Evaluating the Internal Environment

Key Questions in Situation Analysis

Question 1: How well is the companys strategy working?
Question 2: What are the companys resource strengths and weaknesses and its external opportunities and threats? Question 3: Are the companys prices and costs competitive?

Question 4: Is the company competitively stronger or weaker than key rivals?

Question 5: What strategic issues and problems merit front-burner managerial attention?

Competitive Advantage
Firms achieve strategic competitiveness and earn above-average returns when their core competencies are effectively
Acquired Bundled Leveraged

Over time, the benefits of any value-creating strategy can be duplicated by competitors

Competitive Advantage (contd)

Sustainability of a competitive advantage is a function of
The rate of core competence obsolescence due to environmental changes The availability of substitutes for the core competence The difficulty competitors have in duplicating or imitating the core competence

Generic Building Blocks of Competitive Advantage

Outcomes from External and Internal Environmental Analyses

Examine opportunities and threats

Examine unique resources, capabilities, and competencies (sustainable competitive advantage)

The Context of Internal Analysis

Effective analysis of a firms internal environment (learning what the firm can do ) requires:
Fostering an organizational setting in which experimentation and learning are expected and promoted Using a global mind-set Thinking of the firm as a bundle of heterogeneous resources and capabilities that can be used to create an exclusive market position

Creating Value
By exploiting their core competencies or competitive advantages, firms create value Value is measured by
A products performance characteristics

The products attributes for which customers are willing to pay

Firms create value by innovatively bundling and leveraging their resources and capabilities

Creating Competitive Advantage

Core competencies, in combination with product-market positions, are the firms most important sources of competitive advantage Core competencies of a firm, in addition to its analysis of its general, industry, and competitor environments, should drive its selection of strategies

The Challenge of Internal Analysis

Strategic decisions in terms of the firms resources, capabilities, and core competencies
Are non-routine Have ethical implications Significantly influence the firms ability to earn above-average returns

The Challenge of Internal Analysis (contd)

To develop and use core competencies, managers must have
Courage Self-confidence Integrity The capacity to deal with uncertainty and complexity A willingness to hold people (and themselves) accountable for their work

Conditions Affecting Managerial Decisions about Resources, Capabilities and Core Competencies

Resources, Capabilities and Core Competencies Resources

Are the source of a firms capabilities Are broad in scope Cover a spectrum of individual, social and organizational phenomena Alone, do not yield a competitive advantage

Resources, Capabilities and Core Competencies Resources

Are a firms assets, including people and the value of its brand name Represent inputs into a firms production process, such as:
Capital equipment Skills of employees Brand names Financial resources Talented managers

Resources, Capabilities and Core Competencies Resources

Tangible resources

Financial resources Physical resources Technological resources

Organizational resources
Human resources innovation resources Reputation resources

Intangible resources

Tangible Resources
Financial Resources The firms borrowing capacity The firms ability to generate internal funds The firms formal reporting structure and its formal planning, controlling, and coordinating systems

Organizational Resources

Physical Resources

Sophistication and location of a firms plant and equipment Access to raw materials
Stock of technology, such as patents, trademarks, copyrights, and trade secrets

Technological Resources

Intangible Resources
Human Resources Knowledge Trust Managerial capabilities Organizational routines

Innovation Resources

Ideas Scientific capabilities Capacity to innovate Reputation with customers Brand name Perceptions of product quality, durability, and reliability Reputation with suppliers For efficient, effective, supportive, and mutually beneficial interactions and relationships

Reputational Resources

Resources, Capabilities and Core Competencies Capabilities

Are the firms capacity to deploy resources that have been purposely integrated to achieve a desired end state Emerge over time through complex interactions among tangible and intangible resources Often are based on developing, carrying and exchanging information and knowledge through the firms human capital

Resources, Capabilities and Core Competencies Capabilities

The foundation of many capabilities lies in:
The unique skills and knowledge of a firms employees The functional expertise of those employees

Capabilities are often developed in specific functional areas or as part of a functional area

Examples of Firms Capabilities

Copyright 2004 South-Western. All rights reserved.

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EXAMPLES OF CAPABILITIES
Company Capability Logistics -- distributing vast amounts of goods quickly and efficiently to remote locations Result 200,000-percent return to shareholders during first 30 years since IPO1

An extraordinarily frugal system for delivering the lowest cost structure in the mutual fund industry, using both techno-logical leadership and economies of scale

25,000-percent return to shareholders during the 30-plus year tenure of CEO John Connelly.2 As for ongoing expenses, shareholders in Vanguard equity funds pay, on average, just $30 per $10,000, vs. a $159 industry average. With bond funds, the bite is just $17 per $10,000 30 percent of revenue from products introduced within the past four years

Generating new ideas then turning those ideas into new, profitable products

THE VRINE MODEL

Test
Valuable? Does the resource or capability allow the firm to meet a market demand or protect the firm from market uncertainties?
Rare? Assuming the resource or capability is valuable, is it scarce relative to demand? Or, is it widely possessed by most competitors? Assuming a valuable and rare resource, how difficult is it for competitors to either imitate the resource or capability or substitute for it with other resources and capabilities that accomplish similar benefits?

Competitive implication
If so, it satisfies the value requirement. Valuable resources are needed just to compete in the industry, but value by itself does not convey an advantage
Valuable resources which are also rare convey a competitive advantage, but its relative permanence is not assured. The advantage is likely only temporary Valuable resources and capabilities which are difficult to imitate or substitute provide the potential for sustained competitive advantage

Performance implication
Valuable resources and capabilities convey the potential to achieve normal profits (i.e., profits which cover the cost of all inputs including the cost of capital)
A temporary competitive advantage conveys the potential to achieve above normal profits, at least until the competitive advantage is nullified by other firms A sustained competitive advantage conveys the potential to achieve above normal profits for extended periods of time (until competitors eventually find ways to imitate or substitute or the environment changes in ways that nullify the value of the resources)

Inimitable and nonsubstitutable?

Exploitable?

For each step of the preceding steps of the VRINE test, can the firm actually exploit the resources and capabilities that it owns or controls?

Resources and capabilities that satisfy the VRINE requirements but which the firm is unable to exploit actually result in significant opportunity costs (other firms would likely pay large sums to purchase the VRINE resources and capabilities). Alternatively, exploitability unlocks the potential competitive and performance implications of the resource or capability

Firms which control unexploited VRINE resources and capabilities generally suffer from lower levels of financial performance and depressed market valuations relative to what they would otherwise enjoy (though not as depressed as firms lacking resources and capabilities which do satisfy VRINE)

Resources, Capabilities and Core Competencies Core Competencies

Resources and capabilities that serve as a source of a firms competitive advantage:

Distinguish a company competitively and reflect its personality Emerge over time through an organizational process of accumulating and learning how to deploy different resources and capabilities

Resources, Capabilities and Core Competencies Core Competencies

Activities that a firm performs especially well compared to competitors Activities through which the firm adds unique value to its goods or services over a long period of time

Building Sustainable Competitive Advantage

Four Criteria of Sustainable Competitive Advantage
Valuable Rare Costly to imitate Nonsubstituable

The Four Criteria of Sustainable Competitive Advantage

Valuable Capabilities Help a firm neutralize threats or exploit opportunities Are not possessed by many others Historical: A unique and a valuable organizational culture or brand name Ambiguous cause: The causes and uses of a competence are unclear Social complexity: Interpersonal relationships, trust, and friendship among managers, suppliers, and customers

Rare Capabilities Costly-to-Imitate Capabilities

Nonsubstitutable Capabilities No strategic equivalent

Building Sustainable Competitive Advantage

Valuable capabilities
Help a firm neutralize threats or exploit opportunities

Rare capabilities
Are not possessed by many others

Building Sustainable Competitive Advantage

Costly-to-Imitate Capabilities
Historical

A unique and a valuable organizational culture or brand name The causes and uses of a competence are unclear (causal ambiguity) Interpersonal relationships, trust, and friendship among managers, suppliers, and customers

Ambiguous cause

Social complexity

Building Sustainable Competitive Advantage

Nonsubstitutable Capabilities
No strategic equivalent

THE VRINE MODEL

Test
Valuable? Does the resource or capability allow the firm to meet a market demand or protect the firm from market uncertainties?
Rare? Assuming the resource or capability is valuable, is it scarce relative to demand? Or, is it widely possessed by most competitors? Assuming a valuable and rare resource, how difficult is it for competitors to either imitate the resource or capability or substitute for it with other resources and capabilities that accomplish similar benefits?

Competitive implication
If so, it satisfies the value requirement. Valuable resources are needed just to compete in the industry, but value by itself does not convey an advantage
Valuable resources which are also rare convey a competitive advantage, but its relative permanence is not assured. The advantage is likely only temporary Valuable resources and capabilities which are difficult to imitate or substitute provide the potential for sustained competitive advantage

Performance implication
Valuable resources and capabilities convey the potential to achieve normal profits (i.e., profits which cover the cost of all inputs including the cost of capital)
A temporary competitive advantage conveys the potential to achieve above normal profits, at least until the competitive advantage is nullified by other firms A sustained competitive advantage conveys the potential to achieve above normal profits for extended periods of time (until competitors eventually find ways to imitate or substitute or the environment changes in ways that nullify the value of the resources)

Inimitable and nonsubstitutable?

Exploitable?

For each step of the preceding steps of the VRINE test, can the firm actually exploit the resources and capabilities that it owns or controls?

Resources and capabilities that satisfy the VRINE requirements but which the firm is unable to exploit actually result in significant opportunity costs (other firms would likely pay large sums to purchase the VRINE resources and capabilities). Alternatively, exploitability unlocks the potential competitive and performance implications of the resource or capability

Firms which control unexploited VRINE resources and capabilities generally suffer from lower levels of financial performance and depressed market valuations relative to what they would otherwise enjoy (though not as depressed as firms lacking resources and capabilities which do satisfy VRINE)

The Companys Strengths, Weaknesses, Opportunities and Threats

S W O T represents the first letter in Strengths Weaknesses Opportunities Threats For a companys strategy to be wellconceived, it must be
Matched to its resource strengths and weaknesses Aimed at capturing its best market opportunities and defending against external threats to its well-being

Identifying Resource Strengths and Competitive Capabilities

Common types of resource strengths include
Skills or specialized expertise in a competitively important capability Valuable physical assets

Valuable human assets or intellectual capital Valuable organizational assets Valuable intangible assets Competitively valuable alliances or cooperative ventures

Identifying Resource Weaknesses and Competitive Deficiencies

A weakness is something a firm lacks, does poorly, or a condition placing it at a disadvantage in the marketplace Resource weaknesses relate to
Inferior or unproven skills, expertise, or intellectual capital Deficiencies in competitively important physical, organizational, or intangible assets

Missing or competitive inferior capabilities in key areas

Identifying a Companys Market Opportunities

Opportunities most relevant to a company are those offering Good match with its financial and organizational resource capabilities Best prospects for growth and profitability Most potential for competitive advantage

Identifying External Threats to Profitability and Competitiveness

Emergence of cheaper/better technologies Introduction of better products by rivals Entry of lower-cost foreign competitors Onerous regulations

Rise in interest rates Potential of a hostile takeover Unfavorable demographic shifts Adverse shifts in foreign exchange rates Political upheaval in a country

Value Chain Analysis

Allows the firm to understand the parts of its operations that create value and those that do not A template that firms use to:
Understand their cost position
Identify multiple means that might be used to facilitate implementation of a chosen businesslevel strategy

Value Chain Analysis (contd)

Primary activities involved with:
A products physical creation A products sale and distribution to buyers The products service after the sale

Support activities
Provide the support necessary for the primary activities to take place

Value Chain Analysis (contd)

Value chain
Shows how a product moves from raw-material stage to the final customer

To be a source of competitive advantage, a resource or capability must allow the firm:

To perform an activity in a manner that is superior to the way competitors perform it, or To perform a value-creating activity that competitors cannot complete

The Basic Value Chain

Human Resource Management

Technological Development

Service Marketing and Sales Outbound Logistics Operations Inbound Logistics

Firm Infrastructure

Procurement

The Value-Creating Potential of Primary Activities

Inbound logistics
Activities used to receive, store, and disseminate inputs to a product (materials handling, warehousing, inventory control, etc.)

Operations
Activities necessary to convert the inputs provided by inbound logistics into final product form (machining, packaging, assembly, etc.)

Outbound logistics
Activities involved with collecting, storing, and physically distributing the product to customers (finished goods warehousing, order processing, etc.)

The Value-Creating Potential of Primary Activities (contd)

Marketing and sales
Activities completed to provide means through which customers can purchase products and to induce them to do so (advertising, promotion, distribution channels, etc.)

Service
Activities designed to enhance or maintain a products value (repair, training, adjustment, etc.)

Each activity should be examined relative to competitors abilities and rated as superior, equivalent or inferior

The Value-Creating Potential of Primary Activities: Support

Procurement
Activities completed to purchase the inputs needed to produce a firms products (raw materials and supplies, machines, laboratory equipment, etc.)

Technological development
Activities completed to improve a firms product and the processes used to manufacture it (process equipment, basic research, product design, etc)

Human resource management

Activities involved with recruiting, hiring, training, developing, and compensating all personnel

The Value-Creating Potential of Primary Activities: Support (contd)

Firm infrastructure
Activities that support the work of the entire value chain (general management, planning, finance, accounting, legal, government relations, etc.)

Effectively and consistently identify external opportunities and threats Identify resources and capabilities Support core competencies

Each activity should be examined relative to competitors abilities and rated as superior, equivalent or inferior

Selected difference between Southwest and large Airlines

Southwest Technology and design Operations Major Airlines

Single aircraft

Multiple types of
aircrafts

Short segment flights Smaller markets and secondary

airports in major markets

Hub and spoke

system

No baggage transfers to others

airlines

No meals Single class of service No seat assignments

Meals Seat assignments Multiple classes of

service

Baggage transfer to
other airlines

Southwest made choices so that competitors did not copy - because copying would require them to abandon activities essential to their strategies

Marketing

Limited use of travel agents Word of mouth

Extensive use of
travel agents

Outsourcing
The purchase of a value-creating activity from an external supplier
Few organizations possess the resources and capabilities required to achieve competitive superiority in all primary and support activities

By forming and emphasizing fewer capabilities

A firm can concentrate on those areas in which it can create value Specialty suppliers can perform outsourced capabilities more efficiently

Outsourcing Decisions
A firm may outsource all or only part of one or more primary and/or support activities.
Firm Infrastructure

Human Resource Management

Outsourced activity

Technological Development

Service Marketing and Sales Outbound Logistics Operations Inbound Logistics

Procurement

Strategic Rationales for Outsourcing

Improve business focus
Lets a company focus on broader business issues by having outside experts handle various operational details

Provide access to world-class capabilities

The specialized resources of outsourcing providers makes world-class capabilities available to firms in a wide range of applications

Strategic Rationales for Outsourcing (contd)

Accelerate business re-engineering benefits
Achieves re-engineering benefits more quickly by having outsiderswho have already achieved world-class standardstake over process

Sharing risks
Reduces investment requirements and makes firm more flexible, dynamic and better able to adapt to changing opportunities

Frees resources for other purposes

Redirects efforts from non-core activities toward those that serve customers more effectively

Outsourcing Issues
Greatest value
Outsource only to firms possessing a core competence in terms of performing the primary or supporting the outsourced activity

Evaluating resources and capabilities

Do not outsource activities in which the firm itself can create and capture value

Environmental threats and ongoing tasks

Do not outsource primary and support activities that are used to neutralize environmental threats or to complete necessary ongoing organizational tasks

Outsourcing Issues (contd)

Nonstrategic team of resources
Do not outsource capabilities that are critical to the firms success, even though the capabilities are not actual sources of competitive advantage

Firms knowledge base

Do not outsource activities that stimulate the development of new capabilities and competencies

Cautions and Reminders

Never take for granted that core competencies will continue to provide a source of competitive advantage All core competencies have the potential to become core rigidities Core rigidities are former core competencies that now generate inertia and stifle innovation Determining what the firm can do through continuous and effective analyses of its internal environment increases the likelihood of long-term competitive success

Cautions and Reminders (contd)

Determining what the firm can do through continuous and effective analyses of its internal environment increase the likelihood of long-term competitive success