Dynamic capabilities, the scope of strategy, and Lean

Dynamic capabilities framework is a promising framework for strategic management. Based on and expanding upon the resource-based view of the firm, its founding paper by David J. Teece, Gary Pisano, and Amy Shuen, Dynamic Capabilities and Strategic Management (1997), has been cited in almost 20,000 articles.

In this post, I will examine the basics of the dynamic capabilities framework and point to some interesting areas for future examination regarding its significance for the adoption of a variety of operating models, such as Lean, Lean startup, and social business.

Recent academic work

David J. Teece has written actively on dynamic capabilities in recent years. If you wish to dig deeper into the subject, several of the articles are available online, such as:

Terminology

In order to be able to discuss the dynamic capabilities view effectively, it is useful to spend a few moments defining some useful terminology.

Best practices. Well-known, effective ways to arrange operations. However, best practices cannot provide long-term competitive advantage, because they are by nature practices that are brought in to companies from the outside and as such do not differ from practices of competitors.

Signature processes. Effective ways to arrange operations that have been created within the company and complement its other practices. Other companies may attempt to imitate signature processes (and thus adopt them as best practices), although such efforts may require imitating multiple aspects of a company’s operations in order to be effective. The most well-known case is imitation of the Toyota Production System, although there are conflicting reports as to whether the imitation has been successful. We’ll get back to this in a while.

Resources. Resources are factors controlled by a company. One way to categorize and think about resources is to split them into tangible (transferable) and intangible (intransferable) assets and processes.

  • Tangible people/assets: Cash, plant, patents, talent.
  • Tangible systems/processes: Contracts, alliances, IT systems.
  • Intangible people/assets: Brand, reputation, loyalty
  • Intangible systems/processes: Culture

VRIN resources. The basis of competitive advantage in the resource-based view, VRIN refers to resources that fulfill the following criteria:

  • Valuable. A resource must create value.
  • Rare. The resource must be rare. Otherwise, everyone in the industry could easily get their own such resource.
  • In-imitable. The resource cannot be perfectly copied. Otherwise, competitors could build their own resources in a short time.
  • Non-substitutable. The resource must not have substitutes. Otherwise, competitors could replace the resource with a different means to an end and remove the competitive advantage.

Complementary resources. Complementary resources are resources the value of which is greater together than the sum of their values individually.

Ordinary capabilities. Ordinary capabilities are orchestrations of the company’s resources that enable an existing product or service to be made, sold, and serviced. They constitute the technical fitness of the company.

Dynamic capabilities. Dynamic capabilities are orchestrations of the company’s resources that enable the company to (1) identify and assess opportunities (sensing), (2) mobilize resources to address opportunities and to capture value from doing so (seizing), and (3) continuously renew itself (transforming). They constitute the evolutionary fitness of the company.

Network effects. Network effects mean that the value of the product or service is different depending on its other users. The classic example is the telephone: being the only telephone owner in the world would mean that the telephone is completely worthless. In recent times, network effects have become even more important, as they are central in various fights between ecosystems, for example in social networking sites and in mobile phones.

Dynamic capabilities framework

According to the dynamic capabilities view, the long-term survival of a company depends on its ability to create dynamic capabilities, which come in three categories:

  1. Sensing: identifying and assessing opportunities.
  2. Seizing: mobilizing resources to address opportunities and to capture value from them.
  3. Transforming: continuously renewing itself.

Only by building capabilities in all categories can a company ensure its survival.

The dynamic capabilities view considers markets to be endogenous, which contrasts most previous strategic thinking. A company has to adapt to a changing environment, whether because of technology or other shifts in demand, but it can also affect the market and create new opportunities for itself.

Dynamic capabilities are especially relevant in rapidly changing environments, where inability to sense changes in the market or technology can prove fatal. This is emphasized if there are network effects present in the market, in which case late reaction can cause a permanent loss of position. For example, consider various mobile communication and computing markets for the past few years, where Apple has succeeded in making huge profits in MP3 players, mobile phones, and tablet computers. Even though Apple has come under pressure in these markets (especially from Android in mobile phones), its success there has generated abundant profits. Dynamic capabilities view considers the world to be dynamic and any economic profits available from a particular market to be temporary (Schumpeterian rents). In such a world, ordinary capabilities are not enough, because eventually any individual ordinary capability will become obsolete or commoditized.

What this means in practice: A company cannot be lead only by adjusting its strategy on annual basis, nor can it be lead solely by the vision of its top management. Instead, the top management has to create dynamic capabilities within the company that enable it to react quickly and adjust to changes easily.

Dynamic capabilities view brings issues such as research, development, and innovation strategy and organizational learning to the core of a company’s strategic planning.

Toyota Production System (Lean) and capabilities

In order to explore this concept further, let’s turn to a real-world example. The Toyota Production System includes many well-known and widely documented processes, such as Just-In-Time production (JIT), production leveling (heijunka), and mistake-proofing (poka-yoke). All of these processes were once upon a time signature processes of Toyota, and important parts of their ordinary capabilities, the way they conducted their operations.

It is nowadays a common view that these processes have been successfully copied. For example, here is a quote from Bob Lutz (Life Lessons From the Car Guy, 2011):

The operations portion of the automobile business has been thoroughly optimized over many decades, doesn’t vary much from one automobile company to another, and can be managed with a focus on repetitive process. It is the “hard” part of the car business and requires little in the way of creativity, vision or imagination. Almost all car companies do this very well, and there is little or no competitive advantage to be gained by “trying even harder” in procurement, manufacturing or wholesale.

So, Toyota’s ordinary capabilities at one point of time were copied. However, Toyota definitely does not share Lutz’s view that improvement in manufacturing is now done.

In Mike Rother’s Toyota Kata (which, by the way, is one of the best books on Lean), there is a story that goes like this: Several years ago, Toyota was happy to show its factories to competitors, who were eager to copy “best practices” for use in their own plants. One such best practice was the use of flow racks. However, a few years later, when most US plants had flow racks, the Toyota plant had got rid of theirs. They had simply evolved beyond that point.

OK, but that anecdote is a few years old by now, so surely now everything has been figured out, right? Not necessarily. A recent Bloomberg article, ‘Gods’ Make Comeback at Toyota as Humans Steal Jobs From Robots, details how Toyota has increased its efforts at improving manual skills in order to be able to then use this know-how to design and program more productive automated production lines, and how they have already reached impressive results.

This is a display of dynamic capabilities at work. Whereas manufacturing processes can be copied, it is much more difficult, if not impossible, to copy improvement and learning processes, and these processes give rise to dynamic capabilities.

The new landscape of strategy

As a practical matter, the dynamic capabilities view turns parts of company operations related to innovation, improvement, and learning into strategic decisions. The decisions on how a company will build capabilities for sensing, seizing, and transforming, are on the same level of importance and focus as decisions on current value propositions and value chains.

As food for thought, here are three examples of improvement practices that are at their core strategic when considered from a dynamic capabilities view:

  • Lean: Affects sensing, seizing, and transforming, and thus constitutes a complete package of dynamic capabilities.
  • Lean startup: Affects sensing and seizing, and can form a part of a dynamic capabilities strategy.
  • Social business: Affects sensing and transforming, and can form a part of a dynamic capabilities strategy.

This framework can thus answer the old question: Why should I be Lean? The reason to be Lean is that it is one way to build the dynamic capabilities a company needs for long-term survival. It is not the only way, so obviously there is still a choice, but at its core, adoption of Lean is a strategic decision.

Photo: Sun Earth Day 2013 by NASA @ Flickr (CC, cropped image)

Author: Ville Kilkku

I run my own consultancy business, so if you find the ideas on this blog intriguing, contact me at consulting@kilkku.com or call me at +358 50 588 5043 and we can discuss how I can help you solve your business problems. I am currently based in Tornio, Finland, but work globally. Google+