Dynamic Competition Done Right: CRESSE Conference 2024

Dynamic Competition Done
Right
David J. Teece
Professor of the Graduate School, University of
California, Berkeley,
and Executive Chairman, Berkeley Research
Group
July 7th, 2024
CRESSE Conference 2024, Chania, Crete
Slide 1

Two modalities of competition
STATIC COMPETITION:
(efficiency driven
competition)
Not an unfair characteristic
of many elements of the
Bain-Mason structuralist
school, the Chicago school,
the post Chicago school
Slide 2
DYNAMIC COMPETITION:
(innovation driven competition)
Elaborates the creative destruction
mantra of Joseph Schumpeter
Jorge Padilla, Judge Douglas
Ginsbury, and Karen Wong-Ervine
have recently declared the
existence of a DYNAMIC
COMPETITION SCHOOL OF
THOUGHT. (ALJ 2025)

Dynamic efficiencies is an oxymoron
• Dynamic efficiencies is a non viable “patch” to the static
competition paradigm
• Innovation qualitatively different from efficiency… process
innovation excepted.
• Pursuit of efficiency usually drives out innovation and vice versa.
• Scholarship (e.g. M. Tushman, P. Adler) is clear on this point. It is
not controversial in the management literature.
Slide 3

Schumpeter I : The breeding ground for innovation is unconcentrated markets.
Schumpeter II : The breeding ground for innovation is concentrated markets.
Schumpeter III : COMPETITION, WHEN TECHNOLOGY DRIVEN, LEADS TO
FIERCE COMPETITION AND OFTEN LEADS TO “CREATIVE DESTRUCTION”
Margrethe Vestager “Competition: The mother of
invention” [Comm’r, European Commission] April 18,
2016
Slide 4

The parentage of invention/innovation in the
literature is inconsistent with Margrethe Vestager’s
pronouncement. Primary enablers include:
• Scientific and technological advancement
• Curiosity and creativity
• Necessity
• Incentives
• Legal, social and political factors
Competition matters too, but it is secondary.
Slide 5

DYNAMIC COMPETITION* …Schumpeter was clear about
the phenomena but silent on policy prescriptions:
• Schumpeter noted that:
“What counts is competition from the new commodity, the new technology, the new
source of supply, the new type of organization—competition which commands a decisive
cost or quality advantage and which strikes not at the margins of the profits and the output
of existing firms, but at their foundations and their very lives.”**
• Edward Mason noted that:
“every serious student of the ”monopoly problem” must take this to heart.” He then went
on to say, “But whether Schumpeter’s views of competition… could be made to yield
principles applicable by government agencies and the courts… is a different matter.”***
• The economics profession hasn’t taken Schumpeter to heart and has been overly
preoccupied with an imagined Schumpeter-Arrow (1962) debate which has been an
enormous distraction and led to a fixation on market structure and little else.
Slide 6
*Schumpeter provided the concept of dynamic competition; I provided the label. See“Innovation, Dynamic
competition, and Antitrust Policy” Regulation Fall 1990
** See J Schumpeter “Capitalism, Socialism and Democracy”
*** “Schumpeter on Monopoly and the large firm” AER 1951

Dynamic competition did not suddenly arrive
with digitalization:
• An industrial era phenomenon too
• The cotton gin, the steam engine, refrigeration, electricity are examples of
technological innovation that were apparent during Schumpeter’s time.
Each spurred competition and economic transformation.
• Digital platforms are organizational / business model innovations
that are not just about new products and processes.
• Wipe away transactional awkwardness (not summarized well by
transaction costs, whether Coasian or Williamsonian).
• Enable scale and scope economies leading to increasing returns (Brian
Arthur); the disruption often overturns the incumbent.
• But marketplace outcomes are not inexorably determined.
Slide 7

Observations about digital platform
competition
• Competitive advantage of the USA and Chinese Big Tech due in
part to heavy R&D expenditures, not just naked increasing returns
• Brian Arthur and David Teece (forthcoming paper “Increasing
returns and chance events”) note the importance of agile, shrewd,
and entrepreneurial management to platform success.
• With the growth of digital platforms, traditional hardware
businesses (e.g. autos) are increasingly becoming software
businesses. When these capabilities are missing, incumbents are
forced to retreat.
Slide 8

28.5%
14.9% 14.8%
12.1%
7.8%
14.3%
8.5%
4.5%
Meta Amazon Alphabet Microsoft Apple Tier 1
(Top 25)
Tier 2
(Next 75)
Tier 3
(Next 900)
R&D
Expenditure
/
Revenue
R&D Intensity for Selected Companies and Averages (2023)
Slide 9

Features of the Dynamic Competition
paradigm
• Firms compete (a) in the market and also (b) for the market
and (c) most importantly to create / establish new markets
• More intuitive and closer to reality than (static) competition
• Brings attention to the supply side which has, for theoretical /
analytical convenience, been largely pushed out of
competition / antitrust economics
• Brings entrepreneurship and entrepreneurial managers and
agile organizations into focus as drivers of competition
Slide 10

Features of the Dynamic Competition
paradigm (cont’d)
• Dynamic competition places minimal weight on market structure
metrics such as HHI.
• long run consumer welfare (LRCW) is the goal of antitrust
• Advancing a robust innovation ecosystem is a good proxy for LRCW
• The dynamic competition paradigm draws on complexity economics
and capability theory.
• Recognizes that dynamic competition may or may not lead to creative
destruction. Some innovation is competency enhancing and, ceteris paribus,
is socially better than creative destruction.
Slide 10 (cont’d)

Advocates of strong competition policy must surely
favor dynamic over static … and the two are often at
war with each other
• Dynamic competition is heavy weight competition; static competition
is light weight.
• EU has a proclivity to use dynamic competition concepts selectively…
seeing anticompetitive effects as certain, and procompetitive as
speculative. This has led to the usurpation (some might say
bastardization) of the dynamic competition paradigm.
Slide 11

Conundrum
• With dynamic competition, traditional hallmark of monopoly...
higher prices, lower output… are not observable (given that
economics have difficulty coming up with robust and credible
BFWs*)... Speculation is insufficient for a court of law… even
though it might get some traction in a seminar room.
• In regimes of rapid technological change, there is a need to rethink
conceptually the whole question of monopoly; but how?
Slide 12
*Fiona Scott Morton has on many occasions simply asserted that innovation would be
even higher and prices even lower“but for”market power in the tech sector

MONOPOLY POWER in the context of
dynamic competition
• Monopoly power cannot be measured by traditional (textbook)
marginal cost pricing tests (particularly true on one side of a MSP)
when innovation is present.
• Market structure tests are also highly questionable.
• SSNIP test not meaningful when products are highly differentiated.
• An assessment of capabilities ought be insightful.
• High market share and high capabilities less troubling than high market
share and weak capabilities
Slide 13
The conceptually correct question (in the context of innovation) is to ask if
price levels are more than sufficient to draw forth the investment required to
develop, design, and provide the products and services customers want.

• “The crucial difference between monopoly and competition is that
with competition market forces both compel and invite
improvement in the product offerings available to the customer.”
• “Actionable monopoly likely exists when there is no compulsion
from the marketplace to contest its position. In short, with
monopoly, a firm in the tech sector is able to hold a position of
market dominance without innovating.”
Slide 14
Resolving the conundrum: How might the
adoption of the dynamic competition paradigm
shape the assessment of policy relevant
monopoly?
David J. Teece “Understanding dynamic competition: New perspectives on potential
competition, “monopoly”, and market power” ALJ forthcoming 2025

Indicia of (policy relevant) monopoly power in regimes of rapid
technological change
Mainstream (Static Competition)
Paradigm
Dynamic Competition Paradigm
High HHI ---
---
Sustaining high market share without
innovating
High prices and output restriction Stagnant sales
High monopoly profits, high Ricardian
profits, high Schumpeterian profits
High non-Schumpeterian or non-
Ricardian profits
"Easy life"
"Easy life" with little to no investment
in future innovation
High value for Lerner index (P-MC)/P ---
Slide 15 Key: (---) means generally irrelevant

MAINSTREAM (STATIC) COMPETITION DYNAMIC COMPETITION
Unconcentrated markets Robust innovation ecosystems
New entry New entry/ and associated competency-enhancing and destroying innovation
Price competition Price competition and performance improvement
Competition for shares of existing markets Competition to create new (future) markets and competition for and in those
markets
- High R&D/expenditures and other investments in innovation
- Active asset orchestration
- Constant repurposing (repositioning) of assets , and active M&A
- Disruption and renewal/restructuring both manifestations of competition
- Variety and experimentation in business methods and models
- High rates of new enterprise formation
Cost-reducing, efficiency-focused
organizational culture
Organizational culture that favors innovation
Homogenous competitors Heterogenous competitors / complementors as incipient competitors
Markets in equilibrium Markets in disequilibrium
Zero economic profit Positive Ricardian, Knightian/ Schumpeterian profits
Indicia of Competition

Dynamic Competition Proposition: potential and future
competition disciplines more than actual competition
• [dynamic competition] “is as much more effective than the other
[static competition] as a bombardment is in comparison with
forcing a door, and so much more important that it becomes a
matter of comparative indifference whether competition in the
ordinary [static] sense functions more or less promptly”
- J. Schumpeter, Capitalism, Socialism and Democracy
• Firms are on a quest for “the next big thing (technological winner).
• Yet our understanding of potential competition and future
competition has not advanced very much in over 100 years.
Slide 17
“Only The Paranoid Survive” Andy Grove,
CEO of Intel

Competition without [actual] competitors!
• With uncertainty, perceived potential competition exerts great
discipline.
• When there is deep uncertainty there is no dominant strategy. Chances of
“surprise” are higher and managers have to be more vigilant in the face of
unseen competitors.
• Nobel Laureate Tjalling Koopmans made an important distinction
between primary and secondary uncertainty.
• Secondary uncertainty can be reduced by collating information on that
which is knowable; primary uncertainty will not yield to data collection
and organization.
• The agencies can do a lot more to ascertain the depth and breadth
of potential competition by using civil investigator demands.
Slide 18

Incentives and capabilities
• The merger guidelines have claimed for some time that both
INCENTIVES and CAPABILITIES are relevant to the assessment of
potential competition
• One cannot understand competition unless you understand
incentives (and their limited explanatory power) and capabilities
(with their high explanatory power)
• Strategy unless coupled to relevant capabilities will fail.
Slide 19

INCENTIVES
• Nobel Laureates Esther Duflo and Abhijit Banerjee note that:
“financial incentives are nowhere near as powerful as they are usually
assumed to be” and that “Chief executives… are driven by the desire to “win
and be the best”*
• Profits (and pecuniary incentives) is often not the primary factor
that drives corporate behavior.
*New York Times, October 26 2019
Sainsbury Stores (UK): “provide the best butter in the world”
Apple under Steve Jobs: “make a small dent in the universe”
Slide 20
Sole reliance on incentives is inappropriate. They ought not be
the divining rod for assessing motivations for mergers.

• Strong capabilities likely result in high market shares yet is always
an “omitted variable” in antitrust analysis.
• Sometimes, what is attributed to anticompetitive conduct is
merely the result of superior capabilities
• One should never lose sight of Nobel Laureate Ronald Coase’s
admonition:
“if an economist finds something—a business practice of one sort or
other—that he does not understand, he looks for a monopoly
explanation.”*
Slide 21
CAPABILITIES: an omitted variable in antitrust
analysis
* Ronald Coase “Industrial Organization: A proposal for Research”National Bureau of Economic
Research, 1972

• Capabilities receive mention in the DOJ/FTC merger guidelines but are
not defined or described.
• Reflects the fact that the economics of (organizational) capabilities has been
overlooked in scholarly and professional research.
• This is rather incongruous as LSE economist, John Sutton has declared
that the capabilities of firms is central to economic progress:
“The proximate cause [of differences in the wealth of nations] lies, for the most
part, in the capabilities of firms.”*
• Perhaps economics has inadvertently morphed into a theory of value
creation through exchange. Resources / goods often a fixed supply;
even when not fixed they are produced by a “black box” production
house (firm). What’s needed is a theory of the innovating.
*John Sutton, Fellow of the Acad., Keynes Lecture in Econ. at the British Acad.: Rich Trade, Scarce Capabilities, Industrial
Development Revisited (Oct. 26, 2000), in PROCEEDINGS OF THE BRITISH ACAD., 2001, at 265.
Slide 22
CAPABILITIES (cont’d)

Type Nature
ORDINARY (Operational)
CAPABILITIES:
Doing things right (best practices)
SUPER ORDINARY CAPABILITIES:
Beyond best practice for particular
specialized technological
tasks/activities
DYNAMIC CAPABILITIES:
Doing the right things, and figuring out
the next big thing.
Taxonomy of capabilities

Economist Frank Knight very clearly understood that with
uncertainty, dynamic capabilities is the basis of firm level
competitive advantage.
“With uncertainty present, doing things, the actual execution of
activity becomes in a real sense a secondary part of life; the primary
problem or function is deciding what to do and how to do it”
- Frank Knight (1921)
“Companies must be willing and ready to change from doing the right
things too long to the next big thing”
- John Chambers, former CEO, Cisco Systems
Slide 24

The Hyundai Motors story shows that capabilities
often evolve… from ordinary to superordinary
capabilities
From assembling a
Ford Cortina (1967)
to designing &
producing the
Elantra, Sonata,
Grandeur, Genesis,
and Equus (2018),
IONIQ (2024)
Slide 25
• Assembling (and
technology assimilation)
• Imitation assimilation
• Developing
Korean cars under
license
• Imitation
assimilation
• Developing own
designs
(innovation)
Phase 1
~1967-1976
Phase 2
~1973-1994
Phase 3
Today
Phases 1 & 2 involved building ordinary capabilities
Phase 3 involved building dynamic capabilities on top
Phases 1 & 2 are more about competing on price; Phase 3 is about
competing on quality/design/performance (innovation)

Capabilities theory is the portmanteau that allows
concepts from the field of strategic management to
be incorporated into antitrust economics
• Capabilities gives substance to business historian Alfred
Chandler’s “visible hand” of management.
• The visible hand of management complements the invisible hand of the
market.
• Organizational and management capabilities are omitted
variables from the static competition framework but are an
integral part of the dynamic competition framework.
• Merger analysis and assessments of conduct about an
understanding of capabilities are likely to be misguided.
Slide 26

The lack of understanding of capabilities led economists to
predict that entry barriers were high in the automobile
business… then along came Hyundai and Tesla
• Tesla spent only $140 million and $650 million respectively to develop its Roadster
and Model S… Tesla relied heavily on alliances with Lotus, Daimler, and Toyota to
access components and designs. It built capabilities and an ecosystem for
distribution and found partners to install charging stations. Tesla overcame the
supposed network effects that the incumbents enjoyed (e.g., relationship with
distributors)…. they pursued an “open innovation” model to crowd-source new
technology.
• Tesla quickly built capabilities to take on the incumbents and, in the process, blew a
big hole in the conventional wisdom about competition in the automobile industry.
• Tesla and Hyundai are both new entrants that have overcome so called entry barriers
– reminding us that high entry barriers can yield to dynamic competitors
See David J. Teece, Tesla and the Reshaping of the Auto Industry, 14 MGMT.
AND ORG. REV. 501 (2018). Slide 27

The Hyundai Motors story – structural barriers
overcome
Ordinary Capabilities, and then Dynamic Capabilities, were
built by:
Slide 28
Phase 1
Ordinary
Capabilities
Phase 2
Ordinary
Capabilities
Phase 3
Superordinary
and Dynamic
Capabilities
o Independent R&D centers
o Increase in hiring & training of
engineers
o Goal to develop an independent
‘state-of-the-art’ internal
combustion engine (version
launched in 1984 when Hyundai
organized a task force for
developing its own ICE)
o Licensing & technical
assistance (Mitsubishi for
gasoline engines,
transmissions, and rear axle
designs)
o Styling & design from
Italdesign
o Recruiting experts from British
Leyland
o Learning by doing – assembly
for Ford Cortina
o Learning by doing – design
o Observation tours (factory
and facility)

CAPABILITIES MUST PLAY A CENTRAL ROLE
IN ANTITRUST ANALYSIS
• Failure to consider capabilities implies a large omitted variables
problem when considering marketplace evolution and outcomes.
• Cannot understand market positions without understanding capabilities.
• Any assessment of conduct absent an understanding of capabilities is
likely flawed.
• When wedded to a capabilities framework, the dynamic
competition paradigm provides a new lens to understand the
supply side of markets, whether existing markets or future
markets.
Slide 29

Disruption is a dynamic competition
phenomena
Creative destruction / disruption “strikes not at the margins of the profits
and outputs of existing firms but at their foundations” (Schumpeter)
Demand side disruption:
Clay Christensen and others
Supply side disruption:
Abernathy and Clark; Henderson and Clark and others
Slide 30
Not all innovation is disruptive. Competency
enhancing / and complementary innovation is
not but it’s still procompetitive

Christensen’s model of disruption
Slide 31

Procompetitive justification for mergers look more
compelling if architectural / systemic innovation is at
issue
• Assembling all the components and subsystems required to
effectuate architectural / systemic innovation is a Herculean tool.
• Blocking acquisitions required to effectuate such combinations
will likely harm competition.
• It’s easy for an enforcer in a static mindset to find issue with a
mergers (e.g. Meta – Giphy) decision by the UK competition
authorities and courts makes them look foolish. Giphy’s
capabilities were nonexistent.
Slide 32

Innovation markets, future markets, and
innovation spaces: GM / ZF case
• DOJ argued that the parties competed in a market in which
“innovation” itself was the market.
• Yet there were no transactions in the DOJ innovation market.
• Gilbert and Sunshine were struggling because they did not have a
capabilities framework in their tool kit.
• What the DOJ might have pleaded was that GM and ZF had unique
superordinary capabilities in heavy duty automatic gear boxes,
and that a merger would lead to monopoly control over certain
superordinary capabilities. A kinda essential facilities argument
was embedded in their thinking?
Slide 33

Innovation spaces and the EU’s Dow Dupont
decision
• These EC concepts are very similar to Gilbert and Sunshine concepts, but
they likewise fall flat without reference to a capabilities framework of some
kind.
• Innovation Spaces asks: who will be free (and able) to compete in the future
• This is really a question about capabilities.
• Capabilities are usually more widely distributed than most people think… particularly if
you look internationally.
• Example: cloud computing: who would have thought to consider Amazon a potential
entrant into a marketplace that IBM, Microsoft, and Oracle would be more obvious
contenders?
• Innovation spaces perhaps tractable in pharma and pesticides. Linear model of
innovation is likely only applicable in highly regulated markets.
• Future Markets: to figure out who might compete one must look at
capabilities.
Slide 34

Should acquisition of nascent competitors be
blocked?
• There are ways to assess the capabilities of a nascent technology
enterprise. The likelihood of viability is higher with the crossing of three
thresholds.
• “Proof of principle.” Has the technology been proven to work?
• “Viable business model.” Has value creation, value delivery (to the
user/customer), and value capture (bottom hire profitability) evident, even if not
just yet achieved?
• Scalability. Is the business ready and able to be scaled?
• Competition agencies can subpoena venture capitalists who fund
nascent enterprises as points 1-3 are likely a part of the VCs due
diligence exercise.
• Failure to access VC money is a good indication that a putative new
entrant isn’t viable [e.g. Giphy/Facebook].
Slide 35

Conclusion
• Padilla et al’s recognition of a dynamic competition “school” is both
salutary and significant.
• Scaffolding in place but much more development needed and it will require
interdisciplinary engagement of economists and organizational theorists.
• Brings with it a rebirth of the supply side analysis
• Dynamic competition has already been bastardized before it’s out the
gate… as enforcement authorities have used it to concoct new theories
of harm and ignored new theories of benefits.
• This lopsided evolution will impair antitrust policy…and contribute further to
Europe’s digital winter.
• EU sees anticompetitive effect as tangible and predictable while pro-
competitor arguments are labelled speculative.
Slide 36
There is an urgent need to adopt a dynamic competition
perspective and apply it correctly in an evenhanded manner.

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