“In physics, if you’ve got a bad theory and there is evidence out there that clearly shows it wrong, it tends to die. But in economics, the death of bad theory seems to take much longer. When bad theorists get control of resources in a university, they can keep replicating themselves. I’ve always had one foot in the real world.”

Economists, especially those in the academy, “are ordinarily concerned above all that their arguments be found persuasive by other economists,” wrote Teece and Sidney Winter (now the Deloitte & Touche Professor of Management at Penn, then a professor of economics and management at Yale), in a 1984 article titled “The Limits of Neoclassical Theory in Management Education.” Since those economists “rarely suffer in their professional lives the discomforts and anxieties of reliance on indispensable expertise operating from an alien conceptual framework,” they are “ill-equipped to deal with the complexity and diversity of management problems.”

While most management issues deal with dynamics, Teece and Winter argued, economic theory deals “almost exclusively with static equilibrium analysis.” For that and other reasons, “one can doubt very seriously that the discipline thus shaped makes a wholly constructive contribution to management.” Though that article was written 24 years ago, its message still resonates.

“Mainline economics in the U.S. and to a considerable extent in the U.K. has, over the last 30 to 40 years, grown very narrow and very stylized,” says Richard Nelson. “Two of the topics that it has grown very narrow and stylized about are, first, what business firms are and how they operate, and second, what technological change is all about, how it occurs, and who does it. As a result of that, a number of people who got their Ph.D.s in economics, such as David Teece and Sid Winter and myself, have gone down a very different intellectual path than our brothers and sisters in economics have gone down, and a lot of what David Teece does is not recognized at all as economics by many of the people in standard economics departments.”

Teece’s contribution to understanding the business firm has been “enormously important,” in Winter’s view. “It’s been particularly important in teaching management, particularly in the importance of the term capabilities, and his thinking about strategy in capabilities terms.

“I think he has a great instinct for the big picture, which may be one of his more outstanding traits,” Winter adds. “The style is top-down. You don’t bury yourself in details without orientation. On the contrary, you start with a conceptual orientation and … drill down.” And for all the complexities inherent in Teece’s subject matter, he brings to bear “a set of intellectual heuristics that are very orienting for a very wide range of problems.”

 

“My academic research has been involved with trying to incorporate innovation into the theory of a firm,” Teece is saying. “When you think about it, that is the quintessential issue that everyone in the world is interested in, but only a handful of scholars are touching it—because it’s interdisciplinary; it’s hard to do; you can’t formalize it very well. I’ve done it, I suppose, as well as anybody, and that’s really why my stuff is getting cited. As Mansfield said, ‘You always get brownie points for asking the right questions, even if you don’t get a very good answer.’”

The essence of his research, he adds, “is: ‘What is the foundation of the world of business enterprise?’ Adam Smith did The Wealth of Nations, and I’m trying to keep a record. It sounds highfalutin, but I’m trying do the same thing in terms of distilling the key essence of what makes companies great.”

Among the questions that Teece has addressed, in his own words:

Why do firms exist?

Why are they hierarchical?

Why don’t firms outsource everything, if markets are as efficient as the economics textbooks claim they are?

Why are firms diversified if there are gains to specialization?

Why should economies of scale and scope lead to large diversified firms rather than strategic partnering?

If firms have know-how, where does that know-how reside? If it is merely in the minds of the employees, how can the firm prevent the employee from extracting all the value?

How can firms profit from innovation if they don’t have strong intellectual property?

“These questions might sound banal to the layperson, but I can assure you they are deep questions, and we don’t have answers as good as we would like,” he told the graduating scholars at St. Petersburg State University School of Management, where he was delivering the Commencement address. That was nearly six years ago (before it became the Graduate School of Management), and though he’s been working on those questions since then, they’ve still got some depth to them.

In his 1986 “Profiting from Technological Innovation: Implications for integration, collaboration, licensing and public policy,” Teece addressed the subject of why innovating firms often “fail to obtain significant economic returns from an innovation, while customers, imitators and other industry participants benefit.” Among the examples he cited was that of EMI, the British electronics corporation, which developed the first CAT scanner in the late 1960s but soon lost its market leadership to “imitator” companies such as Technicare and GE because of their superior “complementary capabilities”—training, technical support, servicing, and the like. Conversely, IBM’s PC offered only a “very modest technological advance” over other home computers, but succeeded wildly because it was able to offer its name and commitment to the project, with all the marketing, servicing, retail-distribution, and technological advantages that implied.

By teasing out some very tangled threads, such as industries and technologies in which patents are effective and those in which they aren’t, Teece was able to build a very persuasive case. It’s fair to say that the article had a significant effect.

“The greatest homage that can be paid to a scholarly contribution, is, in my view, the reader’s private acknowledgement that the world looked different to me after I read that,” wrote Winter in a 2006 article for Research Policy titled “The logic of appropriability: From Schumpeter to Arrow to Teece,” which heaped praise onto Teece’s paper and traced his intellectual lineage from two highly influential economists, Joseph Schumpeter and Kenneth Arrow. The paper’s “well-justified fame,” Winter added, “is attributable to the fact that a great many readers had such a reaction, recognizing the change the article produced in their basic perceptions.”

“I see this paper as an important early step in David’s more general research and writing on the nature and importance of dynamic firm capabilities,” says Nelson, and indeed, Teece’s work on dynamic capabilities may be his most important legacy. His 1997 “Dynamic Capabilities and Strategic Management” (with Gary Pisano and Amy Shuen) sought to identify the decision-making process that supports the “orchestration capability” of a firm’s core and complementary assets, and explored a new framework for analyzing the “sources and methods of wealth creation and capture” by firms. The core elements of dynamic capabilities are its three organizational and managerial processes—“coordination/integrating, learning, and reconfiguring”—which represent a “subset of the processes that support sensing, seizing, and managing threats” to a firm.

Dr. Constance Helfat, the Quinn Professor in Technology and Strategy at Dartmouth’s Tuck School of Business, recalls Teece working on the theory of dynamic capabilities as far back as 1985. “He probably had it in his head before then, but I remember that he drew it out on a piece of paper in early 1985,” says Helfat.

“I thought it was a phenomenal idea,” she adds, explaining that its importance lies in the way it elucidates “how an organization can strategically adapt to change and even create change. There is a stream of literature on organizational capabilities, activities that firms are able to perform in teams, that was starting to become important at the time. But it was not focusing on how do you change. What David identified [concerns] the range of capabilities that is important for different types of change.”

While Teece is not shy about saying that the article has been “absolutely explosive in terms of its impact”—with good reason, given its most-cited status for the decade—he and his colleagues acknowledged that it was basically an “outline” for the dynamic-capabilities approach. Further theoretical work—and Mansfield-style empirical research—would be critical to helping understand “how firms get to be good, how they sometimes stay that way, why and how they improve, and why they sometimes decline.”

Ten years later, he extended the theory’s reach in “Explicating Dynamic Capabilities: The Nature and Microfoundations of (Sustainable) Enterprise Performance.” Dynamic capabilities, he wrote, can be broken down into the capacity to “sense and shape opportunities and threats”; to “seize opportunities”; and to “maintain competitiveness through enhancing, combining, protecting, and, when necessary, reconfiguring the business enterprise’s intangible and tangible assets.”

The two yardsticks for measuring/calibrating those capabilities, Teece wrote, are “‘technical’ fitness and ‘evolutionary’ fitness.” The former refers to how well a capability performs its function, regardless of how well it enables a firm to make a living, while evolutionary fitness refers to “how well the capability enables a firm to make a living.” Contrary to certain earlier models (such as the Five Competitive Forces model of Michael Porter), Teece argued that strategizing against competitors is less effective than identifying and taking advantage of new opportunities: “Entrepreneurial management has little to do with analyzing and optimizing. It is more about sensing and seizing—figuring out the next big opportunity and how to address it.”

“David has an unusual skill at being able to identify phenomena that, once you say them, are completely obvious, but until then nobody has identified and articulated what they are,” says Helfat. The fact that the dynamic-capabilities theory has “practically taken over the field of strategy today,” she adds, “tells you how right he was.”