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PERSPECTIVE A dynamic capabilities-based entrepreneurial theory of the multinational enterprise David J Teece Institute for Business Innovation, Haas School of Business, UC Berkeley, USA Correspondence: DJ Teece, Berkeley Research Group, 2200 Powell Street, Suite 1200, Emeryville, CA 94608, USA. Tel: +1 510 285 3300; Fax: +1 510 285 3271; email: [email protected] Received: 15 December 2011 Revised: 27 August 2013 Accepted: 31 August 2013 Abstract This paper develops a dynamic capabilities-based theory of the multinational enterprise (MNE). It first reviews scholarship on the MNE, with a focus on what has come to be known as internalizationtheory. One prong of this theory develops contractual/transaction cost-informed governance perspec- tives; and another develops technology transfer and capabilities perspectives. In this paper, it is suggested that the latter has been somewhat neglected. However, if fully integrated as part of a more complete approach, it can buttress transaction cost/governance issues and expand the range of phe- nomena that can be explained. In this more integrated framework, dynamic capabilities coupled with good strategy are seen as necessary to sustain superior enterprise performance, especially in fast-moving global environ- ments. Entrepreneurial management and transformational leadership are incorporated into a capabilities theory of the MNE. The framework is then used to explain how strategy and dynamic capabilities together determine firm-level sustained competitive advantage in global environments. It is suggested that this framework complements contract-based perspectives on the MNE and can help integrate international management and international business perspectives. Journal of International Business Studies (2014) 45, 837. doi:10.1057/jibs.2013.54 Keywords: transaction cost theory; transaction cost economics, or transaction cost analysis; internationalization theories and foreign market entry; competitive advantage; dynamic capabilities and capability development; entrepreneurship business strategy; intellectual capital The online version of this article is available Open Access INTRODUCTION A multinational enterprise (MNE) is a business rm that sets strategy and manages operations for the development and utiliza- tion of income-generating assets in more than one country in the pursuit of prots over time. A robust theory of the business enterprise ought to be able to provide insight into global scope, network characteristics, and the basis of sustained competitive advantage (SCA), if any. Accordingly, the study of international business should not be divorced from the study of international management, and the theory of the MNE should not be a distant cousin to the theory of the business enterprise more generally. However, incomplete global integration and the existence of heterogeneous national economies and geographies leave special issues and considerations that a theory of the MNE must embrace, but hasnt yet done so. Journal of International Business Studies (2014) 45, 837 © 2014 Academy of International Business All rights reserved 0047-2506 www.jibs.net

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PERSPECTIVE

A dynamic capabilities-based entrepreneurialtheory of the multinational enterprise

David J Teece

Institute for Business Innovation, Haas School ofBusiness, UC Berkeley, USA

Correspondence:DJ Teece, Berkeley Research Group,2200 Powell Street, Suite 1200, Emeryville,CA 94608, USA.Tel: +1 510 285 3300;Fax: +1 510 285 3271;email: [email protected]

Received: 15 December 2011Revised: 27 August 2013Accepted: 31 August 2013

AbstractThis paper develops a dynamic capabilities-based theory of the multinationalenterprise (MNE). It first reviews scholarship on the MNE, with a focus onwhat has come to be known as “internalization” theory. One prong of thistheory develops contractual/transaction cost-informed governance perspec-tives; and another develops technology transfer and capabilities perspectives.In this paper, it is suggested that the latter has been somewhat neglected.However, if fully integrated as part of a more complete approach, it canbuttress transaction cost/governance issues and expand the range of phe-nomena that can be explained. In this more integrated framework, dynamiccapabilities coupled with good strategy are seen as necessary to sustainsuperior enterprise performance, especially in fast-moving global environ-ments. Entrepreneurial management and transformational leadership areincorporated into a capabilities theory of the MNE. The framework is thenused to explain how strategy and dynamic capabilities together determinefirm-level sustained competitive advantage in global environments. It issuggested that this framework complements contract-based perspectives onthe MNE and can help integrate international management and internationalbusiness perspectives.Journal of International Business Studies (2014) 45, 8–37. doi:10.1057/jibs.2013.54

Keywords: transaction cost theory; transaction cost economics, or transaction costanalysis; internationalization theories and foreign market entry; competitive advantage;dynamic capabilities and capability development; entrepreneurship business strategy;intellectual capital

The online version of this article is available Open Access

INTRODUCTIONA multinational enterprise (MNE) is a business firm that setsstrategy and manages operations for the development and utiliza-tion of income-generating assets in more than one country inthe pursuit of profits over time. A robust theory of the businessenterprise ought to be able to provide insight into global scope,network characteristics, and the basis of sustained competitiveadvantage (SCA), if any. Accordingly, the study of internationalbusiness should not be divorced from the study of internationalmanagement, and the theory of the MNE should not be a distantcousin to the theory of the business enterprise more generally.However, incomplete global integration and the existence ofheterogeneous national economies and geographies leave specialissues and considerations that a theory of the MNE must embrace,but hasn’t yet done so.

Journal of International Business Studies (2014) 45, 8–37© 2014 Academy of International Business All rights reserved 0047-2506

www.jibs.net

The theory of the firm has long contendedwith issues such as why firms exist and whatdetermines their boundaries. More specifically,a robust theory of the firm should also be able toexplain:

(1) why some firms grow and go global while somefirms stay domestic;

(2) the product, as well as geographical identity andscope, of the firm’s activities1;

(3) market-entry timing and mode; and(4) explain the drivers of foreign direct investment

(FDI) and the role of subsidiaries.

Most critically, an acceptable theory of the MNEshould be able to provide insight into how theenterprise builds and protects SCA.2

This paper endeavors to fill voids and inadequaciesin the theory of the MNE and competitive advantageby drawing on scholarship on organizational cap-abilities,3 business strategy, and entrepreneurship.One goal is to bring greater cohesion to the field ofinternational business by securing convergencebetween “internalization scholars” and what I willcall “international management scholars”, such asBartlett, Ghoshal, and Doz, who have come to eschewinternalization theories in favor of other approaches.Another goal is to bring greater integration with thefield of strategic management, which also claims tohave something to say about the SCA of global firms.A third goal is to respond to the challenge of severalscholars to bring the international business literatureinto better contact with entrepreneurship theory.Mark Casson (1986b: 54) some time ago called for a“dynamic theory of countries’ advantages using theeconomic theory of the entrepreneur”.4 Jones andWadhwani (2007: 2) likewise recognized the oppor-tunity and the need to employ “an entrepreneurialperspective to deepen our understanding of aspects ofthe history of global capitalism”.A final goal is to integrate economic, organiza-

tional, and entrepreneurial theories of the firm bydemonstrating how both governance and entrepre-neurship/capabilities perspectives are needed toshed light on the nature of the MNE, and thefoundations of SCA.5 I agree with my UC Berkeleycolleague Oliver Williamson that capabilities andgovernance perspectives are “both rival and comple-mentary … more the latter than the former”(Williamson, 1999: 1106). I also submit that thecapabilities view encompasses governance/contrac-tual views and can provide the framework withinwhich governance/transaction cost minimizationdecisions take place.6

These four goals constitute an ambitious, multi-disciplinary agenda. That agenda transcends thedeep theoretical issues addressed by Frank Knight(1921) and by Nobel Laureate Coase (1937).7

The structure of the paper is as follows. It beginswith a review of a number of early approaches to thetheory of the MNE, and then identifies variousshortcomings, with attendant hints as to how onemight amend these deficiencies. The direction oftravel is toward a capabilities theory, which is embel-lished as the paper evolves. The framework is thenapplied to classic MNE questions, and exploratoryinsights are reviewed. The paper builds upon earlierefforts to bring capabilities into the theory of theMNE (Augier & Teece, 2007, 2008; Pitelis & Teece,2010; Teece, 2006a). Because of the richness inexisting theories in the field of international busi-ness and prior efforts to bridge some of the divides(e.g., Rugman & Verbeke, 1992, 2003), there isplenty of good scholarship to draw upon and toincorporate into the capabilities/entrepreneurshipframework, thereby hopefully creating amore robustand integrative theory of the MNE, while simulta-neously blurring the lines between the internationalbusiness and international management literatures.

CONTEMPORARY THEORIES OF THE MNEThe internalization perspective has dominatedmuch of the literature on the MNE over the past 30years (Dunning & Lundan, 2008). This perspectiveattempts to explain the reasons for internationalproduction and the phenomenon of the MNE byappealing to “market failure” considerations. Such“failures” help explain why firms internalize transac-tions across national borders. However, the perspec-tive does not address the reasons for differential firmperformance.8

The internalization perspective is arguably morerobust than the earlier Hymer–Kindleberger para-digm. The former is substantially an efficiency-basedexplanation of FDI and the MNE; the latter a marketpower explanation. While Hymer (1968) did note inone article a specifically Coasian justification forinternalization, he was deeply wedded to standardtheories of the firm, and to the Mason–Bain struc-ture–conduct–performance paradigm of industrialorganization (Dunning & Pitelis, 2008). Hymer’sanalysis became impaired when he quickly movedfrom determining that the MNE had special advan-tages to asserting that the exploitation of its mono-poly power and monopolistic advantages was themain reason for its existence and evolution, and was

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therefore something to be regulated or otherwiselimited by government controls (Teece, 1981a).9

The internalization school advanced understand-ing of the MNE beyond where Hymer left it, not leastby emphasizing market failures due to contractingproblems. This led to an efficiency-based explana-tion of the MNE. There are two prongs (rationales) tointernalization:

(1) transaction costs/hold-up issues that are avoidedby internalization; and

(2) resource transfer cost savings and learningissues, which are facilitated when technologytransfers occur inside the MNE.

The first prong was advanced by Buckley andCasson (1976), Dunning (1981), Rugman (1981),Teece (1975, 1976, 1981a), Williamson (1981),and others. This particular internalization “school”sees contractual issues and associated market fail-ures as the crucial reason for internalization. Thisclass of papers can be thought of as representingthe transaction-cost-based, comparative-governance-based, or exchange-based theory of internaliza-tion.10 Early contributions in this vein (e.g., Casson,1979) explicitly viewed it as a two-way street, notingthat internalized transactions could, when circum-stances warranted, be externalized (outsourced), butthat awareness has generally given way to a narrowerfocus on what firms choose to integrate.Buckley and Casson’s (1976) work was the most

thorough early attempt in this genre to extendCoase’s (1937) paper into the global context. Theyargued that MNEsminimized transaction costs result-ing from the public goods aspects of some intermedi-ate, mostly intangible, assets via global coordinationand themanagerial control of these assets. This prongof the internalization school examined the relativeadvantages associated with different entry modes(e.g., exports, licensing, and FDI). In this same vein,Hennart (1982) explored conditions under whichinternational interdependencies could be dealtwith in a transaction-costs-efficient manner throughemployment contracts, rather than arm’s length mar-ket transactions. Rugman (1981) also highlighted therole of MNEs in overcoming market imperfections ininternational markets.11 This version of the internali-zation paradigm has become so pervasive that MarkCasson could quite correctly claim that by the mid-1980s “the modern theory of the MNE is essentially ageneral theory of contractual relations in interna-tional business” (Casson, 1986a: 6).The second and relatively neglected prong to

internalization does not see its essence as resulting

from transaction costs saved because hold-up risksare abated. Rather, it emphasizes the common(organizational) culture of an integrated enterpriseand the ease of coordination inside the firm, ascompared with coordination through the market.Besides easing potential contractual problems, inte-gration opens pathways to learning, and to sharingknow-how and expertise through cross-border tech-nology and know-how transfer within the MNE. Inthis view, the MNE also provides for easy inter-change of personnel across borders, and for betterappropriability and trade secrecy. It thus mitigatesintellectual property concerns, too, since technol-ogy transfer is to wholly owned business units andnot to third parties, purportedly yielding greatercontrol.In this second prong of the theory, facilitating

opportunity identification, personnel exchanges,learning, integration, and assisting in technologytransfer are likely to be very important, and cannotall be squeezed under the rubric of economizing ontransaction costs. The essence of the MNE in thisprong of the literature is less about saving on trans-action costs and more about being entrepreneurialand effective in the development, transfer, andorchestration of differentiated organizational andtechnological capabilities (Teece, 1981a). Cantwell(1989) developed a variant of this prong and called itthe “industrial dynamics” and technological accu-mulation perspective, as it moved the focus awayfrom industrial structure toward industrial evolutionin which FDI led to the generation of “fresh techno-logical advantages” abroad and at home (2).This second prong has evolved into a knowledge-

based approach to the MNE. Somewhat in the spiritof Teece (1976, 1977a, 1981a), Kogut and Zander(1992) saw the MNE as an instrument for generatingand harboring tacit and explicit knowledge, and fortransferring technology and industrial know-howacross borders. In these formulations, the expansionof enterprise boundaries required and facilitated thetransfer of knowledge. Internal knowledge transac-tions are preferred, not primarily for transaction costreasons, but because of the lower resource costs oftransmitting knowledge internally vs across a market(Tallman, 2003; Teece, 1976, 1977a). In Kogut andZander’s model, opportunism is rejected as anongoing factor because firms exist to provide a socialcommunity supporting voluntaristic actions.Both prongs of internalization provide important

and relevant insights into the MNE. Cantwell (1989)was early to recognize the need to combine con-tractual frameworks with a theory of capability

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development. Notwithstanding his early contribu-tions, international business scholarship has left cap-abilities considerations underdeveloped, to itsconsiderable detriment (e.g., Birkinshaw & Hood,1998; Cantwell, 2009; Langlois, 2007). Because ofthe shortcomings of the first prong set out in the nextsection, the time is now ripe for the second prong (i.e., capabilities) to be strengthened, augmented withentrepreneurial considerations, and linked to a trans-action-cost-based comparative governance perspec-tive.12 Once this is accomplished, the second prongought to be sufficiently robust to serve as the structurewithin which the transaction cost perspective can benested.

SOME SHORTCOMINGS OF NAKEDTRANSACTION-COST-BASED THEORIES OF THE

MNEIn this section, I first highlight some shortcomings ofthe quasi-neoclassical transaction-cost-comparativegovernance perspective, and then provide hints asto how these can be remedied.13 Subsequent sec-tions aim to provide a combined entrepreneurial/capabilities conceptual perspective within whichtransaction costs can be contained.

Capabilities and Learning UnexploredEarly contributions to internalization, such as Hymer(1976), Buckley and Casson (1976), and, to someextent, Williamson (1981), drew to varying degreeson neoclassical marginal analysis and ignored orunderplayed the importance of dynamics and, inparticular, learning and capability augmentation.Even when the framework was broadened to includeadditional phenomena, capabilities and learning wereneglected. For instance, in explaining the boundariesof the MNE, John Dunning (1995) suggested thatownership and location matter along with internali-zation factors (his OLI model). Buckley and Casson(1998) seemed to accept these elements, too. In sub-sequent work, moreover, Buckley and Casson haveendeavored to address dynamics, innovation, flexibil-ity, real options, international entrepreneurship, jointventures and cultural issues. They have not, however,embraced issues of capabilities in a robust manner.Buckley (forthcoming) summarizes this impressivework and explains why behavioral and sociologicalviews are hard to integrate with internalization, asthey do not follow the rational choice axioms. Whilethe challenge is considerable, the goal (theoreticalintegration) is attainable. Earlier work by Teece (1982)shows that transaction-cost-type and capabilities-type

theories can coexist. Furthermore, one possibleinterpretation of the ownership factor in Dunningis that it is a proxy for capabilities (albeit a static one,particularly in early iterations of the OLI model).14 Itis clear that initial steps toward a capabilitiesapproach have already been taken.However, even if Dunning’s ownership factor is

interpreted as embracing firm-specific factors andnational institutions (systems of innovation and pro-duction), and even if the ownership factor is acceptedas a proxy for firm-level capabilities, there is stilla dearth of theoretical structure and content aroundtheir nature, origins, orchestration, replicability/transferability, and imitability. This is becauseneither transaction-cost-based internalization theorynor OLI explains very well the sources of firm-levelasset ownership and capability advantages vis-à-viscompetitors. While capabilities are obviously builtin large part through learning, the O factor in Dunn-ing has little to say about that (Pitelis, 2007).15 Itis important to recognize that learning is a keymechanism by which firm-specific assets develop.16

In more recent writing, Dunning and Lundan usethe path-dependent resources and capabilities of afirm and its institutional infrastructure to explaindynamic growth, and highlight the need to link themicrostructure of capabilities to the evolution of the(institutional) macrostructure (Cantwell, Dunning, &Lundan, 2010; Dunning & Lundan, 2008). Althoughthis recent scholarship has been helpful in enhancingour understanding of the dynamics of the internaliza-tion process of firms, large gaps nevertheless exist.The theory of technological accumulation discussedin Cantwell (1989) remains an important mechanismby which firms build technological capabilities. How-ever, given the ever-greater global dispersion of tech-nology, reliance on in-house R&D as the sole basis ofcompetitive advantage is no longer tenable. Technol-ogies from both within and beyond the enterprisemust be orchestrated effectively to achieve timelydelivery of differentiated products and servicesthat customers value (Augier &Teece, 2007; Pitelis,2004).

Cross-Border Market Creation and Co-CreationIgnoredMarket creation and co-creation are both entrepre-neurial and dynamic concepts that have always beenseminal functions of the MNE. However, marketcreation and co-creation have been largely ignoredin the first (transaction cost) prong of the internali-zation literature. These activities are very differentfrom market-entry mode selection decisions, upon

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which MNE theory has in recent decades put somuch emphasis (e.g., Brouthers, 2013; Hennart,2009; Zahra, Ireland, & Hitt, 2000).The transaction cost approach to internalization

theory has focused on entry mode – such as procure-ment/supply contracts, joint ventures, and whollyowned subsidiaries. To explain entry mode, transac-tion cost theory implicitly assumes preexisting mar-kets, which “fail” under certain conditions (e.g.,where asset specificity or complex know-how trans-fers are involved), necessitating the emergence of theMNE and FDI to address these failures by internaliz-ing (under a management structure) transactionsthat would otherwise likely evolve in an unfavorableway for one of the parties. However, it has long beenrecognized that the market failure assumption ismerely an analytic convenience. Markets only failrelative to a hypothetical perfect market, whichrarely exists. Infatuation with market failure and thefunctions (or lack thereof) of markets has deflectedattention away from more important issues aroundthe very existence of markets. Market creation andco-creation functions are not merely a response to amarket that has somehow failed to perform (relativeto an idealistic standard). Rather, it is often the casethat the market has quite simply failed to emergeand/or needs to be created or co-created (Pitelis &Teece, 2010) by entrepreneurially managed businessenterprises.17

Put differently, even if markets do exist, they maybe very thin or otherwise imperfect. This is particu-larly true for more specialized, idiosyncratic, anduncertain demand-and-supply requirements andopportunities.18 Hence, rather than solving transac-tional difficulties by simply internalizing all activity,entrepreneurial MNE managers must often considerwhat is tantamount to creating markets for ideas orfor products, and bolstering the capabilities of sup-pliers in order to have markets they can sell into orfrom which they can source raw materials andcomponents. A market creation and co-creationview of the MNE is obviously rather different fromcontractual approaches.19

It follows from the above that the rationale for theMNE is not just to achieve efficiencies (relative to someexternal benchmark) from internal transfers of tech-nology and intermediate products, but also to createandmanage co-specialization and, if need be, to createnew markets and expand old ones. Indeed, it isrecognized elsewhere in this paper that a prime reasonwhy MNEs exist is that their cross-border pres-ence, entrepreneurial capacities, and organizationalcapabilities are integral to the market creation and co-

creation process, both upstream and downstream, andalso laterally.Some consideration of market creation is already

present in Casson’s important work on entrepre-neurship (Casson, 1982, 1997, 2005). However,market-making in his theory is rather neoclassical,overly focused on individual action, and notlinked very well to the MNE. In particular, Casson’sapproach does not seem to recognize the importanceof the capabilities of the enterprise and its manage-ment in shaping markets, influencing trends, shap-ing demand, and assembling the complementsneeded for new markets to be viable.The reality that needs to be reflected in the theory

is that entrepreneurial MNEs can help build the newecosystems within which global firms operate. MNEsfacilitate investment in complements and otherinfrastructure needed for new products to belaunched successfully. By investing in complements,MNEs can enhance the vitality of particular businessecosystems. Ecosystems are thus partly endogenous,as they are often co-created by (global) companies.20

This is in contrast to Porter (1980, 1985) and the basicindustrial economics model, which has the industryas the domain of analysis, and market structuredetermined exogenously. In this paper, the conceptof ecosystems (not the industry) is advanced as theappropriate domain for competitive analysis.

Entrepreneurship Suppressed, EquilibriumAssumed, Management Muted, LeadershipIgnoredThe Coasian view of the firm has resources allocatedand decisions made by a manager who internalizestransactions until an indifference point is reachedwhere the marginal cost of internalization is equal tothe marginal cost of relying on the market. Theseperspectives employ neoclassical tools (bothmarginalanalysis and equilibrium concepts) to explain man-agement behavior and the nature of the enterprise.Moreover, factors of production and technology aregiven, and prices are (implicitly) known. The eco-nomic problem (or business model choice) becomesone of whether to engage in market exchange or in(vertical) integration. In a cross-border context, thelatter implies FDI.21 In the Coasian firm, there is atbest a modest role for the manager, no room for theentrepreneur, and no need for the leader.Williamson (1981, 1985) extended Coase by dee-

pening the contractual underpinnings of the trans-action cost framework. In so doing, he created apredictive model of firm boundaries by featuring therole of asset specificity. In Williamson’s contractual

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schema, bounded rationality coupled with uncer-tainty leads to an inordinate number of potentialcontingencies, which in turn render complete con-tingent-claims contracting impossible. Contracts aretherefore necessarily incomplete. This in turn leadsto recontracting hazards. These are mitigated, if noteliminated, by internalization. Location issues arenot addressed, except indirectly (i.e., inasmuch asthey impact transaction cost).22

In short, in endeavoring to build a theory of thefirm, neither Coase nor Williamson focused on theimportant role the business enterprise plays in search-ing for and/or developing new opportunities, eitherat home or abroad. Nor did they feature learning orleadership. Rather, the evolution of the enterprise(including the MNE) is due, in these frameworks, tomanagement’s desire to minimize transaction costs,and in particular to guard against opportunism.Opportunity, on the other hand, is almost completelyneglected.Organizational change is also missing. What lim-

ited change there is – Williamson’s “fundamentaltransformation” being perhaps the main exemplar –is not due to entrepreneurship or innovation. Rather,it arises from past investments that are “held up” (i.e.,rent is extracted) because of extortionate recontract-ing by opportunistic contractual partners who takeadvantage of changes in bargaining positions onceidiosyncratic investments have been made.Put differently, internalization theories, to the

extent to which they rely on Coase and Williamson,posit ubiquitous contractual problems, which inturn lead to “market failures”. Internalization over-comes these problems primarily by changing gov-ernance structures. Entrepreneurial and managerialfunctions such as opportunity discovery, learning,and knowledge creation play almost no role in theiranalyses. Neither entrepreneurship nor leadership isneeded or featured.In reality, however, entrepreneurs and entrepre-

neurial managers working in an organizational con-text discover and create new knowledge and helpcommercialize new technologies at home andabroad. They learn about new opportunities, andsometimes help create them and transfer technolo-gies as needed. Because the market for information/knowledge about new opportunities (Gans & Stern,2010; Teece, 1981b) isn’t well developed, entrepre-neurs and managers must build organizationalcapabilities inside businesses firms to assist in knowl-edge creation and knowledge capture (Teece, 1986b,2006b). To be effective, such firms often need to beglobal in scope. The neglect of these entrepreneurial/

managerial functions in the theory of the firm wouldappear to be a serious omission.23 The neglect of therole of the leader, particularly in organizationaltransformation, is equally serious.

“Control” Follows Ownership of (Foreign)Subsidiaries; Inter-Firm Relationships EnigmaticMost “governance”-based theories of FDI implicitlyassume, or explicitly state (e.g., Hennart, 2010), thatstrategic control comes through ownership andresides with the parent, that getting incentives rightis not only necessary but sufficient to achieve align-ment of goals and economic efficiency, and thatsubsidiaries are just that. In isolation, and puttingfinancial constraints to one side, this view of theMNE tends to see the wholly owned subsidiaries asthe preferred organizational form, because protect-ing specific assets from recontracting hazards is themain purpose of the MNE.24

In reality, the common ownership of businessunits doesn’t eliminate incentive problems, nor doesit necessarily achieve control. This is particularlytrue in the MNE context, where the identification ofhost countries’ employees with the MNE shareholderis less than perfect. This is well recognized by interna-tional business scholars; but the internalization the-ory of the MNE struggles to find an elegant way totake this into account. If asset ownership is neithernecessary nor sufficient for incentive alignment, asHelper and Sako (2012) suggest, then internalizationtheory must somehow be modified if it is to capturethe essence of the MNE. Certainly, evidence thatMNEs choose to internalize in order to guard againstrecontracting hazards is weak at best.25

The business historian Alfred Chandler was one ofthe first to identify the structural virtues of a fullyintegrated firm that was global in scope. In his para-digm, (vertical) integration was necessary to achievecoordination (Chandler, 1977). However, cross-bordercommunication technology has improved dramati-cally in recent decades, and capabilities are moreglobally dispersed than ever. As a result, coordinationin the supply chain seems to be less dependent oninternalization than it once was. The implications forinternalization theories are considerable.Consider Apple, which is known for the ingenuity

of its designs, yet it owns none of its own manufac-turing. It has tight supply relations with many com-panies – some pure contractors (e.g., Foxconn,headquartered in Taiwan with factories in China)and at least one competitor (Samsung, headquarteredin Korea). Apple helps provide financing to some ofits suppliers, and may obtain exclusive purchase

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arrangements from them for short periods (e.g., threeyears). Contractual arrangements appear to suffice forApple to achieve the necessary coordination, whileretaining the flexibility needed to respond to marketforces. Powerful examples of heavily outsourced com-panies, such as Apple, serve to remind us that stan-dard contractual approaches to internalization needto be combined with, and arguably embedded into,entrepreneurial, capability, and “network” paradigmsof the firm.These outsourcing arrangements have been stu-

died under several names, including “internationalproduction networks” (e.g., Ernst & Guerrieri, 1998)and “global value chains” (e.g., Gereffi, Humphrey,& Sturgeon, 2005). Buckley introduced the expres-sion “global factory” to characterize a network inwhich “Brand owners will control design, engineer-ing and marketing while outsourcing large areas ofproduction to parts suppliers and they may wellcontract out final assembly” (Buckley, 2007: 115).Buckley claims that his global factory network is“held together by control of key assets and flows ofknowledge and intermediate products” (Buckley,2009: 230). The global (virtual) factory conceptappears to be the structure selected by Buckley toaccommodate notions of dynamic capabilities.

Competitive Advantage NeglectedAs Geoffrey Jones notes, “the recognition that multi-nationals are profoundly heterogeneous is one ofthe most important lessons from history” (Jones,2005: 289). The theory of the multinational firm ineconomics – and transaction cost theory is noexception – does not deal effectively with thisheterogeneity, and hence cannot address issuesrelating to competitive advantage, that is, the foun-dation for enterprise- or business-level financialperformance that is both superior (“supernormal”)and durable. While different governance forms areseen as suitable for certain transaction types, theframework is silent as to how competitive advantageis built and preserved for particular firms. It is truethat the invention of new and superior governancemodes can be a source of temporary competitiveadvantage, but, as a general matter, there is no easyway to protect innovations in governance fromrapid imitation. Hence, governance advantages willerode, sometimes rather quickly.Moreover, thanks to the very development of

transaction cost economics and its wide dissemina-tion, knowledge of the tools of good governance isavailable in the public domain. Adoption of goodgovernance protocols may of course be impaired by

factors inside the enterprise. If so, new governancemodes may serve to create differentiation. But trans-action cost analysis does not contribute significantinsights into when and where this is the case.Accordingly, it is of limited relevance to scholarsand practitioners seeking an understanding of com-petitive advantage.Neglect of firm-level heterogeneity and the parti-

culars of competitive advantage is perhaps the pri-mary reason for the schism between the fields ofinternational business and international (strategic)management. The former largely ignores it; the latterembraces it. Until this chasm is bridged, interna-tional business scholars will have little to say tomanagers, and international management scholarswill have little to contribute to public policy or theunderstanding of national competitiveness.

TOWARD A CAPABILITIES THEORY OF THEMNE

Antecedents: Resources and Early CapabilitiesPerspectivesInternalization theories have yielded importantinsights into the MNE. This is true with respect toboth prongs of the approach. However, as the inter-national business field has matured, and as thetheory of the firm in economics has evolved, rela-tively neglected (capabilities-related) factors nowseem more salient. My early efforts to understandinternational technology transfer, which were madeunder the internalization rubric (e.g., Teece, 1976,1977a), used elements of a capabilities story thattranscended transaction costs. However, in theseearly treatments, capabilities considerations weresoon swamped by contractual concerns (Teece,1985, 1986a). This needs to be readdressed in myown 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 ofcircumstance. Essentially, capabilities flow from theastute bundling or orchestration of resources. Theorganizational and managerial “technology” of thefirm and its ability to transfer technology (embeddedin routines and resources) across distances and bor-ders are very much implicated in the firm’s nationaland global capabilities.The (dynamic) capabilities framework is an entre-

preneurial approach that emphasizes the importanceof (signature) business processes, both inside thefirm and also in linking the firm to external partners.It also recognizes the importance of critical resourcesand good strategy. It is not animated primarily bytransaction cost or contractual concerns. Rather, it

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builds on the resource-based approach. It is focusedmore on opportunity than on opportunism, and onthe efficient and effective transfer of technologybetween and among the various organizational unitsof the firm.Teece (1980, 1982) explored Penrose’s ideas of

resource fungibility by assessing how the nature of aresource, and in particular its “tradability” (or lack ofit), affected diversification. A firm with excess factorservices (i.e., above those needed for its current andprojected production program) may find it moreprofitable to monetize those services via a new userather than through amarket transaction.While thisresearch focused on product diversification, it wasalso applicable to international diversification.What has been missing is systematic attention to

how (entrepreneurial) management can deploy orredeploy the nontradable assets and resources at itsdisposal. Wernerfelt (1984) and Barney (1991) beganthe task of filling this gap, building on Penrose’sview that making better use of resources was impor-tant to enterprise growth and development. Penroseherself viewed entrepreneurship as one of theresources of the firm, stating, “[W]e include ‘entre-preneurs’ among the resources of the firm and therange of ideas of entrepreneurs among the servicesrendered” (Penrose, 1959: 86). In this regard, she wasperhaps describing a dynamic capability, at least inthe sense referred to here.Despite Penrose’s abiding interest in the interna-

tional firm, she did not pay particular attention tothe application of her theory to the case of the MNE(Pitelis, 2007). Moreover, although Penrose did recog-nize the importance of entrepreneurship, she did notfully address the roles of entrepreneurs in designingbusiness models or organizations (Augier & Teece,2007), or in building competitive advantage. Rather itwas Wernerfelt (1984) and Barney (1986, 1991) whoarticulated the relationships among firm resourcesand competitive advantage. They focused on thepossession of the right resources as themainmechan-ism for the generation of economic rent. Theresources to worry about were defined by Barney(1991) as those meeting his criteria of valuable, rare,inimitable, and non-substitutable (VRIN). Implicitly,Barney was inviting strategists to focus on intellectualcapital (Teece, 2000), since this is the class of assetsthat most frequently meets the VRIN criteria.As already noted, Teece (1976, 1977a) and

Cantwell (1989) early on had threads of a resourceand capabilities approach under development. Thisinitially manifested itself as a knowledge-basedapproach to the MNE with Teece (1981a,1981b) and

Kogut and Zander (1992, 1995). However, knowl-edge-based approaches – which emphasize how thegeneration and transfer of knowledge, along withtransaction cost problems in the market for know-how, dictate integration and/or foreign ownership –

are insufficiently robust to capture many relevantentrepreneurial and capabilities features. Interest-ingly, recent work in international business (someof it generated by advocates of the transaction-cost-based or exchange-based paradigm) has alreadybegun to focus on an entrepreneurial/capabilitiesapproach (e.g., Buckley, 2009; Casson, 2000, 2005;Dunning & Lundan, 2010;26 Pitelis, 2004; Pitelis &Teece, 2010; Rugman & Verbeke, 2003). It is nowtime to carry these efforts forward on a comprehen-sive basis into a (dynamic capabilities-based entre-preneurial) theory of the MNE.27

A robust theory of the MNE that explains its scope,its boundaries, and the role of subsidiaries, while alsoproviding insights into the competitive advantage ofparticular MNEs, requires that the entrepreneurship,resources, and capabilities concepts be somehowamalgamated. The (dynamic) capabilities approach,advanced in the field of strategic management andapplied below in the context of the MNE, endeavorsto do so, and is the subject matter of most of theremainder of the paper. The goal is to help shape amore robust theory of the MNE that highlights howfirm-level sustainable (durable) competitive advan-tage is both built and maintained.Understanding sustainable competitive advantage

(and not just the boundaries of the firm) is a broadermandate for a theory of the MNE than what inter-nalization scholars typically accept. Coming up witha better theory of the MNE that does double duty(i.e., explains boundaries and competitive advan-tage) requires a comprehensive, multidisciplinaryapproach to understanding managerial decision-making and business organization in a contextwhere intangible assets are important, and wherethere are rapid changes, frequent discontinuities,and great complexity, engendered in part by the factthat the world’s needs and desires have not (yet)become irrevocably homogenized.28 Labor is notfully mobile, and many national institutions remaindistinct. The world is, and is likely to remain, onlysemiglobalized (Ghemawat, 2003). It is this world offirm-level heterogeneity and semiglobalization – andnot the hypothetical worlds of perfect competitionor oligopoly – that animates the inquiry here.The capabilities framework resonates well with

Cantwell’s (1989) work.29 Cantwell recognized, cor-rectly, that a theory of theMNE based on an exchange

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(or transaction cost/governance) framework masksany active role for management (Cantwell, 1989:215). He also argued that ownership advantages areendogenous and developed through innovation andstrategy, and showed howMNEs extend their capabil-ities and their overall innovation potential usingglobal networks.The capabilities perspective can also be seen as

consistent with other international business litera-ture, including recent thinking on knowledge man-agement in a networked MNE (e.g., Rugman &D’Cruz, 2000; Rugman & Verbeke, 2001, 2002,2003; Vahlne & Johanson, 2013). As noted earlier,some knowledge-based theories of the MNE can bethought of as special cases of a resources/capabilitiestheory of the MNE. An essential characteristic oforganizations/firms is that they can generate andembody knowledge, which can’t be easily boughtand sold. Sometimes the only way to capitalize onknowledge is to start a firm and build the necessarycomplementary assets (Teece, 1986b, 2006b). Tofully capitalize on opportunities, such firms mustoften be global from the beginning. In short, cap-abilities generally have to be built, as they cannot bebought.The dynamic capabilities framework developed

below goes beyond the knowledge and technologicalelements highlighted in earlier research to moreexplicitly include managerial and organizationalcapabilities as determinants of competitive advan-tage. It contends that the active development andastute orchestration of tangible and intangible assetsby both parent and subsidiaries lie at the heart of therationale for the MNE and, together with strategy,determine its longer-run success.30

Definitions and Core Building BlocksThe original definition of dynamic capabilities byTeece, Pisano, and Shuen (1997: 516) referred to theability of an organization and its management tointegrate, build, and reconfigure internal and exter-nal competencies to address rapidly changing envir-onments.31 Eisenhardt and Martin (2000) extendedthis to also embrace what I refer to as “shaping theenvironment”.Teece et al. (1997) identified the core building

blocks of dynamic capabilities under the tripartiterubrics of processes, positions, and paths. This wassupplemented in Teece (2007) by a more appliedfocus organized around sensing, seizing, and trans-forming. In what follows, I relate the two taxonomies,and then show how strategy fits in. Important clarify-ing distinctions between ordinary and dynamic

capabilities are made. Application to the MNEfollows.

ProcessesTeece et al. (1997) identified three classes of processes/managerial functions that are relevant to dynamiccapabilities under the following rubrics: coordina-tion/integration; guided learning; and reconfigura-tion/transformation. Organizational processes embedthe strategy and business model of the business intothe day-to-day routines of employees. The effective-ness of organizational routines is buttressed bystrong and consistent organizational values.Dynamic capabilities thus reside, at least in part, in

the managerial, entrepreneurial, and leadershipskills of the firm’s top management, and in manage-ment’s ability to design, develop, implement, andmodify these routines. Either way, firms with super-ior dynamic capabilities have learned to adjust tochanging environments, and also to shape the (busi-ness) environment.

Positions (resources)32

As noted earlier, the asset positioning of a companymatters. I am referring not just to balance sheetassets (plant and equipment and the like) but alsoto human capital and knowledge assets. Teeceet al. (1997) identified technological assets, comple-mentary assets (technological or otherwise), finan-cial assets, reputational assets, market structureassets, and institutional assets. It is obvious that aroad construction company will need access toheavy equipment (e.g., bulldozers and dump trucks),and a home-building company will need access toarchitectural services, as well as construction toolsand skilled and unskilled labor. A bank will needfinancial assets, and the talent to build and runsystems for loan origination and underwriting, etc.The firm’s position, as defined by its resources, is

enhanced if the resources meet Barney’s VRIN cri-teria. As I have noted elsewhere (Teece, 2000), theclass of assets most likely to satisfy VRIN criteria isintellectual capital, particularly technology andknow-how. Intellectual capital readily meets mostof the VRIN criteria because it tends to be tacit andidiosyncratic, and has fuzzy edges. In essence, thecriteria distinguish between ubiquitous resourcesavailable to all at competitive prices and those thatare more specific or unique. Furthermore, the VRINcriteria recognize that a unique asset is not valuablefor its own sake. It delivers value to the firm and itsstakeholders only if it supports a point of differencethat is appealing to the customer, and which,

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furthermore, cannot easily be replicated by otherswith different assets.Needless to say, it should be immediately apparent

that, in fast-paced competitive environments, posi-tions/resources alone are generally of fleeting value.The way assets need to be deployed (usually inclusters or combinations) is likely to be dynamicand involve astute and entrepreneurial “orchestra-tion” activity by management. As noted in Teece etal. (1997: 515):

The global competitive battles in high-technology indus-tries… have demonstrated the need for an expanded para-digm to understand how competitive advantage is achieved.Well-known companies… have followed a “resource-basedstrategy” of accumulating valuable technology assets… How-ever, this strategy is often not enough to support a significantcompetitive advantage.

Clearly, the manner in which assets and otherresources are coordinated and orchestrated is at leastas important to competitive success as the identity ofthe assets themselves. This is where asset orchestra-tion and market creation (or co-creation) come intoplay (Pitelis & Teece, 2010). Whereas neoclassicaland transaction cost economics assume that marketsexist, even if they don’t function well, the capabil-ities approach makes no such assumption. Marketsmay have to be created, in the sense that newproducts and services are introduced for whichafter-sales support and product training, forinstance, may be lacking and may have to be built.This is what Singer did globally to allow marketdevelopment of the sewing machine. In India, Gill-ette has likewise been promoting the benefits ofremoving beards in order to broaden the market forits safety razors. The need for such creation activitiesto expand markets is assumed away in transaction-based approaches, where there is almost always aparty (or customer) to transact with. This reduces theproblem to one of contracts, when in fact thefundamental problem may be one of market exis-tence or market expansion.The problem stems in part from what was referred

to earlier as the equilibrium assumption. In a “per-fect” world of markets (spot, term, future, etc.), thefirm has full information about competitors, aboutcomplementors in investment decisions, and aboutwhat consumers really want. But, in reality, much ofthis information is proprietary, tacit, or diffuse, andthus inaccessible. The decision to invest depends onsensing an opportunity and also on sensing howpotential competitors and complementors willrespond. This is not a capability required in aneoclassical world of perfect competition.

The focus of the dynamic capabilities framework ison how firms can create, extend, integrate, modify,and deploy their resources and/or specific assets whilesimultaneously managing competitive threats andeffectuating necessary transformations.33 Whereasother approaches emphasize tangible asset/resourceownership and protection, the dynamic capabilitiesperspective emphasizes intangible assets and resourceaugmentation, and also asset orchestration.By embedding (managerial) asset orchestration

into the theory of the MNE, the field of internationalbusiness can build bridges to topics in internationalmanagement.

Paths (strategy)It is important to recognize that strategy must gohand in hand with processes, resources (positions),and capabilities. Strategy, when developed success-fully, involves deploying the firm’s scarce assets tosupport market needs and gain advantage overrivals, while recognizing market and technologicalopportunities and any constraints imposed by thefirm’s historical path of evolution.Put differently, the managerial orchestration that

is core to enhancing processes and exploiting posi-tions must be guided and informed by strategy – andvice versa.34 Strategy needs to be consistent, coher-ent, and embrace innovation. While it is necessarilyshaped by the legacy of the past, it also shapes thepath ahead. Strategy will determine which productsto make, which customers to target, how to deploythe firm’s resources, what the optimal timing will be,and how to keep competitors at bay.A strategy can be defined as “a coherent set of

analyses, concepts, policies, arguments, and actionsthat respond to a high-stakes challenge” (Rumelt,2011: 6). A good strategy has:

(1) prescient diagnoses;(2) a guiding policy; and(3) coherent action.

These three functions constitute what Rumelt(2011) calls the “kernel of strategy”.35 A good strat-egy will often not appear fully formed, but insteademerge after a period of trial and error (provided thebusiness environment is sufficiently forgiving toallow experimentation). While the actions dictatedby the strategy may be visible to rivals, and freelyimitable, rivals may not perceive it in their interestto do so until it is too late, because the underlyingdiagnosis and policy can be kept secret.In the framework advanced here, dynamic

capabilities and business strategies codetermine

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performance.36 Firms with weaker capabilities willrequire different strategies from firms with strongercapabilities. Strong dynamic capabilities requirefirms to sense, seize, and transform in conjunctionwith a sound strategy. A sound strategy must in turnhave a strong kernel.For purposes of operationalizing the framework,

dynamic capabilities can usefully be disaggregatedinto three clusters of processes and entrepreneurial/managerial orchestration activities conducted insidefirms (Teece, 2007):

(1) identification and assessment of opportunities athome and abroad (sensing);

(2) mobilization of resources globally to addressopportunities, and to capture value from doingso (seizing); and

(3) continued renewal (transforming).

These activities are required of the firm’s manage-ment if the firm is to sustain itself as markets andtechnologies change. In a global context, the MNE’smanagement must not only be entrepreneurial, butalso cosmopolitan, or what Perlmutter (1969) called“geocentric”.It is important to emphasize that the framework

advanced here sees the effectiveness of dynamiccapabilities as being compromised by poor strategy.Strategy and dynamic capabilities can be seen asanalytically distinct concepts, although they arein practice interrelated (Table 1). For instance, sen-sing is important to dynamic capabilities but alsocontains a strong element of diagnosis, which isimportant to strategy; seizing needs to be connectedto both a guiding policy and coherent action; andtransforming that is value protecting and enhancingrequires a guiding policy and coherent action. Thenature of the managerial tasks for various elementsof strategy is outlined in Table 1. Entrepreneurialmanagement is especially relevant to the firm’sability to be prescient and sense opportunities andthreats (both market- and technology-related).

Replicability and Imitability: Ordinary vs DynamicCapabilitiesIn the dynamic capabilities framework, considerableemphasis is placed on the replicability and

imitability of organizational processes and positions(Teece, Pisano, & Shuen, 1997). Clearly, if one isinterested in sustainable competitive advantage, oneneeds to take imitability into account. That which iseasily replicated by the firm is scalable, possiblyglobally.37 However, that which is easily imitatedby others will clearly not be able to support superiorfinancial returns. When examining competitiveadvantage, it is therefore critical to distinguishbetween “ordinary” (and easily replicable) capabil-ities and dynamic capabilities, which by their verynature are hard to replicate. As explained below,ordinary capabilities support technical fitness, whiledynamic capabilities support evolutionary fitness.The former is about the enterprise “doing thingsright;” the latter has more to do with “doing theright things”.

Ordinary capabilities: FoundationsIt is perhaps easier to understand what dynamiccapabilities are as a class by juxtaposing them againstordinary capabilities.38 Ordinary capabilities can bebroken into operational, administrative, and govern-ance capabilities (Teece, forthcoming). Here I empha-size that ordinary capabilities are about producingand selling a defined (and static) set of products andservices. The degree of proficiency, however obtained,indicates the strength of the ordinary capability, forwhich 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 growexcept in environments with low competition, notechnological disruptions, and very limited globali-zation.39 When local capabilities in jurisdictionswhere MNEs operate are weak relative to those theMNE can transfer to an affiliate, ordinary capabilitiesmay nevertheless allow an MNE to possess competi-tive advantages for indefinite periods.Ordinary capabilities and their diffusion matter to

the MNE.40 They undergird the MNE’s technicalfitness. Technical fitness41 supports static efficien-cies; but unless competition is very weak, anddemand is strong,42 ordinary capabilities are unli-kely to support durable competitive advantage. Suchcapabilities allow an organization to keep “earning

Table 1 The interrelation of dynamic capabilities and strategy

Strategy kernel Diagnosis Guiding policy Coherent action

Related dynamic capabilities clusters Sensing Seizing/Transformation Seizing/TransformationNature of managerial orchestration Entrepreneurial Administrative Leadership

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its living by producing and selling the same product,on the same scale and to the same customer popula-tion over time” (Winter, 2003: 992).Ordinary capabilities enable the firm to perform

definable tasks. They rest on (1) non-VRIN resourcesand (2) practices, even best practices. The level ofordinary capabilities can therefore be measuredagainst a particular task or standard. “Best practice”,in a sense, does precisely that.43 Best managementpractices, for example, can be thought of as thosethat “continuously collect and analyze performanceinformation, that set challenging and interlinkedshort- and long-run targets, and that reward highperformers and retrain/fire low performers” (Bloom,Genakos, Sadun, & Van Reenen, 2012).44 Many bestpractices, however, diffuse rather quickly in a worldwhere everyone has access to similar benchmarks.Bob Lutz (2011), the former vice chairman at Gen-eral Motors, illustrates this point for the automotiveindustry:

The operations portion of the automobile business has beenthoroughly optimized overmany decades, doesn’t varymuchfrom one automobile company to another, and can bemanaged with a focus on repetitive process. It is the “hard”part of the car business and requires little in the way ofcreativity, vision or imagination. Almost all car companies dothis very well, and there is little or no competitive advantageto be gained by “trying even harder” in procurement,manufacturing or wholesale.

This statement is revealing, as it indicates how bestpractices, hence ordinary capabilities, are widelydistributed, at least in the global automotive indus-try.45 If so, they can no longer be the foundation ofcompetitive advantage, as elaborated below.

Ordinary capabilities: Replication and transfer.What undermines the power of ordinary capabilitiesto serve as the foundation of competitive advantagefor a particular MNE is that such capabilities can beimitated much more easily today than in earliertimes. A good deal of know-how, which used to betacit and proprietary just two or three decades ago, isnow explicit and in the public domain – availablefrom consultants, schools of engineering, and thepublic literature.46 Explicit (codified) knowledge tra-vels easily, and the Internet, by allowing low-costaccess to information, has helped enable this. Theimplication is that the barriers to the transfer ofordinary capabilities have been dramatically reducedin recent decades.Indeed, many basic business services (e.g.,

accounting, sales, human resource management) can

today be readily outsourced to computing resourcesresident in the “cloud”.47 These developments –

enabled by Internet protocols, the general march ofcomputer-processing power, and the growth of “fatclients” – greatly facilitate starting up, as well asrunning, a business. Many routine operational andadministrative capabilities can be supported remotelyby independent providers. Hence, they are no longeras critical to competitive advantage. For example, theimplications of “cloud computing” for the MNE areprofound. In short, the Internet facilitates the avail-ability of ordinary capabilities not just because oflow cost and easy access to the flow of information,as Richard Nelson has emphasized,48 but because oflow cost and easy access to the computing, softwareresources, and data storage needed to support basic,yet high-quality, business functions.Knowledge transfer within an organization pre-

sents a host of difficulties (Szulanski, 1996). Andreplicability does not always imply imitability.Knowledge may remain difficult for external organi-zations to replicate to the extent that it is embeddedin interactions among people, tasks, and tools(Argote & Ingram, 2000).Notably, MNEs investing abroad “appear to adopt

good management practices in almost every countryin which they operate” (Bloom et al., 2012: 14).Indeed, Bloom et al. found that foreign multina-tionals are generally better managed than host-country firms. MNEs may thus succeed for a whilewith strong ordinary capabilities, because ordinarycapabilities developed at home may temporarily bedistinctive abroad.49

Some less-developed economies still lack domesticfirms performing what, from a developed-countryperspective, would be thought of as mundanetasks. Yum! brand’s success in China, for example,appears to be due in large part to its ability to trans-fer and adapt ordinary capabilities (Starvish,2011). This adaptation is itself partially a dynamiccapability.Another “barrier” to imitation is the simple failure

of rivals to implement publicly available best prac-tices (Knott, 2003). Bloom et al. (2012: 13) found intheir study that there is a wide dispersion withrespect to good management practices within everycountry and across countries, as shown in Figure 1.In a survey of more than 10,000 organizations across20 countries, they also found that foreign MNEswere generally better managed (i.e., they had betterordinary capabilities) than domestic firms (Bloomet al., 2012: 23). Brazil and India had a large tail ofvery badly managed firms.

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Nevertheless, competition and imitation will, overtime, lead to the erosion of any advantage fromordinary capabilities. This may occur slowly, butcan be rapid in contexts where the absorptivecapacity of external organizations is high. AnMNE subsidiary relying solely on strong ordinarycapabilities in a particular host country will find, ifthe ordinary capabilities are imitable (e.g., viaknowledge spillovers through employee turnover)and competitors can enter, that its advantage willsteadily diminish. In short, ordinary capabilitieswill not support long-run competitive advantageunless competition is suppressed by governmen-tally or privately imposed entry barriers, or by weakphysical and social infrastructure that preventsordinary capabilities from quickly diffusingthroughout the economy.

DYNAMIC CAPABILITIES: ASSESSMENTSince the late 1970s, local differentiation, globalintegration, and innovation have characterized suc-cessful firms operating globally. In the global econ-omy today, the competitive advantage of thebusiness firm appears to rest on the developmentand deployment of intangible assets,50 relationships,and human capital. These developments haveplaced a premium on the ability of companies tobecome entrepreneurial and agile at home and

abroad, requiring in turn that management operatewith less authority, and organize to allow and pro-mote flexibility, responsiveness, and learning. Thisrequires dynamic capabilities.As already noted, dynamic capabilities are under-

girded by processes (routines) and resources (posi-tions). Dynamic capabilities rely not just on bestpractices but on “signature” practices; not just onany resources but on VRIN resources. They alsorequire astute managerial orchestration guided bywhat Rumelt (2011) has called “good strategy”. Table2 illustrates this, and contrasts it with ordinarycapabilities.Signature processes and signature business models

are beyond industry best practices. Such processesembody a company’s history, experience, culture,and creativity (Gratton &Ghoshal, 2005). Because oftheir deep roots, they are not so easily replicated byothers who do not share this history, and may havedifferent values, too. Over longer periods of time,such processes and business models may becomesomewhat imitable by others. As Gratton andGhoshal point out, such a transformation occurredwith Toyota’s leanmanufacturingmodel, the ToyotaSystem of Production.Whether signature processes and business models

are “good” may take some time to become apparent.Eventually, it should show up in key performance

0.8

0.6

0.4

0.2

0.0

0.8

0.6

0.4

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1 2 3 4 5 1 2 3 4 5 1 2 3 4 5

Frac

tion

of fi

rms

Firm management scores, from 1 (worst practice) to 5 (best practice)

U.S. Brazil China

U.K. India Greece and Portugal

Bars are the histogramof firms in each country

Line is the smoothedU.S. density, shownfor comparison tothe U.S.

Figure 1 Best-practice diffusion.Source: Bloom et al. (2012).

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indicators. However, the replicability of a process orbusiness model is often confounded, particularlyexternally, by what Lippman and Rumelt (1982) call“uncertain imitability”. This, along with a high tacitcomponent to the underlying knowledge, may keepa signature process effectively proprietary.There is an obvious opportunity for all business

enterprises to learn, and to embed that learning innew signature processes and business models.Hence the MNE competing in diverse contexts hasthe opportunity to develop distinct signature pro-cesses and models in different geographies. Accord-ingly, the MNE as such may have an advantage inthe development of new products and signatureprocesses and models, as it can more readily runmultiple, simultaneous experiments than can apure domestic enterprise. Moreover, adaptationand adoption of new processes inside the MNE arelikely to be easier than they would be across unaffi-liated enterprises. Certainly, top managementcan endeavor to drive such adoption inside thecompany.A corollary of the fact that VRIN resources and

signature processes and business models are pro-ducts of the firm’s heritage and past managerialdecisions is that dynamic capabilities tend to getbuilt, are difficult to imitate, and cannot generally bebought. For example, Tim Cook, a long-time execu-tive at Apple and its current CEO, said in February2013: “Apple has the ability to innovate in all threeof these spheres and create magic… This isn’t some-thing you can just write a check for. This is some-thing you build over decades” (AFP, 2013). This isthe reason for the “stickiness” of dynamic capabil-ities – that is, they don’t tend to travel well, they arecomplex, and they are hard to figure out and toimplement.Once again, Bob Lutz (2011) of General Motors put

it most succinctly:

Where the real work of making a car company successfulsuddenly turns complex, and where the winners are sepa-rated from the losers, is in the long-cycle product develop-ment process, where short-term day-to-day metrics and thetabulation of results are meaningless.

Dynamic capabilities also help characterize howan enterprise obtains strengths, extends thesestrengths (for instance by developing new businessmodels), synchronizes business processes and mod-els with the business environment, and/or shapes thebusiness environment in its favor (Teece et al.,1997). They are higher-order, difficult-to-replicatecapabilities. Asset orchestration is implicated, anddynamic capabilities support the firm beyondmerely achieving superior “coordination”. They arebased on processes that are beyond best practice, andon 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 theability to sense new opportunities and threats, sup-ports evolutionary fitness.51 This inevitably requiresthat firms constantly create new technologies, differ-entiated and superior processes, and better businessmodels to stay ahead of the competition, stay intune with the market, and even shape the market ifnecessary.52 The firmmust be able to simultaneouslycope with changes in the external environmentand with changes caused by processes internal tothe firm (Greiner, 1998).53 It will be aided if it hassufficient resources and superior information, talent,and capital, including relationship capital. However,absent the required ability to orchestrate resources,and to create and execute a quality strategy, suchresources are likely to be of little value.As noted, strong dynamic capabilities will help

organizations to stay relevant to marketplace needsand technological opportunities. Organizationsmust change their capabilities to reflect anticipatedchanges in markets, technologies, and the businessenvironment more generally. However, as Winterexplains, change can be reactive – firms can easilyget into a “fire fighting” mode, which he describesas “high paced, contingent, opportunistic and per-haps creative search for satisfactory alternativebehaviors”. Winter (2003: 993) called this “ad hocproblem-solving”. This is in contrast to routine-directed problem-solving. In Winter’s terminology,the latter is a capability. He correctly recognized

Table 2 Elements of the capabilities framework

Core building blocks Weak ordinary capabilities Strong ordinary capabilities Strong dynamic capabilities

Processes (routines) Sub-par practices Best practices Signature practices and business modelsPositions (resources) Few ordinary resources Munificent ordinary resources VRIN resourcesPaths (strategy) Doing things poorly Doing things right Doing the right things (good strategy)

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that it is possible that on close examination even“fire fighting” approaches to problem-solving mayhave micro-routines embedded within. Certainly,skills are implicated.The individual and organizational skills at issue

with dynamic capabilities are much more orientedto creating unique problem-solving methodologiesand signature processes. Problem-solving is verymuch a dynamic capability.54 There is much dis-tance between the purely routinized and that whichis purely ad hoc. The middle ground also constitutesa (dynamic) capability. Indeed, most invention isn’tfully directed. The innovation process is neithercompletely routinized nor ad hoc.The capabilities approach, expanded upon below,

sees MNE activity as driven by the opportunity toleverage capabilities and create and capture valuefrom innovation on a global scale. Entrepreneurialmanagers are not just resource allocators; they alsosense, shape, and exploit opportunities. A theory ofthe (multinational) firm that doesn’t recognize thislogic and these phenomena, and their associatedlocational dimensions, will be unable to explain theMNE's sustainable competitive advantage.55

To create and exploit opportunities globally, entre-preneurial activity must be linked up with capitaland other complementary assets, because propertyrights over discoveries and inventions are incom-plete. Some ownership and control over comple-mentary assets is likely to be needed to assist the

MNE in the appropriation of value needed to sup-port continued investment (Teece, 1986b, 2006b).As explained in Teece (1980, 1982, 1986b), man-agers, entrepreneurs, and innovators cannot justleave it up to the market to line up specific assetsand develop new ones, and integrate them into awell-functioning global invention, production, andmarketing system that provides the theoretical rai-son d’être and management for the MNE. They arethemselves the instruments that make markets workwell. Even if Coasian transaction costs were zero,learning, co-creation, and orchestration functionswould still need to be carried out. The entrepreneu-rially managed MNE is a vehicle designed to do so.The firm is indeed, as Coase (1937: 388) noted, an

island of conscious power – but it is unsatisfactory toframe managerial capacity primarily in transactioncost-minimizing terms, as Coase asserted. Rather,the functions of management can be framed interms of assisting in the building and/or securingand deploying of VRIN resources and signatureprocesses not typically available for sale (or, if avail-able, not routinely priced in a liquid market). Thebusiness firm is an island of (non-market) resourceallocation orchestrated to enhance learning, valuecreation, know-how transfer, and value capture.These factors help explain why it is necessary totransform internalization theory into an entrepre-neurial/capabilities theory of the MNE. The eco-nomic logic of the framework is reflected in Figure 2.

Capabilities (Dynamic)

Organizational Heritage;Managerial Decisions

(Orchestration Processes:Sensing, Seizing,

Transforming)

Resources (VRIN)

Strategy,(Prescient Diagnoses

Guiding Policy;Coherent Action)

Competitive Advantage

Build

Build

Buy?

Buy?

(Ordinary)Capabilities

(Generic)Resources

Figure 2 Logical structure of the dynamic capabilities paradigm.

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CAPABILITIES AND MNE PERFORMANCEWhile ordinary capabilities are insufficient for long-term survival and growth, dynamic capabilitiesenable the firm to have a better chance of establish-ing and maintaining competitive advantage (andconcomitant superior performance) in economieswhere change is rapid, and intangible assets arecritical to competitive differentiation.56 However, asindicated in Figure 2, the firm also needs goodstrategy.Dynamic capabilities are hard to develop, and

difficult to transfer across borders, in part becausethey are tacit, in part because they are oftenembedded in a unique set of relationships andhistories, and in part because of uncertain imitabil-ity. In short, dynamic capabilities undergird the“future” of any MNE, because, along with strategy,they undergird competitive advantage in fast-moving, knowledge-based economies. They oftenlie at the heart of both short- and long-cycle productdevelopment processes.Bartlett and Ghoshal (2002: 14) noted that “as

major global competitors achieve parity in the scaleof their operations and their international marketpositions, the ability to link and leverage knowledgeis increasingly the factor that differentiates thewinners from the losers and survivors”. Theseauthors were tilting toward elements of a dynamiccapabilities framework, because such a framework isalso about linking and leveraging know-how. Goodstrategy, strong ordinary capabilities, scale (in somecircumstances), and strong dynamic capabilities areall needed for long-term growth and survival in theframework advanced here.As noted, ordinary capabilities are about doing

things right, whereas dynamic capabilities are aboutdoing the right things, at the right time, based onunique processes, organizational culture, and a pres-cient assessment of the business environment andtechnological opportunities.57 By the right things, Irefer to investment in new products, processes, andbusiness models that are in tune with the firm’sbusiness environments at home and abroad, andwith its strategy. The late Steve Jobs made a strongstatement with respect to the importance of spend-ing money on the right things:

Innovation has nothing to do with how many R&D dollarsyou have. When Apple came up with the Mac, IBM wasspending at least one hundred times more on R&D. It’s …

about …how much you get it. (cited in Kirkpatrick, 1998)

“Getting it” requires strong dynamic capabilities.The dynamic capabilities perspective goes beyond

organizational “fit”,58 and also beyond a financial-statement view of enterprise strength, to emphasizerecognition of the most promising opportunitiesand the managerial orchestration needed to create,accommodate, and fashion resources both insideand outside the firm, at home and abroad. Includedare the external linkages and alliances that arecommon in the global economy, and well documen-ted and analyzed in the international businessliterature.At a quite general level, dynamic capabilities are

about how an enterprise seizes the future and devel-ops the products, processes, and business models tomeet (and shape) ever-changing markets. Dynamiccapabilities result from superior top managementorchestration skills. They are hard to teach, in partbecause there is a large tacit component (Teece et al.,1997).The greater the diversity and rate of change in

business environments, and the greater the impor-tance of intangible (including relationship) assets,the more critical good strategy and strong dynamiccapabilities become for the MNE’s growth and finan-cial performance. To maintain competitiveness, theMNE must develop and maintain asset alignmentboth internally and with collaborating firms. TheMNE and its partner firms must develop and deliverjoint “solutions” that are in tune with customerneeds in multiple environments. It is not just amatter of selecting the right organizational bound-aries to achieve fit, although that is clearly oneelement.59 Strong dynamic capabilities include theprocesses, business models, and leadership skillsneeded to effectuate high-performance sensing, seiz-ing, and transforming. Strong dynamic capabilitieshelp ensure evolutionary fitness; ordinary capabil-ities are more attuned to the requirements for tech-nical fitness.60

THE CAPABILITIES APPROACH JUXTAPOSEDAGAINST TRADITIONAL MNE THEORY

Prior sections of this paper have treated the firm in ageneral way, consistent with the need to encompassmultinationality. This section explores particularissues squarely within the established domain ofinternational business studies. It is, after all, thepotential for synergistic interaction between head-quarters and foreign locations (Cantwell, 2009),with their distinct institutional contexts and cap-abilities profiles, that distinguishes the MNE casefrom the general theory of the firm. Efforts are madeto explain how a capabilities approach leads to an

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all-encompassing perspective that can incorporateboth prongs of the internalization paradigm.

Leveraging Capabilities Through HorizontalExpansionThe specification of market-entry strategies is a keyattribute of various internalization/governance the-ories of the MNE. One way to observe the differentinsights from the two main approaches to internali-zation is to examine how they impact perspectiveson MNE expansion.The impact of the transaction-cost-based interna-

lization approach is already evident in the literatureon the MNE (e.g., Hennart, 2009; Zahra et al., 2000).However, this stream of work tells us very little aboutwhich markets the MNE should create and enter;implicitly, one can perhaps read into internalizationthat the right markets are those in which the servicesof firm-specific assets generate value. In other words,transaction-cost-based internalization theories helpspecify entry mode, but not the best direction andtiming for expansion. These are important decisions,and a robust theory of the MNE should be able tohelp explain them.Clearly horizontal market-entry strategies of the

MNE are not just about figuring out the right con-tractual mode. Firm-specific capabilities will need tobe assessed, both as to relevance abroad and as totransfer costs. Modifications and adaptations maysometimes be required. Intellectual property issueswill need to be analyzed. Replication of capabilities ina different context may be difficult (Teece, 1976,1977a). In the main, the problems likely to beencountered are not contractual ones; they relatemore to technology (and capability) transfer costs,and the assessment of market opportunity.In effectuating such transfers, it is important for

the MNE to minimize the “liability of foreignness”(Hymer, 1976; Zaheer, 1995) while simultaneouslyexploiting home-country benefits. As Helfat andLieberman note:

Established firms enter markets where they have pre-entryresources and capabilities that are similar to the resourcerequirements of the market of entry. The choice of geo-graphic markets is most strongly influenced by specializedresources and capabilities, including knowledge of the localmarket and tacit technological skills. (Helfat & Lieberman,2002: 738)61

Thus firm-level capabilities act simultaneouslyboth as a constraint on and as an enabler of whatfirms can do with respect to foreign market entry.International expansion will be facilitated when the

firm capabilities align withmarket needs abroad, andmanagement in the parent or subsidiary can keep itthat way. The unevenness in the global business andeconomic landscape navigated by MNEs createsopportunities to both transfer and deploy existingcapabilities, and create new ones, thereby fuelingcross-border expansion.62

Hence, while the boundaries of the MNE may bepartially determined by transaction costs, in largermeasure they are likely to be determined by capabil-ities and the need for, and difficulty associated with,replication and the associated transfer of technolo-gies and capabilities. This aspect of the argumentechoes the theory of technological accumulationoutlined by Cantwell (1989, 1995, 1999). It alsoimplies that MNEs will invest abroad to augmenttheir existing capabilities, as their geographicallydispersed networks facilitate the accumulation oftechnological assets over time.Accordingly, the boundaries of the MNE can be

seen as resulting from entrepreneurial managementdeveloping and assembling the particular constella-tion of specific assets that the firm’s activities requirein each location where it elects to operate. The MNEbecomes the locus for creating and leveraging pro-ducts and capabilities, and for capturing value fromthis process globally.63 In the language of economictheory, value is achieved not just by minimizingtransaction costs but also by exploiting (throughmanagement actions) the implicit bid–ask spreadsassociated with the “transfer” of intangible assets.The MNE’s country of origin is a key contextual

factor. Regional and national systems of innovation,for instance, shape firm experiences, knowledge, andcapabilities. Moreover, good management is not uni-formly distributed either. Entrepreneurial manage-ment is a scarce resource that is itself geographicallyconcentrated. Hence, as Madhok and Osegowitsch(2000: 326) note: “Home country characteristics havea strong bearing on the evolution of the domesticindustry and the international competitiveness ofindividual firms”. Firms are in part products of theenvironments in which they were born; by goingglobal, they can tap into regional and national sys-tems of innovation outside the home country. Thecapabilities of the MNE stem in part from the diverseenvironments in which they operate and compete.However, most country advantages may be open

to all that choose to invest in a particular hostcountry. Low-cost labor, for example, is generallyfungible across all foreign entrants. Hence, as dis-cussed below, country-specific advantages are not socompelling in the (dynamic) capabilities-based

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approach to competitive advantage. They may helpexplain entry, but they are at best one factor behindcompetitive advantage at the enterprise or businesslevel. In short, the essence of the MNE is that “itaccepts, adapts to, and capitalizes on institutional,cultural, and market heterogeneity while simulta-neously trying to capture economies associated withsome kind of (scalable) advantage in certain assets orprocesses it owns or is currently developing” (Teece,2006a: 125).

How and When Do MNEs Enter New GeographicMarkets?The mode of entry into a foreign market is the topicon which internalization theories have beenthought to have their firmest footing. However, asdiscussed above, one cannot fully understandchoices with respect to global expansion mode bylooking at transaction cost/governance issuesalone. At least two other factors are at work. First,the presence of pre-entry capabilities, includingslack resources, matters considerably. An MNE will(and should) be reluctant to enter a foreign market(or even a proximate domestic market) if it doesn’thave (or cannot readily access) at least strongordinary capabilities and enough slack to replicatethem without hitting internal resource con-straints. The slack resources at issue might even befinancial. Indeed, in Teece (1986b: 296), cash washighlighted as an important factor in explainingthe mode of market entry. As Madhok (1997)notes, the firm boundary issues are largely capabil-ity-related. When a firm has strong ordinary anddynamic capabilities, the incremental costs of FDIare likely to be low.Conversely, when timing is of the essence and

certain capabilities are absent, joint ventures are likelyto be preferred by the enterprise endeavoring to goglobal. When an MNE enters a foreign market, it willneed to replicate some of the capabilities (processes,skills, etc.) employed in the home market. Adjust-ments may be necessary because the skills and know-how the MNE possesses in one context might notquite work in a different geographic context. Gettingthis fit right requires dynamic capabilities.Time–cost tradeoffs have been analyzed and

empirically estimated for technology transfer pro-cesses (Teece, 1977b, 1980, 1986b). If the time–costtradeoff is too steep, managers should associatewith (joint) venture partners who can help flattenthem.64 Joint ventures and collaboration not onlyreduce financial outlays; they often also enhance theMNE’s ability to access local capabilities. Thus mode

of entry will depend not just on contractual factorsbut also on who owns and controls the requiredcapabilities, the time it takes to transfer them, andthe timing imperatives of market entry.Scholars have begun to study why and how some

firms internationalize very early in life (e.g., Rennie,1993; Oviatt & McDougall, 1994). The “born global”phenomenon is consistent with dynamic capabil-ities. Small companies can have strong dynamiccapabilities, and may be able to access abroad theordinary capabilities necessary to make their foreignmarket-entry strategies viable. Small entrepreneurialfirms can quickly create and (with local partners) co-create new markets abroad.Recent evidence (Arregle, Miller, Hitt, & Beamish,

2013) indicates that prior investment in a regionmade up of multiple countries impacts future deci-sions to invest in these countries: that is, capabilitiescan be redeployed within regions more readily thanbetween them. This finding, which goes beyondprevious country-level analyses, is consistent withcapability transfer being easier with geographicproximity, and with institutional and language simi-larity. The finding is more consistent with capabil-ities theories than with transaction cost/contracttheories, although the two approaches reinforceeach other, because contracting is also easier wheninstitutions are more alike.Dynamic capabilities themselves (involving as

they do sensing, seizing, and, ultimately, transform-ing) can in most cases be sequenced over time andacross different geographic markets. It is more chal-lenging if the firm has to perform all three simulta-neously in each of its businesses, and in all of itsmarkets. However, such simultaneity is sometimesrequired.65 For example, Yum! Brands (the owner offast-food brands KFC, Taco Bell, and Pizza Hut) hassimultaneously engaged in rapid expansion inChina, and in retrenchment and transformation inone of its established markets, the United Kingdom.

The Role of Headquarters and the Subsidiary inDynamic Capabilities TheoryThe governance (transaction cost) theory of interna-lization has little to say about the role of headquartersand foreign subsidiaries.66 Capabilities perspectives,on the other hand, provide insights into the respec-tive roles of headquarters and subsidiaries.The headquarters function is where certain cap-

abilities reside. The M-form (multidivisional form)of organization facilitates decomposition of theMNE’s architecture by allowing considerable auton-omy to regional/country and divisional managers.

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Headquarters can enhance the firm’s capabilities byallowing and facilitating technology transfers amongthe divisions, and by encouraging and supporting theexploitation of complementarities.67

Top management at headquarters performs a mostimportant global asset orchestration function in thedynamic capabilities framework. They allocate thefinancial resources needed for the MNE to createmarkets outside the home jurisdiction while leavingoperational matters to lower levels of the organiza-tion. As Peter Buckley (2009) notes in his (recent)work on the “global factory”, the management stylethat network configurations require is vastly differ-ent from conventional “command and control”methods. Indeed, he refers to headquarters as “a‘controlling intelligence’ or orchestrator of activ-ities” (233). In essence, Buckley is advancing adynamic capabilities perspective on the MNE.Subsidiaries nevertheless play a vital role in the

firm’s dynamic capabilities. They can generate know-how and capabilities from their own histories thatcan be transferred to other business units at home orabroad. This tends to be neglected and/or overlookedin transaction cost approaches. It’s a significant andvibrant component of the literature on internationalmanagement (e.g., Birkinshaw, 2000).In fact, it has been recognized (Bartlett & Ghoshal,

1989) that the MNE need not be especially hier-archical; it may well need to behave more like anetwork. Subsidiaries can have considerable auton-omy, simultaneously being integrated in a world-wide operation. New products and processes can bedeveloped by the parent or a subsidiary then sharedglobally. This decentralized M-form MNE allowsand encourages local knowledge creation and localdiscovery of opportunities, with subsequent orches-tration activities applied by top management. Trans-action cost approaches provide few insights into thisdistribution of activity. However, it is consistentwith work by Rugman and Bennett (1982) on worldproduct mandates, and with later research byBirkinshaw and Hood (1998) on how local initiativesby foreign subsidiaries help generate and leveragelocal capabilities onto the global stage, andstrengthen the MNE’s competitive advantage.It is important to recognize that once an MNE

creates a subsidiary that establishes its own networksand learning path, the subsidiary can accumulatespecific assets and capabilities that can find usefulapplication elsewhere. As a sizable literature has docu-mented, subsidiaries can engage in “reverse” technol-ogy transfer to the parent that may well generateopportunities (e.g., Birkinshaw, 1997; Birkinshaw &

Pedersen, 2008; Phene & Almeida, 2008; Prahalad &Doz, 1981). Rugman and Verbeke (1992, 2001, 2003)also recognized quite properly that firm-specific assetscould arise anywhere in the MNE. This is consistentwith a capabilities perspective.In short, capabilities perspectives elevate the

MNE’s subsidiaries in that they can be seen to con-tribute to the competitive advantage of the MNE, asrecognized by many, including Birkinshaw, Hood,and Young (2005). Learning and the development ofsignature processes and VRIN resources are seen tobe subsidiary-specific. This distribution of activityprovides the opportunity to recognize what Bartlettand Ghoshal (1989) called “the transnational solu-tion”, combining astute (country-specific) blends ofadaptation, rationalization, and centralization.

Global Distribution of R&D and InnovativeEcosystemsAn entrepreneurial/managerial theory of the firmmust also be able to explain asset augmentation(i.e., the creation of firm-specific assets), asset exploi-tation, extension, and renewal. In the dynamiccapabilities framework, asset augmentation comesfundamentally from R&D and learning processes(e.g., learning by doing; learning by using), whetherinternal or from (and with) partners, and from apply-ing the logic of the “profiting from technologicalinnovation” paradigm (Teece 1986b, 2006b). It alsorequires recognizing that innovation necessitates col-laboration with a panoply of partners in an ecosys-tem. Ongoing engagement with ecosystem partnerscan be seen as leading to the migration of the locus ofvalue creation from the firm to the level of thebusiness ecosystem. External sourcing and collab-oration can, when done well, augment the firm’sinternal capabilities (Capron & Mitchell, 2009;Chesbrough, 2003). However, it can also drain themif partners are laggards, and fail to contribute asagreed.The transaction cost-based internalization theory

by no means ignored the role of R&D. Indeed, itis of central importance in Buckley and Casson(1976). However, the development of firm-specifictechnological assets through internal and externalcombinations – and hence through dynamic cap-abilities – has not been emphasized much in thetransaction cost approach.68 The capability to inno-vate not only depends on the amount spent onR&D; it also depends critically on how that is spent,both as to whether it is done in house or outsourced,and on how well it is managed. Once again, goodmanagement requires excellence with respect to the

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orchestration function described earlier. Here theorchestration is of technology both inside and exter-nal to the firm, both at home and abroad, and acrossdifferent technological domains.Early studies of R&D in the foreign subsidiaries of

US-based MNEs showed that, in the 1970s, compa-nies used R&D not just to access offshore talent, but(and mainly) to adapt technologies and products forlocal markets (Mansfield, Romeo, & Teece, 1979).This is still the case, but the degree to which USenterprises use subsidiaries to develop new productshas undoubtedly increased. Indeed, Cantwell andKosmopoulou (2002) see R&D migrating to siteswhere local conditions are most conducive to tech-nology creation. Location decisions have much todo with market access and tapping into talent, andless to do with transaction cost issues.The “foreign” subsidiary can also play a role not

only in technology creation, but also in capturingvalue from innovation generated in any part of theMNE. The foreign subsidiary can invest in co-specia-lizedmanufacturing assets, co-specialized distribution/marketing assets, and/or co-specialized technologies.Ownership of such assets can play an important rolein the MNE’s ability to profit from innovation. This isa quite general result from the innovation literature(Teece 1986b, 2006b), but it seems especially applic-able to the MNE. These issues have been expanded atlength by Cantwell and Mudambi (2005). For thepurpose of this paper, themain point is that the globaldistribution of R&D can be seen as a phenomenonthat supports the creation of capabilities in differentgeographies: capabilities that perhaps then need to beintegrated to produce new products, as in the case ofthe civilian aircraft industry. Governance (transactioncost) theory produces only limited insight into thisphenomenon. Insights from the strategy and capabil-ities perspectives seem more pertinent.

Location and “Country” Factors and MNE TheoryRugman has built a theory of the MNE that postu-lates the need to recognize that MNE locationdecisions are impacted by country-specific andfirm-specific factors. In the Rugman matrices, forexample, labor-intensive manufacturing operationsof MNEs will be drawn to low-wage environments.The dynamic capabilities framework suggests,

however, that, while country and regional factorsmay impact investment location decisions, theyusually have little relevance to understanding howMNE competitive advantage is anchored. The simplereason is that country factors are often exploitable toa substantial degree both by domestic firms and by

multiple MNEs. Unless a particular MNE has aprivileged relationship with a nation-state, or aunique and difficult-to-replicate history there, coun-try advantages are accessible by all MNE investors.Hence country factors may explain why economic

activity of relevance to an MNE is in a particularoffshore location. Internalization theory will helpdetermine whether that activity is best accessed viaoutsourcing or by FDI. However, country (and regio-nal) factors available to incumbents and new entrantsalike will have little to do with explaining firm-levelcompetitive advantage, except inasmuch as they helpexplain the history of particular units of the MNE.This is a place where traditional MNE theory and thetheory of competitive advantage part ways.In short, country and regional factors can be

foundational for MNE competitive advantage onlywhen a particular MNE is able to access local advan-tages and avoid local disabilities in a way that otherscannot (or fail to) copy. For example, learning orother knowledge development that takes place indistinct host-country environments might form thebasis for signature processes and VRIN resources thatcould contribute to competitive advantage for thecompany as a whole, and these would still bedifficult for rivals to replicate.In the framework advanced here, MNE competi-

tive advantage flows from MNE-specific factors.These include not only the firm’s innovation, corpo-rate culture, and management, but also the location-specific history and resources related to the firm’sunique global footprint. This is where nationalsystems of innovation (Nelson, 1993) are relevant,and this is all the more important because sources ofinnovation are more globally dispersed than everbefore. If a host-country national system (and theMNE’s history) affords privileged access to thenational system, or to the outcome of the innova-tion process, then individual MNE competitiveadvantage is possible.

INTERNATIONAL BUSINESS ANDINTERNATIONAL (STRATEGIC) MANAGEMENTThe field of international business has been consid-erably animated by the tools and perspective oftransaction cost economics. It has provided usefulinsights into enterprise structure and scope, into alli-ance arrangements, and into governance more gener-ally. It outlines best practice with respect to contractdesign (an ordinary, not a dynamic, capability).Contractual issues are of interest to policymakers

and managers alike. However, there are a multi-plicity of issues – such as global product mandates

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and understanding individual firm performance –

where the transaction cost approach has providedparsimonious insight at best. International man-agement scholars have, as a consequence, some-times developed communities of their own withinmanagement academies rather than the interna-tional business academies. As a result, their workhas not been well integrated into the internationalbusiness literature. Moreover, it often lacks a goodtheoretical grounding. Ad hoc theorizing is com-mon. International management desperately needsa theory to help amalgamate its many disparatethreads.Scholars wedded to governance-based or exchange-

based approaches may wish to explain profits and thecompetitive advantage of particular firms by appeal-ing to the raison d’être of firms in general. This is notpossible. A general theory of the MNE that does notrecognize firm-level heterogeneity is of little utility toscholars and practitioners interested in diagnosingthe prospects and plights of particular firms.The MNE manager’s job in neoclassical theory and

in early internalization/governance approaches isquite minimal. It is merely to:

(1) set output levels in each market such that mar-ginal revenue equals marginal cost, and selectinputs by rotating a price line around a transfor-mation curve; and

(2) determine firm boundaries by outsourcing untilthe marginal cost of performing activities intern-ally is equal to the cost of outsourcing, and aligncontractual structures according to the transac-tion specificity of assets.69

There is little recognition in internalization/gov-ernance approaches of the importance of discovery,learning, adjustment, and other forms of capabilitybuilding. Unspecified mechanisms also somehowcreate firm-specific assets somewhere.In a robust theory of the MNE, the manager’s

role needs to be broader. The dynamic capabilitiesframework achieves this by imbuing managementwith both entrepreneurial and leadership functions.Bartlett and Ghoshal define what they call “trans-

national corporations” that have traits not unlikesuccessful firms that are dynamically competitive.Their transnational enterprises build assets and cap-abilities that are dispersed and interdependent; over-seas operations provide local differentiation but arenevertheless integrated into worldwide operations.These enterprises manage innovation throughco-development and global sharing (Bartlett &Ghoshal, 2002: 75).

The “transnational” approach, like much of therest of the literature in international management(e.g., Doz & Kosonen, 2008, 2010; Wilson & Doz,2011), appears to apply an implicit theory of theMNE that is animated more by firm-specific capabil-ities, learning, and networks than by transactioncost or governance considerations. Asset orchestra-tion and entrepreneurial cross-border market crea-tion and co-creation are at the core. What’s missingis the careful identification of foundations andassumptions. This paper has endeavored to showhow the implicit tenets in international manage-ment theory can fit comfortably within a broadercapabilities/entrepreneurship-based theory of theMNE that explains not only its nature, as per RonaldCoase, but also its competitive advantage and asso-ciated financial performance over time. The(dynamic) capabilities framework advanced hereallows international business and internationalmanagement research to coexist in harmony.In contrast to contractual approaches, the cap-

abilities approach has an important role for theentrepreneurial manager, not just in asset orches-tration but also in creating new products andservices. It endeavors to explain heterogeneity andthe determinants of firm-level profitability, not justthe existence of firms. Access to distinct resources,the development of signature processes, engage-ment in co-creation activity, and implementationof good strategy each play a role. These conceptshave, to date, had at best an awkward and quitelimited home in contractual/governance-basedtheories.

CONCLUSIONThe thrust of this paper is that transaction-cost-based or comparative-governance-based theories ofthe MNE are too narrow to capture a good deal ofwhat is critical to the MNE and its financial perfor-mance. (The OLI model, which has evolved toembrace capabilities alongside internalization, goessome way toward filling the gap.) Yet governance-oriented theories of the MNE still do not ask enoughof the right questions, and they “read out” of thetheory of the MNE cross-firm heterogeneity and anysignificant role for entrepreneurs, managers, andleaders. Notwithstanding, there is still utility to theparadigm.What makes MNEs distinctive is the fact that they

each have separate histories, and they each spanjurisdictions and territories where markets, factors ofproduction, firms and technologies, and nationaland regional infrastructure are likely to be different.

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Where certain capabilities and markets are absent,they need to be created. In these environments,entrepreneurs and managers in parents and subsidi-aries build signature processes, deploy distinctresources, and design good business models andstrategies in pursuit of profits. The basic question tobe answered by a robust theory of the MNE is notsimply where to locate in order to minimize produc-tion and transaction costs, but where to locate tobuild or deploy signature processes and obtainmarketaccess while guarding intellectual property and lever-aging the firm’s existing VRIN resources into newbusiness/market environments.What makes the MNE conceptually “interesting”,

and a challenge to model and manage, is that itoperates/sells inmultiple environments. Its activitiesmust be consonant with those various environ-ments, and, importantly, these environments oftenneed to be shaped, andmarkets need to be “created”.Accordingly, an MNE’s dynamic capabilities must bemore amplified and leveraged than those of a firmwith a less ambitious, purely domestic, focus.Importantly, the transaction cost/market failures

paradigm that has hitherto anchored internalization(and much international business research) oftendeflects attention from critical managerial issues,and creates artificial tensions with research in inter-national management. In the MNE theory advancedhere, management’s task is not just to overcomecontractual difficulties; it must also build and lever-age distinctive resources, signature processes, andsignature business models, and combine assetsinternally and externally, guided by a prescientstrategy. The MNE’s growth and survival is not justabout adapting to market failures; it’s also aboutcreating and deploying VRIN resources and signa-ture processes and distinct business models to enableexcellence in meeting (or possibly even modifying)market demand in ways that are hard for competi-tors to imitate. This, in turn, may lead the MNE toengage in technology and capability transfer, andpossibly even the strengthening of complementorsand suppliers.70 Put differently, the building andleveraging (extending) of dynamic capabilities cananimate FDI decisions. In contrast, what seems toanimate the firm in the transaction cost/marketfailure paradigm is mitigating contractual hazards.Clearly this is not sufficient to explain MNE activity,much less MNE heterogeneity.Over the past 30 years, the international business

literature has had a strong contractual/transactioncost flavor that has served it well. All along, therehave been various strands that have toyed with

capability ideas, but the international business lit-erature has embraced issues of entrepreneurship andcapabilities in only a limited fashion. Certainlythere has been a gradual migration under way bysome leading scholars of the contractual/exchangeapproach toward an implicit or explicit capabilitiesapproach. However, when one slides from one para-digm to another in a subtle, undeclared way withoutannouncement of old assumptions abandoned andnew ones embraced, the literature runs the risk ofbecoming confused. Hence there is a need to be cleararound the shifts that are going on, or progress willstall. Two of the goals of this paper have been todeclare the tension, and to try to resolve it.The multidisciplinary framework presented here

advances capabilities concepts without ignoringgovernance/contractual issues. As internationalbusiness scholars begin to more fully embrace theentrepreneurship/capabilities approach, a more uni-fied theory of the MNE can emerge that will supporta revamped internalization school, allowing a moreproductive dialogue among management scholarsand practitioners. A more active interchange ofresearch with strategy and management scholars –

as well as with researchers in (evolutionary) econom-ics, organizations, and entrepreneurship – shouldfollow. A richer internalization theory of the MNEwill also allow management scholars as well aseconomists to talk meaningfully about the sourcesand persistence (or lack thereof) of firm-level compe-titive advantage and associated superior financialperformance. With these developments, there is agood chance that the field of international businesswill escape its current confusion, and lead the way inadvancing a parsimonious, tractable, and plausibletheory of the firm and competitive advantage thatwill inform research, teaching, policy, and prescrip-tion across multiple fields of inquiry.

ACKNOWLEDGEMENTSThis paper is based in part on a presentation madeat the Academy of International Business 2011 AnnualMeeting, Nagoya, Japan, on 26 June 2011. Ideas basedon a revised version were presented at the Academyof International Business 2013 Annual Meeting inIstanbul, Turkey, on 4 July 2013. I wish to thank PeterBuckley, John Cantwell, Jay Connor, Pankaj Ghemawat,Jean-Francois Hennart, Richard Nelson, Christos Pitelis,Alan Rugman, Stephen Tallman, Alain Verbeke, threeanonymous reviewers, and especially Greg Lindenand Sunyoung Leih for helpful comments andassistance.

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NOTES1As Ronald Coase (1991) pointed out, it is not

enough for a theory of the firm to merely explain firmboundaries. In particular, an acceptable theory of thefirm needs to explain its “essence”. Such a theory hasyet to fully emerge, either in the domestic or in theMNE context. One might also hope that the theorycould explain recent developments, such as greateroutsourcing, greater geographical dispersion ofR&D activity, and the increase in international newventures.

2This is obviously a more ambitious goal than mosteconomists ever set themselves. See Hart (2011) formore discussion.

3Barreto (2010: 258) notes that “the dynamiccapabilities view has attracted substantial attentionfrom scholars publishing in top tier journals.”

4“Entrepreneurship was a persistent, but seldomcentral, theme in these studies. In her early study of theinternationalization of American Radiator Company, MiraWilkins criticized the insufficiency of international busi-ness theories based purely on comparative advan-tage and strategic thinking, and highlighted theimportance of evolutionary choices and uncertainty inentrepreneurial decision-making. She emphasized theimportance of understanding a series of specific path-dependent entrepreneurial decisions in the firm’sgrowth that shaped options and outcomes… Wilkinsalso discussed the ‘alert American entrepreneurs’ who‘sought opportunities beyond the national boundaries’(Jones and Wadhwani, 2007: 6).

5As Paul Walker notes, “expanding the orthodoxview of the firm to include the new reality of theknowledge economy should be an urgent issue on theeconomic research agenda” (Walker, 2009: 29).

6Peter Buckley likewise notes that “transactioncosts are, of course, not the whole story (again) butthey are an indispensable part of the whole story”(Buckley, 2009: 227).

7The goal here is not only to explain the nature offirms and their scope as per Coase (1937); it is also toexplain profit as per Knight (1921), although Knight’sinterest in profits was primarily at the economy-widelevel, less so at the firm level.

8Williamson (1999) seems to agree that an unad-dressed issue in this literature is the generation ofdifferential firm performance.

9Hymer confused competitive advantage andmonopoly power. Competitive advantage need not,and usually does not, imply that the firm possesses anypolicy-relevant market power.

10Oliver Williamson (1985) sometimes chooses tocall transaction cost economics the “governance”

approach, as the framework endeavors to explain howtransactions are organized or “governed”.

11Writing within this first prong, the Coasian para-digm, Teece (1976: 104) also noted that “technologytransfer can be facilitated within the multinational firmbecause of economies realized with respect to trans-actions costs, and the superior incentive and controldevices that the firm possesses and has available foruse”.

12Governance structures are arrangements by whicha transaction can be managed (governed) to mitigatepotential market exchange problems. Governancestructures encompass: (1) incentive intensity; (2) formof administrative control; and (3) contract law regime(Williamson, 1991).

13None of the textbook models of the firm – whethergeneric or MNE oriented – captures the changes to theMNE that movement toward a (global) knowledgeeconomy seems to entail. As Oliver Hart has recognized,“most formal models of the firm are extremely rudi-mentary, capable only of portraying hypothetical firmsthat bear little relation to the complex organizations wesee in the world” (Hart, 1989: 1757).

14Ownership advantages were not entirely firm-specific in Dunning’s treatment. However, Rugman(1981) interpreted O advantages primarily as firm-specific advantages (FSAs) – that is, specific toindividual firms. I owe thanks to Cantwell for valuablecomments on this point.

15The literature is still unsettled with respect towhether ownership advantages are endogenous orexogenous (Cantwell & Narula, 2003). Scholarshave noted that changes in the value of bothexogenous and endogenous variables affect eachother. Dunning, for instance, explains that asset-seeking FDI at time t may well affect L advantagesof the host country in time t + 1, and the choice ofL affects their future O advantages, which requires “areconfiguration of traditional OLI variables” (Dunning,2001: 178).

16As learning takes place in multiple organizationaland geographic sites, and with different comple-mentarities, different performance levels are achievedby different businesses. Different learning processesenable particular firms to stay on different paths andachieve peaks on today’s rugged and very globalindustrial landscape. Moreover, idiosyncratic path-dependent learning follows management’s initiation ofaction, the establishment of routines, and thedevelopment of organizational memory. This produces“rugged landscapes” (Levinthal, 1997: 934).Furthermore, the industrial landscape quite simply isn’tflat, either domestically or abroad. Heterogeneity is the

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norm, and is explained in part by the existence of path-dependent learning.

17The distinction being made here is a specificinstance of the general difference between “formal”and “appreciative” theorizing (Nelson &Winter, 1982).The former is a precise approach based on abstractmodels that attempt to reveal something meaningfulabout the real world despite their simplifications.Appreciative theorizing is qualitative, and takesobservations of the real world as its starting point.

18The task at hand for managers is bigger thansimplifying transactional difficulties by engaging indirect investment in wholly owned subsidiaries. Earlypath-breaking ideas, such as copiers or scanners, areoften met with skepticism and over-pessimistic guess-timates of their market potential. In such cases, it is leftto the originators of these ideas to try to provethemselves right. This has often required amassing theco-specialized and complementary assets needed to setup an organization and adopt the requisite structuresand strategies to create or co-create new markets(Pitelis & Teece, 2010) and reveal new sources ofdemand.

19I also noted in my very early work that “theliterature on the multinational enterprise, whetheremphasizing market power or efficiency, suffers froma common deficiency: underemphasis on dynamics”(Teece, 1986a: 36); and that “transaction costeconomics must be married to organizational decisiontheory if the dynamics of channel selection are to bebetter understood” (Teece, 1986a: 37). Market creationand co-creation are of course dynamic processes. In theabove quote, organizational decision theory is a poorlyworded proxy for what I now call dynamic capabilitiestheory, discussed below.

20A look at the cross-border activities of global firms isin line with our arguments. Take, for example, a firmsuch as Coca-Cola, and its cross-border activities inChina and India. These do not simply involve activitiesthat are tantamount to solving existing market failures.Instead, they involve the transfer of capabilities and thecreation of markets by designing and setting upbottling companies and distribution systems; by inven-ting new refrigerating technology; and by influencinguser perceptions.

21There is little room for uncertainty or innovation inthe various Coasian models of the MNE, and exten-sions have not succeeded in creating theories thatincorporate learning, capability enhancement, andinnovation in a meaningful way.

22Williamson recognizes Koopmans’ (1957) distinc-tions between primary and secondary uncertainty – butuncertainty implicates transaction cost economics only

through its impact on the contracting process. LikeCoase, Williamson does not recognize Knightian, orfundamental, uncertainty.

23Buckley has recently recognized that “the linksbetween the (multinational) firm, entrepreneurshipand transaction costs are strong” (Buckley, 2009: 227).However, his treatment of entrepreneurship is mainlycontractual.

24The econometric results in Monteverde and Teece(1982) showed that vertical integration was driven notjust by asset specificity. “Systems effects” and firm-leveleffects were empirically much larger. In particular, thereare a variety of contractual arrangements, some morefirm-like, some more market-like.

25There is considerable sentiment that transactioncost approaches to vertical integration and MNEexpansion (through wholly owned subsidiaries) puttoo much emphasis on “hold-up” and recontractinghazards. For example, General Motors’ acquisition ofFisher Body, which has been used as the canonicalexample of hold-up, has been shown on closerexamination to reflect just the opposite (i.e., GMmanagement trusted the Fisher Brothers, which is thereason they bought the company) (Chandler &Salsbury, 1971; Goldberg, 2008).

26Dunning, with his OLI approach, made a step inthe right direction; but OLI is also mostly static, and failsto recognize capability building or entrepreneurial andlearning considerations (Pitelis, 2007). Rugman andVerbeke (1992, 2001) incorporate strategic manage-ment thinking into the internalization theory using theconcepts of “location-bound” and “non-location-bound”.

27Interestingly, Casson has written extensively andwith considerable insight on entrepreneurship, aimingto integrate entrepreneurial decision-making into thetheory of the firm. Using a definition arising frominformation cost economics, Casson (2005: 325) viewsjudgmental decision-making as the defining charac-teristic of the entrepreneur, which requires the entre-preneur to develop skills for optimizing informationselection and processing. Although Casson endeav-ored to incorporate the entrepreneur into the theoryof the firm, his theory does not seem to fully capturethe entrepreneurial function of the MNE manager asadvanced here. A key reason is that organizationalknowledge and capabilities are distinct from thesummation of the individuals’ knowledge and skills,and Casson’s approach seems to be focused more onthe latter. Also, they often remain tacit (Polanyi,1958).

28In today’s global economy, there is considerablestandardization of products and certain manufacturing

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technologies, and markets are more open than theyused to be. However, homogenization of tasks andtechnologies has not yet occurred, and is unlikely todo so any time soon. Differences in consumerpreferences and purchasing power also remain, andwill likely continue to do so.

29“When it comes to the international expansionof manufacturing production itself a pure theory ofexchange is on weaker ground… [Technology] mayaccumulate within the firm not so much because of thecharacteristics of the market for technology onceit has been created, as because of the conditionsunder which it is most easily generated and used inproduction” (Cantwell, 1989: 216).

30In Dunning’s eclectic paradigm, and in Teece(1986b), competitive advantage flows from theownership of particular unique intangible assets (suchas firm-specific technology), and from the ownership ofcertain complementary assets.

31As Machiavelli noted in The Prince 500 years ago:“The prince who relies entirely on fortune is lost when itchanges… he whose actions do not accord with thetimes will not be successful… if times and affairschange, he is ruined if he does not change his courseof action”.

32Note that the “positioning” referenced here is notmarket positioning, in the manner used by Porter(1980). Market share is of little relevance to thisanalysis, except when there are strong network effects.The external business environment – writ large – is,however, highly relevant. This is perhaps bettersummarized by the concept of the ecosystem ratherthan industry (Teece, 2012).

33The approach does not deny that firms arenecessary to delimit recontracting hazards and othernegative consequences of opportunism. Rather, thetheory goes beyond this to recognize the need toorganize so as to embrace opportunity, and to capturegains from discovering and exploiting scope economiesderived from complementarities and co-specialization.

34An observation variously attributed to Charles deGaulle and Lou Gerstner holds that “You have to be faston your feet and adaptive, or else a strategy is useless”.Whoever originally said this, it makes an importantpoint: a good strategy must be combined with strongdynamic capabilities to be effective.

35According to Rumelt (2011: 7), a guiding policyspecifies the approach to dealing with the obstaclescalled out in the diagnosis. Coherent actions arefeasible, coordinated actions diagnosed to carry outthe guiding policy.

36For presentational purposes, strategy can beviewed as embedded in dynamic capabilities. They

are interdependent. In many cases, however, it ishelpful for strategy to be analytically separated. Thisis the approach followed in the remainder of thispaper.

37McDonald’s is an excellent example of a firm thathas grown globally based on an ability to replicate andmanage assets in multiple jurisdictions.

38Ordinary in the sense of maintaining the statusquo (that is, not out of the ordinary) (Helfat & Winter,2011: 1244).

39For instance, the most proficient manufacturer ofvacuum tubes with bountiful ordinary capabilities wasdefeated, as were others in the vacuum tube industry,by the invention and mass production of transistors.However, in markets that are protected from com-petition – possibly because of government regulationsor trade barriers, or which are small-scale – ordinarycapabilities may allow a company to be profitable andgrow reasonably well.

40Dynamic capabilities are generally required for thetransfer and adaptation of ordinary capabilities on aglobal scale. However, when global markets arerelatively homogeneous, such scaling may not requiresignificant adaptation. The mere transfer of tech-nologies (without adaptation) to different geographiesrepresents the extension of ordinary capabilities – onestep short of dynamic capabilities.

41Technical fitness is defined by how effectively acapability performs its function, regardless of how wellthe capability enables a firm to make a living (Teece,2007: 1321).

42Of course, in many poor countries with extensivestate control of resources, competitive forces are weak,and firms with ordinary capabilities can survive andprosper if ordinary capabilities are rare.

43Benchmarkers often study “best of breed” or peerlessperformers of particular functions (e.g., what can theshipping department learn from Federal Express?).

44Bloom et al. (2012) identified 18 managementpractice domains. These seem to represent particularordinary capabilities, as discussed below.

45The fast-food industry is another example,although capabilities are perhaps not yet as completeon a global basis.

46Nelson dates this development from the mid-1970s.

47Cloud computing enables “ubiquitous, con-venient, on-demand network access to a shared poolof configurable computing resources (e.g., networks,servers, storage, applications, and services) that can berapidly provisioned and released with minimal manage-ment effort or service provider interactions” (Mell &Grance, 2011). These resources can be provisioned

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to small businesses or across large multinationalcorporations.

48Unpublished comments made at the Academy ofInternational Business meeting, Nagoya, Japan, 26 June2011.

49Bloom and Van Reenen (2010) explored reasonswhy ordinary capabilities were less prevalent indeveloping countries. Their large-scale, cross-countrysurvey results suggested that an information gap wasperhaps the biggest contributor; managers weregenerally not well-informed about how their ownpractices compared to best practices. Specificconditions that could also lead to poor managementpractices in developing countries include weak productmarket competition, state ownership, family-basedmanagement, and poor business education.

50Intellectual capital, in particular, is generally harderto develop, transfer, and imitate (Teece, 2000).

51Evolutionary fitness refers to how well the capabilityenables a firm to make a living (Teece, 2009: 7).Dynamic capabilities allow an organization to changein a manner that supports evolutionary fitness. Theygovern how new products and services are developedand positioned, how new business models are created,and how ordinary capabilities improve.

52For instance, an important function in drugdevelopment is achieving regulatory approval. Atpresent, many major pharmaceutical companies havewell-developed processes (for running the approvalprocess). In time, however, such processes couldbecome standardized, and available from a businessservice provider. When this occurs, a higher-ordercapability in the pharmaceutical industry will becomea lower-order (ordinary) capability.

53There may be multiple niches available to a firm forsurviving, given the environment. The higher theenvironmental complexity that can be handled by thefirm, the better the long-run performance.

54Winter (2003) approaches dynamic capabilities asbeing rooted in higher-level change routines. The coreof a capability is patterned activity oriented to relativelyspecific objectives (p. 992). He differentiates dynamiccapabilities from ad hoc problem-solving, and views adynamic capability as a skill or routine that must bemaintained (p. 994).

55Discovering and exploiting discrepancies in factorprices across jurisdictions is an element of theentrepreneurial function of the MNE.

56Drnevich and Kriauciunas (2011: 275) found thatfirms may achieve higher relative performance byincreasing ordinary capability usage in stable environ-ments and increasing dynamic capability usage indynamic environments.

57Many discussions of operations strategy drift intowhat I think of as dynamic capabilities. Some scholarssee operations strategy as developing resources andconfiguring processes so that there is good strategic fitwith the business environment (Van Mieghem, 2008:18). In the fast-food industry, for example, ordinarycapabilities involve key performance indicator metrics,training systems, motivation, monitoring, and so on.Dynamic capabilities address figuring out new productto put on the menu, new operating hours (e.g., latenight), and new locations (central vs suburban). Theseare critical decisions in the MNE context.

58Simon (1969) defines three modes of coping withthe environment: passive insulation, reactive negativefeedback, and predictive adaptation. Miles and Snow(1978) also lay out a taxonomy with respect to howfirms can adapt.

59Building organizations that possess andappropriately exercise dynamic capabilities isn’t at alleasy. It’s not simply about standardization, ration-alization, or centralization; these are more associatedwith ordinary capabilities than with dynamiccapabilities. In the global context, dynamic capabilitiesinvolve being sensitive to local markets and nationalsystems of innovation, while also achieving integrationacross markets where scale allows and requires it.

60Fitness is somewhat akin to contingency theory,and the alignment of organizational design withcontext (Burns & Stalker, 1961).

61This is somewhat consistent with the revisedthinking of Hennart (2009).

62As Rugman and Verbeke (1993: 74–75) note, “asubstantial body of literature exists which suggests thatlarge MNEs are becoming increasingly independentfrom individual countries; they use selective parts ofnational diamonds to gain global advantages. In eachof these cases, anMNE’s core competence is consideredto be its ability to coordinate and control operationswhich are globally dispersed as a result of a wide varietyof location advantages associated with industrialnations or regions”.

63Of course, the advantages of complex coordinationbeing conducted inside the firm are featured in manytheories of the firm (e.g., Barnard, 1938; Hennart,1977, 1982). However, the type of “coordination”discussed here – coordination that involves orches-trating co-specialized complements and intellectualproperty – is rather different from what has beenfeatured before.

64Dierickx and Cool (1989) do not use the languageof time-cost tradeoffs; they speak of “time compressiondiseconomies” (p. 1504). They appear to be getting atthe same idea.

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65As O’Reilly, Harreld, and Tushman (2009) note, thisis not only required, it is sometimes achieved.

66This is despite the fact that Oliver Williamson, one ofthe pioneers of transaction cost thinking, wrote a gooddeal about theM-form structure (e.g., Williamson, 1975).

67Headquarters management can perform an impor-tant set of functions by promoting and protectingorganizational learning, co-specialized technologytransfer, and capability accumulation. Entrepreneurialleadership can come from the parent or thesubsidiaries.

68The exception here is Chesbrough and Teece(1996). However, this treatment gave insufficientweight to capabilities.

69This formulation is based on Coase (1937).Williamson (1985) frames the boundary choice issueas one of minimizing both what he calls “governance”

costs and “production” costs. Governance costsdepend importantly on whether the task at handrequires investment in idiosyncratic (transaction-specific)assets.

70The Boeing 787 Dreamliner case is relevant here asa counter-example. In designing a supply chain for itsnew 787 Dreamliner passenger jet, Boeing decidedto rely far more than ever before on a global arrayof suppliers to develop parts and subsystems.Unfortunately, it also cut back its monitoringcapability, without having first ensured that allsuppliers had the requisite design and productioncapabilities. Problems with inadequate componentsled to a delay of more than three years (Kesmodel,2011). The problems were not, at heart, contractualones; they arose more from capability deficienciesthan from opportunism.

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ABOUT THE AUTHORDavid J Teece is the Tusher Chair in Global Businessand the Director of the Institute for Business Innova-tion, Haas School of Business, University of Califor-nia, Berkeley. He is also chairman of the BerkeleyResearch Group, and has published over 20 booksand over 200 articles on the role of innovation,technical change, and capabilities in the competitiveperformance of the business enterprise, and ondomestic and international policy.

This work is licensed under a CreativeCommons Attribution-NonCommer-

cial-NoDerivs 3.0 Unported License. To view a copyof this license, visit http://creativecommons.org/licenses/by-nc-nd/3.0/

Accepted by John Cantwell, Editor-in-Chief, 31 August 2013. This paper has been with the author for three revisions.

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