Chapter 3 Examining the Internal Context of Strategy

OBJECTIVES 1 2 3 4 5 Explain the internal context of strategy Identify a firm’s resources and capabilities and explain their role in its performance 2 Define dynamic capabilities and explain their role in both strategic change and a firm’s performance 3 Explain how value‑chain activities are related to firm performance and competitive advantage 4 Explain the role of managers with respect to resources, capabilities, and value‑chain activities 5

COMPARATIVE INDUSTRY REFORMANCE ROA Semiconductor Global Auto ROS Grocery Store How do such differences in profitability materialize?

TWO THEORIES FOR HOW AND WHY SOME FIRMS PERFORM BETTER THAN OTHERS Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung A firm’s resources and capabi- lities determine performance A firm’s activities determine performance Success issues from fundamental differences in what firms own and what they can do Success is driven by a firm’s value chain activities: How it configures these activities to add more value than competitors

RESOURCES, CAPABILITIES, AND MANAGERIAL DECISIONS Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Resources Managers Competitive advantage/ disadvantage Strategy Performance Management strategic decision making Capabilities

RESOURCES AND CAPABILITIES: FUNDAMENTAL BUILDING BLOCKS OF STRATEGY Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Strategy Capabilities (competencies) Resources The inputs that firms use to create goods and services Undifferentiated or firms-specific Tangible or intangible Easy to acquire or difficult A firm’s 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 Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Company Capability Result Logistics -- distributing vast amounts of goods quickly and efficiently to remote locations 200,000-percent return to share-holders 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 share-holders during the 30-plus year tenure of CEO John Connelly.2 As for ongoing expenses, share-holders 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 advant- age, 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 non- substitut- able? 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) Exploit- able? 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 opportu- nity costs (other firms would likely pay large sums to purchase the VRINE resources and capabilities). Alternatively, exploitability unlocks the potential competitive and perfor-mance 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 VRINE MODEL: VALUE Example Union Pacific Railroad’s 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 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 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

THE VRINE MODEL: RARITY Example When McDonald’s 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

THE VRINE MODEL: INIMITABILITY AND NON-SUBSTITUTABILITY Example Barnes & Noble’s 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

TANGIBLE AND INTANGIBLE ADVANTAGES + = Location selection + Rural real-estate = Wal-Mart High traffic real-estate Brand + = McDonald’s

THE VRINE MODEL: EXPLOITABLITY Example 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 Definition A resource of capability that the organization has the capability to exploit (i.e., the capability to generate value from)

HOW WOULD YOU DO THAT? Do patents on Zoloft ® provide value? Valuable? Do Pfizer's patents provide “rarity”? Rare? Pfizer’s Zoloft ® Inimitable and non-substitutable? Can competitors imitate? Can they substitute? Exploitable? Can Pfizer exploit?

STOCK AND FLOW OF CAPABILITIES Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Capability Flow Stock

DYNAMIC CAPABILITIES Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Mail Boxes Etc. franchise Start-up plans People Value Brand Location Processes Dynamic capability: how we integrate recon- figure, acquire, or divest resources for competitive advantage? Mail boxes, etc., has developed the ability to combine resources better than the competition

VALUE CHAIN: INTERNET STARTUP EXAMPLE Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Firm Infrastructure Financing, legal support, accounting Support Activities Human Resources Recruiting, training, incentive system, employee feedback Technology Development Inventory system Site software Pick & pack procedures Site look & feel Customer research Return procedures Procurement CDs Shipping Computers Telecom lines Shipping services Media Inbound shipment of top titles Server operations Billing Collections Picking and shipment of top titles from warehouse Shipment of other titles from third- party distributors Pricing Promotions Advertising Product information and reviews Affiliations with other websites Returned items Customer feedback Warehousing Inbound Logistics Operations Outbound Logistics Marketing & Sales After-Sales Service Primary Activities

USING VALUE CHAINS TO GAIN COMPETITIVE ADVANTAGE Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Identical Differentiated Find a different way to perform activities Longer-lasting advantage Shorter-term advantage (competitors catch up) Find a better way to perform the same activities

TRADE OFF PROTECTION YOUR RIVALS CHOOSE NOT TO COPY YOU Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Selected difference between Southwest and large Airlines Technology and design Operations Marketing Southwest Single aircraft Short segment flights Smaller markets and secondary airports in major markets No baggage transfers to others airlines No meals Single class of service No seat assignments Limited use of travel agents Word of mouth Major Airlines Multiple types of aircrafts 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

RESULTS OF TRADE OFF PROTECTION Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung 2004 Revenue ($000,000) 2004 Cost of Available Seat Miles (CASM) Airline AirTran 279 8.42 Alaska 656 10.03 American 4,541 9.72 AmericaWest 579 7.81 Continental 2,397 9.49 Delta 3,641 10.23 JetBlue 334 6.03 Northwest 2,753 10.31 Southwest 1,655 7.77 United 3,988 10.16 US Air 1,660 11.34

INNOVATION AND INTEGRATION OF THE VALUE CHAIN   INNOVATION AND INTEGRATION OF THE VALUE CHAIN Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Area of innovation Source Assemble Deliver IKEA Transferred assembly and delivery to the consumer Dell Choose an entirely direct distribution model (rather than through retailers) and outsourced component manufacturing

STRATEGIC LEADERSHIP Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung “Companies that overlook the role of leadership in the early phases of strategic planning often find themselves scrambling when it’s time to execute. No matter how thorough the plan, with-out the right leaders it is unlikely to succeed” – McKinsey & Company

SENIOR VS. MIDDLE MANAGERS Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung Decide how to use other resources and capabilities, configure their firm’s value-chain activities, and set the context which determines how front-line and middle managers can add value Senior Are better positioned than senior managers to contribute to competitive advantage and firm success in four areas Entrepreneurship Communications Psychoanalyst Tightrope walker Middle Source: Quy Nguyen Huy

SUMMARY 1 2 3 4 5 Explain the internal context of strategy Identify a firm’s resources and capabilities and explain their role in its performance 2 Define dynamic capabilities and explain their role in both strategic change and a firm’s performance 3 Understand how value‑chain activities are related to firm performance and competitive advantage 4 Explain the role of managers with respect to resources, capabilities, and value‑chain activities 5

BLANK SLIDE Full quote: “The creation of something new is not accomplished by the intellect but by the play of instinct acting from inner necessity. The creative mind plays with the objects it loves.” - Carl Jung