Assessing the Internal Environment of the Firm Chapter 3 Assessing the Internal Environment of the Firm McGraw-Hill/Irwin Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.

After studying this chapter, you should have a good understanding of: Learning Objectives After studying this chapter, you should have a good understanding of: The primary and support activities of a firm's value chain. How value-chain analysis can help managers create value by investigating internal and external relationships among activities The different types of tangible and intangible resources, as well as organizational capabilities The four criteria that a firm's resources must possess to maintain a sustainable advantage How to make meaningful comparisons of performance across firms The value of recognizing how the interests of a variety of stakeholders can be interrelated

Firms and Resources Why are some firms so successful, and other less so, within very similar environments? Why are firms so different from each other?

The Value Chain: Primary and Support Activities Exhibit 3.1 The Value Chain General administration Human resource management Technology development Procurement Inbound logistics Operations Outbound Marketing and sales Service Margin Support Activities Primary Activities Source: Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1998 by Michael E. Porter.

The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities Exhibit 3.2 Location of distribution facilities to minimize shipping times Excellent material and inventory control systems Efficient plant operations Appropriate level of automation Quality production control systems to reduce costs and enhance quality Efficient plant layout and workflow design Effective shipping processes to provide quick delivery Efficient finished goods ware-housing processes Shipping of goods in large lot sizes to minimize transport-ation costs Highly motivated, competent sales force Innovative approaches to promotion and advertising Selection of appropriate distribution channels Customer segments and needs identified Effective pricing Effective use of procedures to solicit customer feedback and to act on information Quick response to customer needs and emergencies Ability to furnish replacement parts as required PROFIT MARGIN Source: Adapted with permission of The Free Press, a division of Simon & Schuster, from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by Michael E. Porter. Inbound Logistics Operations Outbound Logistics Marketing and Sales Service

Value Chain: Support Activities (1) General Administration Effective planning Excellent relationships with diverse stakeholders Ability to integrate and coordinate value chain activities Effective culture and reputation Human Resource Management Effective recruiting, training, and retention Union relationships Effective reward and incentive programs

Value Chain: Support Activities (2) Technology Development Effective R&D Relationships between R&D and other depts. Creative and innovation in culture Personnel qualifications Procurement Win-win relationships with suppliers Processes and procedures optimize quality, price, service, speed Proper lease versus buy decisions

The Sustainability of Resources and Capabilities: Four Criteria Exhibit 3.6 Physically unique Path dependency Causal ambiguity Social complexity` No equivalent strategic resources or capabilities Difficult to imitate Difficult to substitute Not many firms possess Rare Neutralize threats and exploit opportunities Valuable Implications Is the resource or capability

Implications for Competitiveness Criteria for Sustainable Competitive Advantage and Strategic Implications Exhibit 3.7 Is a Resource… Valuable Rare Difficult to Imitate Without Substitutes Implications for Competitiveness No Competitive disadvantage Yes Competitive parity Temporary competitive advantage Sustainable competitive advantage Source: Adapted from Barney 1991. Firm Resources a Sustained Competitive Advantage. Journal of Management, 17:99-120.

Tangible Resources Financial Physical Technological Organizational Exhibit 3.4 (adapted) Financial Firm’s cash account and cash equivalents Firm’s capacity to raise equity Firm’s borrowing capacity Physical Modern plant and facilities Favorable manufacturing locations State-of-the-art machinery and equipment Technological Trade secrets Innovative production processes Patents, copyrights, trademarks Organizational Effective strategic planning processes Excellent evaluation and control systems Source: Adapted from J.B. Barney, 1991, Firm resources and sustained competitive advantage, Journal of Management, 17: 101; R.M. Grant, 1991, Contemporary Strategy Analysis (Cambridge, U.K.: Blackwell Business), 100-102. Hitt, M.A., Ireland, R.D. & Hoskisson, R.E. 2001. Strategic Management: Competitivenesss and Globalization. Fourth Edition. South-Western College Publishing: Cincinnati, Ohio.

Intangible Resources Human Innovation & creativity Reputation Exhibit 3.4 (adapted) Human Experience and capabilities of employees Trust Managerial skills Firm-specific practices and procedures Innovation & creativity Technical and scientific skills Innovation capacities Reputation Brand name Reputation with customers for quality and reliability Reputation with suppliers for fairness

Organizational Capabilities Competencies or skills employed to transfer inputs to outputs The capacity to combine tangible and intangible resources, using organizational processes to attain a desired end

Examples of Organizational Capabilities Outstanding customer service Excellent product development capabilities Innovativeness of products and services The ability to hire, motivate, and retain human capital

Marks & Spencer: How Resources and Capabilities Lead to Advantages Exhibit 3.5 Resource Competitive Advantages in Great Britain Tangible Ownership (vs. leasing) of property 1% of revenues allocated to occupancy costs (versus 3% to 9% industry average) Customer recognition with minimal advertising No promotional sales Lower labor turnover 8.7% labor costs versus 10%-20% industry average Brand reputation Intangible Employee loyalty Capabilities Supplier chain Lower costs and higher quality of goods sold Fewer layers of hierarchy Source: Adapted from Collins, D. & Montgomery, C. 1995. Competing on resources: Strategy in the 1990s. Harvard Business Review, 73(4): 123. Managerial judgment

Firm Performance: Financial Ratios Liquidity Long-term solvency Asset management Profitability Market value

Performance: Bases for Comparison Historical comparisons Industry norms Key competitors or strategic group

Historical Trends: ROS for a Hypothetical Company Exhibit 3.8 Historical Trends: ROS for a Hypothetical Company 20% 10% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Return n Sales Years 1, 2, 3 Years 4, 5, 6 Years 6, 7, 8 Years 8, 9, 10 Years 6, 7, 8, 9, 10 Year

How Financial Ratios Differ Across Industries Exhibit 3.9 How Financial Ratios Differ Across Industries Financial Ratio Semi- conductors Grocery Stores Skilled nursing facilities Quick ratio (times) 1.5 0.5 1.1 Current ratio (times) 3.2 1.6 1.9 Total liabilities to net worth (%) 34.8 114.0 93.0 Collection period (days) 54.8 2.9 40.2 Assets to sales (%) 98.1 21.2 108.7 Return on sales (%) 3.1 0.9 2.0 Source: Dun & Bradstreet, Industry Norms and Key Business Ratios, 1999-2000. Desktop Edition. SIC # 0100-8999.

Exhibit 3.10 Comparison of Procter & Gamble’s Sales and R&D Budget to its Key Competitors COMPANY (OR DIVISION) SALES* (billions) R&D BUDGET P&G DRUG DIVISION $0.8 $0.38 BRISTOL-MYERS SQUIBB $20.2 $1.8 PFIZER $27.4 $4.0 MERCK $32.7 $2.1 * Most recently completed fiscal year. Data: Lehman Brother Procter & Gamble Co. Source: Berner, R. 2000. Procter & Gamble: Just say no to drugs. Business Week: October 9:128.

ECI’s Balanced Business Scorecard Exhibit 3.11 Financial Perspective GOALS MEASURES Survive Cash Flow Succeed Quarterly sales growth and operating income by division Prosper Increased market share and ROE Internal Business Perspective GOALS MEASURES Manufacturing excellence Cycle time Unit cost Yield Design productivity Silicon efficiency Engineering efficiency New product introduction Actual introduction schedule versus plan Customer Perspective GOALS MEASURES New products Percent of sales from new products Responsive supply On-time delivery (defined by customer) Customer partnership Number of cooperative engineering efforts Innovation and Learning Perspective GOALS MEASURES Technology leadership Time to develop next generation Manufacturing learning Process time to maturity Product focus Percent of products that equal 80% sales Time to market New product introduction versus competition Source: Adapted from Kaplan, R.S. & Norton, D.P. 1992. The balanced scorecard: Measures that drive performance. Harvard Business Review, 69(1): 71-79.