Dynamic Capabilities and Strategic Management Author(s): David J. Teece, Gary Pisano, Amy Shuen Source: Strategic Management Journal, Vol. 18, No. 7 (Aug., 1997), pp. 509-533 Published by: John Wiley & Sons Stable URL: http://www.jstor.org/stable/3088148 Accessed: 19/07/2010 14:20 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=jwiley. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. John Wiley & Sons is collaborating with JSTOR to digitize, preserve and extend access to Strategic Management Journal. http://www.jstor.org

Strategic Management Journal, Vol. 18:7, 509-533 (1997) DYNAMIC CAPABILITIES AND STRATEGIC MANAGEMENT DAVID J. TEECE1*, GARY PISANO2 and AMY SHUEN3 1Haas School of Business, University of California, Berkeley, California, U.S.A. 2Graduate School of Business Administration, Harvard University, Boston, Massa- chusetts, U.S.A. 3School of Business, San Jose State University, San Jose, California, U.S.A. The dynamic capabilities framework analyzes the sources and methods of wealth creation and capture by private enterprise firms operating in environments of rapid technological change. The competitive advantage of firms is seen as resting on distinctive processes (ways of coordinating and combining), shaped by the firm's (specific) asset positions (such as the firm's portfolio of difficult-to-trade knowledge assets and complementary assets), and the evolution path(s) it has adopted or inherited. The importance of path dependencies is amplified where conditions of increasing returns exist. Whether and how a firm's competitive advantage is eroded depends on the stability of market demand, and the ease of replicability (expanding internally) and imitatability (replication by competitors). If correct, the framework suggests that private wealth creation in regimes of rapid technological change depends in large measure on honing internal technological, organizational, and managerial processes inside the firm. In short, identifying new opportunities and organizing effectively and efficiently to embrace them are generally more fundamental to private wealth creation than is strategizing, if by strategizing one means engaging in business conduct that keeps competitors off balance, raises rival's costs, and excludes new entrants. ? 1997 by John Wiley & Sons, Ltd. INTRODUCTION The fundamental question in the field of strategic management is how firms achieve and sustain competitive advantage.1 We confront this question here by developing the dynamic capabilities approach, which endeavors to analyze the sources of wealth creation and capture by firms. The development of this framework flows from a recognition by the authors that strategic theory is replete with analyses of firm-level strategies for sustaining and safeguarding extant competitive advantage, but has performed less well with Key words: competences capabilities innovation strategy path dependency knowledge assets *Correspondence to: David J. Teece, Institute of Management, Innovation and Organization, Haas School of Business, Uni- versity of California, Berkeley, CA 94720-1930, U.S.A. ' For a review of the fundamental questions in the field of strategy, see Rumelt, Schendel, and Teece (1994). CCC 0143-2095/97/070509-25$ 17.50 ? 1997 by John Wiley & Sons, Ltd. respect to assisting in the understanding of how and why certain firms build competitive advan- tage in regimes of rapid change. Our approach is especially relevant in a Schumpeterian world of innovation-based competition, price/performance rivalry, increasing returns, and the 'creative destruction' of existing competences. The approach endeavors to explain firm-level success and failure. We are interested in both building a better theory of firm performance, as well as informing managerial practice. In order to position our analysis in a manner that displays similarities and differences with existing approaches, we begin by briefly reviewing accepted frameworks for strategic man- agement. We endeavor to expose implicit assump- tions, and identify competitive circumstances where each paradigm might display some relative advantage as both a useful descriptive and norma- tive theory of competitive strategy. While numer- ous theories have been advanced over the past Received 17 April 1991 Final revision received 4 March 1997

510 D. J. Teece, G. Pisano and A. Shuen two decades about the sources of competitive advantage, many cluster around just a few loosely structured frameworks or paradigms. In this paper we attempt to identify three existing paradigms and describe aspects of an emerging new para- digm that we label dynamic capabilities. The dominant paradigm in the field during the 1980s was the competitive forces approach developed by Porter (1980). This approach, rooted in the structure-conduct-performance paradigm of industrial organization (Mason, 1949 Bain, 1959), emphasizes the actions a firm can take to create defensible positions against com- petitive forces. A second approach, referred to as a strategic conflict approach (e.g., Shapiro, 1989), is closely related to the first in its focus on product market imperfections, entry deterrence, and strategic interaction. The strategic conflict approach uses the tools of game theory and thus implicitly views competitive outcomes as a func- tion of the effectiveness with which firms keep their rivals off balance through strategic invest- ments, pricing strategies, signaling, and the con- trol of information. Both the competitive forces and the strategic conflict approaches appear to share the view that rents flow from privileged product market positions. Another distinct class of approaches empha- sizes building competitive advantage through cap- turing entrepreneurial rents stemming from funda- mental firm-level efficiency advantages. These approaches have their roots in a much older discussion of corporate strengths and weaknesses they have taken on new life as evidence suggests that firms build enduring advantages only through efficiency and effectiveness, and as developments in organizational economics and the study of technological and organizational change become applied to strategy questions. One strand of this literature, often referred to as the 'resource-based perspective,' emphasizes firm-specific capabilities and assets and the existence of isolating mech- anisms as the fundamental determinants of firm performance (Penrose, 1959 Rumelt, 1984 Teece, 1984 Wernerfelt, 1984).2 This perspective 2 Of these authors, Rumelt may have been the first to self- consciously apply a resource perspective to the field of strat- egy. Rumelt (1984: 561) notes that the strategic firm 'is characterized by a bundle of linked and idiosyncratic resources and resource conversion activities.' Similarly, Teece (1984: 95) notes: 'Successful firms possess one or more forms of intangible assets, such as technological or managerial know- recognizes but does not attempt to explain the nature of the isolating mechanisms that enable entrepreneurial rents and competitive advantage to be sustained. Another component of the efficiency-based approach is developed in this paper. Rudimentary efforts are made to identify the dimensions of firm-specific capabilities that can be sources of advantage, and to explain how combinations of competences and resources can be developed, deployed, and protected. We refer to this as the 'dynamic capabilities' approach in order to stress exploiting existing internal and external firm- specific competences to address changing environments. Elements of the approach can be found in Schumpeter (1942), Penrose (1959), Nelson and Winter (1982), Prahalad and Hamel (1990), Teece (1976, 1986a, 1986b, 1988) and in Hayes, Wheelwright, and Clark (1988): Because this approach emphasizes the develop- ment of management capabilities, and difficult- to-imitate combinations of organizational, func- tional and technological skills, it integrates and draws upon research in such areas as the manage- ment of R&D, product and process development, technology transfer, intellectual property, manu- facturing, human resources, and organizational learning. Because these fields are often viewed as outside the traditional boundaries of strategy, much of this research has not been incorporated into existing economic approaches to strategy issues. As a result, dynamic capabilities can be seen as an emerging and potentially integrative approach to understanding the newer sources of competitive advantage. We suggest that the dynamic capabilities approach is promising both in terms of future research potential and as an aid to management endeavoring to gain competitive advantage in increasingly demanding environments. To illus- trate the essential elements of the dynamic capa- bilities approach, the sections that follow compare and contrast this approach to other models of strategy. Each section highlights the strategic how. Over time, these assets may expand beyond the point of profitable reinvestment in a firm's traditional market. Accordingly, the firm may consider deploying its intangible assets in different product or geographical markets, where the expected returns are higher, if efficient transfer modes exist.' Wererfelt (1984) was early to recognize that this approach was at odds with product market approaches and might consti- tute a distinct paradigm of strategy.

Dynamic Capabilities 511 insights provided by each approach as well as the different competitive circumstances in which it might be most appropriate. Needless to say, these approaches are in many ways complemen- tary and a full understanding of firm-level, com- petitive advantage requires an appreciation of all four approaches and more. MODELS OF STRATEGY EMPHASIZING THE EXPLOITATION OF MARKET POWER Competitive forces The dominant paradigm in strategy at least during the 1980s was the competitive forces approach. Pioneered by Porter (1980), the competitive forces approach views the essence of competitive strategy formulation as 'relating a company to its environment ... [T]he key aspect of the firm's environment is the industry or industries in which it competes.' Industry structure strongly influ- ences the competitive rules of the game as well as the strategies potentially available to firms. In the competitive forces model, five industry- level forces-entry barriers, threat of substitution, bargaining power of buyers, bargaining power of suppliers, and rivalry among industry incumbents-determine the inherent profit poten- tial of an industry or subsegment of an industry. The approach can be used to help the firm find a position in an industry from which it can best defend itself against competitive forces or influence them in its favor (Porter, 1980: 4). This 'five-forces' framework provides a sys- tematic way of thinking about how competitive forces work at the industry level and how these forces determine the profitability of different industries and industry segments. The competitive forces framework also contains a number of underlying assumptions about the sources of com- petition and the nature of the strategy process. To facilitate comparisons with other approaches, we highlight several distinctive characteristics of the framework. Economic rents in the competitive forces framework are monopoly rents (Teece, 1984). Firms in an industry earn rents when they are somehow able to impede the competitive forces (in either factor markets or product markets) which tend to drive economic returns to zero. Available strategies are described in Porter (1980). Competitive strategies are often aimed at altering the firm's position in the industry vis-a- vis competitors and suppliers. Industry structure plays a central role in determining and limiting strategic action. Some industries or subsectors of industries become more 'attractive' because they have struc- tural impediments to competitive forces (e.g., entry barriers) that allow firms better oppor- tunities for creating sustainable competitive advantages. Rents are created largely at the indus- try or subsector level rather than at the firm level. While there is some recognition given to firm- specific assets, differences among firms relate primarily to scale. This approach to strategy reflects its incubation inside the field of industrial organization and in particular the industrial struc- ture school of Mason and Bain3 (Teece, 1984). Strategic conflict The publication of Carl Shapiro's 1989 article, confidently titled 'The Theory of Business Strategy,' announced the emergence of a new approach to business strategy, if not strategic management. This approach utilizes the tools of game theory to analyze the nature of competitive interaction between rival firms. The main thrust of work in this tradition is to reveal how a firm can influence the behavior and actions of rival firms and thus the market environment.4 Examples of such moves are investment in capacity (Dixit, 1980), R&D (Gilbert and New- berry, 1982), and advertising (Schmalensee, 1983). To be effective, these strategic moves require irreversible commitments.5 The moves in question will have no effect if they can be costlessly undone. A key idea is that by manipu- lating the market environment, a firm may be able to increase its profits. 3 In competitive environments characterized by sustainable and stable mobility and structural barriers, these forces may become the determinants of industry-level profitability. How- ever, competitive advantage is more complex to ascertain in environments of rapid technological change where specific assets owned by heterogeneous firms can be expected to play a larger role in explaining rents. 4 The market environment is all factors that influence market outcomes (prices, quantities, profits) including the beliefs of customers and of rivals, the number of potential technologies employed, and the costs or speed with which a rival can enter the industry. 5For an excellent discussion of committed competition in multiple contexts, see Ghemawat (1991).

512 D. J. Teece, G. Pisano and A. Shuen This literature, together with the contestability literature (Baumol, Panzar, and Willig, 1982), has led to a greater appreciation of the role of sunk costs, as opposed to fixed costs, in determining competitive outcomes. Strategic moves can also be designed to influence rivals' behavior through signaling. Strategic signaling has been examined in a number of contexts, including predatory pricing (Kreps and Wilson, 1982a, 1982b) and limit pricing (Milgrom and Roberts, 1982a, 1982b). More recent treatments have emphasized the role of commitment and reputation (e.g., Ghemawat, 1991) and the benefits of firms simul- taneously pursuing competition and cooperation6 (Brandenburger and Nalebuff, 1995, 1996). In many instances, game theory formalizes long-standing intuitive arguments about various types of business behavior (e.g., predatory pric- ing, patent races), though in some instances it has induced a substantial change in the conventional wisdom. But by rationalizing observed behavior by reference to suitably designed games, in explaining everything these models also explain nothing, as they do not generate testable predic- tions (Sutton, 1992). Many specific game- theoretic models admit multiple equilibrium, and a wide range of choice exists as to the design of the appropriate game form to be used. Unfortu- nately, the results often depend on the precise specification chosen. The equilibrium in models of strategic behavior crucially depends on what one rival believes another rival will do in a particular situation. Thus the qualitative features of the results may depend on the way price competition is modeled (e.g., Bertrand or Courot) or on the presence or absence of stra- tegic asymmetries such as first-mover advantages. The analysis of strategic moves using game theory can be thought of as 'dynamic' in the sense that multiperiod analyses can be pursued both intuitively and formally. However, we use the term 'dynamic' in this paper in a different sense, referring to situations where there is rapid change in technology and market forces, and 'feedback' effects on firms.7 We have a particular view of the contexts in 6 Competition and cooperation have also been analyzed ouside of this tradition. See, for example, Teece (1992) and Link, Teece and Finan (1996). 7 Accordingly, both approaches are dynamic, but in very different senses. which the strategic conflict literature is relevant to strategic management. Firms that have a tremendous cost or other competitive advantage vis-a-vis their rivals ought not be transfixed by the moves and countermoves of their rivals. Their competitive fortunes will swing more on total demand conditions, not on how competitors deploy and redeploy their competitive assets. Put differently, when there are gross asymmetries in competitive advantage between firms, the results of game-theoretic analysis are likely to be obvious and uninteresting. The stronger competitor will generally advance, even if disadvantaged by cer- tain information asymmetries. To be sure, incum- bent firms can be undone by new entrants with a dramatic cost advantage, but no 'gaming' will overturn that outcome. On the other hand, if firms' competitive positions are more delicately balanced, as with Coke and Pepsi, and United Airlines and American Airlines, then strategic conflict is of interest to competitive outcomes. Needless to say, there are many such circum- stances, but they are rare in industries where there is rapid technological change and fast-shift- ing market circumstances. In short, where competitors do not have deep- seated competitive advantages, the moves and countermoves of competitors can often be use- fully formulated in game-theoretic terms. How- ever, we doubt that game theory can comprehen- sively illuminate how Chrysler should compete against Toyota and Honda, or how United Air- lines can best respond to Southwest Airlines since Southwest's advantage is built on organizational attributes which United cannot readily replicate.8 Indeed, the entrepreneurial side of strategy-how significant new rent streams are created and protected-is largely ignored by the game- theoretic approach.9 Accordingly, we find that the approach, while important, is most relevant 8 Thus even in the air transport industry game-theoretic formu- lations by no means capture all the relevant dimensions of competitive rivalry. United Airlines' and United Express's difficulties in competing with Southwest Airlines because of United's inability to fully replicate Southwest's operation capabilities is documented in Gittel (1995). 9 Important exceptions can be found in Brandenburger and Nalebuff (1996) such as their emphasis on the role of com- plements. However, these insights do not flow uniquely from game theory and can be found in the organizational economics literature (e.g., Teece, 1986a, 1986b de Figueiredo and Teece, 1996).