S p r i n g 1 9 9 8 | V o l . 4 0 , N o .

3 | R E P R I N T S E R I E S

California
Management Review

Capturing Value from

Knowledge Assets:
The New Economy, Markets for
Know-how, and Intangible Assets
David J. Teece

© 1998 by The Regents of

the University of California
 Capturing Value from
Knowledge Assets:
THE NEW ECONOMY, MARKETS FOR
KNOW-HOW, AND INTANGIBLE ASSETS

David J. Teece

anagement is always confronting new challenges. Sometimes these

M are simply yesterday’s challenges presented anew in a slightly differ-

ent context. But from time to time, new challenges emerge that have
no close precedent. Managing intellectual capital in the information
age is possibly one such challenge, as advanced industrial economies have
entered a new epoch. Many sectors are animated by new economics, where the
payoff to managing knowledge astutely has been dramatically amplified, in part
because of the phenomena of increasing returns, in part because of new infor-
mation technology, and in part because of the changing role of intellectual prop-
erty. Moreover, the context in which knowledge assets are created and exploited
is today truly global.

Knowledge and Competitive Advantage

It has long been recognized that “economic prosperity rests upon knowl-
edge and it useful application.”1 Indeed, “the increase in the stock of useful
knowledge and the extension of its application are the essence of modern eco-
nomic growth.”2 Enlightened economic historians have long emphasized the
role of technology and organization in economic development.
Accordingly, one must inquire about the present cacophony on knowl-
edge management. At least two classes of explanations appear to be valid. One
class is simply that policy and strategy analysts have worn intellectual blinders,
so that what has been obvious to some—namely, that knowledge and its applica-
tions are at the very roots of modern economic growth and prosperity—has not
been transparent to all. Competing theories that stressed the role of the capital

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 Capturing Value from Knowledge Assets

stock and natural resources would appear to have received unwarranted

extended play in textbooks and policy pronouncements. Meanwhile, the study
of innovation and knowledge transfer has been, until quite recently, relegated
to a backwater in mainstream economics as well as in the other social sciences.
However, a small cadre of dedicated economists have long emphasized
the role of technological innovation, often with few accolades.3 Now the main-
stream economic theorists4 and mainstream business have begun to recognize
the importance of this literature. Moreover, the ideas have become established
and disseminated to a wider audience through the efforts of insightful protago-
nists like Ikujiro Nonaka and Hirotaka Takeuchi.5
The second class of factors relates to structural changes that have occurred
in the economies of advanced developed countries. These have modified the
nature of what is strategic and have served to highlight the importance of
knowledge and its management.

Liberalization of Markets
Since the Kennedy round of trade negotiations in the 1960s, markets
for goods and services have become increasingly liberalized. Tariff and non-tariff
barriers have been lowered. While the world is far from being properly charac-
terized as having adopted free trade, significant progress has been made. Final
goods, intermediate goods, and factors of production flow globally with far more
freedom than in earlier times. Restrictions on knowledge transfers by both
importers and exporters have also been relaxed.
Accordingly, firms cannot so rapidly earn supra-competitive returns by
locating behind trade barriers. Transportation costs have also fallen, and infor-
mation about market opportunities often diffuses instantaneously. Together,
these developments have reduced the shelter previously afforded to privileged
positions in domestic markets. Competition has been sharpened.

Expansion of What’s Tradable

Markets have not only liberalized, but also have been created for many
types of “intermediate” products where markets hitherto didn’t exist. This has
been most amplified in securities markets where swaps and swaptions, index
futures, program trading, butterfly spreads, puttable bonds, eurobonds, collater-
alized mortgage bonds, zero-coupon bonds, portfolio insurance, and synthetic
cash are now commonplace.6 This sudden burst of financial innovation began
but 20 years ago, propelled by the move to floating exchange rates and the need
to protect transactions from uncertainty. It has been aided by developments in
computer and information technology, which have enabled the design of new
financial products and the execution of complex transactions. Also contributing
has been the desire to circumvent taxation and regulation.
In addition, firms have shown greater affection for outsourcing as suppli-
ers take advantage of the growth in the number of potential suppliers at home

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 Capturing Value from Knowledge Assets

and abroad. In the petroleum industry, for instance, markets exist not only for
many grades of crude oil and refined products, but also for a range of intermedi-
ate products (e.g., MTB) which were rarely traded, if at all, a mere decade ago.
Moreover, certain forms of intellectual property are “exchanged” (cross-licensed)
or sold with far greater frequency than was hitherto experienced.7
Whenever a market exists that is open to all qualified comers, including
newcomers, then competitive advantage for firms cannot flow from participation
in that market.8 Except in rare instances where one or a few firms can “corner
the market,” having a market-based exchange relationship cannot yield compet-
itive advantage because it can be so easily replicated by others, who can simply
enter the same (efficient) market and secure access to the same inputs or dispose
of the same outputs. In short, efficient markets are a great leveler.

Strengthening of Intellectual Property Regimes

Intellectual property is an aspect of property rights which augments the
importance of know-how assets. Knowledge assets are often inherently difficult
to copy; moreover, like physical assets, some knowledge assets enjoy protection
against theft under the Intellectual property laws of individual nation states. In
advanced nations, these laws typically embrace patents, trademarks, trade
secrets, and copyright.
Intellectual property systems have been strengthened since the 1980s,
both in the U.S. and abroad. Moreover, intellectual property is not just impor-
tant in the new industries—such as microelectronics and biotechnology—it
remains important in pharmaceuticals and chemicals and is receiving renewed
interest in more mature industries such as petroleum and steel.
The growth of information technology has also amplified the importance
of intellectual property and has injected intellectual property into new contexts.
For example, it is not uncommon to discover the foundations of corporate suc-
cess for wholesalers and retailers buried in copyrighted software and in informa-
tion technology supporting order entry and logistics.

The Growing Importance of Increasing Returns

Contemporary textbook understandings of how markets operate and how
firms compete has been derived from the work of economists such as Marshall
and Chamberlain. These views assume diminishing returns and assign industry
participants identical production functions (implying the use of identical tech-
nologies by all competitors) where marginal costs increase. Industry equilibrium
with numerous participants arise because marginal-cost curves slope upwards,
thereby exhausting scale advantages at the level of the firm, making room for
multiple industry participants. This theory was useful for understanding 18th
century English farms and 19th century Scottish factories and even some 20th
century American manufacturers. However, major deficiencies in this view of
the world have been apparent for some time—it is a caricature of the firm.

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 Capturing Value from Knowledge Assets

Moreover, knowledge is certainly not shared ubiquitously and passed around

at zero cost.9
In this century, developed economies have undergone a transformation
from largely raw material processing and manufacturing activities to the pro-
cessing of information and the development, application, and transfer of new
knowledge. As a consequence, diminishing returns activities have been replaced
by activities characterized by increasing returns. The phenomena of increasing
returns is usually paramount in knowledge-based industries. With increasing
returns, that which is ahead tends to stay ahead. Mechanisms of positive feed-
back reinforce the winners and challenge the losers. Whatever the reason one
gets ahead—acumen, chance, clever strategy—increasing returns amplify the
advantage. With increasing returns, the market at least for a while tilts in favor
of the provider that gets out in front. Such a firm need not be the pioneer and
need not have the best product.
The increasing returns phenomena is itself driven by several factors.
Consider, first, standards and network externalities. To establish networks and
interoperability, compatibility standards are usually critical. If such standards are
proprietary, ownership of a dominant standard can yield significant “rents.” The
more a protocol gains acceptance, the greater the consumer benefits (network
externalities), and the better the chance the standard has of becoming dominant.
Second, consider customer lock-in. Customer learning and customer
investment in high-technology products amplify switching costs. This pushes
competition “forward” in the sense that providers will compete especially hard
for the original sale, knowing that sales of follow-along equipment and other
services will be easier. While such “lock-in” is rarely long lived, it need not be
momentary.
Third, consider large up-front costs. Once a high-tech industry is estab-
lished, large up-front research, development, and design engineering costs are
typical. This is most amplified with software products where the first copy costs
hundred of millions, and the original cost of the second copy is zero, or very
nearly so.
Fourth, consider producer learning. In certain cases, producers become
more efficient as experience is gained. If the underlying knowledge base is tacit,
so that it resists transfer to other producers, competitors with less experience are
at a comparative disadvantage. Producer learning is important where complex
processors and complex assembly is involved.
The economics of increasing returns suggest different corporate strategies.
In winner-take-all or winner-take-the-lion’s-share contexts, there is heightened
payoff associated with getting the timing right (one can be too early or too late)
and with organizing sufficient resources once opportunity opens up. Very often,
competition is like a high-stakes game of musical chairs. Being well positioned
when standards gel is essential. The associated styles of competition are, as Brian
Arthur points out, much like casino gambling.10 Strategy involves choosing what

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 Capturing Value from Knowledge Assets

games to play, as well as playing with skill. Multimedia, web services, voice
recognition, mobile (software) agents, and electronic commerce are all tech-
nological/market plays where the rules are not set, the identity of the players
poorly appreciated, and the payoffs matrix murky at best. Rewards go to those
good at sensing and seizing opportunities.
Seizing opportunities frequently involves identifying and combining the
relevant complementary assets needed to support the business. Superior tech-
nology alone is rarely enough upon which to build competitive advantage. The
winners are the entrepreneurs with the cognitive and managerial skills to dis-
cern the shape of the play, and then act upon it. Recognizing strategic errors
and adjusting accordingly is a critical part of becoming and remaining successful.
In this environment, there is little payoff to penny pinching, and high
payoff to rapidly sensing and then seizing opportunities. This is what is referred
to here and elsewhere11 as dynamic capabilities. Dynamic capabilities are most
likely to be resident in firms that are highly entrepreneurial, with flat hierar-
chies, a clear vision, high-powered incentives, and high autonomy (to ensure
responsiveness). The firm must be able to effectively navigate quick turns, as
Microsoft did once Gates recognized the importance of the internet. Cost mini-
mization and static optimization provide only minor advantages. Plans are often
made and junked with alacrity. Companies must constantly transform and
retransform. A “mission critical” orientation is essential.

Decoupling of Information Flows from the Flow of Goods and Services

New information technology and the adoption of standards is greatly
assisting connectivity. Once every person and every business is connected elec-
tronically through networks, information can flow more readily. The traditional
nexus between the economics of goods and services and the economics of infor-
mation can be broken, and information can be unbundled.
The traditional trade-off between reach (connectivity) and richness
(customization, bandwidth) is also being transformed, or at least modified. An
insurance salesman is no longer needed to sell term life policies. Sufficient infor-
mation can be collected by mail or on an internet to enable customers to engage
in comparative shopping, and for underwriters to do sufficient assessment of
policy holders. As a result, traditional distribution channels are no longer needed
for simple life or auto insurance products.
Historically, the transfer/communication of rich information has required
proximity and specialized channels to customers, suppliers, and distributors.
New developments are undermining traditional value chains and business mod-
els. In some cases, more “virtual” structures are viable, or shortly will be viable,
especially in certain sectors like financial services. New information technology
is facilitating specialization. Bargaining power will be reduced by an erosion in
the ability to control information, and customer switching costs will decline,
changing industry economics.

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 Capturing Value from Knowledge Assets

The new information technology is also dramatically assisting in the shar-

ing of information. Learning and experience can be much more readily captured
and shared. Knowledge learned in the organization can be catalogued and trans-
ferred to other applications within and across organizations and geographies.
Rich exchange can take place inside the organization, obviating some of the
need for formal structures.

Ramifications of New Information and Communications Technologies

Linked information and communications systems in production, distribu-
tion, logistics, accounting, marketing, and new product development have the
potential to bring together previously fragmented flows of data, thereby permit-
ting the real time monitoring of markets, products, and competitors. The requi-
site data can then be fed to multifunctional teams working on new product
development. Networked computers using rapid communications systems thus
enable major advances in corporate and intercorporate monitoring and control
systems. Within organizations, computer networks can strengthen links between
strategic and operations management, while also assisting linkages externally to
discrete and geographically dispersed providers of complementary services.
Network computing, supported by an advanced communications infra-
structure, can thus facilitate collaborative entrepreneuralism by stripping out
barriers to communication. It challenges existing organization boundaries, divi-
sions, and hierarchies and permits formal organization to be more specialized
and responsive. Interorganizationally, networked organizations have blurred and
shifting boundaries, and they function in conjunction with other organizations.
The networked organization may be highly “virtual,” integrating a temporary
network of suppliers and customers that emerge around specific opportunities
in fast-changing markets. Recurrent reorganization becomes the norm, not the
exception.
Service firms, such as lawyers, accountants, management consultants,
and information technology consultants—pose interesting issues. If knowledge
and experience remain personal and are not somehow shared (either by transfer
to other organization members or by being embedded in product) then the firm
can at best expect to achieve constant return to scale. Larger organizations will
have no advantage over boutiques and will possibly suffer bureaucratic burdens
that will sap productivity.
Formalization, the sharing of personal knowledge, and the development
of structural approaches as a mechanism to transfer learning throughout the
firm may on the other hand sap creativity and impede learning. Ideally, one
would like to develop approaches or models which have a common essential
logic, but which enable customization of particular features. This is but one of
the many challenges to service firms in the new economy where knowledge
sharing itself can often be the basis of competitive advantage.

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Product Architecture and Technology “Fusion”

With complexity becoming increasingly common, new products are rarely
stand-alone items. Rather, they are components of broader systems or architec-
tures. Innovation at the architectural level is more demanding and takes place
with less frequency than at the component level, but it has greater impact.
The development of system-level integration [SLI] of ASICs—so-called
systems on a chip—illustrates the point. New manufacturing processes and
improved design tools have fostered SLI. Because million-gate ASICs are now
possible, they can support entire systems on a single piece of silicon. If Dataquest
is right, and if industry will be able to place 40 million gates on a single chip by
2000, it will be technically possible to place multiple systems on a single chip.12
SLI ASICs have already been designed into high-volume applications
such as set-top boxes, multimedia, and wireless telephony. Dataquest estimates
that SLI ASICs will pass $15 billion in revenues by the year 2000. However,
what is even more significant is the ability of SLI ASICs to fuel further growth
of consumer electronics through dramatic reductions in size and power usage,
enhanced differentiation and functionally, quicker product development, and
still lower cost. This is what the technology can deliver.
Whether the technology does in fact yield its potential depends, however,
on certain organizational and managerial changes. Design reuse is of paramount
importance when designing high-complexity ASICs or SLI devices. System
designers must design on the block level and be able to reuse and alter intellec-
tual property in a number of subsequent designs. As Dataquest notes, “design
methodology, design reuse, and intellectual property will play vital roles in
determining the winners among both suppliers and users.”13
The organization of firms and industries and the architecture of products
are interrelated. Since, the relevant intellectual property needed to effectuate
SLI is almost never owned by a single firm but is widely distributed throughout
the industry, new arrangements are needed to support rapid diffusion and
expansion of SLI architecture. Indeed, harnessing the full potential of the tech-
nology necessarily involves cooperation amongst industry participants, many
of whom might also be competitors.
A related development is the increase in convergence or integration of
previously disparate technologies. One thinks not just of the convergence of
computers and communications, but of mechanical industries and electronics
(“mechatronics”)14 or of “robochemistry,” the science of applying computeriza-
tion to drug molecule research, which according to some accounts is leading to
“a new age in medicine.”15 This by no means occurs automatically and requires
internal structures that are flexible and permeable.

Implications
These developments suggest a different dynamic to competition and com-
petitive advantage. The expansion of markets illustrates the point. Since markets

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 Capturing Value from Knowledge Assets

are a great leveler, competitive advantage at the level of the firm can flow only
from the ownership and successful deployment of non-tradable assets. If the
asset or its services are traded or tradable in a market or markets, the assets in
question can be accessed by all; so the domains in which competitive advantage
can be built narrows as markets expand. Not even human resources can provide
the basis for competitive advantage if the skills at issue can be accessed by all in
an open labor market.
One class of assets that is especially difficult, although not impossible, to
trade involves knowledge assets and, more generally, competences. The market
for know-how is riddled with imperfections and “unassisted markets are seri-
ously faulted as institutional devices for facilitating trading in many levels of
technological and managerial know-how.”16 Hence, the development of many
types of new markets has made know-how increasingly salient as a differentia-
tor, and therefore as a source of the competitive advantage of firms. This can be
expected to remain so until know-how becomes more commodity like; and this
may happen soon for some components of intellectual property.
The strengthening of intellectual property is an important counterforce
to the growing ease of imitation. As the diffusion of knowledge and information
accelerates, intellectual property becomes more salient. While intellectual prop-
erty can be traded, and can sometimes be invented around, it can no longer be
infringed with impunity and without penalty.
Increasing returns frequently sharpens the payoff to strategic behavior
and amplifies the importance of timing and responsiveness. Meanwhile, the
decoupling of information flows from the flow of goods and services is trans-
forming traditional value analysis, and it is suggesting the benefits of more vir-
tual structures and obviating some of the need for hierarchy. Simultaneously,
the march of technologies such as integrated circuits is transforming the linkage
between intellectual property and products. Technological innovation is requir-
ing the unbundling of the two and the formation of more robust markets for
intellectual property. It is in this new environment that a critical dimension of
knowledge management has emerged: capturing value from innovative activity.

Capturing Value from Knowledge and Competence

The proper structures, incentives, and management can help firms gener-
ate innovation and build knowledge assets. The focus here is not, however, on
the creation of knowledge assets, but on their deployment and use.17 While
knowledge assets are grounded in the experience and expertise of individuals,
firms provide the physical, social, and resource allocation structure so that
knowledge can be shaped into competences. How these competences and
knowledge assets are configured and deployed will dramatically shape competi-
tive outcomes and the commercial success of the enterprise. Indeed, the compet-
itive advantage of firms in today’s economy stems not from market position, but
from difficult to replicate knowledge assets and the manner in which they are

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 Capturing Value from Knowledge Assets

deployed. The deployment dimension—involving as it does both entrepreneurial

and strategic elements—is where dynamic capabilities are especially important.
It is always useful to distinguish between the creation of new knowledge
and its commercialization. The creation of new knowledge through autonomous
(specialized) innovation is a critical function. It can be the domain of the indi-
vidual, or of the research laboratory, or of autonomous business units. It need
not require complex organization. Indeed, one can argue that such knowledge
creation is increasingly well suited to smaller organizational units.
However, the commercialization of new technology is increasingly the
domain of complex organization. The new challenges require new organiza-
tional forms and the development and astute exercise of dynamic capabilities.
They also require an understanding of the nature of knowledge and competence
as strategic assets. The nature of knowledge and the manner in which it can or
cannot be bought and sold is critical to the strategic nature of knowledge and
competence.

The Nature of Knowledge

Knowledge can be thought of in many ways. In a business context, the
following taxonomies are useful.

Codified/Tacit18
Tacit knowledge is that which is difficult to articulate in a way that is
meaningful and complete. The fact that we know more than we can tell speaks
to the tacit dimension. Stand-alone codified knowledge—such as blueprints,
formulas, or computer code—need not convey much meaning.
There appears to be a simple but powerful relationship between codifica-
tion of knowledge and the costs of its transfer. Simply stated, the more a given
item of knowledge or experience has been codified, the more economically
it can be transferred. This is a purely technical property that depends on the
ready availability of channels of communication suitable for the transmission
of well-codified information—for example, printing, radio, telegraph, and data
networks. Whether information so transferred will be considered meaningful
by those who receive it will depend on whether they are familiar with the code
selected as well as the different contexts in which it is used.19
Uncodified or tacit knowledge, on the other hand, is slow and costly to
transmit. Ambiguities abound and can be overcome only when communications
take place in face-to-face situations. Errors of interpretation can be corrected by
a prompt use of personal feedback. Consider the apprenticeship system as an
example. First, a master craftsman can cope with only a limited number of
pupils at a time. Second, his teaching has to be dispensed mostly through exam-
ples rather than by precept—he cannot easily put the intangible elements of his
skill into words. Third, the examples he offers will be initially confusing and
ambiguous for his pupils so that learning has to take place through extensive

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and time-consuming repetition, and mystery will occur gradually on the basis
of “feel.” Finally, the pupil’s eventual mastery of a craft or skill will remain idio-
syncratic and will never be a carbon copy of the master’s. It is the scope provided
for the development of a personal style that defines a craft as something that
goes beyond the routine and hence programmable application of a skill.
The transmission of codified knowledge, on the other hand, does not
necessarily require face-to-face contact and can often be carried out largely by
impersonal means, such as when one computer “talks” to another, or when a
technical manual is passed from one individual to another. Messages are better
structured and less ambiguous if they can be transferred in codified form.

Observable/Non-Observable in Use
Much technology is (publicly) observable once sold. A new CT scanner,
laser printer, or microprocessor is available for conceptual imitation and reverse
engineering once it has been introduced into the market. New products are
typically of this kind. Process technology, however, is often different. While in
some cases the “signature” of a process may be embedded in a product and is
therefore ascertainable through reverse engineering, this is generally not the
case. While clues about a manufacturing process may sometimes be gleaned by
closely observing the product, much about process technology can be protected
if the owners of process technology are diligent in protecting their trade secrets
in the factory. Thus, process technology is inherently more protectable than
product technology, the patent system put to one side.

Positive/Negative Knowledge
Innovation involves considerable uncertainty. Research efforts frequently
go down what turns out to be a blind alley. It is well recognized that a discovery
(positive knowledge) can focus research on promising areas of inquiry, thereby
avoiding blind alleys. However, it is frequently forgotten that knowledge of fail-
ures (“this approach doesn’t work”) is also valuable as it can help steer resource
allocation into more promising avenues. For this reason, firms often find it nec-
essary to keep their failures as well as their successes secret, even holding aside
issues of embarrassment.

Autonomous/Systematic Knowledge
Autonomous knowledge is that which yields value without major modifi-
cations of systems in which it might be embedded. Fuel injection, the self-starter,
and power steering were innovations that did not require major modifications
to the automobile, although the latter did enable manufactures to put more
weight on the front axle and to more readily fit cars with radial tires. Systematic
innovation, on the other hand, requires modification to other sub-systems.
For instance, the tungsten filament light bulb would not have found such wide
application without the development of a system for generating and distributing
electricity.

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Intellectual Property Regime

There are many other dimensions along which knowledge could be
defined or along which innovations could be classified.20 However, the only
other key dimension to be identified here is whether or not the knowledge
in question enjoys protection under the intellectual property laws.
Patents, trade secrets, trademarks provide protection for different medi-
ums in different ways. The strongest form of intellectual property is the patent.
A valid patent provides rights for exclusive use by the owner, although depend-
ing on the scope of the patent it may be possible to invent around it, albeit at
some cost. Trade secrets do not provide rights of exclusion over any knowledge
domain, they do protect covered secrets in perpetuity. Trade secrets can well
enhance the value of a patent position. Different knowledge mediums qualify
for different types of intellectual property protection. The degree that intellectual
property keeps imitators at bay may depend also on other external factors, such
as regulations, which may block or limit the scope for invent-around
alternatives.

Replicability, Imitability, and Appropriability21

Replication involves transferring or redeploying competences from one
concrete economic setting to another. Since productive knowledge is typically
embodied, this cannot be accomplished by simply transmitting information.
Only in those instances where all relevant knowledge is fully codified and
understood can replication be collapsed into a simple problem of information
transfer. Too often, the contextual dependence of original performance is poorly
appreciated, so unless firms have replicated their systems of productive knowl-
edge on many prior occasions, the act of replication is likely to be difficult.22
Indeed, replication and transfer are often impossible absent the transfer of peo-
ple, though this can be minimized if investments are made to convert tacit
knowledge to codified knowledge. Often, however, this is simply not possible.
In short, knowledge assets are normally rather difficult to replicate. Even
understanding what all the relevant routines are that support a particular com-
petence may not be transparent. Indeed, Lippman and Rumelt have argued that
some sources of competitive advantage are so complex that the firm itself, let
alone its competitors, does not understand them.23 As Nelson and Winter24 and
Teece25 have explained, many organizational routines are quite tacit in nature.
Imitation can also be hindered by the fact that few routines are stand-alone.
Imitating a part of what a competitor does may not enhance performance at
all. Understanding the overall logic of organization and superior performance
is often critical to successful imitation.
Some routines and competences seem to be attributable to local or
regional forces that shape a firm’s capabilities. Porter, for example, shows that
differences in local product markets, local factor markets, and institutions play
an important role in shaping competitive capabilities.26 Replication in a different

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geographical context may thus be rather difficult. However, differences also exist
within populations of firms from the same country. Various studies of the auto-
mobile industry, for example, show that not all Japanese automobile companies
are top performers in terms of quality, productivity, or product development.27
The role of firm-specific history is a critical factor in such firm-level (as opposed
to regional- or national-level) differences.28
At least two types of strategic value flow from replication. One is simply
the ability to support geographic and product line expansion. To the extent that
the capabilities in question are relevant to customer needs elsewhere, replication
can confer value. Another is that the ability to replicate indicates that the firm
has the foundations in place for learning and improvement. Understanding
processes, both in production and in management, is the key to process
improvement, so that an organization cannot improve that which it does not
understand. Deep process understanding is often required to accomplish codifi-
cation and replication. Indeed, if knowledge is highly tacit, it indicates that
underlying structures are not well understood, which limits learning because
scientific and engineering principles cannot be as systematically applied. Instead,
learning is confined to proceeding through trial-and-error, and the leverage that
might otherwise come from the application of modern science is denied.
Imitation is simply replication performed by a competitor. If self-replica-
tion is difficult, imitation is likely to be even harder. In competitive markets, it
is the ease of imitation that determines the sustainability of competitive advan-
tage. Easy imitation implies the rapid dissipation of rents.
Factors that make replication difficult also make imitation difficult. Thus,
the more tacit the firm’s productive knowledge, the harder it is to replicate by
the firm itself or its competitors. When the tacit component is high, imitation
may well be impossible, absent the hiring away of key individuals and the
transfer of key organizational processes.
Intellectual property rights impede imitation of certain capabilities in
advanced industrial countries and present a formidable imitation barrier in cer-
tain particular contexts. Several other factors, in addition to the patent system,
cause there to be a difference between replication costs and imitation costs. The
observability of the technology or the organization is one such important factor.
As mentioned earlier, vistas into product technology can be obtained through
strategies such as reverse engineering, this is not the case for process technology,
as a firm need not expose its process technology to the outside in order to bene-
fit from it. Firms with product technology, on the other hand, confront the
unfortunate circumstances that they must expose what they have got in order
to profit from the technology. Secrets are thus more protectable if there is no
need to expose them in contexts where competitors can learn about them.
The term “appropriability regimes” describes the ease of imitation. Appro-
priability is a function both of the ease of replication and the efficacy of intellec-
tual property rights as a barrier to imitation. Appropriability is strong when a

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technology is both inherently difficult to repli- FIGURE 1. Appropriability Regimes

for Knowledge Assets
cate and the intellectual property system pro-
vides legal barriers to imitation. When it is
inherently easy to replicate and intellectual
property protection is either unavailable or Inherent Replicability

Intellectual Property Rights

ineffectual, then appropriability is weak. Inter- Easy Hard
mediate conditions also exist (see Figure 1).

Loose
Appropriability and Markets Weak Moderate
for Know-How and Competence
Assets can be the source of competitive
advantage only if they are supported by a
regime of strong appropriability or are non-

Tight
Moderate Strong
tradable or “sticky.” As discussed earlier, once
an asset is readily tradable in a competitive
market it can no longer be a source of firm-
level competitive advantage. Financial assets
today are of that kind.
The main classes of assets that are not
tradable today are locational assets, knowledge assets, and competences.29
Were a perfect market for know-how to someday emerge, knowledge would no
longer be the source of competitive advantage. This is unlikely to happen any-
time soon, but understanding the limits on the market for know-how is impor-
tant to understanding how firms can capture value from knowledge assets.
Like the market for pollution rights, or the market for art, buying and
selling know-how and intellectual property has special challenges. These compli-
cate exchange, and may limit in some fundamental sense the level of sophistica-
tion to which the market can ever evolve. They also explain why the market
today is rather primitive.
By way of foundation, it is well recognized that markets work well when:
▪ there are informed buyers and sellers aware of trading opportunities,
▪ the objective performance properties or subjective utility of products can
be readily ascertained,
▪ there are large numbers of buyers and sellers, and
▪ contracts can be written, executed, and enforced at low cost.
Thus the market for (standard) commodities like wheat, coal, stocks,
bonds, and sports utility vehicles works well because these properties are largely
satisfied.
However, know-how and intellectual property are “products” of an
entirely different kind. These products have properties which complicate pur-
chase and sale (see Figure 2). These include:

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 Capturing Value from Knowledge Assets

FIGURE 2. Inherent Tradeability of Different Assets

Physical
Characteristics Know-How/IP
Commodities

1. Recognition of trading Inherent difficulty Posting frequent

opportunities
2. Disclosure of attributes Relatively difficult Relatively easy
3. Property Rights Limited [patents, trade Broad
secrets, copyright, etc.]
4. Item of Sale License Measurable units
5. Variety Heterogeneous Homogeneous
6. Unit of consumption Often Unclear Weight, volume, etc.

Inherent tradeability Low High

▪ Recognition of Trading Opportunities—Parties typically don’t know who

owns what, and who might be interested in trading. This is less so for
patents since they are published. But software (particularly source code)
protected by copyright and trade secrets is frequently a matter of great
secrecy. There are obvious reasons why even knowledge about the exis-
tence of such intellectual property is held very close. Accordingly, out of
ignorance, software is often “reinvented” despite the fact that potentially
advantageous trades could be consummated.
▪ Disclosure of Performance Features—Buyers must be well informed as to the
availability of intellectual property but sellers may be reluctant to negoti-
ate because their intellectual property rights are problematic. Sellers
might be reluctant to negotiate because of fear that disclosure, even if
pursuant to a nondisclosure agreement, might inadvertently lead intellec-
tual property rights to be jeopardized.
▪ Uncertain Legal Rights—When property rights are uncertain, and confi-
dence in nondisclosure agreements or the law of confidences less than
complete, beneficial transactions may be eschewed because of perceived
risks. In addition to the disclosure issues identified above, sellers may be
uncertain about factors such as the enforceability of use restrictions and
sublicensing rights or simply about the ability to measure and collect
royalties.
▪ Item of Sale—The “item of sale” may be know-how, or intellectual prop-
erty rights, complete or partial. When intellectual property is bought
and sold, what is transacted is simply a bundle of rights. While rights

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 Capturing Value from Knowledge Assets

are frequently bought and sold [e.g., view rights, pollution rights, airspace
rights, mineral rights, rights to use the electromagnetic spectrum, queuing
rights], such rights are not a pure commodity. Moreover, ownership
requires special policing powers for value preservation. Physical barriers
to theft (e.g., locks and keys) don’t suffice to protect owners; confidence
in contracting and the legal system is necessary to support value.
▪ Variety—While there may be multiple transactions for a given piece of
intellectual property (e.g., identical nonexclusive patent license), intellec-
tual property is itself highly variegated. This complicates exchange by
making valuation difficult and by rendering markets thin. Thin markets
are likely to be less robust than thick markets. Moreover, both buyers and
sellers are likely to wish to customize transactions. To the extent to which
this occurs, transaction costs increase, and the difficulties of setting up an
exchange increase.
▪ Unit of Consumption—Intellectual property is rarely sold lock, stock, and
barrel. Hence, metering arrangements of some kind must be devised.
These are by no means readily identifiable, particularly for software. Is
it a component and if so, should the royalty be a function of the value
of the component or the system in which it is embedded. Clearly, the
value is a function of other intellectual property located alongside the
intellectual property at issue. Questions of the royalty/sales base are
by no means straightforward.

Some Sectoral Differences in the Market for Know-How

The inherent difficulties just identified vary according to the type of
know-how/intellectual property at issue. It is instructive to compare chemicals
and pharmaceuticals with electronics. Indeed, even a cursory examination
would suggest that in chemicals and pharmaceuticals, the inherent difficulties
associated with licensing are less than in other sectors, like electronics. Figure
3 summarizes some of these difficulties.
There are a number of reasons why the market for know-how generally
works better for chemicals and pharmaceuticals. In chemicals and pharmaceuti-
cals, patents work especially well and are ubiquitous. A survey of the efficiency
of patents conducted by researchers at Yale University showed high scores for
patent effectiveness in this sector.30 Patents are in one sense the strongest form
of intellectual property because they grant the ability to exclude, whereas copy-
right and trade secrets do not prevent firms that make independent but dupli-
cative discoveries from practicing their inventions/innovations. Accordingly,
problems of recognition and disclosure disappear when patents are at issue. Also
regulation often bolsters intellectual property since “me too” misappropriators
may sometimes face additional hurdles (in the U.S., FDA approval) before being
able to launch a product in the market.

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 Capturing Value from Knowledge Assets

FIGURE 3. Some Sectoral Differences in the Market for Know-How

Chemical/
Challenge Electronics
Pharmaceuticals

Recognition Manageable Extremely complex,

often impossible
Disclosure Handled by NDA, More difficult
patents common
Interface issues Compatability generally Compatability generally
not an issue critical
Royalty stacking, Infrequent Frequent
royalty base dilemmas
Value context dependent Strongly so Very strongly so
Patent strength Generally high Sometimes limited
Development cycle Often long Generally short

Know-How
Generally Well Often Poorly
Market Works:

Compatibility/interface issues are also less severe in this sector than in

some others. While technologies often must work together in chemicals and
pharmaceuticals, the close coupling of the kind that characterizes electronics
is usually not an absolute prerequisite. Also, the number of individual items
of external intellectual property that must be brought together to design a new
product is often rather limited. Indeed, the items used may all come from inside
the firm, although alliances and licenses are increasingly common. Because
there are less complementarities necessary to make a particular product, intellec-
tual property is often less context dependent, and the same royalty rate is appro-
priate in a multitude of contexts e.g., the float glass process was licensed for the
same amount (i.e., 6% of sales) to multiple jurisdictions around the world.
Finally, the product life cycle is defined not in months, but often in decades.
Hence, requirements for speedy execution of transactions are less severe, and
the opportunity to amortize set-up costs over enormous volumes of business
is often possible.
The situation in the electronics industry is different. For software, patent
protection is uncommon. Hence, if purchasers receive components in source
code, they can read and modify programs, thereby possibly skirting intellectual
property protection. Put differently, source code can be more readily converted
to new programs that don’t leave fingerprints. Object code, on the other hand,
must first be reverse engineered into a reasonable approximation of source
code before it can be advantageously modified. Thus, disseminating software

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components (in source code) for external use creates misappropriation hazards.
While encryption creates barriers to reverse engineering (decryption), it does not
compensate for weak intellectual property. The problem of disclosure (necessary
to inform buyers about what they are being offered) has clear hazards in this
sector. Furthermore, interface issues are critical, as integration is paramount.
Because multiple sources of intellectual property must be combined for systems
on silicon, intellectual property rights must be amalgamated.31
The market for know-how in electronics thus creates considerable chal-
lenges and is unlikely, therefore, to be completely efficient. Accordingly, new
innovations (such as system-level integration in silicon) involve new organiza-
tional challenges, orders of magnitude greater than previously encountered, and
perhaps orders of magnitude greater than the technological challenges. Royalty
stacking situations—where intellectual property owners fail in their pricing pro-
posals to take into account the need for the buyer to combine other intellectual
property to create value—are likely to be frequent, at least until a new business
model is firmly established. Also, the tremendous premium on speed and time to
market puts enormous pressure to accomplish intellectual property transactions
quickly. This is impossible if intellectual property agreements are customized.
However, there is at present almost no standardization in intellectual property
agreements, so the market can readily become bogged down by transactional
complexity.
Because of these difficulties, there is at present little if any market for
software components. Estimates of the annual aggregate costs in the U.S. for
“reinvention” are put at between $2 and $100 billion. These estimates, if correct,
speak to the value of a properly functioning market for software intellectual
property. Absent such a market, certain new product architectures (e.g., systems
on Silicon) may just not happen, or may not realize but a fraction of their
potential.
What was just described for know-how assets also applies to compe-
tences, which can be thought of as clusters of know-how assets. Competences
include discrete business-level organizational processes fundamental to running
the business (e.g., order entry, customer service, product design, quality con-
trol). But they also include generalized organizational skills such as “miniatur-
ization,” “tight tolerance engineering,” and “micromotors.”
Competences are tangible, and can be quite durable. They are typically
supported by routines, not dependent on a single individual, and generally
reside inside the business functions. Like know-how assets, they cannot be
readily bought and sold, absent a transaction for the entire business.
Profiting from innovation is more readily assured when high-
performance business processes and/or world-class competences support a prod-
uct or process offering. This is because the asset/competences cannot be traded,
and the forces of imitation are muted. Not only are such assets/competences
inherently difficult to imitate because they are likely to be built on a high tacit

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 Capturing Value from Knowledge Assets

component, but there may be opaqueness to the underlying processes and

uncertainty, even within the firm, as to the organizational foundations of the
competence.

Complementary Assets
The asset structure of the firm is perhaps the most relevant aspect of its
positioning when the commercialization of knowledge in tangible products and
processes is at issue. Such (upstream) positioning may be more important than
the downstream positioning in the product markets for yesterday’s product. In
many cases there may be a high correlation between a firm’s upstream position
in an asset and its downstream market position.
Complementary assets matter because knowledge assets are typically
an intermediate good and need to be packaged into products or services to yield
value. There are notable exceptions, of course. Software is a classic exception as
it does not need to be manufactured, and with the internet, distribution
becomes instantaneous and almost costless.
However, when the services of complementary assets are required, they
can play an important role in the competitive advantage equation. For instance,
the design for a new automobile is of little value absent access to manufacturing
and distribution facilities on competitive terms.
The effort to embed knowledge in products and to bring the new product
to market must confront the whole question of access to complementary assets.
If already owned by the knowledge owner, there is no issue. If not, then one
must build, or buy if one can. Because the market for complementary assets is
itself riddled with imperfections, competitive advantage can be gained or lost
on how expertly the strategy for gaining access is executed.
Circumstances of such co-specialization can benefit the asset owner, as
demand for the innovation will increase demand for the co-specialized asset. If
difficult to replicate or work around, the complementary asset may itself become
the “choke point” in the value chain, enabling it to earn supernormal rents.
Thus, ownership of difficult to replicate complementary assets can represent a
second line of defense against imitators and an important source of competitive
advantage.

Dynamic Capabilities
In many sectors in today’s global market, competitive advantage also
requires dynamic capabilities. (See Figure 4.) This is the ability to sense and
then to seize new opportunities, and to reconfigure and protect knowledge
assets, competencies, and complementary assets and technologies to achieve
sustainable competitive advantage.
It is relatively easy to define dynamic capabilities, quite another to
explain how they are built. Part of the answer lies with the environmental and

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 Capturing Value from Knowledge Assets

FIGURE 4. Capturing Value from Knowledge Assets

Complementary Assets & Technologies

dynamic *
capabilities

inherent replicability
of the product timing
profits from
knowledge
assets ($$$)
intellectual property standards
protection afforded
the product

basic
(operational) price/performance
competences characteristics of
of the firm the product

*Dynamic Capabilities are the capacity to sense opportunities, and to reconfigure knowledge assets, competencies, and
complementary assets and technologies to achieve sustainable competitive advantage.

technological sensing apparatus that the firm has established, and part lies with
the choice of organizational form, and part lies with the ability to strategize.

External Sensing
In order for an organization to exhibit dynamic capabilities, it must sense
the opportunity and the need for change, properly calibrate responsive actions
and investments, and move to implement a new regime with skill and efficiency.
During “sensemaking,” the organization receives and interprets messages about
new markets, new technologies, and competitive threats. This information is
necessarily evaluated in the light of the individuals’ and the organization’s expe-
rience and knowledge. In formulating an action plan, the organization is neces-
sarily guided to some extent by rules and routines, which structure inquiries and
responses.
Sensemaking, or interpretation, is a critical function. Well performed,
it can enable the organization to connect with its environment and invest its
resources wisely, thereby generating superior returns. The fundamental chal-
lenge to sensemaking is bounded rationality; one cannot learn all there is to
learn about a situation or an opportunity, and action must proceed based on
hunches and informed guesses about the true state of the world. In essence,

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 Capturing Value from Knowledge Assets

business organizations and their management must interpret the world about
them. Interpretative activity is basically a form of theorizing about market and
firm behavior.
Sensemaking can be assisted by sensemaking tools, like scenario planning,
as well as the insights of brilliant outsiders—like a Peter Druker or Gordon
Moore. Scenario planning can help managers develop mental maps of possible
complex future realities. Such mental maps assist in the interpretation of new
data and information from the market and help chart courses of action. Shell Oil
is well known for its effective use of scenario planning, and its investment in this
activity is widely recognized inside and outside the company to have enabled
planners and managers to have extended conversations resulting in shared
visions of possible futures. The object of the exercise has never been to predict
the future, but to understand the fundamental drivers of change and to quickly
chart action plans once key uncertainties are resolved.
When the organization has figured out what is going on, and calibrated
the opportunity, it must choose among available action plans. These are not
infinite in number, but may be restricted to one or two or maybe a handful of
viable alternatives that are satisfactory. Actions are likely to be similar to those
used in the past. Organizational routines—distinct ways of doing things—come
into play. Actions and decision routines are part of the organization’s procedural
memory. Procedures and policies enable internal competition to be fair, objec-
tive, and legitimate. Organizational rationality can exist, despite individuals’
bounded rationality, if rules, routines, and procedures guide individual decision
making.
The openness of markets, stronger intellectual property protection, in-
creasing returns, the unbundling of artifacts and information, and the possibili-
ties for “integration” using new information technology are necessarily a part
of the sensemaking milieu.
Information receipt and interpretation is by no means restricted in
its importance to the understanding of business, market, and technological
trends. There is also the need to identify relevant external technology and bring
it into the firm. An organization’s absorptive capacity with respect to external
technology is a function of “the technical and managerial competence of the
transferee.”32 Absorptive capacity is greatest when what is to be learned is
related to what is already known.33 As Mowery has explained, a firm is far
better equipped to absorb the output of external R&D if one is performing some
amount of R&D internally.34 In short, internal and external R&D are comple-
ments, not substitutes.

Organizational Action
Once an opportunity is sensed, it must then be seized. This is where the
organization’s ability to quickly contract up the requisite external resources and
direct the relevant internal resources comes into play. Schumpeter referred to

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the importance of effectuating “new combinations.” This is precisely what

management must do. It increasingly involves forming alliances to access the
requisite complementary technologies and complementary assets. The alliance
structure is favored because markets simply don’t exist for much of what must
be accessed, and the alliance is a (hybrid) way to do so that shares risks and
rewards but achieves a coalignment of strategy.
However, it also requires an organizational structure where decision
making is immediate and action is swift. This typically implies high-powered
incentives and decision making that is anything but bureaucratic. Smaller entre-
preneurial companies appear to excel in many such environments, although
dynamic capabilities are certainly not restricted to small companies. Larger
enterprises can also deliver much of what is required if they are tuned to
changes in their external environments, and if they have adopted decision-
making processes that both enable and require quick response.

Implications for the Theory of the Firm

The firm is a repository for knowledge—the knowledge being embedded
in business routines and processes. Distinctive processes undergird firm-specific
assets and competences (defined as integrated clusters of firm-specific assets).
The firm’s knowledge base includes its technological competences as well as
its knowledge of customer needs and supplier capabilities. These competences
reflect both individual skills and experiences as well as distinctive ways of doing
things inside firms. To the extent that such competences are difficult to imitate
and are effectively deployed and redeployed in the marketplace (reflecting
dynamic capabilities), they can provide the foundations for competitive
advantage.
The essence of the firm is its ability to create, transfer, assemble, integrate,
and exploit knowledge assets. Knowledge assets underpin competences, and
competences in turn underpin the firm’s product and service offerings to the
market. The firm’s capacity to sense and seize opportunities, to reconfigure its
knowledge assets, competencies, and complementary assets, to select appropri-
ate organization forms, and to allocate resources astutely and price strategically
all constitute its dynamic capabilities.
The knowledge perspective presented here requires us to stress the entre-
preneurial rather than the administrative side of corporate governance. In high-
technology industries, firms are not so much organizations designed to minimize
transactions costs—although this they do—but organizational structures capable
of shaping and reshaping clusters of assets in the distinct and unique combina-
tions needed to serve ever-changing customer needs. Accordingly, boundary
issues (such as vertical integration) are not determined by transactions cost
considerations alone. Rather, they are strongly influenced by tacit knowledge
and imitability/replicability considerations. Even setting aside strategic and
transaction cost issues, the tacit component of knowledge cannot frequently

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 Capturing Value from Knowledge Assets

be transferred absent the transfer of personnel and organizational systems/

routines. Tacit knowledge and its transfer properties help determine the bound-
aries of the firm and may well swamp transaction costs considerations.
Competitive advantage can be attributed not only to the ownership
of knowledge assets and other assets complementary to them, but also to the
ability to combine knowledge assets with other assets needed to create value.
Knowing what assets to develop, and what to abandon, is a critical element in
the success equation. Dynamic capabilities are critical if knowledge assets are
to support sustainable competitive advantage.35
Thus, the competences/capabilities view of the firm sees the proper
boundaries of the firm and governance structure being determined not only
with reference to transactions costs, but also with reference to technological
and knowledge concerns. The boundaries of the firm, and future integration
and outsourcing opportunities, must clearly be made with reference to learning
and knowledge issues as well as transaction cost economics.
The emphasis on the development and exploitation of knowledge assets
shifts the focus of attention from cost minimization to value maximization. Gov-
ernance decisions involve both questions of what assets to build inside the firm
versus accessing externally, as well as how to organize internally. This perspec-
tive thus complements transaction cost economics.

Conclusion
Knowledge, competence and related intangibles have emerged as the key
drivers of competitive advantage in developed nations. This is not just because of
the importance of knowledge itself, but because of the rapid expansion of goods
and factor markets, leaving intangible assets as the main basis of competitive
differentiation in many sectors. There is implicit recognition of this with the
growing emphasis being placed on the importance of intangible assets, reputa-
tion, customer loyalty, and technological know-how.
While there is some recognition of these changes, there is perhaps a fail-
ure to recognize just how deep these issues go. The value-enhancing challenges
facing management are gravitating away from the administrative and towards
the entrepreneurial. This is not to denigrate the importance of administration,
but merely to indicate that better administration is unlikely to be where the
economic “rents” (superior profits) reside. Indeed, if one looks at the sources of
wealth creation today, they are markedly different from what they were barely
two decades ago. The key sources of wealth creation at the dawn of the new
millennium will lie with new enterprise formation; the renewal of incumbents;
the exploitation of technological know-how, intellectual property, and brands;
and the successful development and commercialization of new products and
services.

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The implications for management are clearly quite considerable. New

forms of business organization—and new management styles that enable intan-
gibles to be developed and dynamic capabilities to be practiced—are clearly criti-
cal. There is now sufficient experience with new network organizations and
with alliances to sensitize management to the richness of the organizational
menu that is now available. Moreover, modern information technology clearly
enables a greater variety of transactional structures than was hitherto thought
possible. What is apparent is the need to focus on developing a deeper under-
standing of imitability and replicability issues with respect to intangibles and the
role of markets in undermining traditional forms of competitive advantage.
The extension of markets and the growth of competition is a great benefit
to the consumer and society. However, the post-war evolution of markets has
powerful strategic implications for how and where firms position themselves to
build competitive advantage. This does not appear to be well appreciated. It is no
longer in product markets but in intangibles assets where advantage is built and
defended. There is no such thing as a privileged product market position—unless
it rests on some upstream intangible asset. The focus of strategy analysis must
change, and is changing, as indicated by the burgeoning literature in strategic
management on the resource-based theory of the firm.36 Managers who figure
this out are likely to be well positioned to build and maintain competitive
advantage in the next millennium. They must recognize that in open unregu-
lated markets, the domains in which value can be built are likely to be more and
more confined. Perhaps Andy Grove is right after all when he warns that “only
the paranoid survive.”

Notes
1. D.J. Teece, “The Market for Know-How and the Efficient International Transfer
of Technology,” Annuals of the American Association of Political and Social Sciences
(November 1981), pp. 81-86.
2. S. Kuznets, Modern Economic Growth: Rate, Structure, Spread (New Haven, CT: Yale
University Press, 1966).
3. These included the late Edwin Mansfield, Richard Nelson, Chris Freeman, Sidney
Winter, Paul David, Nathan Rosenberg, Giovanni Dosi, and David Mowery.
4. See P. Romer, “What Determines the Rate of Growth and Technological Change,”
World Bank Working Papers, WPS 279, World Bank, 1989.
5. I. Nonaka and H. Takeuchi, The Knowledge Creating Company (New York, NY:
Oxford University Press, 1995).
6. M. Miller, Merton Miller on Derivatives (London: John Wiley & Sons, 1997).
7. P. Grindley and D.J. Teece, “Managing Intellectual Capital: Licensing and Cross-
Licensing in Semiconductors and Electronics,” California Management Review, 39/2
(Winter 1997): 8-41.
8. That’s not to say that these are not opportunities to take bets against the market,
but such bets represent asset plays by investors which ought not be thought of
as a foundation for competitive advantage, as gains need not require involvement
in operations of any kind.
9. Teece (1981), op. cit.

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 Capturing Value from Knowledge Assets

10. B. Arthur, “Competing Technologies: An Overview,” in G. Dosi et al., eds., Techni-

cal Change and Economic Theory (London: Frances Pinter, 1988).
11. D.J. Teece, G. Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Manage-
ment,” Strategic Management Journal, 18/7 (1997): 509-533.
12. Following Dataquest, we define SLI as an integrated circuit that contains a com-
pute engine, memory, and logic on a single chip and has more than 100,000 uti-
lized gates. Two types of SLI devises can be recognized: ASICs (application-specific
integrated circuits) that are sold to a single user, and ASSPs (application-specific
standard product) that are sold to more than one user.
13. Dataquest, ASIC’s Worldwide, December 18, 1995.
14. Fumio Kodama, Analyzing Japanese High Technologies (London: Pinter, 1991).
15. “A Dynamic Mix of Chips and Biotech,” Forbes, January 26, 1996, pp. 76-81.
16. Teece (1981), op. cit., p. 84.
17. For analysis of the sources of innovation, see D.J. Teece, “Firm Organization,
Industrial Structure, and Technological Innovation,” Journal of Economic Behavior
and Organization, 31 (1996): 193-224.
18. This section is based on Teece (1981), op. cit., p. 82-84.
19. These ideas are developed further in C.E. Shannon and W. Weaver, The Mathemati-
cal Theory of Communication (Chicago, IL: University of Illinois Press, 1949). I am
grateful to Max Boisot for drawing them to my attention.
20. For example, we could identify innovation that were architectural or non archi-
tectural, competency enhancing or competency destroying.
21. This section is based in part on Teece, Pisano and Shuen, op cit.
22. D.J. Teece, “Technology Transfer by Multinational Firms: The Resource Cost of
Transferring Technological Know-how,” The Economic Journal, 87 (1977): 242-261.
23. S.A. Lippman and R.P. Rumelt, “Demand Uncertainty and Investment in Industry-
Specific Capital,” Industrial and Corporate Change, 1/1 (1992): 235-262.
24. R. Nelson and S. Winter, An Evolutionary Theory of Economic Change (Cambridge,
MA: Harvard University Press, 1982).
25. D.J. Teece, “Towards an Economic Theory of the Multiproduct Firm,” Journal of
Economic Behavior and Organization, 3 (1982): 39-63.
26. M.E. Porter, The Competitive Advantage of Nations (New York, NY: Free Press, 1990).
27. See K. Clark and T. Fujimoto, Product Development Performance: Strategy, Organiza-
tion, and Management in the World Auto Industries (Cambridge, MA: Harvard Busi-
ness School Press, 1991).
28. Nelson and Winter, op. cit.
29. Competences may in turn be embedded in other corporate assets, including assets
complementary to knowledge assets.
30. S. Winter, “Knowledge and Competence as Strategic Assets,” in D. Teece, ed., The
Competitive Challenge: Strategies for Industrial Innovation and Renewal (New York, NY:
Harper & Row, Ballinger Division, 1987).
31. This isn’t necessary for broad level integration of physical components, where the
bundling of intellectual property in products simplifies intellectual property trans-
actions.
32. D.J. Teece, The Multinational Corporation and the Resource Cost of International Technol-
ogy Transfer (Cambridge, MA: Ballinger, 1976), p. 48.
33. W.M. Cohen and D.A. Levinthal, “Absorption Capacity: A New Perspective on
Learning and Innovation,” Administrative Sciences Quarterly, 35 (1990): 128-152.
34. D. Mowery, “Firm Structure, Government Policy, and the Organization of Indus-
trial Research,” Business History Review, 58 (1984): 504-531.
35. The astute management of the value in a firm’s competence/knowledge base is a
central issue in strategic management. D.J. Teece, “Profiting from Technological
Innovation,” Research Policy, 15/6 (1986): 285-305. The firm must therefore be

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understood not just in terms of its competences, but also in terms of its dynamic
capabilities and the ability to orchestrate internal and external assets so as to cap-
ture value. Dynamic capabilities reflect the entrepreneurial side of management.
Incentives as well as the formal and informal structure of the firm are all elements
of governance affecting dynamic capabilities. These elements together help define
the firm as we know it. Accordingly, competitive advantage flows from both man-
agement and structure.
36. For an excellent compendium, see Nicolai Foss, ed., Resources, Firms and Strategies:
A Reader in the Resource-Based Perspective (New York, NY: Oxford University Press,
1997).

CALIFORNIA MANAGEMENT REVIEW VOL. 40, NO. 3 SPRING 1998 79

 California Management Review
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