Making use of the Dynamic Capabilities to deal with Complexity

ROSSATO, Jaqueline Matriculation number: 270405 Address: Friedrich-Naumann Str, 01 102.2 Telephone: +55 48 9612 5054 E-mail: inerossato@gmail.com ZULOAGA, Irati Alkorta Matriculation number: 868420 Address: Friedrich-Naumann Str, 01 001.2 Telephone: +34 627797004 E-mail: irate_alk@hotmail.com ALGUEL, Pinar Matriculation number: 770442 Address: Oberwirtstr.36, 65582 Diez Telephone: 0174/1724796 E-mail: pinaralguel@gmail.com

December, 21th 2011

Making use of the Dynamic Capabilities to deal with Complexity

Jaqueline Rossato, Irati Alkorta Zuloaga and Pinar Alguel Wiesbaden Business School, International Business Administration

Abstract

The market has become increasingly competitive and thus, the strategic behavior is no longer a matter of positioning of various physical activities over a chain, has become the organization's ability to reconfigure itself in order to meet complex environments. In this scenario, the dynamic capabilities approach has gained increasing attention in the literature and therefore there is a need to explore and discuss what we know about it. Thus, this paper aims to establish the relationship between the complexity and the ability of organizations to adapt to needs of the market and complex environments. To this we have made a research in different articles about complexity and dynamic capabilities. In conclusion, we understand that efficient use of dynamic capabilities can enhance the organizations' strategies to deal with complex environments and leverage the resources and organization capabilities in order to generate sustainable competitive advantage. Keywords: complex environments; managing complexity; dynamic capabilities 1 Introduction In many researches about management, one can find a prominent common theme explaining why management has become extremely difficult nowadays. The common theme is complexity that is supposed to have increased dramatically over the last years (Groler; Grubner; Milling, 2006). There are many factors that have contributed to the increasing complexity - globalization, tics, and higher competition. All this has leaded organizations to respond to internal changes in order to maintain its market position and ensure survival in the competition. As the market becomes more competitive, strategic behavior is no longer a matter of positioning of various physical activities over a chain, and becomes the organization's ability to reconfigure itself to meet rapidly changing environments. To this end, the need arises to

 explore and experience what is discussed about dynamic capabilities as a reinterpretation of the emergence of new ways to generate and maintain competitive advantage. During this study we support the proposal and acknowledge about the important role of dynamic capabilities as a source of sustainable competitive advantage in complex organizations. It is necessary to direct the on-going discussions between authors, researchers and scholars on the concepts and definitions of complexity and dynamic capabilities, believing that developing dynamic capabilities, is an alternative to deal with complex environments and leverage the resources and organization capabilities in order to generate sustainable competitive advantage over time. 2 Complexity The notion of complexity in business is an ill-defined concept. According Groler; Grubner; Milling (2006), the definitions of complexity can be derived from business administration literature but also from other fields of science, like philosophy, mathematics, information science, cybernetics and biology. Detail complexity can further be divided into three sub-components: number of elements in a system, number of connections between elements, and types of functional relations between elements (Milling, 2002). To understand what is complexity, Axelrod and Cohen (2000) define a complex system as a system where there are strong interactions among its elements, so that current events heavily influence the probabilities of many kinds of later events. Complex and complicated are terms which occur in our everyday lives when we try to find solutions to everyday problems. Some of these problems might be easy to resolve, however there also ones which need a higher degree of reflection. Speaking in colloquial terms, one would argue that these two terms are used in order to refer to actions, procedures or processes displaying an uneasy or difficult structure. However, when one takes a deeper look at the terminology, it becomes clear that the two terms cannot be used interchangeably. As the primary focus of this paper is complexity, the terms complex, complexity as well as complicated shall be defined in a more detailed way. According to the Oxford English Dictionary (OED), complex occurs as a noun, verb, and an adjective in our lexicon. Hence, in the context of a noun, complex refers to a whole comprehending in its compass a number, esp. of interconnected parts or involved particulars; a complex or complicated whole, whereas as an adjective it can either mean
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 something consisting of parts or elements not simply co-ordinated, but some of them involved in various degrees of subordination; complicated, involved, intricate; not easily analysed or distangled (OED 2009) or if for instance dealing with a complex item as something consisting of or comprehending various parts united or connected together, formed by combination of different elements; composite, compound (OED 2009). Accordingly, complexity results as the quality or condition of being complex, () a complicated condition, complication (OED 2009). In contrast to this, complicated occurs as an adjective that designates an object or an issue consisting of an intimate combination of parts or elements not easy to unravel or separate, involved, intricate, confused (OED 2009). However, Sargut and McGrath (2011) characterize complicated systems as having a high number of moving parts which operate in certain patterned ways. An example for this could be the procedures involved when an airplane flies as the different steps can be predicted when it comes to e.g. take-off and landing. In a more business-specific context, one can apply the definitions of complex systems provided by Axelrod and Cohen (2000:7), they define a complex system as a system where there are strong interactions among its elements, so that current events heavily influence the probabilities of many kinds of later events. They conclude thereof that the difference rests with interdependencies and the possibility of future events. Sargut and McGrath (2011) additionally underline that complex systems as well operate in patterned ways but that they differ from complicated systems as their interactions are continually changing. Added to this line of thought, a closer look at the term of complexity reveals three typical properties. These are multiplicity, interdependence, and, diversity. The number of potentially interacting elements is what is subsumed under the term multiplicity whereas interdependence describes how connected these elements are. Diversity as the third property refers to the degree of heterogeneity. Sargut and McGrath apply these three properties to the term complexity by mentioning that the greater the multiplicity, interdependence, and diversity, the greater is the complexity. An organic growth program for example or the payment business, for instance, is highly complex systems since they contain a tremendously high number of interactive, interdependent and diverse elements. To make this clearer, the reader can think of payments made by Visa and Mastercard. When booking a flight at one of the Star Alliance member airlines for example (e.g. Lufthansa, Austrian Airlines) different payment methods can be chosen in combination with the Miles& More point reward system depending on how you
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 pay. Besides the airline, the credit card company receives an annual cardholder fee and the vendor as well accepts a certain amount of money. As it can be seen, a variety of several business ecosystems interact in this context, thus resulting in a complex nature. In case a disruption occurs, it would cause problems for several parties. To sum up, complex and complicated systems work in different ways, because interdependence leads to specific consequences, due to an unpredictability of effects and nonlinearity. In other terms, the major difference between complex and complicated lies within the point that one can predict the results of complicated systems as they operate according to the same procedures and the same starting conditions. A complex system on the other hand disposes of the characteristic that the starting conditions are known but can lead to different outcomes, depending on the interactions of the elements as Sargut and McGrath (2011) argue. Always when we are speaking about a new investment, new decision and in sum about a new decision, we try hard to minimize the risk that this decision have. Living in a complex system, minimizing the risk is even a more important aspect. To do this, managers should be able to: (1) limit or even eliminate the need for accurate predictions (sometimes is necessary to eliminate or at least minimize the volume of predictions); (2) use decoupling and redundancy (in this context decoupling means to try to separate the elements of a system one from other); (3) draw on storytelling and counterfactuals (imagination and reflection are important aspects); and (4) triangulate (to finish with the ways that we can minimize risk we have triangulation). There are two main strategic that can help to a manager to take the best decision about the tradeoff that is going to do. These strategic are: (1) Take a real-options approach - the main idea of this strategy is to make small investment that in a future will give the chance to continue investing on them but on the other hand this future investment are not going to be compulsory, and (2) ensure diversity of thought: In our opinion the basic of this second strategy is very related with the concept of Triangulate. To have the chance to use different methodologies, different processes and different ways to see the thinks, it is very important that a company is composed by people that think in different way. There is diversity in the way of thinking. This will help to the company to be able to face the changes and unexpected situations that will happen. So it is very important the capacity of a company to find the adequate employees, the adequate thinkers.

 The problem commonly faced by managers of complexity systems is making sense of a situation. Many times, it is hard to observe and grasp the tremendous array of relationships from a perspective as one cannot be omniscient due to cognitive limits. Thus, Sargut and McGrath (2011) underline that focusing on one thing can prevent from seeing others. Furthermore, they mention the problematic nature of particularly rare events because they do not occur repetitively enough. This problem emphasized that complexity puts various challenges to managerial activity. Forecasting the future, making tradeoffs, as well as mitigating risks are tasks managers need to face when seeking to manage complexity. In this scenario that dynamic capabilities emerges as an alternative to deal with complex environments and leverage the resources and organization-capable in order to generate sustainable competitive advantage over time. Therefore it is necessary to know and explore what is discussed on the subject. 3 Dynamic Capabilities The concept of dynamic capability (Eisenhardt, Martin 2000, Teece et. al., 1997) evolved from resource-based view (Barney 1991, Wernerfelt, 1984) with the intention of explaining how and why some companies have competitive advantage in rapidly changing markets and unpredictable. Thus, as defined by Teece, Pisano and Shuen (1997), as "the ability of the company has to reconfigure, redirect, transform and shape their skills properly and its internal and external resources to meet the challenges of rapidly changing market." In 2007, Teece addresses the dynamic capabilities in three distinct capacities: (1) sensing - the ability to sense market opportunities and threats, (2) Seizing - ability to take advantage of the opportunity and, (3) managing and transforming - the ability to remain competitive by improving, combining, reconfiguring and protecting the organization's business. One of the pioneering works, the most recognized and quoted on dynamic capabilities, is the work of Teece, Pisano and Shuen (1997). However, more than 10 years have passed since the publication, but the issue continues to attract the attention of management scholars and practitioners from around the world (Easterby-Smith, Lyles, Peteraf, 2009). Part of this interest is due to be closely associated with the resource-based theory (Barney 1991, Peteraf,

 1993; Wernerfelt, 1984), where the focus is on key issues such as skills and business performance. Thus, it is important to know what is discussed in the literature on dynamic capabilities for both follows in Table 1, which presents the main concepts and definitions on the subject.

DYNAMIC CAPABILITIES Main Contributions Teece; Pisano (1994) Collins (1994) Definitions of Dynamic Capabilities "Subset of skills or capabilities that enable the company to create new products and processes, thus responds to changing market circumstances." There are certain organizational capabilities that drive the exchange ratio of common resources. He argues that the ability to change the organizational resources is a story of strategic routines by which managers alter the resource base of the company (purchase and shed resources, integrate and combine them all together) to generate new strategies for creating value. They feature the "Architectural Skills" as they are the architects behind the creation, evolution and recombination of resources in search of new sources of competitive advantage. "The Dynamic Capabilities allow companies to create new products and processes and respond to changing market conditions." "Ability of the company to integrate, build and reconfigure internal and external skills to adapt to the rapidly changing environments." Like, "reflect the organizational ability to achieve new and innovative forms of competitive advantage." "Capabilities that can be used as platforms, from offering new products, goods and services when change is the norm." "The ability of companies to innovate and adapt to changes in technologies and markets, including the ability to learn from mistakes." "The competitive advantage of a company is derived from the company's strategic response to changing environments or new information about opportunities to benefit." Organization's ability to "make the necessary changes" when "faced with the need to change (defined by environmental contingencies and organizational), which results in a greater benefit." "It consists of strategic and organizational specific processes (such as product development, alliances and strategic decision making) that create value in companies operating in dynamic markets by manipulating resources into new strategies for value creation." Use the term "Continuing Metamorphosis" to refer to "profound changes" that takes place within the company to change the "dynamic adjustment of the company's resources and external factors associated with a changing environment." Shows the "importance of an alternative mechanism for generating income (Schumpeterian) called construction capabilities, different feature selection" (obtaining Ricardian rents). The Global Dynamic Capabilities consist in creating combinations of resources difficult to imitate, which includes coodenaao effective inter-organizational relationships on a global basis that can provide a company a competitive edge. "The dynamic capabilities are designed to rise in sustainable competitive advantage in rapidly changing Schumpeterian regimes." 7

Pisano (1994)

Henderson; Cockburn (1994) Helfat (1997) Teece; Pisano; Shuen (1997) Zahra (1999) Helfat; Raubitschek (2000) Cockburn; Henderson; Stern (2000) Zajac; Kraatz; Besser (2000)

Eisenhardt; Martin (2000)

Rindova; Kotha (2001)

Makadok (2001) Griffith; Harvey (2001) Lee et al. (2002)


Zollo; Winter (2002) Zahra; George (2002) Aragn-Correa y Sharma (2003) Winter (2003) Helfat; Peteraf (2003) Learned pattern of collective activity through which the organization systematically generates and modifies its operating routines to achieve greater profitability. "They allow the company to reconfigure their resource base and adapt to market conditions in order to achieve a competitive advantage." If you deal with skills that arise from the implementation of "proactive estrtgias" that allow the organization to align with changes in the global business environment. Describes the Dynamic Capabilities and organizational capabilities (high-level routines or set of routines) affected by the change and that "can change the product, production process, scale, or customers (markets) attended. "By definition, the dynamic capabilities require adaptation and change, because they build, integrate and reconfigure other resources or capabilities." "The ability to reconfigure resources and routines of a company as established and considered as the most appropriate for its main decision-maker" ... "Presence of rapidly changing problems" for which the company has "the ability to change the way that solves their problems (dynamic capacity of a higher order of change capacity )"... through "dynamic ability to change, reconfigure their existing organizational capabilities." "Capabilities of the company, difficult to imitate, needed to adapt to customer demands and new technological opportunities. It also includes the company's ability to configure the environment in which it operates, develop new products and processes and design and implement viable business models". "Capacity (inimitable) with which the company has to form, reform, configure and reconfigure its asset base to respond to changes in markets and technologies." "Orientation behavior of the company for continuous integration, reconfiguration, refurbishment and rebuilding of their resources and capabilities and, more importantly, the increment and reconstruction of their core capabilities in response to a changing environment in order to sustain competitive advantage." "It refers to the ability of organizations to develop and seek new resources and configurations that fit the changing market conditions." "It refers to the ability of companies to maintain or create value by developing and deploying internal competencies to maximize consistency with the requirements of a changing environment."

Zahra et. al. (2006)

Teece (2007)

Augier; Teece (2007)

Wang; Ahmed (2007)

Ng (2007) Oliver; Holzinger (2008)

Table 1 - Key concepts and definitions of dynamic capabilities Source: Compiled by the authors

For Helfat and Peteraf (2009), a dynamic capability is a theory or an approach that has developed and has attracted the attention of many researchers in the field of organizational strategies. There is a lack of empirical studies and it takes a while to achieve robust ones. The complexity of the topic or the gaps have not been limiting factors for studies in a specific area, just the opposite they have motivate new research and, more importantly, serve to raise discussions about management change, strategy and sources of competitive advantage. Therefore, this article seeks to contribute to the area of organizational studies to present the main concepts and definitions of dynamic capabilities and promote a discussion on how organizations and their decision makers have evolved in their thinking and conduct
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 business in constant search for obtaining and maintaining sustainable competitive advantage, and also in environments of rapid change. However, Menon and Mohanty (2008), confirm that the development, use and maintenance of dynamic capabilities are important and necessary for the proper performance of organizations, particularly in environments of rapid change, however, is not sufficient condition or guarantee sustainable competitive advantage. It is noteworthy that this study did not seek to restrict or exhausting all the attributes that could be found within the different perspectives found in the literature on dynamic capabilities. However, the survey of the literature is justified by the need and emergence of the theme for the field of strategy and organizational studies. 4 Conclusions: Capabilities to Managing Environmental Complexity Complexity and dynamic capabilities can be related in an strong way. Concerning to dynamic capabilities we have said that sensing is the ability that organizations should have in order to be able to sense the opportunities and threats of the market. Furthermore, making sense of the situation is one of the main problems of complexity. Here is a big reason, to think that if an organization is able to develop dynamic capabilities, then his ability of sensing will be higher and consequently will be stronger in front of the complex environment. In this context, ensuring a diversity of thought will increase the possibility of sensing the environment as it is. In addition, drawing on storytelling and counterfactuals and creating different scenarios also help to choose the right way. If an organization is able to develop seizing, the second main point of dynamic capabilities, will have develop an ability to take advantage of the best opportunities. This will lead to a decrease in the possibility to make wrong decision, or a decrease of failures. A constant adaptation and reconfiguration of the system is also need in order to be able to answer or respond to all the needs (new and old) that exist on the market. Managing and transforming, the third main pillar of the approach of dynamic capabilities will help to the organization to remain the competitive advantage. Organizations should be able to adapt all their system to the complex environment. All resources, employees, all services that they offer should be ready in order to continue alive.

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