Chapter 3

Examining the Internal Context

of Strategy

OBJECTIVES

Explain the internal context of strategy

Identify a firms resources and capabilities and explain

their role in its performance

Define dynamic capabilities and explain their role in both

strategic change and a firms performance

Explain how valuechain activities are related to firm

performance and competitive advantage

Explain the role of managers with respect to resources,

capabilities, and valuechain activities

COMPARATIVE INDUSTRY REFORMANCE

ROA

Global Auto

Semiconductor

ROS

Grocery Store

How do
such differences
in profitability
materialize?

TWO THEORIES FOR HOW AND WHY SOME FIRMS PERFORM BETTER THAN
OTHERS

A firms resources and capabilities determine performance

A firms activities determine

performance

Success issues from fundamental

differences in what firms
own and what they can do

Success is driven by a firms

value chain activities:
How it configures these
activities to add more value
than competitors

RESOURCES, CAPABILITIES, AND MANAGERIAL DECISIONS

Resources
Managers

Strategy
Management
strategic
decision making

Competitive
advantage/
disadvantag
e

Performance

Capabilities

RESOURCES AND CAPABILITIES: FUNDAMENTAL BUILDING

BLOCKS OF STRATEGY

Strategy

Resou
rces

The inputs that firms use to create goods

and services
Undifferentiated or firms-specific
Tangible or intangible
Easy to acquire or difficult

ie s
t
i
l
i
b
a
Cap
cies
n
e
t
e
(comp
)

A firms skill in using its resources

to create goods and services.
The combination of procedures
and expertise that the firm relies
on to engage in distinct activities
in the process of producing goods
and services

EXAMPLES OF CAPABILITIES
Company

Capability

Result

Logistics -- distributing vast amounts of

goods quickly and efficiently to remote
locations

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 technological leadership and economies of scale

25,000-percent return to share-holders

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

Generating new ideas then turning those

ideas into new, profitable products

30 percent of revenue from products

introduced within the past four years

1: Stalk, Evans, and Shulman, 1992

2: Makadok, 2003

THE VRINE MODEL

Test

Competitive implication

Performance implication

Valuable?

Does the resource or capability allow the

firm to meet a market demand or protect
the firm from market uncertainties?

If so, it satisfies the value require-ment.

Valuable resources are needed just to
compete in the indus-try, but value by
itself does not convey an advantage

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)

Rare?

Assuming the resource or capability is

valuable, is it scarce relative to demand?
Or, is it widely possessed by most
competitors?

Valuable resources which are also rare

convey a competitive advantage, but its relative permanence
is not assured. The advantage is likely
only temporary

A temporary competitive advantage

conveys the potential to achieve above
normal profits, at least until the
competitive advantage is nullified by other
firms

Inimitable
and nonsubstitutable?

Assuming a valuable and rare resource,

how difficult is it for com-petitors to either
imitate the resource or capability or
substitute for it with other resources and
capabilities that accomplish similar
benefits?

Valuable resources and capabilities

which are difficult to imitate or substitute
provide the potential for sustained
competitive advantage

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)

Exploitable?

For each step of the preceding steps

Resources and capabilities that
Firms which control unexploited VRINE
of the VRINE test, can the firm actually
satisfy the VRINE requirements but
resources and capabilities generally
exploit the resources and capabilities that itwhich the firm is unable to exploit
suffer from lower levels of financial
owns or controls?
actually result in significant opportuperformance and depressed market
nity costs (other firms would likely
valuations relative to what they would
pay large sums to purchase the
otherwise enjoy (though not as
VRINE resources and capabilities).
depressed as firms lacking resources and
Alternatively, exploitability unlocks
capabilities which do satisfy VRINE)
the potential competitive and perfor-mance
implications of the resource
or capability

THE VRINE MODEL: VALUE

Example
Union Pacific Railroads rail system is a
tangible resource that allows UP to compete
with other carriers in the long-haul
transportation of a variety of goods
Definition
Value: A resource or
capability is valuable if it
allows a firm to take
advantage of
opportunities or to fend
off threats in its
environment

Maintain an extensive network of rail-line property and

equipment on the U.S. Gulf cost

Operates in the western two-third of the United States

serving 23 states, linking every major West Coast and
Gulf Coast port, and reaching east through major
gateways in Chicago, St.Louis, Memphis, and New
Orleans

Also operates in key north-south corridors

The only U.S. railroad serving all six gateways to Mexico
Interchanges traffic with Canadian rail systems

THE VRINE MODEL: RARITY

Example
When McDonalds signs an agreement to
build a restaurant inside a Wal-Mart store, it
has an intangible advantage over Burger
King that is valuable and rare
Definition
A useful resource or
capability that is scarce
relative to demand.
Valuable resources that
are available to most
competitors (i.e., that
are not rare) simply
allow firms to achieve
parity

10

THE VRINE MODEL: INIMITABILITY AND NON-SUBSTITUTABILITY

Example
Barnes & Nobles large store network gave it
access to customers and purchasing power
that was inimitable
Definition

A resource or capability is inimitable if

competitors cannot acquire the

valuable and rare resource quickly, or
face a disadvantage in doing so
It is non-substitutable if
a competitor cannot achieve the same
benefit using different combinations of
resources and capabilities

but Amazon.com
found a substitute

11

TANGIBLE AND INTANGIBLE ADVANTAGES

Intangible

Tangible

Location
selection

Brand

Rural realestate
High traffic
real-estate

Wal-Mart

McDonalds

12

THE VRINE MODEL: EXPLOITABLITY

Example

Definition
A resource of capability
that the organization
has the capability to
exploit (i.e., the
capability to generate
value from)

Novell: I walk down Novell hallways and

marvel at the incredible potential for
innovation here, but Novell has had a difficult
time in the past turning innovation into
product in the market place
- CEO Eric Schmidt
Xerox: Xerox invented the laser printer,
Ethernet, graphical-interface software and
computer mouse but could not capitalize on
these

13

HOW WOULD YOU DO THAT?

Valuable?

Do patents on Zoloft
provide value?

Rare?

Do Pfizer's patents
provide rarity?

Pfizers
Zoloft
Inimitable and
Can competitors imitate?
non-substitutable? Can they substitute?

Exploitable?

Can Pfizer
exploit?

14

STOCK AND FLOW OF CAPABILITIES

Capability

Flow

Stock

15

DYNAMIC CAPABILITIES

Start-up plans

Mail Boxes Etc. franchise

People
Brand

Value

Location
Processes

Dynamic capability:
how we integrate reconfigure, acquire, or divest
resources for competitive
advantage?

Mail boxes, etc.,

has developed
the ability to
combine
resources better
than the
competition

16

VALUE CHAIN: INTERNET STARTUP EXAMPLE

Firm
Infrastructure
Support
Activities

Financing, legal support, accounting

Recruiting, training, incentive system, employee
feedback

Human
Resources
Technology
Development

Inventory
system

Site
software

Procurement

CDs
Shipping

Computers
Telecom lines

Inbound
shipment of
top titles

Server
operations

Warehousing

Billing
Collections

Inbound
Logistics

Operations

Pick & pack

procedures
Shipping
services
Picking and
shipment of top
titles from
warehouse
Shipment of other
titles from thirdparty distributors

Site look & feel

Return
Customer research procedures
Media
Pricing
Promotions
Advertising

Returned items
Customer
feedback

Product
information and
reviews
Affiliations with
other websites

Outbound
Logistics

Marketing
& Sales

After-Sales
Service

Primary Activities

17

USING VALUE CHAINS TO GAIN COMPETITIVE ADVANTAGE

Identical

Differentiated

Find a different
way to perform
activities

Find a better way

to perform the
same activities

Longerlasting
advantage

Shorter-term
advantage
(competitor
s catch up)

18

TRADE OFF PROTECTION YOUR RIVALS CHOOSE NOT TO COPY YOU

Selected difference between Southwest and large Airlines

Southwest

Major Airlines

Technology
and design

Single aircraft

Multiple types of

Operations

Short segment flights

Smaller markets and secondary

aircrafts

airports in major markets

No baggage transfers to others

airlines

No meals
Single class of service
No seat assignments
Marketing

Limited use of travel agents

Word of mouth

Hub and spoke

system

Meals
Seat assignments
Multiple classes of
service

Baggage transfer to
other airlines

Extensive use of
travel agents

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

19

RESULTS OF TRADE OFF PROTECTION

Airline

2004 Revenue
($000,000)

2004 Cost of Available

Seat Miles (CASM)

AirTran

279

8.42

Alaska

656

10.03

4,541

9.72

579

7.81

Continental

2,397

9.49

Delta

3,641

10.23

334

6.03

Northwest

2,753

10.31

Southwest

1,655

7.77

United

3,988

10.16

US Air

1,660

11.34

American
AmericaWest

JetBlue

20

INNOVATION AND INTEGRATION OF THE VALUE CHAIN

Area of innovation
So
u

rc
e

As
se
m

bl
e

De

liv
er

IKEA Transferred assembly and

delivery to the consumer

Dell

Choose an entirely direct distribution

model (rather than through retailers)
and outsourced component
manufacturing

21

STRATEGIC LEADERSHIP

Companies that overlook the role of leadership in

the early phases of strategic planning often find
themselves scrambling when its time to execute.
No matter how thorough the plan, with-out the right
leaders it is unlikely to succeed
McKinsey & Company

22

SENIOR VS. MIDDLE MANAGERS

Decide how to use other

resources and capabilities,
configure their firms valueSenior chain activities, and set the
context which determines
how front-line and middle
managers can add value
Are better positioned than
senior managers to
contribute to competitive
Middle advantage and firm success
in four areas
Entrepreneurship
Communications
Psychoanalyst
Tightrope walker
Source: Quy Nguyen Huy

23

SUMMARY

Explain the internal context of strategy

Identify a firms resources and capabilities and explain their role in its
performance

Define dynamic capabilities and explain their role in both strategic

change and a firms performance

Understand how valuechain activities are related to firm performance

and competitive advantage

Explain the role of managers with respect to resources, capabilities, and

valuechain activities

24

BLANK SLIDE

25