Strategic analysis

Resources and Capabilities

Resources

Broad in scope, the term resources covers a spectrum of individual, social, and organizational phenomena.7 Typically, resources alone do not yield a competitive advantage.8 In fact, the core competencies that yield a competitive advantage are created through the unique bundling of several resources.9

Some of a firm’s resources are tangible while others are intangible. Tangible resources are assets that can be seen and quantified. Production equipment, manufacturing plants, and formal reporting structures are examples of tangible resources. Intangible resources typically include assets that are rooted deeply in the firm’s history and have accumulated over time. Because they are embedded in unique patterns of routines, intangible resources are relatively difficult for competitors to analyze and imitate. Knowledge, trust between managers and employees, ideas, the capacity for innovation, managerial capabilities, organizational routines (the unique ways people work together), scientific capabilities, and the firm’s reputation for its goods or services and how it interacts with people (such as employees, customers, and suppliers) are all examples of intangible resources.10 The four types of tangible resources are financial, organizational, physical, and technological. The three types of intangible resources are human, innovation, and reputational.

As a manager or entrepreneur, you will be challenged to understand the strategic value of

7. Eisenhardt, K., & Martin, J. (2000). Dynamic capabilities: What are they? Strategic Management Journal, 21, 1105–1121; Michalisin, M. D., Kline, D. M., & Smith. R. D. (2000). Intangible strategic assets and firm performance: A multi-industry study of the resource-based view, Journal of Business Strategies, 17(2), 91–117.

8. West, G. P., & DeCastro, J. (2001). The Achilles heel of firm strategy: Resource weaknesses and distinctive inadequacies. Journal of Management Studies, 38(3), 26–45.; Deeds, D. L., DeCarolis, D., & J. Coombs. (2000). Dynamic capabilities and new product development in high technology ventures: An empirical analysis of new biotechnology firms. Journal of Business Venturing, 15, 211–229; Chi, T. (1994). Trading in strategic resources: Necessary conditions, transaction cost problems, and choice of exchange structure. Strategic Management Journal, 15, 271–290.

9. Berman, S., Down, J., & Hill, C. (2002). Tacit knowledge as a source of competitive advantage in the National Basketball Association. Academy of Management Journal, 45, 13–31.

10. Feldman, M. S. (2000). Organizational routines as a source of continuous change, Organization Science, 11, 611–629; Knott, A. M., & McKelvey, B. (1999). Nirvana efficiency: A comparative test of residual claims and routines. Journal of Economic Behavior & Organization, 38, 365–383.

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your firm’s tangible and intangible resources. The strategic value of resources is indicated by the degree to which they can contribute to the development of core competencies, and, ultimately, competitive advantage. For example, as a tangible resource, a distribution facility is assigned a monetary value on the firm’s balance sheet. The real value of the facility, however, is grounded in a variety of factors, such as its proximity to raw materials and customers, but also in intangible factors such as the manner in which workers integrate their actions internally and with other stakeholders, such as suppliers and customers.11

Capabilities

Capabilities are the firm’s capacity to deploy resources that have been purposely integrated to achieve a desired end state.12 As the glue that holds an organization together, capabilities emerge over time through complex interactions among tangible and intangible resources. They can be tangible, like a business process that is automated, but most of them tend to be tacit and intangible. Critical to forming competitive advantages, capabilities are often based on developing, carrying, and exchanging information and knowledge through the firm’s human capital.13 Because a knowledge base is grounded in organizational actions that may not be explicitly understood by all employees, repetition and practice increase the value of a firm’s capabilities.

The foundation of many capabilities lies in the skills and knowledge of a firm’s employees and, often, their functional expertise. Hence, the value of human capital in developing and using capabilities and, ultimately, core competencies cannot be overstated. Firms committed to

11. Gavetti, G., & Levinthal, D. (2000). Looking forward and looking backward: Cognitive and experiential search. Administrative Science Quarterly, 45, 113–137; Coff, R. W. (1999). How buyers cope with uncertainty when acquiring firms in knowledge-intensive industries: Caveat emptor. Organization Science, 10, 144–161; Marsh, S. J., & Ranft, A. L. (1999). Why resources matter: An empirical study of knowledge-based resources on new market entry. In M. A. Hitt, P. G. Clifford, R. D. Nixon, & K. P. Coyne (Eds.), Dynamic strategic resources (pp. 43–66). Chichester: Wiley.

12. Helfat, C. E., & Raubitschek, R. S. (2000). Product sequencing: Co-evolution of knowledge, capabilities, and products. Strategic Management Journal, 21, 961–979.

13. Hitt, M. A., Bierman, L., Shimizu, K., & Kochhar, R. (2001) Direct and moderating effects of human capital on strategy and performance in professional service firms: A resource-based perspective. Academy of Management Journal, 44(1), 13–28; Hitt, M. A., Ireland, R. D., & Lee, H. (2000). Technological learning, knowledge management, firm growth and performance: An introductory essay. Journal of Engineering and Technology Management, 17, 231–246; Hoopes, D. G., & Postrel, S. (1999). Shared knowledge: “Glitches,” and product development performance. Strategic Management Journal, 20, 837–865; Quinn, J. B. (1994).The Intelligent Enterprise. New York: Free Press.

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continuously developing their people’s capabilities seem to accept the adage that “the person who knows how will always have a job. The person who knows why will always be his boss.”14

Example 4.4 Advantage through the Value Chain

With a combined total export revenue of around US$5.2 million in the past 3 years, Myanmar’s local coffee industry has experienced tremendous growth. Up to this point, Myanmar’s smallholder coffee farmers sold their raw green coffee beans in a commodity-like market. Their roasting processes were traditional and low efficiency, they produced a poor quality product. But all of that changed in 2015 thanks to a collaboration between the U.S.-funded Value Chain for Rural Areas and the Myanmar Coffee Association. The Ywangan Coffee Cluster now consists of more than 10,000 coffee growers producing high quality Arabica beans and exports in the most recent year exceeded 477 metric tons to Europe, the U.S., and numerous Asian markets.

Improved techniques led to better quality products which in turn led to greater demand. Coffee producers have had to modernize their methods to keep up. One coffee producer Daw Su Su Ang, known as “the Coffee Lady” and owner of Amara Coffee, said that the Value Chain program has helped the factory to host training sessions to improve bean taste and pass down knowledge of natural processing methods while generating better wages for 300 families in 20 villages. Their output doubled in the past year.

Source: Irrawaddy, Shan State’s “Coffee Lady” Moves up the Value Chain, 2019Wi

Global business leaders increasingly support the view that the knowledge possessed by human capital is among the most significant of an organization’s capabilities and may ultimately be at the root of all competitive advantages. But firms must also be able to use the knowledge that they have and transfer it among their operating businesses.15 For example, researchers have suggested that “in the information age, things are ancillary, knowledge is central. A company’s value derives not from things, but from knowledge, know-how, intellectual assets, and competencies—all of it embedded in people.”16 Given this reality, the firm’s challenge is to create an environment that allows people to fit their individual pieces of knowledge together so that, collectively, employees possess as much organizational knowledge as possible.17

To help them develop an environment in which knowledge is widely spread across all employees, some organizations have created a new upper-level managerial position of chief learning officer (CLO). Establishing a CLO position highlights a firm’s belief that “future success will depend on competencies that traditionally have not been actively managed or measured—including creativity

14. Thoughts on the business of life. (1999, May 17). Forbes, p. 352. 15. Argote, L., & Ingram, P. (2000). Knowledge transfer: A basis for competitive advantage in firms.

Organizational Behavior and Human Decision Processes, 82, 150–169. 16. Dess, G. G., & Picken, J. C. (1999). Beyond productivity. New York: AMACOM. 26. 17. Coy, P. (2002, Spring). High turnover, high risk [Special Issue]. Business Week, p. 24.

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and the speed with which new ideas are learned and shared.”18 In general, these firm should manage knowledge in ways that will support its efforts to create value for customers.19

Capabilities are often developed in specific functional areas (such as manufacturing, R&D, and marketing) or in a part of a functional area (for example, advertising). The value chain, popularized by Michael Porter’s book, Competitive Advantage, is a useful tool for taking stock of organizational capabilities. A value chain is a chain of activities. In the value chain, some of the activities are

18. Baldwin, T. T., & Danielson, C. C. (2000). Building a learning strategy at the top: Interviews with ten of America’s CLOs. Business Horizons, 43(6), 5–14.

19. Kuratko, D. F., Ireland, R. D., & Hornsby, J. S. (2001). Improving firm performance through entrepreneurial actions: Acordia’s corporate entrepreneurship strategy. Academy of Management Executive, 15(4), 60–71; Hansen, M. T., Nhoria, N., & Tierney, T. (1999). What’s your strategy for managing knowledge? Harvard Business

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deemed to be primary, in the sense that these activities add direct value. In the preceding figure, primary activities are logistics (inbound and outbound), marketing, and service. Support activities include how the firm is organized (infrastructure), human resources, technology, and procurement. Products pass through all activities of the chain in order, and at each activity, the product gains some value. A firm is effective to the extent that the chain of activities gives the products more added value than the sum of the costs at each step. While both primary and support activities add to a firm’s cost structure, due to their enabling nature, support activities are often candidates for outsourcing. Distinguishing between the two types of activities is a critical first step in understanding the firm’s value chain. Firms do not outsource primary activities if they are a source of competitive advantage.

It is important not to mix the concept of the value chain with the costs occurring throughout the value chain activities. A diamond cutter can be used as an example of the difference. The cutting activity may have a low cost, but the activity adds to much of the value of the end product, since a rough diamond is significantly less valuable than a cut, polished diamond. Research suggests a relationship between capabilities developed in particular functional areas and the firm’s financial performance at both the corporate and business-unit levels,20 suggesting the need to develop capabilities at both levels.

20. Hitt, M. A., & Ireland, R. D. (1986). Relationships among corporate level distinctive competencies, diversification strategy, corporate structure, and performance. Journal of Management Studies, 23, 401–416; Hitt, M. A., & Ireland, R. D. (1985). Corporate distinctive competence, strategy, industry, and performance. Strategic Management Journal, 6, 273–293; Hitt, M. A., Ireland, R. D., & Palia, K. A. (1982). Industrial firms’ grand strategy and functional importance. Academy of Management Journal, 25, 265–298; Hitt, M. A., Ireland, R. D., & Stadter, G. (1982). Functional importance and company performance: Moderating effects of grand strategy and industry type. Strategic Management Journal, 3, 315–330; Snow, C. C., & Hrebiniak, E. G. (1980). Strategy, distinctive competence, and organizational performance. Administrative Science Quarterly, 25, 317–336.

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VRIO Analysis

Figure 4.2 VRIO and Relative Firm Performance

Valuable? Rare? Difficult to Imitate?

Supported by Organization?

Competitive Implications

Perfor- mance

No —– —-

Yes

Competitive Disadvantage

Below Normal

Yes No —- Competitive Parity Normal

Yes Yes No Temporary Competitive Advantage

Above Normal

Yes Yes Yes Sustained Competitive Advantage

Above Normal

Given that almost anything a firm possesses can be considered a resource or capability, how should you attempt to narrow down the ones that are core competencies, and explain why firm performance differs? To lead to a sustainable competitive advantage, a resource or capability should be valuable, rare, inimitable (there are no substitutes), and possessed by the organization despite it being costly to imitate in terms of time or money or both. This VRIO framework is the foundation for internal analysis.1 VRIO is an acronym for valuable, rare, inimitable, and organization (as in owned by the organization).

If you ask managers why their firms do well while others do poorly, a common answer is likely to be “our people.” But this is really not a complete answer. It may be the start of an answer, but you need to probe more deeply—what is it about “our people” that is especially valuable? Why don’t competitors have similar people? Why haven’t competitors hired our people away? Or is it that there is something special about the organization that brings out the best in people? These kinds of questions form the basis of VRIO and get to the heart of why some resources help firms more than others.

Moreover, your ability to identify whether an organization has VRIO resources will also likely explain their competitive position. In the figure, you can see that a firm’s performance relative to industry peers is likely to vary according to the level to which resources, capabilities, and ultimately core competences satisfy VRIO criteria. The four criteria are explored next.

1. VRIO analysis is at the core of the resource-based view of the firm. Wernerfelt, B. (1984). A resource- based view of the firm. Strategic Management Journal, 5, 171–180. Barney, J. B. (1991). Firm resources and sustained competitive advantage. Journal of Management, 19, 99–120.

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Valuable

A resource or capability is said to be valuable if it allows the firm to exploit opportunities or negate threats in the environment. If a resource does not allow a firm to minimize threats or exploit opportunities, it does not enhance the competitive position of the firm. In fact, some scholars suggest that owning resources that do not meet the VRIO test of value actually puts the firm at a competitive disadvantage.2

Example 4.5 Creating Value

Although Colgate is already considered a huge brand in the hygiene industry, they still need to search for ways to keep their market share. The company’s research and development team realized that some customers were not using their current toothbrushes and toothpastes correctly. The company responded by working to develop products that promote proper use and market those products with a focus on proper use. Even companies that already have a large customer base must add value to remain successful.

Source: Forbes, How To Move Beyond R&D To Search For Customer Value, 2019Wi

Rare

A resource is rare simply if it is not widely possessed by other competitors. Of all of the VRIO criteria this is probably the easiest to judge. For example, Coke’s brand name is valuable but most of Coke’s competitors (Pepsi, 7Up, RC) also have widely recognized brand names, making it not that rare. Of course, Coke’s brand may be the most recognized, but that makes it more valuable, not more rare, in this case.

A firm that possesses valuable resources that are not rare is not in a position of advantage relative to competitors. Rather, valuable resources that are commonly held by many competitors simply allow firms to be at par with competitors. However, when a firm maintains possession of valuable resources that are rare in the industry they are in a position of competitive advantage over firms that do not possess the resource. They may be able to exploit opportunities or negate threats in ways that those lacking the resource will not be able to do. Delta’s virtual control of air traffic through Cincinnati gives it a valuable and rare resource in that market.

How rare do the resources need to be for a firm to have a competitive advantage? In practice,

2. Barney, J. B. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120.

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this is a difficult question to answer unequivocally. At the two extremes (i.e., one firm possesses the resource or all firms possess it), the concept is intuitive. If only one firm possesses the resource, it has significant advantage over all other competitors. However, meeting the condition of rarity does not always require exclusive ownership. When only a few firms possess the resource, they will have an advantage over the remaining competitors. For instance, Toyota and Honda both have the capabilities to build cars of high quality at relatively low cost.3 Their products regularly beat rival firms’ products in both short-term and long-term quality ratings.4 Thus, the criterion of rarity requires that the resource not be widely possessed in the industry. It also suggests that the more exclusive a firm’s access to a particularly valuable resource, the greater the benefit for having it.

Example 4.6 Rare Resource

UPS was just awarded the FAA’s first-ever nod of approval to utilize drone technology as a part of its logistics service. As the first company in history to be granted such rights, they currently hold exclusive access to this resource. Other companies will likely be granted similar access to this new frontier of delivery service. In the meantime, this approval is a rare resource that UPS has exclusive rights too and will give them a competitive advantage in the logistics industry.

Source: CNBC, UPS wins first broad FAA approval for drone delivery, Michael Crennen, 2019Fa

Inimitable

An inimitable (the opposite of imitable) resource is difficult to imitate or to create ready substitutes for. A resource is inimitable and non-substitutable if it is difficult for another firm to acquire it or to substitute something else in its place. A valuable and rare resource or capability will grant a competitive advantage as long as other firms do not gain subsequent possession of the resource or a close substitute. If a resource is valuable and rare and responsible for a market leader competitive advantage, it is likely that competitors lacking the resource or capability will do all that they can to obtain the resource or capability themselves. This leads us to the third criterion—inimitability. The concept of imitation includes any form of acquiring

3. Dyer, J. H., Kale, P., & Singh, H. (2004, July–August). When to ally and when to acquire. Harvard Business Review, 109–115.

4. Dyer, J. H., & Hatch, N. (2004). Using Supplier Networks to Learn Faster. Sloan Management Review, 45(3), 57–63.

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the lacking resource or substituting a similar resource that provides equivalent benefits. The criterion important to be addressed is whether competitors face a cost disadvantage in acquiring or substituting the resource that is lacking. There are numerous ways that firms may acquire resources or capabilities that they lack.

Example 4.7 Inimitable

A tablet computer has been around for years but it wasn’t until the iPad when the market finally took off. Apple has designed something that is hard to imitate successfully and this can be proven by the number of knockoffs and imitation products of the iPod, iPad and MacBook that have failed to gain a large portion of market share.

Source: Awaken Your Superhero blog, What Is Your Business Core Competency?, 2018Fa

As strategy researcher Scott Gallagher notes: This is probably the toughest criterion to examine because given enough time and money

almost any resource can be imitated. Even patents only last 17 years and can be invented around in even less time. Therefore, one way to think about this is to compare how long you think it will take for competitors to imitate or substitute something else for that resource and compare it to the useful life of the product. Another way to help determine if a resource is inimitable is why/how it came about. Inimitable resources are often a result of historical, ambiguous, or socially complex causes. For example, the U.S. Army paid for Coke to build bottling plants around the world during World War II. This is an example of history creating an inimitable asset. Generally, intangible (also called tacit) resources or capabilities, like corporate culture or reputation, are very hard to imitate and therefore inimitable.5

Organization

The fourth and final VRIO criterion that determines whether a resource or capability is the source of competitive advantage recognizes that mere possession or control is necessary but not sufficient to gain an advantage. The firm must likewise have the organizational capability to exploit the resources. Think of it in terms of whether the organization owns the capability. Alternatively, think of organization ownership in terms of how much it would cost to copy the capability in terms of time or money or both.

5. Retrieved January 30, 2009, from http://falcon.jmu.edu/~gallagsr/WDFPD-Internal.pdf.

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Example 4.8 Organization

A critical part of Apple’s success is their organizational structure. They take advantage of a hierarchical organizational structure, which is a traditional structure seen in many organizations. The three main characteristics of this structure are spoke-and-wheel hierarchy, product-based divisions, and a weak functional matrix. While this gives them strong organizational control, it also limits organizational flexibility, and is something other corporations should consider when choosing an organizational structure.

Source: Seeking Alpha, Approach Resources: Hindered By High Fixed Costs, 2018Fa

The question of organization is broad and encompasses many facets of a firm but essentially means that the firm is able to capture any value that the resource or capability might generate. Organization, essentially the same form as that taken in the P-O-L-C framework, spans such firm characteristics as control systems, reporting relationships, compensation policies, and management interface with both customers and value-adding functions in the firm.

A valuable but widely held resource only leads to competitive parity for a firm if they also possess the capabilities to exploit the resource. Likewise, a firm that possesses a valuable and rare resource will not gain a competitive advantage unless it can actually put that resource to effective use.

Many firms have valuable and rare resources that they fail to exploit (the question of imitation is not relevant until the firm exploits valuable and rare resources). For instance, for many years Novell had a significant competitive advantage in computer networking based on its core NetWare product. In high-technology industries, remaining at the top requires continuous innovation. Novell’s decline during the mid- to late 1990s led many to speculate that Novell was unable to innovate in the face of changing markets and technology. However, shortly after new CEO Eric Schmidt arrived from Sun Microsystems to attempt to turnaround the firm, he arrived at a different conclusion. Schmidt commented: “I walk down Novell hallways and marvel at the incredible potential of innovation here. But, Novell has had a difficult time in the past turning innovation into products in the marketplace.”6 He later commented to a few key executives that it appeared the company was suffering from “organizational constipation.”7 Novell appeared to still have innovative resources and capabilities, but they lacked the organizational capability (e.g., product development and marketing) to get those new products to market in a timely manner.

6. Personal communication by Saylor.org with Margaret Haddox. (2003). Novell Corporate Librarian. 7. Personal communication by Saylor.org with former executives.

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Example 4.9 Example of a Core Competency (VRIO)

The company now known as RTW Retailwinds has begun implementing celebrity brands, including Kate Hudson, which is now part of their core competency as they continue to expand. The Kate Hudson line of products as well as any future celebrity brands are all valuable, rare and imitable within the same quality standards and can be difficult for other retailers to copy through the same celebrity partners. RTW is one of the largest omni-channel retailers for women and will only continue to grow.

Source: Dayton Daily News, Women’s clothing retailer with local presence moving forward with name change, Ariadna Archibald, 2018Fa

SWOT and VRIO

As you already know, many scholars refer to core competencies. A core competency is simply a resource, capability, or bundle of resources and capabilities that is VRIO. While VRIO resources are the best, they are quite rare, and it is not uncommon for successful firms to simply be combinations of a large number of VR _ O or even V _ _ O resources and capabilities. Recall that even a V _ _ O resource can be considered a strength under a traditional SWOT analysis.

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