These views were standard ways to represent how the capabilities in some segment of the Defence Enterprise such as the Army, Navy or Air Force were expected to or planned to evolve over time, given investments by MOD and the UK Government. In MODAF "Capability" refers to a military capability — an ability to produce military effects — or enabling or supporting capabilities. Nevertheless, the central thesis that politico-military conflicts or business competitions in markets are contests in which the organisation or enterprise with the superior capabilities wins holds.
On this basis the same capability-based strategy and planning techniques are thought to be effective in both spheres. The aim of "Through-Life Capability Management" TLCM was to promote in defence procurement a shift of perspective away from a focus on military equipment towards what was really required from UK Defence organizations: the capabilities, or abilities to produce effects in the world that enhance UK national security.
The MOD considers that such capabilities are delivered by trans-organisation networks of operational units across the Defence Enterprise — and hence uses the terminology " Network Enabled Capability " NEC. This is a part of MOD's interpretation of the concept of Network Centric Warfare which itself was a s interpretation of a System-Of-Systems approach or perspective in the context of Defence. The earlier cultural focus on equipment had led to over-specification, incoherent equipment purchases, unnecessary duplication, an over-emphasis on initial purchase costs, insufficient consideration of recurrent support and maintenance costs, project and programme delays and significant cost overruns that the UK Government could no longer tolerate.
TLCM promoted a capability lifecycle perspective, that sought a balanced investment profile in time that would minimise whole-life costs, while efficiently producing effective, coherent and maximally cost-effective Defence capabilities over the medium term — and thereby ensuring maximum Value-for-Money for the UK taxpayer from Defence.
Capability Management has in recent years become a popular sub-discipline or method of Enterprise Architecture. Enterprise Architecture seeks to build a rigorous model of an enterprise that identifies its component parts and their relationships for the purpose of planning the evolution of the enterprise.
A Capability Management perspective — such as Leonard's model or Teece's Dynamic Capabilities Theory — suggests that a firm is best viewed as a collection of capabilities that have a composition from and configuration of the tangible and intangible assets of the firm. In this view the firm and its portfolio of capabilities evolve in response to the perceived demands of the business environment. An enterprise may comprise one or more firms, or parts of firms or other types of organization and their interrelationships — and so is describable may be modelled in the same terms.
In the IBM Enterprise Architecture Method, the "Enterprise Capabilities Neighborhood" — a segment of the overall Enterprise Architecture description or model — "captures the strategic intent of the enterprise". It "provides the bridge from the organization's strategy to the architectural building blocks that enable and realize the strategy. Collins and De Meo go on to assert that "To focus the EA description on delivering the right plan for the enterprise, it must be based on a detailed understanding of the Enterprise Capabilities the enterprise has decided it needs The IBM EA Method defines the "Strategic Capability Network" which "depicts the strategic capabilities and associated enablers of a business, their interrelationships and their combined roles and significance in A process is how the capability is executed.
Much of the reengineering revolution or Business process reengineering focused on how to redesign business processes. An organization capability refers to the potential of the people in an organization and their cooperation to get things done. Dave Ulrich makes a distinction between capabilities and competencies : individuals have competencies while organizations have capabilities. Both competencies and capabilities have technical and social elements.
At the individual-technical intersection, employees in the firm bring functional skills and competencies such as programming, cost accounting, electrical engineering, etc. At the individual-social intersection, leaders also have a set of competencies or skills such as setting the strategic agenda and building relationships. Moving to the intersection of organizational and technical, are business capabilities. In short, they are the technical things or what the firm must know how to do to execute strategy.
For example, a financial service firm must know how to manage risk and design innovative products. Finally, we have organization capabilities such a talent management, collaboration, and accountability. They integrate all the other parts of the firm and bring it together. When leaders have mastered certain competencies, organization capabilities become visible.
For example, when a leaders master "turning vision in to action" and "aligning the organization," the organization a whole shows more accountability. Capability management's earlier ancestors include the value chain , also known as value chain analysis, first described and popularized by Michael Porter.
Lee Perry, Randall Stott and Norm Smallwood  added to the capabilities body of work the concepts of strategic options based on customer value proposition and business focus  and types of work which characterized work as either:. Building on earlier themes, the concept of dynamic capabilities was introduced in The basic assumption of the dynamic capabilities framework is that in fast changing markets, firms need to respond quickly and innovatively.
Building on the types of work ideas, the authors added performance target setting based on the capability value contribution.
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When compared to actual performance, the method outlined an approach to identify capability gaps and priorities. They also laid out a framework to continually align capabilities based on strategy shifts and external changes through the project agenda. This framework extended the existing DoDAF specification by adding views for capability planning. These views were standard ways to represent how the enterprise was expected to perform over time, expressed in terms of capabilities.
Other important contributions include the concept of value maps for detailing the customer proposition and more recently the profit proposition to identify capabilities that will help create Blue Ocean Strategy. Value maps extend the work of real-time strategy and the capable company by depicting a strategy canvas and providing an action framework to capture markets.
In the mids, a team at Microsoft, in concert with Accelare, developed the motion methodology — a capability-based framework. A complete picture of the capabilities is the enterprise capability model. Capabilities are described in levels of abstraction; usually three levels of details:. At the higher level, are the attributes of ownership, location, and project road maps.
The lower level is where the action is and where performance targets are set, performance assessed and gaps noted. It is at this level sourcing decisions are made or projects established to close gaps. The framework includes strategic, core and enabling capabilities. Companies like Harvard Pilgrim Health Care  and Intercontinental Hotels Group  have used capabilities to focus on where to take out costs and outsource non strategic capabilities while improving service and adding brands. Microsoft is using capability models to enter into conversations with clients to identify capability and process pain points to better align IT solutions to the business.
Capabilities are also being used in new growth platform development. Building of the earlier type of work logic, Accelare added a distinction in assessment of the capabilities necessary to operative the business by examining the financial impact as well as the customer impact. Some capabilities directly contribute to the customer value proposition and have a high impact on company financials. These "advantage capabilities" are shown in the upper right. Value contribution is assured when performance is among the best in peer organizations at acceptable cost.
Keep them inside and protect the intellectual property. Moving to the top left quadrant, strategic support capabilities have high contribution in direct support of advantage capabilities. Keep them close. Value contribution is assured when performed above industry parity at competitive cost. Other capabilities shown in the bottom right are essential.
They may not be visible to the customer but contribute to company's business focus and have a big impact on the bottom line. Focus on efficiency improvement; especially in high volume work. Value contribution is assured when performed at industry parity performance below competitors' cost. Other capabilities are "business necessity". Value contribution is assured when performed at industry parity performance below competitors' costs. They can be candidates for alternate sourcing.
A capability gap assessment can be portrayed in a heat map. Capability value contribution helps stack rank investments, for example advantage capabilities with high heat move to the top of the agenda, followed by business essential capabilities with large inefficiencies. From Wikipedia, the free encyclopedia.
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This section is empty. You can help by adding to it. March The Theory of the Growth of the Firm. New York, John Wiley and Sons. Wellsprings of Knowledge. This class of papers can be thought of as representing the transaction-cost-based, comparative-governance-based, or exchange-based theory of internalization. They argued that MNEs minimized transaction costs resulting from the public goods aspects of some intermediate, mostly intangible, assets via global coordination and the managerial control of these assets.
This prong of the internalization school examined the relative advantages associated with different entry modes e. Rugman also highlighted the role of MNEs in overcoming market imperfections in international markets. The second and relatively neglected prong to internalization does not see its essence as resulting from transaction costs saved because hold-up risks are abated. Rather, it emphasizes the common organizational culture of an integrated enterprise and the ease of coordination inside the firm, as compared with coordination through the market.
Besides easing potential contractual problems, integration opens pathways to learning, and to sharing know-how and expertise through cross-border technology and know-how transfer within the MNE. In this view, the MNE also provides for easy interchange of personnel across borders, and for better appropriability and trade secrecy. It thus mitigates intellectual property concerns, too, since technology transfer is to wholly owned business units and not to third parties, purportedly yielding greater control.
In this second prong of the theory, facilitating opportunity identification, personnel exchanges, learning, integration, and assisting in technology transfer are likely to be very important, and cannot all be squeezed under the rubric of economizing on transaction costs. The essence of the MNE in this prong of the literature is less about saving on transaction costs and more about being entrepreneurial and effective in the development, transfer, and orchestration of differentiated organizational and technological capabilities Teece, a.
This second prong has evolved into a knowledge-based approach to the MNE. Somewhat in the spirit of Teece , a , a , Kogut and Zander saw the MNE as an instrument for generating and harboring tacit and explicit knowledge, and for transferring technology and industrial know-how across borders. In these formulations, the expansion of enterprise boundaries required and facilitated the transfer of knowledge. Internal knowledge transactions are preferred, not primarily for transaction cost reasons, but because of the lower resource costs of transmitting knowledge internally vs across a market Tallman, ; Teece, , a.
Both prongs of internalization provide important and relevant insights into the MNE. Cantwell was early to recognize the need to combine contractual frameworks with a theory of capability development. Notwithstanding his early contributions, international business scholarship has left capabilities considerations underdeveloped, to its considerable detriment e. Because of the shortcomings of the first prong set out in the next section, the time is now ripe for the second prong i. In this section, I first highlight some shortcomings of the quasi-neoclassical transaction-cost-comparative governance perspective, and then provide hints as to how these can be remedied.
Early contributions to internalization, such as Hymer , Buckley and Casson , and, to some extent, Williamson , drew to varying degrees on neoclassical marginal analysis and ignored or underplayed the importance of dynamics and, in particular, learning and capability augmentation. Even when the framework was broadened to include additional phenomena, capabilities and learning were neglected. For instance, in explaining the boundaries of the MNE, John Dunning suggested that ownership and location matter along with internalization factors his OLI model.
Buckley and Casson seemed to accept these elements, too. In subsequent work, moreover, Buckley and Casson have endeavored to address dynamics, innovation, flexibility, real options, international entrepreneurship, joint ventures and cultural issues. They have not, however, embraced issues of capabilities in a robust manner. Buckley forthcoming summarizes this impressive work and explains why behavioral and sociological views are hard to integrate with internalization, as they do not follow the rational choice axioms.
While the challenge is considerable, the goal theoretical integration is attainable. Earlier work by Teece shows that transaction-cost-type and capabilities-type theories can coexist. Furthermore, one possible interpretation of the ownership factor in Dunning is that it is a proxy for capabilities albeit a static one, particularly in early iterations of the OLI model.
While capabilities are obviously built in large part through learning, the O factor in Dunning has little to say about that Pitelis, Although this recent scholarship has been helpful in enhancing our understanding of the dynamics of the internalization process of firms, large gaps nevertheless exist. The theory of technological accumulation discussed in Cantwell remains an important mechanism by which firms build technological capabilities.
Organizational Capabilities Explained
Market creation and co-creation are both entrepreneurial and dynamic concepts that have always been seminal functions of the MNE. However, market creation and co-creation have been largely ignored in the first transaction cost prong of the internalization literature. These activities are very different from market-entry mode selection decisions, upon which MNE theory has in recent decades put so much emphasis e. However, it has long been recognized that the market failure assumption is merely an analytic convenience.
Markets only fail relative to a hypothetical perfect market, which rarely exists. Infatuation with market failure and the functions or lack thereof of markets has deflected attention away from more important issues around the very existence of markets. Market creation and co-creation functions are not merely a response to a market that has somehow failed to perform relative to an idealistic standard.
Put differently, even if markets do exist, they may be very thin or otherwise imperfect. This is particularly true for more specialized, idiosyncratic, and uncertain demand-and-supply requirements and opportunities. A market creation and co-creation view of the MNE is obviously rather different from contractual approaches. It follows from the above that the rationale for the MNE is not just to achieve efficiencies relative to some external benchmark from internal transfers of technology and intermediate products, but also to create and manage co-specialization and, if need be, to create new markets and expand old ones.
Indeed, it is recognized elsewhere in this paper that a prime reason why MNEs exist is that their cross-border presence, entrepreneurial capacities, and organizational capabilities are integral to the market creation and co-creation process, both upstream and downstream, and also laterally.
However, market-making in his theory is rather neoclassical, overly focused on individual action, and not linked very well to the MNE. The reality that needs to be reflected in the theory is that entrepreneurial MNEs can help build the new ecosystems within which global firms operate. MNEs facilitate investment in complements and other infrastructure needed for new products to be launched successfully. By investing in complements, MNEs can enhance the vitality of particular business ecosystems.
Ecosystems are thus partly endogenous, as they are often co-created by global companies. In this paper, the concept of ecosystems not the industry is advanced as the appropriate domain for competitive analysis. The Coasian view of the firm has resources allocated and decisions made by a manager who internalizes transactions until an indifference point is reached where the marginal cost of internalization is equal to the marginal cost of relying on the market.
These perspectives employ neoclassical tools both marginal analysis and equilibrium concepts to explain management behavior and the nature of the enterprise. Moreover, factors of production and technology are given, and prices are implicitly known. The economic problem or business model choice becomes one of whether to engage in market exchange or in vertical integration.
In a cross-border context, the latter implies FDI. Williamson , extended Coase by deepening the contractual underpinnings of the transaction cost framework. In so doing, he created a predictive model of firm boundaries by featuring the role of asset specificity.
Contracts are therefore necessarily incomplete. This in turn leads to recontracting hazards. These are mitigated, if not eliminated, by internalization. Location issues are not addressed, except indirectly i. Nor did they feature learning or leadership. Opportunity, on the other hand, is almost completely neglected. Organizational change is also missing. Internalization overcomes these problems primarily by changing governance structures.
Entrepreneurial and managerial functions such as opportunity discovery, learning, and knowledge creation play almost no role in their analyses. Neither entrepreneurship nor leadership is needed or featured. In reality, however, entrepreneurs and entrepreneurial managers working in an organizational context discover and create new knowledge and help commercialize new technologies at home and abroad. They learn about new opportunities, and sometimes help create them and transfer technologies as needed.
To be effective, such firms often need to be global in scope. In isolation, and putting financial constraints to one side, this view of the MNE tends to see the wholly owned subsidiaries as the preferred organizational form, because protecting specific assets from recontracting hazards is the main purpose of the MNE. This is well recognized by international business scholars; but the internalization theory of the MNE struggles to find an elegant way to take this into account.
If asset ownership is neither necessary nor sufficient for incentive alignment, as Helper and Sako suggest, then internalization theory must somehow be modified if it is to capture the essence of the MNE. Certainly, evidence that MNEs choose to internalize in order to guard against recontracting hazards is weak at best. The business historian Alfred Chandler was one of the first to identify the structural virtues of a fully integrated firm that was global in scope.
In his paradigm, vertical integration was necessary to achieve coordination Chandler, However, cross-border communication technology has improved dramatically in recent decades, and capabilities are more globally dispersed than ever. As a result, coordination in the supply chain seems to be less dependent on internalization than it once was.
The implications for internalization theories are considerable. Consider Apple, which is known for the ingenuity of its designs, yet it owns none of its own manufacturing. It has tight supply relations with many companies — some pure contractors e. Apple helps provide financing to some of its suppliers, and may obtain exclusive purchase arrangements from them for short periods e.
Contractual arrangements appear to suffice for Apple to achieve the necessary coordination, while retaining the flexibility needed to respond to market forces. The global virtual factory concept appears to be the structure selected by Buckley to accommodate notions of dynamic capabilities.
Developing global leaders
While different governance forms are seen as suitable for certain transaction types, the framework is silent as to how competitive advantage is built and preserved for particular firms. It is true that the invention of new and superior governance modes can be a source of temporary competitive advantage, but, as a general matter, there is no easy way to protect innovations in governance from rapid imitation.
Hence, governance advantages will erode, sometimes rather quickly. Moreover, thanks to the very development of transaction cost economics and its wide dissemination, knowledge of the tools of good governance is available in the public domain. Adoption of good governance protocols may of course be impaired by factors inside the enterprise. If so, new governance modes may serve to create differentiation. But transaction cost analysis does not contribute significant insights into when and where this is the case.
Accordingly, it is of limited relevance to scholars and practitioners seeking an understanding of competitive advantage. Neglect of firm-level heterogeneity and the particulars of competitive advantage is perhaps the primary reason for the schism between the fields of international business and international strategic management. The former largely ignores it; the latter embraces it. Until this chasm is bridged, international business scholars will have little to say to managers, and international management scholars will have little to contribute to public policy or the understanding of national competitiveness.
Internalization theories have yielded important insights into the MNE. This is true with respect to both prongs of the approach. However, as the international business field has matured, and as the theory of the firm in economics has evolved, relatively neglected capabilities-related factors now seem more salient. My early efforts to understand international technology transfer, which were made under the internalization rubric e. However, in these early treatments, capabilities considerations were soon swamped by contractual concerns Teece, , a.
This needs to be readdressed in my own work, as well as in the literature at large. A capability is the capacity to utilize resources to perform a task or an activity, against the opposition of circumstance. Essentially, capabilities flow from the astute bundling or orchestration of resources. The dynamic capabilities framework is an entrepreneurial approach that emphasizes the importance of signature business processes, both inside the firm and also in linking the firm to external partners.
It also recognizes the importance of critical resources and good strategy. It is not animated primarily by transaction cost or contractual concerns. Rather, it builds on the resource-based approach. It is focused more on opportunity than on opportunism, and on the efficient and effective transfer of technology between and among the various organizational units of the firm. A firm with excess factor services i. While this research focused on product diversification, it was also applicable to international diversification.
What has been missing is systematic attention to how entrepreneurial management can deploy or redeploy the nontradable assets and resources at its disposal. In this regard, she was perhaps describing a dynamic capability, at least in the sense referred to here. Rather it was Wernerfelt and Barney , who articulated the relationships among firm resources and competitive advantage. They focused on the possession of the right resources as the main mechanism for the generation of economic rent. The resources to worry about were defined by Barney as those meeting his criteria of valuable, rare, inimitable, and non-substitutable VRIN.
Implicitly, Barney was inviting strategists to focus on intellectual capital Teece, , since this is the class of assets that most frequently meets the VRIN criteria. As already noted, Teece , a and Cantwell early on had threads of a resource and capabilities approach under development. This initially manifested itself as a knowledge-based approach to the MNE with Teece a , b and Kogut and Zander , It is now time to carry these efforts forward on a comprehensive basis into a dynamic capabilities-based entrepreneurial theory of the MNE.
A robust theory of the MNE that explains its scope, its boundaries, and the role of subsidiaries, while also providing insights into the competitive advantage of particular MNEs, requires that the entrepreneurship, resources, and capabilities concepts be somehow amalgamated. The dynamic capabilities approach, advanced in the field of strategic management and applied below in the context of the MNE, endeavors to do so, and is the subject matter of most of the remainder of the paper. The goal is to help shape a more robust theory of the MNE that highlights how firm-level sustainable durable competitive advantage is both built and maintained.
Understanding sustainable competitive advantage and not just the boundaries of the firm is a broader mandate for a theory of the MNE than what internalization scholars typically accept. Coming up with a better theory of the MNE that does double duty i. The world is, and is likely to remain, only semiglobalized Ghemawat, It is this world of firm-level heterogeneity and semiglobalization — and not the hypothetical worlds of perfect competition or oligopoly — that animates the inquiry here.
He also argued that ownership advantages are endogenous and developed through innovation and strategy, and showed how MNEs extend their capabilities and their overall innovation potential using global networks. The capabilities perspective can also be seen as consistent with other international business literature, including recent thinking on knowledge management in a networked MNE e. Sometimes the only way to capitalize on knowledge is to start a firm and build the necessary complementary assets Teece, b , b.
To fully capitalize on opportunities, such firms must often be global from the beginning. In short, capabilities generally have to be built, as they cannot be bought. The dynamic capabilities framework developed below goes beyond the knowledge and technological elements highlighted in earlier research to more explicitly include managerial and organizational capabilities as determinants of competitive advantage. It contends that the active development and astute orchestration of tangible and intangible assets by both parent and subsidiaries lie at the heart of the rationale for the MNE and, together with strategy, determine its longer-run success.
The original definition of dynamic capabilities by Teece, Pisano, and Shuen : referred to the ability of an organization and its management to integrate, build, and reconfigure internal and external competencies to address rapidly changing environments. Teece et al. This was supplemented in Teece by a more applied focus organized around sensing, seizing, and transforming.
In what follows, I relate the two taxonomies, and then show how strategy fits in. Important clarifying distinctions between ordinary and dynamic capabilities are made. Application to the MNE follows. Organizational processes embed the strategy and business model of the business into the day-to-day routines of employees. The effectiveness of organizational routines is buttressed by strong and consistent organizational values. Either way, firms with superior dynamic capabilities have learned to adjust to changing environments, and also to shape the business environment.
As noted earlier, the asset positioning of a company matters. I am referring not just to balance sheet assets plant and equipment and the like but also to human capital and knowledge assets. It is obvious that a road construction company will need access to heavy equipment e. A bank will need financial assets, and the talent to build and run systems for loan origination and underwriting, etc. As I have noted elsewhere Teece, , the class of assets most likely to satisfy VRIN criteria is intellectual capital, particularly technology and know-how.
Intellectual capital readily meets most of the VRIN criteria because it tends to be tacit and idiosyncratic, and has fuzzy edges. In essence, the criteria distinguish between ubiquitous resources available to all at competitive prices and those that are more specific or unique. Furthermore, the VRIN criteria recognize that a unique asset is not valuable for its own sake. It delivers value to the firm and its stakeholders only if it supports a point of difference that is appealing to the customer, and which, furthermore, cannot easily be replicated by others with different assets.
The global competitive battles in high-technology industries… have demonstrated the need for an expanded paradigm to understand how competitive advantage is achieved. Clearly, the manner in which assets and other resources are coordinated and orchestrated is at least as important to competitive success as the identity of the assets themselves. Markets may have to be created, in the sense that new products and services are introduced for which after-sales support and product training, for instance, may be lacking and may have to be built. This is what Singer did globally to allow market development of the sewing machine.
In India, Gillette has likewise been promoting the benefits of removing beards in order to broaden the market for its safety razors. The need for such creation activities to expand markets is assumed away in transaction-based approaches, where there is almost always a party or customer to transact with. This reduces the problem to one of contracts, when in fact the fundamental problem may be one of market existence or market expansion. The problem stems in part from what was referred to earlier as the equilibrium assumption. But, in reality, much of this information is proprietary, tacit, or diffuse, and thus inaccessible.
The decision to invest depends on sensing an opportunity and also on sensing how potential competitors and complementors will respond. This is not a capability required in a neoclassical world of perfect competition. By embedding managerial asset orchestration into the theory of the MNE, the field of international business can build bridges to topics in international management. It is important to recognize that strategy must go hand in hand with processes, resources positions , and capabilities. Put differently, the managerial orchestration that is core to enhancing processes and exploiting positions must be guided and informed by strategy — and vice versa.
While it is necessarily shaped by the legacy of the past, it also shapes the path ahead. While the actions dictated by the strategy may be visible to rivals, and freely imitable, rivals may not perceive it in their interest to do so until it is too late, because the underlying diagnosis and policy can be kept secret. In the framework advanced here, dynamic capabilities and business strategies codetermine performance. Strong dynamic capabilities require firms to sense, seize, and transform in conjunction with a sound strategy. A sound strategy must in turn have a strong kernel. Clearly, if one is interested in sustainable competitive advantage, one needs to take imitability into account.
That which is easily replicated by the firm is scalable, possibly globally. As explained below, ordinary capabilities support technical fitness, while dynamic capabilities support evolutionary fitness. It is perhaps easier to understand what dynamic capabilities are as a class by juxtaposing them against ordinary capabilities.
Here I emphasize that ordinary capabilities are about producing and selling a defined and static set of products and services. The degree of proficiency, however obtained, indicates the strength of the ordinary capability, for which practice often makes perfect. Ordinary capabilities simply allow an existing product or service to be made, sold, and serviced. They will not necessarily permit the MNE to grow except in environments with low competition, no technological disruptions, and very limited globalization.
Ordinary capabilities and their diffusion matter to the MNE. Technical fitness 41 supports static efficiencies; but unless competition is very weak, and demand is strong, 42 ordinary capabilities are unlikely to support durable competitive advantage. This statement is revealing, as it indicates how best practices, hence ordinary capabilities, are widely distributed, at least in the global automotive industry.
What undermines the power of ordinary capabilities to serve as the foundation of competitive advantage for a particular MNE is that such capabilities can be imitated much more easily today than in earlier times. A good deal of know-how, which used to be tacit and proprietary just two or three decades ago, is now explicit and in the public domain — available from consultants, schools of engineering, and the public literature.
The implication is that the barriers to the transfer of ordinary capabilities have been dramatically reduced in recent decades. Indeed, many basic business services e. Many routine operational and administrative capabilities can be supported remotely by independent providers. Hence, they are no longer as critical to competitive advantage. In short, the Internet facilitates the availability of ordinary capabilities not just because of low cost and easy access to the flow of information, as Richard Nelson has emphasized, 48 but because of low cost and easy access to the computing, software resources, and data storage needed to support basic, yet high-quality, business functions.
Knowledge transfer within an organization presents a host of difficulties Szulanski, And replicability does not always imply imitability. Indeed, Bloom et al. MNEs may thus succeed for a while with strong ordinary capabilities, because ordinary capabilities developed at home may temporarily be distinctive abroad. Some less-developed economies still lack domestic firms performing what, from a developed-country perspective, would be thought of as mundane tasks. This adaptation is itself partially a dynamic capability. Best-practice diffusion. Source : Bloom et al.
Nevertheless, competition and imitation will, over time, lead to the erosion of any advantage from ordinary capabilities. This may occur slowly, but can be rapid in contexts where the absorptive capacity of external organizations is high. An MNE subsidiary relying solely on strong ordinary capabilities in a particular host country will find, if the ordinary capabilities are imitable e. In short, ordinary capabilities will not support long-run competitive advantage unless competition is suppressed by governmentally or privately imposed entry barriers, or by weak physical and social infrastructure that prevents ordinary capabilities from quickly diffusing throughout the economy.
Since the late s, local differentiation, global integration, and innovation have characterized successful firms operating globally. In the global economy today, the competitive advantage of the business firm appears to rest on the development and deployment of intangible assets, 50 relationships, and human capital. These developments have placed a premium on the ability of companies to become entrepreneurial and agile at home and abroad, requiring in turn that management operate with less authority, and organize to allow and promote flexibility, responsiveness, and learning.
This requires dynamic capabilities. Signature processes and signature business models are beyond industry best practices. Because of their deep roots, they are not so easily replicated by others who do not share this history, and may have different values, too. Over longer periods of time, such processes and business models may become somewhat imitable by others. Eventually, it should show up in key performance indicators. This, along with a high tacit component to the underlying knowledge, may keep a signature process effectively proprietary.
There is an obvious opportunity for all business enterprises to learn, and to embed that learning in new signature processes and business models. Hence the MNE competing in diverse contexts has the opportunity to develop distinct signature processes and models in different geographies. Accordingly, the MNE as such may have an advantage in the development of new products and signature processes and models, as it can more readily run multiple, simultaneous experiments than can a pure domestic enterprise.
Moreover, adaptation and adoption of new processes inside the MNE are likely to be easier than they would be across unaffiliated enterprises. Certainly, top management can endeavor to drive such adoption inside the company. Where the real work of making a car company successful suddenly turns complex, and where the winners are separated from the losers, is in the long-cycle product development process, where short-term day-to-day metrics and the tabulation of results are meaningless.
They are higher-order, difficult-to-replicate capabilities. They are based on processes that are beyond best practice, and on resources that meet the VRIN criteria. Firms with strong dynamic capabilities exhibit technological and market agility. To achieve this, they use less hierarchy. Agility, coupled with the ability to sense new opportunities and threats, supports evolutionary fitness.
However, absent the required ability to orchestrate resources, and to create and execute a quality strategy, such resources are likely to be of little value. As noted, strong dynamic capabilities will help organizations to stay relevant to marketplace needs and technological opportunities. Organizations must change their capabilities to reflect anticipated changes in markets, technologies, and the business environment more generally. This is in contrast to routine-directed problem-solving. Certainly, skills are implicated. The individual and organizational skills at issue with dynamic capabilities are much more oriented to creating unique problem-solving methodologies and signature processes.
Problem-solving is very much a dynamic capability. The middle ground also constitutes a dynamic capability. The innovation process is neither completely routinized nor ad hoc. The capabilities approach, expanded upon below, sees MNE activity as driven by the opportunity to leverage capabilities and create and capture value from innovation on a global scale. Entrepreneurial managers are not just resource allocators; they also sense, shape, and exploit opportunities.
To create and exploit opportunities globally, entrepreneurial activity must be linked up with capital and other complementary assets, because property rights over discoveries and inventions are incomplete. Some ownership and control over complementary assets is likely to be needed to assist the MNE in the appropriation of value needed to support continued investment Teece, b , b. They are themselves the instruments that make markets work well. Even if Coasian transaction costs were zero, learning, co-creation, and orchestration functions would still need to be carried out.
The entrepreneurially managed MNE is a vehicle designed to do so. While ordinary capabilities are insufficient for long-term survival and growth, dynamic capabilities enable the firm to have a better chance of establishing and maintaining competitive advantage and concomitant superior performance in economies where change is rapid, and intangible assets are critical to competitive differentiation.
Dynamic capabilities are hard to develop, and difficult to transfer across borders, in part because they are tacit, in part because they are often embedded in a unique set of relationships and histories, and in part because of uncertain imitability. They often lie at the heart of both short- and long-cycle product development processes.
These authors were tilting toward elements of a dynamic capabilities framework, because such a framework is also about linking and leveraging know-how. Good strategy, strong ordinary capabilities, scale in some circumstances , and strong dynamic capabilities are all needed for long-term growth and survival in the framework advanced here. Included are the external linkages and alliances that are common in the global economy, and well documented and analyzed in the international business literature. At a quite general level, dynamic capabilities are about how an enterprise seizes the future and develops the products, processes, and business models to meet and shape ever-changing markets.
Dynamic capabilities result from superior top management orchestration skills. They are hard to teach, in part because there is a large tacit component Teece et al. To maintain competitiveness, the MNE must develop and maintain asset alignment both internally and with collaborating firms.
It is not just a matter of selecting the right organizational boundaries to achieve fit, although that is clearly one element. Strong dynamic capabilities help ensure evolutionary fitness; ordinary capabilities are more attuned to the requirements for technical fitness. Prior sections of this paper have treated the firm in a general way, consistent with the need to encompass multinationality.
This section explores particular issues squarely within the established domain of international business studies. It is, after all, the potential for synergistic interaction between headquarters and foreign locations Cantwell, , with their distinct institutional contexts and capabilities profiles, that distinguishes the MNE case from the general theory of the firm. Efforts are made to explain how a capabilities approach leads to an all-encompassing perspective that can incorporate both prongs of the internalization paradigm.
One way to observe the different insights from the two main approaches to internalization is to examine how they impact perspectives on MNE expansion. The impact of the transaction-cost-based internalization approach is already evident in the literature on the MNE e. However, this stream of work tells us very little about which markets the MNE should create and enter; implicitly, one can perhaps read into internalization that the right markets are those in which the services of firm-specific assets generate value.
In other words, transaction-cost-based internalization theories help specify entry mode, but not the best direction and timing for expansion. These are important decisions, and a robust theory of the MNE should be able to help explain them. Clearly horizontal market-entry strategies of the MNE are not just about figuring out the right contractual mode. Firm-specific capabilities will need to be assessed, both as to relevance abroad and as to transfer costs.
Modifications and adaptations may sometimes be required. Intellectual property issues will need to be analyzed. Replication of capabilities in a different context may be difficult Teece, , a. In the main, the problems likely to be encountered are not contractual ones; they relate more to technology and capability transfer costs, and the assessment of market opportunity. Established firms enter markets where they have pre-entry resources and capabilities that are similar to the resource requirements of the market of entry.
The choice of geographic markets is most strongly influenced by specialized resources and capabilities, including knowledge of the local market and tacit technological skills. Thus firm-level capabilities act simultaneously both as a constraint on and as an enabler of what firms can do with respect to foreign market entry. International expansion will be facilitated when the firm capabilities align with market needs abroad, and management in the parent or subsidiary can keep it that way. The unevenness in the global business and economic landscape navigated by MNEs creates opportunities to both transfer and deploy existing capabilities, and create new ones, thereby fueling cross-border expansion.
Hence, while the boundaries of the MNE may be partially determined by transaction costs, in larger measure they are likely to be determined by capabilities and the need for, and difficulty associated with, replication and the associated transfer of technologies and capabilities. This aspect of the argument echoes the theory of technological accumulation outlined by Cantwell , , It also implies that MNEs will invest abroad to augment their existing capabilities, as their geographically dispersed networks facilitate the accumulation of technological assets over time.
The MNE becomes the locus for creating and leveraging products and capabilities, and for capturing value from this process globally. Regional and national systems of innovation, for instance, shape firm experiences, knowledge, and capabilities. Moreover, good management is not uniformly distributed either. Entrepreneurial management is a scarce resource that is itself geographically concentrated.
Firms are in part products of the environments in which they were born; by going global, they can tap into regional and national systems of innovation outside the home country. The capabilities of the MNE stem in part from the diverse environments in which they operate and compete. However, most country advantages may be open to all that choose to invest in a particular host country. Low-cost labor, for example, is generally fungible across all foreign entrants.
Hence, as discussed below, country-specific advantages are not so compelling in the dynamic capabilities-based approach to competitive advantage. They may help explain entry, but they are at best one factor behind competitive advantage at the enterprise or business level. The mode of entry into a foreign market is the topic on which internalization theories have been thought to have their firmest footing. At least two other factors are at work. First, the presence of pre-entry capabilities, including slack resources, matters considerably.
The slack resources at issue might even be financial. Indeed, in Teece b : , cash was highlighted as an important factor in explaining the mode of market entry. As Madhok notes, the firm boundary issues are largely capability-related. When a firm has strong ordinary and dynamic capabilities, the incremental costs of FDI are likely to be low. Conversely, when timing is of the essence and certain capabilities are absent, joint ventures are likely to be preferred by the enterprise endeavoring to go global.
When an MNE enters a foreign market, it will need to replicate some of the capabilities processes, skills, etc. Adjustments may be necessary because the skills and know-how the MNE possesses in one context might not quite work in a different geographic context. Getting this fit right requires dynamic capabilities. Time—cost tradeoffs have been analyzed and empirically estimated for technology transfer processes Teece, b , , b. If the time—cost tradeoff is too steep, managers should associate with joint venture partners who can help flatten them.
Thus mode of entry will depend not just on contractual factors but also on who owns and controls the required capabilities, the time it takes to transfer them, and the timing imperatives of market entry. Scholars have begun to study why and how some firms internationalize very early in life e. Small companies can have strong dynamic capabilities, and may be able to access abroad the ordinary capabilities necessary to make their foreign market-entry strategies viable.
Small entrepreneurial firms can quickly create and with local partners co-create new markets abroad. This finding, which goes beyond previous country-level analyses, is consistent with capability transfer being easier with geographic proximity, and with institutional and language similarity. Dynamic capabilities themselves involving as they do sensing, seizing, and, ultimately, transforming can in most cases be sequenced over time and across different geographic markets.
It is more challenging if the firm has to perform all three simultaneously in each of its businesses, and in all of its markets. However, such simultaneity is sometimes required. Brands the owner of fast-food brands KFC, Taco Bell, and Pizza Hut has simultaneously engaged in rapid expansion in China, and in retrenchment and transformation in one of its established markets, the United Kingdom.
The governance transaction cost theory of internalization has little to say about the role of headquarters and foreign subsidiaries. The headquarters function is where certain capabilities reside. Top management at headquarters performs a most important global asset orchestration function in the dynamic capabilities framework. They allocate the financial resources needed for the MNE to create markets outside the home jurisdiction while leaving operational matters to lower levels of the organization.
In essence, Buckley is advancing a dynamic capabilities perspective on the MNE. They can generate know-how and capabilities from their own histories that can be transferred to other business units at home or abroad. Subsidiaries can have considerable autonomy, simultaneously being integrated in a worldwide operation. New products and processes can be developed by the parent or a subsidiary then shared globally.
This decentralized M-form MNE allows and encourages local knowledge creation and local discovery of opportunities, with subsequent orchestration activities applied by top management. Transaction cost approaches provide few insights into this distribution of activity. It is important to recognize that once an MNE creates a subsidiary that establishes its own networks and learning path, the subsidiary can accumulate specific assets and capabilities that can find useful application elsewhere.
Rugman and Verbeke , , also recognized quite properly that firm-specific assets could arise anywhere in the MNE. This is consistent with a capabilities perspective. Learning and the development of signature processes and VRIN resources are seen to be subsidiary-specific. It also requires recognizing that innovation necessitates collaboration with a panoply of partners in an ecosystem. Ongoing engagement with ecosystem partners can be seen as leading to the migration of the locus of value creation from the firm to the level of the business ecosystem.
However, it can also drain them if partners are laggards, and fail to contribute as agreed. Indeed, it is of central importance in Buckley and Casson However, the development of firm-specific technological assets through internal and external combinations — and hence through dynamic capabilities — has not been emphasized much in the transaction cost approach.
Once again, good management requires excellence with respect to the orchestration function described earlier. Here the orchestration is of technology both inside and external to the firm, both at home and abroad, and across different technological domains. This is still the case, but the degree to which US enterprises use subsidiaries to develop new products has undoubtedly increased.
Location decisions have much to do with market access and tapping into talent, and less to do with transaction cost issues. This is a quite general result from the innovation literature Teece b , b , but it seems especially applicable to the MNE. These issues have been expanded at length by Cantwell and Mudambi Governance transaction cost theory produces only limited insight into this phenomenon. Insights from the strategy and capabilities perspectives seem more pertinent. Rugman has built a theory of the MNE that postulates the need to recognize that MNE location decisions are impacted by country-specific and firm-specific factors.
In the Rugman matrices, for example, labor-intensive manufacturing operations of MNEs will be drawn to low-wage environments. The dynamic capabilities framework suggests, however, that, while country and regional factors may impact investment location decisions, they usually have little relevance to understanding how MNE competitive advantage is anchored.
The simple reason is that country factors are often exploitable to a substantial degree both by domestic firms and by multiple MNEs. Unless a particular MNE has a privileged relationship with a nation-state, or a unique and difficult-to-replicate history there, country advantages are accessible by all MNE investors. Hence country factors may explain why economic activity of relevance to an MNE is in a particular offshore location. Internalization theory will help determine whether that activity is best accessed via outsourcing or by FDI. However, country and regional factors available to incumbents and new entrants alike will have little to do with explaining firm-level competitive advantage, except inasmuch as they help explain the history of particular units of the MNE.
This is a place where traditional MNE theory and the theory of competitive advantage part ways. In short, country and regional factors can be foundational for MNE competitive advantage only when a particular MNE is able to access local advantages and avoid local disabilities in a way that others cannot or fail to copy. For example, learning or other knowledge development that takes place in distinct host-country environments might form the basis for signature processes and VRIN resources that could contribute to competitive advantage for the company as a whole, and these would still be difficult for rivals to replicate.
This is where national systems of innovation Nelson, are relevant, and this is all the more important because sources of innovation are more globally dispersed than ever before. The field of international business has been considerably animated by the tools and perspective of transaction cost economics. It has provided useful insights into enterprise structure and scope, into alliance arrangements, and into governance more generally.
It outlines best practice with respect to contract design an ordinary, not a dynamic, capability.
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Contractual issues are of interest to policymakers and managers alike. However, there are a multiplicity of issues — such as global product mandates and understanding individual firm performance — where the transaction cost approach has provided parsimonious insight at best. International management scholars have, as a consequence, sometimes developed communities of their own within management academies rather than the international business academies. As a result, their work has not been well integrated into the international business literature.
Moreover, it often lacks a good theoretical grounding. Ad hoc theorizing is common. International management desperately needs a theory to help amalgamate its many disparate threads. This is not possible. A general theory of the MNE that does not recognize firm-level heterogeneity is of little utility to scholars and practitioners interested in diagnosing the prospects and plights of particular firms. Unspecified mechanisms also somehow create firm-specific assets somewhere. The dynamic capabilities framework achieves this by imbuing management with both entrepreneurial and leadership functions.
Their transnational enterprises build assets and capabilities that are dispersed and interdependent; overseas operations provide local differentiation but are nevertheless integrated into worldwide operations. Asset orchestration and entrepreneurial cross-border market creation and co-creation are at the core. The dynamic capabilities framework advanced here allows international business and international management research to coexist in harmony. In contrast to contractual approaches, the capabilities approach has an important role for the entrepreneurial manager, not just in asset orchestration but also in creating new products and services.
It endeavors to explain heterogeneity and the determinants of firm-level profitability, not just the existence of firms. Access to distinct resources, the development of signature processes, engagement in co-creation activity, and implementation of good strategy each play a role. The thrust of this paper is that transaction-cost-based or comparative-governance-based theories of the MNE are too narrow to capture a good deal of what is critical to the MNE and its financial performance.
The OLI model, which has evolved to embrace capabilities alongside internalization, goes some way toward filling the gap. Notwithstanding, there is still utility to the paradigm. What makes MNEs distinctive is the fact that they each have separate histories, and they each span jurisdictions and territories where markets, factors of production, firms and technologies, and national and regional infrastructure are likely to be different. Where certain capabilities and markets are absent, they need to be created. In these environments, entrepreneurs and managers in parents and subsidiaries build signature processes, deploy distinct resources, and design good business models and strategies in pursuit of profits.
This, in turn, may lead the MNE to engage in technology and capability transfer, and possibly even the strengthening of complementors and suppliers. All along, there have been various strands that have toyed with capability ideas, but the international business literature has embraced issues of entrepreneurship and capabilities in only a limited fashion.
However, when one slides from one paradigm to another in a subtle, undeclared way without announcement of old assumptions abandoned and new ones embraced, the literature runs the risk of becoming confused. Hence there is a need to be clear around the shifts that are going on, or progress will stall. Two of the goals of this paper have been to declare the tension, and to try to resolve it. A more active interchange of research with strategy and management scholars — as well as with researchers in evolutionary economics, organizations, and entrepreneurship — should follow.
A richer internalization theory of the MNE will also allow management scholars as well as economists to talk meaningfully about the sources and persistence or lack thereof of firm-level competitive advantage and associated superior financial performance. With these developments, there is a good chance that the field of international business will escape its current confusion, and lead the way in advancing a parsimonious, tractable, and plausible theory of the firm and competitive advantage that will inform research, teaching, policy, and prescription across multiple fields of inquiry.
As Ronald Coase pointed out, it is not enough for a theory of the firm to merely explain firm boundaries. Such a theory has yet to fully emerge, either in the domestic or in the MNE context. This is obviously a more ambitious goal than most economists ever set themselves. See Hart for more discussion. In her early study of the internationalization of American Radiator Company, Mira Wilkins criticized the insufficiency of international business theories based purely on comparative advantage and strategic thinking, and highlighted the importance of evolutionary choices and uncertainty in entrepreneurial decision-making.
Williamson seems to agree that an unaddressed issue in this literature is the generation of differential firm performance. Hymer confused competitive advantage and monopoly power. Competitive advantage need not, and usually does not, imply that the firm possesses any policy-relevant market power. Governance structures are arrangements by which a transaction can be managed governed to mitigate potential market exchange problems.
Governance structures encompass: 1 incentive intensity; 2 form of administrative control; and 3 contract law regime Williamson, None of the textbook models of the firm — whether generic or MNE oriented — captures the changes to the MNE that movement toward a global knowledge economy seems to entail.
However, Rugman interpreted O advantages primarily as firm-specific advantages FSAs — that is, specific to individual firms. I owe thanks to Cantwell for valuable comments on this point. Scholars have noted that changes in the value of both exogenous and endogenous variables affect each other. As learning takes place in multiple organizational and geographic sites, and with different complementarities, different performance levels are achieved by different businesses. Heterogeneity is the norm, and is explained in part by the existence of path-dependent learning.
The former is a precise approach based on abstract models that attempt to reveal something meaningful about the real world despite their simplifications. Appreciative theorizing is qualitative, and takes observations of the real world as its starting point. The task at hand for managers is bigger than simplifying transactional difficulties by engaging in direct investment in wholly owned subsidiaries.
Early path-breaking ideas, such as copiers or scanners, are often met with skepticism and over-pessimistic guesstimates of their market potential. In such cases, it is left to the originators of these ideas to try to prove themselves right. Market creation and co-creation are of course dynamic processes.
In the above quote, organizational decision theory is a poorly worded proxy for what I now call dynamic capabilities theory, discussed below. A look at the cross-border activities of global firms is in line with our arguments. Take, for example, a firm such as Coca-Cola, and its cross-border activities in China and India. These do not simply involve activities that are tantamount to solving existing market failures. Instead, they involve the transfer of capabilities and the creation of markets by designing and setting up bottling companies and distribution systems; by inventing new refrigerating technology; and by influencing user perceptions.
There is little room for uncertainty or innovation in the various Coasian models of the MNE, and extensions have not succeeded in creating theories that incorporate learning, capability enhancement, and innovation in a meaningful way. Like Coase, Williamson does not recognize Knightian, or fundamental, uncertainty.
However, his treatment of entrepreneurship is mainly contractual. The econometric results in Monteverde and Teece showed that vertical integration was driven not just by asset specificity. In particular, there are a variety of contractual arrangements, some more firm-like, some more market-like.
Dunning, with his OLI approach, made a step in the right direction; but OLI is also mostly static, and fails to recognize capability building or entrepreneurial and learning considerations Pitelis, Interestingly, Casson has written extensively and with considerable insight on entrepreneurship, aiming to integrate entrepreneurial decision-making into the theory of the firm.
Using a definition arising from information cost economics, Casson : views judgmental decision-making as the defining characteristic of the entrepreneur, which requires the entrepreneur to develop skills for optimizing information selection and processing. Although Casson endeavored to incorporate the entrepreneur into the theory of the firm, his theory does not seem to fully capture the entrepreneurial function of the MNE manager as advanced here. Also, they often remain tacit Polanyi, However, homogenization of tasks and technologies has not yet occurred, and is unlikely to do so any time soon.
Differences in consumer preferences and purchasing power also remain, and will likely continue to do so. Market share is of little relevance to this analysis, except when there are strong network effects. The external business environment — writ large — is, however, highly relevant.
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This is perhaps better summarized by the concept of the ecosystem rather than industry Teece, The approach does not deny that firms are necessary to delimit recontracting hazards and other negative consequences of opportunism. Rather, the theory goes beyond this to recognize the need to organize so as to embrace opportunity, and to capture gains from discovering and exploiting scope economies derived from complementarities and co-specialization. Whoever originally said this, it makes an important point: a good strategy must be combined with strong dynamic capabilities to be effective. According to Rumelt : 7 , a guiding policy specifies the approach to dealing with the obstacles called out in the diagnosis.
Coherent actions are feasible, coordinated actions diagnosed to carry out the guiding policy. For presentational purposes, strategy can be viewed as embedded in dynamic capabilities. They are interdependent. In many cases, however, it is helpful for strategy to be analytically separated. This is the approach followed in the remainder of this paper. For instance, the most proficient manufacturer of vacuum tubes with bountiful ordinary capabilities was defeated, as were others in the vacuum tube industry, by the invention and mass production of transistors.
However, in markets that are protected from competition — possibly because of government regulations or trade barriers, or which are small-scale — ordinary capabilities may allow a company to be profitable and grow reasonably well. Dynamic capabilities are generally required for the transfer and adaptation of ordinary capabilities on a global scale.
However, when global markets are relatively homogeneous, such scaling may not require significant adaptation. The mere transfer of technologies without adaptation to different geographies represents the extension of ordinary capabilities — one step short of dynamic capabilities. Technical fitness is defined by how effectively a capability performs its function, regardless of how well the capability enables a firm to make a living Teece, : Of course, in many poor countries with extensive state control of resources, competitive forces are weak, and firms with ordinary capabilities can survive and prosper if ordinary capabilities are rare.
Bloom et al. These seem to represent particular ordinary capabilities, as discussed below. The fast-food industry is another example, although capabilities are perhaps not yet as complete on a global basis. These resources can be provisioned to small businesses or across large multinational corporations. Bloom and Van Reenen explored reasons why ordinary capabilities were less prevalent in developing countries. Their large-scale, cross-country survey results suggested that an information gap was perhaps the biggest contributor; managers were generally not well-informed about how their own practices compared to best practices.
Specific conditions that could also lead to poor management practices in developing countries include weak product market competition, state ownership, family-based management, and poor business education. Intellectual capital, in particular, is generally harder to develop, transfer, and imitate Teece, Evolutionary fitness refers to how well the capability enables a firm to make a living Teece, : 7. Dynamic capabilities allow an organization to change in a manner that supports evolutionary fitness.
They govern how new products and services are developed and positioned, how new business models are created, and how ordinary capabilities improve. For instance, an important function in drug development is achieving regulatory approval. At present, many major pharmaceutical companies have well-developed processes for running the approval process. In time, however, such processes could become standardized, and available from a business service provider.
When this occurs, a higher-order capability in the pharmaceutical industry will become a lower-order ordinary capability. There may be multiple niches available to a firm for surviving, given the environment. The higher the environmental complexity that can be handled by the firm, the better the long-run performance. Winter approaches dynamic capabilities as being rooted in higher-level change routines.
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