Chapter 3 Examining the Internal Environment: Resources, Capabilities, and Activities

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 PERFORMANCE ROA Semiconductor Global Auto ROS Grocery Store How do such differences in profitability materialize?

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

TRUST AS AN ORGANIZATIONAL RESOURCE Trust is an intangible resource 1 A trustworthy reputation for a firm can be leveraged. 2

KNOWLEDGE Explicit (easy competitive intelligence)   KNOWLEDGE Knowledge as a resource Explicit (easy competitive intelligence) Tacit (more valuable)

Learning Organizations   Learning Organizations A Learning Organization Is Defined as: An organization skilled at acquiring, transferring, and creating knowledge, and at modifying its behavior to reflect new knowledge and insights. 7

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 VRIO 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 requirement. Valuable resources are needed just to compete in the industry, 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 non- substitut- able? 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? 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) Organization Activatable? For each step of the preceding steps of the VIRO test, can the firm actually exploit the resources and capabilities that it owns or controls? Resources and capabilities that satisfy the VIRO 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 VIRO resources and capabilities). Alternatively, exploitability unlocks the potential competitive and perfor- mance implications of the resource or capability Firms which control unexploited VIRO 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 VIRO)

Is a resource or capability… Criteria for Sustainable Competitive Advantage and Strategic Implications Is a resource or capability… Valuable Rare Inimitable/ Activatable Implications Substitute for Competitiveness No No No No Competitive disadvantage Yes No No No Competitive parity Yes Yes No No Temporary competitive advantage Yes Yes Yes Yes Sustainable competitive advantage Criteria for Sustainable Competitive Advantage and Strategic Implications Source; Adapted from J. Barney, “Firm Resources a Sustained Competitive Advantage, ‘ Journal of Management 17 (1991), pp. 99-120. 10 1-10

SUSTAINABILITY Sustainability: Just having a competitive advantage is not enough. Can it be sustained? Durability Imitability

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

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? Activatable? Can Pfizer exploit?

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

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 The Value Chain 3-15

GUIDELINES FOR OUTSOURCING Activities that can create value for the firm should not be outsourced. 1 Those activities that represent key sources of learning for the firm should not be outsourced. 2

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

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