Evaluating a Firm’s Internal Capabilities

Chapter 3

Learning Objectives• Be able to describe the critical

assumptions of the resource-base view.• Describe resources & capabilities.• Understand how to use SWOT analysis.• Understand how value chain analysis is

used to improve a firm’s operations & identify valuable resources & capabilities.

• Understand how to apply the VIRO framework.

What Does Internal Analysis Tell Us?

• Internal analysis provides a comparative look at a firm’s capabilities– what are the firm’s strengths?– what are the firm’s weaknesses?– how do these strengths & weaknesses

compare– to competitors?

Why Does Internal Analysis Matter?

Internal analysis helps a firm:• Determine if its resources and

capabilities are likely sources of competitive advantage.

• Establish strategies that will exploit any sources of competitive advantage.

SWOT AnalysisInternal

StrengthsWeaknesses

ExternalOpportunitiesThreats

SWOT• Strengths (Internal Focus) – What does the

firm do well? • Weaknesses (Internal Focus) – Where is the

firm vulnerable?• Opportunities (External Focus) – What

opportunities can the firm take advantage of given its resource bundle.

• Threats (External Focus) – What does the company have to monitor and/or address.

Focus: Opportunities/Threats• Companies scan their external

environment looking for valuable information, e.g., new factors and trends.

• What is happening in the general environment that may affect the company in the short- and/or long-term?

SWOT Example:

• Strengths– First mover

advantage– Low labor cost– Creative employees

• Weaknesses– Inexperienced new

company– No proprietary

information

• Opportunities– Demand for electronic

phone books– Sudden growth in use

of digital technology• Threats

– Easily duplicated product

– Market power of incumbent firms

Limitations of SWOT Analysis• SWOT Analysis is a starting point

for discussion and cannot show how to achieve a competitive advantage.

• Strengths may not lead to a competitive advantage.

Limitations of SWOT Analysis• SWOT Analysis’ focus on the external

environment is too narrow.• SWOT Analysis is a snapshot of a

dynamic environment. • SWOT Analysis overemphasizes a single

dimension of strategy.

Dess, Lumpkin, & Taylor (2007) p. 78

The Theory Behind Internal Analysis

The Resource-Based View:• Developed to answer the question: Why do

some firms achieve better economic performance than others?

• Used to help firms achieve competitive advantage and superior economic performance.

• Assumes that a firm’s resources and capabilities are the primary drivers of competitive advantage and economic performance.

The Resource-Based View• Resources:• Tangible and intangible assets of a firm

used to conceive of and implement strategies.

Capabilities:• A subset of resources that enable a firm

to take full advantage of other resources.

The Resource-Based ViewFour Categories of Resources• Financial (cash, retained earnings)• Physical (plant & equipment,

geographic location)• Human (skills & abilities of individuals)• Organizational (reporting structures,

relationships)

The Resource-Based ViewTwo Critical Assumptions of the RBV• Resource Heterogeneity• Resource Immobility

The Resource-Based ViewResource Heterogeneity• Heterogeneity of resources typically occurs

as the result of ‘bundling’ the resources and capabilities of a firm.

• Managers of a firm could take resources that seem homogeneous and ‘bundle’ them to create heterogeneous combinations.

• Competitive advantage typically stems from several resources and capabilities ‘bundled’ together.

The Chain of Value

InboundLogistics Operations Outbound

Logistics

Marketing &

Sales Service

General AdministrationHuman Resource Management

Technology DevelopmentProcurement

Supp

ort

Act

iviti

es

Primary Activities

(Dess, Lumpkin, & Eisner p. 77).(Dess, Lumpkin, & Eisner p. 77).

Inbound Logistics• Receiving, Storing, & Distributing

Inputs, e.g., material handling, warehousing, inventory control, scheduling, & returns.

• Just-in-Time Inventory Control saves companies money.

Operations• Includes the activities that transform

raw materials into the finished product. This includes processing, machining, packaging, assembly, equipment, testing, printing, and facility operations.

Outbound Logistics• Activities that handle the finished

product including collecting, storing, and distributing the product/service to the customer.

Marketing & Sales• These departments are responsible

for activities associated with making the market aware of the product/ service and turning potential customers into customers.

• When channel customers are involved the marketing and sales force must convince them that their product should be carried.

Service• Primarily responsible for handling

customer problems associated with enhancing or maintain the product/ service. This may include installing, repairing, training, supplying parts, and adjusting the product.

Support Activities• General Administration – Responsible

for firm’s overall welfare.• Human Resources Management –

Responsible for providing the best employees possible as well as managing those important resources.

Support Activities• Technology Development – Responsible for

providing the firm with state of art future products/services as well as ensuring the company has the resources to support this environment.

• Procurement – Responsible for procuring raw material inputs and creating systems that ensure the firm has access to best resources.

The Internal Analysis Tool• If a firm’s resources are:

– Valuable– Rare– Costly to Imitate– Organized to Exploit these Resources …

• Then the firm can expect to gain a sustained competitive advantage.

Applying the VRIO FrameworkThe Question of Value:

• In theory: Does the resource enable the firm to exploit an external opportunity or neutralize an external threat?

• The practical: Does the resource result in an increase in revenues, a decrease in costs, or some combination of the two? (Levi’s reputation allows it to charge a premium for its Docker’s pants)

Applying the VRIO FrameworkThe Question of Rarity• If a resource is not rare, then perfect

competition dynamics are likely to be observed (i.e., no competitive advantage, no above normal profits).

• A resource must be rare enough that perfect competition has not set in.

Applying the VRIO FrameworkThe Question of Imitability• The temporary competitive advantage

of valuable and rare resources can be sustained only if competitors face a cost disadvantage in imitating the resource.

• If there are high costs of imitation, then the firm may enjoy a period of sustained competitive advantage.

Applying the VRIO FrameworkThe Question of Organization• A firm’s structure and control

mechanisms must be aligned so as to give people ability and incentive to exploit the firm’s resources.

• These structure and control mechanisms complement other firm resources—taken together, they can help a firm achieve competitive advantage. (3M Company)

Valuable? Rare?Costly toImitate?

Exploited byOrganization?

CompetitiveImplications

No

Yes

Yes

Yes

Yes

Yes Yes Yes

No

No

No Disadvantage

Parity

TemporaryAdvantage

SustainedAdvantage

The VRIOVRIO Framework

Valuable? Rare?Costly toImitate?

ExploitedBy Org?

CompetitiveImplics.

No

Yes

Yes

Yes

Yes

Yes Yes Yes

No

No

No Disadvantage

Parity

TemporaryAdvantage

SustainedAdvantage

EconomicImplics.

BelowNormal

Normal

AboveNormal

AboveNormal

The VRIOVRIO Framework

Entrepreneurial Application of the VRIO Framework

The Logic Remains the Same:• Small firms and start-ups can apply the

VRIO framework to their resources and capabilities.– Competitive advantage vis-à-vis larger

firms can often be identified.– Recognizing if and why larger firms face

high costs of imitation can be critical to small firm success.

International Application of the VRIO Framework

Two Reasons for International Expansion:

1. Exploit current resource and capability advantages in a new market.

2. Develop new resources and capabilities in a foreign market

Firm A(strategy decisionslead to competitive

advantage)

Firm B’s Possible Responses

No Response

Change Tactics

Change Strategy

Competitive Dynamics of Resource Imitation

Competitive Dynamics:• The strategic decisions and actions of

firms in response to the strategic decisions and actions of other firms.

Competitive Dynamics• A firm may decide to take no action

because:• the other firm is serving a different market.• A response may hurt its own competitive

advantage.• It does not have the resources and

capabilities to mount an effective response.

• It wants to reduce or manage rivalry in the market through tacit collusion.

“No Action” Response (Rolex Casio)

“Change” Responses

Tactics (Tide) Strategy (Monsanto)• specific actions

»tweaking productcharacteristics

• usually imitated soquickly that there isno advantage

• a ‘leap frog’ movemay create advantage

• a fundamental changein a firm’s theory

• may be necessary if current strategybecomes obsolete

• a mimetic change mayachieve parity, but notadvantage

Competitive Dynamics

CustomerNeeds

CompetitorOfferings

Price

Quality

Focal FirmOffering

Competitive Dynamics• Imitation will seldom lead to

competitive advantage.• Firms should use resources and

capabilities to fill unique competitive space.

CustomerNeeds

CompetitorOfferings

Price

Quality

Focal FirmOffering

» higher quality/lower costoffering maylead to advantage

Competitive Dynamics• Similar strategies may lead to

competitive advantage.• Some firms can achieve competitive

advantage even if they are second movers

Wrapping it UpInternal Analysis Assumes:• Determinates of economic performance

are firm-level characteristics (resources & capabilities).– firms may be different (heterogeneity)– differences may be enduring (immobility)

• competitive advantage stems from resources and capabilities that meet the VRIO criteria

Resources &Capabilities

CompetitiveAdvantage

• Valuable• Rare• Costly to Imitate• Organized to Exploit

CA will be sustained if:1.Other firms’ costs of

imitation are greaterthan benefit of imitation.

2.The firm is organizedto exploit advantages

Wrapping it Up: The Resource-Based View

What do these assumptions really mean?

• If one firm has resources that are valuableand other firms don’t, and…

• If other firms can’t imitate these resourceswithout incurring high costs, then…

• The firm possessing the valuable resourceswill likely gain a sustained competitive advantage.

The Resource-Based View