45
Chapter 3
The Internal Organization:
Resources, Capabilities, Core Competencies, and Competitive
Advantages
LEARNING OBJECTIVES
1. Explain why firms need to study and understand their internal organization.
2. Define value and discuss its importance.
3. Describe the differences between tangible and intangible resources.
4. Define capabilities and discuss their development.
5. Describe four criteria used to determine whether resources and capabilities are core
competencies.
6. Explain how firms analyze their value chain for the purpose of determining where
they are able to create value when using their resources, capabilities, and core
competencies.
7. Define outsourcing and discuss reasons for its use.
8. Discuss the importance of identifying internal strengths and weaknesses.
9. Discuss the importance of avoiding core rigidities.
CHAPTER OUTLINE
CHAPTER INTRODUCTION
OPENING CASE: Big Pharma
ANALYZING THE INTERNAL ORGANIZATION
The Context of Internal Analysis
Creating Value
The Challenge of Analyzing the Internal Organization
RESOURCES, CAPABILITIES, CORE COMPETENCIES
Emphasis on Value Creation through Tangible and Intangible Resources
BUILDING CORE COMPETENCIES
Value Chain Analysis
OUTSOURCING
Competencies, Strengths, Weaknesses, and Strategic Decisions
SUMMARY
REVIEW QUESTIONS
46
CHAPTER INTRODUCTION
Chapter Introduction: As indicated in Chapter 1, firms follow two competing models
to generate the inputs needed to formulate and implement strategies. Chapter 2 focused
on the external environment, which is the foundation of the I/O model. The emphasis
in Chapter 3 is on internal resources and their potential to create competitive advantage
for the firm, which falls in line with the resource-based model. This orientation is
perhaps best captured by the elements of Figure 3.1, which should be emphasized.
However, it should also be emphasized that no competitive advantage lasts forever and,
over time, any firm’s value-creating strategy can be duplicated.
OPENING CASE
Big Pharma: The use of data analytics as a business strategy.
The idea of using data strategically remains somewhat novel in some organizations.
However, the reality of “big data” and “big data analytics” (which is “the process of
examining big data to uncover hidden patterns, unknown correlations and other useful
information that can be used to make better decisions”) is quickly changing this situation.
Large pharmaceutical companies are considering the possibility of trying to develop a core
competence in terms of BDA. Health care reform and the changing landscape of health care
delivery systems throughout the world are influencing these firms to think of developing
BDA as a core competence. Many benefits can accrue to big pharma firms capable of
forming BDA as a core competence including quickly identifying trial candidates and
accelerate their recruitment, developing improved inclusion and exclusion criteria to use in
clinical trials, and uncover unintended uses and indications for products. In terms of
customer functionality, superior products can be provided at a more rapid pace as a
foundation for helping patients live better and healthy lives.
Numerous firms such as Coca-Cola, McDonald’s, and Subway have implemented
value-creating strategies using their unique resources, capabilities, and core
competencies. In particular, they have developed unique capabilities related to the
management of their brands.
• The ultimate goal of such strategies is for the firms to achieve a sustainable
competitive advantage that will enable them to earn above-average returns.
• To achieve strategic competitiveness and earn above-average returns, firms must
leverage their core competencies to exploit opportunities in the external
environment.
• However, a competitive advantage does not always last, because value-creating
strategies may be successfully imitated or duplicated by competitors.
47
Several features of the global economy, such as technological changes, can result in the erosion
of the competitive advantage of established competitors. For example, the Internet is
undermining the competitive advantage of brick-and-mortar rivals.
Competitive advantages are often strongly related to the resources firms hold and how they are
managed. Resources are the foundation for strategy and these can generate competitive
advantages leading to wealth creation when they are bundled together uniquely.
People are an especially critical resource for producing innovation and gaining a competitive
advantage. Even if they are not as critical in some industries, they are necessary for the
development and implementation of firms’ strategies.
The sustainability of a competitive advantage is a function of three factors:
• The obsolescence of a core competence - the basis of value creation - as a result of
environmental changes
• The availability of substitutes for the core competence (or the extent to which competitors
can use different core competencies to overcome value created by the original core
competence)
• The imitability of the core competence (or the abilities of competitors to develop the same
core competence)
To sustain a competitive advantage, firms must manage current core competencies while
simultaneously developing new competencies. In other words, strategists must continuously
make investments that will enhance the value of current competencies while striving to develop
new ones (discussed further in Chapter 5).
This chapter represents the next phase in the strategy development process: what a firm can
do. It is linked to the understanding that managers gain by assessing the external environment
to determine what the firm might do, or to identify opportunities that might be pursued.
ANALYZING THE INTERNAL ORGANIZATION
The Context of Internal Analysis
In the global economy, traditional factors such as labor costs, access to financial resources and
raw materials, and protected or regulated markets continue to be sources of competitive
advantage, but to a lesser degree (mostly because the advantages created by these more
traditional sources can be overcome by competitors through an international strategy and by
the flow of resources throughout the global economy).
48
Increasingly, those analyzing their firm’s internal environment should use a global mind-set
(i.e., the ability to study an internal environment in ways that are not dependent on the
assumptions of a single country, culture, or context).
Analysis of the firm’s internal environment requires that evaluators examine the firm’s
portfolio of resources and the bundles of heterogeneous resources and capabilities managers
have created. Understanding how to leverage the firm’s unique bundle of resources and
capabilities is a key outcome decision makers seek when analyzing the internal environment.
By using or exploiting their core competencies, firms are in a position to develop and perform
value-creating strategies better than their competitors or to create and perform value-creating
strategies that competitors either are unable or unwilling to imitate.
Components of Internal Analysis Leading to Competitive Advantage and Strategic
Competitiveness
As illustrated in Figure 3.1:
• A firm's tangible and intangible resources (for example, its facilities and corporate culture,
respectively) represent sources of capabilities
• These capabilities (teams or bundles of resources) represent sources of core competencies
• When exploited and nurtured (and valuable, costly to imitate, rare, and non-substitutable),
core competencies are potential sources of competitive advantage
49
• If a firm is able to use its core competencies to achieve a competitive advantage, it will
achieve strategic competitiveness and earn above-average returns so long as competitors are
unable or unwilling to imitate them successfully
CREATING VALUE
Some thoughts on “value”:
• Firms create value by exploiting core competencies and meeting the standards of global
competition.
• Value is measured by the product’s performance and by its attributes for which customers
are willing to pay.
• Firms must provide value to customers that is superior to the value provided by competitors
in order to create a competitive advantage.
• Customers perceive higher value in global rather than domestic-only brands.
• Firms create value by innovatively bundling and leveraging their resources and capabilities.
• Ultimately, value is the foundation for earning above-average profits.
• Core competencies, combined with product-market positions, are the most important
sources of advantage.
• The core competencies of a firm, in addition to analysis of its general, industry, and
competitor environments, should drive its selection of strategies.
The Challenge of Analyzing the Internal Organization
Correctly identifying, developing, deploying, and protecting firm resources, capabilities, and
core competencies requires managers to make difficult decisions. In part, these challenges are
a result of characteristics of both the internal and external environments of the firm. This
challenge is multiplied because of three conditions that characterize important strategic
decisions - uncertainty, complexity, and intraorganizational conflict.
Conditions Affecting Managerial Decisions about Resources, Capabilities, and Core
Competencies
The conditions or decision characteristics presented in Figure 3.2 are:
• Uncertainty regarding the assessment of the general and industry environments,
assessments, and predictability of competitive actions, and customer preferences. Strategic
leaders need to be aware of how biases affect decisions about how to cope with uncertainty
and how to manage resources and capabilities to form core competencies.
• Complexity regarding the nature of any interrelatedness of the causes of change in the
environment and how the environments are perceived, especially regarding decisions as to
50
which of the firm’s resources and capabilities might serve as the foundation for competitive
advantage.
• Intraorganizational conflicts among managers making decisions about which core
competencies are to be nurtured and about how the nurturing should take place.
Uncertainty is present because of the inherent difficulty in identifying, assessing, and
predicting changes and trends in characteristics of the external environment. Among these
characteristics are correctly predicting the extent, direction, and timing of changes in the
general environment, such as those resulting from societal values, political and economic
conditions, customer preferences, and emerging technologies from other industries (and how
they might ultimately affect the firm).
Complexity is increased because of the uncertain nature of interrelationships among the
characteristics of the external environment and the related challenge regarding how to assess
the effects of changes in one set of characteristics on other characteristics. The issue becomes
more complex when managers must relate the complex external environment to their
assessment of the firm's internal environment and thus affects decisions regarding the firm's
resources, capabilities, and core competencies, and their relationship to opportunities in the
external environment that can be exploited successfully to achieve a competitive advantage.
Intra-organizational conflicts often develop as a result of uncertainty and complexity. When
managers make decisions regarding the identification of the firm's capabilities and choose to
nurture them (with resources) to develop core competencies that can be exploited to achieve a
competitive advantage, they must make these important decisions without absolute certainty
that the decision is correct. And, such decisions may result in changes or shifts in power and
interrelationships among individuals and groups within the firm. When this occurs, there may
be conflict as those who are affected adversely - or perceive that they will be so affected - may
51
resist these changes. In some cases, managers faced with decisions that may have unpleasant
consequences or are uncomfortable often experience denial, an unconscious coping
mechanism used to block out and not initiate major changes that may have some pain
associated with them.
Thus, managers that must make decisions under conditions of uncertainty, complexity, and
intraorganizational conflict must exercise judgment, a capacity for making a successful
decision in a timely manner when no correct model is available or when relevant data are
unreliable or incomplete.
When exercising judgment, decision makers often take intelligent risks. In the current
competitive landscape, executive judgment can be a particularly important source of
competitive advantage. One reason is that over time, effective judgment allows a firm to build
a strong reputation and retain the loyalty of stakeholders whose support is linked to above-
average returns.
Significant changes in the value-creating potential of a firm’s resources and capabilities can
occur in a rapidly changing global economy. Because these changes affect a company’s power
and social structure, inertia or resistance to change may surface. Even though these reactions
may happen, decision makers should not deny the changes needed to assure the firm’s strategic
competitiveness. By denying the need for change, difficult experiences can be avoided in the
short run.
RESOURCES, CAPABILITIES, AND CORE COMPETENCIES
This section develops the background and relationships among resources, capabilities, and core
competencies that represent potential sources on which a firm can build the foundation for a
competitive advantage.
Resources
Resources represent inputs into a firm's production process, such as capital equipment, the
skills of individual employees, brand names, financial resources, and talented managers.
By themselves - or individually - resources generally will not enable a firm to achieve a
competitive advantage. They must be combined or integrated with other firm resources to
establish a capability. When these capabilities are identified and nurtured, they can result in
core competencies, which may lead to a competitive advantage. A firm's resources can be
classified either as tangible or intangible.
52
Emphasis on Value Creation through Tangible and Intangible Resources
The Strategic Focus profiles two companies, Kinder Morgan and Coca-Cola, and describes
some of the ways in which they have used resources to create value for customers. Kinder-
Morgan’s focus is on tangible resources – pipe and pipeline networks, storage terminals,
liquid transportation assets, and financial assets (derived from creative tax approaches to
earnings distributions and cash). Coca-Cola has a number of both tangible and intangible
resources that it uses to create value. Intangible resources include a strong brand (based
on well-managed image from marketing capabilities) that spans its product line. Tangible
resources include financial capabilities and massive storage tanks that support its growing
juice business and its advanced distribution system.
Tangible Resources
Tangible resources are assets that can be seen or quantified, such as a firm's physical assets
(e.g., its plant and equipment). Tangible resources are classified in one of four ways, as
illustrated in Table 3.1.
Tangible Resources
A firm's tangible resources generally can be placed into one of four categories:
• Financial resources, such as borrowing capacity
• Organizational resources, such as its formal reporting structure and systems
• Physical resources, such as location
• Technological resources, such as patents and trademarks
53
Intangible Resources
A firm's intangible resources may be less visible, but they are no less important. In fact, they
may be more important as a source of core competencies. Intangible resources range from
innovation resources, such as knowledge, trust, and organizational routines, to the firm's
people-dependent or subjective resources of know-how, networks, organizational culture, to
the firm's reputation for its goods and services and the way it interacts with others (such as
employees, suppliers, or customers).
Intangible Resources
A firm's intangible resources can be classified as:
• Human resources, such as knowledge, trust, and managerial capabilities
• Innovation resources, such as scientific capabilities and capacity to innovate
• Reputational resources, such as the firm's reputation with customers or suppliers
Because tangible resources are those that can be seen (such as plants), touched (such as
equipment), documented (such as contracts with suppliers of raw materials), or quantified
(such as the value of a specific asset), they generally do not, by themselves, represent
capabilities that serve as sources of core competencies. However, they still have value and will
contribute to the development of capabilities and core competencies.
Because they cannot be quantified, touched, or seen, and are more difficult to explain,
intangible resources are more likely to be sources of sustainable competitive advantage. And,
if they also are difficult for competitors to identify and/or understand, they also may represent
the most likely source(s) of a firm's capabilities, core competencies, and sustained competitive
advantage.
54
The Value of Brands: A Mini-Lecture
One intangible resource that may enable a firm to create a reputation and serve as a
source of competitive advantage is a brand name. Specifically, what a brand name
communicates to customers about the performance characteristics or attributes of a
firm's product(s) represents a direct link to a firm's reputation with its customers.
When the brand name communicates positive characteristics of a product (for example,
superior performance, high quality, or superior value), consumers will tend to purchase
the brand name product rather than similar products offered by competing firms. Thus,
it is important that companies with strong brand names nurture the core competencies
that provide the brand name with value and continually communicate that value through
consistent advertising messages.
When a firm has a brand name that serves as a foundation for competitive advantage,
the firm often will try to leverage the power of that brand name. Using an example in
the chapter, Harley-Davidson's name now adorns a limited edition Barbie doll, a popular
restaurant in New York City, and a line of L’Oreal cologne. Moreover, Harley-Davidson
Motorclothes generates over $100 million in revenue for the firm each year, and the
Harley brand adorns many clothing items, from black leather jackets to fashions for tots.
The value of a brand name can be lessened or reduced by competitive actions that the
firm either does not recognize or to which it fails to respond. In the consumer goods
segment, national brands are under attack by private label store brands. And some
appear to be losing the battle as customer preferences are shifting toward private labels
that may be perceived as providing more value than the national brands. In many cases,
national brands have reacted to such threats by cutting prices.
However, cost-cutting is not the only strategy that can be used to safeguard a brand.
• For companies whose brand names are expected to thrive and continue to provide a
competitive advantage (such as Nike or Hanes), their challenge is to nurture and
exploit the resources, capabilities, and core competencies that are the source of
competitive advantage.
• For companies whose brands are under fire (such as Marlboro or Budweiser), the
challenge is to re-establish the value of the brand. They must reconfigure their
existing bundle of resources, capabilities, and core competencies to renew them as
sources of competitive advantage.
• For companies whose brands are troubled, because the brands are no longer a source
of competitive advantage, the challenge is even greater: they must identify and
55
develop new bundles of resources and capabilities and nurture them to establish a
new source of competitive advantage.
• Firms also may choose to package their brand as a way to differentiate themselves
from competitors, as Century 21 Real Estate has done by using technology to make
its offices virtual home stores by offering many discounted home services, including
cable service, appliances, insurance, and mortgages.
• Other firms (e.g., Procter & Gamble, General Motors, and Philip Morris) support
their brand-name products through heavy advertising expenditures.
Note: It is important to remember that resources - both tangible and intangible -
represent the primary sources that enable a firm to establish capabilities, the capacity
for a set or bundle of unique resources to perform a task or activity integratively. In
other words, individual resources alone, while they may have value, will contribute to
the development of capabilities only when they are put together in unique combinations
to provide the foundation for core competencies and the establishment of competitive
advantage. Examples include a firm’s information-based tangible resources (Table 3.1)
and/or its intangible resources (Table 3.2).
Capabilities
As implied in the definition, a firm’s capabilities represent its capacity to integrate individual
firm resources to achieve a desired objective, though this ability does not emerge overnight.
Capabilities develop over time as a result of complex interactions that take advantage of the
interrelationships between a firm’s tangible and intangible resources that are based on the
development, transmission, and exchange or sharing of information and knowledge as carried
out by the firm’s employees (its human capital).
A firm’s ability to achieve a competitive advantage is thus reflected in its knowledge base and
the ability of its human capital to successfully exploit firm capabilities. Thus, human capital is
of significant value in the firm’s ability to develop capabilities and core competencies to
achieve strategic competitiveness.
The knowledge possessed by the firm’s human capital may be one of the most significant
sources of a firm’s competitive advantage because it represents everything that the firm has
learned, and thus everything that it knows about successfully linking or bundling sets of
individual resources to develop capabilities as a foundation for developing core competencies
and, ultimately, to achieve a competitive advantage.
56
Establishing and nurturing the skills and abilities of the workforce is of critical importance to
a firm’s ability not only to establish, but to sustain a competitive advantage by acquiring new
knowledge and developing new skills that will enhance existing capabilities and core
competencies, as well as aid in the development of new ones.
Firms also have functional area capabilities they have nurtured and are now considered as core
competencies. As a result, these core competencies provide the foundation for the firm’s
competitive advantage.
Examples of Firms’ Capabilities
Table 3.3 provides examples of functional areas, capabilities, and firm examples across a
variety of industries. It indicates that a number of functional area capabilities have the potential
to serve as the foundation for a firm’s competitive advantage.
Core Competencies
Once a firm has identified its resources and capabilities, it is ready to identify its core
competencies, the resources and capabilities that are a source of competitive advantage for the
firm over its competitors. Core competencies emerge over time through an organizational
process of accumulating and learning how to deploy different resources and capabilities. As
the capacity to take action, core competencies are the “crown jewels of a company,” the
activities the company performs especially well compared with competitors and through which
the firm adds unique value to its goods or services over a long period.
57
Not all of a firm’s resources and capabilities are strategic assets - that is, assets that have
competitive value and the potential to serve as a source of competitive advantage. Some
resources and capabilities may result in incompetence, because they represent competitive
areas in which the firm is weak compared to competitors. Thus, some resources or capabilities
may stifle or prevent the development of a core competence.
When the firm's resources and capabilities result in a core competence, the firm will be able to
produce goods or services with features and characteristics that are valued by customers. This
implies that firms can implement value-creating strategies only when its capabilities and
resources can be combined to form core competencies.
The question is asked: “How many core competencies are required for a competitive
advantage?” McKinsey & Company recommends that firms identify 3 or 4 competencies
around which to frame their strategic actions.
BUILDING CORE COMPETENCIES
This section discusses two conceptual tools/frameworks firms can use to identify competitive
advantages:
• Four criteria determine which of the firm’s resources and capabilities are core
competencies.
• Value chain analysis, a tool for determining which value-creating competencies should be
maintained, upgraded, and developed and which should be outsourced.
Four Criteria for Sustainable Competitive Advantage
Four criteria should be used to determine whether or not a firm’s capabilities are core
competencies and can be a source of competitive advantage.
The Four Criteria of Sustainable Strategic Capabilities
58
Before they can be sources of competitive advantage, capabilities must be:
• valuable • rare • costly-to-imitate • nonsubstitutable
It is important to understand that a firm’s capabilities must meet all four of the criteria noted
earlier before they can be core competencies and enable the firm to achieve a sustainable
competitive advantage.
However, a short-term competitive advantage is available when firm capabilities are valuable,
rare, and non-substitutable. The length of time that a firm possessing such capabilities can
expect to sustain a competitive advantage depends on how long it takes for competitors to
successfully imitate the value-creating activity or process, or reproduce valued features or
characteristics of the product or service.
Thus, the ability to sustain a competitive advantage is dependent on firm capabilities being
valuable, rare, non-substitutable, and costly to imitate.
Valuable
Capabilities that are valuable help a firm exploit opportunities and/or neutralize threats in the
external environment. Valuable capabilities allow a firm to develop and implement strategies
that create customer value.
Rare
Capabilities are rare when they are possessed by few, if any, current or potential competitors.
If many firms have the same capabilities, the same value-creating strategies will be selected.
As a result, none of the firms will be able to achieve a sustainable competitive advantage. A
competitive advantage will be achieved by firms that develop and exploit capabilities that are
different from those held by other firms.
Costly to Imitate
Capabilities are costly to imitate when other firms are unable to develop them except at a cost
disadvantage relative to firms that already have them. This usually is a result of one or a
combination of three conditions:
1. Unique historical conditions can make duplication of capabilities costly. For example,
establishing facilities in a key location that can preempt competition when no other locations
59
have similar value-related characteristics or developing a unique organizational culture in the
early stages of the organization's life may not be cheap to duplicate by firms that are developing
theirs at a different time.
A unique culture may not only serve as a source of competitive advantage, but also can be a
source of competitive disadvantage. The latter may be the case when a firm's culture prevents
it from recognizing or successfully adapting to changes in a turbulent environment.
2. Causal ambiguity also may prevent competitors from perfectly imitating a competency if
the link between a firm's capabilities and core competencies is not identified or understood.
Competitors may not be able to identify or determine how a firm uses its competencies to
achieve a sustainable competitive advantage.
3. Social complexity means that a firm's capabilities are the product of complex social
phenomena such as interpersonal relationships within the firm (e.g., how managers and
subordinates at Hewlett-Packard work with each other) or a firm’s reputation with its
customers and suppliers.
Nonsubstitutable
A firm's capabilities are nonsubstitutable when they do not have strategic equivalents. Firm
resources are strategically equivalent when each can be separately exploited to implement the
same strategies. If capabilities are invisible, it is even more difficult for competitors to identify
viable substitutes. Examples of capabilities that can be difficult to identify or to find suitable
substitutes include firm-specific knowledge and trust-based working relationships.
Outcomes from Combinations of the Criteria for Sustainable Competitive Advantage
Highlights from Table 3.5 are:
• Resources and capabilities that are neither valuable, rare, costly to imitate, nor
nonsubstitutable mean that the firm will be at a competitive disadvantage and will earn
below-average returns.
60
• Resources and capabilities that are valuable, but are neither rare nor costly to imitate and
may or may not be nonsubstitutable mean that the firm can achieve competitive parity and
earn average returns.
• Resources and capabilities that are both valuable and rare, but are not costly to imitate and
may or may not be nonsubstitutable, may enable the firm to achieve a temporary competitive
advantage and will earn above-average to average returns.
• Resources and capabilities that are valuable, rare, costly to imitate, and nonsubstitutable
will enable the firm to achieve a sustainable competitive disadvantage and earn above-
average returns.
Value Chain Analysis
A framework that firms can use to identify and evaluate the ways in which their resources and
capabilities can add value is value chain analysis. This framework is useful because it enables
firms to understand which parts of their operations or activities create value by segmenting the
value chain into primary and secondary activities as illustrated in Figure 3.3.
A Model of the Value Chain
Figure 3.3 illustrates how the value-creating activities performed by the firm can be separated
into value chain activities and support functions.
Value chain activities represent traditional line activities such as supply chain management,
operations, distribution, marketing, and follow-up service.
61
Support functions are represented by a firm's staff activities and include its financial
infrastructure, human resource management practices, and management information systems
activities.
Creating Value Through Value Chain Activities
Figure 3.4 illustrates the link between the value chain activities and customer value. All areas
of the value chain can help firms deliver value to customers.
Supply-chain management consists of activities including sourcing, procurement,
conversion, and logistics management that are necessary for the firm to receive raw
materials and convert them into final products.
Operations consist of activities necessary to efficiently change raw materials into finished
products. Developing employees’ work schedules, designing production processes and
physical layout of the operations’ facilities, determining production capacity needs, and
selecting and maintaining production equipment are examples of specific operations
activities.
Distribution consists of activities related to getting the final product to the customer.
Efficiently handling customers’ orders, choosing the optimal delivery channel, and
62
working with the finance support function to arrange for customers’ payments for delivered
goods are examples of these activities.
Marketing (including sales) consists of activities taken for the purpose of segmenting
target customers on the basis of their unique needs, satisfying customers’ needs, retaining
customers, and locating additional customers. Advertising campaigns, developing and
managing product brands, determining appropriate pricing strategies, and training and
supporting a sales force are specific examples of these activities.
Follow-up service consists of activities taken to increase a product’s value for customers.
Surveys to receive feedback about the customer’s satisfaction, offering technical support
after the sale, and fully complying with a product’s warranty are examples of these
activities.
Creating Value Through Support Functions
Figure 3.5 illustrates the link between the support functions a company performs and customer
value. All support functions can help firms deliver value to customers.
63
Finance consists of activities associated with effectively acquiring and managing financial
resources. Securing adequate financial capital, investing in organizational functions in
ways that will support the firm’s efforts to produce and distribute its products in the short-
and long-term, and managing relationships with those providing financial capital to the
firm are specific examples of these activities.
Human Resource consists of activities associated with managing the firm’s human capital.
Selecting, training, retaining, and compensating human resources in ways that create a
capability and hopefully a core competence are specific examples of these activities.
Management Information Systems consist of activities taken to obtain and manage
information and knowledge throughout the firm. Identifying and utilizing sophisticated
technologies, determining optimal ways to collect and distribute knowledge, and linking
relevant information and knowledge to organizational functions are activities associated
with this support function.
Using the value chain framework enables managers to study the firm’s resources and
capabilities in relationship to the primary and support activities performed to design,
manufacture, and distribute products, and to assess them relative to competitors’ capabilities.
For these activities to be sources of competitive advantage, a firm must be able to:
• Perform primary or support activities in a manner superior to the ways that competitors
perform them
• Perform a primary or support activity that no competitor is able to perform to create superior
value for customers and achieve a competitive advantage
This implies that, given that individual firms comprise unique or heterogeneous bundles of
activities, reconfiguring the value chain - or re-bundling resources and capabilities - may
enable a firm to develop unique value-creating activities.
The managerial challenge is that the value-creation process is difficult and there is no one best
way to assess a firm’s primary and support activities or to evaluate the value-creating potential
of those activities either within the firm or relative to competitors, because of incomplete or
ambiguous data.
By being objective, managers may be able to use the value chain framework to identify new,
unique ways to combine resources and capabilities to create value that are difficult for
competitors to recognize, understand, or imitate. The longer a firm is able to keep competitors
“in the dark” as to how resources and capabilities have been combined to create value, the
longer a firm will be able to sustain a competitive advantage.
64
Firms can use outsourcing as an alternative to identify primary or support activities for which
its resources and capabilities are not core competencies and do not enable the firm to add
superior value and achieve competitive advantage.
OUTSOURCING
Outsourcing describes a firm's decision to purchase a value-creating activity from an external
supplier. Outsourcing has become important - and may become more important in the future -
for two reasons:
• There are limits to the abilities of firms to possess all of the bundles of resources and
capabilities that are required to achieve superior performance (relative to competitors) in all
its primary and support activities.
• With limited resources and capabilities, firms can increase their ability to develop resources
and capabilities to form core competencies and achieve competitive advantage by nurturing
a few core competencies.
Firms engaging in outsourcing can increase their flexibility, mitigate risks, and reduce their
capital investment.
Other research suggests that outsourcing does not work effectively without extensive internal
capabilities to coordinate external sourcing as well as core competencies.
To ensure that the appropriate primary and support activities are outsourced, four skills are
essential for managers involved in outsourcing programs:
• Strategic thinking – understanding whether/how outsourcing creates competitive advantage
within the company
• Deal making – ability to secure rights from external providers that can be fully used by
internal managers
• Partnership governance – ability to oversee and govern appropriately the relationship with
the company to which the services were outsourced
• Change management – because outsourcing can significantly change how an organization
operates, managers administering these programs must also be able to manage that change,
including resolving employee resistance that accompanies any significant change effort
COMPETENCIES, STRENGTHS, WEAKNESSES, AND STRATEGIC DECISIONS
Tools such as outsourcing help the firm focus on its core competencies as the source of its
competitive advantages. However, evidence shows that the value-creating ability of core
65
competencies should never be taken for granted. Moreover, the ability of a core competence
to be a permanent competitive advantage can’t be assumed.
All core competencies have the potential to become core rigidities. As Leslie Wexner, CEO of
The Limited, Inc., says: “Success doesn’t beget success. Success begets failure because the
more that you know a thing works, the less likely you are to think that it won’t work. When
you’ve had a long string of victories, it’s harder to foresee your own vulnerabilities.” Thus,
each competence is a strength and a weakness - a strength because it is the source of
competitive advantage and, hence, strategic competitiveness, and a weakness because, if
emphasized when it is no longer competitively relevant, it can sow the seeds of organizational
inertia.
Events occurring in the firm’s external environment create conditions through which core
competencies can become core rigidities, generate inertia, and stifle innovation. According to
one observer, “Often the flip side, the dark side, of core capabilities is revealed due to external
events when new competitors figure out a better way to serve the firm’s customers, when new
technologies emerge, or when political or social events shift the ground underneath.”
In the final analysis, changes in the external environment do not cause core competencies to
become core rigidities; rather, strategic myopia and inflexibility on the part of managers are
the cause. Thus, nurturing existing competencies must be balanced by efforts to encourage the
development of new competencies.
SUMMARY
• In the current competitive landscape, the most effective organizations recognize that
strategic competitiveness and above-average returns result only when core
competencies (identified by studying the firm’s internal organization) are matched with
opportunities (determined by studying the firm’s external organization).
• No competitive advantage lasts forever. Over time, rivals use their own unique
resources, capabilities, and core competencies to form different value-creating
propositions that duplicate the local firm’s ability to create value for customers.
Because competitive advantages are not permanently sustained, firms must exploit
their current advantages while simultaneously using their resources and capabilities to
form new advantages that can lead to future competitive success.
• Effectively managing core competencies requires careful analysis of the firm’s
resources (inputs to the production process) and capabilities (resources that have been
purposely integrated to achieve a specific task or set of tasks). The knowledge the
firm’s human capital possesses is among the most significant of an organization’s
capabilities and ultimately provides the base for most competitive advantages. The firm
66
must create an organizational culture that allows people to integrate their individual
knowledge with that held by others so that, collectively, the firm has a significant
amount of value-creating organizational knowledge.
• Capabilities are more likely source of core competitiveness and subsequently of
competitive advantages that are individual resources. How a firm nurtures and supports
its capabilities so they can become core competencies is less visible to rivals, making
efforts to understand and imitate the focal firm’s capabilities difficult.
• Only when a capability is valuable, rare, costly to imitate, and nonsubstitutable is it a
core competence and a source of competitive advantage. Over time, core competencies
must be supported, but they cannot be allowed to become core rigidities. Core
competencies are a source of competitive advantage only when they allow the firm to
create value by exploiting opportunities in its external environment. When this is no
longer possible, the company shifts its attention to forming other capabilities that
satisfy the four criteria of sustainable competitive advantage.
• Value chain analysis is used to identify and evaluate the competitive potential of
resources and capabilities. By studying their skills relative to those associated with
value chain activities and support functions, firms can understand their cost structure
and identify the activities through which they are able to create value.
• When the firm cannot create value in either a value chain activity or a support function,
outsourcing is considered. Used commonly in the global economy, outsourcing is the
purchase of a value-creating activity from an external supplier. The firm should
outsource only to companies possessing a competitive advantage in terms of the
particular value chain activity or support function under consideration. In addition, the
firm must continuously verify that it is not outsourcing activities through which it could
create value.
67
REVIEW QUESTIONS
1. Why is it important for a firm to study and understand its internal organization?
2. What is value? Why is it critical for the firm to create value? How does it do so?
3. What are the differences between tangible and intangible resources? Why is it important
for decision makers to understand these differences? Are tangible resources more valuable
for creating capabilities than are intangible resources, or is the reverse true? Why?
4. What are capabilities? How do firms create capabilities?
5. What four criteria must capabilities satisfy for them to become core competencies? Why is
it important for firms to use these criteria to evaluate their capabilities’ value-creating
potential?
6. What is value chain analysis? What does the firm gain by successfully using this tool?
7. What is outsourcing? Why do firms outsource? Will outsourcing’s importance grow in the
future? If so, why?
8. How do firms identify internal strengths and weaknesses? Why is it vital that managers
have a clear understanding of their firm’s strengths and weaknesses?
10. What are core rigidities? What does it mean to say that each core competence could become
a core rigidity?
68
References
Michael A. Hitt, R. Duane Ireland, Robert E. Hoskisson. (2020). Strategic Management
Competitiveness and Globalization: Concepts and Cases Twelfth Edition.
Cengage Learning Asia Pte Ltd.
