Uncertainty, Innovation, and Dynamic Capabilities: An Introduction
David Teece and Sohvi Leih
Globalization and rapid technological change have led to a period of volatile earnings for many companies. It’s not that business is becoming more risky, but rather that business is becoming more uncertain. Recognizing the difference between risk and uncertainty is critical. Risk can be quantified using probabilities, while uncertainty can be difficult to quantify at all. With uncertainty, the unknowns are unknown, requiring creative management responses, novel coping mechanisms, and entrepreneurial efforts. And it is uncertainty, not risk, which is the more prevalent circumstance in today’s economic and business environments. Modern organizations must frequently make decisions based on incomplete information, lacking knowledge of the future despite the increasing prominence of “big data.” When the future is yet to be created, traditional approaches can often fall short. What does this mean for managers struggling to make decisions and develop strategies in a highly uncertain environment?
The Concept of Capability
The dynamic capabilities framework was first developed in the 1990s. The theory presents a theory of the firm and of firm-level competitive advantage in environments characterized by deep uncertainty. Broadly, a capability is a set of activities a firm performs that enables products and services to be made and delivered, and profits to be generated. Dynamic capabilities refer to the higher-level capabilities that allow firms to build and reconfigure internal and external resources to respond to (or even shape) rapidly changing business environments. Whereas ordinary capabilities are about doing things right, dynamic capabilities are about doing the right things.
Whereas ordinary capabilities are about doing things right,
dynamic capabilities are about doing the right things.
The type of environment in which dynamic capabilities will be most relevant is one with medium to high competitive conditions - also known as “hypercompetition.” Within such an environment, it is tempting to rely on familiar principles of risk management based on known statistical probabilities. Risk management has become a well-defined function in banks, insurance companies, and other organizations. But managing uncertainty using the same principles can be dangerous.
Uncertainty is ubiquitous in today’s complex world. Major unexpected shocks, dubbed “Black Swan events” by financial theorist Nicholas Taleb, occur frequently and are inherently unpredictable. Such shocks are particularly common in the technological arena. For managers in the innovation economy, it is critical to navigate these unexpected events with minimal disruption and without resorting to crisis management, which can be very damaging.
To manage deep uncertainty, organizations must perfect the art of imagining a future and endeavoring to build it. Reason and analysis is only one element of the process; awareness of potential opportunities is most often aided by imagination. Additionally, entrepreneurial capabilities are paramount. Strong dynamic capabilities have an entrepreneurial or “asset orchestration” dimension that allow organizations to rapidly ideate, test, and deploy new innovations. Sensing capabilities, which allow firms to detect potential market changes, should not be neglected. Similarly, organizations with strong seizing and transformation capabilities will be more resilient when shocks require rapid realignment or expansion. And a strong culture of continuous renewal keeps organizations nimble and responsive.
Firms must learn to manage deep uncertainty, a difficult task that requires imagination and goes far beyond traditional processes of risk management. What’s required to manage uncertainty is not optimization but entrepreneurship, exploration, learning, adaptation, and transformation. The articles included in California Management Review’s special issue on Dynamic Capabilities cover each of these dimensions in depth.
Dynamic Capabilities and Organizational Agility Uncertainty is very different from risk, which can be managed using traditional tools and approches. Firms seeking to develop strong dynamic capabilities must be able to manage deep uncertainty, characterized by unknown unknowns.
How Do Firms Adapt to Discontinuous Change? Blockbuster, Kodak, Lehman Brothers, Nokia: there are countless examples of firms that failed to adapt effectively to changes in their external environment. This particularly true in industries characterized by rapid technological change.
Adapting to Fast-Changing Markets and Technologies Some firms are adept at anticipating and exploiting the opportunities created by technological innovation, while others struggle. This article explores the processes of sensing, seizing, and transforming within rapidly changing industries.
Designing Organizations for Dynamic Capabilities Valve Corporation is a gaming company founded in 1996 by Gabe Newell and Mike Harrington. In addition to producing popular titles like Half Life and Portal, over the past twenty years, Valve has proven that flattened hierarchies can enable dynamic capabilities.