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Management Papers Wharton Faculty Research

10-2003

Understanding Dynamic Capabilities

Sidney G. Winter
University of Pennsylvania

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Recommended Citation
Winter, S. G. (2003). Understanding Dynamic Capabilities. Strategic Management Journal, 24 (10), 991-995. http://dx.doi.org/
10.1002/smj.318

This paper is posted at ScholarlyCommons. http://repository.upenn.edu/mgmt_papers/30

For more information, please contact repository@pobox.upenn.edu.
Understanding Dynamic Capabilities
Abstract
Defining ordinary or “zero- level” capabilities as those that permit a firm to “make a living” in the short term,
one can define dynamic capabilities as those that operate to extend, modify or create ordinary capabilities.
Logically, one can then proceed to elaborate a hierarchy of higher-order capabilities (Collis 1994). However, it
is argued here that the strategic substance of capabilities involves patterning of activity, and that costly
investments are typically required to create and sustain such patterning – for example, in product
development. Firms can accomplish change without reliance on dynamic capability, by means here termed “ad
hoc problem solving.” Whether higher order capabilities are created or not depends on the costs and benefits
of the investments relative to ad hoc problem solving, and so does the “level of the game” at which strategic
competition effectively occurs.

Keywords
dynamic capabilities, change, cost-benefit, problem solving

Disciplines
Business Administration, Management, and Operations

This journal article is available at ScholarlyCommons: http://repository.upenn.edu/mgmt_papers/30

 Understanding Dynamic Capabilities

Sidney G. Winter

The Wharton School

Department of Management
2000 SH-DH, 3620 Locust Walk
The Wharton School
Philadelphia PA 19104-6370
winter@wharton. upenn.edu

November 2002

Acknowledgments: I am indebted to Tammy Madsen, Maurizio Zollo and participants in the

Wharton Technology Mini-Conference for comments on earlier drafts; remaining flaws are my
own responsibility. Research support from the Reginald H. Jones Center of the Wharton School
is gratefully acknowledged.

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 Abstract

Understanding Dynamic Capabilities

Sidney G. Winter

The Wharton School

Defining ordinary or “zero- level” capabilities as those that permit a firm to “make a

living” in the short term, one can define dynamic capabilities as those that operate to extend,

modify or create ordinary capabilities. Logically, one can then proceed to elaborate a hierarchy

of higher-order capabilities (Collis 1994). However, it is argued here that the strategic substance

of capabilities involves patterning of activity, and that costly investments are typically required

to create and sustain such patterning – for example, in product development. Firms can

accomplish change without reliance on dynamic capability, by means here termed “ad hoc

problem solving.” Whether higher order capabilities are created or not depends on the costs and

benefits of the investments relative to ad hoc problem solving, and so does the “level of the

game” at whic h strategic competition effectively occurs.

2
 Understanding Dynamic Capabilities

Sidney G. Winter

The Wharton School

Many strategy scholars remain skeptical about the value of the concept of “dynamic

capabilities.” While some see dynamic capabilities as the key to competitive advantage (Teece,

Pisano and Shuen 1997), others seem to doubt that there actually are such things. Still others

believe that they exist, but suspect that they are “born not made” – i.e., they doubt that deliberate

efforts to strengthen such capabilities are a genuine option for managers. And some believe that

while they are a genuine option, they are not necessarily something that confers competitive

advantage. This note seeks to reduce the mystery surrounding both the terminology and the

phenomenon. It identifies some key issues and argues that clarity is served by keeping these

issues distinct. As regards terminology, it offers a proposal that seems constructive – but of

course will really prove to be so only if it is widely adopted.

Routines and capabilities. Following my own proposal (Winter 2000), I begin by

founding the concept of organizational capability on the broader concept of organizational

routine: An organizational capability is a high level routine (or collection of routines) that,

together with its implementing input flows, confers upon an organization’s management a set of

decision options for producing significant outputs of a particular type. For present purposes, the

points deserving emphasis here are the connotations of “routine” – behavior that is learned,

highly patterned, repetitious or quasi-repetitious, founded in part in tacit knowledge – and the

specificity of objectives. Brilliant improvisation is not a routine, and there is no such thing as a

general-purpose routine.
 “Dynamic” connotes change. There is a broad consensus in the literature that “dynamic

capabilities” contrast with ordinary (or “operational”) capabilities by being concerned with

change. Collis (1994) is particularly explicit and formal in making the point that dynamic

capabilities govern the rate of change of ordinary capabilities. Following the example of the

differential calculus, he points to the existence of second order, third order, etc. dynamic

capabilities and explicitly makes the extension “ad infinitum.” This terminological approach is

adopted here, but with an important caveat as to whether higher order capabilities “exist” in an

interesting sense. From a logical point of view, the “existence” of higher order rates of change is

in question only in the mathematical sense that some derivatives might not exist; and from a

computational point of view, a time sequence of N+1 values of a variable suffices to compute

one value of the Nth order rate of change. But if dynamic capabilities are similar to capabilities

in that they involve patterned activity oriented to relatively specific objectives, then there is no

guarantee that the organizational processes governing high order change are highly patterned,

and substantial reason to think otherwise. In this important substantive sense, high order

dynamic capabilities do not necessarily exist. This point is pursued below.

The “zero level” in the capability hierarchy. Constants and technical issues aside,

everything is the derivative of its integral and the integral of its derivative. To make effective

use of the concept of a hierarchy of rates of change, we need a convention to identify the “zero

level,” the analogue of position for variables moving in space. Because capabilities are complex,

structured and multi-dimensional, this question may not have an answer that seems both clear

and compelling in all cases. There is, however, a heuristic guide available that conforms to

common sense and existing practice, at least for the capabilities of firms competing in markets.

Consider a hypothetical firm “in equilibrium”, an organization that keeps earning its living by

producing and selling the same product, on the same scale and to the same customer population

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over time. The capabilities exercised in that stationary process are the zero level capabilities, the

“how we earn a living now” capabilities. Without them, the firm could not collect the revenue

from its customers that allows it to buy more inputs and do the whole thing over again. By

contrast, capabilities that would change the product, the production process, the scale or the

customers (markets) served are not at the zero level. New product development, as practiced in

many firms, is a prototypical example of a first order “dynamic capability”. The capabilities that

support the creation of new outlets by McDonalds or Starbucks are another prototypical example,

focused on the domain of scale and (geographic) markets rather than product attributes. These

examples are prototypical because they unquestionably involve first order change, given the

definition of the zero level, and it is equally beyond question that they are highly patterned and

“routine” in many respects. Given the terminological framework under construction here, these

examples are a conclusive answer to anyone who doubts the “existence” of dynamic capabilities.

(Of course, their doubts may relate to a different understanding of “dynamic capability.”)

It is worth noting that the “zero level” is only locally defined. For a firm that does its

own R&D, the producing and selling the product is zero order activity. For an independent R&D

lab, developing new products is zero order activity.

There are many ways to change. It is quite possible to change without having a dynamic

capability. To begin with, change often occurs by force majeure from the environment,

predictably or not, for better or worse. Whether it is because such an external challenge arrives

or because an autonomous decision to change is made at a high level, organizations often have to

cope with problems they are not well prepared for. They may be pushed into “fire fighting”

mode, a high-paced, contingent, opportunistic and perhaps creative search for satisfactory

alternative behaviors. It is useful to have a name for the category of such change behaviors that

do not depend on dynamic capabilities – behavior that are largely non-repetitive and at least

3
“intendedly rationa l” and not merely reactive or passive. I propose “ad hoc problem-solving”.

Ad hoc problem solving is not routine; in particular, not highly patterned and not repetitious. As

suggested above, it typically appears as a response to novel challenges from the environment or

other relatively unpredictable events. Thus, ad hoc problem solving and the exercise of dynamic

capabilities are two different ways to change – or two categories comprising numerous different

ways to change.

Of course, close study of a series of “fires” may well reveal that there is pattern even in

“fire fighting.” Some of the pattern may be learned and contribute positively to effectiveness,

and in that sense be akin to a skill or routine. In organizational improvisation, as in jazz, creative

achievement typically rises from a foundation of patterned and practiced performance, a fund of

micro-patterns that are recombined and sequenced in creative ways (Miner, Bassoff and

Moorman 2001). Responses to highly dynamic environments may also be patterned at a higher

level, guided by adherence to relatively simple rules and structural principles (Eisenhardt and

Martin 2000). At the other end of the spectrum, even the most incremental effort at product

modification can run into unexpected snags that are beyond the scope of the dynamic capability,

and require a complementary dose of ad hoc problem solving. To acknowledge these points is

not, however, to concede that there is no difference between dynamic capabilities and ad hoc

problem solving; to say that would be to indulge in the “shades of gray” fallacy. For the

concepts and the contrast to be useful aids to understanding, it is not necessary that the pure

forms exist in the world, or even that we have high “inter-rater reliability” in sorting real cases

into only two conceptual boxes.

Contrasting cost structures. Dynamic capabilities typically involve long-term

commitments to specialized resources. The more pervasive and detailed the patterning of the

activity involved, the higher the costs of the commitments tend to be. The ability to sustain a

4
particular patterned approach to new product development, for example, depends to some extent

on continuity in the engineering personnel involved; there may be substantial continuity in

facilities and equipment as well. Similarly, an established replicator organization has a central

staff that is the locus of its ability to bring together real estate, design skills, construction,

equipment and furnishings, advertising campaigns, new employees, etc., and create a new outlet.

The size of that central capability determines the pace at which new outlets can be opened. For

these sorts of commitments to be economically sound, the capability must be exercised: to have a

dynamic capability and find no occasion for change is merely to carry a cost burden. On the

other hand, an aggressive search for such occasions may also be a mistake. Attempting too much

change – perhaps in a deliberate effort to exercise the dynamic capability – can impose

additional costs when the frequent disruption of the underlying capability outweighs the

competitive value of the novelty achieved. There is an ecological demand for balance between

the costs of the capability and the use that is actually made of it.

By contrast, the costs of ad hoc problem solving largely disappear if there is no problem

to solve. Many of those costs take the form of opportunity costs of personnel who have

alternative productive roles in the (zero level) capability. True, it is conceivable that a similar

pattern could obtain in an organization that had dynamic capabilities. This would mean that

people could step out of their zero-level roles and into their dynamic capability roles – their

learned, patterned change roles – and then step back again when change was completed. The

plausibility of this image is undercut by the “rustiness” problem: successful maintenance of a

skill or routine typically requires frequent exercise. Regardless of whether that objection is

decisive in itself, it seems that, in practice, prominent examples of dynamic capabilities generally

involve a lot of specialized personnel who are committed full time to their change roles, and

5
other types of investments as well. The contrast with the lighter cost burdens of ad hoc problem

solving is clear.

No “rule for riches” here. It should now be apparent that it is not necessarily

advantageous for a firm to invest in (first order) dynamic capabilities. Rivals who rely on ad hoc

problem- solving to accomplish change when needed are carrying a lower cost burden. If

opportunities for competitively significant change are sparse enough or expensive enough to

realize, then the added cost of dynamic capabilities will not be matched by corresponding

benefits on the average – even if an occasional notable success might suggest the contrary. Also,

if the change environment does sustain dynamic capabilities relative to ordinary capabilities

(plus ad hoc problem-solving), competition among many firms pursuing a similar dynamic

capabilities strategy may compete away the rents, because (e.g.) product markets are saturated

with rival innovations or because the salaries of scientists and engineers are bid up. A related

and long-familiar example of a disadvantageous dynamic capability is innovative R&D that does

not pay off in the presence of strong rivals who invest only in imitative R&D (See, e.g., Nelson

and Winter 1982.) The (descriptive) rule for riches is to occupy a favored and relatively un-

contested place in the ecology of behaviors – for example, by having a strong R&D unit when

others in the industry lack both innovative and imitative capabilities. While an individual actor

can exert some influence on that ecology, it may well have difficulty in identifying the favored

and uncontested niches, or in forestalling unfavorable change after such a niche has been

exploited for a while. Hence, the rule is of little prescriptive value.

Higher order capabilities. If exogenous change is “competence destroying” at the level of

first order dynamic capabilities, those who invest in routinizing the response to familiar types of

change may find themselves disadvantaged relative to more flexible players who have invested

in higher order capabilities. Deliberate investments in organizational learning may, for example,

6
facilitate the creation and modification of dynamic capabilities for the management of

acquisitions or alliance (Zollo and Winter 2002). Collis (1994) argues that the existence of

higher order capabilities provides a rebuttal to any claim that there is generally advantage to be

had from strength at any particular level of dynamic capability: there is always a higher level,

and in his view superiority at the higher level always “trumps” superiority at a lower level. Here,

the same skeptical conclusion about advantage rests on the alternative argument that ad hoc

problem solving is always a substitute for dynamic capability and may be economically superior.

Collis also makes, however, the related interesting suggestion that there is a historical tendency

for the locus of competitive action to rise in the capability hierarchy. Strategic innovation often

involves “changing the game” in a way that “takes it to a higher level” – a phrase that often

connotes a focus on strengthening higher order change capabilities. This notion appeals at the

descriptive level and there is clearly some logic to it. Knowledge advances cumulatively,

imitation spreads solutions around, and problems that are visible, urgent and recur at high

frequency tend to get solved before problems with the opposite attributes. But these

considerations do not suffice to make the progression to a higher “order” of competition a logical

necessity, since the levels differ in the cost-benefit bala nce of capability investments, and

exogenous change could at any time tip an existing balance in favor of lower order capabilities

supplemented by ad hoc problem solving. The argument for such upward progression is

therefore missing an appropriate assumption that restricts the character of exogenous change in

such a way as to assure that the investment in higher order capabilities tends to pay off, while the

cost-cutting move in the opposite direction does not. Just how such an assumption might be

framed is unclear, but the logic is incomplete without it.

Reprise. Probably some of the mystery and confusion surrounding the concept of

dynamic capability arises from linking the concept too tightly to notions of generalized

7
effectiveness at dealing with change and generic formulas for sustainable competitive advantage.

The argument here is that clarity is served by breaking this linkage. There is no way to hedge

against every contingency. There is no general rule for riches. That investing in dynamic

capabilities (of whatever order) can be a partial hedge against the obsolescence of existing

capability, and can sometimes yield relatively sustainable advantage, is obvious from the nature

of “dynamic capability,” as defined here. That this cannot be uniformly or inevitably

advantageous is equally obvious, from the meaning of “investing”: the thought experiment of

raising the costs while holding the gross benefits constant makes the net benefit disappear, and

certainly the world is capable of turning such a thought experiment into a real experiment. The

concept of dynamic capability is a helpful addition to the tool kit of strategic analysis, but

strategic analysis itself remains a matter of understanding how the idiosyncratic attributes of the

individual firm affect its prospects in a particular competitive context.

8
References

Collis, D. J. (1994). “Research note: How valuable are organizational capabilities?” Strategic
Management Journal 15 (Winter special issue): 143-152.
Eisenhardt, K. M. and J. Martin (2000). “Dynamic capabilities: What are they?” Strategic
Management Journal 21 (Oct-Nov (special issue)): 1105-1121.
Miner, A. S., P. Bassoff, and C. Moorman . (2001). “Organizational improvisation and learning:
A field study.” Administrative Science Quarterly 46: 304-337.
Teece, D., G. Pisano, and A. Shuen (1997). “Dynamic capabilities and strategic management.”
Strategic Management Journal 18: 509-533.
Nelson, R. R., and S.G. Winter (1982). “The Schumpeterian trade-off revisited.” American
Economic Review 72: 114-132.
Winter, S. G. (2000). “The satisficing principle in capability learning.” Strategic Management
Journal 21 (Oct-Nov (special issue)): 981-996.
Zollo, M., and S.G. Winter (2002). “Deliberate learning and the evolution of dynamic
capabilities.” Organization Science 13: 339-351.