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Learning from Mistakes

In 1997, Daimler AG introduced an “ultra-urban” car at the Frankfurt Motor Show amid much fanfare. 1 Envisioned by Nicholas Hayek (inventor of Swatch Watch) and Mercedes-Benz, it received acclaim for its innovation, advanced engineering, and functionality as well as being simply fun to drive. Over one million were sold worldwide before it entered the U.S. market a decade later. What was this car that was transforming the urban transportation market? It was the Smart fortwo—a pocket-sized two-seater, high-efficiency vehicle made with cutting-edge materials that were as light as they were strong and had an impressively engineered Mercedes-Benz engine that made it fun to drive.

On January 16, 2008, the first Smart fortwo streaked through the streets of Manhattan, New York. The Smart fortwo was an immediate sensation in the United States, with sales of 24,600 units in its first year. With rising gas prices, a buoyant economy, and increasingly ecologically-aware consumers, Daimler had not only found a market, but also it was blazing a trail all across the United States. However, sales quickly dropped—just 20,000 cars were sold over the following three years. So where did Smart take a wrong turn?

Daimler AG correctly identified the trends in the external market, which showed an increase in urbanization and traffic congestion, higher gas prices, and a desire by consumers to have a smaller ecological impact. And, as Annette Winkler, Head-Smart Product Unit at Daimler AG, pointed out, “opting for a two-seater is more than a car purchase, it is a lifestyle choice.” However, the Smart was quite pricey for its size (about $13,000) and didn’t get better gas mileage than the latest crop of compacts, such as the Chevrolet Sonic ($14,800), Hyundai Accent ($14,500), and BMW Mini Cooper ($20,200), all of which had back seats—unlike the Smart fortwo. Further, Smart failed to capitalize on Mercedes-Benz’s brand and its association with power, prestige, and safety. Safety became a big issue—after all, the car didn’t have a back seat! Finally, engineers overestimated consumers’ expectations for a great engine and underestimated the American consumers’ desire for bigger cars.

Roger Penske, chairman and chief executive officer of Penske Automotive Group, was very optimistic about the Smart fortwo’s potential in the U.S. market. He bought exclusive rights on the U.S. market in 2008, expecting to sell 200,000 units each year. However, when sales sank to merely 5,208 units in 2011, he sold his rights. Unfortunately, the market had changed—gas prices had leveled off, the economy had tanked, and the U.S. vehicle market had become saturated with several small-car competitors, such as the Honda Fit, Nissan Versa, Ford Fiesta, Toyota Yaris, and Chevrolet Aveo—at much more attractive prices.

A postscript: On July 1, 2011, Smart fortwo became a subsidiary of Mercedes-Benz USA, which sold it at its dealerships. Though sales were up to 10,009 units in 2012, by then Smart had hung $5.3 billion in cumulative losses on Mercedes-Benz.

Discussion Questions

1. Why didn’t Smart work out in the United States market?

2. Have they missed their opportunity or can they build a viable market position?

In this chapter we will place heavy emphasis on the value-chain concept. That is, we focus on the key value-creating activities (e.g., operations, marketing and sales, and procurement) that a firm must effectively manage and integrate in order to attain competitive advantages in the marketplace. However, firms must not only pay close attention to their own value-creating activities but must also maintain close and effective relationships with key organizations outside the firm boundaries, such as suppliers, customers, and alliance partners.

LO3.1

The benefits and limitations of SWOT analysis in conducting an internal analysis of the firm.

The Smart car’s sales have been well below expectations because of major problems associated with several value chain activities. Most of these are related to R&D as well as marketing and sales, for example, seating for only two people, relatively poor gas mileage, and pricing that put it at a disadvantage against rivals such as Hyundai.

Before moving to value-chain analysis, let’s briefly revisit the benefits and limitations of SWOT analysis. As discussed in Chapter 2 , a SWOT analysis consists of a careful listing of a firm’s strengths, weaknesses, opportunities, and threats. While we believe SWOT analysis is very helpful as a starting point, it should not form the primary basis for evaluating a firm’s internal strengths and weaknesses or the opportunities and threats in the environment. Strategy Spotlight 3.1 elaborates on the limitations of the traditional SWOT approach.

We will now turn to value-chain analysis. As you will see, it provides greater insights into analyzing a firm’s competitive position than SWOT analysis does by itself.

Value-Chain Analysis

Value-chain analysis views the organization as a sequential process of value-creating activities. The approach is useful for understanding the building blocks of competitive advantage and was described in Michael Porter’s seminal book Competitive Advantage. 2 Value is the amount that buyers are willing to pay for what a firm provides them and is measured by total revenue, a reflection of the price a firm’s product commands and the quantity it can sell. A firm is profitable when the value it receives exceeds the total costs involved in creating its product or service. Creating value for buyers that exceeds the costs of production (i.e., margin) is a key concept used in analyzing a firm’s competitive position.

value-chain analysis

a strategic analysis of an organization that uses value-creating activities.

Porter described two different categories of activities. First, five primary activities— inbound logistics, operations, outbound logistics, marketing and sales, and service—contribute to the physical creation of the product or service, its sale and transfer to the buyer, and its service after the sale. Second, support activities —procurement, technology development, human resource management, and general administration—either add value by themselves or add value through important relationships with both primary activities and other support activities. Exhibit 3.1 illustrates Porter’s value chain.

primary activities

sequential activities of the value chain that refer to the physical creation of the product or service, its sale and transfer to the buyer, and its service after sale, including inbound logistics, operations, outbound logistics, marketing and sales, and service.

support activities

activities of the value chain that either add value by themselves or add value through important relationships with both primary activities and other support activities; including procurement, technology development, human resource management, and general administration.

To get the most out of value-chain analysis, view the concept in its broadest context, without regard to the boundaries of your own organization. That is, place your organization within a more encompassing value chain that includes your firm’s suppliers, customers, and alliance partners. Thus, in addition to thoroughly understanding how value is created within the organization, be aware of how value is created for other organizations in the overall supply chain or distribution channel. 3

Next, we’ll describe and provide examples of each of the primary and support activities. Then, we’ll provide examples of how companies add value by means of relationships among activities within the organization as well as activities outside the organization, such as those activities associated with customers and suppliers. 4

STRATEGY SPOTLIGHT

3.1

THE LIMITATIONS OF SWOT ANALYSIS

SWOT analysis is a tried-and-true tool of strategic analysis. SWOT (strengths, weaknesses, opportunities, threats) analysis is used regularly in business to initially evaluate the opportunities and threats in the business environment as well as the strengths and weaknesses of a firm’s internal environment. Top managers rely on SWOT to stimulate self-reflection and group discussions about how to improve their firm and position it for success.

But SWOT has its limitations. It is just a starting point for discussion. By listing the firm’s attributes, managers have the raw material needed to perform more in-depth strategic analysis. However, SWOT cannot show them how to achieve a competitive advantage. They must not make SWOT analysis an end in itself, temporarily raising awareness about important issues but failing to lead to the kind of action steps necessary to enact strategic change.

Consider the ProCD example from Chapter 2, page 51. A brief SWOT analysis might include the following:

Strengths	Opportunities
First-mover advantage	Demand for electronic phone books
Low labor cost	Sudden growth in use of digital technology
Weaknesses	Threats
Inexperienced new company	Easily duplicated product
No proprietary information	Market power of incumbent firms

The combination of low production costs and an early-mover advantage in an environment where demand for CD-based phone books was growing rapidly seems to indicate that ProCD founder James Bryant had a golden opportunity. But the SWOT analysis did not reveal how to turn those strengths into a competitive advantage, nor did it highlight how rapidly the environment would change, allowing imitators to come into the market and erode his first-mover advantage. Let’s look at some of the limitations of SWOT analysis.

Strengths May Not Lead to an Advantage

A firm’s strengths and capabilities, no matter how unique or impressive, may not enable it to achieve a competitive advantage in the marketplace. It is akin to recruiting a concert pianist to join a gang of thugs—even though such an ability is rare and valuable, it hardly helps the organization attain its goals and objectives! Similarly, the skills of a highly creative product designer would offer little competitive advantage to a firm that produces low-cost commodity products. Indeed, the additional expense of hiring such an individual could erode the firm’s cost advantages. If a firm builds its strategy on a capability that cannot, by itself, create or sustain competitive advantage, it is essentially a wasted use of resources. ProCD had several key strengths, but it did not translate them into lasting advantages in the marketplace.

SWOT’s Focus on the External Environment Is Too Narrow

Strategists who rely on traditional definitions of their industry and competitive environment often focus their sights too narrowly on current customers, technologies, and competitors. Hence they fail to notice important changes on the periphery of their environment that may trigger the need to redefine industry boundaries and identify a whole new set of competitive relationships. Reconsider the example from Chapter 2 of Encyclopaedia Britannica, whose competitive position was severely eroded by a “nontraditional” competitor—CD-based encyclopedias (e.g., Microsoft Encarta) that could be used on home computers.

SWOT Gives a One-Shot View of a Moving Target

A key weakness of SWOT is that it is primarily a static assessment. It focuses too much of a firm’s attention on one moment in time. Essentially, this is like studying a single frame of a motion picture. You may be able to identify the principal actors and learn something about the setting, but it doesn’t tell you much about the plot. Competition among organizations is played out over time. As circumstances, capabilities, and strategies change, static analysis techniques do not reveal the dynamics of the competitive environment. Clearly, ProCD was unaware that its competitiveness was being eroded so quickly.

SWOT Overemphasizes a Single Dimension of Strategy

Sometimes firms become preoccupied with a single strength or a key feature of the product or service they are offering and ignore other factors needed for competitive success. For example, Toyota, the giant automaker, paid a heavy price for its excessive emphasis on cost control. The resulting problems with quality and the negative publicity led to severe financial losses and an erosion of its reputation in many markets.

SWOT analysis has much to offer, but only as a starting point. By itself, it rarely helps a firm develop competitive advantages that it can sustain over time.

Sources: Shapiro, C. & Varian, H. R. 2000. Versioning: The Smart Way to Sell Information. Harvard Business Review, 78(1): 99–106; and Picken, J. C. & Dess, G. G. 1997. Mission Critical. Burr Ridge, IL: Irwin Professional Publishing.

EXHIBIT 3.1 The Value Chain: Primary and Support Activities

Source: Reprinted with the permission of Free Press, a division of Simon & Schuster Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 The Free Press. All rights reserved.

LO3.2

The primary and support activities of a firm’s value chain.

Primary Activities

Five generic categories of primary activities are involved in competing in any industry, as shown in Exhibit 3.2. Each category is divisible into a number of distinct activities that depend on the particular industry and the firm’s strategy.5

Inbound Logistics Inbound logistics is primarily associated with receiving, storing, and distributing inputs to the product. It includes material handling, warehousing, inventory control, vehicle scheduling, and returns to suppliers.

inbound logistics

receiving, storing, and distributing inputs of a product.

EXHIBIT 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

Inbound Logistics

• Location of distribution facilities to minimize shipping times.

• Warehouse layout and designs to increase efficiency of operations for incoming materials.

Operations

• Efficient plant operations to minimize costs.

• Efficient plant layout and workflow design.

• Incorporation of appropriate process technology.

Outbound Logistics

• Effective shipping processes to provide quick delivery and minimize damages.

• Shipping of goods in large lot sizes to minimize transportation costs.

Marketing and Sales

• Innovative approaches to promotion and advertising.

• Proper identification of customer segments and needs.

Service

• Quick response to customer needs and emergencies.

• Quality of service personnel and ongoing training.

Source: Adapted from Porter, M.E. 1985. Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press.

Just-in-time (JIT) inventory systems, for example, were designed to achieve efficient inbound logistics. In essence, Toyota epitomizes JIT inventory systems, in which parts deliveries arrive at the assembly plants only hours before they are needed. JIT systems will play a vital role in fulfilling Toyota’s commitment to fill a buyer’s new car order in just five days.6 This standard is in sharp contrast to most competitors that require approximately 30 days’ notice to build vehicles. Toyota’s standard is three times faster than even Honda Motors, considered to be the industry’s most efficient in order follow-through. The five days represent the time from the company’s receipt of an order to the time the car leaves the assembly plant. Actual delivery may take longer, depending on where a customer lives.

Operations Operations include all activities associated with transforming inputs into the final product form, such as machining, packaging, assembly, testing, printing, and facility operations.

operations

all activities associated with transforming inputs into the final product form.

Creating environmentally friendly manufacturing is one way to use operations to achieve competitive advantage. Shaw Industries (now part of Berkshire Hathaway), a world-class competitor in the floor-covering industry, is well known for its concern for the environment.7 It has been successful in reducing the expenses associated with the disposal of dangerous chemicals and other waste products from its manufacturing operations. Its environmental endeavors have multiple payoffs. Shaw has received many awards for its recycling efforts—awards that enhance its reputation.

Outbound Logistics Outbound logistics is associated with collecting, storing, and distributing the product or service to buyers. These activities include finished goods, warehousing, material handling, delivery vehicle operation, order processing, and scheduling.

outbound logistics

collecting, storing, and distributing the product or service to buyers.

Campbell Soup uses an electronic network to facilitate its continuous-replenishment program with its most progressive retailers.8 Each morning, retailers electronically inform Campbell of their product needs and of the level of inventories in their distribution centers. Campbell uses that information to forecast future demand and to determine which products require replenishment (based on the inventory limits previously established with each retailer). Trucks leave Campbell’s shipping plant that afternoon and arrive at the retailers’ distribution centers the same day. The program cuts the inventories of participating retailers from about a four- to a two-weeks’ supply. Campbell Soup achieved this improvement because it slashed delivery time and because it knows the inventories of key retailers and can deploy supplies when they are most needed.

The Campbell Soup example also illustrates the win–win benefits of exemplary value-chain activities. Both the supplier (Campbell) and its buyers (retailers) come out ahead. Since the retailer makes more money on Campbell products delivered through continuous replenishment, it has an incentive to carry a broader line and give the company greater shelf space. After Campbell introduced the program, sales of its products grew twice as fast through participating retailers as through all other retailers. Not surprisingly, supermarket chains love such programs.

Marketing and Sales These activities are associated with purchases of products and services by end users and the inducements used to get them to make purchases.9 They include advertising, promotion, sales force, quoting, channel selection, channel relations, and pricing.10,11

marketing and sales

activities associated with purchases of products and services by end users and the inducements used to get them to make purchases.

Consider product placement. This is a marketing strategy that many firms are increasingly adopting to reach customers who are not swayed by traditional advertising. A recent example is the starring role that BMW has in the film Mission Impossible: Ghost Protocol. 12

In this latest in the series of Mission Impossible films, the i8 concept, a next-generation supercar from BMW, helps Tom Cruise and co-star Paul Patton race through Mumbai traffic. The car’s appearance highlights the brand’s return to Hollywood after a hiatus of more than a decade.

In addition to featuring the upcoming i8, BMW uses the film to promote its current X3 SUV, 6-series convertible, and 1-Series compact. In lieu of an upfront payment, the firm has promised to promote the film in its print and television ads, says Uwe Ellinghaus, head of brand management at BMW. As Ellinghaus claims, “Mission Impossible is a whole new dimension for BMW. It’s what James Bond used to be.”

At times, a firm’s marketing initiatives may become overly aggressive and lead to actions that are both unethical and illegal.13 For example:

• Burdines. This department store chain is under investigation for allegedly adding club memberships to its customers’ credit cards without prior approval.

• Fleet Mortgage. This company has been accused of adding insurance fees for dental coverage and home insurance to its customers’ mortgage loans without the customers’ knowledge.

• HCI Direct. Eleven states have accused this direct-mail firm with charging for panty hose samples that customers did not order.

• Juno Online Services. The Federal Trade Commission brought charges against this Internet service provider for failing to provide customers with a telephone number to cancel service.

Strategy Spotlight 3.2 discusses an example that most students are familiar with: how Frito-Lay uses crowdsourcing to create competition for ads. The best ones air during the Super Bowl.

Service This primary activity includes all actions associated with providing service to enhance or maintain the value of the product, such as installation, repair, training, parts supply, and product adjustment.

service

actions associated with providing service to enhance or maintain the value of the product.

Let’s see how two retailers are providing exemplary customer service. At Sephora.com , a customer service representative taking a phone call from a repeat customer has instant access to what shade of lipstick she likes best. This will help the rep cross-sell by suggesting a matching shade of lip gloss. CEO Jim Wiggett expects such personalization to build loyalty and boost sales per customer. Nordstrom, the Seattle-based department store chain, goes even a step further. It offers a cyber-assist: A service rep can take control of a customer’s Web browser and literally lead her to just the silk scarf that she is looking for. CEO Dan Nordstrom believes that such a capability will close enough additional purchases to pay for the $1 million investment in software.

Support Activities

Support activities in the value chain can be divided into four generic categories, as shown in Exhibit 3.3. Each category of the support activity is divisible into a number of distinct value activities that are specific to a particular industry. For example, technology development’s discrete activities may include component design, feature design, field testing, process engineering, and technology selection. Similarly, procurement may include activities such as qualifying new suppliers, purchasing different groups of inputs, and monitoring supplier performance.

Procurement Procurement refers to the function of purchasing inputs used in the firm’s value chain, not to the purchased inputs themselves.14 Purchased inputs include raw materials, supplies, and other consumable items as well as assets such as machinery, laboratory equipment, office equipment, and buildings.15,16

procurement

the function of purchasing inputs used in the firm’s value chain, including raw materials, supplies, and other consumable items as well as assets such as machinery, laboratory equipment, office equipment, and buildings.

STRATEGY SPOTLIGHT

3.2 CROWDSOURCING

FRITO-LAY’S SUPER BOWL ADS

While firms have long realized the potential of outsourcing—the practice of sending service and manufacturing jobs overseas and profiting from cheap labor—marketing and sales leaders increasingly pursue a similar concept: crowdsourcing. Although crowd-sourcing does not physically send jobs abroad, it uses another pool of cheap labor: everyday people, often amateurs, using their spare time to create content and solve problems.

Take PepsiCo’s Frito-Lay division for example. Frito-Lay has been long known for its Crash the Super Bowl contest, an annual online commercial competition that invites regular consumers to create their own Doritos ads. The contest started in 2006 with a little over 1,000 entries and grew to more than 6,000 entries by 2011. Frito-Lay will air at least one of these fan-made commercials during the Super Bowl. Frito-Lay benefits from this user-generated content on multiple dimensions. The Crash the Super Bowl campaigns are a huge public relations success. In 2007, the International Public Relations Association awarded a Golden World Award to Frito-Lay because the campaign garnered 1.3 billion earned media impressions, created an enthusiastic online community of 1 million users, and helped to generate a 12 percent sales leap for the Doritos brand in January 2007.

One may think that user-generated Super Bowl ads are only a nice marketing gimmick. Think again! The low-budget ads came out on top of the USA Today Super Bowl Ad Meter in 2009, 2011, and 2012. The 2007 ad was even named by Time.com as the 9th best commercial of the year. Continuing the crowdsourcing success, Frito-Lay raised the challenge for the 2013 Crash the Super Bowl contest. In one of the biggest marketing pushes for its Doritos brand, the winner of the 2013 competition would get the opportunity to work with celebrity director Michael Bay on the next installment of Transformers. The winner would also receive a $1 million bonus if the ad came out on the top of the USA Today Super Bowl Ad Meter. Given that user-generated ads have won three of the last four Ad Meters, chances don’t look too bad.

Sources: Robinson-Jacobs, K. 2012. Crunch time for contest lovers. Dallas Morning News, September 21: 1D; Consumer PR—Doritos crashes the Superbowl. 2007. IPRA: np; and Keegan, R. W. 2007. Top 10 TV ads. www.time.com , December 9: np.

EXHIBIT 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

General Administration

• Effective planning systems to attain overall goals and objectives.

• Excellent relationships with diverse stakeholder groups.

• Effective information technology to integrate value-creating activities.

Human Resource Management

• Effective recruiting, development, and retention mechanisms for employees.

• Quality relations with trade unions.

• Reward and incentive programs to motivate all employees.

Technology Development

• Effective R&D activities for process and product initiatives.

• Positive collaborative relationships between R&D and other departments.

• Excellent professional qualifications of personnel.

Procurement

• Procurement of raw material inputs to optimize quality and speed and to minimize the associated costs.

• Development of collaborative win-win relationships with suppliers.

• Analysis and selection of alternative sources of inputs to minimize dependence on one supplier.

Source: Adapted from Porter, M.E. 1985. Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press.

Microsoft has improved its procurement process (and the quality of its suppliers) by providing formal reviews of its suppliers. One of Microsoft’s divisions has extended the review process used for employees to its outside suppliers. 17 The employee services group, which is responsible for everything from travel to 401(k) programs to the on-site library, outsources more than 60 percent of the services it provides. Unfortunately, the employee services group was not providing them with enough feedback. This was feedback that the suppliers wanted to get and that Microsoft wanted to give.

The evaluation system that Microsoft developed helped clarify its expectations to suppliers. An executive noted: “We had one supplier—this was before the new system—that would have scored a 1.2 out of 5. After we started giving this feedback, and the supplier understood our expectations, its performance improved dramatically. Within six months, it scored a 4. If you’d asked me before we began the feedback system, I would have said that was impossible.”

Strategy Spotlight 3.3 addresses LG Electronics’ exemplary procurement practices.

Technology Development Every value activity embodies technology. 18 The array of technologies employed in most firms is very broad, ranging from technologies used to prepare documents and transport goods to those embodied in processes and equipment or the product itself. 19 Technology development related to the product and its features supports the entire value chain, while other technology development is associated with particular primary or support activities.

technology development

activities associated with the development of new knowledge that is applied to the firm’s operations.

The Allied Signal and Honeywell merger brought together roughly 13,000 scientists and an $870 million R&D budget that should lead to some innovative products and services in two major areas: performance materials and control systems. Some of the possible innovations include:

• Performance materials. The development of uniquely shaped fibers with very high absorption capability. When employed in the company’s Fram oil filters, they capture 50 percent more particles than ordinary filters. This means that cars can travel further with fewer oil changes.

• Control systems. Working with six leading oil companies, Honeywell developed software using “self-learning” algorithms that predict when something might go wrong in an oil refinery before it actually does. Examples include a faulty gas valve or hazardous spillage. 20

Human Resource Management Human resource management consists of activities involved in the recruiting, hiring, training, development, and compensation of all types of personnel. 21 It supports both individual primary and support activities (e.g., hiring of engineers and scientists) and the entire value chain (e.g., negotiations with labor unions). 22

human resource management

activities involved in the recruiting, hiring, training, development and compensation of all types of personnel.

Like all great service companies, JetBlue Airways Corporation is obsessed with hiring superior employees. 23 But they found it difficult to attract college graduates to commit to careers as flight attendants. JetBlue developed a highly innovative recruitment program for flight attendants—a one-year contract that gives them a chance to travel, meet lots of people, and then decide what else they might like to do. They also introduced the idea of training a friend and employee together so that they could share a job. With such employee-friendly initiatives, JetBlue has been very successful in attracting talent.

Jeffrey Immelt, GE’s chairman, addresses the importance of effective human resource management: 24

Human resources has to be more than a department. GE recognized early on—50 or 60 years ago—that in a multibusiness company, the common denominators are people and culture. From an employee’s first day at GE, she discovers that she’s in the people-development business as much as anything else. You’ll find that most good companies have the same basic HR processes that we have, but they’re discrete. HR at GE is not an agenda item; it is the agenda.

STRATEGY SPOTLIGHT

3.3

CREATIVE WHEN NO ONE’S LOOKING: PROCUREMENT AT LG ELECTRONICS

While LG Electronics spent $l.2 billon to market its many innovative electronic products in 2009, one of its truly pioneering actions has been the creation of a better supply chain. Although customers might not care about such investments, they would care about the price of one of the company’s cell phones, the LG Cookie, which was 30 percent lower than its comparable direct competitors. This price reduction was due in part to cost reduction and innovation at the company’s shipping bays. The Cookie has helped cement LG’s status as the world’s third-largest handset maker.

Previously, each of LG’s divisions negotiated their own deals. Thus, even though they might purchase from the same supplier, different divisions could receive different prices. By centralizing purchases, LG has cut more than $2 billion from its annual $30 billion shopping bill. Thomas Linton, LG’s first-ever procurement officer, has merged the various processes of the 115 factories and subsidiaries into a 50-page procurement manual and has worked more closely with suppliers, such as Taiwan’s TSMC. In early 2009 the company forecast strong demand from China for wafers, the silicon disks used to make chips. Linton quickly locked in suppliers, resulting in savings of $1 billion, according to the company. Other savings resulted from buying aluminum instead of higher-priced copper for the guts of electrical goods such as home appliances, thus saving $25 million in 2009. Moreover, Linton retained just enough control over LG’s supply chain to find substantial cost savings other companies that outsourced their supply chain to top-tier suppliers were unable to find. For instance LG, together with its suppliers, benchmarked their power cords against the ones used in competing products and found surprising results: they were much longer! Shortening the cords and standardizing the color to all black resulted in $10 million annual cost savings.

As a result of implementing such lean procurement procedures, the company weathered the recent economic downturn better than many competitors. And, in 2010, it won the Institute for Supply Management’s award for leadership and innovation in procurement.

Sources: Ihlwan, M. 2010. Creative when no one’s looking: LG’s re-engineering its supply chain so its innovative products will cost less. Bloomberg BusinessWeek, April 25: 37; Choi, T. & Linton, T. 2011. Don’t let your supply chain control your business. Harvard Business Review, 89(12): 112–117.

LO3.3

How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and suppliers.

General Administration General administration consists of a number of activities, including general management, planning, finance, accounting, legal and government affairs, quality management, and information systems. Administration (unlike the other support activities) typically supports the entire value chain and not individual activities.25

general administration

general management, planning, finance, accounting, legal and government affairs, quality management, and information systems; activities that support the entire value chain and not individual activities.

Although general administration is sometimes viewed only as overhead, it can be a powerful source of competitive advantage. In a telephone operating company, for example, negotiating and maintaining ongoing relations with regulatory bodies can be among the most important activities for competitive advantage. Also, in some industries top management plays a vital role in dealing with important buyers.26

The strong and effective leadership of top executives can also make a significant contribution to an organization’s success. As we discussed in Chapter 1, chief executive officers (CEOs) such as Herb Kelleher, Andrew Grove, and Jack Welch have been credited with playing critical roles in the success of Southwest Airlines, Intel, and General Electric.

Information systems can also play a key role in increasing the effectiveness of a wide variety of value chain activities and enhancing a firm’s performance. Strategy Spotlight 3.4 discusses how CarMax has used its proprietary information system to enhance its competitive advantage.

Interrelationships among Value-Chain Activities within and across Organizations

We have defined each of the value-chain activities separately for clarity of presentation. Managers must not ignore, however, the importance of relationships among value-chain activities.27 There are two levels: (1) interrelationships among activities within the firm and (2) relationships among activities within the firm and with other stakeholders (e.g., customers and suppliers) that are part of the firm’s expanded value chain.28

STRATEGY SPOTLIGHT

3.4

COMPETITIVE ANALYTICS AT CARMAX

Organizations increasingly face the challenge to make sense of the enormous amount of data available for analysis. While not too long ago companies used data analytics almost exclusively for financial forecasting and supply chain management, businesses increasingly demand that their information systems generate competitive advantage. This development led to the emergence of a new breed of information systems, also known as competitive analytics systems.

Consider CarMax, the largest U.S. retailer of used cars, for an example of how competitive analytics looks in practice. With $9 billion in 2011 revenue, CarMax’s success has many reasons, such as its compelling service offering, no haggle prices, and proven quality guaranteed by its 125-point inspection. Besides these more traditional sources of competitive advantage, CarMax also operates a proprietary information system that captures, analyzes, interprets, and disseminates information about all cars on the CarMax lot. CarMax’s data analytics helps track “every purchase, number of test drives and credit applications per car and color preferences in every demographic and region,” states Katharine W. Kenny, CarMax vice president of investor relations. The ability to integrate various value chain activities in this proprietary system allows CarMax to realize a competitive advantage.

The key features of this system provide CarMax management with real-time business insights into different store operations, such as inventory management, pricing, and sales consultant productivity. This advanced information system allows CarMax to decrease uncertainties in traditionally hard to forecast areas such as inventory management, allowing management to improve operational efficiency, and anticipate future trends. Moreover, CarMax also invests heavily in store technology, with some CarMax stores using Apple iPads to assist customers, who are becoming more tech savvy. According to CEO Tom Folliard, all these IT initiatives are targeted to give customers “a better experience from the time they walk in the door to the time they leave, so they are more likely to buy a car and they’re more likely to tell their friends about it.”

Sources: Kiron, D. & Shockley, R. 2011. Creating business value with analytics. MIT Sloan Management Review, 51(1): 57–63; Felberbaum, M. 2012. CEO: CarMax focused on customer experience. Bloomberg BusinessWeek, June 25: np.

With regard to the first level, consider CarMax’s proprietary information system. It provides management with real-time information about several aspects of store operations, including pricing, salesperson productivity, and inventory management.

With regard to the second level, Campbell Soup’s use of electronic networks enabled it to improve the efficiency of outbound logistics.29 However, it also helped Campbell manage the ordering of raw materials more effectively, improve its production scheduling, and help its customers better manage their inbound logistics operations.

The “Prosumer” Concept: Integrating Customers into the Value Chain

When addressing the value-chain concept, it is important to focus on the interrelationship between the organization and its most important stakeholder—its customers.30 A key to success for some leading-edge firms is to team up with their customers to satisfy their particular need(s). As stated in a recent IBM Global CEO Study:

In the future, we will be talking more and more about the “prosumer”—a customer/producer who is even more extensively integrated into the value chain. As a consequence, production processes will be customized more precisely and individually.31

Including customers in the actual production process can create greater satisfaction among them. It also has the potential to result in significant cost savings and to generate innovative ideas for the firm, which can be transferred to the customer in terms of lower prices and higher quality products and services.

In terms of how a firm views its customers, the move to create the prosumer stands in rather stark contrast to the conventional marketing approach in which the customer merely consumes the products produced by the company. Another area where this approach differs from conventional thinking concerns the notion of tying the customer into the company through, for example, loyalty programs and individualized relationship marketing.

interrelationships

collaborative and strategic exchange relationships between value-chain activities either (a) within firms or (b) between firms. Strategic exchange relationships involve exchange of resources such as information, people, technology, or money that contribute to the success of the firm.

How Procter & Gamble Embraced the Prosumer Concept In the early 2000s P&G’s people were not clearly oriented toward any common purpose. The corporate mission “To meaningfully improve the everyday lives of the customers” had not been explicitly or inspirationally rolled out to the employees. To more clearly focus everyone’s efforts, P&G expanded the mission to include the idea that “the consumer is the boss.” This philosophy became one in which people who buy and use P&G products are valued not just for their money but also as a rich source of information and direction. “The consumer is the boss” became far more than a slogan in P&G. It became a clear, simple, and inclusive cultural priority for both employees and the external stakeholders such as suppliers.

The P&G efforts in the fragrance areas are one example. P&G transformed this small underperforming business area into a global leader and the world’s largest fine fragrance company. They accomplished this by clearly and precisely defining the target consumer for each fragrance brand and by identifying subgroups of consumers for some brands. P&G still kept the partnerships with established fashion houses such as Dolce & Gabbana, Gucci, and Lacoste. However, the main point was to make the consumer the boss, focusing on innovations that were meaningful to consumers, including, for instance, fresh new scents, distinctive packaging, and proactive marketing. In addition, P&G streamlined the supply chain to reduce complexity and lower its cost structure.

The idea that “the consumer is the boss” goes even further. It also means that P&G tries to build social connections through digital media and other forms of interactions (thus incorporating the crowdsourcing concept that we introduced in Chapter 2). Baby diapers are one example. P&G used to use handmade diapers for its product tests. Today, however, this product is shown digitally and created in alternatives in an on-screen virtual world. Changes can be made immediately as new ideas emerge, and it can be redesigned on screen. Thus, P&G is creating a social system with the consumers (and potential consumers) that enable the firm to co-design and co-engineer new innovations with buyers. At P&G the philosophy of “the consumer is the boss” set a new standard.

Applying the Value Chain to Service Organizations

The concepts of inbound logistics, operations, and outbound logistics suggest managing the raw materials that might be manufactured into finished products and delivered to customers. However, these three steps do not apply only to manufacturing. They correspond to any transformation process in which inputs are converted through a work process into outputs that add value. For example, accounting is a sort of transformation process that converts daily records of individual transactions into monthly financial reports. In this example, the transaction records are the inputs, accounting is the operation that adds value, and financial statements are the outputs.

What are the “operations,” or transformation processes, of service organizations? At times, the difference between manufacturing and service is in providing a customized solution rather than mass production as is common in manufacturing. For example, a travel agent adds value by creating an itinerary that includes transportation, accommodations, and activities that are customized to your budget and travel dates. A law firm renders services that are specific to a client’s needs and circumstances. In both cases, the work process (operation) involves the application of specialized knowledge based on the specifics of a situation (inputs) and the outcome that the client desires (outputs).

The application of the value chain to service organizations suggests that the value-adding process may be configured differently depending on the type of business a firm is engaged in. As the preceding discussion on support activities suggests, activities such as procurement and legal services are critical for adding value. Indeed, the activities that may only provide support to one company may be critical to the primary value-adding activity of another firm.

Exhibit 3.4 provides two models of how the value chain might look in service industries. In the retail industry, there are no manufacturing operations. A firm such as Nordstrom

adds value by developing expertise in the procurement of finished goods and by displaying them in their stores in a way that enhances sales. Thus, the value chain makes procurement activities (i.e., partnering with vendors and purchasing goods) a primary rather than a support activity. Operations refer to the task of operating Nordstrom’s stores.

EXHIBIT 3.4 Some Examples of Value Chains in Service Industries

For an engineering services firm, research and development provides inputs, the transformation process is the engineering itself, and innovative designs and practical solutions are the outputs. The Beca Group, for example, is a large consulting firm with over 2,500 employees, based in the Asia Pacific region. In its technology and innovation management practice, Beca strives to make the best use of the science, technology and knowledge resources available to create value for a wide range of industries and client sectors. This involves activities associated with research and development, engineering, and creating solutions as well as downstream activities such as marketing, sales, and service. How the primary and support activities of a given firm are configured and deployed will often depend on industry conditions and whether the company is service and/or manufacturing oriented.

Resource-Based View of the Firm

The resource-based view (RBV) of the firm combines two perspectives: (1) the internal analysis of phenomena within a company and (2) an external analysis of the industry and its competitive environment.32 It goes beyond the traditional SWOT (strengths, weaknesses, opportunities, threats) analysis by integrating internal and external perspectives. The ability of a firm’s resources to confer competitive advantage(s) cannot be determined without taking into consideration the broader competitive context. A firm’s resources must be evaluated in terms of how valuable, rare, and hard they are for competitors to duplicate. Otherwise, the firm attains only competitive parity.

resource-based view of the firm

perspective that firms’ competitive advantages are due to their endowment of strategic resources that are valuable, rare, costly to imitate, and costly to substitute.

LO3.4

The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities.

As noted earlier (in Strategy Spotlight 3.1), a firm’s strengths and capabilities—no matter how unique or impressive—do not necessarily lead to competitive advantages in the marketplace. The criteria for whether advantages are created and whether or not they can be sustained over time will be addressed later in this section. Thus, the RBV is a very useful framework for gaining insights as to why some competitors are more profitable than others. As we will see later in the book, the RBV is also helpful in developing strategies for individual businesses and diversified firms by revealing how core competencies embedded in a firm can help it exploit new product and market opportunities.

In the two sections that follow, we will discuss the three key types of resources that firms possess (summarized in Exhibit 3.5): tangible resources, intangible resources, and organizational capabilities. Then we will address the conditions under which such assets and capabilities can enable a firm to attain a sustainable competitive advantage.33

Types of Firm Resources

Firm resources are all assets, capabilities, organizational processes, information, knowledge, and so forth, controlled by a firm that enable it to develop and implement value-creating strategies.

EXHIBIT 3.5 The Resource-Based View of the Firm: Resources and Capabilities

Tangible Resources
Financial	• Firm’s cash account and cash equivalents.
	• Firm’s capacity to raise equity.
	• Firm’s borrowing capacity.
Physical	• Modern plant and facilities.
	• Favorable manufacturing locations.
	• State-of-the-art machinery and equipment.
Technological	• Trade secrets.
	• Innovative production processes.
	• Patents, copyrights, trademarks.
Organizational	• Effective strategic planning processes.
	• Excellent evaluation and control systems.
Intangible Resources
Human	• Experience and capabilities of employees.
	• Trust.
	• Managerial skills.
	• Firm-specific practices and procedures.
Innovation and creativity	• Technical and scientific skills.
	• Innovation capacities.
Reputation	• Brand name.
	• Reputation with customers for quality and reliability.
	• Reputation with suppliers for fairness, non–zero-sum relationships.
Organizational Capabilities
• Firm competencies or skills the firm employs to transfer inputs to outputs.
• Capacity to combine tangible and intangible resources, using organizational processes to attain desired end.
EXAMPLES:
• Outstanding customer service.
• Excellent product development capabilities.
• Innovativeness of products and services.
• Ability to hire, motivate, and retain human capital.

Source: Adapted from Barney, J. B. 1991. Firm Resources and Sustained Competitive Advantage. Journal of Management: 17: 101; Grant, R. M. 1991. Contemporary Strategy Analysis: 100–102. Cambridge England: Blackwell Business and Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. 2001. Strategic Management: Competitiveness and Globalization (4th ed.). Cincinnati: South-Western College Publishing.

Tangible Resources These are assets that are relatively easy to identify. They include the physical and financial assets that an organization uses to create value for its

tangible resources

organizational assets that are relatively easy to identify, including physical assets, financial resources, organizational resources, and technological resources.

customers. Among them are financial resources (e.g., a firm’s cash, accounts receivables, and its ability to borrow funds); physical resources (e.g., the company’s plant, equipment, and machinery as well as its proximity to customers and suppliers); organizational resources (e.g., the company’s strategic planning process and its employee development, evaluation, and reward systems); and technological resources (e.g., trade secrets, patents, and copyrights).

Many firms are finding that high-tech, computerized training has dual benefits: It develops more effective employees and reduces costs at the same time. Employees at FedEx take computer-based job competency tests every 6 to 12 months.34 The 90-minute computer-based tests identify areas of individual weakness and provide input to a computer database of employee skills—information the firm uses in promotion decisions.

Intangible Resources Much more difficult for competitors (and, for that matter, a firm’s own managers) to account for or imitate are intangible resources, which are typically embedded in unique routines and practices that have evolved and accumulated over time. These include human resources (e.g., experience and capability of employees, trust, effectiveness of work teams, managerial skills), innovation resources (e.g., technical and scientific expertise, ideas), and reputation resources (e.g., brand name, reputation with suppliers for fairness and with customers for reliability and product quality).35 A firm’s culture may also be a resource that provides competitive advantage.36

intangible resources

organizational assets that are difficult to identify and account for and are typically embedded in unique routines and practices, including human resources, innovation resources, and reputation resources.

For example, you might not think that motorcycles, clothes, toys, and restaurants have much in common. Yet Harley-Davidson has entered all of these product and service markets by capitalizing on its strong brand image—a valuable intangible resource.37 It has used that image to sell accessories, clothing, and toys, and it has licensed the Harley-Davidson Café in New York City to provide further exposure for its brand name and products.

Social networking sites have the potential to play havoc with a firm’s reputation. Consider the unfortunate situation Comcast faced when one of its repairmen fell asleep on the job—and it went viral:

Ben Finkelstein, a law student, had trouble with the cable modem in his home. A Comcast cable repairman arrived to fix the problem. However, when the technician had to call the home office for a key piece of information, he was put on hold for so long that he fell asleep on Finkelstein’s couch. Outraged, Finkelstein made a video of the sleeping technician and posted it on YouTube. The clip became a hit—with more than a million viewings. And, for a long time, it undermined Comcast’s efforts to improve its reputation for customer service.38

Organizational Capabilities Organizational capabilities are not specific tangible or intangible assets, but rather the competencies or skills that a firm employs to transform inputs into outputs.39 In short, they refer to an organization’s capacity to deploy tangible and intangible resources over time and generally in combination, and to leverage those capabilities to bring about a desired end.40 Examples of organizational capabilities are outstanding customer service, excellent product development capabilities, superb innovation processes, and flexibility in manufacturing processes.41

organizational capabilities

the competencies and skills that a firm employs to transform inputs into outputs.

In the case of Apple, the majority of components used in their products can be characterized as proven technology, such as touch screen and MP3 player functionality.42 However, Apple combines and packages these in new and innovative ways while also seeking to integrate the value chain. This is the case with iTunes, for example, where suppliers of downloadable music are a vital component of the success Apple has enjoyed with their iPod series of MP3 players. Thus, Apple draws on proven technologies and their ability to offer innovative combinations of these.

LO3.5

The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees and managers.

Firm Resources and Sustainable Competitive Advantages

As we have mentioned, resources alone are not a basis for competitive advantages, nor are advantages sustainable over time.43 In some cases, a resource or capability helps a firm to increase its revenues or to lower costs but the firm derives only a temporary advantage because competitors quickly imitate or substitute for it.44

For a resource to provide a firm with the potential for a sustainable competitive advantage, it must have four attributes.45 First, the resource must be valuable in the sense that it exploits opportunities and/or neutralizes threats in the firm’s environment. Second, it must be rare among the firm’s current and potential competitors. Third, the resource must be difficult for competitors to imitate. Fourth, the resource must have no strategically equivalent substitutes. These criteria are summarized in Exhibit 3.6. We will now discuss each of these criteria. Then, we will examine how Dell’s competitive advantage, which seemed secure as late as 2006, has eroded in recent years.

Is the Resource Valuable? Organizational resources can be a source of competitive advantage only when they are valuable. Resources are valuable when they enable a firm to formulate and implement strategies that improve its efficiency or effectiveness. The SWOT framework suggests that firms improve their performance only when they exploit opportunities or neutralize (or minimize) threats.

The fact that firm attributes must be valuable in order to be considered resources (as well as potential sources of competitive advantage) reveals an important complementary relationship among environmental models (e.g., SWOT and five-forces analyses) and the resource-based model. Environmental models isolate those firm attributes that exploit opportunities and/or neutralize threats. Thus, they specify what firm attributes may be considered as resources. The resource-based model then suggests what additional characteristics these resources must possess if they are to develop a sustained competitive advantage.

Is the Resource Rare? If competitors or potential competitors also possess the same valuable resource, it is not a source of a competitive advantage because all of these firms have the capability to exploit that resource in the same way. Common strategies based on such a resource would give no one firm an advantage. For a resource to provide competitive advantages, it must be uncommon, that is, rare relative to other competitors.

This argument can apply to bundles of valuable firm resources that are used to formulate and develop strategies. Some strategies require a mix of multiple types of resources—tangible assets, intangible assets, and organizational capabilities. If a particular bundle of firm resources is not rare, then relatively large numbers of firms will be able to conceive of and implement the strategies in question. Thus, such strategies will not be a source of competitive advantage, even if the resource in question is valuable.

EXHIBIT 3.6 Four Criteria for Assessing Sustainability of Resources and Capabilities

Is the resource or capability …	Implications
Valuable?	• Neutralize threats and exploit opportunities
Rare?	• Not many firms possess
Difficult to imitate?	• Physically unique
	• Path dependency (how accumulated over time)
	• Causal ambiguity (difficult to disentangle what it is or how it could be re-created)
	• Social complexity (trust, interpersonal relationships, culture, reputation)
Difficult to substitute?	• No equivalent strategic resources or capabilities

Can the Resource Be Imitated Easily? Inimitability (difficulty in imitating) is a key to value creation because it constrains competition.46 If a resource is inimitable, then any profits generated are more likely to be sustainable.47 Having a resource that competitors can easily copy generates only temporary value.48 This has important implications. Since managers often fail to apply this test, they tend to base long-term strategies on resources that are imitable. IBP (Iowa Beef Processors) became the first meatpacking company in the United States to modernize by building a set of assets (automated plants located in cattle-producing states) and capabilities (low-cost “disassembly” of carcasses) that earned returns on assets of 1.3 percent in the 1970s. By the late 1980s, however, ConAgra and Cargill had imitated these resources, and IBP’s profitability fell by nearly 70 percent, to 0.4 percent.

Groupon is a more recent example of a firm that has suffered because rivals have been able to imitate its strategy rather easily:

Groupon, which offers online coupons for bargains at local shops and restaurants, created a new market.49 Although it was initially a boon to consumers, it offers no lasting “first mover” advantage. Its business model is not patentable and it is easy to replicate. Not surprisingly, there are many copycats. It seemed to represent a way to populate small businesses with an endless stream of enthusiastic customers. However, it has proven very hard to earn profits. For example, Groupon lost $256.7 million on $1.6 billion in revenues in 2011—and by late 2012, its stock was under $3 a share, a drop of about 80 percent from its value since its public trading debut. Privately-held LivingSocial, which is 31 percent owned by Amazon, had $558 million in losses on just $245 million in revenue. And even as Google and PayPal increased their coupon offers, there was a tremendous amount of churn in the industry in 2012. The number of daily deal sites in the United States rose by almost 8 percent (142 sites), according to Daily Deal Media, which tracks the industry. Meanwhile, globally, 560 daily deal sites closed over the same period!

What are some of Groupon’s main challenges? If they decrease their enormous marketing expenses, their growth could slow and their competitors would strengthen. But if they increase spending, they will have difficulty becoming a sustainably profitable company. And a key rival, LivingSocial, has been able to give discounts on Amazon products and gift cards because of Amazon’s investment in it.

Clearly, an advantage based on inimitability won’t last forever. Competitors will eventually discover a way to copy most valuable resources. However, managers can forestall them and sustain profits for a while by developing strategies around resources that have at least one of the following four characteristics.50

Physical Uniqueness The first source of inimitability is physical uniqueness, which by definition is inherently difficult to copy. A beautiful resort location, mineral rights, or Pfizer’s pharmaceutical patents simply cannot be imitated. Many managers believe that several of their resources may fall into this category, but on close inspection, few do.

Path Dependency A greater number of resources cannot be imitated because of what economists refer to as path dependency . This simply means that resources are unique and therefore scarce because of all that has happened along the path followed in their development and/or accumulation. Competitors cannot go out and buy these resources quickly and easily; they must be built up over time in ways that are difficult to accelerate.

path dependency

a characteristic of resources that is developed and/or accumulated through a unique series of events.

The Gerber Products Co. brand name for baby food is an example of a resource that is potentially inimitable. Re-creating Gerber’s brand loyalty would be a time-consuming process that competitors could not expedite, even with expensive marketing campaigns. Similarly, the loyalty and trust that Southwest Airlines employees feel toward their firm and its cofounder, Herb Kelleher, are resources that have been built up over a long period of time. Also, a crash R&D program generally cannot replicate a successful technology when research findings cumulate. Clearly, these path-dependent conditions build protection for the original resource. The benefits from experience and learning through trial and error cannot be duplicated overnight.

Causal Ambiguity The third source of inimitability is termed causal ambiguity. This means that would-be competitors may be thwarted because it is impossible to disentangle the causes (or possible explanations) of either what the valuable resource is or how it can be re-created. What is the root of 3M’s innovation process? You can study it and draw up a list of possible factors. But it is a complex, unfolding (or folding) process that is hard to understand and would be hard to imitate.

causal ambiguity

a characteristic of a firm’s resources that is costly to imitate because a competitor cannot determine what the resource is and/or how it can be re-created.

Often, causally ambiguous resources are organizational capabilities, involving a complex web of social interactions that may even depend on particular individuals. When Continental and United tried to mimic the successful low-cost strategy of Southwest Airlines, the planes, routes, and fast gate turnarounds were not the most difficult aspects for them to copy. Those were all rather easy to observe and, at least in principle, easy to duplicate. However, they could not replicate Southwest’s culture of fun, family, frugality, and focus since no one can clearly specify exactly what that culture is or how it came to be.

Strategy Spotlight 3.5 describes Amazon’s continued success as the world’s largest online marketplace. Competitors recently tried to imitate Amazon’s free shipping strategy, but with limited success. The reason is that Amazon has developed an array of interrelated elements of strategy which their rivals find too difficult to imitate.

Social Complexity A firm’s resources may be imperfectly inimitable because they reflect a high level of social complexity . Such phenomena are typically beyond the ability of firms to systematically manage or influence. When competitive advantages are based on social complexity, it is difficult for other firms to imitate them.

social complexity

a characteristic of a firm’s resources that is costly to imitate because the social engineering required is beyond the capability of competitors, including interpersonal relations among managers, organizational culture, and reputation with suppliers and customers.

A wide variety of firm resources may be considered socially complex. Examples include interpersonal relations among the managers in a firm, its culture, and its reputation with its suppliers and customers. In many of these cases, it is easy to specify how these socially complex resources add value to a firm. Hence, there is little or no causal ambiguity surrounding the link between them and competitive advantage.

Consider how a Chinese beverage company succeeded by creating close partnerships with its distributors: 51

When Wahaha, the largest Chinese beverage producer, decided to take on Coca-Cola and PepsiCo, they began their attack in the rural areas of China. Why? They believed that they possessed a competitive advantage over the international giants because of the partnerships that they had built with the distributors across the more remote locations in China.

Four years prior to the launch of a key product, “Wahaha Future Cola,” the firm developed a policy for how to tie in “channel members” over the long term as a response to the increasing problem of accounts receivable and bad debt. This policy provided incentives for the channel members to pay an annual deposit in advance to cover any potential future bad debt and to operate according to Wahaha’s payment policy.

Sounds OK, but what did the distributors get in return? They received an interest rate from Wahaha that was superior to the bank rate. In addition, further discounts were offered for early payment, and annual bonuses were awarded to distributors that met the criterion for prompt payment.

Are Substitutes Readily Available? The fourth requirement for a firm resource to be a source of sustainable competitive advantage is that there must be no strategically equivalent valuable resources that are themselves not rare or inimitable. Two valuable firm resources (or two bundles of resources) are strategically equivalent when each one can be exploited separately to implement the same strategies.

Substitutability may take at least two forms. First, though it may be impossible for a firm to imitate exactly another firm’s resource, it may be able to substitute a similar resource that enables it to develop and implement the same strategy. Clearly, a firm seeking to imitate another firm’s high-quality top management team would be unable to copy the team exactly. However, it might be able to develop its own unique management team.

Though these two teams would have different ages, functional backgrounds, experience, and so on, they could be strategically equivalent and thus substitutes for one another.

STRATEGY SPOTLIGHT

3.5

AMAZON PRIME: VERY DIFFICULT FOR RIVALS TO COPY

Amazon Prime, introduced in 2004, is a free-shipping service that guarantees delivery of products within two days for an annual fee of $79. According to Bloomberg Businessweek, it may be the most ingenious and effective customer loyalty program in all of e-commerce, if not retail in general. It converts casual shoppers into Amazon addicts who gorge on the gratification of having purchases reliably appear two days after they order. Analysts describe Prime as one of the main factors driving Amazon’s stock price up nearly 300 percent from 2008 to 2010. Also, it is one of the main reasons why Amazon’s sales grew 30 percent during the recession, while other retailers suffered.

Analysts estimate that Amazon Prime has more than 5 million members in the United States, a small slice of Amazon’s 152 million active buyers worldwide. However, analysts claim that Prime members increase their purchases on the site by about 150 percent after they join and may be responsible for as much as 20 percent of Amazon’s overall sales in the United States. Such shoppers are considered the “whales” of the $161 billion (in 2011) U.S. e-commerce market, one of the fastest-growing parts of U.S. retail. And, according to Hudson Square Research, Amazon, with a hefty 8 percent of the U.S. e-commerce market in 2010, is the single biggest online retailer in the United States.

Amazon Prime has proven to be extremely hard for rivals to copy. Why? It enables Amazon to exploit its wide selection, low prices, network of third-party merchants, and finely tuned distribution system. All that while also keying off that faintly irrational human need to maximize the benefits of a club that you have already paid to join. Yet Amazon’s success also leads to increased pressure from both public and private entities. For a long time, Amazon was able to avoid collecting local sales taxes because Amazon did not have a local sales presence in many states. This practice distorts competition and strains already tight state coffers. Some states have used a combination of legislation and litigation to convince Amazon to collect sales taxes; Amazon began collecting Texas state sales tax in July 2012.

Moreover, rivals—both online and off—have realized the increasing threat posed by Prime and are rushing to respond. For example, in October 2010, a consortium of more than 20 retailers, including Barnes & Noble, Sports Authority, and Toys ’R’ Us, banded together to offer their own copycat $79, two-day shipping program, ShopRunner, which applies to products across their websites. As noted by Fiona Dias, the executive who administers the program, “As Amazon added more merchandising categories to Prime, retailers started feeling the pain. They have finally come to understand that Amazon is an existential threat and that Prime is the fuel of the engine.” Brick-and-mortar retailers are also trying to fight back by matching Amazon’s prices, as they did during the 2012 holiday season, and by tightly integrating their on- and offline offerings.

Sources: Stone, B. 2010. What’s in the box? Instant gratification. Bloomberg Businessweek, November 29–December 5: 39–40; Kaplan, M. 2011. Amazon Prime: 5 million members, 20 percent growth. www.practicalcommerce.com , September 16: np; Fowler, G. A. 2010. Retailers team up against Amazon. www.wsj.com , October 6: np; Halkias, M. 2012. Amazon to collect sales tax in Texas. Dallas Morning News, April 28: 4A.

Second, very different firm resources can become strategic substitutes. For example, Internet booksellers such as Amazon.com compete as substitutes for brick-and-mortar booksellers such as B. Dalton. The result is that resources such as premier retail locations become less valuable. In a similar vein, several pharmaceutical firms have seen the value of patent protection erode in the face of new drugs that are based on different production processes and act in different ways, but can be used in similar treatment regimes. The coming years will likely see even more radical change in the pharmaceutical industry as the substitution of genetic therapies eliminates certain uses of chemotherapy. 52

To recap this section, recall that resources and capabilities must be rare and valuable as well as difficult to imitate or substitute in order for a firm to attain competitive advantages that are sustainable over time. 53 Exhibit 3.7 illustrates the relationship among the four criteria of sustainability and shows the competitive implications.

In firms represented by the first row of Exhibit 3.7 , managers are in a difficult situation. When their resources and capabilities do not meet any of the four criteria, it would be difficult to develop any type of competitive advantage, in the short or long term. The resources and capabilities they possess enable the firm neither to exploit environmental opportunities

nor neutralize environmental threats. In the second and third rows, firms have resources and capabilities that are valuable as well as rare, respectively. However, in both cases the resources and capabilities are not difficult for competitors to imitate or substitute. Here, the firms could attain some level of competitive parity. They could perform on par with equally endowed rivals or attain a temporary competitive advantage. But their advantages would be easy for competitors to match. It is only in the fourth row, where all four criteria are satisfied, that competitive advantages can be sustained over time. Next, let’s look at Dell and see how its competitive advantage, which seemed to be sustainable for a rather long period of time, has eroded.

EXHIBIT 3.7 Criteria for Sustainable Competitive Advantage and Strategic Implications

Is a resource or capability …
Valuable?	Rare?	Difficult to Imitate?	Without Substitutes?	Implications for Competitiveness?
No	No	No	No	Competitive disadvantage
Yes	No	No	No	Competitive parity
Yes	Yes	No	No	Temporary competitive advantage
Yes	Yes	Yes	Yes	Sustainable competitive advantage

Source: Adapted from Barney, J. B. 1991. Firm Resources and Sustained Competitive Advantage. Journal of Management, 17: 99–2.

Dell’s Eroding (Sustainable?) Competitive Advantage In 1984, Michael Dell started Dell Inc. in a University of Texas dorm room with an investment of $1,000.54 By 2006, Dell had attained annual revenues of $56 billion and a net income of $3.6 billion—making Michael Dell one of the richest people in the world. Dell achieved this meteoric growth by differentiating itself through the direct sales approach that it pioneered. Its user-configurable products met the diverse needs of its corporate and institutional customer base. Exhibit 3.8 summarizes how Dell achieved its remarkable success by integrating its tangible resources, intangible resources, and organizational capabilities.

Dell continued to maintain this competitive advantage by strengthening its value-chain activities and interrelationships that are critical to satisfying the largest market opportunities. It achieved this by (1) implementing e-commerce direct sales and support processes that accounted for the sophisticated buying habits of the largest markets and (2) matching its inventory management to its extensive supplier network. Dell also sustained these advantages by investing in intangible resources, such as proprietary assembly methods and packaging configurations, that helped to protect against the threat of imitation.

Dell recognized that the PC is a complex product with components sourced from several different technologies and manufacturers. Thus, in working backward from the customer’s purchasing habits, Dell saw that the company could build valuable solutions by organizing its resources and capabilities around build-to-specification tastes, making both the sales and integration processes flexible, and passing on overhead expenses to its suppliers. Even as the PC industry became further commoditized, Dell was one of the few competitors that was able to retain solid margins. It accomplished this by adapting its manufacturing and assembly capabilities to match the PC market’s trend toward user compatibility.

For many years, it looked as if Dell’s competitive advantage over its rivals would be sustainable for a very long period of time. However, by early 2007, Dell began falling behind its rivals in market share. This led to a significant decline in its stock price—followed by a complete shake-up of the top management team.

EXHIBIT 3.8 Dell’s Tangible Resources, Intangible Resources, and Organizational Capabilities

Inder Sidhu, the author of Doing Both (2010), provides a succinct summary of the central lesson in the Dell story:55

Dell illustrates what can happen when a company emphasizes optimization to the exclusion of reinvention. Dell’s obsession with operational excellence prevented it from delivering innovations that the market wanted, costing it a great deal of goodwill and prestige. When Fortune announced its annual list of “Most Admired Companies” in 2009, Dell, the leader from just four years prior, wasn’t even mentioned in the top 50.

Not surprisingly, Dell’s performance has sagged in recent years. Although its revenues slightly increased from $56 billion to $62 billion between 2006 and 2012, its net income was flat during the same period at about $3.5 billion and, more importantly, its market capitalization dropped about 75 percent from $64 billion to $16 billion.

The Generation and Distribution of a Firm’s Profits: Extending the Resource-Based View of the Firm

The resource-based view of the firm is useful in determining when firms will create competitive advantages and enjoy high levels of profitability. However, it has not been developed to address how a firm’s profits (often referred to as “rents” by economists) will be distributed to a firm’s management and employees or other stakeholders such as customers, suppliers, or governments.56 This is an important issue because firms may be successful in creating competitive advantages that can be sustainable for a period of time. However, much of the profits can be retained (or “appropriated”) by its employees and managers or other stakeholders instead of flowing to the firm’s owners (i.e., the stockholders).*

Consider Viewpoint DataLabs International, a Salt Lake City–based company that makes sophisticated three-dimensional models and textures for film production houses, video games, and car manufacturers. This example will help to show how employees are often able to obtain (or “appropriate”) a high proportion of a firm’s profits:

*Economists define rents as profits (or prices) in excess of what is required to provide a normal return.

Walter Noot, head of production, was having trouble keeping his highly skilled Generation X employees happy with their compensation. Each time one of them was lured away for more money, everyone would want a raise. “We were having to give out raises every six months—30 to 40 percent—then six months later they’d expect the same. It was a big struggle to keep people happy.”57

Here, much of the profits are being generated by the highly skilled professionals working together. They are able to exercise their power by successfully demanding more financial compensation. In part, management has responded favorably because they are united in their demands, and their work involves a certain amount of social complexity and causal ambiguity—given the complex, coordinated efforts that their work entails.

Four factors help explain the extent to which employees and managers will be able to obtain a proportionately high level of the profits that they generate:58

• Employee Bargaining Power. If employees are vital to forming a firm’s unique capability, they will earn disproportionately high wages. For example, marketing professionals may have access to valuable information that helps them to understand the intricacies of customer demands and expectations, or engineers may understand unique technical aspects of the products or services. Additionally, in some industries such as consulting, advertising, and tax preparation, clients tend to be very loyal to individual professionals employed by the firm, instead of to the firm itself. This enables them to “take the clients with them” if they leave. This enhances their bargaining power.

• Employee Replacement Cost. If employees’ skills are idiosyncratic and rare (a source of resource-based advantages), they should have high bargaining power based on the high cost required by the firm to replace them. For example, Raymond Ozzie, the software designer who was critical in the development of Lotus Notes, was able to dictate the terms under which IBM acquired Lotus.

• Employee Exit Costs. This factor may tend to reduce an employee’s bargaining power. An individual may face high personal costs when leaving the organization. Thus, that individual’s threat of leaving may not be credible. In addition, an employee’s expertise may be firm-specific and of limited value to other firms.

• Manager Bargaining Power. Managers’ power is based on how well they create resource-based advantages. They are generally charged with creating value through the process of organizing, coordinating, and leveraging employees as well as other forms of capital such as plant, equipment, and financial capital (addressed further in Chapter 4). Such activities provide managers with sources of information that may not be readily available to others.

Chapter 9 addresses the conditions under which top-level managers (such as CEOs) of large corporations have been, at times, able to obtain levels of total compensation that would appear to be significantly disproportionate to their contributions to wealth generation as well as to top executives in peer organizations. Here, corporate governance becomes a critical control mechanism. For example, consider Henry Silverman, Cendant’s CEO.59 His total compensation for the period from 2000 to 2006 was an astonishing $481 million. The longtime head of Cendant, a travel and real estate services giant, once so infuriated investors with his outsized option grants that in the early part of the decade the firm ended up settling a shareholder lawsuit that protested the size of his pay package. The shareholders certainly didn’t fare as well as Silverman—a $100 investment in Cendant shares in 2000 would have been worth only $51 in 2006!

Such diversion of profits from the owners of the business to top management is far less likely when the board members are truly independent outsiders (i.e., they do not have close ties to management). In general, given the external market for top talent, the level of compensation that executives receive is based on factors similar to the ones just discussed that determine the level of their bargaining power.60

In addition to employees and managers, other stakeholder groups can also appropriate a portion of the rents generated by a firm. If, for example, a critical input is controlled by a monopoly supplier or if a single buyer accounts for most of a firm’s sales, their bargaining power can greatly erode the potential profits of a firm. Similarly, excessive taxation by governments can also reduce what is available to a firm’s stockholders.

Evaluating Firm Performance: Two Approaches

This section addresses two approaches to use when evaluating a firm’s performance. The first is financial ratio analysis, which, generally speaking, identifies how a firm is performing according to its balance sheet, income statement, and market valuation. As we will discuss, when performing a financial ratio analysis, you must take into account the firm’s performance from a historical perspective (not just at one point in time) as well as how it compares with both industry norms and key competitors.61

The second perspective takes a broader stakeholder view. Firms must satisfy a broad range of stakeholders, including employees, customers, and owners, to ensure their long-term viability. Central to our discussion will be a well-known approach—the balanced scorecard—that has been popularized by Robert Kaplan and David Norton.62

Financial Ratio Analysis

The beginning point in analyzing the financial position of a firm is to compute and analyze five different types of financial ratios:

financial ratio analysis

a technique for measuring the performance of a firm according to its balance sheet, income statement, and market valuation.

• Short-term solvency or liquidity

• Long-term solvency measures

• Asset management (or turnover)

• Profitability

• Market value

Exhibit 3.9 summarizes each of these five ratios.

Appendix 1 to Chapter 13 (the Case Analysis chapter) provides detailed definitions for and discussions of each of these types of ratios as well as examples of how each is calculated. Refer to pages 437 to 446.

LO3.6

The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms.

A meaningful ratio analysis must go beyond the calculation and interpretation of financial ratios.63 It must include how ratios change over time as well as how they are interrelated. For example, a firm that takes on too much long-term debt to finance operations will see an immediate impact on its indicators of long-term financial leverage. The additional debt will negatively affect the firm’s short-term liquidity ratio (i.e., current and quick ratios) since the firm must pay interest and principal on the additional debt each year until it is retired. Additionally, the interest expenses deducted from revenues reduce the firm’s profitability.

A firm’s financial position should not be analyzed in isolation. Important reference points are needed. We will address some issues that must be taken into account to make financial analysis more meaningful: historical comparisons, comparisons with industry norms, and comparisons with key competitors.

Historical Comparisons When you evaluate a firm’s financial performance, it is very useful to compare its financial position over time. This provides a means of evaluating trends. For example, Apple Inc. reported revenues of $157 billion and net income of $42 billion in 2012. Virtually all firms would be very happy with such remarkable financial success. These figures represent a stunning annual growth in revenue and net income of 140 percent and 198 percent, respectively, for the 2010 to 2012 time period. Had Apple’s revenues and net income in 2012 been $80 billion and $20 billion, respectively, it would still be a very large and highly profitable enterprise. However, such performance would have significantly damaged Apple’s market valuation and reputation as well as the careers of many of its executives.

EXHIBIT 3.9 A Summary of Five Types of Financial Ratios

I. Short-term solvency, or liquidity, ratios

Current ratio = Current assetsCurrent liabilities

Quick ratio = Current assets - InventoryCurrent liabilities

Cash ratio = CashCurrent liabilities

II. Long-term solvency, or financial leverage, ratios

Total debt ratio = Total assets - Total equityTotal assets

Debt-equity ratio = Total debt/Total equity

Equity multiplier = Total assets/Total equity

Times interest earned ratio = EBITInterest

Cash coverage ratio = EBIT + DepreciationInterest

III. Asset utilization, or turnover, ratios

Inventory turnover = Cost of goods soldInventory

Days' sales in inventory = 365 daysInventory turnover

Receivables turnover = SalesAccounts receivable

Days' sales in receivables = 365 daysReceivables turnover

Total asset turnover = SalesTotal assets

Capital intensity = Total assetsSales

IV. Profitability ratios

Profit margin = Net incomeSales

Return on assets (ROA) = Net incomeTotal assets

Return on equity (ROE) = Net incomeTotal equity

ROE = Net incomeSales × SalesAssets × AssetsEquity

V. Market value ratios

Price-earnings ratio = Price per shareEarnings per share

Market-to-book ratio = Market value per shareBook value per share

Exhibit 3.10 illustrates a 10-year period of return on sales (ROS) for a hypothetical company. As indicated by the dotted trend lines, the rate of growth (or decline) differs substantially over time periods.

Comparison with Industry Norms When you are evaluating a firm’s financial performance, remember also to compare it with industry norms. A firm’s current ratio or profitability may appear impressive at first glance. However, it may pale when compared with industry standards or norms.

Comparing your firm with all other firms in your industry assesses relative performance. Banks often use such comparisons when evaluating a firm’s creditworthiness. Exhibit 3.11 includes a variety of financial ratios for three industries: semiconductors, grocery stores, and skilled-nursing facilities. Why is there such variation among the financial ratios for these three industries? There are several reasons. With regard to the collection period, grocery stores operate mostly on a cash basis, hence a very short collection period. Semiconductor manufacturers sell their output to other manufacturers (e.g., computer makers) on terms such as 2/15 net 45, which means they give a 2 percent discount on bills paid within 15 days and start charging interest after 45 days. Skilled-nursing facilities also have a longer collection period than grocery stores because they typically rely on payments from insurance companies.

The industry norms for return on sales also highlight differences among these industries. Grocers, with very slim margins, have a lower return on sales than either skilled-nursing facilities or semiconductor manufacturers. But how might we explain the differences between skilled-nursing facilities and semiconductor manufacturers? Health care facilities, in general, are limited in their pricing structures by Medicare/Medicaid regulations and by insurance reimbursement limits, but semiconductor producers have pricing structures determined by the market. If their products have superior performance, semiconductor manufacturers can charge premium prices.

EXHIBIT 3.10 Historical Trends: Return on Sales (ROS) for a Hypothetical Company

EXHIBIT 3.11 How Financial Ratios Differ across Industries

Financial Ratio	Semiconductors	Grocery Stores	Skilled-Nursing Facilities
Quick ratio (times)	1.9	0.6	1.3
Current ratio (times)	3.6	1.7	1.7
Total liabilities to net worth (%)	35.1	72.7	82.5
Collection period (days)	48.6	3.3	36.5
Assets to sales (%)	131.7	22.1	58.3
Return on sales (%)	24	1.1	3.1

Source: Dun & Bradstreet. Industry Norms and Key Business Ratios, 2010–2011. One Year Edition, SIC #3600–3699 (Semiconductors); SIC #5400–5499 (Grocery Stores); SIC #8000–8099 (Skilled-Nursing Facilities). New York: Dun & Bradstreet Credit Services.

Comparison with Key Competitors Recall from Chapter 2 that firms with similar strategies are members of a strategic group in an industry. Furthermore, competition is more intense among competitors within groups than across groups. Thus, you can gain valuable insights into a firm’s financial and competitive position if you make comparisons between a firm and its most direct rivals. Consider a firm trying to diversify into the highly profitable pharmaceutical industry. Even if it was willing to invest several hundred million dollars, it would be virtually impossible to compete effectively against industry giants such as Pfizer and Merck. These two firms have 2012 revenues of $60 billion and $47 billion, respectively, and both had R&D budgets of $8 billion. 64

LO3.7

The value of the “balanced scorecard” in recognizing how the interests of a variety of stakeholders can be interrelated.

Integrating Financial Analysis and Stakeholder Perspectives: The Balanced Scorecard

It is useful to see how a firm performs over time in terms of several ratios. However, such traditional approaches can be a double-edged sword.65 Many important transactions—investments

in research and development, employee training and development, and, advertising and promotion of key brands—may greatly expand a firm’s market potential and create significant long-term shareholder value. But such critical investments are not reflected positively in short-term financial reports. Financial reports typically measure expenses, not the value created. Thus, managers may be penalized for spending money in the short term to improve their firm’s long-term competitive viability!

Now consider the other side of the coin. A manager may destroy the firm’s future value by dissatisfying customers, depleting the firm’s stock of good products coming out of R&D, or damaging the morale of valued employees. Such budget cuts, however, may lead to very good short-term financials. The manager may look good in the short run and even receive credit for improving the firm’s performance. In essence, such a manager has mastered “denominator management,” whereby decreasing investments makes the return on investment (ROI) ratio larger, even though the actual return remains constant or shrinks.

The Balanced Scorecard: Description and Benefits To provide a meaningful integration of the many issues that come into evaluating a firm’s performance, Kaplan and Norton developed a “balanced scorecard .”66 This provides top managers with a fast but comprehensive view of the business. In a nutshell, it includes financial measures that reflect the results of actions already taken, but it complements these indicators with measures of customer satisfaction, internal processes, and the organization’s innovation and improvement activities—operational measures that drive future financial performance.

balanced scorecard

a method of evaluating a firm’s performance using performance measures from the customers’, internal, innovation and learning, and financial perspectives.

The balanced scorecard enables managers to consider their business from four key perspectives: customer, internal, innovation and learning, and financial. These are briefly described in Exhibit 3.12.

Customer Perspective Clearly, how a company is performing from its customers’ perspective is a top priority for management. The balanced scorecard requires that managers translate their general mission statements on customer service into specific measures that reflect the factors that really matter to customers. For the balanced scorecard to work, managers must articulate goals for four key categories of customer concerns: time, quality, performance and service, and cost.

customer perspective

measures of firm performance that indicate how well firms are satisfying customers’ expectations.

Internal Business Perspective Customer-based measures are important. However, they must be translated into indicators of what the firm must do internally to meet customers’ expectations. Excellent customer performance results from processes, decisions, and actions that occur throughout organizations in a coordinated fashion, and managers must focus on those critical internal operations that enable them to satisfy customer needs. The internal measures should reflect business processes that have the greatest impact on customer satisfaction. These include factors that affect cycle time, quality, employee skills, and productivity.

internal business perspective

measures of firm performance that indicate how well firms’ internal processes, decisions and actions are contributing to customer satisfaction.

Innovation and Learning Perspective Given the rapid rate of markets, technologies, and global competition, the criteria for success are constantly changing. To survive and prosper, managers must make frequent changes to existing products and services as well as introduce entirely new products with expanded capabilities. A firm’s ability to do well from an innovation and learning perspective is more dependent on its intangible than tangible assets. Three categories of intangible assets are critically important: human capital (skills, talent, and knowledge), information capital (information systems, networks), and organization capital (culture, leadership).

innovation and learning perspective

measures of firm performance that indicate how well firms are changing their product and service offerings to adapt to changes in the internal and external environments.

EXHIBIT 3.12 The Balanced Scorecard’s Four Perspectives

• How do customers see us? (customer perspective)

• What must we excel at? (internal business perspective)

• Can we continue to improve and create value? (innovation and learning perspective)

• How do we look to shareholders? (financial perspective)

Financial Perspective Measures of financial performance indicate whether the company’s strategy, implementation, and execution are indeed contributing to bottom-line improvement. Typical financial goals include profitability, growth, and shareholder value. Periodic financial statements remind managers that improved quality, response time, productivity, and innovative products benefit the firm only when they result in improved sales, increased market share, reduced operating expenses, or higher asset turnover.67

financial perspective

measures of firms’ financial performance that indicate how well strategy, implementation and execution are contributing bottom-line improvement.

Consider how Sears, the huge retailer, found a strong causal relationship between employee attitudes, customer attitudes, and financial outcomes.68 Through an ongoing study, Sears developed what it calls its total performance indicators, or TPI—a set of indicators for assessing their performance with customers, employees, and investors. Sears’s quantitative model has shown that a 5.0 percent improvement in employee attitudes leads to a 1.3 percent improvement in customer satisfaction, which in turn drives a 0.5 percent improvement in revenue. Thus, if a single store improved its employee attitude by 5.0 percent, Sears could predict with confidence that if the revenue growth in the district as a whole were 5.0 percent, the revenue growth in this particular store would be 5.5 percent. Interestingly, Sears’s managers consider such numbers as rigorous as any others that they work with every year. The company’s accounting firm audits management as closely as it audits the financial statements.

A key implication is that managers do not need to look at their job as balancing stakeholder demands. They must avoid the following mind-set: “How many units in employee satisfaction do I have to give up to get some additional units of customer satisfaction or profits?” Instead, the balanced scorecard provides a win–win approach—increasing satisfaction among a wide variety of organizational stakeholders, including employees (at all levels), customers, and stockholders.

Limitations and Potential Downsides of the Balanced Scorecard There is general agreement that there is nothing inherently wrong with the concept of the balanced score-card.69 The key limitation is that some executives may view it as a “quick fix” that can be easily installed. If managers do not recognize this from the beginning and fail to commit to it long term, the organization will be disappointed. Poor execution becomes the cause of such performance outcomes. And organizational scorecards must be aligned with individuals’ scorecards to turn the balanced scorecards into a powerful tool for sustained performance.

In a recent study of 50 Canadian medium-size and large organizations, the number of users expressing skepticism about scorecard performance was much greater than the number claiming positive results. A large number of respondents agreed with the statement “Balanced scorecards don’t really work.” Some representative comments included: “It became just a number-crunching exercise by accountants after the first year,” “It is just the latest management fad and is already dropping lower on management’s list of priorities as all fads eventually do,” and “If scorecards are supposed to be a measurement tool, why is it so hard to measure their results?” There is much work to do before scorecards can become a viable framework to measure sustained strategic performance.

Problems often occur in the balanced scorecard implementation efforts when there is an insufficient commitment to learning and the inclusion of employees’ personal ambitions. Without a set of rules for employees that address continuous process improvement and the personal improvement of individual employees, there will be limited employee buy-in and insufficient cultural change. Thus, many improvements may be temporary and superficial. Often, scorecards that failed to attain alignment and improvements dissipated very quickly. And, in many cases, management’s efforts to improve performance were seen as divisive and were viewed by employees as aimed at benefiting senior management compensation. This fostered a “what’s in it for me?” attitude.

ISSUE FOR DEBATE

The World Triathalon’s Initiatives to Extend Its Brand

World Triathlon Corporation (WTC) is a Florida-based company known for recognizing athletic excellence and performance. It provides events, products, and services under the Ironman and Ironman 70.3* branded names. Since its inception, Ironman has been identified with ambitious and courageous individuals who aren’t afraid to push their limits. Tapping into athletes’ desires to pursue their dream of becoming an Ironman was a successful business strategy for WTC. Given the extreme physical challenge, disciplined training, and camaraderie it offered its clients, WTC was able to grow its revenues and profits over the years.

In 2008, Providence Equity Partners, a private equity firm, acquired WTC for an undisclosed amount. The new owners started expanding the exclusive branding of Ironman to products and events that clearly didn’t represent the “spirit” of the brand. For example, those who finished Ironman 70.3 races were allowed to be called “Ironmen,” regardless of the shorter length and lesser degree of difficulty. Additionally, products such as cologne, mattresses, and strollers were branded with “Ironman.” In October 2010, Ironman Access was launched as a membership program wherein individuals could get preferential registration access to Ironman events for a $1,000 annual fee. The response by the triathlete community was quick and decisive—and overwhelming negative. The athletes felt that WTC was losing its values in its pursuit of more profits. The company was trying to expand the brand, but it was alienating its base.

*Ironman 70.3 is the half triathlon; the number refers to the total distance in miles covered in the race—1.2 mile swim, 56 mile bike ride, and 13.1 mile run.

Discussion Questions

1. What actions should WTC take?

2. Is the World Triathlon Corporation acting too aggressively in trying to monetize the brand?

3. What are the long-term implications of their recent strategic actions?

Sources: Beartini, M. & Gourville, J.T. 2012. Pricing to create share value. Harvard Business Review, 90 (6): 96–104; and WTC. 2012. Corporate info. www.ironman.com , January 12: np.

Reflecting on Career Implications …

The Value Chain: It is important that you develop an understanding of your firm’s value chain. What activities are most critical for attaining competitive advantage? Think of ways in which you can add value in your firm’s value chain. How might your firm’s support activities (e.g., information technology, human resource practices) help you accomplish your assigned tasks more effectively? How will you bring your value-added contribution to the attention of your superiors?

The Value Chain: Consider the most important linkages between the activities you perform in your organization with other activities both within your firm as well as between your firm and its suppliers, customers, and alliance partners. Understanding and strengthening these linkages can contribute greatly to your career advancement within your current organization.

Resource-Based View of the Firm: Are your skills and talents rare, valuable, difficult to imitate, and have few substitutes? If so, you are in the better position to add value for your firm—and earn rewards and incentives. How can your skills and talents be enhanced to help satisfy these criteria to a greater extent? More training? Change positions within the firm? Consider career options at other organizations?

Balanced Scorecard: Can you design a “balanced scorecard” for your life? What would be the perspectives that you will include in it? In what ways would such a “balanced scorecard” help you attain success in life?

summary

In the traditional approaches to assessing a firm’s internal environment, the primary goal of managers would be to determine their firm’s relative strengths and weaknesses. Such is the role of SWOT analysis, wherein managers analyze their firm’s strengths and weaknesses as well as the opportunities and threats in the external environment. In this chapter, we discussed why this may be a good starting point but hardly the best approach to take in performing a sound analysis. There are many limitations to SWOT analysis, including its static perspective, its potential to overemphasize a single dimension of a firm’s strategy, and the likelihood that a firm’s strengths do not necessarily help the firm create value or competitive advantages.

We identified two frameworks that serve to complement SWOT analysis in assessing a firm’s internal environment: value-chain analysis and the resource-based view of the firm. In conducting a value-chain analysis, first divide the firm into a series of value-creating activities. These include primary activities such as inbound logistics, operations, and service as well as support activities such as procurement and human resources management. Then analyze how each activity adds value as well as how interrelationships among value activities in the firm and among the firm and its customers and suppliers add value. Thus, instead of merely determining a firm’s strengths and weaknesses per se, you analyze them in the overall context of the firm and its relationships with customers and suppliers—the value system.

The resource-based view of the firm considers the firm as a bundle of resources: tangible resources, intangible resources, and organizational capabilities. Competitive advantages that are sustainable over time generally arise from the creation of bundles of resources and capabilities. For advantages to be sustainable, four criteria must be satisfied: value, rarity, difficulty in imitation, and difficulty in substitution. Such an evaluation requires a sound knowledge of the competitive context in which the firm exists. The owners of a business may not capture all of the value created by the firm. The appropriation of value created by a firm between the owners and employees is determined by four factors: employee bargaining power, replacement cost, employee exit costs, and manager bargaining power.

An internal analysis of the firm would not be complete unless you evaluate its performance and make the appropriate comparisons. Determining a firm’s performance requires an analysis of its financial situation as well as a review of how well it is satisfying a broad range of stakeholders, including customers, employees, and stockholders. We discussed the concept of the balanced scorecard, in which four perspectives must be addressed: customer, internal business, innovation and learning, and financial. Central to this concept is the idea that the interests of various stakeholders can be interrelated. We provide examples of how indicators of employee satisfaction lead to higher levels of customer satisfaction, which in turn lead to higher levels of financial performance. Thus, improving a firm’s performance does not need to involve making trade-offs among different stakeholders. Assessing the firm’s performance is also more useful if it is evaluated in terms of how it changes over time, compares with industry norms, and compares with key competitors.

SUMMARY REVIEW QUESTIONS

1. SWOT analysis is a technique to analyze the internal and external environment of a firm. What are its advantages and disadvantages?

2. Briefly describe the primary and support activities in a firm’s value chain.

3. How can managers create value by establishing important relationships among the value-chain activities both within their firm and between the firm and its customers and suppliers?

4. Briefly explain the four criteria for sustainability of competitive advantages.

5. Under what conditions are employees and managers able to appropriate some of the value created by their firm?

6. What are the advantages and disadvantages of conducting a financial ratio analysis of a firm?

7. Summarize the concept of the balanced scorecard. What are its main advantages?

key terms

(Dess 97-98)

Dess, Gregory, G.T. Lumpkin, Alan Eisner, Gerry McNamara. Strategic Management: Text and Cases, 7th Edition. McGraw-Hill Learning Solutions, 09/2013. VitalBook file.

The citation provided is a guideline. Please check each citation for accuracy before use.