IDEAS home Printed from https://ideas.repec.org/a/inm/ororsc/v12y2001i6p744-758.html
   My bibliography  Save this article

Capabilities as Real Options

Author

Listed:
  • Bruce Kogut

    (Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104)

  • Nalin Kulatilaka

    (School of Management, 595 Commonwealth Avenue, Boston University, Boston)

Abstract

Strategy research consists of a balance between positive and normative theory. Normative theories suggest particular heuristics, or cognitive representations, to find appropriate solutions. Heuristics permit faster solutions to real-time problems; they also suffer from the potential of negative transfer to inappropriate applications.The theory of real options provides the appropriate heuristic framing of competencies and exploratory search. A real options approach marries the theory of financial options to foundational ideas in strategy, organizational theory, and complex systems. We join these approaches to identify three pairs of concepts: scarce factor and the underlying asset in option theory, inertia and irreversibility, and the ruggedness of landscape and option values. Strategic theories of resources largely define a core competence as unique and nonimmutable. In doing so, this definition has wrongly forgotten Barney's initial insight into scarce factor markets as determining the valuation of a competitive asset. Financial theory of real options derives its heuristics of investing in exploratory search by inferring future value of today's investments from market prices.We apply the three conceptual pairs to the evaluation of capabilities as real options through a formal descriptive model. The valuation of core capabilities is derived from observing the price dynamics of correlated strategic factors in the market. Because of inertia, managers cannot easily adjust the wrong set of organizational capabilities to the emergence of market opportunities. However, firms that have made investments in capabilities appropriate to these opportunities are able to respond. From this description, we define core competence as the choice of capabilities that permits the firm to make the best response to market opportunities. The heuristic framing of capabilities as real options guides the normative evaluation of the balance between exploitation and exploration.

Suggested Citation

  • Bruce Kogut & Nalin Kulatilaka, 2001. "Capabilities as Real Options," Organization Science, INFORMS, vol. 12(6), pages 744-758, December.
    • Handle: RePEc:inm:ororsc:v:12:y:2001:i:6:p:744-758
    DOI: 10.1287/orsc.12.6.744.10082
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1287/orsc.12.6.744.10082
    Download Restriction: no
    File URL: https://libkey.io/10.1287/orsc.12.6.744.10082?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Edwin Mansfield, 1988. "The Speed and Cost of Industrial Innovation in Japan and the United States: External vs. Internal Technology," Management Science, INFORMS, vol. 34(10), pages 1157-1168, October.
    2. F. M. Scherer, 1967. "Research and Development Resource Allocation Under Rivalry," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 81(3), pages 359-394.
    3. Ingemar Dierickx & Karel Cool, 1989. "Asset Stock Accumulation and Sustainability of Competitive Advantage," Management Science, INFORMS, vol. 35(12), pages 1504-1511, December.
    4. Howard Kunreuther, 1969. "Extensions of Bowman's Theory on Managerial Decision-Making," Management Science, INFORMS, vol. 15(8), pages 415-439, April.
    5. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    6. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    7. Michael Cohen, 1999. "Commentary on the Organization Science Special Issue on Complexity," Organization Science, INFORMS, vol. 10(3), pages 373-376, June.
    8. Daniel A. Levinthal, 1997. "Adaptation on Rugged Landscapes," Management Science, INFORMS, vol. 43(7), pages 934-950, July.
    9. CARLISS Y. Baldwin & Kim B. Clark, 1992. "Capabilities And Capital Investment: New Perspectives On Capital Budgeting," Journal of Applied Corporate Finance, Morgan Stanley, vol. 5(2), pages 67-82, June.
    10. Ingemar Dierickx & Karel Cool, 1989. "Asset Stock Accumulation and the Sustainability of Competitive Advantage: Reply," Management Science, INFORMS, vol. 35(12), pages 1514-1514, December.
    11. James G. March, 1991. "Exploration and Exploitation in Organizational Learning," Organization Science, INFORMS, vol. 2(1), pages 71-87, February.
    12. Daniel A. Levinthal & James G. March, 1993. "The myopia of learning," Strategic Management Journal, Wiley Blackwell, vol. 14(S2), pages 95-112, December.
    13. Michael D. Cohen & Paul Bacdayan, 1994. "Organizational Routines Are Stored as Procedural Memory: Evidence from a Laboratory Study," Organization Science, INFORMS, vol. 5(4), pages 554-568, November.
    14. Jay B. Barney, 1986. "Strategic Factor Markets: Expectations, Luck, and Business Strategy," Management Science, INFORMS, vol. 32(10), pages 1231-1241, October.
    15. Bill McKelvey, 1999. "Avoiding Complexity Catastrophe in Coevolutionary Pockets: Strategies for Rugged Landscapes," Organization Science, INFORMS, vol. 10(3), pages 294-321, June.
    16. David J. Teece & Gary Pisano & Amy Shuen, 1997. "Dynamic capabilities and strategic management," Strategic Management Journal, Wiley Blackwell, vol. 18(7), pages 509-533, August.
    17. Rebecca Henderson, 1993. "Underinvestment and Incompetence as Responses to Radical Innovation: Evidence from the Photolithographic Alignment Equipment Industry," RAND Journal of Economics, The RAND Corporation, vol. 24(2), pages 248-270, Summer.
    18. Udo Zander & Bruce Kogut, 1995. "Knowledge and the Speed of the Transfer and Imitation of Organizational Capabilities: An Empirical Test," Organization Science, INFORMS, vol. 6(1), pages 76-92, February.
    19. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    20. Nalin Kulatilaka & Enrico C. Perotti, 1998. "Strategic Growth Options," Management Science, INFORMS, vol. 44(8), pages 1021-1031, August.
    21. Milgrom, Paul & Roberts, John, 1990. "The Economics of Modern Manufacturing: Technology, Strategy, and Organization," American Economic Review, American Economic Association, vol. 80(3), pages 511-528, June.
    22. McDonald, Robert & Siegel, Daniel, 1984. "Option Pricing When the Underlying Asset Earns a Below-Equilibrium Rate of Return: A Note," Journal of Finance, American Finance Association, vol. 39(1), pages 261-265, March.
    23. E. H. Bowman, 1963. "Consistency and Optimality in Managerial Decision Making," Management Science, INFORMS, vol. 9(2), pages 310-321, January.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Inseong Song & Jonghoon Bae, 2016. "Politics, strong institution and competitive advantage: an examination of organizational aspiration for competition," Computational and Mathematical Organization Theory, Springer, vol. 22(4), pages 412-443, December.
    2. Corinne A. Coen & Catherine A. Maritan, 2011. "Investing in Capabilities: The Dynamics of Resource Allocation," Organization Science, INFORMS, vol. 22(1), pages 99-117, February.
    3. Philipp N. Baecker, 2007. "Real Options and Intellectual Property," Lecture Notes in Economics and Mathematical Systems, Springer, number 978-3-540-48264-2, October.
    4. Sharon A. Alvarez & Jay B. Barney & Philip Anderson, 2013. "Forming and Exploiting Opportunities: The Implications of Discovery and Creation Processes for Entrepreneurial and Organizational Research," Organization Science, INFORMS, vol. 24(1), pages 301-317, February.
    5. Robert P. Garrett Jr. & Jeffrey G. Covin, 2015. "Internal Corporate Venture Operations Independence and Performance: A Knowledge–Based Perspective," Entrepreneurship Theory and Practice, , vol. 39(4), pages 763-790, July.
    6. Hazhir Rahmandad, 2012. "Impact of Growth Opportunities and Competition on Firm-Level Capability Development Trade-offs," Organization Science, INFORMS, vol. 23(1), pages 138-154, February.
    7. Mehmet Ali Köseoglu & John A. Parnell & Melissa Yan Yee Yick, 2021. "Identifying influential studies and maturity level in intellectual structure of fields: evidence from strategic management," Scientometrics, Springer;Akadémiai Kiadó, vol. 126(2), pages 1271-1309, February.
    8. Linda Argote & Sunkee Lee & Jisoo Park, 2021. "Organizational Learning Processes and Outcomes: Major Findings and Future Research Directions," Management Science, INFORMS, vol. 67(9), pages 5399-5429, September.
    9. John C. Butler & Jovan Grahovac, 2012. "Learning, Imitation, and the Use of Knowledge: A Comparison of Markets, Hierarchies, and Teams," Organization Science, INFORMS, vol. 23(5), pages 1249-1263, October.
    10. Jan W. Rivkin, 2000. "Imitation of Complex Strategies," Management Science, INFORMS, vol. 46(6), pages 824-844, June.
    11. Jan W. Rivkin, 2001. "Reproducing Knowledge: Replication Without Imitation at Moderate Complexity," Organization Science, INFORMS, vol. 12(3), pages 274-293, June.
    12. Michael J. Lenox & Scott F. Rockart & Arie Y. Lewin, 2007. "Interdependency, Competition, and Industry Dynamics," Management Science, INFORMS, vol. 53(4), pages 599-615, April.
    13. Maurizio Zollo & Mario Minoja & Vittorio Coda, 2018. "Toward an integrated theory of strategy," Strategic Management Journal, Wiley Blackwell, vol. 39(6), pages 1753-1778, June.
    14. Hazhir Rahmandad, 2008. "Effect of Delays on Complexity of Organizational Learning," Management Science, INFORMS, vol. 54(7), pages 1297-1312, July.
    15. Montserrat Boronat-Navarro & Alexandra García-Joerger, 2019. "Ambidexterity, Alliances and Environmental Management System Adoption in Spanish Hotels," Sustainability, MDPI, vol. 11(20), pages 1-16, October.
    16. Phebo D. Wibbens, 2023. "A formal framework for the RBV: Resource dynamics as a Markov process," Strategic Management Journal, Wiley Blackwell, vol. 44(6), pages 1562-1586, June.
    17. Tan, Justin & Wang, Liang, 2010. "Flexibility-efficiency tradeoff and performance implications among Chinese SOEs," Journal of Business Research, Elsevier, vol. 63(4), pages 356-362, April.
    18. Jan-Erik Vahlne & Jan Johanson, 2017. "From internationalization to evolution: The Uppsala model at 40 years," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 48(9), pages 1087-1102, December.
    19. Giovanni Gavetti, 2012. "PERSPECTIVE—Toward a Behavioral Theory of Strategy," Organization Science, INFORMS, vol. 23(1), pages 267-285, February.
    20. Giovanni. Gavetti & Daniel A. Levinthal, 2004. "50th Anniversay Article: The Strategy Field from the Perspective of Management Science: Divergent Strands and Possible Integration," Management Science, INFORMS, vol. 50(10), pages 1309-1318, October.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ororsc:v:12:y:2001:i:6:p:744-758. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Asher (email available below). General contact details of provider: https://edirc.repec.org/data/inforea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.