UC Berkeley

This article outlines a capabilities-enriched economic theory of the firm and its sources of competitive advantage. The nature and key categories of intangibles are discussed, with an emphasis on their suitability for providing differentiation in an era when so many services and tangible goods are readily available on a global basis. The linkages in the conversion of intangibles into profits are analyzed, including the frequent need for co-specialized complements. Among the key categories of intangibles are organizational capabilities, which can be either ordinary or dynamic. Ordinary capabilities are, generally, those that can be measured against best practice and with some effort, imitated by rivals. Dynamic capabilities, which reside in both signature processes and management skills, allow the enterprise and its top management to develop conjectures about the evolution of consumer preferences, business problems, markets, and technology; validate them; and realign assets and competences to enable continuous innovation for the creation of competitive advantage. The key concepts of complementarity, entrepreneurial management, and dynamic capabilities are then applied to deepening the economic theory of the firm, combining with the dominant transaction cost approach to provide a richer understanding of why firms are needed in the economic system.