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Hitt, Ireland, Hoskisson, Strategic Management: Competitiveness & Globalization: Concepts & Cases, 13e. © 2020 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or part.

CHAPTER

3 The Internal Organization: Resources, Capabilities, Core Competencies, and

Competitive Advantages

LEARNING OBJECTIVES Studying this chapter should provide you with the strategic management knowledge needed to: 3-1 Explain why firms need to study and understand their internal organization. 3-2 Define value and discuss its importance. 3-3 Describe the differences between tangible and intangible resources. 3-4 Define capabilities and discuss their development. 3-5 Define four criteria used to determine if resources and capabilities are

core competencies. 3-6 Explain how firms analyze their value chain to determine where they are

able to create value when using their resources, capabilities, and core competencies.

3-7 Define outsourcing and discuss reasons for its use. 3-8 Discuss the importance of identifying internal strengths and weaknesses. 3-9 Describe the importance of avoiding core rigidities.

Chapter Introduction (slide 1 of 2)

• Firms and organizations achieve strategic competitiveness and earn above-average returns by acquiring, bundling, and leveraging their resources for the purpose of taking advantage of opportunities in the external environment in ways that create value for customers.

• Competitors will eventually learn how to duplicate the benefits of any firm’s value-creating strategy. • Thus, all competitive advantages have a limited life.

Chapter Introduction (slide 2 of 2)

• In general, a competitive advantage’s sustainability is a function of three factors: 1. The rate of core competence obsolescence because of

environmental changes 2. The availability of substitutes for the core competence 3. The imitability of the core competence

• For all firms, the challenge is to effectively manage current core competencies while simultaneously developing new ones. • Only when firms are able to do this can they expect to:

• Achieve strategic competitiveness • Earn above-average returns • Remain ahead of competitors in both the short and long term

3-1 Analyzing the 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 in the internal organization) with what it might do (a function of opportunities and threats in the external environment) yields insights for the firm to select its strategies.

3-1a The Context of Internal Analysis (slide 1 of 2)

• In today’s global economy, some of the resources that were traditionally critical to firms’ efforts to produce, sell, and distribute their goods or services are now less likely to be the source of competitive advantages. • This is because an increasing number of firms are

using their resources to form core competencies through which they successfully implement an international strategy as a means of overcoming the advantages created by more traditional resources.

3-1a The Context of Internal Analysis (slide 2 of 2)

• Firms analyzing their internal organization should use a global mind-set to do so. • A global mind-set is the ability to analyze,

understand, and manage an internal organization in ways that are not dependent on the assumptions of a single country, culture, or context.

• Analyzing the firm’s internal organization requires that evaluators understand how to leverage the firm’s unique bundle of resources and capabilities.

Figure 3.1 Components of an Internal Analysis

3-1b Creating Value (slide 1 of 2)

• Value is measured by a product’s performance characteristics and by its attributes for which customers are willing to pay.

• Firms create value by innovatively building and leveraging their resources to form capabilities and core competencies.

• Ultimately, creating value for customers is the source of above-average returns for a firm.

• What the firm intends regarding value creation affects its choice of business-level strategy and its organizational structure.

3-1b Creating Value (slide 2 of 2)

• Core competencies, in combination with product-market positions, are the firm’s most important sources of competitive advantage. • A firm’s core competencies, integrated with an

understanding of the results of studying the conditions in the external environment, should drive the selection of strategies.

3-1c The Challenge of Analyzing the Internal Organization (slide 1 of 3)

• The strategic decisions managers make about the internal organization: • Are nonroutine • Have ethical implications • Significantly influence the firm’s ability to earn above-average returns

• Making decisions regarding the firm’s assets: • Involves identifying, developing, deploying, and protecting resources,

capabilities, and core competencies • Is challenging and difficult • Is increasingly internationalized

• A firm can improve by studying its mistakes. • The learning generated by making and correcting mistakes can be

important in the creation of new capabilities and core competencies.

3-1c The Challenge of Analyzing the Internal Organization (slide 2 of 3)

• Three conditions affect managers as they analyze the internal organization and make decisions about resources: 1. Uncertainty 2. Complexity 3. Intraorganizational conflict

Figure 3.2 Conditions Affecting Managerial Decisions about Resources, Capabilities, and Core Competencies

3-1c The Challenge of Analyzing the Internal Organization (slide 3 of 3)

• In making decisions affected by these three conditions, judgment is required. • Judgment is the capability of making successful decisions when

no obviously correct model or rule is available or when relevant data are unreliable or incomplete.

• When exercising judgment, decision makers: • Must be aware of possible cognitive biases, such as overconfidence • Often take intelligent risks

• Strategic leaders are individuals with an ability to examine the firm’s resources, capabilities, and core competencies and make effective choices about their use.

3-2 Resources, Capabilities, and Core Competencies

• The foundation of competitive advantage are: • Resources • Capabilities • Core competencies

• Resources are bundled to create organizational capabilities.

• In turn, capabilities are the source of a firm’s core competencies, which are the basis of establishing competitive advantages.

3-2a Resources (slide 1 of 4)

• Broad in scope, resources cover a spectrum of individual, social, and organizational phenomena.

• By themselves, resources do not allow firms to create value for customers as the foundation for earning above-average returns.

3-2a Resources (slide 2 of 4)

• Some of a firm’s resources are tangible, while others are intangible. • Tangible resources are assets that can be observed

and quantified. • Examples: Production equipment, manufacturing facilities,

distribution centers, and formal reporting structures • Four primary categories of tangible resources are:

1. Financial 2. Organizational 3. Physical 4. Technological

Table 3.1 Tangible Resources

Financial Resources • The firm’s capacity to borrow • The firm’s ability to generate funds through

internal operations Organizational Resources • Formal reporting structures Physical Resources • The sophistication of a firm’s plant and

equipment and the attractiveness of its location • Distribution facilities • Product inventory

Technological Resources • Availability of technology-related resources such as copyrights, patents, trademarks, and trade secrets

Sources: Adapted from J. B. Barney, 1991, Firm resources and sustained competitive advantage, Journal of Management, 17: 101; R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge: U.K.: Blackwell Business, 100– 102.

3-2a Resources (slide 3 of 4)

• Intangible resources are assets that are rooted deeply in the firm’s history, accumulate over time, and are relatively difficult for competitors to analyze and imitate.

• Examples: Knowledge, managerial capabilities, organizational routines, brand name, and organizational culture

• Three primary categories of intangible resources are: 1. Human 2. Innovation 3. Reputational

Table 3.2 Intangible Resources

Human Resources • Knowledge • Trust • Skills • Abilities to collaborate with others

Innovation Resources • Ideas • Scientific capabilities • Capacity to innovate

Reputational Resources • Brand name • Perceptions of product quality, durability, and

reliability • Positive reputation with stakeholders such as

suppliers and customers Sources: Adapted from R. Hall, 1992, The strategic analysis of intangible resources, Strategic Management Journal, 13: 136–139; R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge U.K.: Blackwell Business, 101–104.

3-2a Resources (slide 4 of 4)

Tangible Resources • Tangible resources are hard to leverage.

• That is, it is difficult to derive additional business or value from a tangible resource.

Intangible Resources • Compared to tangible resources, intangible resources:

• Are less visible and more difficult for competitors to understand, purchase, imitate, or substitute for

• Are more relied on to be the foundation for a firm’s capabilities • Can be leveraged

3-2b Capabilities

• Capabilities are: • Created by combining individual tangible and intangible

resources • Used to complete the organizational tasks required to produce,

distribute, and service the goods or services the firm provides to customers for the purpose of creating value for them

• The foundation for building core competencies and hopefully competitive advantages

• Often based on developing, carrying, and exchanging information and knowledge through the firm’s human capital

• Often developed in specific functional areas or in a part of a functional area

Table 3.3 Example of Firms’ Capabilities (slide 1 of 2)

Functional Areas Capabilities Examples of Firms Distribution • Effective use of logistics

management techniques • Walmart

Human Resources

• Motivating, empowering, and retaining employees

• Microsoft

Management Information Systems

• Effective and efficient control of inventories through point-of- purchase data collection methods

• Walmart

Marketing • Effective promotion of brand- name products

• Effective customer service • Innovative merchandising

• Procter & Gamble • Ralph Lauren

Corp. • McKinsey & Co. • Nordstrom Inc. • Crate & Barrel

Table 3.3 Example of Firms’ Capabilities (slide 2 of 2)

Functional Areas Capabilities Examples of Firms Management • Ability to envision the future of

clothing • Hugo Boss • Zara

Manufacturing • Design and production skills yielding reliable products

• Product and design quality • Miniaturization of components

and products

• Komatsu • Witt Gas

Technology • Sony

Research & Development

• Innovative technology • Development of sophisticated

elevator control solutions • Rapid transformation of

technology into new products and processes

• Digital technology

• Caterpillar • Otis Elevator Co. • Chaparral Steel • Thomson

Consumer Electronics

3-2c Core Competencies

• Core competencies: • Are capabilities that serve as a source of competitive

advantage for a firm over its rivals • Emerge over time through an organizational process

of accumulating and learning how to deploy different resources and capabilities

• The activities the company performs especially well compared to competitors

• The activities through which the firm adds unique value to the goods or services it sells to customers

3-3 Building Core Competencies

• Two tools help firms identify their core competencies: 1. The four criteria of sustainable competitive

advantage 2. Value chain analysis

3-3a The Four Criteria of Sustainable Competitive Advantage (slide 1 of 2)

• Core competencies are capabilities that are: • Valuable

• Valuable capabilities allow the firm to exploit opportunities or neutralize threats in its external environment.

• Rare • Rare capabilities are capabilities that few, if any, competitors

possess. • Costly to imitate

• Costly-to-imitate capabilities are capabilities that other firms cannot easily develop.

• Nonsubstitutable • Nonsubstitutable capabilities are capabilities that do not have

strategic equivalents.

Table 3.4 The Four Criteria of Sustainable Competitive Advantage

Valuable Capabilities • Help a firm neutralize threats or exploit opportunities

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

Nonsubstitutable Capabilities • No strategic equivalent

3-3a The Four Criteria of Sustainable Competitive Advantage (slide 2 of 2)

• Capabilities failing to satisfy the four criteria are not core competencies, meaning that although every core competence is a capability, not every capability is a core competence. • In slightly different wording:

• For a capability to be a core competence, it must be valuable and unique from a customer’s point of view.

• For a core competence to be a potential source of competitive advantage, it must be inimitable and nonsubstitutable by competitors.

3-3b Value Chain Analysis (slide 1 of 2)

• Value chain analysis allows the firm to understand the parts of its operations that create value and those that do not. • Understanding these issues is important because the

firm earns above-average returns only when the value it creates is greater than the costs incurred to create that value.

3-3b Value Chain Analysis (slide 2 of 2)

• The value chain is: • A template that firms use to analyze their cost position and to

identify the multiple means that can be used to facilitate implementation of a chosen strategy

• Segmented into value chain activities and support functions • Value chain activities are activities or tasks the firm completes in

order to produce products and then sell, distribute, and service those products in ways that create value for customers.

• Support functions include the activities or tasks the firm completes in order to support the work being done to produce, sell, distribute, and service the products the firm is producing.

• A firm can develop a capability and/or a core competence in any of the value chain activities and support functions. • When it does so, it has the ability to create value for customers.

Figure 3.3 A Model of the Value Chain

Figure 3.4 Creating Value through Value Chain Activities

Figure 3.5 Creating Value through Support Functions

3-4 Outsourcing (slide 1 of 2)

• When the firm cannot create value in either a value chain activity or a support function, outsourcing is considered. • Outsourcing is the purchase of a value-creating activity or a

support function activity from an external supplier. • Firms engaging in effective outsourcing:

• Increase their flexibility • Mitigate risks • Reduce their capital investments

• Firms should use outsourcing only for activities where they: • Cannot create value • Are at a substantial disadvantage compared to competitors

3-4 Outsourcing (slide 2 of 2)

• Outsourcing can be effective because few, if any, organizations possess the resources and capabilities required to achieve competitive superiority in each value chain activity and support function.

• By outsourcing activities in which it lacks competence, a firm: • Increases the probability of developing core competencies and

achieving a competitive advantage because it does not become overextended

• Can fully concentrate on those areas in which it has the potential to create value

• There are two significant concerns associated with outsourcing: 1. The potential loss in a firm’s ability to innovate 2. The loss of jobs within the focal firm

• Outsourcing to a foreign supplier is commonly called offshoring.

3-5 Competencies, Strengths, Weaknesses, and Strategic Decisions (slide 1 of 2)

• By analyzing the internal organization, firms identify their strengths and weaknesses as reflected by their resources, capabilities, and core competencies. • If a firm has weak capabilities or does not have core

competencies in areas required to achieve a competitive advantage, it must acquire those resources and build the needed capabilities and competencies.

3-5 Competencies, Strengths, Weaknesses, and Strategic Decisions (slide 2 of 2)

• Having a significant quantity of resources is not the same as having the “right” resources. • The “right” resources are those with the potential to be formed

into core competencies as the foundation for creating value for customers and developing competitive advantages because of doing so.

• The ability of a core competence to be a permanent competitive advantage can’t be assumed. • All core competencies have the potential to become core

rigidities that generate inertia and stifle innovation.