Strategic Management

The Internal Environment

The Internal Organization: Resources, Capabilities, Core Competencies and Competitive Advantages
The fundamental building blocks for building winning strategies
Strategic Management and Strategic
Competitiveness
 Overview: Content areas
 Importance of understanding internal organization
 Value: Definition and importance
 Tangible vs intangible resources
 Capabilities: Definition and development
 Core competencies: Criteria (N=4)
 Value Chain Analysis
 Outsourcing: Definition and “why?”
 Outcome of internal organization assessment
Economic Profits of U.S. Industry Groups,
1994–2012
Economic Profits in the Pharmaceutical
Industry, 1994–2012
Economic Profits in the Steel Industry,
1994–2012

• When the external environment is subject to rapid change, internal resources and
capabilities offer a more secure basis for strategy than market focus
• Resources and capabilities are the primary source of profitability. Firm-specific
strategic differences account for 50-70 percent of observed differences in firms’ profits
Analysing Internal Organization
 By analyzing its internal organization, a firm determines
what it can do. Matching what a firm can do (a function of
its resources, capabilities, and core competencies) with
what it might do (a function of opportunities and threats
in the external environment) allows the firm to develop
vision, pursue its mission, and select and implement its
strategies to achieve………
 Competitive advantage
 A firm’s profitability is greater than the average profitability for
all firms in its industry.
 Sustained competitive advantage
 A firm maintains competitive advantage for a number of years.
Analysing Internal Organization
Resource Base View of Firm
 Getting competitive advantage by
 Selecting a business strategy that exploits valuable resources
and distinctive competencies (ie. competitive advantages)
 Ensuring that all resources and capabilities are fully employed
and exploited
 Building and regenerating valuable resources and distinctive
competencies -- competitive advantages
Analysing Internal Organization
Resource Base View of Firm
Resources, Capabilities, and Competitive
Advantage: The Basic Relationships

INDUSTRY
KEY
COMPETITIVE SUCCESS
ADVANTAGE STRATEGY FACTORS

ORGANIZATIONAL
CAPABILITIES

RESOURCES

Tangible Intangible Human

Analysing Internal Environment
 Organizational core competencies create and
sustain its competitive advantage
 To determine Core Competencies analysis of firm’s
portfolio of resources and bundle of heterogeneous
resources and capabilities is needed.

 Context of Internal Analysis: ‘Global mind-set’

 Ability to study an internal environment in ways that do
not depend on the assumptions of a single country,
culture, or context
Understanding Value
 Creating Value for customers is the source of AAR
 Firms exploit core competencies or competitive
advantage to create value for the customers.
 Value: measured by a product's performance
characteristics and by its attributes for which
customers are willing to pay .
Understanding Value
Understanding Value
Understanding Value
Resources, Capabilities and Core
Competencies
 Resources
 Assets bundled to create organizational capabilities
 Tangible and intangible
 Tangible
 Assets that can be seen, touched and quantified
 Examples include equipment, facilities, distribution centers, formal
reporting structures
 Four specific types
 Intangible
 Assets rooted deeply in the firm’s history, accumulated over time
 In comparison to ‘tangible’ resources, usually can’t be seen or touched
 Examples include knowledge, trusts, organizational routines,
capabilities, innovation, brand name, reputation
 Three specific types
Resources, Capabilities and Core
Competencies
Tangible Resources
Financial Resources • The firm’s borrowing capacity
• The firm’s ability to generate internal funds
Organizational Resources • 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, trademarks, copyrights, and trade
secrets

Intangible Resources
Human Resources • Knowledge
• Trust
• Managerial capabilities
• Organizational routines
Innovation Resources • Ideas
• Scientific capabilities
• Capacity to innovate
Reputational Resources • Reputation with customers and Suppliers
• Brand name
• Perceptions of product quality, durability, and reliability
• For efficient, effective, supportive, and mutually beneficial
interactions and relationships
Defining Organizational Capabilities
 Organizational Capabilities = firm’s capacity for
undertaking a particular activity. (Grant)
 Distinctive Competence = things that an organization
does particularly well relative to competitors. (Selznick)
 Core Competence = capabilities that are fundamental to
a firm’s strategy and performance. (Hamel and Prahalad)
Resources, Capabilities and Core
Competencies
 Capabilities
 Formed by unique bundling of resources to achieve a
specific task/set of tasks
 Source of a firm’s core competencies.
 Product of organizational structure, processes, and
control systems.
 Often based on developing, carrying and exchanging
information and knowledge through the firm’s human
capital.
 Capabilities are often developed in specific functional
areas (such as manufacturing, R&D, and marketing) or in
a part of functional area (eg.Advertising).
Resources, Capabilities and Core
Competencies
Capabilities
Functional Areas Capabilities Examples of Firms
Distribution Effective use of logistics management techniques Wal-Mart / Hindustan Unilever
Human Resources Motivating, empowering, and retaining employees Google / Microsoft
Management Information Effective and efficient control of inventories through point- of- Wal-Mart
Systems purchase data collection methods
Marketing Effective promotion of brand-name products Procter & Gamble
Effective customer service HUL, ITC., McKinsey & Co.
Innovative merchandising Cavincare

Management Ability to envision the future PepsiCo

Effective organizational structure
Manufacturing Design and production skills yielding reliable products Honda/ Toyota
Product and design quality Tata Motors
Miniaturization of components and products Sony
Research & Development Innovative technology 3M
Development of sophisticated elevator control solutions Otis Elevator Co.
Rapid transformation of technology into new products and Thomson Consumer Electronics
processes
Digital technology
Resources, Capabilities and Core
Competencies
 Core Competencies
 Capabilities that serve as a source of CA for a firm over its rivals.
 Defined as "a harmonized combination of multiple resources and skills
that distinguish a firm in the marketplace".
 Shapes the personality of firm.
 developed through the process of continuous improvements over
the period of time rather than a single large change.
 Core competencies fulfill three criteria:
 Provides potential access to a wide variety of markets.
 Should make a significant contribution to the perceived customer benefits
of the end product.
 Difficult to imitate by competitors.
 A company's core competencies may include precision mechanics,
fine optics, and micro-electronics. These help it build cameras but
may also be useful in making other products that require these
competencies.
Competence based strategy is the part of an overall strategy that is concerned
with integrating technology, know-how (including patents), value and culture in order
to create a set of competencies that unfolds superior value for customers and
thereby support the product-market strategy of the firm.
Core competencies are the
collective learning of the
organization, especially how to
coordinate the diverse production
skill and integrate multiple stream of
technologies.
Unlike physical assets, which do
deteriorate over time, competences
are enhanced as applied and shared
across the organization. The
competences act as the glue which
bind businesses together as well as
pave the way for new business
development. In other words core
competences of a business are also
guiding parameters for new markets
and diversification.
Core competencies extend to the whole organization and are part of tactical learning at the same time. We should
not confuse a core competence with a core technology. A technology / technical capabilities is complete in itself
while a core competence is embedded inside the organization. Without one another it can’t exist. We should also
differentiate between core competencies and core capabilities. Core capabilities are crucial for survival but, unlike
a core competency, does not confer any specific differential advantage over other competitors in the industry.
Canon: Products and Core Technical Capabilities

Precision Fine
Mechanics Optics

35mm SLR camera Plain-paper copier

Compact fashion camera Color copier
EOS autofocus camera Color laser copier
Digital camera
Basic fax Laser copier
Video still camera
Laser fax
Mask aligners Inkjet printer
Excimer laser aligners Laser printer
Stepper aligners Color video printer
Calculator
Notebook computer

Micro-
Electronics
How Exactly Distinctive Competencies
Work?

 A Critical Distinction
• If a firm has firm-specific and valuable resources, it must also have the capability to use them
effectively to create distinctive competency.
• A firm can create distinctive competency without firm-specific and valuable resources if it has
unique capabilities.
Building Core Competencies
 Two tools firms use to identify and build on their core
competencies
 Four specific criteria that firm can use to determine those
capabilities that are core competencies.
 Value Chain Analysis: Firms use to select the value creating
competencies that should be maintained, or developed, and
those that should be outsourced.
Building Core Competencies
Criteria for sustainable competitive advantage
Valuable Capabilities • Help a firm neutralize threats or exploit opportunities to create value
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

Non-substitutable Capabilities • No strategic equivalent : each can be separately exploited to implement

the same strategy.

Outcomes from combinations of the criteria for sustainable competitive advantage

Is the Resource Is the Resource Is the Resource Is the Resource or Competitive Performance
or Capability or Capability or Capability Capability Consequences Implications
Valuable? Rare? Costly to Imitate? Non- substitutable?

No No No No Competitive Below-average
disadvantage returns
Yes No No Yes/no Competitive parity Average returns

Yes Yes No Yes/no Temporary Average returns to

competitive above-average
advantage returns
Yes Yes Yes Yes/no Sustainable Above-average
competitive returns
advantage
What makes a resource valuable?

Appropriability
Scarcity

Demand

Value creation zone

The dynamic interplay of three fundamental market forces determines the
value of a resource.

Source: Collis and Montgomery, Corporate Strategy (1996)

 Resource Imitability
Cannot be imitated:
Patents
Unique location
Unique assets
(e.g. Mineral rights)

Difficult to Imitate:
Brand Loyalty
Favorable cost position
Employee Satisfaction
Reputation for Fairness

Can be Imitated (but may not be):

Capacity Pre-emption
Economies of Scale
Easy to Imitate:
Cash
Commodities

Source: Collis and Montgomery, Corporate Strategy: Resources and the Scope of the Firm (1996).
First-Mover Advantages in Resource
Acquisition
 Patents
 Brand Recognition
 Reputation
 Accumulated Learning
 Attractive Locations
 Installed Base
 Identifying a Company’s
Identifying a Company's Capabilities
Capabilities and Value Chain
Functional Area Capability Example

• Corporate head office

• Capability in basic e.g., IBM, AT&T,
• Management information
research Sony
• Research and development
• Ability to produce • 3M
• Manufacturing innovative products
• Canon
• Product design • Speed of new
product development
• Marketing

• Sales and distribution

Source: Robert M. Grant, Contemporary Strategy Analysis, Basil Blackwell, 1991.

Building Core Competencies
 Value Chain
 Primary activities
 Involved with product’s physical creation, sales and distribution,
and service after the sale
 Includes outbound/inbound logistics, operations,
marketing/sales, and Service.
 Support activities
 Provide assistance necessary for the primary activities to take
place
 Includes firm infrastructure, HRM, technology development and
procurement
Building Core Competencies
Building Core Competencies
Primary Activities Secondary Activities
Procurement
Inbound Logistics
Activities completed to purchase the inputs needed to produce a
Activities, such as materials handling, warehousing, and inventory
firm’s products. Purchased inputs include items fully consumed during
control, used to receive, store, and disseminate inputs to a product.
the manufacture of products (e.g., raw materials and supplies, as well
Operations as fixed assets—machinery, laboratory equipment, office equipment,
Activities necessary to convert the inputs provided by inbound logistics
and buildings).
into final product form. Machining, packaging, assembly, and equipment
maintenance are examples of operations activities. Technological Development
Activities completed to improve a firm’s product and the processes
used to manufacture it. Technological development takes many
Outbound Logistics
forms, such as process equipment, basic research and product design,
Activities involved with collecting, storing, and physically distributing
and servicing procedures.
the final product to customers. Examples of these activities include
finished-goods warehousing, materials handling, and order processing. Human Resource Management
Marketing and Sales Activities involved with recruiting, hiring, training, developing, and
Activities completed to provide means through which customers can compensating all personnel.
purchase products and to induce them to do so. To effectively market Firm Infrastructure
and sell products, firms develop advertising and promotional campaigns, Firm infrastructure includes activities such as general management,
select appropriate distribution channels, and select, develop, and
planning, finance, accounting, legal support, and governmental
support their sales force.
relations that are required to support the work of the entire value
Service chain. Through its infrastructure, the firm strives to effectively and
consistently identify external opportunities and threats, identify
Activities designed to enhance or maintain a product’s value. Firms
engage in a range of service-related activities, including installation, resources and capabilities, and support core competencies.
repair, training, and adjustment. Each activity should be examined relative to competitors’ abilities.
Each activity should be examined relative to competitors’ abilities. Accordingly, firms rate each activity as superior, equivalent, or
Accordingly, firms rate each activity as superior, equivalent, or inferior. inferior.
 Value chain for Irizar, a Spanish manufacturer of
bodies for luxury buses and coaches

FQM- Facilitators Quality Management ; JIT -Just-in-time; EOS- Economies of scale; ISO- International Organization of Standardization
Source: Adapted from Ramon Casadesus-Masanell and Joan Enric Ricart Costa, "Competing Through Business Models (A): Business Models Essentials,
Module Note,“ HBS No. 708 452, Boston, MA: Harvard Business School, 2008. Copyright © 2008 by the President and Fellows of Harvard College.
Value chain for Irizar, a Spanish manufacturer of
bodies for luxury buses and coaches
Value Chain System for an Entire Industry
 A company’s cost/differentiation competitiveness depends not
only on the costs/differentiation of internally performed
activities (its own value chain) but also on costs/differentiation
in the value chains of its suppliers and distribution channel
allies.

 Industry Value Chain:

 The firm’s internal value chain
 The value chains of industry suppliers
 The value chains of channel intermediaries

 Effects of the Industry Value Chain:

 Costs and margins of suppliers and channel partners can affect prices to end consumers.
 Activities of channel partners can affect industry sales volumes and customer satisfaction.
Value Chain System for an Entire Industry
 Industry
and Firm
Value Chain
Value Chain of a Producer of Polo Shirts

 Which activities in the value chain are primary activities?

Which are secondary activities?
 Which activities are linked to the value chain for the entire
industry?
 How activity cost(s) could be reduced without harming the
competitive strength of company?
Value Chain Analysis
 Value Chain Analysis
 Facilitates an activity-by-activity comparison, of how
effectively and efficiently a firm delivers value to its
customers, relative to its competitors.

 The Value Chain Analysis Process

 Segregate the firm’s operations into different types of
primary and secondary activities to identify the major
components of its internal cost structure.
 Use activity-based costing to evaluate the activities.
 Do the same for significant competitors.
 .
Outsourcing
 Purchase of a value-creating activity from an external
supplier
 Effective execution includes an increase in flexibility, risk
mitigation and capital investment reduction
 Trend continues at a rapid pace
 Firms must outsource activities where they cannot create
value or are at a substantial disadvantage compared to
competitors
 Can cause concerns
 Usually revolves around innovative ability and loss of jobs
 .
Benchmarking
 Benchmarking:
 a potent tool for improving a company’s own internal activities that is based on learning
how other companies perform them and borrowing their “best practices.”
 Help improve a firm’s internal activities based on learning from other companies’ “best
practices.”
 Assesses whether the cost competitiveness and effectiveness of a firm’s value chain
activities are in line with its competitors’ activities.

 Sources of Benchmarking Information

 Reports, trade groups, analysts and customers
 Visits to benchmark companies
 Data from consulting firms
 Benchmarking the costs of company activities against rivals provides hard evidence
of whether a company is cost-competitive.
 .
Benchmarking and Ethical Conduct
 Avoid discussions or actions that could lead to or imply an interest in
restraint of trade, market and/or customer allocation schemes, price fixing,
dealing arrangements, bid rigging, or bribery. Don’t discuss costs with
competitors if costs are an element of pricing.
 Refrain from the acquisition of trade secrets from another by any means
that could be interpreted as improper, including the breach of any duty to
maintain secrecy. Do not disclose or use any trade secret that may have
been obtained through improper means or that was disclosed by another
in violation of duty to maintain its secrecy or limit its use.
 Be willing to provide to your benchmarking partner the same type and level
of information that you request from that partner.
 Communicate fully and early in the relationship to clarify expectations,
avoid misunderstanding, and establish mutual interest in the benchmarking
exchange.
 .
Benchmarking and Ethical Conduct
 Be honest and complete with the information submitted.
 The use or communication of a benchmarking partner’s name with the data
obtained or practices observed requires the prior permission of the
benchmarking partner.
 Honor the wishes of benchmarking partners regarding how the information
that is provided will be handled and used.
 In benchmarking with competitors, establish specific ground rules up-front.
For example, “We don’t want to talk about things that will give either of us
a competitive advantage, but rather we want to see where we both can
mutually improve or gain benefit.”
 Check with legal counsel if any information-gathering procedure is in doubt.
If uncomfortable, do not proceed. Alternatively, negotiate and sign a specific
nondisclosure agreement that will satisfy the attorneys representing each
partner.
 .
Strategic Options for Remedying
a Cost/ Value Disadvantage
 Places in the total value chain system for a firm to look
for ways to improve its efficiency and effectiveness:
 The firm’s own internal activity segments
 The suppliers’ part of the overall value chain system
 The forward channel portion of the value chain
system
 .
Strategic Options for Remedying
a Cost/ Value Disadvantage: Internal Activities
 Implement best practices throughout the firm, particularly for
high-cost activities.
 Eliminate some cost-producing activities altogether by
revamping the value chain.
 Relocate high-cost activities to areas where they can be
performed more cheaply.
 Outsource activities that can be performed by vendors or
contractors more cheaply than if done in-house.
 Invest in productivity enhancing, cost-saving technological
improvements.
 Find ways to detour around activities or items where costs are
high.
 Redesign products and/or components to facilitate speedier
and more economical manufacture or assembly.
Strategic Options for Remedying
a Cost/ Value Disadvantage: Supplier Related Activities

 Pressure suppliers for lower prices.

 Switch to lower-priced substitute inputs.
 Collaborate closely with suppliers to identify mutual cost-
saving opportunities.
 Work with suppliers to enhance the firm’s differentiation.
 Select and retain suppliers who meet higher-quality
standards.
 Coordinate with suppliers to enhance design or other
features desired by customers.
 Provide incentives to suppliers to meet higher-quality
standards, and assist suppliers in their efforts to improve.
Strategic Options for Remedying
a Cost/ Value Disadvantage: Forward Channel Related Activities
 Achieving Cost-Based Competitiveness:
 Pressure forward channel allies to reduce their costs and markups so as to make
the final price to buyers more competitive.
 Collaborate with forward channel allies to identify win-win opportunities to
reduce costs.
 Change to a more economical distribution strategy, including switching to
cheaper distribution channels.
 Achieving Non-Cost-Based Competitiveness
 Engage in cooperative advertising and promotions with forward channel allies.
 Use exclusive arrangements with downstream sellers or other mechanisms that
increase their incentives to enhance delivered customer value.
 Create and enforce standards for downstream activities and assist in training
channel partners in business practices.
From Value Chain to Competitive
Advantage
 Performing value chain analysis help the firm in
either:
 outmatch rivals on differentiation or
 beat them on costs
From Value Chain to Competitive
Advantage
From Value Chain to Competitive
Advantage
Outcome of Value Chain Analysis
 Firms must identify their strengths and weaknesses
 Appropriate resources and capabilities needed to develop
desired strategy and create value for customers/other
stakeholders
 Tools (I.e., outsourcing) can help a firm focus on core
competencies as the source for CA

 Core competencies have potential to become core

rigidities
 Competencies emphasized when no longer competitively relevant
can become a weakness
 External environmental conditions and events impact a
firm’s core competencies
Source of Competitive Advantage
Differentiation and Cost
Source of Competitive Advantage
Differentiation and Cost:The Generic Building Blocks of CA
Source of Competitive Advantage
Efficiency
 The quantity of inputs it takes to produce a given output
 Productivity leads to greater efficiency and lower costs
 Employee productivity
 Capital productivity
Source of Competitive Advantage
Quality
 Superior quality = customer perception of greater value
in a specific product’s attributes
 Form, features, performance, durability, reliability, style, design
etc.
 Quality products = goods and services that are reliable
and that are differentiated by attributes that customers
perceive to have higher value
 The impact of quality on competitive advantage
 High-quality products increase the value of (differentiate) the
products in customers’ eyes
 Greater efficiency and lower unit costs are associated with
reliable products
Source of Competitive Advantage
Innovation
 The act of creating new products or processes
 Product innovation
 Creates products that customers perceive as more valuable,
increasing the company’s pricing options
 Process innovation
 Creates value by lowering production costs or better service delivery
 Perhaps the most important building block of competitive
advantage
Source of Competitive Advantage
Customer Responsiveness
 Doing a better job than competitors of identifying and
satisfying customers’ needs
 Superior quality and innovation are integral to superior
responsiveness to customers
 Customizing goods and services to the unique demands of
individual customers or customer groups
 Sources of enhanced customer responsiveness
 Customer response time, design, service, after-sales service and
support
 Differentiates a company/its products; leads to brand
loyalty and premium pricing
Durability of Competitive Advantage
 Barriers to Imitation
 Imitating Resources
 Imitating Capabilities
 Capability of Competitors
 Strategic commitment
 Absorptive capacity (Ability to exploit external knowledge)
 Industry Dynamism
Why Companies Fail?
 Inertia
 Companies find it difficult to change their strategies and structures
 Prior strategic commitments
 Limit a company’s ability to imitate and cause competitive disadvantage
 The Icarus paradox (Danny Miller in his 1990)
 A company can become so specialized based on past success that it
loses sight of market realities
 success seduces companies into failure through fostering overconfidence,
complacency, specialization, exaggeration, dogma and ritual
 Craftsmen, builders, pioneers, salesmen
 Of the companies in the 1966 Fortune 100, 66 no longer existed by
2006. Failure of Merrill Lynch, RBS, AIG, Citibank, Lehman Brothers and
Fresh & Easy.
Avoiding Failure and Sustaining
Competitive Advantage
 Focus on the building blocks of competitive advantage
 Institute continuous improvement in learning
 Track best industrial practice in use - benchmarking
 Overcome inertia
 Luck
Analyzing Competitive Advantage and
Profitability
 Benchmarking company performance against that of
competitors and the company’s own historic
performance
 Return on invested capital

ROIC = Net profit

Invested capital

• Net profit = Total revenues – Total costs

Definition of Basic Accounting Terms
Drivers of Profitability
Ways to Increase ROIC
 Increase the company’s return on sales
 Reduce cost of goods sold
 Reduce spending on sales force, marketing, general, and
administrative expenses
 Reduce R&D spending
 Increase sales revenue more than costs
 Increase sales revenues from invested capital
 Reduce the amount of working capital
 Reduce amount of fixed capital
 Competence, Core Competence and
Distinctive Competence
A Core Competency is and the
foundational capability an
organization has in order to "get
something done". If it is core it is
not necessarily distinctive. For
example many people have a core
competency of singing....

A Distinctive Competency is one

that is more unique and, in some
way, derives an advantage to the
person or organization above
others.

To define a firm's distinctive competence, management must complete an assessment of both internal and
external corporate environments. When management finds an internal strength that both meets market
needs and gives the firm a comparative advantage in the marketplace, that strength is the firm's distinctive
competence.
Components of Strategic

Internal Analysis
Competitiveness

Competitive
Core Discovering Core Advantage
Competencies Competencies

Capabilities

Four Criteria Value

Resources of Sustainable Chain
• Tangible
• Intangible Advantages Analysis

• Valuable • Outsource
• Rare
• Costly to Imitate
• Nonsubstitutable