Chapter 3 – The Internal Environment

Knowledge Objectives Studying this chapter should provide you with the strategic management knowledge needed to: Explain the need for firms to study and understand their internal environment. Define value and discuss its importance. Describe the differences between tangible and intangible resources. Define capabilities and discuss how they are developed.

Knowledge Objectives – cont’d Studying this chapter should provide you with the strategic management knowledge needed to: Describe four criteria used to determine whether resources and capabilities are core competencies. Explain how value chain analysis is used to identify and evaluate resources and capabilities. Define outsourcing and discuss the reasons for its use. Discuss the importance of preventing core competencies from becoming core rigidities.

The Strategic Management Process Strategy Implementation Chapter 10 Corporate Governance Chapter 11 Organizational Structure and Controls Chapter 13 Strategic Entrepreneurship

Agenda Creating Competitive Advantage Resources, Capabilities, & Core Competencies Value Chain Analysis Outsourcing

Creating Competitive Advantage Core competencies, in combination with product-market positions, are the firm’s most important sources of competitive advantage The identification of core competencies, in addition to an analysis of the general, industry, and competitor environments, should drive a firm’s selection of strategies

Analysis Outcomes Examine opportunities and threats Examine unique resources, capabilities, and competencies (sustainable competitive advantage)

Creating Value By exploiting their competitive advantages, firms create value Value is measured by A product’s performance characteristics The product’s attributes for which customers are willing to pay

Creating 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

Creating Competitive Advantage 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

Agenda Creating Competitive Advantage Resources, Capabilities, & Core Competencies Value Chain Analysis Outsourcing

RBV Logic Resources Are a firm’s assets, including people and the value of its brand name Are the source of a firm’s capabilities Alone, do not yield a competitive advantage

Tangible Resources Assets that can be seen and quantified Financial Resources Financial Resources • The firm’s borrowing capacity • The firm’s ability to generate internal funds • The firm’s formal reporting structure and its formal planning, controlling, and coordinating systems Physical Resources • Sophistication and location of a firm’s plant and equipment • Access to raw materials Technological Resources • Stock of technology, such as patents, trade-marks, copyrights, and trade secrets Organizational Resources Physical Resources Technological Resources Sources: Adapted from Barney, J. B. (1991). “Firm resources and sustained competitive advantage”. Journal of Management, 17: 101; Grant, R. M. (1991). “Contemporary Strategy Analysis”, Cambridge, UK: Blackwell Business: 100-102.

Intangible Resources Assets that are embedded in routines Human Resources Human Resources • Knowledge • Trust • Managerial capabilities • Organizational routines Innovation Resources • Ideas • Scientific capabilities • Capacity to innovate Reputational Resources • Reputation with customers • Brand name • Perceptions of product quality, durability, and reliability • Reputation with suppliers Innovative Resources Reputational Resources Sources: Adapted from Hall, R. (1992).”The strategic analysis of intangible resources”, Strategic Management Journal: 136-139; Grant, R. M. (1991). “Contemporary Strategy Analysis”, Cambridge, UK: Blackwell Business: 100-102.

Value of Knowledge Assets Annual Market Book Ratio of sales value value market to Company ($ bn) ($ bn) ($ bn) book value Google 3.2 60.4 2.9 20.8 Genentech 3.9 75.0 6.8 11.0 Yahoo! 3.6 47.9 7.1 6.7 eBay 3.2 42.8 6.7 6.4 Southwest Airlines 6.5 11.7 5.5 2.1 Union Pacific (Railroad) 12.2 16.7 12.7 1.3 Ford Motor Company 171.6 16.7 16.0 1.0 Note: The data on market valuations are as of May 1, 2005. All other financial data is based on the most recently available balance sheets and income statements.

RBV Logic Capabilities Are the firm’s capacity to deploy resources Emerge over time through complex interactions among tangible and intangible resources Often are based on developing, carrying, and exchanging information and knowledge through the firm’s human capital The foundation of many capabilities lies in: The unique skills and knowledge of a firm’s employees The functional expertise of those employees

Examples of Firms’ Capabilities Functional areas Capabilities Examples of firms Distribution Effective use of logistics management techniques Wal-Mart Human resources Motivating, empowering, and retaining employees Microsoft Management information systems Effective and efficient control of inventories through point-of-purchase data collection methods Gillette Marketing Effective promotion of brand-name products Polo Ralph Lauren Effective customer service Nordstrom Innovative merchandising Crate & Barrel Management Ability to envision the future of clothing Gap Effective organizational structure PepsiCo Manufacturing Design and production skills yielding reliable products Komatsu Product and design quality Miniaturization of components and products Sony Research & development Innovative technology Caterpillar Development of sophisticated elevator control solutions Otis Elevator Rapid transformation of technology into new products and processes Chaparral Steel Digital technology Thomson Computer Electronics

RBV Logic Core Competencies Activities that a firm performs especially well compared to competitors Resources and capabilities that serve as a source of a firm’s 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

Building Competitive Advantage

Building Competitive Advantage Valuable Capabilities Help a firm neutralize threats or exploit opportunities Rare Capabilities Are not possessed by many others Costly-to-Imitate Capabilities 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 Nonsubstitutable Capabilities No strategic equivalent

Limitations of the RBV Radical environmental changes RBV helps managers to select strategies and gain sustainable competitive advantage only as industry environment remains fixed Managerial influence Imitability paradox: The less costly to develop or acquire resources, the less likely that these resources will result in sustainable competitive advantage Not all firms able to gain sustainable advantage

Core Rigidities 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

Agenda Creating Competitive Advantage Resources, Capabilities, & Core Competencies Value Chain Analysis Outsourcing

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 business-level strategy Reminder: 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

Value Chain Analysis – cont’d Primary activities involved with: A product’s physical creation A product’s sale and distribution to buyers The product’s service after the sale Support activities Provide the support necessary for the primary activities to take place

The Basic Value Chain Shows how a product moves from raw-material stage to the final customer Service Marketing and Sales Human Resource Management Technological Development Outbound Logistics Firm Infrastructure Procurement Operations Inbound Logistics

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.)

Primary Activities – cont’d 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 product’s value (repair, training, adjustment, etc.) → Each activity should be examined relative to competitors’ abilities and rated as superior, equivalent, or inferior.

Support Activities Procurement Activities completed to purchase the inputs needed to produce a firm’s products (raw materials and supplies, machines, laboratory equipment, etc.) Technological development Activities completed to improve a firm’s 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

Support Activities – cont’d 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.

Agenda Creating Competitive Advantage Resources, Capabilities, & Core Competencies Value Chain Analysis Outsourcing

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

Outsourcing Decisions A firm may outsource all or only part of one or more primary and/or support activities. Service Marketing and Sales Human Resource Management Outsourced activity Technological Development Outbound Logistics Firm Infrastructure Procurement Operations Inbound Logistics

Rationales for Outsourcing

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 Accelerate business re-engineering benefits Achieves re-engineering benefits more quickly by having outsiders – who have already achieved world-class standards – take over process

Rationales for Outsourcing – cont’d Sharing risks Reduces investment requirements and makes firm more flexible, dynamic and better able to adapt to changing opportunities Freeing 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 organizational tasks

Outsourcing Issues – cont’d Nonstrategic team of resources Do not outsource capabilities that are critical to the firm’s success, even though the capabilities are not actual sources of competitive advantage Firm’s knowledge base Do not outsource activities that stimulate the development of new capabilities and competencies