1. McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. STRATEGIC MANAGEMENT Chapter 3 Assessing the Internal Environment of the Firm Strategic Management: creating competitive advantages Gregory G. Dess G. T. Lumpkin Marilyn L. Taylor Part 1: Strategic Analysis Part 1: Strategic Analysis

2. 1-2 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives After reading this chapter, you should have a good understanding of: The benefits and limitations of SWOT analysis in conducting an internal analysis of the firm. The primary and support activities of a firm’s value chain.

3. 1-3 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and suppliers. The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities. After reading this chapter, you should have a good understanding of: Learning Objectives

4. 1-4 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees. The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms. After reading this chapter, you should have a good understanding of: Learning Objectives

5. 1-5 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The value of recognizing how the interests of a variety of stakeholders can be interrelated. After reading this chapter, you should have a good understanding of: Learning Objectives

6. 1-6 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The Limitations of SWOT Analysis Strengths may not lead to an advantage SWOT’s focus on the external environment is too narrow SWOT gives a one-shot view of a moving target SWOT overemphasizes a single dimension of strategy

7. 1-7 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Value-Chain Analysis Sequential process of value-creating activities The amount that buyers are willing to pay for what a firm provides them Value is measured by total revenue Firm is profitable to the extent the value it receives exceeds the total costs involved in creating its product or service

8. 1-8 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The Value Chain 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. General administration Human resource management Technology development Procurement Inbound logistics Operations Outbound logistics Marketing and sales Service

9. 1-9 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Primary Activities 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 Inbound Logistics Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

10. 1-10 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Primary Activities 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 Inbound Logistics Operations Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

11. 1-11 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Primary Activities 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 Inbound Logistics Operations Outbound Logistics Adapted from Exhibit 3.2 The Value Chain: Some Factors to Consider in Assessing a Firm’s Primary Activities

12. 1-12 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Primary Activities 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 Inbound Logistics 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

13. 1-13 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Primary Activities 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 Inbound Logistics 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

14. 1-14 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Support Activities 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 General Administration Adapted from Exhibit 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

15. 1-15 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Support Activities 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 General Administration Human Resource Management Adapted from Exhibit 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

16. 1-16 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Support Activities 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 General Administration Human Resource Management Technology Development Adapted from Exhibit 3.3 The Value Chain: Some Factors to Consider in Assessing a Firm’s Support Activities

17. 1-17 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Support Activities 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 General Administration 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

18. 1-18 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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)

19. 1-19 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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

20. 1-20 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Types of 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 Tangible Resources Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities

21. 1-21 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Technological resources Trade secrets Innovative production processes Patents, copyrights, trademarks Organizational resources Effective strategic planning processes Excellent evaluation and control systems Types of Resources Tangible Resources Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities Relatively easy to identify, and include physical and financial assets used to create value for customers

22. 1-22 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Types of 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 Tangible Resources Intangible Resources Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities

23. 1-23 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Types of Resources Innovation and creativity Technical and scientific skills Innovation capacities Reputation Effective strategic planning processes Excellent evaluation and control systems Tangible Resources Intangible Resources Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities Difficult for competitors (and the firm itself) to account for or imitate, typically embedded in unique routines and practices that have evolved over time

24. 1-24 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Types of 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 Tangible Resources Intangible Resources Organizational Capabilities Adapted from Exhibit 3.4 The Resource-Based View of the Firm: Resources and Capabilities

25. 1-25 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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).

26. 1-26 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Firm Resources and Sustainable Competitive Advantages Is the resource or capability… Valuable Rare Difficult to imitate Difficult to substitute Implications Adapted from Exhibit 3.6 Four Criteria for Assessing Sustainability of Resources and Capabilities Neutralize threats and exploit opportunities Not many firms possess Physically unique Path dependency Causal ambiguity Social complexity No equivalent strategic resources or capabilities

27. 1-27 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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

28. 1-28 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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

29. 1-29 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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

30. 1-30 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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)

31. 1-31 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Criteria for Sustainable Competitive Advantage and Strategic Implications ValuableRareDifficult WithoutImplications to ImitateSubstancefor Competitiveness NoNoNoNoCompetitive disadvantage YesNoNoNoCompetitive parity YesYesNoNoTemporary competitive advantage YesYesYesYesSustainable competitive advantage Is a resource or capability… 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.

32. 1-32 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Evaluating Firm Performance Two approaches for evaluating firm performance Financial ratio analysis Balance sheet Income statement Balanced scorecard (stakeholder perspective) Employees Customers Owners

33. 1-33 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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

34. 1-34 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Financial Ratio Analysis: Historical Comparisons Exhibit 3.8 Historical Trends: Return on Sales (ROS) for a Hypothetical Company

35. 1-35 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Financial Ratio Analysis: Comparison with Industry Norms 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 GrocerySkilled-Nursing Financial RatioSemiconductorsStoreFacilities Quick Ratio (times)1.50.51.1 Current ratio (times)3.21.61.9 Total liabilities to net worth (%)34.8114.093.0 Collection period (days)54.82.940.2 Assets to sales (%)98.121.2108.7 Return on sales (%)3.10.92.0

36. 1-36 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Financial Ratio Analysis: Comparison with Key Competitors 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. Sales*R&D budget Company (or division($ billions)($ billions) P&G Drug Division$ 0.8$ 0.38 Bristol-Myers Squibb20.21.80 Pfizer27.44.00 Merck32.72.10 *Most recently completed fiscal year. Data: Lehman Brothers, Procter & Gamble Co.

37. 1-37 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. 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)

38. 1-38 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The Balanced Scorecard Time Quality Performance and service Cost Customer Perspective

39. 1-39 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The Balanced Scorecard Processes Cycle time Quality Employee skills productivity Decisions Actions Coordination Resources and capabilities Customer Perspective Internal Business Perspective

40. 1-40 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The Balanced Scorecard Introduction of new products and services Greater value for customers Increased operating efficiencies Customer Perspective Internal Business Perspective Innovation and Learning Perspective

41. 1-41 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. The Balanced Scorecard Profitability Growth Shareholder value Increased market share Reduced operating expenses Higher asset turnover Customer Perspective Internal Business Perspective Innovation and Learning Perspective Financial Perspective