operational planning and policy - assignment Organizational Resources & Capabilities

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CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness

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Chapter 3 described how to use the tools of industry and competitor analysis to assess a company’s external environment and lay the groundwork for matching a company’s strategy to its external situation.

Chapter 4 discusses techniques for evaluating a company’s internal situation, including its collection of resources and capabilities and the activities it performs along its value chain.

Internal analysis enables managers to determine whether their strategy is likely to give the company a significant competitive edge over rival firms. Combining internal and external analyses facilitates an understanding of how to reposition a firm to take advantage of new opportunities and to cope with emerging competitive threats.

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Learning Objectives

This chapter will help you understand:

How to evaluate how well a firm’s strategy is working.

How to assess the company’s strengths and weaknesses in light of market opportunities and external threats.

Why a company’s resources and capabilities are critical in gaining a competitive edge over rivals.

How value chain activities affect a company’s cost structure and customer value proposition.

How a comprehensive evaluation of a firm’s competitive situation can assist managers in making critical decisions about their next strategic moves.

In this chapter, the analytic spotlight will be trained on six questions:

How well is the firm’s present strategy working?

What are the firm’s most important resources and capabilities, and will they give the firm a lasting competitive advantage over rival companies?

What are the firm’s strengths and weaknesses in relation to the market opportunities and external threats?

How do a firm’s value chain activities impact its cost structure and customer value proposition?

Is the firm competitively stronger or weaker than key rivals?

What strategic issues and problems merit front-burner managerial attention?

In probing for answers to these questions, five analytic tools—resource and capability analysis, SWOT analysis, value chain analysis, benchmarking, and competitive strength assessment—will be used.

All five are valuable techniques for revealing a firm’s competitiveness and for helping managers match their strategy to the firm’s particular circumstances.

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QUESTION 1: How Well Is the Company’s Present Strategy Working?

The three best indicators of how well a company’s strategy is working are:

Whether it is achieving its stated financial and strategic objectives

Whether its financial performance is above the industry average

Whether it is gaining customers and gaining market share

Strategic success in a firm’s present competitive approach requires asking:

Has the firm been successful actions in attracting customers and improving its market position?

Has the firm gained a sustainable competitive advantage based on low product costs or better product offerings?

Is the firm appropriately concentrating its resources on serving a broad spectrum of customers or a narrow market niche?

Are the firm’s functional strategies in R&D, production, marketing, finance, human resources, information technology strengthening its competitive position?

Has the firm been successful in its efforts to establish alliances with other enterprises?

Persistent shortfalls in meeting its performance targets and weak marketplace performance relative to rivals are reliable warning signs that the firm has a weak strategy, suffers from poor strategy execution, or both.

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FIGURE 4.1 Identifying the Components of a Single-Business Company’s Strategy

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FIGURE 4.1 Identifying the Components of a Single-Business Company’s Strategy

Single business strategic action plan components include:

Moves to respond to changing conditions in the macro-environment or in industry and competitive conditions

Basing competitive advantage on lower costs, better products, superior service of a market niche or specific buyers

Expanding or narrowing geographic coverage

Partnering to build valuable partnerships and strategic alliances with other enterprises in the same industry

Key functional strategies of the overall business strategy:

R&D, technology, product design; supply chain management; production; sales, marketing, and distribution; information technology; human resources; and finance.

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Specific Indicators of Strategic Success

Sales and earnings growth trends

Company’s overall financial strength

Customer retention rate

Stock price trends

Rate of new customers acquired

Evidence of improvement in internal processes

defect rate, order fulfillment, delivery times, days of inventory, and employee productivity

Specific indicators of how well a firm’s strategy is working include:

Trends in the company’s sales and earnings growth.

Trends in the company’s stock price.

The company’s overall financial strength.

The company’s customer retention rate.

The rate at which new customers are acquired.

Evidence of improvement in internal processes such as defect rate, order fulfillment, delivery times, days of inventory, and employee productivity.

Strategic Management Principle Sluggish financial performance and second-rate market accomplishments almost always signal weak strategy, weak execution, or both.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (1 of 8)

Profitability Ratios	How Calculated	What It Shows
Gross profit margin	Sales revenues − Cost of goods sold Sales revenues	Shows the percentage of revenues available to cover operating expenses and yield a profit.
Operating profit margin (or return on sales)	Sales revenues − Operating expenses Sales revenues or Operating income Sales revenues	Shows the profitability of current operations without regard to interest charges and income taxes. Earnings before interest and taxes is known as EBIT in financial and business accounting.
Net profit margin (or net return on sales)	Profits after taxes Sales revenues	Shows after-tax profits per dollar of sales.
Total return on assets	Profits after taxes + Interest Total assets	A measure of the return on total investment in the enterprise. Interest is added to after-tax profits to form the numerator, since total assets are financed by creditors as well as by stockholders.

The stronger a company’s current overall performance, the more likely it has a well-conceived, well-executed strategy. The weaker a company’s financial performance and market standing, the more its current strategy must be questioned and the more likely the need for radical changes.

Table 4.1 provides a compilation of the profitability ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (2 of 8)

Profitability Ratios	How Calculated	What It Shows
Net return on total assets (ROA)	Profits after taxes Total assets	A measure of the return earned by stockholders on the firm’s total assets.
Return on stockholders’ equity (ROE)	Profits after taxes Total stockholders’ equity	The return stockholders are earning on their capital investment in the enterprise. A return in the 12% to 15% range is average.
Return on invested capital (ROIC)—sometimes referred to as return on capital employed (ROCE)	Profits after taxes Long-term debt + Total stockholders’ equity	A measure of the return that shareholders are earning on the monetary capital invested in the enterprise. A higher return reflects greater bottom-line effectiveness in the use of long-term capital.

Table 4.1 provides a compilation of the financial profitability ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (3 of 8)

Liquidity Ratios	How Calculated	What It Shows
Current ratio	Current assets Current liabilities	Shows a firm’s ability to pay current liabilities using assets that can be converted to cash in the near term. Ratio should be higher than 1.0.
Working capital	Current assets − Current liabilities	The cash available for a firm’s day-to-day operations. Larger amounts mean the firm has more internal funds to (1) pay its current liabilities on a timely basis and (2) finance inventory expansion, additional accounts receivable, and a larger base of operations without resorting to borrowing or raising more equity capital.

Table 4.1 provides a compilation of the assets-to-liabilities liquidity ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (4 of 8)

Leverage Ratios	How Calculated	What It Shows
Total debt-to-assets ratio	Total debt Total assets	Measures the extent to which borrowed funds (both short-term loans and long-term debt) have been used to finance the firm’s operations. A low ratio is better—a high fraction indicates overuse of debt and greater risk of bankruptcy.
Long-term debt-to-capital ratio	Long-term debt Long-term debt + Total stockholders’ equity	A measure of creditworthiness and balance-sheet strength. It indicates the percentage of capital investment that has been financed by both long-term lenders and stockholders. A ratio below 0.25 is preferable since the lower the ratio, the greater the capacity to borrow additional funds. Debt-to-capital ratios above 0.50 indicate an excessive reliance on long-term borrowing, lower creditworthiness, and weak balance- sheet strength.

Table 4.1 provides a compilation of the financial leverage ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (5 of 8)

Leverage Ratios	How Calculated	What It Shows
Debt-to-equity ratio	Total debt Total stockholders’ equity	Shows the balance between debt (funds borrowed, both short term and long term) and the amount that stockholders have invested in the enterprise. The further the ratio is below 1.0, the greater the firm’s ability to borrow additional funds. Ratios above 1.0 put creditors at greater risk, signal weaker balance sheet strength, and often result in lower credit ratings.
Long-term debt-to-equity ratio	Long-term debt Total stockholders’ equity	Shows the balance between long-term debt and stockholders’ equity in the firm’s long-term capital structure. Low ratios indicate a greater capacity to borrow additional funds if needed.
Times-interest-earned (or coverage) ratio	Operating income Interest expenses	Measures the ability to pay annual interest charges. Lenders usually insist on a minimum ratio of 2.0, but ratios above 3.0 signal increasing creditworthiness.

Table 4.1 provides a compilation of the debt-to-equity leverage ratios and income-to-expenses coverage ratio most commonly used to evaluate a company’s financial performance and balance sheet strength.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (6 of 8)

Activity Ratios	How Calculated	What It Shows
Days of inventory	Inventory Cost of goods sold ÷ 365	Measures inventory management efficiency. Fewer days of inventory are better.
Inventory turnover	Cost of goods sold Inventory	Measures the number of inventory turns per year. Higher is better.
Average collection period	Accounts receivable Total sales ÷ 365 or Accounts receivable Average daily sales	Indicates the average length of time the firm must wait after making a sale to receive cash payment. A shorter collection time is better.

Table 4.1 provides a compilation of the inventory and accounts receivable collection activity ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (7 of 8)

Other Ratios	How Calculated	What It Shows
Dividend yield on common stock	Annual dividends per share Current market price per share	A measure of the return that shareholders receive in the form of dividends. A “typical” dividend yield is 2% to 3%. The dividend yield for fast-growth firms is often below 1%; the dividend yield for slow-growth firms can run 4% to 5%.
Price-to-earnings (P/E) ratio	Current market price per share Earnings per share	P/E ratios above 20 indicate strong investor confidence in a firm’s outlook and earnings growth; firms whose future earnings are at risk or likely to grow slowly typically have ratios below 12.
Dividend payout ratio	Annual dividends per share Earnings per share	Indicates the percentage of after-tax profits paid out as dividends.

Table 4.1 provides a compilation of dividend yield, price-to-earnings, and dividend payout ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

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TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean (8 of 8)

Other Ratios	How Calculated	What It Shows
Internal cash flow	After-tax profits + Depreciation	A rough estimate of the cash a firm’s business is generating after payment of operating expenses, interest, and taxes. Such amounts can be used for dividend payments or funding capital expenditures.
Free cash flow	After-tax profits + Depreciation – Capital expenditures – Dividends	A rough estimate of the cash a firm’s business is generating after payment of operating expenses, interest, taxes, dividends, and desirable reinvestments in the business. The larger a firm’s free cash flow, the greater its ability to internally fund new strategic initiatives, repay debt, make new acquisitions, repurchase shares of stock, or increase dividend payments.

Table 4.1 provides a compilation of cash flow ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

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QUESTION 2: What Are the Company’s Strengths and Weaknesses in Relation to the Market Opportunities and External Threats?

SWOT analysis is a tool for identifying situational reasons underlying a firm’s performance.

Internal strengths (the basis for strategy)

Internal weaknesses (deficient capabilities)

Market opportunities (strategic objectives)

External threats (strategic defenses)

SWOT can help explain why a strategy is working well (or not) by taking a close look a company's strengths in relation to its weaknesses and in relation to the strengths and weaknesses of competitors. Are the firm’s strengths enough to make up for its weaknesses? Has the firm’s strategy built on these strengths and shielded the firm from its weaknesses? Do the firm's strengths exceed those of its rivals? Similarly, a SWOT analysis can help determine whether a strategy has been effective in fending off external threats and positioning the firm to take advantage of market opportunities.

SWOT analysis is a widely used diagnostic tool popular for its ease of use, also because it can be used to evaluate the efficacy of a strategy and as the basis for crafting a strategy from the outset to determine whether the firm is positioned to pursue new market opportunities and to defend against emerging threats to its future well-being.

Connect Activity

Consider adding a LearnSmart assignment requiring the student to review this section of the chapter as an interactive question and answer review. The assignment can be graded and posted automatically.

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Identifying a Company’s Internal Strengths

A competence is an activity that a firm has learned to perform with proficiency and at an acceptable cost—a true capability, in other words.

A core competence is an activity that a firm performs proficiently and that is also central to its strategy and competitive success.

A distinctive competence is a competitively important activity that a firm performs better than its rivals—it represents a competitively superior internal strength.

A firm’s strengths represent its competitive assets. Basing a firm’s strategy on its most competitively valuable strengths gives the firm its best chance for market success. When a company’s proficiency rises from that of mere ability to perform an activity to the point of being able to perform it consistently well and at acceptable cost, it is said to have a competence—a true capability, in other words. If a firm’s competence level in some activity domain is superior to that of its rivals it is known as a distinctive competence. A core competence is a proficiently performed internal activity that is central to a firm’s strategy and is typically distinctive as well. A core competence is a more competitively valuable strength than a competence because of the activity’s key role in the firm’s strategy and the contribution it makes to the firm’s market success and profitability

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Identifying a Company’s Internal Weaknesses

A weakness

Is something a firm lacks or does poorly (in comparison to others) or a condition that puts it at a competitive disadvantage in the marketplace

Types of weaknesses

Inferior or unproven skills, expertise, or intellectual capital in competitively important areas of the business

Deficiencies in physical, organizational, or intangible assets

A firm’s weaknesses are shortcomings that constitute competitive liabilities, weakness, or competitive deficiency, and is something a firm lacks or does poorly (in comparison to others) or a condition that puts it at a competitive disadvantage in the marketplace. A firm’s internal weaknesses can relate to (1) inferior or unproven skills, expertise, capabilities, or intellectual capital in competitively important areas of the business; (2) deficiencies in competitively important physical, organizational, or intangible assets.

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Identifying a Company’s Market Opportunities

Characteristics of market opportunities

Newly emerging and fast-changing markets may represent “golden opportunities” but are often hidden in “fog of the future.”

Opportunities can evolve in mature markets.

Opportunities with market factors aligned with the firm’s strengths offer the most potential for the firm to gain competitive advantage.

Depending on the prevailing circumstances, a firm’s opportunities can be plentiful or scarce, fleeting or lasting, and can range from wildly attractive to marginally interesting to unsuitable. A firm is well advised to pass on a particular market opportunity unless it has or can acquire the competencies needed to capture it.

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Identifying External Threats

Types of threats

Normal course-of-business

Sudden-death (survival)

Considering threats

Identify threats to the firm’s future prospects

Evaluate strategic actions to be taken to neutralize or lessen impact

Simply making lists of a firm’s strengths, weaknesses, opportunities, and threats is not enough. The payoff from SWOT analysis comes from the conclusions about a firm’s situation and the implications for strategy improvement that flow from the four lists.

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TABLE 4.2 What to Look for in Identifying a Company’s Strengths, Weaknesses, Opportunities, and Threats (1 of 4)

Strengths and Competitive Assets	Weaknesses and Competitive Deficiencies
Ample financial resources to grow the business	No distinctive core competencies
Strong brand-name image or company reputation	Lack of attention to customer needs
Cost advantages over rivals	Weak balance sheet, too much debt
Attractive customer base	Higher costs than competitors
Proprietary technology, superior technological skills, important patents	Too narrow a product line relative to rivals
Strong bargaining power over suppliers or buyers	Weak brand image or reputation

Table 4.2-1 lists many of the things to consider in compiling a company’s strengths and weaknesses. Sizing up a company’s complement of strengths and deficiencies is akin to constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses represent competitive liabilities. Ideally, the company’s competitive assets should outweigh its competitive liabilities by an ample margin.

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TABLE 4.2 What to Look for in Identifying a Company’s Strengths, Weaknesses, Opportunities, and Threats (2 of 4)

Strengths and Competitive Assets (continued)	Weaknesses and Competitive Deficiencies (continued)
Superior product quality	Lack of adequate distribution capability
Wide geographic coverage or strong global distribution capability	Lack of management depth
Alliances or joint ventures that provide access to valuable technology competencies, or attractive geographic markets	A plague of internal operating problems or obsolete facilities Too much underutilized plan capacity

Table 4.2-2 lists many of the things to consider in compiling a company’s strengths and weaknesses. Sizing up a company’s complement of strengths and deficiencies is akin to constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses represent competitive liabilities. Ideally, the company’s competitive assets should outweigh its competitive liabilities by an ample margin.

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TABLE 4.2 What to Look for in Identifying a Company’s Strengths, Weaknesses, Opportunities, and Threats (3 of 4)

Market Opportunities	External Threats
Meet sharply rising buyer demand for the industry’s product	Increasing intensity of competition
Serve additional customer groups or market segments	Slowdowns in market growth
Expand into new geographic markets	Likely entry of potent new competitions
Expand the company’s product line to meet a broader range of customer needs	Growing bargaining power of customers or suppliers
Enter new product lines or new businesses	A shift in buyer needs and tastes away from the industry’s product
Take advantage of failing trade barriers in attractive foreign markets	Adverse demographic changes that threaten to curtail demand for the industry’s product

Table 4.2-3 displays a sampling of potential threats and market opportunities. Sizing up a company’s complement of strengths and deficiencies is akin to constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses represent competitive liabilities. Ideally, the company’s competitive assets should outweigh its competitive liabilities by an ample margin.

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TABLE 4.2 What to Look for in Identifying a Company’s Strengths, Weaknesses, Opportunities, and Threats (4 of 4)

Market Opportunities (continued)	External Threats (continued)
Take advantage of an adverse change in the fortunes of rival firms	Adverse economic conditions that threaten critical suppliers or distributors
Acquire rival firms or companies with attractive technological expertise or competencies	Changes in technology—particularly disruptive technology that can undermine the company’s distinctive competencies
Take advantage of emerging technological developments to innovate Enter into alliances or other cooperative ventures	Restrictive foreign trade policies Costly new regulatory requirements Tight credit conditions Rising prices on energy or other key inputs

Table 4.2-4 displays a sampling of potential threats and market opportunities. Sizing up a company’s complement of strengths and deficiencies is akin to constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses represent competitive liabilities. Ideally, the company’s competitive assets should outweigh its competitive liabilities by an ample margin.

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What Do SWOT Listings Reveal?

New strategy

SWOT is the foundation for positioning the firm to use its strengths to seize opportunities and to shore up its competitive deficiencies to mitigate external threats.

Existing strategy

SWOT insights into the firm’s overall business situation can translate into recommended strategic actions.

The SWOT analysis process involves more than making four lists. In crafting a new strategy, it offers a strong foundation for understanding how to position the firm to build on its strengths in seizing new business opportunities and how to mitigate external threats by shoring up its competitive deficiencies. In assessing the effectiveness of an existing strategy, it can be used to glean insights regarding the firm's overall business situation (thus the name Situational Analysis); and it can help translate these insights into recommended strategic actions.

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FIGURE 4.2 The Steps Involved in SWOT Analysis: Identify the Four Components of SWOT, Draw Conclusions, Translate Implications into Strategic Actions

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Figure 4.2 shows the steps involved in gleaning insights from SWOT analysis.

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QUESTION 3: What Are the Company’s Most Important Resources and Capabilities, and Will They Give the Company a Lasting Competitive Advantage?

Competitive assets

Resources and capabilities

They determine competitiveness and the ability to succeed in the marketplace.

A firm’s strategy depends on these to develop sustainable competitive advantage over its rivals.

A firm’s resources and capabilities are its competitive assets and they determine whether its competitive power in the marketplace will be impressively strong or disappointingly weak. Companies with second-rate competitive assets nearly always are relegated to a trailing position in the industry.

Connect Activity

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Identifying the Company’s Resources and Capabilities

A resource

A productive input or competitive asset that is owned or controlled by a firm (e.g., a fleet of oil tankers)

A capability

The capacity of a firm to perform some activity proficiently (e.g., superior skills in marketing)

A resource is a competitive asset that is owned or controlled by a firm.

A capability or competence is the capacity of a firm to perform an internal activity competently through deployment of a firm’s resources.

A firm’s resources and capabilities represent its competitive assets and are determinants of its competitiveness and ability to succeed in the marketplace.

Resource and capability analysis is a powerful tool for sizing up a firm’s competitive assets and determining if they can support a sustainable competitive advantage over market rivals.

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TABLE 4.3 Types of Company Resources (1 of 2)

Tangible resources

Physical resources: land and real estate; manufacturing plants, equipment, or distribution facilities; the locations of stores, plants, or distribution centers, including the overall pattern of their physical locations; ownership of or access rights to natural resources (such as mineral deposits)

Financial resources: cash and cash equivalents; marketable securities; other financial assets such as a company’s credit rating and borrowing capacity

Technological assets: patents, copyrights, production technology, innovation technologies, technological processes

Organizational resources: IT and communication systems (satellites, servers, workstations, etc.); other planning, coordination, and control systems; the company’s organizational design and reporting structure

Tangible resources are the most easily identified, because tangible resources are those that can be touched or quantified readily. Obviously, they include various types of physical resources such as manufacturing facilities and mineral resources, but they also include a company’s financial resources, technological resources, and organizational resources such as the company’s communication and control systems.

Technological resources are included among tangible resources, by convention, even though some types, such as copyrights and trade secrets, might be more logically categorized as intangible.

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TABLE 4.3 Types of Company Resources (2 of 2)

Intangible resources

Human assets and intellectual capital: the education, experience, knowledge, and talent of the workforce, cumulative learning, and tacit knowledge of employees; collective learning embedded in the organization, the intellectual capital and know-how of specialized teams and work groups; the knowledge of key personnel concerning important business functions; managerial talent and leadership skill; the creativity and innovativeness of certain personnel

Brands, company image, and reputational assets: brand names, trademarks, product or company image, buyer loyalty and goodwill; company reputation for quality, service, and reliability; reputation with suppliers and partners for fair dealing

Relationships: alliances, joint ventures, or partnerships that provide access to technologies, specialized know-how, or geographic markets; networks of dealers or distributors; the trust established with various partners

Company culture and incentive system: the norms of behavior, business principles, and ingrained beliefs within the company; the attachment of personnel to the company’s ideals; the compensation system and the motivation level of company personnel

Intangible resources are harder to discern, but they are often among the most important of a firm’s competitive assets. They include various sorts of human assets and intellectual capital (skills and knowledge), as well as its brands, image, and reputational assets. While intangible resources have no material existence on their own, they are often embodied in something material.

It is important to remember that it is not exactly how a resource is categorized that matters, rather, that all of the firm’s different types of resources are included in the inventory.

The real purpose of using categories in identifying a firm’s resources is to ensure that none of a firm’s resources go unnoticed when sizing up its competitive assets

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Identifying Capabilities

An organizational capability

Is the intangible but observable capacity of a firm to perform a critical activity proficiently using a related combination (cross-functional bundle) of its resources

Is knowledge-based, residing in people and in a firm’s intellectual capital or in its organizational processes and systems, embodying tacit knowledge

A resource bundle

Is a linked and closely integrated set of competitive assets centered around one or more cross-functional capabilities

Organizational capabilities are more complex entities than resources; indeed, they are built up through the use of resources and draw on some combination of the firm’s resources as they are exercised.

Two approaches to identifying a firm’s capabilities:

A complete listing of resources the firm has accumulated considering whether (and to what extent the firm has built up any related capabilities through their use).

A functional approach that identifies capabilities related to specific functions that draw on a limited set of resources involving a single department or organizational unit and cross-functional capabilities that are multidimensional—they spring from effective collaboration among people with different types of expertise working in different organizational units.

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Assessing the Competitive Power of a Company’s Resources and Capabilities

The Total Economic Value produced by a firm is equal to V-C. It is the difference between the buyer's perceived value (V) regarding a product or service and what it costs (C) the firm to produce it.

Competitively superior resources and capabilities are strategic assets capable of producing a sustainable competitive advantage with far greater profit potential.

A competitive advantage means that you can produce more value (V) for the customer than rivals can, or the same value at lower cost (C). In other words, your V-C is greater than the V-C of competitors. V-C is what we call the Total Economic Value produced by a company.

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VRIN: Four Tests of a Resource’s Competitive Power

The VRIN Test for sustainable competitive advantage asks if a resource or capability is Valuable, Rare, Inimitable, and Non-substitutable.

V: Is the resource (or capability) competitively valuable?

R: Is it rare—is it something rivals lack?

I: Is it hard to copy (inimitable)?

N: Is it invulnerable to the threat of substitution of different types of resources and capabilities (non-substitutable)?

The competitive power of a resource or capability is measured by how many of four specific tests it can pass. These tests are referred to as the VRIN tests for sustainable competitive advantage—VRIN is a shorthand reminder standing for Valuable, Rare, Inimitable, and Nonsubstitutable. The first two tests determine whether a resource or capability can support a competitive advantage. The last two determine whether the competitive advantage can be sustained. Resources can contribute to a sustainable competitive advantage only when resource substitutes aren’t on the horizon.

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Social Complexity and Causal Ambiguity

Two factors that inhibit the ability of rivals to imitate a firm’s most valuable resources and capabilities.

Social complexity refers to factors in a firm’s culture, the interpersonal relationships among managers or R&D teams, its trust-based relations with customers or suppliers that contribute to its competitive advantage.

Causal ambiguity about the how the firm uses its resources and relationships puts competitors at a loss in understanding how to imitate these complex resources.

Social complexity and causal ambiguity are two factors that inhibit the ability of rivals to imitate a firm’s most valuable resources and capabilities. Causal ambiguity makes it very hard to figure out how a complex resource contributes to competitive advantage and, therefore, exactly what to imitate.

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Managing Resources and Capabilities Dynamically

Threats to resources and capabilities

Rivals develop better substitutes over time.

Current capabilities decay from benign neglect.

Disruptive changes in the competitive environment.

Manage capabilities dynamically

Attend to the ongoing modification of existing competitive assets.

Take advantage of opportunities to develop totally new kinds of capabilities.

Rivals that are initially unable to replicate a key resource may develop better and better substitutes over time. Resources and capabilities can depreciate like other assets if they are managed with benign neglect. Disruptive changes in technology, customer preferences, distribution channels, or other competitive factors can also destroy the value of key strategic assets. Rivals that are initially unable to replicate a key resource may develop better and better substitutes over time. Resources and capabilities can depreciate like other assets if they are managed with benign neglect. Disruptive changes in technology, customer preferences, distribution channels, or other competitive factors can also destroy the value of key strategic assets.

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The Role of Dynamic Capabilities

To sustain its competitiveness and help drive improvements in its performance, a firm requires a dynamically evolving portfolio of resources and capabilities.

A dynamic capability is the ongoing capacity of a firm to modify its existing resources and capabilities or create new ones.

Improve on existing resources and capabilities incrementally.

Add new resources and capabilities to the firm’s competitive asset portfolio.

Companies that know the importance of recalibrating and upgrading their most valuable resources and capabilities ensure that these activities are done on a continual basis. By incorporating these activities into their routine managerial functions, they gain the experience necessary to be able to do them consistently well. At that point, their ability to freshen and renew their competitive assets becomes a capability in itself—a dynamic capability.

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QUESTION 4: How Do Value Chain Activities Impact a Company’s Cost Structure and Its Customer Value Proposition?

Signs of a firm’s competitive strength

Its prices and costs are in line with rivals.

Its customer-value proposition is competitive and cost effective.

Its bundled capabilities are yielding a sustainable competitive advantage.

Strategic Management Principle

The higher a firm’s costs are above those of close rivals, the more competitively vulnerable it becomes. Conversely, the greater the amount of customer value that a firm can offer profitably relative to close rivals, the less competitively vulnerable the firm becomes.

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The Concept of a Company Value Chain

The value chain

Identifies the primary activities and related support activities that create customer value

Identifies the inner workings of the firm's customer value proposition and business model

Permits a deep look at the firm’s cost structure and its ability to profitably offer low prices

Reveals the emphasis that a firm places on activities that enhance differentiation and support higher prices

Every firm’s business consists of a collection of activities undertaken in the course of producing, marketing, delivering, and supporting its product or service.

All the various activities that a firm performs internally combine to form a value chain—so called because the underlying intent of a firm’s activities is

ultimately to create value for buyers.

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FIGURE 4.3 A Representative Company Value Chain

Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), pp. 37-43.

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As shown in Figure 4.3, a company’s value chain consists of two broad categories of activities: the primary activities foremost in creating value for customers and the requisite support activities that facilitate and enhance the performance of the primary activities. The kinds of primary and secondary activities that constitute a company’s value chain vary according to the specifics of a company’s business; hence, the listing of the primary and support activities in Figure 4.3 is illustrative rather than definitive.

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Comparing Value Chains of Rival Companies

Value chain analysis

Facilitates a comparison, activity-by-activity, of how effectively and efficiently a firm delivers value to its customers, relative to its competitors

The value chain analysis process

Segregates a firm’s operations into different types of primary and secondary activities to identify major components of its internal cost structure

Uses activity-based costing to evaluate activities

Same for significant competitors

Value chain analysis facilitates a comparison of how rivals, activity by activity, deliver value to customers. Even rivals in the same industry may differ significantly in terms of the activities they perform. How each activity is performed may affect a company’s relative cost position as well as its capacity for differentiation. Thus, even a simple comparison of how the activities of rivals’ value chains differ can reveal competitive differences.

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The Value Chain System

An industry value chain includes

Internal value chain

Value chains of upstream industry suppliers

Value chains of forward channel intermediaries

Effects of the industry value chain

Costs and profit margins of suppliers and channel partners can affect prices to end consumers.

Activities of channel partners can affect industry sales volumes and customer satisfaction.

A company’s value chain is embedded in a larger system of activities that includes the value chains of its suppliers and the value chains of whatever wholesale distributors and retailers it utilizes in getting its product or service to end users. This value chain system (sometimes called a vertical chain) has implications that extend far beyond the company’s costs.

Strategic Management Principle

A firm’s cost competitiveness depends not only on the costs of internally performed activities (its own value chain) but also on costs in the value chains of its suppliers and distribution channel allies.

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FIGURE 4.4 A Representative Value Chain System

Source: Based in part on the single-industry value chain display in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), p. 35.

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A typical value chain system that incorporates the value chains of suppliers and forward-channel allies (if any) is shown in Figure 4.4. As was the case with company value chains, the specific activities constituting value chain systems vary significantly from industry to industry.

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Illustration Capsule 4.1 The Value Chain for Boll & Branch

Source: Adapted from Christina Brinkley, “What Goes into the Price of Luxury Sheets?” The Wall Street Journal, March 29, 2014, www.wsj.com/articles/SB100001424052702303725404579461953672838672 (accessed February 16, 2016).

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Illustration Capsule 4.1 shows representative costs for various external and internal value chain activities performed by Boll & Branch, a maker of luxury linens and bedding sold directly to consumers online.

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The Value Chain for Boll & Branch

Which activities in the value chain are primary activities? Which are secondary activities?

Which activities are linked to the value chain for the entire industry?

Where in the industry activity chain could Boll & Branch possibly reduce cost(s) without reducing its competitive strength?

A company’s primary and secondary activities identify the major components of its internal cost structure. The combined costs of all the various primary and support activities constituting a company’s value chain define its internal cost structure. Evaluating a company’s internal and external cost-competitiveness involves using what accountants call activity-based costing to determine the costs of performing each value chain activity.

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Benchmarking: Assessing the Cost and Effectiveness of Value Chain Activities

Benchmarking

Involves improving internal activities based on learning from other companies’ “best practices”

Assesses whether the cost competitiveness and effectiveness of a company’s value chain activities are in line with its competitors’ activities

Sources of benchmarking information

Market data reports from consulting companies and market analysts, publications of industry trade groups and government agencies, and customers

Visits to benchmark firms

Benchmarking is a potent tool for improving a firm’s own internal activities that is based on learning how firms perform them and borrowing their “best practices.” The comparison is often made between companies in the same industry, but benchmarking can also involve comparing how activities are done by companies in other industries.

Strategic Management Principle

Benchmarking the costs of a firm's activities against those of rivals provides hard evidence of whether the firm is cost-competitive.

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Illustration Capsule 4.2 Benchmarking in the Solar Industry

What benchmarks does the solar industry use in comparing costs among industry competitors?

How has SunPower responded to the continued downward pricing pressure in the industry?

Why is the collection of competitive intelligence to accurately benchmark delivered costs of such importance in the solar industry?

As competition grows, benchmarking plays an increasingly critical role in assessing a solar company’s relative costs and price positioning compared to other firms. This is often measured using the all-in installation and production costs per kilowatt hour generated by a solar asset, called the “Levelized Cost of Energy” (LCOE). Kilowatt hours are the units of electricity that are sold to consumers.

SunPower’s quarterly earnings calls highlighted efforts to compete on benchmark prices by simplifying its company structure; divesting from non-core assets; and diversifying beyond the low-cost, large-scale utility solar market and into residential and commercial solar – where it could compete more easily on price.

For solar to play a major role in U.S. power generation, costs must keep falling. As solar companies race towards lower costs, benchmarking will continue to be a core strategic tool in determining pricing and market positioning.

Connect Activity

Consider adding a File Attachment assignment requiring the student to develop a graphic showing the elements of Delivered Cost in the Cement Industry and CEMEX in particular. Have the student include details on the costs of each element relative to industry averages as well as a discussion of how the analysis informs competitive advantage. You can post instructions for the student within the assignment and collect their attachments for grading.

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Strategic Options for Remedying a Cost or Value Disadvantage

Areas in the total value chain system assess ways to improve efficiency and effectiveness.

Internal activity segments

Suppliers’ part of the value chain system

Forward-channel portion of the value chain system

There are three main areas in a company’s total value chain system where company managers can try to improve its efficiency and effectiveness in delivering customer value: (1) a company’s own internal activities, (2) suppliers’ part of the value chain system, and (3) the forward-channel portion of the value chain system.

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Improving Internally Performed Value Chain Activities

Implement best practices throughout the firm, particularly for high-value activities.

Redesign products, components and activities to facilitate speedier and more economical manufacture or assembly.

Relocate high-cost activities to external value chains to be performed more cheaply by vendors or contractors.

Reallocate resources to activities that address buyers’ most important purchase criteria.

Adopt productivity-enhancing, cost-saving technological improvements that spur innovation, improve design, and enhance creativity.

Strategic approaches to reducing internally performed value chain activity costs that will improve a firm’s cost-competitiveness by:

Implementing best practices throughout the firm, particularly for high-cost activities.

Redesigning the product and/or some of its components to eliminate high-cost components or facilitate speedier and more economical manufacture or assembly.

Relocating high-cost activities (such as manufacturing) to geographic areas where they can be performed more cheaply or outsource activities to lower-cost vendors or contractors.

Adopting technologies that spur innovation, improve design, and enhance creativity.

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Improving Supplier-Related Value Chain Activities

Pressure suppliers for lower prices.

Switch to lower-priced substitute inputs.

Collaborate closely with suppliers to identify mutual cost-saving opportunities.

Work with suppliers to enhance the firm’s differentiation.

Select and retain suppliers who meet higher-quality standards.

Coordinate with suppliers to enhance design or other features desired by customers.

Provide incentives to suppliers to meet higher-quality standards, and assist suppliers in their efforts to improve.

Supplier-related cost disadvantages can be attacked by pressuring suppliers for lower prices, switching to lower-priced substitute inputs, and collaborating closely with suppliers to identify mutual cost-saving opportunities.

A firm can enhance its customer value proposition through its supplier relationship by selecting and retaining suppliers that meet higher-quality standards, providing quality-based incentives to suppliers, and integrating suppliers into the design process.

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Improving Value Chain Activities of Distribution Partners

Achieving cost-based competitiveness

Pressure forward-channel allies to reduce their costs and markups.

Collaborate with forward-channel allies to identify win-win opportunities to reduce costs.

Change to a more economical distribution strategy, including switching to cheaper distribution channels.

Any of three means can be used to achieve better cost-competitiveness in the forward portion of the industry value chain:

Pressure distributors, dealers, and other forward-channel allies to reduce their costs and markups.

Collaborate with forward channel intermediaries to identify win–win opportunities to reduce costs

Change to a more economical distribution strategy, including switching to cheaper distribution channels (selling direct via the Internet) or integrating forward into company-owned retail outlets.

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Enhancing Differentiation Through Activities at the Forward End of the Value Chain System

Engage in cooperative advertising and promotions with forward-channel allies.

Use exclusive arrangements with downstream sellers or other mechanisms that increase their incentives to enhance delivered customer value.

Create and enforce standards for downstream activities and assist in training channel partners in business practices.

The means to enhancing differentiation through activities at the forward end of the value chain system include (1) engaging in cooperative advertising and promotions

with forward allies (dealers, distributors, retailers, etc.), (2) creating exclusive arrangements with downstream sellers or utilizing other mechanisms that increase their incentives to enhance delivered customer value, and (3) creating and enforcing standards for downstream activities and assisting in training channel partners in business practices.

Strategic Management Principle

Performing value chain activities with capabilities that permit the firm to either outmatch rivals on differentiation or beat them on costs will give the firm a competitive advantage.

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Translating Proficient Performance of Value Chain Activities into Competitive Advantage

Option 1: Beat rivals by creating more customer value from value chain activities, for a differentiation-based competitive advantage

1. Managers decide to perform value chain activities in ways that drive improvements in quality, features, performance, and other differentiation-enhancing aspects.

2. Competencies gradually emerge in performing value chain activities that drive improvements in quality, features, and performance.

3. Company proficiency in performing some of these differentiation-enhancing activities rises to the level of a core competence.

4. Company proficiency in performing the core competence continues to build and evolves into a distinctive competence.

5. Company gains a competitive advantage based on superior differentiation capabilities.

A company that does a first-rate job of managing its activities of its value chain relative to competitors stands a good chance of profiting from its competitive advantage. A company’s external value-creating activities in its value can offer a competitive advantage.

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Translating Proficient Value Chain Activity Performance into Competitive Advantage

Option 2: Beat rivals by conducting value chain activities more efficiently, for a cost-based competitive advantage

1. Company managers decide to perform value chain activities in the most cost-efficient manner.

2. Competencies gradually emerge in driving down the cost of value chain activities (such as production, inventory management, etc.).

3. Company capabilities in performing certain value chain activities more efficiently rise to the level of a core competence.

4. Company proficiency in performing the core competence continues to build and evolves into a distinctive competence.

5. Company gains a competitive advantage based on superior differentiation capabilities.

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QUESTION 5: Is the Company Competitively Stronger or Weaker Than Key Rivals?

Assessing overall competitive strength

How does the firm rank relative to competitors on each of the important factors that determine market success?

Does the firm have a net competitive advantage or disadvantage versus major competitors?

Using resource analysis, value chain analysis, and benchmarking to determine a company’s competitiveness on value and cost is necessary but not sufficient. A more

comprehensive assessment needs to be made of the firm’s overall competitive strength. The answers to two questions are of particular interest: First, how does the

firm rank relative to competitors on each of the important factors that determine market success? Second, all things considered, does the firm have a net competitive advantage or disadvantage versus major competitors?

Strategic Management Principles

High-weighted competitive strength ratings signal a strong competitive position and possession of competitive advantage; low ratings signal a weak position and competitive disadvantage.

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Steps in the Competitive Strength Assessment Process

Make a list of the industry’s key success factors and measures of competitive strength or weakness.

Assign weights to each competitive strength measure based on its perceived importance.

Score competitors on each competitive strength measure and multiply by each measure by its corresponding weight.

Sum the weighted strength ratings on each factor to get an overall measure of competitive strength for each firm.

Use overall strength ratings to draw conclusions about the firm’s net competitive advantage or disadvantage and to take specific note of areas of strength and weakness.

Step 1. Make a list of the industry’s key success factors and other telling measures of competitive strength or weakness (6 to 10 measures usually suffice).

Step 2. Assign weights to each competitive strength measure based on its perceived importance. (The sum of the weights for each measure must add up to 1.)

Step 3. Calculate weighted strength ratings by scoring each competitor on each strength measure (using a 1-to-10 rating scale, where 1 is very weak and 10 is very strong) and multiplying the assigned rating by the assigned weight.

Step 4. Sum the weighted strength ratings on each factor to get an overall measure of competitive strength for each company being rated.

Step 5. Use the overall strength ratings to draw conclusions about the size and extent of the company’s net competitive advantage or disadvantage and to take specific note of areas of strength and weakness.

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TABLE 4.4 A Representative Weighted Competitive Strength Assessment

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Table 4.4 provides an example of competitive strength assessment in which a hypothetical firm (ABC Company) competes against two rivals. In the example, relative cost is the most telling measure of competitive strength, and the other strength measures are of lesser importance. The firm with the highest rating on a given measure has an implied competitive edge on that measure, with the size of its edge reflected in the difference between its weighted rating and rivals’ weighted ratings.

The overall competitive strength scores indicate how all the different strength measures add up—whether the firm is at a net overall competitive advantage or disadvantage against each rival. The higher a firm’s overall weighted strength rating, the stronger its overall competitiveness versus rivals.

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Strategic Implications of a Competitive Strength Assessment

The higher a firm’s overall weighted strength rating, the stronger its overall competitiveness versus rivals.

The rating score indicates the total net competitive advantage for a firm relative to other firms.

Firms with high competitive strength scores are targets for benchmarking.

The ratings show how a firm compares against rivals, factor by factor (or capability by capability).

Strength scores can be useful in deciding what strategic moves to make.

A company’s competitive strength scores pinpoint its strengths and weaknesses against rivals and point directly to the kinds of offensive and defensive actions it can use to exploit its competitive strengths and reduce its competitive vulnerabilities.

A competitively astute company should utilize the strength scores in deciding what strategic moves to make. When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense to consider offensive moves to exploit rivals’ competitive weaknesses. When a company has important competitive weaknesses in areas where one or more rivals are strong, it makes sense to consider defensive moves to curtail its vulnerability.

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QUESTION 6: What Strategic Issues and Problems Merit Front-Burner Managerial Attention?

Which and how serious are the strategic issues that managers must address—and resolve—for the firm to be more financially and competitively successful in the years ahead.

A good strategy must contain ways to deal with all the strategic issues and obstacles that stand in the way of the firm’s financial and competitive success in the years ahead.

The final and most important analytic step is to zero in on exactly what strategic issues company managers need to address—and resolve—for the firm to be more financially and competitively successful in the years ahead. This step involves drawing on the results of both industry analysis and the evaluations of the company’s internal situation.

The task here is to get a clear fix on exactly what strategic and competitive challenges confront the company, which of the company’s competitive shortcomings need fixing,

and what specific problems merit company managers’ front-burner attention. Pinpointing the specific issues that management needs to address sets the agenda for deciding what actions to take next to improve the company’s performance and business outlook.

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Strategic Priority “How To” Issues

How to meet challenges of new foreign competitors

How to combat the price discounting of rivals

How to both reduce high costs and prepare for price reductions

How to sustain growth as buyer demand slows

How to adapt to the changing demographics of the firm’s customer base

Compiling a “priority list” of problems creates an agenda of strategic issues that merit prompt managerial attention. Compiling a list of problems and roadblocks creates a strategic agenda of problems that merit prompt managerial attention. A good strategy must contain ways to deal with all the strategic issues and obstacles that stand in the way of the company’s financial and competitive success in the years ahead.

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Strategic Priority “Should We” Issues

Expand rapidly or cautiously into foreign markets?

Reposition the firm to move to a different strategic group?

Counter increasing buyer interest in substitute products?

Expand the firm’s product line?

Correct the firm’s competitive deficiencies by acquiring a rival firm with the missing strengths?

Pinpointing the specific issues that management needs to address sets the agenda for deciding what actions to take next to improve the company’s performance and business outlook.

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APPENDIX: IMAGE DESCRIPTIONS FOR UNSIGHTED STUDENTS

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Appendix 1 Figure 4.1 Identifying the Components of a Single-Business Company’s Strategy, Text Alternative

Single business strategic action plan components include:

Moves to respond to changing conditions in the macro-environment or in industry and competitive conditions

Initiatives to build competitive advantage based on:

Lower costs and prices relative to rivals?

A better product or service (design, features, quality, wider selection, etc.)?

Superior ability to service a market niche or specific group of buyers?

Efforts to expand or narrow geographic coverage

Efforts to build competitively valuable partnerships and strategic alliances with other enterprises within its industry

Key functional strategies of the overall business strategy:

R&D, technology, product design; supply chain management; production; sales, marketing, and distribution; information technology; human resources; and finance.

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Appendix 2 Figure 4.2 The Steps Involved in SWOT Analysis: Identify the Four Components of SWOT, Draw Conclusions, Translate Implications into Strategic Actions, Text Alternative

What can be gleaned from the SWOT listings?

The first two steps of SWOT analysis are:

Identify company strengths and competitive assets.

Identify company weaknesses and competitive deficiencies.

These two steps lead to conclusions concerning the company’s overall business situation. This includes determining what are the underlying reasons for the success (or lack of success) of the company’s strategy. It also includes what the attractive and unattractive aspects of the company’s situation are.

The last two steps of SWOT analysis are:

Identify market opportunities.

Identify external threats.

These two steps reveal implications for improving company strategy. This includes using company strengths as the foundation for the company’s strategy; shoring up weaknesses that are interfering with the success of the strategy; pursuing those market opportunities best suited to company strengths; correcting weaknesses that impair pursuit of important market opportunities; repair weaknesses that heighten vulnerability of external threats; and using company strengths to lessen the impact of important external threats.

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Appendix 3 Figure 4.3 A Representative Company Value Chain, Text Alternative

Primary activities and costs of a company's value chain are:

Supply chain management

Operations

Distribution

Sales and marketing service

Profit margin

These primary activities and costs are supported by the following

Product R&D

Technology

Systems development

Human resource management

General administration

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Appendix 4 Figure 4.4 A Representative Value Chain System, Text Alternative

A representative value chain system shows the following

Supplier-related value chains: activities, costs, and margins of suppliers

A firm's own value chain: internally performed activities, costs, and margins

Forward-channel value chains: (1) activities, costs, and margins of forward-channel allies and strategic partners and (2) buyer or end-user value chains

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Appendix 5 Illustration Capsule 4.1 The Value Chain for Boll & Branch, Text Alternative

The cost of goods, including the raw cotton; the spinning, weaving, and dyeing; cutting, sewing, and finishing; the transportation of the material, and the factory fee is $68.46.

The inspection fees, ocean freight/insurance, import duties, warehouse/packing, packaging, customer shipping, and promotions/donations total $154.38.

Boll & Branch’s markup is about 60%.

Boll & Branch’s retail price is $250.00, resulting in a gross margin of $95.62.

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Appendix 6 Table 4.4 A Representative Weighted Competitive Strength Assessment

Rating scale: 1 equals very weak, 10 equals very strong		ABC CO.	ABC CO.	RIVAL 1	RIVAL 1	RIVAL 2	RIVAL 2
Key success factor/strength measure	Importance weight	Strength Rating	Weighted Score	Strength Rating	Weighted score	Strength Rating	Weighted Score
Quality/product performance	0.10	8	0.80	5	0.50	1	0.10
Reputation/image	0.10	8	0.80	7	0.70	1	0.10
Manufacturing capability	0.10	2	0.20	10	1.00	5	0.50
Technological skills	0.05	10	0.50	1	0.05	3	0.15
Dealer network/ distribution capability	0.05	9	0.45	4	0.20	5	0.25
New product innovation capability	0.05	9	0.45	4	0.20	5	0.25
Financial resources	0.10	5	0.50	10	1.00	3	0.30
Relative cost position	0.30	5	1.50	10	3.00	1	0.30
Customer servicer capabilities	0.15	5	0.75	7	1.05	1	0.15
Sum of importance weights	1.00	0	0	0	0	0	0
Overall weighted	0	0	ABC Co = 5.95	0	Rival 1 = 7.70	0	Rival 2 = 2.10

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Concepts and Cases

22e

Thompson

Peteraf

Gamble

Strickland

T h e Q u e s t f o r C o m p e t i t i v e A d v a n t a g e

STRATEGY Crafting & Executing