1. Chapter Three
Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability

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Internal Analysis
The purpose of internal analysis is to pinpoint the strengths and weaknesses of the organization.
Strengths lead to superior performance. Weaknesses lead to inferior performance.
Internal Analysis includes an assessment of:
Quantity and quality of a company’s resources and capabilities
Ways of building unique skills and company-specific or distinctive competencies
Building and sustaining a competitive advantage requires a company to achieve superior:
Efficiency
Quality
Innovations
Responsiveness to customers
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3. Competitive Advantage
A firm’s profitability is greater than the average profitability for all firms in its industry.
Sustained Competitive Advantage
A firm maintains above average and superior profitability and profit growth for a number of years.
The Primary Objective of Strategy
is to achieve a Sustained Competitive Advantage
which in turn results in Superior Profit and Profit Growth.
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4. Internal Analysis: A Three-Step Process
Understand the process by which companies create value for customers and profit for themselves.
Resources
Capabilities
Distinctive competencies
Understand the importance of superiority in creating value and generating high profitability.
Efficiency
Quality
Analyze the sources of the company’s competitive advantage.
Strengths – that are driving profitability
Weaknesses – opportunities for improvement
Innovation
Responsiveness to Customers
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5. Distinctive Competencies and Role of Resources and Capabilities
Tangible (physical) and intangible (non-physical)
Allow a company to create value for its customers
Must have skills to take advantage of the resources
Firm-specific and difficult-to-imitate resources
as well as valuable resources that create strong
demand for a company’s products lead to
distinctive competencies
Capabilities
Coordinating resources & putting to productive use
Skills reside in the organization’s rules, routines
and procedures
Product of its organization, processes & controls
Firm-specific capabilities to manage its resources
lead to distinctive competencies
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6. Competitive Advantage, Value Creation, and Profitability
How profitable a company becomes depends on three basic factors:
VALUE or UTILITY the customer gets from owning the product
PRICE that a company charges for its products
COSTS of creating those products
Consumer surplus is the “excess” utility a consumer captures beyond the price paid.
Basic Principle: the more utility that consumers get from a company’s products or services, the more pricing options the company has.
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7. Value Creation per Unit
Figure 3.2
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8. Comparing Toyota and General Motors
Figure 3.4
Superior value creation requires that the gap between perceived utility (U) and costs of production (C) be greater than that obtained by competitors.
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The Value Chain
Figure 3.5
A company is a chain of activities for transforming inputs into outputs that customers value – including the primary and support activities.
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10. Building Blocks of Competitive Advantage
The Generic Distinctive Competencies
Allow a company to:
Differentiate product offering
Offer more utility to customer
Lower the cost structure
regardless of the industry,
its products, or its services 
Figure 3.6   
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 Efficiency
Measured by the quantity of inputs it takes to produce a given output:
Efficiency = Outputs / Inputs
Productivity leads to greater efficiency and lower costs:
Employee productivity
Capital productivity
Superior efficiency helps a company attain a competitive advantage through a lower cost structure.
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12.  Quality
Quality products are goods and services that are:
Reliable and
Differentiated by attributes that customers perceive to have higher value
The impact of quality on competitive
advantage:
High-quality products differentiate and increase the value of the products in customers’ eyes.
Greater efficiency and lower unit costs are associated with reliable products.
Superior quality = customer perception of greater value in a product’s attributes
Form, features, performance, durability, reliability, style, design
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 Innovation
Innovation is the act of creating new products or new processes
Product innovation
Creates products that customers perceive as more valuable and
Increases the company’s pricing options
Process innovation
Creates value by lowering production costs
Successful innovation can be a major source of competitive advantage – by giving a company something unique, something its competitors lack.
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14.  Responsiveness to Customers
Superior quality and innovation are integral to superior responsiveness to customers.
Customizing goods and services to the unique demands of individual customers or customer groups.
Enhanced customer responsiveness
Customer response time, design, service, after-sales service and support
Identifying and satisfying customers’ needs – better than the competitors
Superior responsiveness to customers differentiates a company’s products and services and leads to brand loyalty and premium pricing.
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15. Analyzing Competitive Advantage and Profitability
When a companies profitability is greater than the average of all other companies in the same industry that compete for the same customers
Benchmarking
Comparing company performance against that of competitors and the company’s historic performance
Measures of Profitability
Return On Invested Capital (ROIC)
Net profit Net income after tax Capital invested Equity + Debt to creditors
Net Profit
Net Profit = Total revenues – Total costs = =
ROIC
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16. The Durability of Competitive Advantage
The DURABILITY of a company’s competitive advantage over its competitors depends on:
Barriers to Imitation
Making it difficult to copy a company’s distinctive competencies
Imitating Resources
Imitating Capabilities
Capability of Competitors
Strategic commitment
Commitment to a particular way of doing business
Absorptive capacity
Ability to identify, value, assimilate, and use knowledge
Industry Dynamism
Ability of an industry to change rapidly
Competitors are also seeking to develop distinctive competencies that will give them a competitive edge.
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Why Companies Fail
Inertia
Companies find it difficult to change their strategies and structures
Prior Strategic Commitments
Limit a company’s ability to imitate and cause competitive disadvantage
The Icarus Paradox
A company can become so specialized and inner directed based on past success that it loses sight of market realities
Categories of rising and falling companies:
• Craftsmen • Builders • Pioneers • Salespeople
When a company loses its competitive advantage, its profitability falls below that of the industry  It loses the ability to attract and generate resources  Profit margins and invested capital shrink rapidly.
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18. Avoiding Failure: Sustaining Competitive Advantage
Focus on the Building Blocks of Competitive Advantage
Develop distinctive competencies and superior performance in:
Efficiency  Quality
Innovation  Responsiveness to Customers
Institute Continuous Improvement and Learning
Recognize the importance of continuous learning within the organization
Track Best Practices and Use Benchmarking
Measure against the products and practices of the most efficient global competitors
Overcome Inertia
Overcome the internal forces that are barriers to change
Luck may play a role in success, so always exploit a lucky break - but remember:
“The harder I work, the luckier I seem to get.”
J P Morgan
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