1. ¹Centre for International Business and Management (CIBAM), Judge Business School, University of Cambridge, Cambridge, UK
2. ²Institute of Management, Innovation and Organization, Haas School of Business, University of California, Berkeley, California, USA

Correspondence: David J Teece, Institute of Management, Innovation and Organization, Haas School of Business, University of California, Berkeley, CA 94720, USA. Tel: +1 (510) 642-1075; Fax: +1 (510) 642-2826; E-mail: teece@haas.berkeley.edu

Abstract

Extant explanations of the nature and scope of firms, such as transaction costs, property rights, metering and 'resources' can be integrated into a more general (capability-based) theory of the nature and essence of the firm that recognizes the importance to the firm of creating (and capturing) value from innovation. We note that the appropriability of returns from creative and innovative activity often requires the entrepreneurial creation and co-creation of markets. Accordingly, market failure and transaction costs approaches need to be revamped to capture the essence of entrepreneurial and managerial activity that extends beyond the mere exercise of authority. We suggest that the nature and objective of the firm in an economy with innovation and incomplete markets is to capture value (profit) from its advantages and actions; and that the way in which the firm tries to achieve this (by establishing quasi-sustainable competitive advantage) is its essence. This is non-separable from its nature and objectives. It often involves market co-creation.