Chapter 3 - Internal Analysis - Strengths, Weaknesses, and Competitive Advantage PDF

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Dr. Corey Fox

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Chapter 3: Internal Analysis: Strengths, Weaknesses, and Competitive Advantage I. The Value Chain Figure 3.1 displays the Value Chain, or the steps in the process it takes to transform raw inputs into finished outputs. Developed by Michael Porter, the value chain is a way to depict and evaluate the activities a company performs. The horizontal elements in Figure 3.1 capture the production process that a firm uses to acquire and import raw materials, transform them into valuable outputs, and put them in the hands of customers. The vertical axis represents four administrative elements— firm infrastructure, human resource management, technology development, and procurement—that span all of the firm's economic activities. Porter's value chain not only provides a framework to describe the activities a company performs, it also can help to identify which activities represent the firm's competitive strengths and weaknesses.

Value Chain A visual description of the steps required to turn raw materials into finished products and/or services. The value chain also describes key functions of the company linked to each stage and functions that span its productive activities.

Apple's dominance in its markets can be traced to its strengths in the support activities of technology development and procurement. For example, the original iPhone featured a unique raw material, Corning's ultrastrong Gorilla Glass. Apple's iTunes website and Apple Stores showcase its strengths in operations. The company is also well-known for its strong marketing and sales efforts, including its sleek logo and advertising campaigns that have made Apple products a “must have” product for billions of customers across the globe. Disney's early strength, as the opening case indicated, came in operations, by way of its illusion-of-life cartooning process and innovative film production, both of which were enabled by the company's technological development. The company used its stable of memorable and unique characters such as Mickey Mouse, Snow White, and the Little Mermaid to create and sustain its brand identity in film and theme park entertainment. That identity contributes to Disney's strength in marketing and sales, theaters, theme parks, and retail operations such as the Disney Store. The value chain helps managers identify areas in which a firm has an absolute strength, but provides no guidance about strength relative to competitors. So, the value chain can be used to answer the important question, “What is a firm good at?” However, it can't be used to answer the critical question, “What is the firm better at than relevant competitors?” The second question can be answered through two processes. First, we'll define a set of concepts—resources, capabilities, and priorities—to help in understanding the sources of a firm's strengths. Second, we will introduce VRIO thinking, a way of measuring the magnitude and durability of a firm's strengths versus competitive rivals.

Concept Check 3.1: Figure 3.1: The Value Chain Walmart's sophisticated information system shows how technology development adds value by creating critical firm infrastructure. Its information systems give Walmart an advantage in inbound logistics because it can find low-cost ways to move products from its suppliers to warehouses, and in outbound logistics, when it uses the same systems to move products at low cost to its retail stores. High-end retailer Nordstrom's legendary return policy is part of its core activities in marketing and sales as well as after-sales service. The ability to return virtually any Nordstrom item with no receipt and no questions asked creates unique value for customers.

1.

A(n) _______________ is a visual description of the steps required to turn raw materials into finished products and/or services. A. B. C. D.

Ethical Path Moral Sequence Value Chain Virtuous Circle

Chapter 3: Internal Analysis: Strengths, Weaknesses, and Competitive Advantage 2.

The horizontal elements of the value chain represents _______________. A. B. C. D.

3.

The Production Process Human Resource Management Technology Development Administrative Elements

The vertical axis of the value chain depicts _______________. A. Methods to acquire and import raw materials B. Firm infrastructure C. Techniques firms use to transform raw materials into valuable outputs D. The production process

4.

The value chain helps managers identify areas in which a firm has an absolute strength, but provides no guidance about strength relative to competitors. A. True B. False

II. The Resource-Based View Resources, capabilities, and priorities can be thought of as answers to basic questions that firms face. Resources are what a firm employs to create value and competitive advantage. Capabilities represent how firms do things—the processes they use. Priorities explain why firms allocate critical resources to achieve key objectives.

Resources All assets, brands, lands, information, knowledge, and so on controlled by a firm that enable it to conceive of and implement strategies that improve its efficiency and effectiveness.

Capabilities The procedures, processes, and routines firms employ in their activities.

Priorities A firm's values and rankings of what is most important.

Resources: Resources provide the answer to the question, “What creates the firm's strengths?” One definition states that “resources include all Assets, capabilities, organizational processes, firm attributes, information, knowledge, etc. controlled by a firm that enables the firm to conceive of and implement strategies that improve its

efficiency and effectiveness.” This definition clearly identifies what could be a resource, but its breadth makes it difficult to identify and limit what types of things count as a resource. Resources are the “what” of competitive advantage.

Assets Tangible or intangible resources or factors of production that create economic value for the firm when employed. Most resources are, or could be, counted and quantified on a firm's balance sheet as assets. Accountants classify resources as tangible or intangible assets. Tangible resources are those with physical presence, such as land, factories, machinery, equipment, or cash. Intangible resources are economically valuable assets that “do not have physical presence,” and include brands, licenses patents, knowledge, and reputation. Four categories of resources are important contributors to competitive advantage: 1. Physical resources, such as plant or equipment 2. Financial resources, such as free cash flow 3. Human resources, including employee know-how, management skill, and talents 4. Intangible resources, such as brands and patents These four types of resources enable both the core operational and important support/administrative activities in the value chain. Nordstrom could not operate without the physical resources of stores or a website for customers to visit, or without the financial resources of cash or credit to purchase inventory. Similarly, without the human resources of salespeople there would be no customer service, which gives Nordstrom its strength in marketing and sales. Finally, without the intangible resource of Nordstrom's elite brand and culture and training programs, the shopping experience would provide little of the satisfaction that customers have come to expect.

Capabilities: Capabilities are processes that the firm has developed to coordinate human activity in order to achieve specific goals. Capabilities represent the “how” of competitive advantage. McDonald's corporation holds a commanding 24 percent market share in the US fastfood industry, nearly four times as large as rival Wendy's. McDonald's operates more than 34,000 stores worldwide, many of them in highly accessible locations,

Chapter 3: Internal Analysis: Strengths, Weaknesses, and Competitive Advantage such as freeway off-ramps, towns, and mall locations. Although the stores themselves are resources, McDonald's has also developed a set of Operating Capabilities, or processes, that are implemented in each of these stores. The process of filling customers' orders at industry-leading speed is a capability at the heart of what makes McDonald's successful. Speedy customer service involves several steps: procuring customer orders accurately and quickly, communicating the orders to the cooks, cooking the food, packaging it, and delivering it to the customer. This process is repeated hundreds of times a day at all 34,000 individual store locations, leading to high store-level capability for order turnaround.

Operating Capabilities Procedures, processes, or routines for delivering value to customers, employees, suppliers, or investors. Competitive advantage relies on a strong set of operating capabilities. A firm's advantage becomes stronger if it develops Dynamic Capabilities, processes that are designed to continuously expand existing resources or to improve or modify operating capabilities. Dynamic capabilities are practiced and refined over time and through repetition. For example, Procter & Gamble (P&G) has many brand resources, such as Crest, Tide, Pampers, Pantene, and Febreeze. But it also has been through the process of creating a new brand many times. Through repetition, P&G has refined its capability to create new brands to the point that it now has a dynamic capability that can help it expand its existing brand resources with new additions, such as the Olay Pro-X skin cleaning system.

Dynamic Capabilities The procedures, processes, and routines firms employ in their activities. Dynamic capabilities can help firms modify and evolve processes to keep pace with environmental changes such as new competitors, shifting demographics, or emerging technologies. They can also enable firms to incorporate learning into their processes. For example, Toyota follows a method of continuous improvement of its processes, known as kaizen, in which ideas from many different sources are used to eliminate waste of effort or materials. Companies with strong dynamic capabilities have a more secure foundation for competitive advantage than those without them, for two reasons. First, dynamic capabilities entail complex connections and coordination among different internal units within the firm. For

example, finding the optimal site for a restaurant requires input from marketing about demographic information and target customer segments; the corporate counsel about sales contracts and local regulations; and real estate professionals skilled at identifying, negotiating, and closing on properties. These strong coordination processes contribute to the competitive advantage of good restaurant locations. Second, dynamic capabilities take time to develop and require significant learning. Processes or routines represent deeply engrained habits of behavior that take years for companies to perfect. As firms and their managers master the ongoing process of learning and adjusting in the face of competitor, customer, or market changes, they develop a formidable set of dynamic capabilities.

Priorities: Resources and capabilities help firms create and deliver unique value. So, what drives the choices into which resources and capabilities a firm should invest money and time? The answer is priorities, which are a firm's ranking about what is most important. Priorities are driven by a company's underlying values, its leaders' beliefs about what is right and wrong, good and bad, desirable and undesirable. Management guru Peter Drucker described values as the ultimate test for action. Drucker noted that corporate decisions about hiring from the inside or outside, a company's stance about the importance of R&D, marketing, or any other functions look like technical questions of strategy; however, they are really questions about what companies and their leaders truly value. Values lead to priorities that help executives, managers, and employees make decisions. Priorities drive the creation of resources and capabilities in two ways. First, priorities guide resource allocation processes such as capital investment, human capital acquisition and training, and brand development. Second, priorities maintain those allocations over time when things get tough.

Concept Check 3.2:

Chapter 3: Internal Analysis: Strengths, Weaknesses, and Competitive Advantage

1.

Which of the following terms describes all possessions, competencies, organizational processes, firm attributes, information, knowledge, and so on, controlled by a firm that enable the firm to conceive of and implement strategies that improve its efficiency and effectiveness? A. B. C. D.

2.

_________ are the procedures, processes, and routines firms employ in their activities. A. B. C. D.

3.

Assets Priorities Dynamic Capabilities Resources

Assets Priorities Resources Capabilities

Procedures, processes, or routines for delivering value to customers, employees, suppliers, or investors are known as _________.

keep Oswald “alive” the way Disney kept Mickey Mouse alive through products, TV shows, and theme park. Oswald's life on film ended as Mintz's team ran out of new ideas for the character in 1943, shortly after Disney created to Bambi, Dumbo, and Pinocchio. Walt Disney lost a valuable competitive asset when Mintz enforced his ownership of the copyright on Walt's fateful trip to New York, but Mintz lacked the capability to sustain the character he had captured. Competitive advantages arise when resources or capabilities possess two attributes: Value and Rarity. Two other principles determine the durability, or sustainability, of competitive advantage: Inimitability, the characteristics that make a resource or capability difficult to imitate, and an organization's ability to exploit profit returns generated by its unique and valuable resources. Together, these four characteristics—value, rarity, inimitability, and organization to exploit profits—are often abbreviated as VRIO. We'll examine each one in turn.

Value Worth or utility. Rarity To be uncommon, or not available to other

A. B. C. D. 4.

Assets Operating Capabilities Dynamic Liabilities Priorities

Which of the following represents procedures, processes, and routines that continuously expand existing resources or improve operating capabilities? A. B. C. D.

Competitive Parity Operating Capabilities Dynamic Capabilities Positive Network Externalities

III. Creating a Sustainable Competitive Advantage: The VRIO Model of Sustainability Walt Disney's experiences with Oswald the Rabbit illustrate the difference between having a competitive advantage and sustaining that advantage through time. Although the first cartoons were both profitable and promising of a strong future, the Oswald advantage was unsustainable because Disney didn't own the rights to the character. Charles Mintz proved unable to sustain the character Oswald because Mintz lacked the capability to

competitors.

Inimitability An attribute of a resource or capability that describes the degree of difficulty a competitor would face in copying, imitating, or mimicking the value of that resource or capability.

Value: Mickey Mouse earned returns for Disney and allowed the company to grow because this character created value for film distributors and viewers. Value denotes worth for customers. A resource creates value if its contributions allow a company to produce a product or service that is of worth to end users. Products or services have value when they create direct pleasure, satisfaction, or happiness for the end user, or when they create indirect opportunities for users to experience pleasure and satisfaction. Users won't pay for products or services unless they create value in their lives. In fact, a fundamental premise of our economic system holds that the price someone will pay for a good depends on the value that good produces. The higher the value, the higher the price that buyers are willing to pay. Although not an absolute rule, resources and capabilities that provide firms with the opportunity to

Chapter 3: Internal Analysis: Strengths, Weaknesses, and Competitive Advantage produce and sell at lower costs than their rivals create value for customers. Low price itself may produce some direct pleasure for users, but its benefits are mostly indirect, because purchasing products and services at a low cost usually leave users with more money to spend on other things that provide them pleasure or satisfaction. Similarly, unique products or services often create direct pleasure or satisfaction for customers. Resources that help a firm bring such differentiated products and services to the market create value for customers. Of course, those resources also create economic value for the firm, defined as profits.

leveraged its learning and investments in large aircraft to introduce the first successful commercial jetliner, the 707, in late 1957. A British company, De Havilland, actually developed the first commercial jet aircraft, the Comet. However, the Comet failed because De Havilland wasn't as far along the learning curve on designing or building large aircraft that could safely fly passengers. Path dependence helps to block imitation when resources or capabilities follow a sequential development path—for example, when previous investments enable later ones, or when significant learning underlies the resource or capability.

Rarity:

Tacit Knowledge:

To be rare is to be uncommon, or not available to other competitors. Unique is often used as a synonym for rare. McDonald's tries to find unique locations for its restaurants, such as being the only restaurant at a freeway exit, or the closest to the on-ramp, or its presence as the sole dining option inside many Walmart stores. Rare or unique resources create competitive advantage through a basic principle of economics— scarcity. When products or services are scarce, users are often willing to pay a higher price for them than they would if the same products or services were more commonly available, leading to higher company profits.

For many processes, such as cooking French Fries at McDonald's, the actions needed to imitate the sequence can be codified, or written down, and easily learned by others. Such easy-to-codify-and-learn knowledge is referred to as explicit knowledge. Tacit knowledge is just the opposite. Many valuable skills and processes, such as Walt Disney's knack for choosing good stories or Steve Jobs's ability to spot great design in a product, can't be learned easily, if they can be learned at all. These skills are difficult, maybe even impossible, to learn, teach, or coach, because they are based on tacit knowledge. Tacit knowledge is sticky, or immobile, and difficult to imitate by competitors.

Inimitability: Causal Ambiguity: Inimitability is the extent to which competitors cannot easily reproduce a product by employing equal, or equivalent, sources of value in their own products and services. Think about attending a Major League Baseball, an NBA, or NFL game. The histories of the teams, the star players, the amenities of professional stadiums, and the rules adopted by each league to govern play mean that other leagues simply can't imitate the experience these leagues provide. In fact, the last successful rival competitive league was the American Basketball Association (ABA), and it merged with the NBA in 1976! Several factors drive inimitability, thereby acting as barriers to imitation:

Path Dependence Path dependence means that the process through which a resource or capability came into being may make it difficult for competitors to imitate. During World War II, British aerospace companies focused on building small fighter planes while Boeing, an American company, built large bombers and ta...