Chapter 3 Examining the Internal Environment: Resources, Capabilities, and Activities

1. Chapter 3Examining the Internal Environment: Resources, Capabilities, and Activities

2. OBJECTIVES 1 Explain the internal context of strategy Identify a firm’s resources and capabilities and explain their role in its performance 2 Define dynamic capabilities and explain their role in both strategic change and a firm’s performance 3 Explain how value‑chain activities are related to firm performance and competitive advantage 4 Explain the role of managers with respect to resources, capabilities, and value‑chain activities 5

3. COMPARATIVE INDUSTRY REFORMANCE ROA Global Auto ROS • Semiconductor Grocery Store How dosuch differences in profitability materialize?

4. RESOURCES, CAPABILITIES, AND MANAGERIAL DECISIONS Resources Managers Competitive advantage/disadvantage Strategy Performance Management strategic decision making Capabilities

5. RESOURCES AND CAPABILITIES: FUNDAMENTAL BUILDING BLOCKS OF STRATEGY • The inputs that firms use to create goods and services • Undifferentiated or firms-specific • Tangible or intangible • Easy to acquire or difficult Strategy Capabilities (competencies) Resources A firm’s skill in using its resources to create goods and services. The combination of procedures and expertise that the firm relies on to engage in distinct activities in the process of producing goods and services

6. EXAMPLES OF CAPABILITIES Company Capability Result Logistics -- distributing vast amounts of goods quickly and efficiently to remote locations 200,000-percent return to share-holders during first 30 years since IPO1 An extraordinarily frugal system for delivering the lowest cost structure in the mutual fund industry, using both techno-logical leadership and economies of scale 25,000-percent return to share-holders during the 30-plus year tenure of CEO John Connelly.2 As for ongoing expenses, share-holders in Vanguard equity funds pay, on average, just $30 per $10,000, vs. a $159 industry average. With bond funds, the bite is just $17 per $10,000 Generating new ideas then turning those ideas into new, profitable products 30 percent of revenue from products introduced within the past four years 1: Stalk, Evans, and Shulman, 1992 2: Makadok, 2003

7. 1 Trust is an intangible resource 2 A trustworthy reputation for a firm can be leveraged. TRUST AS AN ORGANIZATIONAL RESOURCE

8. Knowledge as a resource Explicit (easy competitive intelligence) Tacit (more valuable) KNOWLEDGE

9. Valuable? Does the resource or capability allow the firm to meet a market demand or protect the firm from market uncertainties? If so, it satisfies the value requirement. Valuable resources are needed just to compete in the industry, but value by itself does not convey an advantage Valuable resources and capabilities convey the potential to achieve “normal profits” (i.e., profits which cover the cost of all inputs including the cost of capital) Rare? Assuming the resource or capability is valuable, is it scarce relative to demand? Or, is it widely possessed by most competitors? Valuable resources which are also rare convey a competitive advantage, but its relative permanence is not assured. The advantage is likely only temporary. A temporary competitive advantage conveys the potential to achieve above normal profits, at least until the competitive advantage is nullified by other firms Inimitable and non-substitut-able? Assuming a valuable and rare resource, how difficult is it for competitors to either imitate the resource or capability or substitute for it with other resources and capabilities that accomplish similar benefits? Valuable resources and capabilities which are difficult to imitate or substitute provide the potential for sustained competitive advantage A sustained competitive advantage conveys the potential to achieve above normal profits for extended periods of time (until competitors eventually find ways to imitate or substitute or the environment changes in ways that nullify the value of the resources) Exploit-able? For each step of the preceding steps of the VRINE test, can the firm actually exploit the resources and capabilities that it owns or controls? Resources and capabilities that satisfy the VRINE requirements but which the firm is unable to exploit actually result in significant opportu-nity costs (other firms would likely pay large sums to purchase the VRINE resources and capabilities). Alternatively, exploitability unlocks the potential competitive and perfor- mance implications of the resource or capability Firms which control unexploited VRINE resources and capabilities generally suffer from lower levels of financial performance and depressed market valuations relative to what they would otherwise enjoy (though not as depressed as firms lacking resources and capabilities which do satisfy VRINE) THE VRINE MODEL Test Competitive implication Performance implication

10. Sustainability: Just having a competitive advantage is not enough. Can it be sustained? Durability Imitability SUSTAINABILITY

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

12. Value DYNAMIC CAPABILITIES Mail Boxes Etc. franchise Start-up plans People Brand Location Processes Dynamic capability: how we integrate recon-figure, acquire, or divest resources for competitiveadvantage? Mail boxes, etc., has developed the ability to combine resources better than the competition

13. Inventory system Site software Pick & pack procedures Site look & feel Return procedures Customer research CDs Shipping Computers Telecom lines Shipping services Media VALUE CHAIN: INTERNET STARTUP EXAMPLE Firm Infrastructure Financing, legal support, accounting Support Activities Recruiting, training, incentive system, employee feedback HumanResources Technology Development Procurement Inbound shipment of top titles Server operations Billing Collections Picking and shipment of top titles from warehouse Shipment of other titles from third- party distributors Pricing Promotions Advertising Product information and reviews Affiliations with other websites Returned items Customer feedback Warehousing • Inbound • Logistics • Operations • Outbound • Logistics • Marketing • & Sales • After-Sales Service Primary Activities

14. USING VALUE CHAINS TO GAIN COMPETITIVE ADVANTAGE Identical Differentiated Find a different way to perform activities Longer-lasting advantage Shorter-term advantage (competitors catch up) Find a better way to perform the same activities

15. INNOVATION AND INTEGRATION OF THE VALUE CHAIN Area of innovation Assemble Source Deliver IKEA Transferred assembly and delivery to the consumer Dell Choose an entirely direct distribution model (rather than through retailers) and outsourced component manufacturing

16. Southwest Major Airlines Technologyand design • Single aircraft • Multiple types of aircrafts • Hub and spoke system • Meals (based on class of service) • Seat assignments • Multiple classes of service • Baggage transfer to other airlines Operations • Short segment flights • Smaller markets and secondaryairports in major markets • No baggage transfers to others airlines • No meals • Single class of service • No seat assignments Marketing • Limited use of travel agents • Word of mouth • Extensive use of travel agents TRADE OFF PROTECTION - YOUR RIVALS CHOOSE NOT TO COPY YOU Selected difference between Southwest and large Airlines Southwest made choices so that competitors did not copy - because copying would require them to abandon activities essential to their strategies

17. 1 Activities that can create value for the firm should not be outsourced. 2 Those activities that represent key sources of learning for the firm should not be outsourced. GUIDELINES FOR OUTSOURCING

18. Outsourcing and Offshoring • What is Outsourcing? • Sourcing the function, product, or service of a value chain activity from another company. • Outsourcing arrangements are put in place to improve competitiveness in a function or set of functions. • What is Offshoring? • Taking the activity from a high-cost country to a low-cost country. • What are some examples of outsourcing?

19. BUSINESS CASE FOR OUTSOURCING: ANALYSIS AND ACCURACY • More than 80% of organizations base their sourcing decisions on inadequate financial information. • Organizations fail to include up to 20% of internal costs in their calculations of a business case. • More than 70% of discrete projects and longer-term outsourcing initiatives exceed original business case costing estimates. • Building a financial business case for sourcing is a challenge – difficult to identify and estimate all possible costs • Also difficult to quantify choices and assess risks

20. HIDDEN COSTS OF GLOBAL SOURCING Project Management Onshore/Offshore Coordination Demands RelationshipManagement Cross-Cultural Issues Connectivity and Telecom Single Domestic vs. Multiple Cross-Border Transition and Knowledge Transfer Virtual Decentralized Teams Project Trips Multiple Personnel, Long Trips Hidden Costs

21. OUTSOURCING KEYS TO SUCCESS • Commit time and effort – beyond the initial cost savings, corporations must be prepared to invest in quality control and training to keep the outsourced or offshored activity competitive and efficient • Treat outsourcing partners as partners: what was previously handled internally is now managed by a third party. Take advantage of the relationship to learn new things about product and process innovation. • Involve middle management: middle management is the lifeblood of strategy execution. Middle managers bridge offshore activities with internal ones and put additional outsourcing arrangements into place as opportunities arise.

22. STRATEGIC LEADERSHIP “Companies that overlook the role of leadership in the early phases of strategic planning often find themselves scrambling when it’s time to execute. No matter how thorough the plan, without the right leaders it is unlikely to succeed” – McKinsey & Company

23. Key tasks in the role of management: • Identify resources and capabilities • Specify the resources that will create competitive advantage • Locate an attractive industry in which to deploy them • Select the strategy to get the most out of them • Choose when to change the mix of resources, capabilities, and targeted markets • Middle managers contribute to corporate success within many roles: • Entrepreneur • Communicator • Psychoanalyst • Tightrope walker“In Praise of Middle Managers”, HBR (see text endnotes) BOTH SENIOR AND MIDDLE MANAGERS PLAY KEY ROLES