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KIM Jong-Nyun

Building Dynamic Capabilities

KIM Jong-Nyun

Apr. 9, 2010

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A common description of winning is that it is "Seventy percent luck and 30 percent skill." This is also often applied in corporate management. In his book Great to Great, Jim Collins commented on the relationship between management performance and luck as follows.

Leaders of great companies look out the window to apportion credit to factors outside themselves when things go well. At the same time, they look in the mirror to apportion responsibility, never blaming bad luck when things go poorly. Leaders of failed companies look in the mirror and give themselves the credit when things go well. When things go south, they look out the window and blame others.

Corporate performance is the result of external factors such as luck and internal factors like competitiveness exerting their influence simultaneously. In the past, surrounding business conditions, especially the state of an industry, was considered the key to corporate performance. This "Industry Effect" theory suggests that it is crucial to steer toward a business that is doing well. However, since the 1990s, corporate earnings within an industry have become more polarized regardless of whether or not the industry is in an up or down cycle. It was no longer possible to blame weak performance on an industry's direction.

This gave rise to a "Resource-based View" which claims that a company's strengths, i.e., competitive advantage, are the most important factor in corporate performance. However, this concept is basically regarded as static; in other words, it can fully explain the profitability of a company but it is limited in delineating business dynamics such as change and growth. To overcome such limitations, the concept of Dynamic Capability emerged. It refers to their ability to address a rapidly changing environment by integrating and reconfiguring resources or by seeking a new growth path.

In an environment where corporate environment is changing fast, a company should have a competitive edge as well as dynamic capability. How can dynamic capability be measured? A model developed by Samsung Economic Research Institute measures it on three levels: "open corporate culture," "networking," and "investment dynamism."

First, open corporate culture refers to a company's ability to change. Once an open culture is established, employees' resistance against change and their trust in the company will rise. Creating a great workplace reduces resistance against change. For example, SAS, a business analytics and business intelligence software firm, has been named to Fortune's " 100 Best Companies to Work For" list for 12 straight years . The firm guaranteed autonomy and safety of employees and resisted layoffs and forced retirement. As a result, the company's job turnover rate is only 4 percent compared with industry average of 20 percent. Considering that the hiring cost of an employee is equal to or double his/her annual salary, this is a considerable reduction of costs.

Second, networking capability is needed to overcome self-limits and to harmonize with existing strengths. Procter & Gamble built an effective R&D system called Connect & Develop to connect technology and ideas from the outside to internal R&D strengths thereby significantly reducing R&D costs. As such, networking aims at creating a corporate ecosystem by employing various means such as strategic alliances or mergers and acquisitions (M&As). It is an activity that Korean companies need to adopt; from 2006 to 2008, among the top 100 global companies, each averaged 37 M&As, but among the top 100 Korean companies the per-company average was only three.

Third, investment dynamism refers to the quantity, diversity and promptness of investment for next-generation industries, and is a direct motivation for corporate growth. In order for a company to grow either organically or through M&As, investing in future industries is a necessity. The success of Korean companies can also be attributed to bold investments. Since the 1970s, major companies heavily invested in semiconductors, LCD, steel, automobiles and shipbuilding, even during economic downturns.

A key foreign example for investment dynamism is Amazon.com. Starting as the world's first online book store, it dominated the global market through its unique ordering system. Starting with US$150 million in 1997, sales increased more than 20-fold to US$3.12 billion by 2001. Since then, Amazon.com has been enjoying sales of 30% on annual average, posting US$24.5 billion in 2009. Even major volatility such as the IT bubble burst did not derail growth driven by steady investments and business transformation.

The aforementioned explanation of dynamic capabilities offers some lessons to companies. First, even if a company is a leading company, it should secure new competency, i.e., dynamic capability, to prepare for the future. Global companies that once could boast of being at the top are now being shaken by a changing industry paradigm. Nokia is struggling from Samsung Electronics' fast catch up, while Toyota Corporation, which has warned of being in the fourth stage of a five-stage path to business failure, is facing its worst vehicle recall.

Second, companies need to focus on resolving the contradiction between dynamic capability and competitiveness. Companies should strengthen dynamic capability to cope with severe environment changes, but in this case it can collide with existing strengths. This means that while enhancing adaptability to change, a company must ensure existing strengths are not weakened.

Third, a company's growth strategy should be rebuilt based on an indicator that comprehensively measures competitiveness and dynamic capability. Dynamic capability is a virtue that enables sustainable growth of a company against major changes in the corporate environment. Companies, therefore, should create the growth capability matrix between the growth in competitiveness and dynamic capability to create strategy that best suits itself.

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