Fundamental issues in capabilities research.

• Author: Ouyang, Hongwu 'Sam'
• Position: Report

1. FUNDAMENTAL ISSUES IN CAPABILITIES RESEARCH

   As the Resource-Based View (RBV) of the firm has gained wide acceptance in management field, organizational capability as a central concept in the RBV, also becomes popular in strategy, human resource management, and organizational research (Conner & Prahalad, 1996; Day, 1994; Douglas & Judge, 2001; Grant, 1991; Helfat, 2003; Helfat, et al., 2007; Madhok, 1996). In the meantime, capability has also become an important tool for practitioners (Hamel & Prahalad, 1994; Hansen, et al., 2005; Stalk, et al., 1992).

   Increasing attention to capabilities does not mean this concept and the research on capabilities are free of disagreements and controversies (Ambrosini and Bowman, 2009; Barney, 2001; Foss, 2003; Priem, 2001; Williamson, 1999). On the contrary, research on capability is still in the "emerging excitement phase" of the life cycle of an umbrella concept (Hirsch & Levin, 1999), and there are still many significant differences over such fundamental issues as definitions, antecedents and consequences of capabilities. For instance, scholars have not reached a consensus over the definition of capabilities. Some define capabilities as routines while others define capability as knowledge, efficiency and real options, and some critics even claim that capability definitions are tautological (Williamson, 1999). Moreover, with regard to the sources of capability, some think capabilities result from organizational process and systems, while others argue that resources and environment also play an important role. As for the consequences of capabilities, while many believe that capabilities satisfying certain conditions can lead to sustained competitive advantages, others suspect that the relations between capabilities and sustained competitive advantages are quite vulnerable (Collis, 1994, Eisenhardt & Martin, 2000; Powell, 2001).

   Given the current state and breadth of the research on capabilities, this paper does not deal with all the issues related to capabilities, instead chooses to focuses on such fundamental issues as the nature of capabilities in a firm, sources of capabilities, and the capabilities-competitive advantages-performance relationship. This paper contributes to the literature by clarifying the advantages and disadvantages of various perspectives in capability research, identifying the appropriate and promising directions, and raising the issues future research should tackle. The paper is organized as follows. In the first section, different definitions of capability are discussed and a working definition of capability is provided. In the second section, the antecedents of capabilities are analyzed. In the third section, the impact of capabilities on firm's competitive advantages and performance is explored. The final section is the discussion of issues future capability research needs to focus on.

2. NATURE OF CAPABILITIES

   Scholars have offered a number of definitions of capability (see Table 1). There are major differences among these definitions. First, the substance or sources of capability differ among these definitions. They range from knowledge, routines, efficiency in performing certain activities to options for future investment. Second, some definitions such as knowledge and routine-oriented definitions are organization-based and focus on the organizational side, whereas other definitions such as efficiency-oriented definition are broader and may include technological aspects.

   The first group of definitions adopts the knowledge perspective of the firm and regards knowledge as the most important resource in the firm (Day, 1994; Grant, 1996; Leonard-Barton, 1992). Capabilities are either knowledge in essence or combining knowledge. Leonard-Barton (1992) considers capabilities as interrelated and interdependent knowledge systems that provide competitive advantages, and Dosi et al. (2000) view capabilities as organizational knowledge that enables the firm to perform characteristic production. Grant (1996) goes one step further and suggests that the firm is composed of individuals with specialized knowledge and organizational capability is about the integration of specialized knowledge embedded in individuals. The major advantage of this definition is that it calls our attention to a significant aspect and activity in the firm, especially in large technology firms, i.e., knowledge integration (Kogut & Zander. 1992). By treating knowledge as the key resource and knowledge integration as the most important activity or task for any firm, however, the knowledge perspective tends to be narrow. For large firms in the knowledge-intensive industries, how to integrate knowledge residing in various individuals and units is a crucial task, but in many service industries and consumer products industries such as beverage, and small firms in particular, relationship building, client management, and marketing are as important as knowledge integration for a firm's performance, if not more important. So using knowledge and knowledge integration to define a firm's capability may underestimate the importance of other resources such as equipment, leadership, and customer relations, which are especially important in startups where knowledge integration is relatively limited and simple. In other words, excluding too many resources important for a firm's performance makes the definition lose its generalibility. The other problem with this definition is that it is an individualist view of the firm, and implicitly assumes that the individual-level knowledge is the most important knowledge, if not the only knowledge. This clearly is not the case. As we know that there are many organization-level routines and tacit organizational knowledge in firms, which do not reside in any particular individuals (Nelson and Winter, 1982).

   A related but broader view of capability is routine-oriented and follows the tradition of behavior theory (Collis, 1994; Stalk, et al., 1992; Winter, 2000, 2003; Zahra & George, 2002; Zollo & Winter, 2002). Winter's definition is representative and often quoted. He defines capability as "high-level routines or collection of routines that together with its implementing input flows, confers upon an organization's management a set of decision options for producing significant outputs of a particular type" (Winter, 2003: 991). There are two important elements in this definition: one is that capabilities are embedded in organizational structure and processes, and the other is that they are related to transformation of inputs to outputs or a variety of activities crucial to the firm's survival and prosperity (Collis, 1994). Despite the popularity of the capability-as-routines definition, there is one problem with this definition. Since all routines are effortless and some routines are not just a single pattern but rather a set of possible patterns, they are hard to notice and measure. In particular for those high-level capabilities involving many complex routines across departments, identifying the routines associated with the capability may be very subjective and difficult. This makes it difficult to operationlize capability.

   In contrast to the first two definitions' focus on the input side, the third definition of capabilities is efficiency-oriented and focuses on the transformation process (Amit & Schoemaker, 1993; Ethiraj, et al., 2005; Makadok, 2001; McGrath, et al., 1995). For instance, capability is defined as the efficiency with which a firm uses the inputs available to it and converts them into desirable outputs, and capability is regarded as intermediate goods which help transform resources into outputs and improve the productivity of resources (Amit & Schoemaker, 1993; Makadok, 2001). Accepting that capabilities encompass some objectives the firm tries to achieve, McGrath et al (1995) go one step further by defining capability of a firm as the firm's ability to reliably and consistently meet or exceed its objectives. By this logic, the gap between the firm's actual performance and its desired objective indicates the level of capability. Using the gap between the actual performance and the firm's objective to define capabilities has a strong assumption that firms know exactly their potential maximum efficiency frontiers, which serve as the basis of the objective. This assumption conflicts with the fact that in many companies, even top management cannot reach an agreement over the major existing capabilities of the firm, let alone the potential efficiency frontier (Denrell et al., 2004).

   The final view considers capability as real options. Kogut and Kulatilaka (2001; 2004) define core capabilities as "embodying exploratory investments to hedge the future" and they are platforms that create a generic set of resources and represent investment in the future opportunities. Rightfully the real option perspective brings the future, uncertainty, and sequential flexibility into the strategy discourse and subjects capability to market test and makes it possible to have market-based valuation of capabilities. Yet, besides the "impossibility of proving failure" problem inherent in the logic of the real options theory, the capability-as-option perspective has a strong assumption about the firm's managers as a unitary player. Since the real options theory involves uncertain future, it inevitably deals with the subjective judgment of managers involved in the search. In reality, the judgments on the side of managers about a project and capability may be different for various reasons. So the differences and the consequent organizational challenges posed by these differences may limit the flexibility the real options offer (Adner and Levinthal, 2004). This also makes the valuation and application of real option-based capabilities rather complicated and difficult.

   Working definition of capability: Return to common sense

   It is clear that all these definitions...