Competing For Advantage Chapter 4 – The Internal Organization: Resources, Capabilities, and Core Competencies

Profitability in the U.S. Retailing Industry, 1996-2001

Why Internal Analysis? Early strategy theory rooted in industry structural analysis - external focus This approach has lost its appeal because: internationalization & deregulation has all but removed safe havens technology and changes in demand have blurred industry lines

Outcomes from Organizational Analyses

Components of Internal Analysis Leading to Competitive Advantage and Value Creation Figure 4.3 illustrates the relationships among resources, capabilities, and core competencies and shows how firms use the four criteria of sustainable competitive advantage and value chain analysis to identify sources of value and ultimately competitive advantage and strategic competitiveness. Figure 4.3 also provides an outline of topics for much of the rest of this chapter. Combinations of resources and capabilities are managed to create core competencies. This can begin a discussion to define and provide examples of these building blocks of competitive advantage.

Tangible Resources Four types of tangible resources/assets: Financial Organizational Physical Technological

Intangible Resources Three types of intangible resources/assets: Human Innovative Reputational

Increasing Value of Intangible Resources Less visibility and less imitable More sustainability More leverage within network of users The value of intangible resources is increasing relative to the value of tangible resources. Intangible resources are less visible, making it difficult for competitors to analyze, understand, imitate, purchase, or substitute for them. A competitive advantage based on an intangible resource is therefore more sustainable. Unlike tangible assets, intangible resources can be leveraged within a network of users to benefit each user. Additional Discussion Notes for Tangible vs. Intangible Resources - These notes include additional materials that cover the differences between tangible and intangible resources, using Coca-Cola as an example to illustrate the concepts. Tangible vs. Intangible Resources Resources are what a firm has to work with—its assets—including its people and the value of its brand name. Tangible resources are in essence those things that you can put your hands on such as property, plant and equipment, personnel, raw materials, and so on. One highly illustrative example of tangible resources and how the strategic utilization/manipulation of them can have a great impact on a firm’s profits are diamonds. Cartier owns or controls over 95% of the world’s diamond mines. If the entire supply of diamonds were to be released onto the world market the gems would devalue to 10% of the current market price or less. Cartier controls the amount, timing, quality, grade (size), and destination point of virtually every batch of diamonds that is released on the world market. In doing so Cartier is able to control the market price of the gems and therefore are able to manipulate profits. While the concept of tangible resources is easy to imagine the idea of intangibles can be elusive. If tangibles are that which we can put our hands on, intangibles are everything else. Some examples are goodwill, reputation, and brand value. For example, the late Robert Goizeuta, former CEO of Coca-Cola, once explained intangibles and their value in this way: Goizeuta said if everything tangible that Coke owns were to be destroyed in some bizarre accident, if a fire were to burn down each and every factory, office building and bottling plant right down to a total loss of every desk, chair, and pencil, the intangible resources that Coke owns would be those things that the company still possesses, namely, brand value, the secret recipe, its distribution channels, and business relationships that it has developed over the years. These would allow Coke to go to a bank and borrow billions of uncollateralized dollars to rebuild its infrastructure. The textbook suggests that intangible resources can be categorized: Human Resources: Knowledge, Trust, Managerial capabilities, Organizational routines Innovation Resources: Ideas, Scientific capabilities, Capacity to innovate, Intellectual property Reputational Resources: Reputation with customers , Brand name, Reputation with suppliers, Perceived product quality, durability, and reliability Similar to the Coca-Cola example, the Harley-Davidson brand name has such cachet that it adorns a limited-edition Barbie doll, a popular restaurant in New York City, and a line of L’Oreal cologne. Moreover, Harley-Davidson MotorClothes annually generates over $100 million in revenue for the firm and offers a broad range of clothing items, from black leather jackets to fashions for tots. In sum, because reputation is difficult to imitate and substitute, it can garner competitive advantage.

Evaluation of Resources Strength or Weakness relative to competitors basic business requirements key vulnerabilities

Tangible Resources Org. Capabilities Inputs into Outputs Intangible Resources Examples….. Customer Service Product Development Employee Productivity

Examples of Firm’s Capabilities Discuss some capabilities that can be found in an organization's functional areas. Table 4.3 illustrates that capabilities are often developed in specific functional areas (such as manufacturing, R&D, and marketing) or in a part of a functional area (for example, advertising). Research suggests that a relationship exists between capabilities developed in particular functional areas and the firm’s financial performance at both the corporate and business-unit levels, suggesting the need to develop capabilities at all levels. Firms committed to continuously developing their people’s capabilities are the most likely to sustain a competitive advantage longer than those firms that do not make such commitments. Educational benefits and employee training can have immediate positive effects on the skill levels of employees and managers, as well as new ideas leading to technological innovation. Also, applicants are drawn to firms that have a reputation for excellent employee treatment, which can increase the quality of human resources in the firm. Global business leaders increasingly support the view that the knowledge possessed by human capital is among the most significant of an organization’s capabilities and may ultimately be at the root of all competitive advantages. But firms must also be able to utilize the knowledge that they have and transfer it among their operating businesses.

Core Competencies central to the firm’s competitiveness rewarded in market place combination of skills & knowledge, not products or functions flexible, long term platforms embedded in the organization’s systems distinctive competencies are those the firm performs better than rivals All core competencies have the potential to become core rigidities

Supporting and nurturing more than four core competencies may prevent a firm from developing the focus needed to fully exploit its competencies in the marketplace Core Competencies (cont.) - Core competencies distinguish a company competitively and reflect its personality. Features of core competencies: Core competencies emerge within a firm over time Core competencies are the capacity of an organization to take action Core competencies are the activities that a firm performs well relative to its competitors, adding unique value for its customers Core competencies do not represent all of a firm's resources and capabilities, only those with strategic value Supporting and nurturing more than four core competencies may prevent a firm from developing the focus needed to fully exploit its competencies in the marketplace

Tools for Building Core Competencies Four Criteria of Sustainable Competitive Advantage Value Chain Analysis Building Core Competencies – Two tools are commonly used to identify and build core competencies that will create and sustain competitive advantages.

Sustainable Competitive Advantage Must be valuable, rare, costly to imitable, and non-substitutable Sustainability is a function of Durability - how long will it last? Technology? Reputation? Fixed Assets? Imitability - how quickly can it be copied? Transparent - easy to see? Transferable - can it be done elsewhere? Replicable - can we do it here?

Four Criteria for Determining Core Competencies Discuss the four criteria for determining core competencies: Capabilities are valuable Capabilities are rare Capabilities are costly to imitate Capabilities cannot be substituted

Factors that Limit Imitation Physical Uniqueness – location, patents Path Dependency – accumulation effect Causal Ambiguity – unable to disentangle Social Complexity – social interactions are not readily understood nor duplicated Absorptive Capacity – ability to identify, value, assimilate and use knowledge

Core Competencies as a Strategic Capability How to distinguish between strategic capabilities and non-strategic capabilities: Strategic capabilities meet the four criteria of sustainable competitive advantage and have a strategic relevance

Outcomes from Combinations of the Criteria for Sustainable Competitive Advantage Table 4.5 shows the competitive consequences and performance implications resulting from combinations of the four criteria of sustainability. Discuss how this analysis helps managers determine the strategic value of the firm's capabilities. Capabilities that fall into the first row of the table should not be emphasized. Capabilities yielding competitive parity and either temporary or sustainable competitive advantage should be supported. Additional Discussion Notes for Discovering Core Competencies - These notes include additional materials that cover the criteria to determine core competencies, using Cartier and Starbucks as an examples to illustrate the process. Core Competencies A firm’s core competencies are those things that it does that give it a competitive advantage over another firm. They are generally valuable, rare, costly to imitate, and nonsubstitutable. They may or may not be unique to the firm. They may simply be an industry practice that a firm does better, or a set of industry practices that the firm does in a specific combination or sequence that allows the firm to be more efficient than its competitors. Using the Cartier example, to be able to manipulate the supply of gems in the market, Cartier must be very efficient and competent at predicting the demand for its gems. If they were not very skilled at this, there would be fluctuations in the supply and demand curve and, therefore, market price that would leave an opportunity for arbitrage. The value of this arbitrage represents lost profits for Cartier. It was this ability to predict demand that allowed Cartier to see higher profits than its competitors in the 1800s, eventually eroding the market share and profitability of these competitors. Cartier subsequently acquired these firms to create the monopoly it now holds on the world’s diamond market. As noted in the textbook, an important question is “How many core competencies are required for the firm to have a sustained competitive advantage?” While responses to this question vary, McKinsey & Co. recommends that its clients identify no more than three or four competencies. Recent actions by Starbucks demonstrate this point. Growing rapidly, Starbucks decided that it could use the Internet as a distribution channel to achieve additional growth. However, the firm quickly realized that it lacked the capabilities required to successfully distribute its products through this channel—and that its unique coffee, not the delivery of that product, is its competitive advantage. In part, this recognition forced Starbucks to renew its emphasis on existing capabilities to create more value through its supply chain. To do so, the firm trimmed the number of its milk suppliers from sixty-five to fewer than twenty-five and negotiated long-term contracts with coffee-bean growers. The firm also decided to place automated espresso machines in its busy units. These machines reduced Starbucks’ cost while providing improved service to its customers, who can now move through the line much faster. Using its supply chain and service capabilities in these ways allows Starbucks to strengthen its competitive advantages of coffee and the unique venue in which on-site customers experience it. When capabilities are valuable, rare, costly to imitate, and nonsubstitutable, they are effectively called core competencies. Alternatively, every core competence is a capability, but not every capability is a core competence. Operationally, one could argue that for a capability to be a core competence, it must be valuable and nonsubstitutable from a customer’s point of view, but unique and inimitable from a competitor’s point of view. As discussed in the textbook, an important key to success occurs when the link between the firm’s capabilities and its competitive advantage is causally ambiguous, where rivals can’t tell how a firm uses its capabilities as the foundation for competitive advantage. Gordon Forward, CEO of Chaparral Steel, allows rivals to tour his firm’s facilities and see almost everything. In Chaparral Steel’s causally ambiguous operations, workers use the concept of mentalfacturing, by which manufacturing steel is done by using their minds instead of their hands.

Creating Value Key Terms Value – measured by a product's performance characteristics and by its attributes for which customers are willing to pay Creating Value - exploiting core competencies and meeting global standards of competition to create superior value for customers

Value Creation per Unit

Comparing Toyota and General Motors

Relative costs and prices Where do cost/price differences come from? raw materials and components differences in technology, plant, equipment efficiencies, learning, experience, wages, productivity marketing, sales, promotion, warehousing, distribution, administration costs distribution inflation, exchange and tax rates

Porter’s Value Chain Views the organization as a series (chain) of activities, which may or may not create value

Porter’s Value Chain (cont.) Primary Activities Inbound logistics – Supply Chain Management Operations Outbound logistics - Distribution Marketing and sales Customer service Contribute to the physical creation of the product/service, its sale and transfer to the buyer, and its service after the sale

Tables 4.6 and 4.7 list the items to consider when assessing the value-creating potential of primary activities and support activities, respectively. The intent in examining both primary and support activities is to determine areas where the firm has the potential to create and capture value. All activities in both tables should be evaluated relative to competitors’ capabilities.

Porter’s Value Chain (cont) Support Activities Procurement Technological development Human resource management Firm infrastructure

The Value-Creating Potential of Support Activities Tables 4.6 and 4.7 list the items to consider when assessing the value-creating potential of primary activities and support activities, respectively. The intent in examining both primary and support activities is to determine areas where the firm has the potential to create and capture value. All activities in both tables should be evaluated relative to competitors’ capabilities.

The Value Chain Firm Infrastructure HRM Margin p o r t Firm Infrastructure HRM Technological Development Margin Procurement Service Marketing & Sales Inbound Logistics Operations Outbound Logistics Margin Primary

…tries to pull the arrow back….. A low cost strategy….. Firm Infrastructure HRM Technological Development Margin Procurement Service Marketing & Sales Inbound Logistics Operations Outbound Logistics Margin …tries to pull the arrow back…..

Low Cost - Support Activity examples…... Fewer layers of management Policies to reduce turnover IBM Printer - 150 to 62 parts, 3.5 minutes Margin Monitor supplier performance Service Marketing & Sales Inbound Logistics Operations Outbound Logistics Margin

Low cost - Primary Activity examples…. Inbound - Toyota Operations - Subway Outbound - Campbell Soup’ Continuous Replenishment Marketing/Sales - WalMart Customer Service - Federal Express

A differentiation strategy….. Firm Infrastructure HRM Technological Development Margin Procurement Service Marketing & Sales Inbound Logistics Operations Outbound Logistics Margin ….tries to pull the arrow forward...

Differentiation - Support Activity examples…... Commitment to quality Compensation rewarding innovation Amazon Recommendations Margin Purchasing high-quality components Service Marketing & Sales Inbound Logistics Operations Outbound Logistics Margin

Differentiation - Primary Activity examples…... Inbound - Dell Operations - Marriott Outbound - WebVan Market/Sales - Nordstrom’s Customer Service - Pirtek

Your Firm Buyers Suppliers Your Rivals

Your Firm Buyers Suppliers Your Rivals Opportunities for Advantage Buyers Suppliers Your Rivals

Your Firm Buyers Suppliers Your Rivals Opportunities for Adding Value Opportunities for Adding Value Buyers Suppliers Your Rivals

Source of Competitive Advantage The resource or capability must allow the firm to perform an activity in a manner superior to the way competitors perform it The resource or capability must allow the firm to perform a value-creating activity that competitors cannot perform To be a source of competitive advantage, two conditions must be met by a resource or capability: The resource or capability must allow the firm to perform an activity in a manner superior to the way competitors perform it. The resource or capability must allow the firm to perform a value-creating activity that competitors cannot perform.

Outsourcing Key Terms Outsourcing – purchase of a value-creating activity from an external supplier Outsourcing - This is the practice of going outside of a firm to acquire value-creating activities, when it is a viable option to do so. This trend continues to increase at a rapid pace.

Outsourcing Viability When a firm does not have the capabilities in the areas needed to succeed When a firm lacks a resource or possesses inadequate skills needed to implement a strategy When few organizations possess the resources and capabilities needed for competitive superiority in all primary and support activities necessary to compete When extensive internal capabilities exist for effectively coordinating external sourcing and internal core competencies Outsourcing value-creating activities can be a viable option for a firm under certain conditions: When a firm does not have the capabilities in the areas needed to succeed When a firm lacks a resource or possesses inadequate skills essential to successfully implement a strategy When few organizations possess the resources and capabilities required to achieve competitive superiority in all primary and support activities necessary to compete When extensive internal capabilities exist for effectively coordinating external sourcing and internal core competencies

Benefits of Outsourcing Increased flexibility Mitigation of risks Reduced capital investments

Essential Skills for Outsourcing Strategic thinking Deal making Partnership governance Managing change What skills are essential for managers who are responsible for outsourcing activities? Strategic thinking Deal making Partnership governance Managing change Additional Discussion Notes for Outsourcing These notes include additional materials that cover outsourcing as a method for acquiring value-creating activities, using BMW USA as an example to illustrate the concept. In addition, the strategic rationale for outsourcing is discussed, including Apple as an example to demonstrate the logic. Outsourcing Firms outsource to varying degrees. BMW USA, for example, outsources virtually everything and the plant here is primarily an assembly line plant. In contrast Apple Computers manufactures virtually every component in house, right down to the proprietary software components that make up the operating system. There are benefits to each approach. Building everything in house give the firm’s managers greater control over the quality of the components while outsourcing pushes the burden of raw materials and works-in-process inventories off on the component suppliers and frees up capital for other uses. Using the proceeding examples, if BMW were to keep all processes in house, the plant would need to be exponentially larger. BMW would also then be required to tie up billions of dollars in capital to store raw materials for the various components on site and employ a vast labor force for the manufacture and processing of the components. This would require a vast infrastructure to support the processes. Each year, when making changes to the new car models, a very large outlay of capital and resources to retool the entire operation would be required. By outsourcing the manufacture of these components, this burden is spread across many firms. Strategic Rationales for Outsourcing This diversification leads to a more efficient utilization of resources. For instance, if the new model required a new type of component that had never been previously incorporated into BMW cars, say a turbocharger, this would require adding an entire turbocharger manufacturing plant to the existing factory if everything were to be insourced. There would also be an engineering and learning curve associated with the development of this new component. Using an outsourcing strategy allows BMW to shop for a contract with the manufacturer of highest quality product at the best price currently on the market. In doing so, not only will BMW be freeing up resources that can be better utilized elsewhere in the firm, they are also capitalizing on the expertise of the supplier. In contrast Apple does virtually everything in house. The problems that this practice created for the company illustrate the issues that can arise from this type of strategy. For example, the firm had a limited number of design and engineering teams at its disposal. This led to very long lead times in designing and manufacturing of individual components that went into several of its personal computer models. By the time these models were completed and released onto the market, they had been made obsolete by models previously released by Apples competitors, most notably Compaq and IBM. This is illustrated with Apple’s release of the Mac Portable in 1989. This machine took nearly three years to develop and weighed nearly seventeen pounds when released. Sales of the machine were nearly nonexistent; Compaq’s LTE, released six weeks after the Mac Portable, was eighteen months in development and weighed just less than seven pounds.