Assessing the Internal Environment of the Firm Chapter 3 Assessing the Internal Environment of the Firm

Agenda Process of internal analysis The primary and support activities of a firm’s value chain. The resource-based view of the firm VRIS Financial ratio analysis Balanced Scorecard

Learning Objectives After reading this chapter, you should have a good understanding of: The value of recognizing how the interests of a variety of stakeholders can be interrelated.

Competitive Advantage Components of Internal Analysis Capabilities Teams of Resources The Source of The Source of Sources of Competitive Advantage Core Competencies Resources * Tangible Intangible Components of Internal Analysis Above-Average Returns Strategic Competitiveness Gained through Core Competencies Sustained Competitive Advantage The Foundation of The Pathway to

Components of Internal Analysis Resources * Tangible Intangible Components of Internal Analysis

What a firm Has... Resources What a firm has to work with: its assets, including its people and the value of its brand name

Resources represent inputs into a firm’s production process... What a firm Has... Resources What a firm has to work with: its assets, including its people and the value of its brand name Resources represent inputs into a firm’s production process... such as capital equipment, skills of employees, brand names, finances and talented managers

What a firm Has... Resources What a firm has to work with: its assets, including its people and the value of its brand name Resources represent inputs into a firm’s production process... such as capital equipment, skills of employees, brand names, finances and talented managers “Some genius invented the Oreo. We’re just living off the inheritance.” F. Ross Johnson, Former President & CEO, RJR Nabisco

What a firm Has... Resources Resources What a firm has to work with: Tangible Resources Financial * Physical Human Resources Organizational its assets, including its people and the value of its brand name Resources represent inputs into a firm’s production process... such as capital equipment, skills of employees, brand names, finances and talented managers “Some genius invented the Oreo. We’re just living off the inheritance.” F. Ross Johnson, Former President & CEO, RJR Nabisco

What a firm Has... Resources Resources What a firm has to work with: Tangible Resources Financial * Physical Human Resources Organizational its assets, including its people and the value of its brand name Resources represent inputs into a firm’s production process... such as capital equipment, skills of employees, brand names, finances and talented managers Intangible Resources Technological * Innovation Brand Names Corporate Culture “Some genius invented the Oreo. We’re just living off the inheritance.” F. Ross Johnson, Former President & CEO, RJR Nabisco

Components of Internal Analysis Resources * Tangible Intangible Components of Internal Analysis

Components of Internal Analysis Capabilities Teams of Resources The Source of Resources * Tangible Intangible Components of Internal Analysis

Capabilities What a firm Does... Capabilities represent: the firm’s capacity or ability to integrate individual firm resources to achieve a desired objective.

Capabilities What a firm Does... Capabilities represent: the firm’s capacity or ability to integrate individual firm resources to achieve a desired objective. Capabilities develop over time as a result of complex interactions that take advantage of the interrelationships between a firm’s tangible and intangible resources that are based on the development, transmission and exchange or sharing of information and knowledge as carried out by the firm's employees.

Capabilities What a firm Does... Capabilities represent: the firm’s capacity or ability to integrate individual firm resources to achieve a desired objective. Capabilities develop over time as a result of complex interactions that take advantage of the interrelationships between a firm’s tangible and intangible resources that are based on the development, transmission and exchange or sharing of information and knowledge as carried out by the firm's employees. Capabilities become important when they are combined in unique combinations which create core competencies which have strategic value and can lead to competitive advantage.

The Value Chain General administration Human resource management Technology development Procurement Inbound logistics Outbound logistics Marketing and sales Operations Service Adapted from Exhibit 3.1 The Value Chain: Primary and Support Activities Source: Adapted with permission of The Free Press, a division of Simon & Schuster, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter.

Primary Activities Inbound Logistics Associated with receiving, storing and distributing inputs to the product Location of distribution facilities Material and inventory control systems Systems to reduce time to send “returns” to suppliers Warehouse layout and designs Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

Primary Activities Inbound Logistics Associated with transforming inputs into the final product form Efficient plant operations Appropriate level of automation in manufacturing Quality production control systems Efficient plant layout and workflow design Operations Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

Primary Activities Inbound Logistics Associated with collecting, storing, and distributing the product or service to buyers Effective shipping processes Efficient finished goods warehousing processes Shipping of goods in large lot sizes Quality material handling equipment Operations Outbound Logistics Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

Primary Activities Inbound Logistics Associated with purchases of products and services by end users and the inducements used to get them to make purchases Highly motivated and competent sales force Innovative approaches to promotion and advertising Selection of most appropriate distribution channels Proper identification of customer segments and needs Effective pricing strategies Operations Outbound Logistics Marketing and Sales Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

Primary Activities Inbound Logistics Associated with providing service to enhance or maintain the value of the product Effective use of procedures to solicit customer feedback and to act on information Quick response to customer needs and emergencies Ability to furnish replacement parts Effective management of parts and equipment inventory Quality of service personnel and ongoing training Warranty and guarantee policies Operations Outbound Logistics Marketing and Sales Service Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

General Administration Support Activities General Administration Typically supports the entire value chain and not individual activities Effective planning systems Ability of top management to anticipate and act on key environmental trends and events Ability to obtain low-cost funds for capital expenditures and working capital Excellent relationships with diverse stakeholder groups Ability to coordinate and integrate activities across the value chain Highly visible to inculcate organizational culture, reputation, and values Adapted from Exhibit 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

General Administration Support Activities General Administration Activities involved in the recruiting, hiring, training, development, and compensation of all types of personnel Effective recruiting, development, and retention mechanisms for employees Quality relations with trade unions Quality work environment to maximize overall employee performance and minimize absenteeisn Reward and incentive programs to motivate all employees Human Resource Management Adapted from Exhibit 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

General Administration Technology Development Support Activities General Administration Related to a wide range of activities and those embodied in processes and equipment and the product itself Effective R&D activities for process and product initiatives Positive collaborative relationships between R&D and other departments State-of-the art facilities and equipment Culture to enhance creativity and innovation Excellent professional qualifications of personnel Ability to meet critical deadlines Human Resource Management Technology Development Adapted from Exhibit 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

General Administration Technology Development Support Activities General Administration Function of purchasing inputs used in the firm’s value chain Procurement of raw material inputs Development of collaborative “win-win” relationships with suppliers Effective procedures to purchase advertising and media services Analysis and selection of alternate sources of inputs to minimize dependence on one supplier Ability to make proper lease versus buy decisions Human Resource Management Technology Development Procurement Adapted from Exhibit 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

The Value Chain General administration Human resource management Technology development Procurement Inbound logistics Outbound logistics Marketing and sales Operations Service Adapted from Exhibit 3.1 The Value Chain: Primary and Support Activities Source: Adapted with permission of The Free Press, a division of Simon & Schuster, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter.

Importance of relationships among value activities Interrelationships among Value-Chain Activities within and across Organizations Importance of relationships among value activities Interrelationships among activities within the firm Relationships among activities within the firm and with other organizations (e.g., customers and suppliers)

Resource-Based View of the Firm Two perspectives The internal analysis of phenomena within a company An external analysis of the industry and its competitive environment Three key types of resources Tangible resources Intangible resources Organizational capabilities

Types of Resources Tangible Resources Relatively easy to identify, and include physical and financial assets used to create value for customers Financial resources Firm’s cash accounts Firm’s capacity to raise equity Firm’s borrowing capacity Physical resources Modern plant and facilities Favorable manufacturing locations State-of-the-art machinery and equipment Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities

Types of Resources Tangible Resources Relatively easy to identify, and include physical and financial assets used to create value for customers Technological resources Trade secrets Innovative production processes Patents, copyrights, trademarks Organizational resources Effective strategic planning processes Excellent evaluation and control systems Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities

Types of Resources Tangible Resources Difficult for competitors (and the firm itself) to account for or imitate, typically embedded in unique routines and practices that have evolved over time Human Experience and capabilities of employees Trust Managerial skills Firm-specific practices and procedures Intangible Resources Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities

Types of Resources Tangible Resources Difficult for competitors (and the firm itself) to account for or imitate, typically embedded in unique routines and practices that have evolved over time Intangible Resources Innovation and creativity Technical and scientific skills Innovation capacities Reputation Effective strategic planning processes Excellent evaluation and control systems Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities

Organizational Capabilities Types of Resources Tangible Resources Competencies or skills that a firm employs to transform inputs to outputs, and capacity to combine tangible and intangible resources to attain desired end Outstanding customer service Excellent product development capabilities Innovativeness of products and services Ability to hire, motivate, and retain human capital Intangible Resources Organizational Capabilities

How Resources and Capabilities Lead to Advantages Adapted from Exhibit 3.5 Marks & Spencer: How Resources and Capabilities Lead to Advantages Source: Adapted with permission of Harvard Business Review: Exhibit from “Competing on Resources: Strategy in the 1990’s” by D. J. Collis and C. Montgomery, 73, no. 4 (1995).

Firm Resources and Sustainable Competitive Advantages Is the resource or capability… Valuable Rare Difficult to imitate Difficult to substitute Implications Neutralize threats and exploit opportunities Not many firms possess Physically unique Path dependency Causal ambiguity Social complexity No equivalent strategic resources or capabilities

Is the Resource Valuable? Organizational resources can be a source of competitive advantage only when they are valuable Enable a firm to formulate and implement strategies that improve its efficiency or effectiveness

Is the Resource Rare? Organizational resources also possessed by competitors are not sources of competitive advantage Common strategies based on similar resources give no one firm an advantage Competitive advantages are gained only from uncommon resources, resources that are rare to other competitors

Can the Resource be Imitated? Difficulty in imitating resources is key to value creation because it constrains competition Profits generated from inimitable resources are more likely to be sustainable Physical uniqueness Path dependency Causal ambiguity Social complexity

Are Substitutes Readily Available? There must be no strategically equivalent valuable resources that are themselves not rare or inimitable Substitutability may take at least two forms Competitor may be able to substitute a similar resource that enables it to develop and implement the same strategy Very different firm resources can become strategic substitutes (such as e-business as a substitute for physical retail facility)

Is a resource or capability… Criteria for Sustainable Competitive Advantage and Strategic Implications Is a resource or capability… Valuable Rare Difficult Without Implications to Imitate Substance 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 Exhibit 3.7 Criteria for Sustainable Competitive Advantage and Strategic Implications Source; Adapted from J. Barney, “Firm Resources a Sustained Competitive Advantage, ‘ Journal of Management 17 (1991), pp. 99-120.

Core Competencies--Cautions and Reminders

Core Competencies--Cautions and Reminders It should never be taken for granted that core competencies will continue to provide a source of competitive advantage

Core Competencies--Cautions and Reminders It should never be taken for granted that core competencies will continue to provide a source of competitive advantage All core competencies have the potential to become Core Rigidities

Core Competencies--Cautions and Reminders It should never be taken for granted that core competencies will continue to provide a source of competitive advantage All core competencies have the potential to become Core Rigidities Core Rigidities are former core competencies that sow the seeds of organizational inertia and prevent the firm from responding appropriately to changes in the external environment

Evaluating Firm Performance Two approaches for evaluating firm performance Financial ratio analysis Balance sheet Income statement Balanced scorecard (stakeholder perspective) Employees Customers Owners

Financial Ratio Analysis Five types of financial ratios Short-term solvency or liquidity Long-term solvency measures Asset management (or turnover) Profitability Market value Meaningful ratio analysis must include Analysis of how ratios change over time How ratios are interrelated

Financial Ratio Analysis: Historical Comparisons Exhibit 3.8 Historical Trends: Return on Sales (ROS) for a Hypothetical Company

Financial Ratio Analysis: Comparison with Industry Norms Grocery Skilled-Nursing Financial Ratio Semiconductors Store Facilities Quick Ratio (times) 1.5 0.5 1.1 Current ratio (times) 3.2 1.6 1.9 Total liabilities to net worth (%) 34.8 114.0 93.0 Collection period (days) 54.8 2.9 40.2 Assets to sales (%) 98.1 21.2 108.7 Return on sales (%) 3.1 0.9 2.0 Exhibit 3.9 How Financial Ratios Differ across Industries Source: Dun & Bradstreet, Industry Norms and Key Business Ratios, 1999-2000, Desktop Edition, SIC #0100-8999

Financial Ratio Analysis: Comparison with Key Competitors Sales* R&D budget Company (or division ($ billions) ($ billions) P&G Drug Division $ 0.8 $ 0.38 Bristol-Myers Squibb 20.2 1.80 Pfizer 27.4 4.00 Merck 32.7 2.10 *Most recently completed fiscal year. Data: Lehman Brothers, Procter & Gamble Co. Exhibit 3.10 Comparison of Procter & Gamble’s and Key Competitors’ Drug Revenues and R&D Expenditures Source: R. Berner, “Procter & Gamble: Just Say No to Drugs,” Business Week, October 9, 2000, p. 128; data courtesy of Lehman Brothers and Procter & Gamble.

The Balanced Scorecard Provides a meaningful integration of many issues that come into evaluating a firm’s performance Four key perspectives How do customers see us? (customer perspective) What must we excel at? (internal perspective) Can we continue to improve and create value? (innovation and learning perspective) How do we look to shareholders? (financial perspective)

The Balanced Scorecard Customer Perspective Time Quality Performance and service Cost

The Balanced Scorecard Customer Perspective Processes Cycle time Quality Employee skills productivity Decisions Actions Coordination Resources and capabilities Internal Business Perspective

The Balanced Scorecard Customer Perspective Introduction of new products and services Greater value for customers Increased operating efficiencies Internal Business Perspective Innovation and Learning Perspective

The Balanced Scorecard Customer Perspective Profitability Growth Shareholder value Increased market share Reduced operating expenses Higher asset turnover Internal Business Perspective Innovation and Learning Perspective Financial Perspective