Positioning firms along the capabilities ladder

A major challenge for innovation scholars is the measurement of capabilities. We develop and apply a novel methodology for quantifying the capability development of firms, where capabilities are measured in terms of expenditures on specific activities. These activities can be sorted in a hierarchy of increasing difficulty, and firms can be sorted according to their positions on the capabilities ladder. Our nestedness algorithm, inspired by biology and network science, defines an activity as complex if it is performed by only a few firms at the upper rungs of the ladder. We analyze company annual reports of almost 45,000 Indian firms for the time period 2000–2020, and observe significant nestedness. Lower rungs of the capabilities ladder correspond to basic managerial and production activities. Mid-level rungs correspond to internationalization and acquiring absorptive capacity. Higher-level rungs are more related to Mergers & Acquisitions (M&A) and innovation. Information and Communication Technology (ICT) capabilities seem to have become more fundamental lower-level rungs on the capabilities ladder in recent years. There is a close relationship between size and capabilities for small firms, but this weakens for larger firms. Some heterogeneity is observed across industrial sectors and across regions. We find that capability ranking can explain future growth patterns and survival probability of firms, summing up in one number their future potential trajectories.