0. Chapter 3 Examining the Internal Context of Strategy

1. 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

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

3. 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

4. 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

5. 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

6. 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

7. 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)

8. 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

9. 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

10. 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

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

12. 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)

13. 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?

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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