Firms with strong dynamic capabilities are resilient and can successfully navigate unexpected events with minimal disruption, rather than resorting to crisis management. For example, there is evidence that firms with stronger dynamic capabilities were more resilient during the Global Financial Crisis. 

We analysed the link between dynamic capabilities and innovation during the pandemic, a recent period of deep uncertainty. We found that, all else equal, firms with stronger dynamic capabilities were more innovative in the first few months of COVID-19.

The most dynamic 25 per cent of firms also undertook more innovation in the wake of COVID-19 than the least dynamic 25 per cent of firms across all areas of innovation in the survey.

The most dynamic firms were better able to adapt and innovate in the highly uncertain COVID-19 environment. Sensing was particularly useful early in the pandemic, while transforming was most valuable across multiple forms of innovation. Given that transforming is a weakness for most Australian firms, lifting capabilities in this area could help to improve innovation.

We also found that firms with stronger dynamic capabilities performed better in the wake of the COVID-19 pandemic, especially from June 2020 onwards. This suggests that the innovations made early in the pandemic set firms up for success later on, and that dynamic capabilities were crucial in adapting to this shock. 

All else equal, firms with higher scores had significantly better customer, financial and employee-related performance after June 2020. They also had significantly better employee-related performance in the first few months of COVID-19. Employee-related performance was measured across a range of metrics, including number of employees, as well as implementation of strategies to reduce employee turnover, and improve staff skills, satisfaction and commitment. 

Some firms had stronger dynamic capabilities than others, but almost all had room for improvement. Firms scored across the full range of possible outcomes (from an average response of 1 or “strongly disagree” to 6 or “strongly agree”) but were clustered around 4 to 5 (“slightly agree” to “agree”), with a mean score of 4.6. Almost 60 per cent of firms scored above the mean.

Within each category, differences between firms were also significant. The top 25 per cent of firms in each category had an average score of around 5.0 to 5.4 (“agree” or a bit higher). This was 1 point higher than the bottom 25 per cent in each category, which had an average score of around 4.0 to 4.6 (“slightly agree” or a bit higher). These differences point to considerable room for improvement and learning. 

Transforming is hard. Firms must focus their efforts here. Previous research has shown almost one in three Australian CEOs believe their company won’t exist 10 years from now if they continue down the same path. The things that make a business successful today make it more difficult to change for tomorrow. 

Business leaders are often reluctant to take assets and capabilities from an existing part of the business to grow a new part of the business, but ultimately this can be their downfall. Transforming requires managers to be bold and take smart risks to build competitive advantage.

 

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Slack & agility was the enabler with the strongest relationship to dynamic capabilities. This is about firms having access to labour and financial resources that are not tied up in “business as usual” to build competencies and pursue longer-term opportunities as they arise. Slack & agility is an important enabler for all three capabilities, but particularly for transforming. 

Being willing to cannibalise, or to scale up new areas of the business at the expense of existing sources of revenue, is particularly important for seizing new opportunities. Experts agree this is where a lot of firms fall short. Our results confirm this is very difficult for businesses to do. 

Scanning the environment is particularly important for identifying new opportunities and threats. The weakest score in the scanning category was on effective engagement with researchers at universities. There has been a lot of focus on the relationship between businesses and universities in recent years, particularly through the Federal Government’s University Research Commercialisation Action Plan. Previous CEDA research identified collaboration between industry, academia and government as a key barrier to unlocking our innovation potential. Our results support this ambition.

Tolerance for failure is important for transforming capabilities. Firms scored relatively highly on this enabler, which is at odds with the common narrative of a growing culture of risk aversion among Australian businesses. At face value, this result suggests that risk aversion is not currently our biggest impediment, at least from a dynamic capabilities perspective. 

Greater diversity within firms can help foster dynamic capabilities. Leaders’ experience is instrumental in setting firm strategy, structure and processes, which are all crucial for providing an environment in which dynamic capabilities are developed and maintained.

We found that firms with stronger dynamic capabilities had more diverse boards. Specifically, 81 per cent of top performing companies with a board had at least one director that was female, at least one that had science and technology expertise and at least one with international experience, compared with just 26 per cent of the weakest firms.

All three of these categories of diversity (female, science/technology experience and international experience) were related to a company’s sensing abilities. Having gender and professional diversity on their board was also related to a company’s ability to transform.  

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Both small and large businesses are vital to Australia’s economic success. Most businesses in the Australian economy are small-to-medium-sized enterprises (SMEs), making them the drivers of employment and productivity growth, while larger firms have a bigger impact on business investment. Dynamic capabilities are relevant to firms of all sizes, though particularly when management is shared across a team.

On average, larger businesses (with at least 200 full-time equivalent employees) had stronger dynamic capabilities than SMEs (average score of 4.8 versus 4.4). Similarly, national firms (operating across all states and territories) scored higher than firms operating in a single state or territory (4.8 versus 4.5).

The industries with the highest average scores were finance & insurance services and mining. This is consistent with Australian research on ordinary capabilities in which finance & insurance services and mining were among the industries with the highest share of firms in the top level of strategic management. 

In contrast, the weakest average score was for the production & distribution industry group, which includes manufacturing; construction; transport, postal & warehousing; wholesale trade and retail trade. Again, this is broadly consistent with the Australian research on ordinary capabilities showing manufacturing, construction, and transport, postal & warehousing were among the lowest tiers of strategic management capability.