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Strategic Management Concepts: A Competitive Advantage Approach

Sixteenth Edition

Chapter 4

The Internal Assessment

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Learning Objectives (1 of 2)

4.1 Describe the nature and role of an internal assessment in formulating strategies.

4.2 Discuss why organizational culture is so important in formulating strategies.

4.3 Identify the basic functions (activities) that make up management and their relevance in formulating strategies.

4.4 Identify the basic functions of marketing and their relevance in formulating strategies.

4.5 Discuss the nature and role of finance and accounting in formulating strategies.

After studying this chapter, you should be able to do the following:

4-1. Describe the nature and role of an internal assessment in formulating strategies.

4-2. Discuss why organizational culture is so important in formulating strategies.

4-3. Identify the basic functions (activities) that make up management and their relevance

in formulating strategies.

4-4. Identify the basic functions of marketing and their relevance in formulating strategies.

4-5. Discuss the nature and role of finance/accounting in formulating strategies.

4-6. Discuss the nature and role of production/operations in formulating strategies.

4-7. Discuss the nature and role of research and development (R&D) in formulating

strategies.

4-8. Discuss the nature and role of management information systems (MIS) in formulating

strategies.

4-9. Explain value chain analysis and its relevance in formulating strategies.

4-10. Develop and use an Internal Factor Evaluation (IFE) Matrix.

Learning Objectives (2 of 2)

4.6 Discuss the nature and role of production/operations in formulating strategies.

4.7 Discuss the nature and role of research and development (R&D) in formulating strategies.

4.8 Discuss the nature and role of management information systems (MIS) in formulating strategies.

4.9 Explain value chain analysis and its relevance in formulating strategies.

4.10 Develop and use an Internal Factor Evaluation (IFE) Matrix.

Figure 4-1 A Comprehensive Strategic-Management Model

Source: Source: Fred R. David, “How Companies Define Their Mission,” Long Range Planning 22, no. 3 (June 1988): 40. Also, Ratnaningsih, Anik, and Nadjadji Anwar, Patdono Suwignjo, and Putu Artama Wiguna, “Balance Scorecard of David’s Strategic Modeling at Industrial Business for National Construction Contractor of Indonesia,” Journal of Mathematics and Technology, no. 4, (October 2010): 20.

Key Internal Forces

Distinctive competencies

A firm’s strengths that cannot be easily matched or imitated by competitors

Building competitive advantages involves taking advantage of distinctive competencies.

Figure 4-2 The Process of Gaining Competitive Advantage in a Firm

Weaknesses → Strengths → Distinctive Competencies → Competitive Advantage

Strategies are designed in part to improve on a firm’s weaknesses, turning them into strengths—and maybe even into distinctive competencies that can provide the firm with competitive advantages over rival firms.

The Process of Performing an Internal Audit

The internal audit

Requires gathering, assimilating, and prioritizing information about the firm's management, marketing, finance, accounting, production/operations, research and development (R and D), and management information systems operations

Provides more opportunity for participants to understand how their jobs, departments, and divisions fit into the whole firm

All organizations have strengths and weaknesses in the functional areas of business. No enterprise is equally strong or weak in all areas. Strategic planning is most successful when managers and employees from all functional areas work together to provide ideas and information.

The Resource-Based View (R B V) (1 of 3)

The Resource-Based View (R B V) Approach

contends that internal resources are more important for a firm than external factors in achieving and sustaining competitive advantage

The Resource-Based View (R B V) (2 of 3)

Proponents of the R B V contend that organizational performance will primarily be determined by internal resources that can be grouped into three all-encompassing categories:

physical resources

human resources

organizational resources

Physical resources include all plant and equipment, location, technology, raw materials, machines; human resources include all employees, training, experience, intelligence, knowledge, skills, abilities; and organizational resources include firm structure, planning processes, information systems, patents, trademarks, copyrights, databases, and so on.

The Resource-Based View (R B V) (3 of 3)

For a resource to be valuable, it must be either (1) rare, (2) hard to imitate, or (3) not easily substitutable.

These three characteristics of resources are called Empirical Indicators

These enable a firm to implement strategies that improve its efficiency and effectiveness and lead to a sustainable competitive advantage.

The basic premise of the RBV is that the mix, type, amount, and nature of a firm’s internal resources should be considered first and foremost in devising strategies that can lead to sustainable competitive advantage.

Integrating Strategy and Culture

Organizational culture significantly affects planning activities.

If strategies can capitalize on cultural strengths, such as a strong work ethic or highly ethical beliefs, then management often can swiftly and easily implement changes.

Every business entity has a unique organizational culture that impacts strategic-planning activities.

Organizational Culture

Organizational culture is “a pattern of behavior that has been developed by an organization as it learns to cope with its problem of external adaptation and internal integration and that has worked well enough to be considered valid and to be taught to new members as the correct way to perceive, think, and feel.”

Remarkably resistant to change, culture can represent a major strength or weakness for any firm. It can be an underlying reason for strengths or weaknesses in any of the major business functions.

Cultural Products

Values

Beliefs

Rites

Rituals

Ceremonies

Myths

Stories

Legends

Sagas

Language

Metaphors

Symbols

Folktales

Heroes and heroines

These products or dimensions are levers that strategists can use to influence and direct strategy formulation, implementation, and evaluation activities.

Table 4-2 Aspects of Organizational Culture

Dimension	Low	Degree	Degree	Degree	High
1. Strong work ethic; arrive early and leave late	1	2	3	4	5
2. High ethical beliefs; clear code of business ethics followed	1	2	3	4	5
3. Formal dress; shirt and tie expected	1	2	3	4	5
4. Informal dress; many casual dress days	1	2	3	4	5
5. Socialize together outside of work	1	2	3	4	5
6. Do not question supervisor’s decision	1	2	3	4	5
7. Encourage whistle-blowing	1	2	3	4	5
8. Be health conscious; have a wellness program	1	2	3	4	5
9. Allow substantial “working from home”	1	2	3	4	5
10. Encourage creativity, innovation, and open-mindedness	1	2	3	4	5
11. Support women and minorities; no glass ceiling	1	2	3	4	5
12. Be highly socially responsible; be philanthropic	1	2	3	4	5
13. Have numerous meetings	1	2	3	4	5
14. Have a participative management style	1	2	3	4	5
15. Preserve the natural environment; have a sustainability program	1	2	3	4	5

Fifteen Example (Possible) Aspects of an Organization’s Culture

Table 4-2 provides some example (possible) aspects of an organization’s culture. Note that you might want to ask employees and managers to rate the degree that the dimension characterizes the firm.

Management

The functions of management consist of five basic activities:

planning

organizing

motivating

staffing

controlling

These activities are important to assess in strategic planning because an organization should continually capitalize on its management strengths and improve on its management weaknesses.

The Basic Functions of Management (1 of 2)

Planning: forecasting, establishing objectives, devising strategies, and developing policies

Organizing: organizational design, job specialization, job descriptions, span of control, coordination, job design, and job analysis

Motivating: leadership, communication, work groups, behavior modification, delegation of authority, job enrichment, job satisfaction, needs fulfillment, organizational change, employee morale, and managerial morale

Planning consists of all those managerial activities related to preparing for the future.

Organizing includes all those managerial activities that result in a structure of task and authority relationships.

Motivating involves efforts directed toward shaping human behavior.

The Basic Functions of Management (2 of 2)

Staffing: wage and salary administration, employee benefits, interviewing, hiring, firing, training, management development, employee safety, equal employment opportunity, and union relations

Controlling: quality control, financial control, sales control, inventory control, expense control, analysis of variances, rewards, and sanctions

Staffing refers to human resource (HR) activities.

Controlling refers to all those managerial activities directed toward ensuring that actual results are consistent with planned results.

Management Audit Checklist of Questions (1 of 2)

Does the firm use strategic-management concepts?

Are company objectives and goals measurable and well communicated?

Do managers at all hierarchical levels plan effectively?

Do managers delegate authority well?

Is the organization's structure appropriate?

This checklist of questions can help determine specific strengths and weaknesses in the functional area of business. An answer of no to any question could indicate a potential weakness. Positive or yes answers to the checklist questions suggest potential areas of strength.

Management Audit Checklist of Questions (2 of 2)

Are job descriptions and job specifications clear?

Is employee morale high?

Are employee turnover and absenteeism low?

Are organizational reward and control mechanisms effective?

Marketing

the process of defining, anticipating, creating, and fulfilling customers’ needs and wants for products and services

Marketing can be described as the process of defining, anticipating, creating, and fulfilling customers’ needs and wants for products and services.

Functions of Marketing

Customer analysis

Selling products and services

Product and service planning

Pricing

Distribution

Marketing research

Cost/ benefit analysis

These are the seven basic functions of marketing. Each will be described on the following slides.

Customer Analysis

the examination and evaluation of consumer needs, desires, and wants

involves administering customer surveys, analyzing consumer information, evaluating market positioning strategies, developing customer profiles, and determining optimal market segmentation strategies

Customer analysis is the first function of marketing.

Selling Products and Services

Selling

includes many marketing activities, such as advertising, sales promotion, publicity, personal selling, sales force management, customer relations, and dealer relations

Selling products and services is the second function of marketing. Successful strategy implementation generally rests on the ability of an organization to sell some product or service.

Product and Service Planning

includes activities such as test marketing; product and brand positioning; devising warranties; packaging; determining product options, features, style, and quality; deleting old products; and providing for customer service

important when a company is pursuing product development or diversification

Product and service planning is the third function of marketing.

Pricing

Five major stakeholders affect pricing decisions: consumers, governments, suppliers, distributors, and competitors

Sometimes an organization will pursue a forward integration strategy primarily to gain better control over prices charged to consumers.

Pricing is the fourth function of marketing.

Distribution

includes warehousing, distribution channels, distribution coverage, retail site locations, sales territories, inventory levels and location, transportation carriers, wholesaling, and retailing

especially important when a firm is striving to implement a market development or forward integration strategy

Distribution is the fifth function of marketing.

Marketing Research

the systematic gathering, recording, and analyzing of data about problems relating to the marketing of goods and services

can uncover critical strengths and weaknesses

Marketing research is the sixth function of marketing.

Cost/Benefit Analysis

Three steps are required:

compute the total costs associated with a decision

estimate the total benefits from the decision

compare the total costs with the total benefits

Cost/benefit analysis is the seventh function of marketing.

Marketing Audit Checklist of Questions (1 of 2)

Are markets segmented effectively?

Is the organization positioned well among competitors?

Has the firm’s market share been increasing?

Are present channels of distribution reliable and cost effective?

Does the firm have an effective sales organization?

Does the firm conduct market research?

These questions about marketing must be examined in strategic planning.

Marketing Audit Checklist of Questions (2 of 2)

Are product quality and customer service good?

Are the firm's products and services priced appropriately?

Does the firm have an effective promotion, advertising, and publicity strategy?

Are marketing, planning, and budgeting effective?

Do the firm's marketing managers have adequate experience and training?

Is the firm's Internet presence excellent as compared to rivals?

Finance/Accounting Functions (1 of 4)

The functions of finance/accounting comprise three decisions:

The investment decision

The financing decision

The dividend decision

According to James Van Horne, the functions of finance/accounting comprise three decisions: the investment decision, the financing decision, and the dividend decision.

Finance/Accounting Functions (2 of 4)

Investment Decision (Capital Budgeting)

the allocation and reallocation of capital and resources to projects, products, assets, and divisions of an organization

Financing Decision

determines the best capital structure for the firm and includes examining various methods by which the firm can raise capital

After strategies are formulated, capital budgeting decisions are required to successfully implement strategies.

Firms may raise capital by, for example, issuing stock, increasing debt, selling assets, or using a combination of these approaches.

Finance/Accounting Functions (3 of 4)

Dividend Decisions

concern issues such as the percentage of earnings paid to stockholders, the stability of dividends paid over time, and the repurchase or issuance of stock

determine the amount of funds that are retained in a firm compared to the amount paid out to stockholders

Three financial ratios that are helpful in evaluating a firm’s dividend decisions are the earnings-per-share ratio, the dividends-per-share ratio, and the price-earnings ratio.

Finance/Accounting Functions (4 of 4)

How has each ratio changed over time?

How does each ratio compare to industry norms?

How does each ratio compare with key competitors?

Financial ratios are computed from an organization’s income statement and balance sheet. Computing financial ratios is like taking a photograph—the results reflect a situation at just one point in time. Comparing ratios over time and to industry averages is more likely to result in meaningful statistics that can be used to identify and evaluate strengths and weaknesses.

Financial ratio analysis should be conducted on three separate fronts.

Table 4-4 A Summary of Key Financial Ratios (1 of 4)

Ratio

How Calculated

What it measures

Liquidity Ratios

Current Ratio	Current assets over Current liabilities	The extent to which a firm can meet its short-term obligations
Quick Ratio	Current assets minus inventory over Current liabilities	The extent to which a firm can meet its short-term obligations without relying on the sale of its inventories

Leverage Ratios

Debt-to-Total-Assets Ratio	Total debt over Total assets	The percentage of total funds provided by creditors
Debt-to-Equity Ratio	Total debt over Total stockholders’ equity	The percentage of total funds provided by creditors versus by owners
Long-Term Debt-to-Equity Ratio	Long-term debt over Total stockholders’ equity	The balance between debt and equity in a firm’s long-term capital structure
Times-Interest-Earned Ratio	Profits before interest and taxes over Total interest charges	the extent to which earnings can decline without the firm becoming unable to meet its annual interest costs

A Summary of Key Financial Ratios (2 of 4)

Ratio

How Calculated

What it measures

Activity Ratios

Inventory turnover	Sales over Inventory of finished goods	Whether a firm holds excessive stocks of inventories and whether a firm is slowly selling its inventories compared to the industry average
Fixed Assets turnover	Sales over Fixed assets	Sales productivity and plant and equipment utilization
Total Assets turnover	Sales over Total assets	Whether a firm is generating a sufficient volume of business for the size of its asset investment
Accounts Receivable turnover	Annual credit sales over Accounts receivable	The average length of time it takes a firm to collect credit sales (in percentage terms)
Average Collection Period	Accounts receivable over total credit sales per 365 days	The average length of time it takes a firm to collect on credit sales (in days)

A Summary of Key Financial Ratios (3 of 4)

Ratio

How Calculated

What it measures

Profitability Ratios

Gross Profit Margin	Sales minus cost of goods sold over Sales	the total margin available to cover operating expenses and yield a profit
Operating Profit Margin	Earnings before interest and taxes EBIT over Sales	Profitability without concern for taxes and interest
Net Profit Margin	Net income over sales	After-tax profits per dollar of sales
Return on total Assets (R O A)	Net income over Total assets	After-tax profits per dollar of assets; this ratio is also called return on investment (R O I)
Return on Stockholders’ Equity (R O E)	Net Income over Total stockholders’ equity	After-tax profits per dollar of stockholders’ investment in the firm
Earnings Per Share (E P S)	Net income over Number of shares of common stock outstanding	Earnings available to the owners of common Stock
Price-Earnings Ratio	Market price per share over Earnings per share	Attractiveness of firm on equity markets

A Summary of Key Financial Ratios (4 of 4)

Ratio

How Calculated

What it measures

Growth Ratios

Sales	Annual percentage growth in total sales	Firm’s growth rate in sales
Net Income	Annual percentage growth in profits	Firm’s growth rate in profits
Earnings Per Share	Annual percentage growth in EPS	Firm’s growth rate in EPS
Dividends Per Share	Annual percentage growth in dividends per share	Firm’s growth rate in dividends per share

Finance/Accounting Audit Checklist (1 of 2)

Where is the firm financially strong and weak as indicated by financial ratio analyses?

Can the firm raise needed short-term capital?

Can the firm raise needed long-term capital through debt and/or equity?

Does the firm have sufficient working capital?

Are capital budgeting procedures effective?

Some finance and accounting questions that should be examined in any strategic analysis of the firm are given here.

Finance/Accounting Audit Checklist (2 of 2)

Are dividend payout policies reasonable?

Does the firm have good relations with its investors and stockholders?

Are the firm's financial managers experienced and well trained?

Is the firm's debt situation excellent?

Production/Operations

Production/operations function

consists of all those activities that transform inputs into goods and services

Production/operations management deals with inputs, transformations, and outputs that vary across industries and markets.

Production and operations activities often represent the largest part of an organization’s human and capital assets.

Table 4-6 The Basic Functions (Decisions) Within Production/Operations

Decision Areas	Example Decisions
1. Process	these decisions include choice of technology, facility layout, process flow analysis, facility location, line balancing, process control, and transportation analysis. Distances from raw materials to production sites to customers are a major consideration.
2. Capacity	these decisions include forecasting, facilities planning, aggregate planning, scheduling, capacity planning, and queuing analysis. Capacity utilization is a major consideration.
3. Inventory	these decisions involve managing the level of raw materials, work-in- process, and finished goods, especially considering what to order, when to order, how much to order, and materials handling.
4. Workforce	these decisions involve managing the skilled, unskilled, clerical, and managerial employees by caring for job design, work measurement, job enrichment, work standards, and motivation techniques.
5. Quality	these decisions are aimed at ensuring that high-quality goods and ser- vices are produced by caring for quality control, sampling, testing, quality assurance, and cost control.

Table 4-7 Implications of Various Strategies on Production/Operations

Various Strategies	Implications
1. Become a low-cost provider	Creates high barriers to entry Creates larger market Requires longer production runs and fewer product changes
2. Become a high-quality provider	Requires more quality-assurance efforts Requires more expensive equipment Requires highly skilled workers and higher wages
3. Provide great customer service	Requires more service people, service parts, and equipment Requires rapid response to customer needs or changes in customer tastes Requires a higher inventory investment
4. Be the first to introduce new products	Has higher research and development costs Has high retraining and tooling costs
5. Become highly automated	Requires high capital investment Reduces flexibility May affect labor relations Makes maintenance more crucial
6. Minimize layoffs	Serves the security needs of employees and may develop employee loyalty Helps attract and retain highly skilled employees

Production/Operations Audit Checklist

Are supplies of raw materials, parts, and subassemblies reliable and reasonable?

Are facilities, equipment, machinery, and offices in good condition?

Are inventory-control policies and procedures effective?

Are quality-control policies and procedures effective?

Are facilities, resources, and markets strategically located?

Does the firm have technological competencies?

Questions such as these should be examined during the analysis of production and operations.

Research and Development Audit

Does the firm have R&D facilities? Are they adequate?

If outside R&D firms are used, are they cost-effective?

Are the organization's R&D personnel well qualified?

Are R&D resources allocated effectively?

Are management information and computer systems adequate?

Is communication between R&D and other organizational units effective?

Are present products technologically competitive?

Organizations invest in R&D because they believe that such an investment will lead to a superior product or service and will give them competitive advantages.

Management Information Systems

Management Information System

Receives raw material from both external and internal evaluation of an organization

Improves the performance of an enterprise by improving the quality of managerial decisions

Collects, codes, stores, synthesizes, and presents information in such a manner that it answers important operating and strategic questions

The heart of an information system is a database containing the kinds of records and data important to managers.

Management Information Systems Audit (1 of 2)

Do all managers in the firm use the information system to make decisions?

Is there a chief information officer or director of information systems position in the firm?

Are data in the information system updated regularly?

Do managers from all functional areas of the firm contribute input to the information system?

Are there effective passwords for entry into the firm's information system?

Questions such as these should be asked when conducting an MIS audit.

Management Information Systems Audit (2 of 2)

Are strategists of the firm familiar with the information systems of rival firms?

Is the information system user-friendly?

Do all users of the information system understand the competitive advantages that information can provide firms?

Are computer training workshops provided for users of the information system?

Is the firm’s information system continually being improved in content- and user-friendliness?

Value Chain Analysis (V C A)

refers to the process whereby a firm determines the costs associated with organizational activities from purchasing raw materials to manufacturing product(s) to marketing those products

aims to identify where low-cost advantages or disadvantages exist anywhere along the value chain from raw material to customer service activities

According to Porter, the business of a firm can best be described as a value chain, in which total revenues minus total costs of all activities undertaken to develop and market a product or service yields value.

Figure 4-8 Transforming Value Chain Activities into Sustained Competitive Advantage

More and more companies are using VCA to gain and sustain competitive advantage by being especially efficient and effective along various parts of the value chain.

Benchmarking

an analytical tool used to determine whether a firm's value chain activities are competitive compared to rivals and thus conducive to winning in the marketplace

entails measuring costs of value chain activities across an industry to determine “best practices”

Benchmarking enables a firm to take action to improve its competitiveness by identifying (and improving on) value chain activities where rival firms have comparative advantages in cost, service, reputation, or operation.

The Internal Factor Evaluation (I F E) Matrix

List key internal factors as identified in the internal-audit process.

Assign a weight that ranges from 0.0 (not important) to 1.0 (all-important) to each factor.

Assign a 1-to-4 rating to each factor to indicate whether that factor represents a strength or weakness.

Multiply each factor's weight by its rating to determine a weighted score for each variable.

Sum the weighted scores for each variable to determine the total weighted score for the organization.

A summary step in conducting an internal strategic-management audit is to construct an Internal Factor Evaluation (IFE) Matrix.

Table 4-8 A Sample Internal Factor Evaluation Matrix for a Retail Computer Store (1 of 2)

Key internal Factors	Weight	Rating	Weighted Score
Strengths	Blank	Blank	Blank
1. Inventory turnover increased from 5.8 to 6.7.	0.05	3	0.15
2. Average customer purchase increased from $97 to $128.	0.07	4	0.28
3. Employee morale is excellent.	0.10	3	0.30
4. In-store promotions resulted in 20% increase in sales.	0.05	3	0.15
5. Newspaper advertising expenditures increased 10%.	0.02	3	0.06
6. Revenues from repair/service in the store up 16%.	0.15	3	0.45
7. In-store technical support personnel have MIS college degrees.	0.05	4	0.20
8. Store’s debt-to-total assets ratio declined to 34%.	0.03	3	0.09
9. Revenues per employee up 19%.	0.02	3	0.06

The table reveals that the two most important factors to be successful in the retail computer store business are “Revenues from repair/service in the store” and “Employee morale.” Note that the store is doing best on “Average customer purchase” amount and “In-store technical support.” The store is having major problems with its carpet, bathroom, paint, and checkout procedures. Note also that the matrix contains substantial quantitative data rather than vague statements.

Table 4-8 A Sample Internal Factor Evaluation Matrix for a Retail Computer Store (2 of 2)

Key internal Factors	Weight	Rating	Weighted Score
Weaknesses	Blank	Blank	Blank
1. Revenues from software segment of store down 12%.	0.10	2	0.20
2. Location of store negatively impacted by new Highway 34.	0.15	2	0.30
3. Carpet and paint in store somewhat in disrepair.	0.02	1	0.02
4. Bathroom in store needs refurbishing.	0.02	1	0.02
5. Revenues from businesses down 8%.	0.04	1	0.04
6. Store has no website.	0.05	2	0.10
7. Supplier on-time delivery increased to 2.4 days.	0.03	1	0.03
8. Often customers have to wait to check out	0.05	1	0.05
Total	1.00	BLANK	2.50

Current assets

Current liabilities

Current assets minus inventory

Current liabilities

Total debt

Total assets

Total debt

Total stockholders' equity

Long-term debt

Total stockholders' equity

Profits before interest and taxes

Total interest charges

Sales

Inventory of finished goods

Sales

Fixed assets

Sales

Total assets

Annual credit sales

Accounts receivable

Total credit sales/365 days

Sales minus cost of goods sold

Sales

Earnings before interest and taxes EBIT

Sales

Net income

Sales

Net income

Total assets

Net income

Total stockholders' equity

Net income

Number of shares of common stock outstan

ding

Market price per share

Earnings per share