits can be complemented by incremental operational improvements that enhance efficiency and effectiveness. When radical innovation is called for, incremental action alone will not suffice. Dynamic capabilities engender and support bold but well-calibrated decisions that keep the enterprise thriving longer term.

Unique, authentic and difficult to imitate
Because dynamic capabilities are hard to develop and deploy, they are difficult for rivals to imitate. They are entrepreneurial in nature. To be effective, dynamic capabilities must be deeply baked into an organization’s culture, and they must animate the top management team. An entrepreneurial business culture favors experimentation and learning and tolerates failure. And while it should be authentic, emerging from the firm’s unique history and culture, it must also allow management to make a decisive break with the past when conditions call for it. 

Being vigilant, agile and prepared for the unknown unknowns will give a firm’s leadership the best chance to respond adroitly to challenges and opportunities that may arise in the VUCA world. To do so, business leaders should understand the difference between dynamic and ordinary capabilities and stop trying to manage uncertainty as merely risk. 


David J. Teece is the chairman and principal executive officer of BRG.


 
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