Analyzing Resources & Capabilities OUTLINE The role of resources and capabilities in strategy formulation. The resources of the firm Organizational capabilities Appraising the profit potential of resources and capabilities Putting resource and capability analysis to work—a practical guide

Some game theory observations Is the simulation game turning out to be a prisoner’s dilemma, battle of the sexes, or game of chicken coordination problem? Consider the recent behavior of some builders pedal to the metal Quiet Defect Her Way His Way Chicken Aggressor 1, 1 -2, 2 1, 0 -1, -1 Q Her C 0, 0 -2, 2 A D His 2, - 2 -1, -1 -1, -1 0, 1 2, -2 -10, -10 Defect or not His choice or her choice Swerve or not

Shifting the Focus of Strategy Analysis: From the External to the Internal Environment THE FIRM Goals and Values Resources and Capabilities Structure and Systems THE INDUSTRY ENVIRONMENT Competitors Customers Suppliers STRATEGY STRATEGY The Firm-Strategy Interface The Environment-Strategy Interface 5

Rationale for the Resource-based Approach to Strategy More variation in profitability within an industry than between industries (see simulation!) Still variations in profit within the same strategic group who are deploying similar assets, follow similar strategies and have the same mobility barriers If industry or group doesn’t drive profitability then what does? Rumelt’s isolating mechanisms Resources and capabilities as the primary sources of profitability – embedded in products and services Also, when the external environment is subject to rapid change, internal resources and capabilities may offer a more secure basis for strategy than market focus.

The Links between Resources, Capabilities and Competitive Advantage INDUSTRY KEY SUCCESS FACTORS COMPETITIVE ADVANTAGE STRATEGY ORGANIZATIONAL CAPABILITIES What you do with resources “PROFITS” Acronym Physical Reputational Organizational Financial Informational Technological Skills RESOURCES TANGIBLE INTANGIBLE HUMAN Financial Physical Skills/know-how Capacity for communication & collaboration Motivation Technology Reputation Culture

The Rent-Earning Potential of Resources and Capabilities What is rent? THE EXTENT OF THE COMPETITIVE ADVANTAGE ESTABLISHED Scarcity Relevance Durability THE PROFIT EARNING POTENTIAL OF A RESOURCE OR CAPABILITY SUSTAINABILITY OF THE COMPETITIVE ADVANTAGE Transferability Replicability Property rights Relative bargaining power APPROPRIABILITY Other frameworks VRIO/VRINE (Barney, 1991/2003) Heterogeneity, ex-ante/ex-post/imperfect mobility/ (Peteraf, 1993) Embeddedness 8 8

Competitive Advantage Scarcity and relevance All value (rent) comes from scarcity relative to demand (Lewin and Phelan) Oxygen on moon, World’s oldest janitor Monopoly rent=artificial scarcity, Ricardian rent=natural scarcity Differential rent = difference in the quality between resources (talent, fertility) Marshallian or entrepreneurial rent = temporary scarcity Quasi-rents relates to generating more rent in one use than another (Jordan with Bulls), see also X-inefficiency or infra-marginal efficiency Asset accumulation (Dierickx & Cool, 1986) Not all rare assets are tradeable – must be accumulated (built) over time Reputation, brand name, tacit knowledge – stocks and flows Samurai swords, English country gardens Implication Acquire or develop scarce resources to create value Recognize that competitors might have superior resources Resources can earn more rent in some uses than others

Sustainability of Rents Durability – longer lived assets produce more rents (rents are a flow, value is a stock) Ex-post limits to competition (I in VRIO) Why doesn’t supply increase? Naturally (or artificially) scarce (BLM) land, Michael Jordan’s quasi-rents (until cloning) Information or time Time compression diseconomies or causal ambiguity Lack of close substitutes Questions: Why do business professors earn more than liberal arts professors? Why do professors at Harvard earn more than professors at UNLV?

Appropriability Who claims the rent stream? Importance of property rights Contracts, rule of law as engine of economic growth Firms/owners as residual claimants Strategic Factor Markets (Barney, 1986) Superior information or luck (Peteraf ex-ante limits to competition) Utah Railroad Game Labor and mobility (Peteraf imperfect mobility) Culkin, Home Alone Bargaining power and value-added again Resources will flow to maximise quasi-rents Champion team versus team of champions Superior coordination and cooperation (culture) advantages (the O in Barney’s VRIO)

Appraising Resources RESOURCE CHARACTERISTICS INDICATORS Financial Borrowing capacity Debt/ Equity ratio Internal funds generation Credit rating Tangible Net cash flow Resources Physical Plant and equipment: Market value of size, location, technology fixed assets. flexibility. Scale of plants Land and buildings. Alternative uses for Raw materials. fixed assets Technology Patents, copyrights, know how No. of patents owned R&D facilities. Royalty income Intangible Technical and scientific R&D expenditure Resources employees R&D staff Reputation Brands. Customer loyalty. Company Brand equity reputation (with suppliers, customers, Customer retention government) Supplier loyalty Human Training, experience, adaptability, Employee qualifications, Resources commitment and loyalty of employees pay rates, turnover.

Capabilities A firm’s capacity to deploy resources for a desired end result Core competences – make a disproportionate contribution to ultimate customer value (products) Honda engine tech for instance. Capabilities as routines Hierarchy of capabilities

Identifying Organizational Capabilities: A Functional Classification FUNCTION CAPABILITY EXEMPLARS Corporate Financial management ExxonMobil, GE Management Strategic control IBM, Samsung Coordinating business units BP, P&G Managing acquisitions Citigroup, Cisco MIS Speed and responsiveness through Wal-Mart, Dell rapid information transfer Capital One R&D Research capability Merck, IBM Development of innovative new products Apple, 3M Manufacturing Efficient volume manufacturing Briggs & Stratton Continuous Improvement Nucor, Harley-D Flexibility Zara, Four Seasons Design Design Capability Apple, Nokia Marketing Brand Management P&G, LVMH Quality reputation Johnson & Johnson Responsiveness to market trends MTV, L’Oreal Sales, Distribution Sales Responsiveness PepsiCo, Pfizer & Service Efficiency and speed of distribution LL Bean, Dell Customer Service Singapore Airlines Caterpillar

Eastman Kodak’s Dilemma Resources & Capabilities Businesses Chemical Imaging Organic Chemistry Polymer technology Optomechtronics Thin-film coatings Brands Global Distribution Film Cameras 1980’s Fine Chemicals Pharmaceuticals Diagnostics 1990’s DIVESTS: Eastman Chemical, Sterling Winthrop, Diagnostics Need to build digital imaging capability Digital Imaging Products (e.g. Photo CD System; Advantix cameras & film

Evolution of Capabilities and Products: 3M Road signs & markings Videotape Sandpaper Carborundum mining Floppy disks & data storage products Scotchtape Audio tape Acetate film Post-it notes Housewares/kit- chen products PRODUCTS Surgical tapes & dressings Pharmaceuticals Materials sciences Flexible circuitry Health sciences CAPABILITIES Microreplication New-product development & introduction Thin-film technologies Abrasives Adhesives

The Value Chain: The McKinsey Business System TECHNOLOGY PRODUCT DESIGN MANUFACTURING MARKETING DISTRIBUTION SERVICE 5 5

The Porter Value Chain FIRM INFRASTRUCTURE SUPPORT HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT PROCUREMENT INBOUND OPERATIONS OUTBOUND MARKETING SERVICE LOGISTICS LOGISTICS & SALES SUPPORT ACTIVITIES PRIMARY ACTIVITIES 6 6

The Architecture of Organizational Capability SKILLS & KNOWLEDGE Organization Structure Management Systems VALUES & NORMS TECHNICAL SYSTEMS RESOURCES Human skills & know-how Technology Culture (values, norms) MANAGERIAL SYSTEMS Dorothy Leonard “Core Capabilities & Core Rigidities” A modified view

Two approaches to identifying an organization’s resources and capabilities Starting from the inside Starting from the outside Key Success Factors How do customers choose? What do we need to survive competition? What resources & capabilities do we need to deliver these KSFs?

Assessing a Companies Resources and Capabilities: The Case of VW   Importance VW’s Relative Strength R1. Finance 6 4 R2. Technology 7 5 R3. Plant and equipment 8 R4. Location R5. Distribution   Importance VW’s Relative Strength C1. Product development 9 4 C2. Purchasing 7 5 C3. Engineering C4. Manufacturing 8 C5. Financial management 6 3 C6. R&D C7. Marketing & sales C8. Government relations RESOURCES CAPABILITIES

Appraising VW’s Resources and Capabilities (Hypothetical only) 10 Key Strengths Superfluous Strengths C3 R3 C8 C4 C2 Relative Strength R2 R5 5 R1 C1 R4 C6 C7 C5 Zone of Irrelevance Key Weaknesses 1 1 5 10 Strategic Importance 9

Appraising the Capabilities of a Business School (illustrative only) C1 Alumni relations C2 Student placement C3 Teaching C4.Administration C5 Course devlpmnt C6 Student recruitment C7 Research C8 Corporate relations C9 Marketing C10 IT C11 PR C12 HRM 5 6 9 3 2 4 8 10 7 1 Superfluous strengths Key strengths Superior Relative Strength Parity Inconsequential weaknesses 12 11 Key weaknesses Deficient Not important Critically important Importance

Case What is basis of competitive advantage in soccer? What is the relationship between strategy and financials? What resources and capabilities should Man U develop?