An Exploration of Dynamic Capabilities in the Banking Sector

^{An Exploration of Dynamic Capabilities, with specific reference to the Banking Sector.}

Introduction

This portfolio consists of three inter-related sections exploring the concept of dynamic capabilities (DCs), with specific reference to the banking sector. I have chosen to focus on the DCs framework due to its increasing relevance and importance within both the business and academic world.  As the 21st century approached, internet-based technologies significantly challenged the conventional views of competitive advantage. The concept of DCs primarily emerged as a framework to understanding how organisations adapt their pool of resources to stay competitive in today’s ever-changing environment (Teece et al. 2007). Some academics have gone as far as to suggest the framework is “the new touchstone firm based performance-based theory” (Arend & Bromiley, 2009). The portfolio begins by reviewing prominent research within the DCs field, and progresses towards collecting primary research on DCs in practice. It concludes by using the qualitative evidence as a unique lens in which to analyse the existing theory.

Section 1: Reviewing Research on Dynamic Capabilities

In recent years, the DCs framework has been one of the most researched and vibrant concepts in strategic management (Gremme & Wohlgemuth, 2017). The concept emerged in the early 1990s when existing strategic management theories could not fully account for why some organisations succeeded in an increasingly dynamic environment, while others failed.As an extended paradigm of the resource-based view of the firm (Barney, 1991), the central purpose of DCs is to understand how organisations renew their VRIN (valuable, rare, non-imitable and non-substitutable) capabilities in order to sustain competitive advantage in the face of ever-changing environments. In what remains the most cited paper in the DCs field, Teece et al. (1997: 1319) define DCs as the “ability to integrate, build, and reconfigure internal and external competences to address rapidly changing environments.” Since then, research on DCs has grown and evolved immensely, resulting in considerable theoretical variety. As the literature surrounding DCs is boundless, I focus on the seminar papers that are among the highest cited in the broader domain of strategic management publications (Furrer et al., 2008). With the help of these papers, I identify and discuss five key themes surrounding the DCs construct, highlighting both theoretical convergences and divergences, and which I later use in Section 2 and 3 to analyse DCs in practise. These themes attempt to cover a brief life cycle of DCs beginning with microfoundations and then towards processes and routines, the organisational context, the market context and finally, extend it to whether DCs can drive competitive advantage.

The Microfoundations of DCs

The identification of the building blocks or microfoundations of DCs must be somewhat opaque, otherwise sustainable competitive advantage would erode with the effective application of DCs concepts (Teece, 2007). That is not to say, however, that research on microfoundations has not been a prominent feature within the DCs field. The microfoundations of DCs can beclassified as to whether they support sensing, seizing or transforming capabilities (Clegg et al., 2011). While sensing involves identifying opportunities and threats existing outside of the organisation, seizing is the ability to take advantage of the sensed opportunities and finally, transforming refers to the continuous renewal and reconfigurations of capabilities. The microfoundations that underpin the above capabilities, broadly refer to unique skills, processes, organisational structures and knowledge transfer routines (Eisenhardt & Martin, 2000). For instance, selecting new technology and identifying target market segments are both examples of microfoundation processes required to sense opportunities (Teece, 2007). Moreover, designing innovative business models and displaying decentralised structures and processes are other examples of microfoundation processes required for seizing and transforming capabilities, respectively. Thus, it is evident that microfoundations of DCs are regarded as a core aspect of the DCs scholarship.

DCs as “Routines” and “Processes”

After exploring the microfoundations, it is clear that DCs can be viewed as higher-order ‘routines’ and ‘processes’ that contribute to transforming more mundane routines. Eisenhardt & Martin (2000) argue that DCs consist of organisational and strategic routines through which organisations alter their resource configurations and then recombine them to generate new strategies. Examples of these specific value-creating routines and processes, include product development, building strategic alliances and acquisition know-how. This is supported by Zollo & Winter (2002) who explain that DCs are routines that adjust and modify an organisations’ operating routines. Moreover, Teece et al. (1997) characterise DCs as unique organisational processes that are shaped by the stock of assets an organisation holds and the paths (strategic alternatives) available to it. Thus, in the most general sense, there appears to be agreement amongst scholars that DCs are organisational routines and processes. It is important to note, however, that whilst Teece et al. (1997) characterise DCs as idiosyncratic processes, others argue that commonalities exist as there is ‘best practise’ when implementing certain DCs (Eisenhardt & Martin, 2000).

The Impact of Organisational Flexibility on DCs

The power of organisational design is another key aspect of DCs that has been explored. It can be argued that in order to effectively build a capacity for sensing, shaping and seizing opportunities, organisations need to be agile (Teece, 2009). Traditional forms of organisational design – top-down hierarchical structures, rules and regulations, routinized formal processes – tend to create structural rigidities that could hinder creativity, initiative and market responsiveness (Rumelt, 1995). Decentralisation, however, facilitates creativity and innovation, while minimising bureaucratic impediments to project approval and implementation. Moreover, Teece (2007) contends that in order to sustain DCs, decentralisation must be favoured as it brings top management closer to the customer, new technologies and the market. Evans et al. (2006) goes further and argues that regulatory and institutional structures must often be reshaped for new markets to emerge. Thus, there appears to be a general consensus amongst scholars that organisational flexibility prepares the ground for DCs by enabling organisations to sense, shape and seize new opportunities.

The Impact of Market Dynamism on DCs

The effectiveness of DCs is argued to vary depending on market dynamism. In moderately dynamic markets, markets are said to be dynamic but with predictable and linear changes, whereas, in high velocity markets, markets are dynamic but with unpredictable and non-linear changes. Numerous scholars claim that the sustainability and effectiveness of DCs increases with market dynamism, as there is a stronger drive for organisations to exhibit DCs in light of external changes in high velocity markets (Teece et al., 1997; Zollo, & Winter, 2002; Wang & Ahmed, 2007). Per contra, other scholars argue that DCs can be effectively deployed in both types of market dynamisms discussed (Zott, 2003; Ambrosini & Bowman, 2009; Helfat, 1997). Moreover, Eisenhardt & Martin (2000) elaborates that the patterns of DCs will vary with market dynamism. For instance, when markets are moderately dynamic, DCs are complicated and predictable processes that rely on existing knowledge and rules of thumb. In contrast, in high-velocity markets, DCs are simple and experiential processes that prevent managers from locking into specific behaviours or inappropriate past experiences. For example, Yahoo’s successful alliancing process is predominantly unstructured for this reason (Eisenhardt & Martin, 2000). To conclude, one can see that whether the effectiveness of DCs increases with market dynamism remains an ongoing debate.

DCs as a Source of Competitive Advantage and Improved Performance

Numerous researchers agree that in regimes of rapid change, DCs play a crucial role in determining newer sources of competitive advantage (Zott, 2003; Teece, 2007; Ambrosini & Bowman, 2009). In today’s highly dynamic environment, it is argued that achieving ‘technical fitness’, such as adopting best practises and displaying tight cost control, is no longer sufficient to sustain superior performance (Teece, 2007). Instead, it is argued that organisations need to display difficult-to-replicate DCs, and hence simultaneously develop sensing, seizing and transformational capabilities to build and maintain competitive advantage. Wang & Ahmed (2007) go on to argue that exhibiting DCs can be associated with improved performance, particularly when specific capabilities are aligned with the organisation’s strategic choice. However, some researches argue that competitive advantage is more difficult to achieve through DCs than Teece (1997, 2007) suggests and concludes that sustainable competitive advantage lies in resource configurations, rather than DCs (Eisenhardt & Martin, 2000). Furthermore, in more recent papers, some scholars are beginning to dispute to what degree DCs have a direct impact on performance, with some concluding that DCs should not be defined in terms of their outcomes (Helfat et al., 2007; Arend and Bromiley, 2009). Thus, to an extent DCs can be viewed as a source of sustaining competitive advantage, however, there appears to be more divergent views regarding the links between DCs and performance.

To conclude, although one can see that there is a degree of theoretical divergence, which should be expected in the (relatively) early-stage developments of a theoretical construct, it is also evident that there is coherence surrounding certain themes of DCs. This has allowed us to gain a greater understanding as to what constitutes the DCs construct, and what does not. There is also a consensus amongst scholars that there is an ongoing need to enhance empirical support to understand if and how DCs can originate, evolve and fade in practise, which I will begin to examine in the following section.

Section 2: Primary Research on Dynamic Capabilities in Practise

This section focuses on to what extent different organisations within the banking sector have the DCs required to create and sustain competitive advantage in response to the dynamic environment. The banking sector is an industry that has experienced both external change, such as the Global Financial Crisis, as well as internal change primarily driven by digitalisation, making it a very interesting market to explore.

I undertook an extensive market mapping and networking process, which resulted in the successful identification of four expert and willing interviewees, working in four different companies within the banking sector, ranging from incumbent banks (Company A &B) to new challenger banks (Company C & D). It was fascinating to interview people from within this spectrum, as I could see first-hand the striking organisational differences between the different organisations, personified by the wood panelled entrance halls of a company that was founded in 1692 compared to the open plan office of the branchless challenger bank. Using the themes identified in Section 1, all interviewees were provided with a summary sheet on DCs to ensure a full understanding of the framework. A quick overview of each company studied is shown in the spectrum below (Figure 1), followed by the interviews conducted. Due to the word constraint, there is a combination of voice recordings and key quotes.

1. Given the current highly dynamic and competitive environment, to what extent has X changed their strategies in order to adapt?

Interviewee C:

“For the larger banks, one of the big things that is driving strategy is changing channel preferences amongst consumers. This means pivoting from the branch network towards digital channels in a way that continues to drive customer loyalty.”

Interviewee D:

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2. Based on the summary sheet provided, can you give any examples of DCs displayed at X?

Interview A:

“We see a bigger opportunity in augmenting the human relationship with technology that would lead to richer conversations.”

Interviewee D:                                                       

3. Would you say X’s organisational structure perhaps hinders their ability to adapt to the changing environment? Or is it a strength?

Interviewee A:

 “I would say it’s both. Any larger organisation that has invested a lot of money in building capabilities and is now in a world where things are changing rapidly, will find it challenging to adapt.”

“That said, being a bigger bank and, having greater capital stores, having an established client base, and a very strong brand is an enormous strength.” 

Interviewee C:                                         

“We are having to slowly change our old manufacturing production line into the automated, robot driven production line, while still ensuring the bank is resilient and compliant.”

Interviewee D:

“We have a very decentralised structure, which allows us to release products quickly, giving us an advantaged over larger banks who are constrained by organisational structure and regulation.”

“However, as we get bigger, it will be interesting to see how DCs will be sustained and how we ensure that we comply to the increased regulation that comes with being a bigger bank.”

4. Given Eisenhardt & Martin’s (2000) definition of a moderately dynamic market and a high velocity market, which best describes the banking sector?

Interviewee B

Interviewee D

“I would say both, it depends on which part of the market you are looking at.”

5. Exhibiting DCs can be viewed as a source of sustained competitive advantage. Do you agree?

Interviewee A:

“If I think about how the world is developing, where people do more things on their phones and interact with computer programs rather than humans, we don’t really align to that model because we provide our clients with opportunity to talk to humans, who can have an objective rational conversation with you but can also connect with you on an emotional level.”

Interviewee C:

“To translate our high customer service into digital channels, we are having to reconfigure the way we deliver this to sustain our competitive advantage.”

Interviewee D:

“We maintain and achieve competitive advantage by continuing to move at speed. We take an agile approach to product development; we design it, build it, test it, iterate the test and then roll it out to a few group of users. Working in this way couples with the fact that we don’t have a hierarchical structure and this is what allows us to take market share from the big banks.”

To conclude, it is evident that organisations across the spectrum differ in their ability to put DCs into practise. This may partly be a result of organisational design, but also partly as a result of their customers valuing cutting-edge technology differently. It was particularly fascinating to learn from Interviewee B, who has a lot of global experience, about how a new challenger bank (a Chinese multinational conglomerate) in a high-velocity market has used DCs in a breath-taking way. Through the process of reconfiguration, they have significantly transformed the loan process for their users. Their strategy is described as ‘310’, as it takes 3 minutes to apply for a loan, 1 second to get a yes or no and 0 hours to process that loan. Thus, having gained a better understanding of how DCs originate and evolve in practise, it will be interesting to see if the existing theory supports this evidence, which I begin to analyse in the following section.

Section 3: Reflective Piece on Theory vs. Practise

In Section 1, I identified five key themes surrounding the concept of DCs and in Section 2, I explored if and how organisations within the banking sector have put DCs into practise. Consequently, this section focuses on to what extent the qualitative evidence collected supplements or contradicts the themes and ideas from existing theory.

In my opinion, the evidence collected supports the theory surrounding the microfoundations of DCs, which was a key theme identified. Various examples of microfoundation processes underpinning sensing, seizing and transforming capabilities, that Teece (2007) put forward, were evident in the interviews. For instance, Interviewee C stated that as a result of changing channel preferences and digitalisation, established banks are beginning to shift away from the branch network towards digital channels, in order to seize new opportunities and stay relevant. Moreover, Interviewee D agreed with Teece’s (2007) view that decentralised processes and structures are key for transforming capabilities, as it provides the ground for knowing when to break or disregard ineffective routines.

The interviews further support the theoretical view that DCs are organisational and strategic processes, aimed at renewing and reconfiguring capabilities (Teece et al, 1997; Eisenhardt & Martin, 2000). For instance, through the process of reconfiguration, established banks in the UK are beginning to see an opportunity in augmenting the human relationship with technology to achieve richer conversations (Interviewee A). Moreover, examples of specific value-creating routines and processes, such as alliance-building and product development, were discussed by Interviewee C and D. In my opinion, Interviewee D agrees with Eisenhardt & Martin (2000) argument that capabilities exhibit commonalities. They claimed that for their product development routines to be successful and effective, cross-functional teams were crucial, hence implying there are more and less effective ways to execute particular DCs.

The impact of organisational flexibility, another key theme, resulted in polarising views among the interviewees. As assumed in the literature, decentralisation prepares the ground for DCs, as it prevents structural rigidities that could hinder the ability to sense, seize and transform new capabilities (Teece, 2007). To some extent, this is supported by the qualitative evidence as it was evident that the regulations and hierarchy that comes with being a larger bank, makes inventing new ways of working and adapting to the changing environment challenging (Interviewee A). Moreover, the decentralised structure existent in Company D acts as a catalyst in allowing them to continuously reconfigure their capabilities, resulting in their ability to get new products out quickly (Interviewee D).

Interviewee C went further to explain that established banks need to begin moving away from their old manufacturing line towards a robot-driven production line, supporting Evans et al. (2008) argument that regulatory structures must often reshape themselves in such a way that allows agility.

That being said, it is also evident that to some extent some interviewees disagree that decentralisation is essential for successful implementation of DCs. For instance, there are many benefits that come with being a larger bank and having top-down hierarchal structures, such as greater access to capital stores and a stronger brand reputation (Interviewee 1 and 2). This point is reinforced by a recent article in the Sunday Times (Treanor, 2019), that contended a bank had recently frozen almost £1m of bonuses for 3 executives while investigations into accounting errors continue, highlighting the importance and need for structure and regulations. Furthermore, as new entrants start to expand, it will be interesting to see how they too will ensure that they comply to the increased regulation, as well as how their DCs will be sustained (interviewee 4). Thus, many of the incumbent banks argue that trust is at the core of the customer relationship rather than speed, and since this relationship is primary based on contact it is perhaps harder for incumbent banks to put this into process and routines.

When asked the question as to whether the interviewees regarded the banking sector as a high velocity market or a moderately dynamic market, the majority answered that it depended on which part of the market you focused on. It was argued in the interviews that challenger banks are, in a sense, part of a high velocity market as customers are continuously relying on cutting-edge technology, whereas, the more established banks are perhaps part of a moderately dynamic market since change occurs more linearly due to regulation (Interviewee B). Therefore, to some degree it appears as though the evidence agrees that the effectiveness of DCs will increase with market dynamism as they are more needed, supporting Teece et al. (1997) and Zollo & Winter (2002) argument. Although one may think it is a slow-moving industry, the services and technology surrounding it are very adaptive and fast-learning. Thus, it is evident that there are some parts of the sector that are more conducive to digitalisation and DCs, such as challenger banks offering low cost current accounts, whereas, there are other parts that are much more complex and therefore it is harder to be conducive to digitalisation, such as being responsible for high-net-worth-individuals and their investments.

DCs as a source of newer competitive advantage was another key theme debated in the interviews. To some extent the evidence supports the theory, as some Interviewees agree with Teece’s (2007) claim that competitive advantage lies in an organisations ability to sense, seize and transform capabilities, as this is what allows them to move at speed (Interviewee D). This is further supported by, Interviewee C who argued that in order to sustain their competitive advantage, they are having to put DCs into practise and reconfigure the way they augment that face-to-face interactions.  However, the evidence also pointed out that displaying DCs alone are not enough to ensure sustained competitive advantage (Interviewee A and C). With everyone fixated by technology disintermediation and organisations rushing into innovation ventures for new ways of doing business, it is importance to consider what these organisations are searching for. Is it to close the gap versus the competition or are they trying to open up new opportunities? In my opinion, to answer this one must look at the needs of the customers and the company’s strategic position. For instance, Interviewee A pointed out that they add value to their clients by giving them the opportunity to connect and build a relationship with a human rather than a mobile phone, thus their clients don’t expect them to change as rapidly as some of the newer banks. It is also evident in the interviews that while in some parts of the market, companies competitive advantage lies in their ability to rapidly change to the market (Interviewee D), in other parts of the market, competitive advantage lies in their brand, longevity and their ability to create customer relationships (Interviewee A). This supports Eisenhardt & Martin’s (2000) argument that achieving competitive advantage through DCs is not as straight forward as assumed by Teece (1997, 2007). Thus, one can see that the relevance and ease of implementing DCs varies by both segment of the banking sector and time (due to scale and increased regulation). However, despite the changing environment and the fact that established banks may find it harder to implement effective DCs, it is evident that they still sustain their competitive advantage, as their customers are after stability and a strong reputation.

To conclude, it is evident that some themes apply to the evidence more than others and that the concept of DCs is still in need of much theoretical and empirical development (Easterby‐Smith et al, 2009). However, the qualitative evidence collected has provided me with a unique lens in which to analyse the existing theory, which has been a fascinating experience. Moreover, while DCs can no way be a general theory to explain the banking industry, it was both surprising and satisfying to see how the framework and concepts of DCs were both quickly recognised by all the interviewees and relevant. It has been hugely insightful and rewarding to go from reading academic papers to visiting senior people in the banking industry and having a live conversation about how DCs are actually put into practise. One thing that has particularly stood out to me is that organisations from opposite sides of the spectrum can learn from each other, whether that is to do with organisational flexibility or ways to comply to regulation while still finding ways to innovate successfully. 

References

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Grade Target Mark

My desired target mark is a 1^st for four main reasons. Firstly, I have put an enormous amount of time into this portfolio and have been very resourceful in getting some extremely high-quality interviews, despite the difficulties. Secondly, I choose this module as it is a field that deeply interests me, and therefore I have fully immersed myself, not only in this portfolio, but throughout the term, which is reflected by my attendance and contribution in seminars. Thirdly, I feel as though I have achieved and demonstrated the intended learning outcomes of this portfolio, whilst showing that I have the ability to build upon what has been taught. Moreover, I have attempted to engage with the material critically and demonstrate independent thought throughout. Finally, I believe a 1^st is within my capabilities based on my previous grades and the fact that I like to believe I am someone who is constantly pushing myself to my maximum potential. It has been fascinating module and I have learnt an enormous amount, which has hopefully has been portrayed.