Journal of Business Research 57 (2004) 518 532

Understanding competence-based management Identifying and managing five modes of competence

Abstract This paper develops a taxonomy of five modes of competences that an organization must develop and maintain in its various activities to achieve overall competence. Each competence mode is distinguished by the specific forms of flexibility it brings to an organization to respond to the changing opportunities and threats in its environment. Each form of flexibility is in turn distinguished by the kinds of strategic options it creates for an organization. Key interrelationships among the five competence modes are identified, and important aspects of managing each of the competence modes and their interrelationships are discussed. D 2002 Elsevier Inc. All rights reserved.
Keywords: Competence-based management; Organisational competence; Flexibilities; Strategic options; Open systems

1. Introduction The competence perspective has brought both significant theoretical extensions and important practical benefits to contemporary management thinking. While understanding industry structures was perhaps the primary concern of strategic management theory in the 1970s, for example, and while characterizing firms as unique bundles of resources became an important perspective in the 1980s, conceptualizing and analyzing the competences of organizations became a key focus of management thinking in the 1990s. As Rumelt (1994) has noted, the concept of competence resonates with the many managers and researchers who have concluded that analyzing the structures of industries and the resource bases of firms will not adequately explainor point the way toachievement of competitive success. Despite the broad interest in the competence perspective, both researchers working to develop competence theory and managers interested in applying competence concepts have often encountered difficulties in rigorously defining competences conceptually and in identifying the real competences of organizations. This discussion draws on recent thinking about competences to identify five aspects or modes of competence that can help
* Tel.: +41-21-618-0111; fax: +41-21-618-0707. E-mail address: ron.sanchez@imd.ch (R. Sanchez). 0148-2963/$ see front matter D 2002 Elsevier Inc. All rights reserved. doi:10.1016/S0148-2963(02)00318-1

researchers and managers to define, analyze and manage organizational competences more successfully. The discussion also suggests how the five competence modes are interrelated and how some key interrelationships between competence modes affect the management of competences in an organization. This discussion is organized in the following way. Section 1 revisits some basic conceptualizations and definitions of competence. The definition of competence suggested by Sanchez et al. (1996) is elaborated in Section 2 to identify some essential dynamic, systemic, cognitive and holistic dimensions of organizational competence. Recent research on identifying various elements and characteristics of competences is summarized in Section 3. Drawing on this research, Section 4 develops a taxonomy of five competence modes that exist at various levels of systemic activity within an organization. The five competence modes are distinguished by the distinctive sets of capabilitiesor more precisely, the distinctive flexibilitiesthey bring to an organization functioning as an adaptive open system. Each of these distinctive kinds of flexibility can be characterized in turn by the types of strategic options that each form of flexibility brings to an organization. Section 5 considers some key interrelationships among the five competence modes that must be managed to achieve organizational coherence and competitive success in the use of the organizations competences.

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2. Definitions of competence Since the first concerted efforts to conceptualize the competence of an organization began to emerge in the early 1990s, the many characterizations of competence proposed by researchers have consistently referred to some key constituent elements of competence, such as skills, capabilities, knowledge, learning, coordination, organization and relationships (see, e.g., Prahalad and Hamel, 1990; Schoemaker, 1999; Leonard-Barton, 1992; Dosi and Teece, 1993). Nevertheless, taken together, the various conceptualizations suggested by researchers have often resulted in some confusion as to the essential aspects of an organizations competences and how those might be identified in a specific firm or within an industry. Chiesa and Manzini (1997) suggest three reasons for this confusion, observing that the various definitions that have been put forward: (i) often use different terminology for similar concepts; (ii) appear to refer to inherently different levels of activities within organizations; (iii) generally adopt a static view of competences that does not adequately consider how competences are built or can be changed within an organization. Given such conceptual inconsistencies and omissions which are not at all unusual in a still emerging perspective three essential steps in establishing a theoretically sound, extendible and useful theory of competence-based management are (i) development and use of a consistent set of concepts and vocabulary for describing competences; (ii) classification of the different kinds and levels of activities within organizations that collectively contribute to achieving organizational competence; (iii) articulating the interactions of different kinds and levels of organizational activities that are critical in processes of competence building and leveraging. Sections 3 and 4 below summarize the research progress that has been made to date in each of these three steps. Section 5 then draws on that research to develop a taxonomy of competence modes that identifies five distinct modes of competence within an organization.

3. Defining competence in dynamic, systemic, cognitive and holistic terms The first effort to articulate a comprehensive vocabulary for describing competences was undertaken by Sanchez et al. (1996, pp. 7 11) with the objective to develop a vocabulary that is conceptually adequate, internally consistent and capable of serving as a language for discussing competencebased competition. This vocabulary and its underlying

concepts sought to recognize different levels of activities within an organization and the interactions of those activities in its processes of competence building and leveraging. Consider, for example, the following definitions. Assets: Anything tangible or intangible the firm can use in its processes for creating, producing and offering its products (goods or services) to a market. Capabilities: Repeatable patterns of action in the use of assets to create, produce and/or offer products to a market. Because capabilities are intangible assets that determine the uses of tangible assets and other kinds of intangible assets, capabilities are considered to be an important special category of assets. Capabilities arise from the coordinated activities of groups of people who pool their individual skills in using assets. Skills: Special forms of capability, usually embedded in individuals or teams, that are useful in specialized situations or related to the use of a specialized asset. These three definitions establish a hierarchy of interrelated concepts: At the highest level of classification, assets include all tangibles and intangibles useful to a firm, including capabilities which are a special category of intangible asset because they use or operate on other tangible and intangible assets. Capabilities then consist of repeatable patterns of action in the use of all other assets. Repeating patterns of action in turn requires individual and team skills in the use of assets to perform the specialized tasks that collectively generate organizational action. Extending this hierarchical approach to ordering of the essential elements of the competences of an organization, Sanchez and Heene (1996, 1997) proposed an open systems model of firms that further incorporates (i) the strategic logic of an organization for creating value in markets, which is held to be the essential activity through which an organization may achieve its goals, and (ii) an organizations management processes for coordinating assets in the activities it pursues in an effort to achieve its goals. This systems model, which is shown in the left side of Fig. 1, provides a hierarchical ordering of the fundamental, interactive elements of organizational competence. In essence, the strategic logic of the organization for creating value is enacted through management processes for deploying and coordinating intangible and tangible assets in the organizations operations for bringing product offers to markets. This open system model of an organization further identifies critical flows of decisions, policies, procedures and budgets emanating from an organizations management processes, flows of resources between its own firm-specific resources and firm-addressable resources outside the firm, and feedback flows of data and revenues from product markets and from the organizations monitoring of its assets and operations. Thus, this systems view of an organization also incorporates some essential interactions between an organizations assets (including capabilities and skills), its management processes and its strategic logic for using assets in pursuit of its goals.

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Fig. 1. Five modes of competence in competence-based management.

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Drawing on this hierarchical ordering of the systemic, interactive elements of an organization, Sanchez et al. (1996, p. 8) propose a working definition of competence. Competence is the ability to sustain the coordinated deployment of assets in ways that help a firm achieve its goals. Though simple, this definition embodies essential aspects of the four cornerstones of competence theory, which aspires to recognize and capture the dynamic, systemic, cognitive and holistic nature of organizational competences. Each of these four aspects of the nature of the competent organization deserves further comment. First, competence must include the ability to respond to the dynamic nature of an organizations external environment and of its own internal processes. The requirement of sustainability in the above definition of competence encompasses both forms of dynamics. To be sustainable, a competence must respond to the dynamics of the external environment by enabling an organization to maintain its ability to create value in the marketplace even as changes take place in market preferences and available technologies. Sustainability also requires overcoming internal organizational dynamics that result in various forms of organizational entropy,1 such as a gradual loss of organizational focus, a narrowing and increasing rigidity in the patterns of activity the organization can or does perform, a progressive lowering of organizational expectations for performance and success, and the like. The notion of organizational entropy reflects the concept of entropy in the laws of thermodynamics. The essential feature of the law of entropy is that systems naturally tend to devolve to lower states of energy, which takes the form of a loss of structure and information content. Ongoing inputs of energy (negentropy) are required simply to maintain a system in its current state of structure and information. Further inputs of energy are then required to increase the structure and information content of a system. Analogously, in organizations as systems, managers must provide continuous inputs of energy and attention to maintain or improve the order and structure in an organizations value-creation processes. Second, competence must include an ability to manage the systemic nature of organizations and of their interactions with other organizations. The requirement of coordination of assets addresses this dimension of competence. In the first instance, competence requires an ability to coordinate an organizations own firm-specific assetsi.e., the assets within the boundaries of the firm and thus under its direct controlin processes of creating value through product creation and realization. In addition, competence involves accessing and coordinating important firm-addressable assets that lie beyond the boundaries of the firm. Providers of key firm-addressable assets include materials and components suppliers, distributors, consultants, financial institutions and customers.

Third, competence must include an ability to manage the cognitive processes of an organization. The requirement of deployment of assetsdirecting organizational assets to specific value-creating activitiesaddresses this dimension of competence. A firms managers are ultimately responsible for deciding the ways in which a firm will try to create value in its targeted product markets. Thus, achieving organizational competence poses a twofold cognitive challenge to managers. Managers must be able to ascertain and assure that a firms operations meet at least the minimum efficiency requirements needed to carry out the strategies of the firm, but they must also be able to define and select strategies that have the potential to create value in targeted markets when they are carried out efficiently. In other words, managers are responsible for both efficient and effective use of an organizations assets. Fourth, competence must include the ability to manage the holistic nature of an organization as an open system. The requirement of goal achievement addresses the multiplicity of individual and institutional interests that intermingle in and are served through any organization. To lead an organization in achieving goals requires that managers be able to define organizational goals that promise a satisfactory level of goal achievement for all individual and institutional providers of the essential resources the organization needs. Thus, the definition of organizational competence recognizes the existence of multiple stakeholders and the importance of meeting the expectations of all providers of essential resources in sustaining the value-creating processes of an organization. We next consider some important theoretical antecedents in the development of competence perspective, as well as the ways in which the concept of competence is now being extended to improve the ability of researchers and managers to identify specific aspects of organizational competences.

4. Research into organizational competences By setting a systemic, dynamic, cognitive and holistic framework for building management theory, the competence perspective has integrated and extended some key ideas developed over the last several decades under various bannersincluding resource base, dynamic capabilities and core competences perspectives. We next briefly summarize here these important antecedents and suggest how each has contributed to the development of contemporary competence theory. (For a more complete discussion of the evolution of ideas relevant to contemporary competence theory, see Sanchez, 2001.) We then consider more recent research that has extended the competence perspective by identifying a number of criteria that are useful in distinguishing and classifying important aspects of organizational competences.

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4.1. Resources, dynamic capabilities and core competences Economist Penrose (1959) characterized a firm as a collection of productive resources and developed a theory of the growth of firms in which the availability of slack physical and human resources within a firm stimulates a search by managers for opportunities to expand a firms activities. Building on this focus on resource endowments of organizations, Wernerfelt (1984) argued that resources are tied semipermanently to the firm and further that firms will usually face resource position barriers when they acquire a new resource because they will face higher costs compared to firms that were first movers in creating and using a given resource. Barney (1986, 1991) further proposed that a firms resources can be sources of sustained competitive advantage when resources that are imperfectly mobile and inimitable enable a firm to implement strategies that improve efficiency and effectiveness. Dierickx and Cool (1989) subsequently added an important dynamic dimension to the discussion of resources by investigating ways in which the rent-earning potential of a firms resources depend on the properties of a firms asset stocks and flows. Dierickx and Cool argued that four properties affecting the accumulation of asset stockstime-compression diseconomies, asset mass efficiencies, asset stock interconnectedness and casal ambiguityprevent other firms from imitating a firms endowment of strategic resources: Paralleling the work on resources in the 1980s was growing interest in firms abilities to use current resources, to create new resources and to devise new ways of using current or new resources. Nelson and Winter (1982) proposed that a firms skills are embedded in organizational routines, which are the repetitive activities a firm develops in its use of specific resources. Teece et al. (1990, 1997) proposed a notion of dynamic capabilities as a firms ability to integrate, build and reconfigure internal and external routines in the use of firm-specific resources. They argued that a firms organizational and managerial processes combined with its current resource positions create path dependencies that constrain a firms ability to develop new kinds of routines and resources. Amit and Schoemaker (1993) further argued that the resources (or strategic industry factors) that can be sources of competitive advantage cannot be predicted with certainty ex ante, leading to uncertainty, complexity and social conflict in managerial processes for changing a firms set of strategic assets and introducing important cognitive and social dimensions to resource accumulation processes. In the early 1990s, a broad research initiative into organizational competences was stimulated by a series of articles on core competences by Hamel (1989, 1991, 1994) and Prahalad and Hamel (1990, 1993). In summarizing the ideas put forward by Hamel and Prahalad, Rumelt (1994) proposed that core competences are distinguished by spanning across products or businesses, by changing more slowly than the products they make possible, by embodying the collective learning of the firm, and by embracing competition to

acquire the best skills and capabilities. Hamel and Heene (1994) then identified several goals for a more integrative theory of strategic management that would be founded on new notions of organizational competence and that would illuminate the characteristics of a firms strategic architecture and the concepts, tools, techniques and models a firm uses in combining resources and capabilities to build and leverage organizational competences. Sanchez et al. (1996) subsequently proposed concepts, definitions and vocabulary for describing competences and competence-based competitive phenomena. They then argued (1996, p. 9) that the capabilities and competences of firms as organizations arise from a macrolevel organizational knowledge about how to coordinate and deploy assets and capabilities. 4.2. Recent research in the competence perspective More recent research by both competence theorists and practitioners has proposed a number of criteria for classifying and distinguishing key aspects of organizational competences. We next consider how these criteria help to deepen our understanding and improve our ability to identify organizational competences. 4.2.1. The level within the organization at which competences exist Different forms of competence arise from different levels of activity within an organization. Some organizational competences seem to arise largely from the capabilities of a firm to create and produce specific kinds of products. Other competences seem to derive primarily from the abilities of some firms to organize and coordinate assets in innovative and effective ways. Yet other competences seem to depend mostly on top managements ability to imagine new strategies for creating value in markets (Chiesa and Manzini, 1997). 4.2.2. The time horizon over which a competence is likely to apply Competences differ in the time required to create a competence, as well as in the time a competence may endure as a basis for competitive success. Some kinds of competences are likely to endure longer than others, to require modification less frequently than others or to commit a firms capabilities to actions with longer planning horizons than others (Mosakowski and McKelvey, 1997). 4.2.3. The knowledge base on which a competence depends Competences may be derived from different kinds of knowledge within an organization. Some competences appear to depend on know-howpractical, hands-on forms of knowledge gained through incremental improvements to products and processes. Other competences depend on know-whytheoretical forms of understanding that enable

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the creation of new kinds of products and processes. Other forms of competence seem to come from a firms knowwhata strategic form of understanding about the valuecreating purposes to which available know-how and knowwhy forms of knowledge may be applied (Sanchez, 1996, 1997a). 4.2.4. The simplicity versus the complexity of the processes underlying the competence Some firms have competences that seem to arise from managing a complex web of interrelationships and coordinating a large number of interdependent processes, while other firms appear to have created competences by simplifying their processes and focusing on a small number of key value-adding activities (Baden-Fuller and Volberda, 1997). 4.2.5. The scope of applicability of the competence Some aspects of an organizations competence appear to consist of assets and capabilities that apply broadly to an industry context. Other aspects of competence seem to apply more narrowly to an organizations specific product market. Other aspects of competence appear to be unique means of differentiating a firms product offers within its targeted market segments (Rispoli, 1996). 4.2.6. The locus of the key assets used Some organizations competences appear to be derived in large measure from use of their own firm-specific assets, while the competences of other organizations seem to be derived largely from their ability to access and coordinate firm-addressable assets beyond their own organizational boundaries (Durand, 1997; Stein, 1997). 4.2.7. The nature of the fit between a competence and the demands of the firms competitive environment Competences often appear to be contingenti.e., to be capable of creating value in certain kinds of competitive contexts, but not necessarily in others (Winterscheid and McNabb, 1996; Volberda, 1996). 4.2.8. The impact of competence on dynamic versus static efficiency Some competences seem to arise from the static efficiency of a firmits ability to use current assets in costeffective ways. Other competences appear to derive largely from a firms dynamic efficiencyits ability to incur low costs when changing the assets it uses or when changing the uses to which its assets are applied. Moreover, some competences seem to depend on an organizations specific combinations of static and dynamic efficiencies (Black and Boal, 1997).

5. Five modes of competence We now develop a taxonomical approach to identifying competences that is derived from the open systems view of firms shown in the left side of Fig. 1. This approach incorporates various criteria suggested above for distinguishing different aspects of organizational competence. As shown in the central portion of Fig. 1, this taxonomical approach leads to the identification of five modes of competences, each of which arises from a specific level of activity with an organization as an open system. The term mode of competence is used in this discussion to refer to an important way in which the competence of an organization is expressed through specific kinds of activities and processes. Further, as the discussion below explains, each competence mode results from a distinctive kind of organizational flexibility to respond to changing and diverse environmental conditions, such as evolving market demands, technological change and competitive developments in an industry. Each kind of flexibility can in turn be described by the kind of portfolio of strategic options that each flexibility brings to an organization (Sanchez, 1993, 1995), as summarized in the right side of Fig. 1. (The emphasis here on creating organizational flexibility and strategic options should be seen not as a contradiction of the traditional strategy emphasis on commitment, e.g., Ghemawat (1991), but rather as a needed conceptual complement. In the first instance, creating capabilities gives a firm certain flexibility to pursue one or more strategic options for action. Subsequently, as events unfold, a firms managers will choose to exercise one or more of the firms available strategic options by committing to the specific courses of action associated with each option they exercise. In effect, competence building creates a firms strategic options for action, while competence leveraging involves committing to certain options for action, while deferring or abandoning others.) 5.1. Competence mode I: cognitive flexibility to imagine alternative strategic logics Competence mode I derives from the cognitive flexibility of an organization to conceive of alternative ways of creating value in markets. The source of this mode of competence is, in essence, the collective corporate imagination of an organizations managers in perceiving feasible market opportunities for the organization to create value. Competence mode I depends on an organizations managers ability to perceive market needs and identify specific market preferences the organization might serve, to determine the characteristics of products and services that can satisfy those needs and preferences, to design supply chains and select appropriate distribution channels for realizing new products, and ultimately to define product offers that will be perceived by markets as having attractive net delivered customer value. (Net delivered customer value is the net of the perceived value provided by the product,

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service, image and personal interaction components of a product offer, less the perceived financial, time, energy and psychic costs associated with the product offer.) To determine which of the product offers it can imagine are also feasible for the organization to develop requires an ability to identify the essential capabilities required to create and realize each imagined product offer. In the terminology of the competence perspective, competence mode I is the ability of an organization to define alternative strategic logics for using resources in processes for creating value in markets and thereby achieving the organizations goals (cf. Schoemaker, 1992; Mahoney and Sanchez, 1997). Although ideas for new kinds of product offers may originate from many sources within an organization, competence mode I resides primarily with the strategic managers of an organization, because strategic managers must normally launch or at least support longer-term strategic initiatives like creating new kinds of product offers. In this regard, strategic managers may act as visionary leaders that broaden the horizons of the organization by launching new market initiatives, or they may act as bottlenecks that constrain the growth of the organization by withholding support for new products or new marketing approaches proposed within the organization or suggested by potential strategic partners. Most managements, of course, lie somewhere between the two extremes, and the position that top managers occupy on the continuum between visionary leadership and risk-averse naysaying determines the extent to which competence mode I is realized in their organization. Competence mode I is fundamentally based on know-what forms of knowledgean understanding by top managers of the feasible strategic uses to which know-why and know-how forms of knowledge available to the firm can be applied (Sanchez 1996, 1997a). In this regard, the know-what knowledge base of strategic managers must enable them to recognize the essential forms of know-why and know-how knowledge required to compete successfully in an industry, in a product market within the industry and in any niche markets for differentiated products a firm may enter. The know-what knowledge of managers must also enable them to recognize the contextual limits of a strategic logic for using know-how and know-why knowledgei.e., the characteristics of competitive environments in which a given strategic logic for value creation will or will not be effective. The processes through which strategic managers define and select strategic logics can vary widely across firms. In some organizations, decisions to develop new kinds of product offers may be a top-down process largely initiated by top management. In other organizations, top management may encourage a bottom-up approach that invites the broad participation of all employees, or they may use a middle-top-down approach in which middle managers are the primary originators and champions of new strategic logics for value creation. Firms also differ in the complexity or simplicity of the processes by which they define and select strategic logics for

value creation. Some companies, for example, conduct extensive marketing research and detailed analyses in an effort to discover unserved market needs and evolving market preferences that suggest possibilities for new kinds of product offers. Other companies may rely more on the informed inspiration of key managers and other employees to define new product concepts and market opportunities. In identifying new market initiatives, for example, Sony has often drawn on new product ideas generated internally by its own product designers and development managers. Managers attitudes towards the risks of testing new product concepts, the know-what knowledge base that shapes their assessments of possibilities for value creation, and the marketing processes they follow in identifying and selecting new product offers all determine the cognitive flexibility of an organization to define alternative strategic logics. Competence mode I thus depends importantly on the cognitive flexibility of an organizations top managers that enables them to define a portfolio of strategic options consisting of perceived market opportunities to create value that the organization may feasibly pursue. 5.2. Competence mode II: cognitive flexibility to imagine alternative management processes Competence mode II results from a second form of cognitive flexibility of managers to conceive of alternative management processes for implementing strategic logics identified by competence mode I. The managerial abilities underlying competence mode II include the ability to identify the kinds of resources (assets, knowledge and capabilities) required to carry out a given strategic logic, to create effective organization designs (allocations of tasks, decision making and information flows) for the processes that will use the required resources and to define appropriate controls and incentives for monitoring and motivating the value-creating processes envisioned by a given strategic logic. Like ideas for new product offers, ideas about how to manage the various activities undertaken by an organization may originate from many sources within or external to an organization. Nevertheless, competence mode II derives primarily from the top managers of an organization, who normally have ultimate responsibility for designing and instituting an organizations management processes. In this capacity as in competence mode I, top managers may act as innovative leaders willing to experiment with new governance processes, or as reactionary guardians of existing management structures and prerogatives. Again, the behavior of most managers is likely to lie somewhere between these two extremes, and the position that a top management team occupies on the continuum between leadership in organizational innovation and reactionary organizational rigidity will determine the way in which and the extent to which competence mode II is realized in an organization. Competence mode II depends largely on managers know-why understanding of both the resources that must

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be deployed to effectively implement a strategic logic and the behaviors of people who will responsible for carrying out the functions of the organization. To identify the kinds of resources needed to support a strategic logic, managers must understand clearly why implementing a given strategic logic would create value for targeted customersand from this understanding to determine what contribution each resource must make to each of the organizations valuecreating processes. Insights into why people behave as they do in organizations are essential in imagining alternative organization designs that can be more effective in assuring that people will be motivated and committed to carrying out a given strategic logic. Managers know-why knowledge must also enable them to recognize the contextual limits of a given management processi.e., the environmental and organizational conditions in which a given management process will or will not effectively support a given strategic logic for value creation. In developing competence mode II, managers must be able to ascertain the relative abilities of different management processes to achieve dynamic versus static efficiencies in value-creation processes. Dynamic efficiency is achieved when organizational processes can be redirected efficiently from one value-creating activity to another as the competitive environment of the firm changes. Static efficiency results from minimizing costs in utilizing resources in a given valuecreating activity carried out in a stable environmental context. To contribute to competence mode II, managers must be able to assess the dimensions and degree of change versus stability in their organizations environment and to adopt management processes with appropriately aligned forms and levels of dynamic versus static efficiencies in the value creating processes the organization undertakes. The management processes that strategic managers can imagine and are willing to adopt may vary widely in their organizational complexity or simplicity. Some managers prefer to control organizational processes through highly articulated authority hierarchies, while other managers prefer to devolve substantial decision-making and resourceallocating power to organizational units that are largely self-managing. A preference for control through authority hierarchies typically results in complex multilayered management processes, while the creation of self-managing organizational units may lead to much simpler management processes carried out through relatively flat organizational structures. Recent research suggests that simpler management processes and organizational structures based on selfmanaging work groups may be more capable of responding successfully to a broader scope and greater intensity of environmental change than control-oriented management processes operating through complex authority hierarchies.2 (The potential for system designs of organizations based on self-managing work groups to reduce the complexity of management processes is discussed in Sanchez, 1997b.) Strategic managers attitudes towards trying new governance models, their know-why understanding of the

functional requirements of organizations and the behaviors of people within organizations, their understanding of the dynamic versus static efficiencies of various kinds of management processes, and their preferences for complex versus simple management processes collectively determine the cognitive flexibility of an organization to define alternative management processes for carrying out its strategic logic. An organizations competence mode II therefore determines the organizations portfolio of strategic options to define and adopt alternative approaches to managing its value creation processes. 5.3. Competence mode III: coordination flexibility to identify, configure and deploy resources Competence modes III, IV and V relate to three abilities of an organization to enact strategic logics identified through its competence mode I and management processes defined by its competence mode II. The boundaries within which competence modes III, IV and V can develop and operate in an organization are therefore determined by the limits of the cognitive flexibilities of its top managers in competence modes I and II. Competence mode III drives from the coordination flexibility of an organization to assemble chains of tangible and intangible resources needed to carry out the organizations strategic logics for creating value through its product offers (Sanchez, 1995). Coordination flexibility depends on the ability of a firms managersin this case, usually the midlevel managers of larger firms, but also top managers of smaller firmsto acquire or access, configure and deploy chains of resources for leveraging product offers capable of creating value in the markets targeted by the firm. To acquire or access the resources needed to compose a resource chain for realizing a given product offer, managers must first be able to translate the eight dimensions of the product offer that determine its net delivered customer value (see Section 5.1) into specific product creation and realization processes and the specific resources required to enact those processes. Managers must then be able to define incentives (i.e., ways of distributing the value created by the organization) that are capable of attracting the cooperation of the best available providers of such resources. These resources may include both firm-specific resources that are acquired and become internalized by a firm and firm-addressable resources that the firm can access but that remain external to the firm. To configure a chain of resources for leveraging a product offer, managers must be able to define activities that will be effective in using the identified resources and to design the specific ways those activities will interact in processes for creating and realizing the product offer. To deploy a resource chain, managers must be able to focus the activities of a resource chain on a defined market opportunity within the firms portfolio of perceived market opportunities (identified through competence mode I). Man-

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agers must also be able to coordinate the activities of the resource chain through an appropriate management process that is within the portfolio of management processes acceptable to the strategic managers of the organization (determined by competence mode II). The kind and degree of coordination flexibility an organization needs and the specific form that the flexibility should take will of course depend on the competitive environment the organization faces. In an environment in which market preferences are evolving rapidly, the flexibility to redeploy an existing resource chain from one product offer to a new or modified product offer will be of paramount importance in sustaining value creation. In environments in which market preferences are more or less stable but technologies are changing, the flexibility to define and assemble new resource chains based on newly available technological resources or to integrate new technologies into existing resource chains will be critical. In environments with stable market preferences and technologies, the flexibility to continuously lower costs, to improve product quality by improving the skills and capabilities of existing resources, and to fine tune the interactions of resources within an existing resource chain is likely to be the key to sustaining value creation. In efficiency terms, the coordination flexibility to redeploy or reconfigure resource chains increases the dynamic efficiency of a firm, while the flexibility to incrementally improve existing resources and processes enhances the static efficiency of the firm. The coordination flexibility of an organization results in a portfolio of strategic options to assemble alternative resource chains for creating and realizing product offers. Each of the strategic options generated by an organizations coordination flexibility can be characterized by the range of product offers that can be created and realized by the resource chains an organization can assemble, by the time that it takes an organization to assemble an effective new resource chain and by the costs the organization incurs to assemble a new resource chain (Sanchez, 1995). Firms differ greatly, of course, in their coordination flexibilities. Firms that prefer to use only internalized resources to create and realize products, for example, are likely to have a narrower range of feasible product offers that they can bring to market, may take longer to assemble resource chains and may incur higher fixed costs (and thus risks) to assemble resource chains than firms that are willing and able to draw on firm-addressable resources accessible through market transactions, strategic alliances and other interfirm interactions (Sanchez, 1993; Sanchez and Mahoney, 1996). 5.4. Competence mode IV: resource flexibility to be used in alternative operations While competence mode III derives from the ability of an organization to assemble resource chains in support of product offers, competence mode IV derives from the ability of the resources in an organizations resource chains to be

used in alternative ways. In essence, within the resource chains available to an organization, the intrinsic resource flexibility of the resources composing those chains will constrain the different ways in which the organizations available resource chains can be used (Sanchez, 1995). Competence mode IV is therefore determined by the intrinsic flexibilities of the firm-specific and firm-addressable resources in an organizations resource chains to be used in different ways in the various operations the firm may undertake. The flexibility of a resource can be described by the range of uses that the resources can be applied to, by the time that it takes an organization to change the use of a resource and by the costs the organization incurs to change the use of a resource. The degree of competence mode IV that a firm can develop directly depends on the flexibilities of the resources that the firm can acquire or access in configuring its resource chains. In selecting production resources, for example, until recent years managers were often presented with rather stark choices between highly inflexible production machines that achieved high volumes and low unit costs in performing a single operation, on the one hand, or flexible general purpose machines with lower output rates and higher unit costs in performing a range of possible operations, on the other. Thanks to the incorporation of information technology in a growing array of intelligent programmable production resources, however, firms now face an increasingly attractive set of production equipment choices that often include machines that are fast, highly cost efficient and capable of performing a range of operations. In many production activities in which flexible automation has not yet become an affordable reality, the use of less cost efficient but more flexible human resources still offers a viable alternative to more cost efficient but inflexible specialized production systems. The various resources a firm may select for marketing, distributing and servicing its products will also have different intrinsic flexibilities to handle different ranges and mixes of product offers. Traditional retail channels, for example, generally have limited flexibility to handle a rapidly changing mix of new products. Recognizing this limited flexibility, firms like Nike and Sony have opened company-owned shops in which they can test market a changing array of new product ideas and variations and undertake detailed observations of consumer reactions to new product ideasa process of real-time market research (Sanchez and Sudharshan, 1993). Similarly, mail-order and internet-based marketing channels may have the flexibility to offer a large assortment of products with which consumers are already familiar, but they may not be as effective as conventional retail stores in introducing new kinds of products that require significant consumer education before purchase decisions can be made. Resources also differ in their flexibilities to be incrementally improved as an organization learns by doing. Machines differ, for example, in their flexibilities to be

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adjusted or modified for alternative uses (dynamic efficiency) or to increase output rates or improve conformance to quality standards (static efficiency). Machines equipped with electronic controls increasingly offer a number of key resource flexibilities, like upgradeability of performance levels (for example, by substituting a faster microprocessor in a personal computer), scalability to increase capacity (adding more memory to a personal computer) and extendibility to add new functionalities (adding a fax card to the personal computer). Software has the potential to be a highly flexible resource when it can be adapted in a variety of ways to a number of operations. (Object-oriented software programs, for example, are designed in an explicitly modular way to improve the configurability and customizability of the programs in different applications.) Human resources remain a resource of almost inexhaustible task flexibility, although the flexibilities of human resources (like any other resources) may be underutilized when those resources are deployed within unchanging strategic logics and rigid management processes. The intrinsic flexibilities of the resources an organization acquires or accesses therefore creates a portfolio of strategic options to use those resources in alternative processes for creating and realizing the organizations product offers. 5.5. Competence mode V: operating flexibility in applying skills and capabilities to available resources While competence mode IV derives from the intrinsic flexibilities of the resources in a resource chain to be used in alternative processes, competence mode V derives from the ability of an organization to use the flexibilities of its firmspecific and firm-addressable resources effectively and efficiently over a range of operating conditions. This operating flexibility depends fundamentally on the skills and capabilities an organization can apply at the working level in using its available resources. Competence mode V is therefore expressed by the operating flexibilities that result from the collective capabilities of a firms human resourcesin this case, primarily its front-line managers and employees to sustain efficient use of available resources when facing a range of variations in inputs, in required outputs and in the environmental conditions affecting the operations of the firm. In effect, competence mode V determines the robustness of a firms operations over a range of operating conditions (cf. Leonard-Barton et al., 1994). Control and adaptability are two polar approaches a firm may undertake to achieve operating flexibility. The control approach seeks to insulate the most critical operations of the firm from variations in inputs, outputs or environmental conditions by containing and managing the impacts of those variations in upstream or downstream operations. Rather than trying to adjust its main production line to variations in input materials, for example, a firm may create an upstream material inspection and reprocessing operation to assure a supply of standard inputs to the main production

line. Similarly, products may be designed so that product variations destined for different market segments may be created at a late point in downstream assembly or distribution operations, so that upstream production of core components used in all or many product variations remains constant (Sanchez, 1995, 1996, 1999). Alternatively, a firm may base the design of its main production process on machines and processes that are broadly adaptable to variations in inputs, outputs and environmental conditions. Although the process design decisions to use control or adaptability approaches to managing variability result from exercise of competence modes III and IV, the flexibility of an organization to operate effectively within a given process designi.e., to manage the impacts of variability as they occurderives from competence mode V and determines its operating flexibility at the working level of the organization. The operating flexibilities of an organization in using its available resources determine the reliability and efficiency with which a firm can sustain production and delivery of its product offers to its targeted markets. Since the competitive success of a product offer will depend on achieving acceptable levels of reliability and efficiency in realizing the product offer, the operating flexibility of an organization is an important final step in the chain of competence modes required to conceive, create and realize successful product offers. Thus, the operating flexibility of an organization determines its portfolio of operationally feasible ways the organization can bring its product offers to targeted markets.

6. Managing the interrelationships of the five competence modes Understanding the five modes of competence discussed above is essential to identifying the various kinds and sources of organizational competences and to effectively managing their interrelationships. As Chiesa and Manzini (1997, p. 198) have noted, the identification of different levels of competence is central in clarifying the link between the competence view of the firm and strategic decisions, operational management [and] end products and services. In this section, we consider the nature of the interrelationships between the five competence modes. We propose some requirements for managing those interrelationships in different competitive contexts to create synergistic dynamics by achieving coherence among the dynamic complementarities between activities that compose the competence modes of the firm (Christensen and Foss 1997, p. 289). As suggested in Fig. 1, the five competence modes parallel the five levels of system elements in the model of the firm as an open system proposed by Sanchez and Heene (1996), with competence mode I determining the strategic logics a firm may adopt, competence mode II determining the management processes it can adopt and so on. We therefore consider some key vertical interdependencies among the competence modes, the dynamic prop-

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erties of these interdependencies and the causal ambiguities that may affect each kind of competence mode. Finally, we consider how the relative importance of the five competence modes and their interactions may vary across stable, evolving and dynamic competitive environments. 6.1. Interdependencies of competence modes To summarize, we have characterized competence mode I as establishing boundaries on the kinds of strategic logics for creating value (and thus the kinds of product offers) an organizations managers can imagine, competence mode II as determining the kinds of management processes an organizations managers are willing and able to use in implementing strategic logics, competence mode II as determining the chains of resources the firm can assemble, competence mode IV as representing the flexibilities of the resources the organization selects for its resource chains, and competence mode V as determining the ability of the firm to use the flexibilities of its resources effectively in its operations. Because the capacity of an organization to successfully create value by defining and implementing a strategic logic depends on having adequate strength in each of these complementary competence modes, each competence mode can act as a potential bottleneck that limits the overall competence of the organization. The competence profiles shown in Fig. 2(a) and (b) illustrate this multiple bottleneck effect. Potential product offers can only be created and realized when they can be supported by adequate flexibilities in all five competence modes. Fig. 2(a) shows the competence profile of an organization with high cognitive flexibility of top managers to imagine many kinds of new product offers and many ways of managing value creation processes, with moderate flexibility of middle managers to assemble chains of moderately flexible resources, but with limited operating flexibility to use available resources effectively in the organizations operations. Although this firm may be able to imagine many new product offers, its limited operating flexibility will constrain the kinds of product offers it can successfully bring to market. In effect, the operating inflexibility of the working level of the organization in competence mode V acts as a bottleneck that limits the organizations ability to benefit from its upstream competences. Fig. 2(b), on the other hand, shows the competence profile of a firm with substantial operating flexibility, moderate flexibility to assemble resource chains, but limited cognitive flexibility of strategic managers to support new kinds of product offers or to try new management processes for bringing product offers to market. An organization with this competence profile may be successful in extracting profits from a limited range of product offers, but it will often fail to perceive opportunities to create new product offers that it is actually capable of creating and marketing, or to adopt new management process that would improve the effectiveness or efficiency of its value-creating activities. In

this instance, the cognitive inflexibility of top managers in competence modes I and II act as a bottleneck that constrains the firms overall potential for creating value. From an adaptive systems perspective, in the long run one may expect the five competence modes of an organization to equilibratei.e., to come into relative balance in their respective flexibilitiessince any competence mode whose flexibility is not actually used is likely to diminish over time to a level that is consistent with the least flexiblei.e., the bottleneckcompetence mode of the firm. Thus, a fundamental task of competence-based management is (i) determining the competence mode or modes that are likely to be the bottlenecks in an organizations current ability to respond to its competitive environment and (ii) assuring creation of an adequate level of flexibility in each competence mode to prevent any mode from becoming a bottleneck in the firms value creating processes. 6.2. Dynamic interactions among competence types Sanchez and Heene (1996) have proposed that the hierarchy of system elements in the firm as an open system (shown in the left side of Fig. 1) is subject to increasing dynamic response times as one moves upward in the hierarchy. In effect, this means that firms can more readily change their current product mix (within the limits of their operating flexibilities) than they can their operations, can more readily change the uses of their operations (within the limits of the flexibilities of the firms resources and resource chains) than they can acquire and configure new resources and so on to the highest level of system elements (strategic logics and management processes). In effect, Sanchez and Heene (1996) propose that firms can more readily change the things they use (resource chains) than the ideas they use (concepts for product offers and for management processes in using resource chains). An analogous argument can be made here with respect to the competence modes associated with each of the system elements in the model of the firm as an open system: As one moves upwards from competence mode V to competence mode I in Fig. 1, it generally takes longer for an organization to change its higher-level competence modes and their derived flexibilities. Given the interdependency of competence modes discussed above, the increasing dynamic response times required to change higher level competence modes have an important consequence for competence-based management. Because each of an organizations competence modes will tend to equilibrate with the least flexible competence mode of the organization, making long-term changes in lower-level competence modes will generally require making complementary changes in higher-level competence modes. Because higher-level competence modes take longer to change, however, the rate of change achievable in an organizations lower level competence modes will often be constrained to be compatible with the maximum rate of

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Fig. 2. (a) Competence profile with bottleneck in competence mode V. (b) Competence profile with bottleneck in competences modes I and II.

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change achievable in its higher-level competence modes. As a consequence, it is an organizations higher-level competence modes and their associated cognitive (in)flexibilities that dynamically constrain the ability of an organization to change its overall competence profile. In this regard, Sanchez and Heene (1996, p. 61) have noted that both leveraging current competences and building new competences impose on strategic managers the never-ending challenge of continuously learning how to better manage their own cognitions in the ongoing contest among managerial cognitions that is central to competence-based competition. 6.3. Causal ambiguities associated with competence modes Perhaps the basic reason why higher-level competence modes take longer to change in an organization is the higher degree of causal ambiguity encountered in higher competence modes. In essence, clear, predictable cause-and-effect relationships become increasingly difficult to discern and confirm as one progresses upward from competence mode V to competence mode I. For example, it is usually much more straightforward to determine whether current operations are performing efficiently (and why or why not) than to determine whether a resource chain has the most appropriate organization design or whether the firm is effectively pursuing its best possible set of value-creating opportunities. It is often observed that we tend to manage what we can measure. Sanchez and Heene (1996) proposed that the increasing causal ambiguity of cause-and-effect relationships in higher-level system elements generally makes the measurement and assessment of processes involving higherlevel system elementsi.e., higher-level competence modesproblematic in most organizations. As a result, many managers tend to focus on measuring and managing lower-level system elements and competence modes, which involve entities that are easier to define, measure and interrelate causally. The tendency to manage through lower-order control loops, however, may create cognitive blind spots (van der Vorst, 1997) with respect to the current state of an organizations higher-level system elements and competence modes. As an antidote to the tendency to micro-manage through lower-order control loops, managers must institute higher-order control loops that focus on defining and assessing the higher-level system elements and competence modes of a firm. Thus, in competitive environments that demand high levels of cognitive flexibility in competence modes I and II, managers must establish ongoing processes for assessing the adequacy of their higher-level competence modes in meeting the requirements of their competitive environments. Critical and reflective processes that probe the (often implicit) assumptions underlying current strategic logics and management processes are essential in helping strategic managers to better manage their own cognitive processes.

6.4. Competitive environments and critical competence modes We now consider the extent to which each of the five competence modes may play a more or less critical role in a firms ability to create value in stable, evolving and dynamic competitive environments, defined by the following characteristics (Sanchez, 1996): Stable: No significant changes in market preferences or available technologies. Evolving: Progressive and identifiable changes in market preferences and available technologies. Dynamic: Frequent and uncertain changes in market preferences and available technologies. As suggested in Fig. 3, the ability of a firm facing a stable competitive environment to create value is likely to depend greatly on its competence mode Vits operating flexibility to maintain and incrementally improve the efficiency and quality levels attainable through its existing resource chains. Although there is always a possibility that an organization may introduce a new product concept or a new way of organizing that changes the rules of the game, the focus of competence management during periods of environmental stability should normally be on improving the competence mode V operating capabilities of the firm. In this context, process improvement techniques like statistical process control (SPC), quality circles and kaizen become important means for improving competence mode V and sustaining successful value creation. The ability of a firm to sustain value creation in an evolving competitive environment is likely to depend most critically on its flexibilities derived from competence modes III and IV. The central concern of competence-based management is likely to be (i) defining and configuring new resource chains to provide new products to serve evolving market preferences and (ii) incorporating new technologies in resource chains as they become available. Of course, the support of top management may be required to assemble and configure the new resource chains needed to create new products proposed by middle managers. The ability of middle managers to use the flexibilities of an organizations

Fig. 3. Critical competence modes in three competitive environment.

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competence modes III and IV may therefore require complementary cognitive flexibilities by the organizations strategic managers in competence modes I and II. The parenthetical listing of competence modes I and II in Fig. 3 reflects this possibility. In dynamic competitive environments, the central challenge in competence-based management is likely to be maintaining adequate cognitive flexibilities of strategic managers in competence modes I and II. When changes in market preferences and available technologies are frequent but uncertain, strategic managers must have the cognitive flexibility to quickly recognize emerging possibilities for defining new kinds of product offers and to imagine the new strategic logics needed to create and realize new kinds of product offers. Moreover, to take advantage of the brief windows of opportunity that are characteristic of dynamic markets, strategic managers must also be cognitively flexible in imagining, experimenting with, and quickly adopting new ways of organizing and managing processes for creating and realizing new kinds of product offers. To enact the strategic logics and management processes that the competence modes I and II enable top managers of an organization to imagine, however, is likely to require a systemic flexibility of the entire organization. Thus, new complementary coordination and resource flexibilities may have to be created by middle managers acting in competence modes III and IV. Further, assuring that an organization will have the right product at the right time may also require significant new operating flexibilities in competence mode V. The key support roles of competence modes III, IV and V in dynamic markets are therefore noted parenthetically in Fig. 3.

ers own cognitive flexibilities to imagine new strategic logics for creating and realizing new kinds of value-creating product offers and new ways of managing processes for creating and realizing new and existing product offers. Most fundamentally, this discussion suggests that organizational competence does not depend simply on achieving excellence in one or two key success factors, but rather on developing an interrelated and balanced set of success factors (Bove et al., 2000) that in turn depend on achieving proper balance and alignment among five distinct modes of organizational competence.

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7. Conclusion This discussion has sought to assist both researchers interested in improving the clarity and precision of the concept of organizational competence and managers interested in more effectively identifying and managing the competences of their organizations. To contribute to improved clarity and precision of the competence concept, this discussion has considered various characteristics of competences, proposed a taxonomy of five competence modes, examined some basic interactions of competence modes within an organization and proposed the importance of achieving both an appropriate balance within an organizations competence modes and a strategic fit between the organizations competence modes and its competitive environment. For managers working to identify and manage organizational competences, this discussion suggests that improving organizational competence depends only partially on improving the resource-base of an organizationfor example, improving the skill profiles of individuals and the capabilities of work groups and teams. Improving organizational competence also requires increasing manag-

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