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

Copyright © Houghton Mifflin Company. All rights reserved. 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 Copyright © Houghton Mifflin Company. All rights reserved.

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. Copyright © Houghton Mifflin Company. All rights reserved.

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 Copyright © Houghton Mifflin Company. All rights reserved.

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 Copyright © Houghton Mifflin Company. All rights reserved.

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. Copyright © Houghton Mifflin Company. All rights reserved.

Value Creation per Unit Figure 3.2 Copyright © Houghton Mifflin Company. All rights reserved.

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. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. 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. Copyright © Houghton Mifflin Company. All rights reserved.

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    Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.  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. Copyright © Houghton Mifflin Company. All rights reserved.

 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 Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.  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. Copyright © Houghton Mifflin Company. All rights reserved.

 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. Copyright © Houghton Mifflin Company. All rights reserved.

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 Copyright © Houghton Mifflin Company. All rights reserved.

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. Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. 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. Copyright © Houghton Mifflin Company. All rights reserved.

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 Copyright © Houghton Mifflin Company. All rights reserved.