Dynamic Capabilities Theory
Dynamic capabilities theory examines how firms integrate, build, and reconfigure their internal
and external firm-specific competencies into new competencies that match their turbulent
environment (Teece, Pisano, & Shuen, 1997).
The theory assumes that firms with greater dynamic capabilities will outperform firms with
smaller dynamic capabilities.
The aim of the theory is to understand how firms use dynamic capabilities to create and sustain a
competitive advantage over other firms by responding to and creating environmental changes
(Teece, 2007).
Organizational capabilities are called “zero-level” (or “zero order”) capabilities, as they refer to
how an organization earns a living by continuing to sell the same product, on the same scale, to
the same customers (Winter, 2003, p. 991).
Dynamic capabilities are called “first-order” capabilities because they refer to intentionally
changing the product, the production process, the scale, or the markets served by a firm (Winter,
2003).
An organization has dynamic capabilities when it can integrate, build, and reconfigure its
internal and external firm-specific capabilities in response to its changing environment . For
example, whereas organizational capabilities have to do with efficient exploitation of existing
resources, dynamic capabilities refer to efficient exploration and implementation of new
opportunities (March, 1991).
According to Helfat et al. (2007), a dynamic capability is “the capacity of an organization to
purposefully create, extend, and modify its resource base” (p. 4). The resource base of an
organization includes its physical, human, and organizational assets (Eisenhardt & Martin,
2000).
Helfat et al. (2007) identified two yardsticks for calibrating/standardizing a firm’s capabilities:
technical (internal) fitness and evolutionary (external) fitness.
Technical fitness refers to how well a capability performs its function divided by its cost.
A dynamic capability is not something that a firm has or does not have. This measure can
show that the dynamic capabilities of some firms may be more or less technically fit
compared to other firms.
Evolutionary fitness refers to how well a capability enables the firm to make a living
outside the company relative to other firms by creating, extending, or modifying its
resource base. Dynamic capabilities help a firm achieve evolutionary fitness (Teece,
2007).
Pavlou and El Sawy (2011) created a framework for a proposed model of dynamic capabilities.
According to the framework, the firm
(1) uses its sensing capabilities to spot, interpret, and pursue opportunities that it
perceives from internal and external stimuli;
(2) uses its learning capabilities to determine what organizational capabilities must be
revamped/restored, rebuilt, or reconfigured into new knowledge;
(3) uses its integrating capabilities to collectively understand and to make the necessary
changes to its operational capabilities;
(4) uses its coordination capabilities to implement and use the reconfigured operational
capabilities; and
(5) continues to scan external and internal stimuli (Ettlie & Pavlou, 2006; Pavlou & El
Sawy, 2006).
The dynamic capabilities approach has tended to incorporate Schumpeterian rents in its
explanation of sustainable competitive advantage (Teece et al., 1997). However, Parayitam
and Guru (2010) have argued that dynamic capabilities can lead to both Ricardian and
Schumpeterian rents for a firm. According to Schumpeter (1911/1934), an entrepreneur will
make profits (rents) because of innovations (strategies) as long as other entrepreneurs are not
able to copy those innovations. In other words, profits emerge when innovations are new, and
profits disappear when innovations are copied; profits can reappear if new innovations are
created. According to Ricardo (1817), profits (rents) occur because of scarcity of resources or
capabilities, such as land, that are available to the entrepreneur but not available to his or her
competitors. Thus the entrepreneur will have lower operating costs compared to those of
other entrepreneurs, which will result, simply speaking, in a competitive advantage for the
entrepreneur. As pointed out by Penrose (1959), turbulent environments may change the
significance of resources for organizations. Future research should integrate both types of
rents into the dynamic capabilities approach (Parayitam & Guru, 2010).
Criticisms and Critiques of the Theory
Dynamic capabilities theory has been criticized for not properly defining the term “dynamic
capabilities,” for constantly changing the definition, and for outright contradictions in the
definition (Arend & Bromiley, 2009; Collis, 1994; Zahra, Sapienza, & Davidss on, 2006).
The term dynamic capabilities has often been described in vague and ambiguous ways—for
example, as “routines to learn routines”— that are tautological and impossible to operationalize
(Eisenhardt & Martin, 2000).
Di Stefano, Peteraf, and Verona (2010) argued that a lack of clarity over basic terms will hinder
further progress for the theory.
The theory has been criticized for being a tautology. Some researchers have identified firms as
having dynamic capabilities by their success (Arend & Bromiley, 2009). For example, some
researchers tautologically state that dynamic capabilities lead to success and that successful firms
have dynamic capabilities.
Critics have argued that two instances of such a tautology were In Search of Excellence (Peters
& Waterman, 1982) and Good to Great (Collins, 2001).
In addition, some critics have complained that poor performing firms also can have dynamic
capabilities, or “continuous morphing/transforming” properties (Rindova & Kotha, 2001, p.
1264) that do not lead to success, such as Yahoo! and Excite.
Some critics have argued that just because a firm does not change does not demonstrate that a
firm lacks the dynamic capabilities to change (Arend & Bromiley, 2009).
Critics have argued that compared with other similar terms, the term dynamic capabilities does
not provide added value in explaining why some firms are successful and others are not. For
example, the following terms address similar issues: absorptive capacity, intrapreneurship,
strategic fit, first-mover advantage, organizational learning, and change management (Arend &
Bromiley, 2009). Some critics are even skeptical that the concept of dynamic capabilities even
exists (Winter, 2003). Because so much research has described dynamic capabilities as abstract
capabilities, many researchers believe that managers’ deliberate efforts to develop and strengthen
dynamic capabilities may not be effective (Winter).
Critics have argued that there are many ways to adapt to a rapidly changing environment and that
the development of dynamic capabilities is but one way to do so. For example, Winter argued
that it is possible for a firm to make appropriate changes to adapt to a rapidly changing
environment as needs arise, or employ what he called an “ad hoc” approach to change.
Winter (2003) also argued that ad hoc problem solving may even be a better, cheaper approach
than investing in dynamic capabilities. Ad hoc problem solving involves only spending money as
needs arise. In contrast, developing a firm’s dynamic capabilities can involve trying to anticipate
every possible need for change and investing significant monies toward each of those potential
change areas. The development of dynamic capabilities most often involves sunk costs, whereas
the costs for ad hoc changes are often only temporarily deployed and can eventually be returned
to their prior uses (Dunning & Lundan, 2010; Romme, Zollo, & Berends, 2010). Few studies
have measured the costs and benefits of developing dynamic capabilities to address this issue.
The theory has received considerable criticism for problems with measuring dynamic capabilities
(Williamson, 1999). Pavlou and El Sawy (2011) noted that there was a lack of a measurement
model for the theory. Galunic and Eisenhardt (2001) argued that the existence of dynamic
capabilities was often just assumed without specifying exact components. Most often,
researchers have used distant proxies, or only vaguely related items, to measure dynamic
capabilities (for example, Arend & Bromiley, 2009; Henderson & Cockburn, 1994). Most
researchers have used only short-term, cross-sectional tests, although the theory requires long-
term, longitudinal, time-series data for proper analysis.
Measuring Variables in the Theory
Dynamic capabilities measures. Pavlou, P. A., & El Sawy, O. A. (2011). Understanding the
elusive black box of dynamic capabilities. Decision Sciences, 42, 239–273
Source: Adapeted from Pavlou, P. A., & El Sawy, O. A. (2011). Understanding the elusive black
box of dynamic capabilities”: Decision Sciences Volume 42 Number 1 February 2011
Source: Adapeted from Pavlou, P. A., & El Sawy, O. A. (2011). Understanding the elusive black
box of dynamic capabilities”: Decision Sciences Volume 42 Number 1 February 2011
Because dynamic capabilities are abstract, intangible, and difficult to describe, they are modeled with a
second-order model that is formed by the proposed four dynamic capabilities that are measurable.
Figure 1: The measurement model of dynamic capabilities.
Source: Adapeted from Pavlou, P. A., & El Sawy, O. A. (2011). Understanding the elusive black
box of dynamic capabilities”: Decision Sciences Volume 42 Number 1 February 2011
MEASUREMENT ITEMS
Dynamic capabilities
Instructions: “Please rate the effectiveness by which your work unit reconfigures its operational
capabilities in the NPD process to address rapidly-changing environments relative to your major
competitors.”
Sensing capability
1. We frequently scan the environment to identify new business opportunities.
2. We periodically review the likely effect of changes in our business environment on customers.
3. We often review our product development efforts to ensure they are in line with what the
customers want.
4. We devote a lot of time implementing ideas for new products and improving our existing products.
Learning capability
1. We have effective routines to identify, value, and import new information and knowledge.
2. We have adequate routines to assimilate new information and knowledge.
3. We are effective in transforming existing information into new knowledge.
4. We are effective in utilizing knowledge into new products.
5. We are effective in developing new knowledge that has the potential to influence product
development.
Integrating capability
1. We are forthcoming in contributing our individual input to the group.
2. We have a global understanding of each other’s tasks and responsibilities.
3. We are fully aware who in the group has specialized skills and knowledge relevant to our work.
4. We carefully interrelate our actions to each other to meet changing conditions. Group members
manage to successfully interconnect their activities.
Coordinating capability
1. We ensure that the output of our work is synchronized with the work of others.
2. We ensure an appropriate allocation of resources (e.g., information, time, reports) within our
group.
3. Group members are assigned to tasks commensurate with their task-relevant knowledge and
skills.
4. We ensure that there is compatibility between group members expertise and work processes.
Overall, our group is well coordinated.
Alliance capabilities measures. Kale, P., & Singh, H. (2007). Building firm capabilities through
learning: The role of the alliance learning process in alliance capability and firm-level alliance
success. Strategic Management Journal, 28, 981–1000.
Operational capabilities measures. Wu, S. J., Melnyk, S. A., & Flynn, B. B. (2010).
Operational capabilities: The secret ingredient. Decision Sciences, 41, 721–754.
Suggestions for Further Research
1. Explore the conditions where firms have dynamic capabilities to change but decide not to
change.
2. Examine the comparative advantages versus costs of developing long-term versus short-term
dynamic capabilities to change.
3. Look for a solution that optimizes the trade-offs between dynamic capabilities and
operational capabilities.
4. Examine the contribution of capabilities as a function of industry and market maturity.
5. Explore the extent to which an activity can be regarded as a dynamic capability if conducted
in a single firm as opposed to in an industry.
Implications of the Theory for Managers
Dynamic capabilities theory examines how firms integrate, build, and reconfigure their internal
and external firm-specific competencies into new competencies.
Firms that are best able to reinvent and match their competencies with the demands of their
changing environment will outperform their competitors.
Your task as a manager is to help your firm sense, learn, integrate, and coordinate capabilities.
Help your firm sense the changes that are going on in your industry and environment.
Read trade journals, articles, magazines, Web sites, and other sources to stay on top of changes
that are occurring for your company and for your industry.
Work with others to determine your organizational capabilities that will need to be reworked into
new capabilities that will better help your firm meet the demands of your turbulent environment.
Once that is completed, work with others to help everyone make sense of the new capabilities
and develop a plan of action to implement and use the newly created capabilities.
Next, design and implement a plan to integrate the new capabilities within the current
organizational processes and get the new capabilities up and running.
Finally, keep the process going, as the best firms will need to continuously keep up with the
changing demands of their turbulent business environment if they want to succeed.
