Chapter 3: The Internal Environment

Chapter 3 The Internal Organization: Resources, Capabilities, Core Competencies and Competitive Advantages
KNOWLEDGE OBJECTIVES 1. 2. 3. 4. 5. 6. 7. 8. Explain the need for firms to study and understand their internal organization. Define value and discuss its importance. Describe the differences between tangible and intangible resources. Define capabilities and discuss how their development. Describe four criteria used to determine whether resources and capabilities are core competencies. Explain how value-chain analysis is used to identify and evaluate resources and capabilities. Define outsourcing and discuss the reasons for its use. Discuss the importance of identifying internal strengths and weaknesses.

CHAPTER OUTLINE Opening Case Managing the Tension Between Innovation and Efficiency THE CONTENT OF INTERNAL ANALYSIS The Context of Internal Analysis Creating Value The Challenge of Analyzing the Internal Organization RESOURCES, CAPABILITIES, AND CORE COMPETENCIES Resources Strategic Focus Hyundai Cars: The Quality Is There, So Why Arent the Cars Selling? Capabilities Core Competencies BUILDING CORE COMPETENCIES Four Criteria of Sustainable Competitive Advantage Value Chain Analysis OUTSOURCING COMPETENCIES, STRENGTHS, WEAKNESSES, AND STRATEGIC DECISIONS SUMMARY REVIEW QUESTIONS EXPERIENTIAL EXERCISES NOTES

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Chapter 3: The Internal Environment LECTURE NOTES Chapter Introduction: As indicated in Chapter 1, firms follow two competing models to generate the inputs needed to formulate and implement strategies. Chapter 2 focused on the external environment, which is the foundation of the I/O model. The emphasis in Chapter 3 is on internal resources and their potential to create competitive advantage for the firm, which falls in line with the resource-based model. This orientation is perhaps best captured by the elements of Figure 3.1, which should be emphasized. OPENING CASE Managing the Tension between Innovation and Efficiency For decades, 3M, the widely-diversified technology company with six business segments, was a model of successful corporate innovation. The firms commitment to innovation, and the importance innovation had to its competitive actions, is suggested by its slogan: The Spirit of Innovation. Thats 3M. In a practical, everyday sense, innovations importance is signaled by 3Ms famous intention of generating at least onethird of its annual sales from products introduced to the marketplace in the most recent five years. 3M has relied on its skill-base of scientists and engineers to meet this goal and to maintain a continual inflow of innovative products. The company developed over thirty core competencies which have been the foundation for more than 55,000 products sold worldwide. But things have begun to change at 3M. As recently as mid-2007, sales of products introduced in the last five years have dropped to only one-fourth of total sales. This shortfall represents nearly a 25 percent deficiency in actual performance versus goal. What are possible root-causes of this decline? Could it be that 3M was spending less money on R&D? A number of Wall Street analysts felt this was the reason that 2006 profits were below expectations. Other people feel that the introduction of the Six Sigma program into the 3M culture was, not only a diversion of peoples attention, but also a deterrent to innovation. Six Sigma is a widely-used series of management techniques designed to decrease production defects and increase efficiency. Focusing on work processes, Six Sigma techniques help spot problems and use rigorous measurements to reduce production variations and eliminate defects. Using techniques such as Six Sigma is completely appropriate in that reducing waste and increasing efficiency contribute to a firms profitability. The issue is that innovation generating and efficient quality focused actions can be at odds with each other. In an analysts words: When (Six Sigma) types of initiatives become ingrained in a companys culture, as they did at 3M, creativity (and innovation that results from it) can easily get squelched. Your students may have some creative ideas as to how innovation and conformity can co-exist.

Teaching Note: Firms such as Coca-Cola, Goldman Sachs, Sony Corporation, Nike, and McDonalds have implemented value-creating strategies using their unique resources, capabilities, and core competencies. In particular, they have developed unique capabilities related to the management of their brands. The ultimate goal of such strategies is for the firms to achieve a sustainable competitive advantage that will enable them to earn above-average returns. To achieve strategic competitiveness and earn above-average returns, firms must leverage their core competencies to exploit opportunities in the external environment. However, a competitive advantage does not always last, because value-creating strategies may be successfully imitated or duplicated by competitors. Several features of the global economy, such as technological changes, can result in the erosion of the competitive advantage of established competitors. For example, the Internet is undermining the competitive advantage of brick-and-mortar rivals.

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Competitive advantages are often strongly related to the resources firms hold and how they are managed. Resources are the foundation for strategy and these can generate competitive advantages leading to wealth creation when they are bundled together uniquely. People are an especially critical resource for producing innovation and gaining a competitive advantage. Even if they are not as critical in some industries, they are necessary for the development and implementation of firms strategies. The sustainability of a competitive advantage is a function of three factors: the obsolescence of a core competencethe basis of value creationas a result of environmental changes the availability of substitutes for the core competence (or the extent to which competitors can use different core competencies to overcome value created by the original core competence) the imitability of the core competence (or the abilities of competitors to develop the same core competence) To sustain a competitive advantage, firms must manage current core competencies while simultaneously developing new competencies. In other words, strategists must continuously make investments that will both enhance the value of current competencies while striving to develop new ones (discussed further in Chapter 5). This chapter represents the next phase in the strategy development process: what a firm can do. It is linked to the understanding that managers gain by assessing the external environment to determine what the firm might do, or to identify opportunities that might be pursued. Teaching Note: It is important to stress that the outcomes of the external and internal analyses of a firm's environment must be linked. Analyzing the external environment enables strategists to identify opportunities that the firm can choose to pursue if it is capable of doing so. This capability is determined by a careful analysis of the firm's internal environment, or by determining whether or not it has the resources, capabilities, and core competencies that will enable it to successfully implement value-creating strategies that fit with its vision and mission (previously discussed in Chapter 1).

Explain the need for organizations to study and understand their internal organization.

ANALYZING THE INTERNAL ORGANIZATION The Context of Internal Analysis In the global economy, traditional factors such as labor costs, access to financial resources and raw materials, and protected or regulated markets continue to be sources of competitive advantage, but to a lesser degree (mostly because the advantages created by these more traditional sources can be overcome by competitors through an international strategy and by the flow of resources throughout the global economy). Increasingly, those analyzing their firms internal environment should use a global mind-set (i.e., the ability to study an internal environment in ways that are not dependent on the assumptions of a single country, culture, or context). Analysis of the firms internal environment requires that evaluators examine the firms portfolio of resources and the bundles of heterogeneous resources and capabilities managers have created. Understanding how to leverage the firms unique bundle of resources and capabilities is a key outcome decision makers seek when analyzing the internal environment.

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Chapter 3: The Internal Environment Teaching Note: It might be appropriate at this point in the discussion to remind students of the primary differences between the I/O and resource-based models. The I/O model presumes that resources and capabilities are distributed homogeneously among firms and freely move between them; the primary determining factor is how firms react to changes in the external environment. The resource-based model presumes a heterogeneous distribution of resources and capabilities and assumes that they do not move freely between firms. By using or exploiting their core competencies, firms are in a position to develop and perform value-creating strategies better than their competitors or to create and perform value-creating strategies that competitors either are unable or unwilling to imitate. Teaching Note: Although it will be discussed in detail in Chapter 4, it is appropriate to provide students with some introductory remarks on value at this point. Value represents a concept of the relationship between a product's features (such as quality) and its price relative to those offered by competitors. As will be discussed in Chapter 4, value can be provided by low cost, high differentiation of product features, or a combination of low cost and differentiated features. Figure Note: Relationships between the components of an internal strategic analysis resources, capabilities, and core competenciesand a sustainable competitive advantage and strategic competitiveness are illustrated in Figure 3.1. This is a very helpful figure as it ties together much of the material in the chapter. FIGURE 3.1 Components of Internal Analysis Leading to Competitive Advantage and Strategic Competitiveness As illustrated in Figure 3.1, a firm's tangible and intangible resources (for example, its facilities and corporate culture, respectively) represent sources of capabilities these capabilities (teams or bundles of resources) represent sources of core competencies when exploited and nurtured (and valuable, costly to imitate, rare, and non-substitutable), core competencies are potential sources of competitive advantage if a firm is able to use its core competencies to achieve a competitive advantage, it will achieve strategic competitiveness and earn above-average returns so long as competitors are unable or unwilling to imitate them successfully

Teaching Note: The importance of a firm's internal characteristicsrepresented by its resources and capabilitieshighlights a shift in the priorities and prescriptions of strategic management research. The field has evolved or developed from a position that understanding industry characteristics and then positioning the firm to take advantage of industry characteristics relative to competitors was of primary importance to recognizing that it is a firm's resources and capabilities (which represent sources of core competencies) that should serve as the foundation for firm strategy. This shift recognizes that industry attractiveness is not dependent only on industry characteristics. Industry attractiveness is ultimately determined by both industry characteristics (which can be translated into opportunities and threats) or what a firm might do and its internal strengths (its resources, capabilities, and core competencies) which determine what a firm is capable of doing to take advantage of (or exploit) external opportunities.

Define value and discuss its importance.

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Creating Value Some thoughts on value: Firms create value by exploiting core competencies and meeting the standards of global competition. Value is measured by the products performance and by its attributes for which customers are willing to pay. Firms must provide value to customers which is superior to the value provided by competitors in order to create a competitive advantage. Customers perceive higher value in global rather than domestic-only brands. Firms create value by innovatively bundling and leveraging their resources and capabilities. Ultimately, value is the foundation for earning above-average profits. Core competencies, combined with product-market positions, are the most important sources of advantage. The core competencies of a firm, in addition to analysis of its general, industry, and competitor environments, should drive its selection of strategies. The Challenge of Analyzing the Internal Organization Correctly identifying, developing, deploying, and protecting firm resources, capabilities, and core competencies requires managers to make difficult decisions. In part, these challenges are a result of characteristics of both the internal and external environments of the firm. This challenge is multiplied because of three conditions that characterize important strategic decisionsuncertainty, complexity, and intraorganizational conflict. Figure Note: Suggest that students refer to Figure 3.2 during your discussion of the three conditions that characterize important strategic decisions. FIGURE 3.2 Conditions Affecting Managerial Decisions about Resources, Capabilities, and Core Competencies The conditions or decision characteristics presented in Figure 3.2 are: Uncertainty regarding the assessment of the general and industry environments, assessments, and predictability of competitive actions, and customer preferences Complexity regarding the nature of any interrelatedness of the causes of change in the environment and how the environments are perceived, especially regarding decisions as to which of the firms resources and capabilities might serve as the foundation for competitive advantage Intraorganizational conflicts among managers making decisions about which core competencies are to be nurtured and about how the nurturing should take place

Teaching Note: The descriptions of uncertainty, complexity, and intraorganizational conflict (see below) expand upon the material presented in the text. This should help you to explain these concepts in greater depth, if you should choose to do so. Uncertainty is present because of the inherent difficulty in identifying, assessing, and predicting changes and trends in characteristics of the external environment. Among these characteristics are correctly predicting the extent, direction, and timing of changes in the general environment, such as those resulting from societal values, political and economic conditions, customer preferences, and emerging technologies from other industries (and how they might ultimately affect the firm). Complexity is increased because of the uncertain nature of interrelationships among the characteristics of the external environment and the related challenge regarding how to assess the effects of changes in one set of characteristics on other characteristics. The issue becomes more complex when managers must relate the complex external environment to their assessment of the firm's internal environment and thus affects decisions

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Chapter 3: The Internal Environment regarding the firm's resources, capabilities, and core competencies, and their relationship to opportunities in the external environment that can be exploited successfully to achieve a competitive advantage. Intraorganizational conflicts often develop as a result of uncertainty and complexity. When managers make decisions regarding the identification of the firm's capabilities and choose to nurture them (with resources) to develop core competencies that can be exploited to achieve a competitive advantage, they must make these important decisions without absolute certainty that the decision is correct. And, such decisions may result in changes or shifts in power and interrelationships among individuals and groups within the firm. When this occurs, there may be conflict as those who are affected adverselyor perceive that they will be so affected may resist these changes. In some cases, managers faced with decisions that may have unpleasant consequences or are uncomfortable often experience denial, an unconscious coping mechanism used to block out and not initiate major changes that may have some pain associated with them. Thus, managers that must make decisions under conditions of uncertainty, complexity, and intraorganizational conflict must exercise judgment, a capacity for making a successful decision in a timely manner when no correct model is available or when relevant data are unreliable or incomplete. When exercising judgment, decision makers often take intelligent risks. In the current competitive landscape, executive judgment can be a particularly important source of competitive advantage. One reason is that, over time, effective judgment allows a firm to build a strong reputation and retain the loyalty of stakeholders whose support is linked to above-average returns. Significant changes in the value-creating potential of a firms resources and capabilities can occur in a rapidly changing global economy. Because these changes affect a companys power and social structure, inertia or resistance to change may surface. Even though these reactions may happen, decision makers should not deny the changes needed to assure the firms strategic competitiveness. By denying the need for change, difficult experiences can be avoided in the short run. STRATEGIC FOCUS Hyundai Cars: The Quality is There, So Why Arent the Cars Selling? Once defined as cheap, tin-pot vehicles, Hyundai automobiles suffered from multiple manufacturing defects. But in a move to reposition itself in a very competitive business, Hyundai Motor Company became intent on establishing a new image of producing high-quality vehicles. In a 2007 study done by a well-known market research and auto-industry consulting firm, Hyundai held leadership positions in five different categories (including large car, minivan, and small SUV). A J.D. Powers study supported these findings. These evaluations supported Hyundais goal of establishing a brand that stood for quality. Hyundais quality ratings exceeded Toyotas ratings and were exceeded only by those of Lexus and Porsche. With quality endorsements by highly respected third parties, Hyundai felt that its quality efforts had been validated and that it was in a position to become a new player in a market dominated by Japanese and European quality automakers. Unfortunately for Hyundai, the market has yet to recognize it as a manufacturer of high-quality vehicles. Is this an example of having one chance to make a first impression? What suggestions do students have for Hyundai to recreate itself and establish an image of quality? Later in this chapter, students will be reminded of the power of a brand. You might want to refer back to this case, asking if there is a handicap associated with branding.

Describe the differences between tangible and intangible resources.

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Chapter 3: The Internal Environment RESOURCES, CAPABILITIES, AND CORE COMPETENCIES This section develops the background and relationships between resources, capabilities, and core competencies that represent potential sources upon which a firm can build the foundation for a competitive advantage. Resources Resources represent inputs into a firm's production process, such as capital equipment, the skills of individual employees, brand names, financial resources, and talented managers. By themselvesor individuallyresources generally will not enable a firm to achieve a competitive advantage. They must be combined or integrated with other firm resources to establish a capability. When these capabilities are identified and nurtured, they can result in core competencies, which may lead to a competitive advantage. A firm's resources can be classified either as tangible or intangible. Tangible Resources Tangible resources are assets that can be seen or quantified, such as a firm's physical assets (e.g., its plant and equipment). Tangible resources are classified in one of four ways, as illustrated in Table 3.1.

TABLE 3.1 Tangible Resources A firm's tangible resources generally can be placed into one of four categories: Financial resources, such as borrowing capacity Organizational resources, such as its formal reporting structure and systems Physical resources, such as location Technological resources, such as patents and trademarks

Teaching Note: One statement made in the chapter deserves special attention. Paraphrased slightly, the authors declare that the value of tangible resources is constrained because they are difficult to leverage: it is hard to derive more business or additional value from a tangible resource. For example, an airplane is a tangible resource or asset, but it can only be used on one route at a time, and it is equally impossible to put the same crew on five different routes at the same time. This is also true for the financial investment made in the airplane, but intangible assets such as a new innovation in manufacturing processes can be applied to many assembly lines. These dynamics are considered next. Intangible Resources A firm's intangible resources may be less visible, but they are no less important. In fact, they may be more important as a source of core competencies. Intangible resources range from innovation resources, such as knowledge, trust, and organizational routines, to the firm's people-dependent or subjective resources of knowhow, networks, organizational culture, to the firm's reputation for its goods and services and the way it interacts with others (such as employees, suppliers, or customers). Teaching Note: It is interesting to note that tangible resources may be less valuable today than they were in the past. To support this conclusion, economist John Kendrick has found intangible assets to have contributed increasingly to U.S. economic growth since the early

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Chapter 3: The Internal Environment 1900s. The ratio of intangible business capital to tangible business capital in 1929 was 30 percent to 70 percent, but that ratio was 63 percent to 37 percent in 1990. Table Note: Three classifications of intangible resources are presented in Table 3.2. TABLE 3.2 Intangible Resources A firm's intangible resources can be classified as: Human resources, such as knowledge, trust, and managerial capabilities Innovation resources, such as scientific capabilities and capacity to innovate Reputational resources, such as the firm's reputation with customers or suppliers

Because tangible resources are those that can be seen (such as plants), touched (such as equipment), documented (such as contracts with suppliers of raw materials), or quantified (such as the value of a specific asset), they generally will not, by themselves, represent capabilities that will serve as sources of core competencies. However, they still have value and will contribute to the development of capabilities and core competencies. Teaching Note: Remind students of the relationships illustrated in Figure 3.2. Resources are the source of firm capabilities, capabilities are the source of core competencies, and core competencies are the foundation for achieving a competitive advantage and strategic competitiveness. Because they cannot be quantified, touched, or seen, and are more difficult to explain, intangible resources are more likely to be sources of sustainable competitive advantage. And, if they also are difficult for competitors to identify and/or understand, they also may represent the most likely source(s) of a firm's capabilities, core competencies, and sustained competitive advantage. Teaching Note: One can report to the class that two surveys asked managers to identify the source of their firms' competitive advantage or overall success. In both instances, one intangible asset was identified as the most important: Company Reputation/Reputation for Quality. As time permits, you may want to have the class discuss what makes a company's reputation. This also can be assigned as a "thought-provoking" question for an outside assignment or for future class discussion.

STRATEGIC FOCUS Seeking to Repair a Tarnished Brand Name In this case, PepsiCo and other soft drink manufacturers operating within India are accused of having unsafe levels of pesticides (per European standards) in their respective products. These accusations, made by a highly respected Indian private research and advocacy group, resulted in the public reacting in a predictable fashion by buying 30 to 40 percent fewer PepsiCo products. Pepsi refuted the accusations. Tests conducted by an Indian government agency support PepsiCos claim that Indian-produced PepsiCo products meet European and American content standards. So who is the public to believe? Critics are now leveling charges against all soft-drink manufacturers in India, claiming that they are using excessive amounts of groundwater to manufacture their products. Now

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Chapter 3: The Internal Environment critics have refocused their claims from using pesticide-infested water to using too much water. In an effort to restore its name as a good corporate citizen and demonstrate sensitivity to the Indian culture and its respect for water, PepsiCo is undertaking various actions within India including digging wells in villages for the local citizenry, harvesting rainwater, and teaching better techniques for growing rice and tomatoes. PepsiCo has been trying to do the right thing as a good corporate neighbor. It faced claims of producing unhealthy product followed by allegations of using an excessive amount of precious water. It appears that PepsiCo is always in the defensive mode. Why is PepsiCo a popular or easy target for environmentalists? PepsiCos CEO is an Indian woman. Is this a consideration in this case?

The Value of Brands: A Mini-Lecture One intangible resource that may enable a firm to create a reputation and serve as a source of competitive advantage is a brand name. Specifically, what a brand name communicates to customers about the performance characteristics or attributes of a firm's product(s) represents a direct link to a firm's reputation with its customers. When the brand name communicates positive characteristics of a product (for example, superior performance, high quality, or superior value), consumers will tend to purchase the brand name product rather than similar products offered by competing firms. Thus, it is important that companies with strong brand names nurture the core competencies that provide the brand name with value and continually communicate that value through consistent advertising messages. When a firm has a brand name that serves as a foundation for competitive advantage, the firm often will try to leverage the power of that brand name. Using an example in the chapter, Harley Davidson's name now adorns a limited edition Barbie doll, a popular restaurant in New York City, and a line of LOreal cologne. Moreover, Harley-Davidson Motorclothes generates over $100 million in revenue for the firm each year, and the Harley brand adorns many clothing items, from black leather jackets to fashions for tots. The value of a brand name can be lessened or reduced by competitive actions, which the firm either does not recognize or to which it fails to respond. In the consumer goods segment, national brands are under attack by private label store brands. And, some appear to be losing the battle as customer preferences are shifting toward private labels that may be perceived as providing more value than the national brands. In many cases, national brands have reacted to such threats by cutting prices. However, cost-cutting is not the only strategy that can be used to safeguard a brand. For companies whose brand names are expected to thrive and continue to provide a competitive advantage (such as Nike or Hanes), their challenge is to nurture and exploit the resources, capabilities, and core competencies that are the source of competitive advantage. For companies whose brands are under fire (such as Marlboro or Budweiser), the challenge is to reestablish the value of the brand. They must reconfigure their existing bundle of resources, capabilities, and core competencies to renew them as sources of competitive advantage. For companies whose brands are troubled, because the brands are no longer a source of competitive advantage, the challenge is even greater: they must identify and develop new bundles of resources and capabilities and nurture them to establish a new source of competitive advantage. Firms also may choose to package their brand as a way to differentiate themselves from competitors, as Century 21 Real Estate has done by using technology to make its offices virtual home stores by offering many discounted home services, including cable service, appliances, insurance, mortgages. Other firms (e.g., Procter & Gamble, General Motors, and Philip Morris) support their brand-name

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products through heavy advertising expenditures. It is important to remember that resourcesboth tangible and intangiblerepresent the primary sources that enable a firm to establish capabilities, the capacity for a set or bundle of unique resources to perform a task or activity integratively. In other words, individual resources alone, while they may have value, will contribute to the development of capabilities only when they are put together in unique combinations to provide the foundation for core competencies and the establishment of competitive advantage. Examples include a firms information-based tangible resources (Table 3.1) and/or its intangible resources (Table 3.2).

Define capabilities and discuss their development.

Capabilities As implied in the definition, a firm's capabilities represent its capacity to integrate individual firm resources to achieve a desired objective, though this ability does not emerge overnight. 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 (its human capital). A firm's ability to achieve a competitive advantage is thus reflected in its knowledge base and the ability of its human capital to successfully exploit firm capabilities. Thus, human capital is of significant value in the firm's ability to develop capabilities and core competencies to achieve strategic competitiveness. Teaching Note: As discussed in the chapter, the strategic value of resources is increased when they are integrated or combined. Unique combinations of the firms tangible and intangible resources can be molded into capabilitieswhat the firm can do when it deploys teams of resources working together. You can use a firm like Microsoft to illustrate this point. The knowledge possessed by the firm's human capital may be one of the most significant sources of a firm's competitive advantage because it represents everything that the firm has learned, and thus everything that it knows about successfully linking or bundling sets of individual resources to develop capabilities as a foundation for developing core competencies and, ultimately, to achieve a competitive advantage. Teaching Note: A number of firms have gone so far as to hire Chief Learning Officers (CLO) to find ways for the organization to acquire, internalize, and share knowledge in competitively relevant ways. Managing knowledge is critical since enterprises view this as their primary source of competitive advantage and believe it should be used in ways that will create value for customers. Establishing and nurturing the skills and abilities of the workforce is of critical importance to a firm's ability not only to establish, but to sustain a competitive advantage by acquiring new knowledge and developing new skills that will enhance existing capabilities and core competencies, as well as aid in the development of new ones. Teaching Note: Firms use a variety of methods to nurture the value of their human capital. For example, Microsoft contends its best asset is the intellectual potential of its employees.

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Chapter 3: The Internal Environment To support the trend, the firm strives to hire people who are more talented than the current set of employees in hopes of defending and extending the domain of its intellectual property. It is not uncommon for prospective employees to be asked questions like, Why are manhole covers round? (The answer: A round cover cannot fall into the hole no matter which way it is turned.) Such questions may seem silly, but the goal is to identify people with powerful reasoning skills, and thus (conceivably) the capacity to generate outstanding software solutions. Firms also have functional area capabilities they have nurtured and are now considered as core competencies. As a result, these core competencies provide the foundation for the firms competitive advantage. Table Note: Table 3.3 illustrates the value-creating potential of functional areas for a broad array of firms in a variety of industries. Rather than going over the table item-by-item, students should be asked to discuss why a particular firms capabilities serve as a source of competitive advantage. In other words, involve your students in a discussion of why one firms functional activity is being performed better than that of its competitors. For example, ask students to compare and contrast the marketing approaches of Proctor & Gamble and Polo Ralph Lauren Company or the manufacturing capabilities of Komatsu and Sony. TABLE 3.3 Examples of Firms Capabilities Table 3.3 provides examples of functional areas, capabilities, and firm examples across a variety of industries. It indicates that a number of functional area capabilities have the potential to serve as the foundation for a firms competitive advantage.

Describe four criteria used to determine whether resources and capabilities are core competencies.

Core Competencies Once a firm has identified its resources and capabilities, it is ready to identify its core competencies, the resources and capabilities that are a source of competitive advantage for the firm over its competitors. Core competencies emerge over time through an organizational process of accumulating and learning how to deploy different resources and capabilities. As the capacity to take action, core competencies are the crown jewels of a company, the activities the company performs especially well compared with competitors and through which the firm adds unique value to its goods or services over a long period. Teaching Note: Remember, resources and capabilities serve as the foundation upon which firms formulate and implement value-creating strategies so that the firm can achieve strategic competitiveness and earn above-average returns. However, if a firm has a deficiency in some of its resources, it may not be able to achieve strategic competitiveness. For example, insufficient financial resources may prevent a firm from implementing the processes or integrating the activities required to add superior value by limiting its ability to hire workers with the necessary skills or to invest in the capital assets (facilities and equipment) that are needed. Thus, firms not only are challenged to scan the external environment to identify opportunities that can be exploited, but also to have an in-depth understanding of their resources and capabilities. This enables the firm to develop strategies to exploit external opportunities while it also avoids competing in areas where the firm's resources and capabilities are inadequate.

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Not all of a firms resources and capabilities are strategic assetsthat is, assets that have competitive value and the potential to serve as a source of competitive advantage. Some resources and capabilities may result in incompetence, because they represent competitive areas in which the firm is weak compared to competitors. Thus, some resources or capabilities may stifle or prevent the development of a core competence. When the firm's resources and capabilities result in a core competence, the firm will be able to produce goods or services with features and characteristics that are valued by customers. This implies that firms can implement value-creating strategies only when its capabilities and resources can be combined to form core competencies. The question is asked: "How many core competencies are required for a competitive advantage?" McKinsey & Company recommends that firms identify 3 or 4 competencies around which to frame their strategic actions. Teaching Note: In support of the McKinsey Rule, it is interesting to note that McDonalds has four main competencies (in real estate, restaurant operations, marketing, and its global infrastructure). Also, with the actual manufacturing of automobiles and trucks expected to become a declining part of its operations, Ford Motor Company is framing its twenty-first century competitive success around competencies in the areas of design, branding, sales, and service operations. BUILDING CORE COMPETENCIES This section discusses two conceptual tools/frameworks firms can use to identify competitive advantages: Four criteria determine which of the firms resources and capabilities are core competencies. Value chain analysis, a tool for determining which value-creating competencies should be maintained, upgraded, and developed and which should be outsourced. Four Criteria for Sustainable Competitive Advantage Four criteria should be used to determine whether or not a firms capabilities are core competencies and can be a source of competitive advantage. Table Note: Table 3.4 describes the four criteria for determining strategic capabilities. These criteria will be discussed in more detail following the table.

TABLE 3.4 The Four Criteria of Sustainable Strategic Capabilities Before they can be sources of competitive advantage, capabilities must be: valuable rare costly-to-imitate nonsubstitutable

It is important to understand that a firm's capabilities must meet all four of the criteria noted earlier before they can be core competencies and enable the firm to achieve a sustainable competitive advantage. However, a short-term competitive advantage is available when firm capabilities are valuable, rare, and nonsubstitutable. The length of time that a firm possessing such capabilities can expect to sustain a competitive

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Chapter 3: The Internal Environment advantage depends on how long it takes for competitors to successfully imitate the value-creating activity or process, or reproduce valued features or characteristics of the product or service. Thus, the ability to sustain a competitive advantage is dependent on firm capabilities being valuable, rare, nonsubstitutable, and costly to imitate. Valuable Capabilities that are valuable help a firm exploit opportunities and/or neutralize threats in the external environment. Valuable capabilities allow a firm to develop and implement strategies that create customer value. Rare Capabilities are rare when they are possessed by few, if any, current or potential competitors. If many firms have the same capabilities, the same value-creating strategies will be selected. As a result, none of the firms will be able to achieve a sustainable competitive advantage. A competitive advantage will be achieved by firms that develop and exploit capabilities that are different from those held by other firms. Costly-to-Imitate Capabilities are costly to imitate when other firms are unable to develop them except at a cost disadvantage relative to firms that already have them. This usually is a result of one or a combination of three conditions: 1. Unique historical conditions can make duplication of capabilities costly. For example, establishing facilities in a key location that can preempt competition when no other locations have similar value-related characteristics or developing a unique organizational culture in the early stages of the organization's life may not be cheap to duplicate by firms that are developing theirs at a different time. A unique culture may not only serve as a source of competitive advantage, but also can be a source of competitive disadvantage. The latter may be the case when a firm's culture prevents it from recognizing or successfully adapting to changes in a turbulent environment. Teaching Note: This may explain why such companies as IBM and General Motors, whose cultures developed early in each company's historyand during relatively calm or stable environmentswere able to rely on formal controls and multiple approvals of strategies and be successful. However, their respective cultures, grounded in rigidity and bureaucracy, may have prevented them from successfully adapting to rapid environmental change in a fastpaced global environment. 2. Causal ambiguity also may prevent competitors from perfectly imitating a competency if the link between a firm's capabilities and core competencies is not identified or understood. Competitors may not be able to identify or determine how a firm uses its competencies to achieve a sustainable competitive advantage. 3. Social complexity means that a firm's capabilities are the product of complex social phenomena such as interpersonal relationships within the firm (e.g., how managers and subordinates at Hewlett-Packard work with each other) or a firms reputation with its customers and suppliers. Nonsubstitutable A firm's capabilities are nonsubstitutable when they do not have strategic equivalents. Firm resources are strategically equivalent when they each can be separately exploited to implement the same strategies. If capabilities are invisible, it is even more difficult for competitors to identify viable substitutes. Examples of capabilities that can be difficult to identify or to find suitable substitutes for include firm-specific knowledge and trust-based working relationships.

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Table Note: Table 3.5 summarizes the relationship between the characteristics of firm capabilities, sustainability of competitive advantage, and performance implications. Rather than repeating the table in a lecture, students should be advised to refer to it as needed. TABLE 3.5 Outcomes from Combinations of the Criteria for Sustainable Competitive Advantage Highlights from Table 3.5 are: Resources and capabilities that are neither valuable, rare, costly-to-imitate, nor nonsubstitutable mean that the firm will be at a competitive disadvantage and will earn below-average returns. Resources and capabilities that are valuable, but are neither rare nor costly to imitate and may or may not be nonsubstitutable mean that the firm can achieve competitive parity and earn average returns. Resources and capabilities that are both valuable and rare, but are not costly to imitate and may or may not be nonsubstitutable, may enable the firm to achieve a temporary competitive advantage and will earn aboveaverage to average returns. Resources and capabilities that are valuable, rare, costly-to-imitate, and nonsubstitutable will enable the firm to achieve a sustainable competitive disadvantage and earn above-average returns.

Teaching Note: Given the criteria for the sustainability of a competitive advantage, ask students if The Gaps Old Navy concept (or another case with which they are likely to be personally familiar) represents a source of competitive advantage that can be sustained over time. One likely interpretation using the criteria set out in Table 3.5 is that The Gaps competitive advantage in the Old Navy concept can only be sustained until competitors successfully imitate or duplicate the value created. Thus, the Old Navy concept represents a temporary competitive advantage. This will enable The Gap to earn above-average returns until the value created is successfully imitated by competitors.

Explain how value-chain analysis is used to identify and evaluate resources and capabilities.

Value Chain Analysis A framework that firms can use to identify and evaluate the ways in which their resources and capabilities can add value is value chain analysis. This framework is useful because it enables firms to understand which parts of their operations or activities create value by segmenting the value chain into primary and secondary activities as illustrated in Figure 3.3. Figure Note: Students should refer to Figure 3.3 and Tables 3.6 and 3.7 during your explanation of the value chain concept. Tables 3.6 and 3.7 develop the criteria for examining the value-creating potential of the firm's primary and secondary activities, respectively, after these terms are introduced in Figure 3.3.

FIGURE 3.3 The Basic Value Chain Figure 3.3 illustrates how the value-creating activities performed by the firm can be separated into primary and secondary activities.

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Chapter 3: The Internal Environment Primary activities represent traditional line activities such as inbound logistics, operations, outbound logistics, marketing and sales, and service. Support activities are represented by a firm's staff activities and include its financial infrastructure, human resource management practices, technological development, and procurement activities.

Table Note: The first step in value chain analysis is to carefully examine each of the firm's primary activities to assess the potential for creating or adding value (see Table 3.6). TABLE 3.6 Examining the Value-Creating Potential of Primary Activities Table 3.6 presents value-creating issues to be addressed for each primary activity. Activities are rated as superior, equivalent, or inferior (relative to competitors). Students can refer to this table during your discussion. Inbound logistics: Examine all activities related to the receipt, control, warehousing, inventory, and distribution of raw materials or component parts into the production process. Operations: Activities to be examined are all of those necessary to convert the inputs (raw materials or components) available as a result of inbound logistics into finished products. Examples include machining, assembly, equipment maintenance, and packaging. Outbound logistics: This category represents the firm's activities involved with the collection, storage, and physical distribution of products to customers. Examples include warehousing or storage of finished products, material handling, and order processing. Marketing and sales: Several marketing and sales activities must be completed to both induce customers to purchase products and ensure that products are available. Activities include developing advertising and promotion campaigns; selecting and developing distribution channels; and selecting, training, developing, and supporting a sales force. Service: These are the activities that a firm offers to enhance or maintain a product's value, including installation, product use training, adjustment, repair, and warranty services.

Table Note: The next step in the value chain analysis process is to examine the firm's support activities to determine any value-creating potential in those activities (see Table 3.7). TABLE 3.7 Examining the Value-Creating Potential of Support Activities Table 3.7 presents value-creating issues to be addressed for each support activity. Activities are rated as superior, equivalent or inferior, relative to competitors. Students can refer to this table during your discussion. Procurement: These are activities that are completed to purchase the inputs needed to produce a firm's products, including items consumed or used in the manufacturing process (such as raw materials or component parts), supplies, and fixed assets (machinery, equipment and facilities). Technological development: All activities that are completed to either improve a firm's products or its production processes. This includes basic research, process and equipment design, product design, and servicing procedures.

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Chapter 3: The Internal Environment Human resource management: These activities are related to the recruiting, hiring, training, developing, and compensating (including performance assessment and reward systems) of a firm's employees. Firm infrastructure: These activities support the activities performed in the firm's value chain, including general management practices, planning, finance, accounting, legal, and government relations. By performing its infrastructure-related activities, a firm identifies external opportunities and threats, and internal strengths and weaknesses related to firm resources and capabilities, and supports or nurtures its core competencies.

Using the value chain framework enables managers to study the firm's resources and capabilities in relationship to the primary and support activities performed to design, manufacture, and distribute products, and to assess them relative to competitors' capabilities. For these activities to be sources of competitive advantage, a firm must be able to: perform primary or support activities in a manner superior to the ways that competitors perform them perform a primary or support activity that no competitor is able to perform to create superior value for customers and achieve a competitive advantage This implies that, given that individual firms are comprised of unique or heterogeneous bundles of activities, reconfiguring the value chainor rebundling resources and capabilitiesmay enable a firm to develop unique value-creating activities. Figure Note: The potential to configure the value chain to create a core competency and achieve competitive advantage is illustrated in Figure 3.4, and with a great deal of detail. FIGURE 3.4 Prominent Application of the Internet in the Value Chain This is a very involved figure, but it helps to illustrate the vast potential of the Internet to change the way managers think about the value chain. Explaining the ins-and-outs of the figure will take a good bit of time, but it is worth the investment.

The managerial challenge is that the value-creation process is difficult and there is no one best way to assess a firm's primary and support activities or to evaluate the value-creating potential of those activities either within the firm or relative to competitors, because of incomplete or ambiguous data. By being objective, managers may be able to use the value chain framework to identify new, unique ways to combine resources and capabilities to create value that are difficult for competitors to recognize, understand, or imitate. The longer a firm is able to keep competitors "in the dark" as to how resources and capabilities have been combined to create value, the longer a firm will be able to sustain a competitive advantage. Firms can use outsourcing as an alternative to identify primary or support activities for which its resources and capabilities are not core competencies and do not enable the firm to add superior value and achieve competitive advantage.

Define outsourcing and discuss the reasons for its use.

OUTSOURCING Outsourcing describes a firm's decision to purchase a value-creating activity from an external supplier. Outsourcing has become importantand may become more important in the futurefor two reasons:

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Chapter 3: The Internal Environment There are limits to the abilities of firms to possess all of the bundles of resources and capabilities that are required to achieve superior performance (relative to competitors) in all its primary and support activities. With limited resources and capabilities, firms can increase their ability to develop resources and capabilities to form core competencies and achieve competitive advantage by nurturing a few core competencies. Firms engaging in outsourcing can increase their flexibility, mitigate risks, and reduce their capital investment. Teaching Note: When outsourcing, a firm seeks the greatest value. In other words, a company wants to outsource only to firms possessing a core competence in terms of performing the primary or support activity that is being outsourced. This was the case between Nissan and IBM. In fact, the firms services division, the group to which Nissan outsourced some of its computer operations, was the fastest-growing part of IBM. A few years back, IBM sold its Global Network division to AT&T at a price of $5 billion. As part of this transaction, IBM agreed to pay AT&T Solutions $5 billion to run its global telecom network through 2004, a deal that allows AT&T and IBM to concentrate their efforts on different operations (those in which the companies have core competencies). Other research suggests that outsourcing does not work effectively without extensive internal capabilities to coordinate external sourcing as well as core competencies. To ensure that the appropriate primary and support activities are outsourced, four skills are essential for managers involved in outsourcing programs: strategic thinking understanding whether/how outsourcing creates competitive advantage within the company deal making able to secure rights from external providers that can be fully used by internal managers partnership governance able to oversee and govern appropriately the relationship with the company to which the services were outsourced change management because outsourcing can significantly change how an organization operates, managers administering these programs must also be able to manage that change, including resolving employee resistance that accompanies any significant change effort Teaching Note: Outsourcing can take several forms, depending on a firm's strategic objectives. Examples of outsourcing strategies that, while different, enable outsourcing firms to achieve their strategic objectives while changing the face of college campuses include: Universities and colleges outsourcing the management of college bookstores to Follett College Stores and Barnes & Noble Food Service management companies such as ARA and Marriott licensing with Burger King to establish national chain restaurants on college campuses Colleges in the U.S. contracting with private firms to manage or build on-campus housing Discuss the importance of identifying internal strengths and weaknesses.

COMPETENCIES, STRENGTHS, WEAKNESSES, AND STRATEGIC DECISIONS Tools such as outsourcing help the firm focus on its core competencies as the source of its competitive advantages. However, evidence shows that the value-creating ability of core competencies should never be taken for granted. Moreover, the ability of a core competence to be a permanent competitive advantage cant be assumed.

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Chapter 3: The Internal Environment All core competencies have the potential to become core rigidities. As Leslie Wexner, CEO of The Limited, Inc., says: Success doesnt beget success. Success begets failure because the more that you know a thing works, the less likely you are to think that it wont work. When youve had a long string of victories, its harder to foresee your own vulnerabilities. Thus, each competence is a strength and a weaknessa strength because it is the source of competitive advantage and, hence, strategic competitiveness, and a weakness because, if emphasized when it is no longer competitively relevant, it can sow the seeds of organizational inertia. Events occurring in the firms external environment create conditions through which core competencies can become core rigidities, generate inertia, and stifle innovation. According to one observer, Often the flip side, the dark side, of core capabilities is revealed due to external events when new competitors figure out a better way to serve the firms customers, when new technologies emerge, or when political or social events shift the ground underneath. In the final analysis, changes in the external environment do not cause core competencies to become core rigidities; rather, strategic myopia and inflexibility on the part of managers are the cause. Thus, nurturing existing competencies must be balanced by efforts to encourage the development of new competencies.

ANSWERS TO REVIEW QUESTIONS

1. Why is it important for a firm to study and understand its internal environment? (p. 71-72)

As they analyze their internal environment, a manager should think of the firm as a bundle of heterogeneous resources and capabilities that can be used to create an exclusive market position. This means that firms should no longer focus only on the traditional sources of competitive advantage (e.g., labor costs, access to capital, and raw materials) as these advantages can be overcome through an international strategy and the relative free flow of global resources. Instead, firms should seek out those resources and capabilities that other firms do not have, at least not in the same combinations. A firm's resources are the source of its capabilities, some of which can lead to core competencies that enable a firm to perform value-creating activities better than its competitors or that its competitors cannot duplicate. 2. What is value? Why is it critical for a firm to create value? How does it do so? (pp. 72-73)

Value is represented by the bundle of performance characteristics and attributes that a firm provides to customers in the form of goods or services for which customers are willing to pay. Broadly speaking, value can be provided by a product's/service's low cost, highly-differentiated features, or a combination of the two (when these strategies are superior to those offered by competitors). Ultimately, it is critical that a firm be able to create customer value since it is the source of a firm's potential to earn above-average returns. Therefore, in the rapidly changing environments of the 21st-century competitive landscape, firms must evaluate continuously the degree to which their core competencies create customer value. What the firm intends to do to create value affects its choice of business-level strategy and its organizational structure 3. What are the differences between tangible and intangible resources? Why is it important for decision makers to understand these differences? Are tangible resources linked more closely to the creation of competitive advantages than are intangible resources, or is the reverse true? Why? (pp. 7678) Tangible resources are represented by assets which can be seen and quantified. They are not only represented by the firm's physical resources (such as plant and equipment), but also by other assets, such as the firm's borrowing capacity, the skills and attributes of its staff, and its technological capacities. Intangible resources (because they are less visible and more embedded in the firm's history) are more difficult for competitors to

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Chapter 3: The Internal Environment understand and imitate. These include such resources as scientific capabilities, knowledge within the firm, organizational routines, or the firm's reputation for quality. Resources are the source of a firm's capabilities. Capabilities are the source of a firm's core competencies, which are the basis of competitive advantages. Intangible resources (as compared to tangible resources) are a superior and more potent source of core competencies. In fact, in the global economy, intellectual and systems capabilities are more important to the success of a corporation than are its physical assets, and the capacity to manage human intellect is now a critical executive skill. Intangible resources are less visible and more difficult for competitors to understand, purchase, imitate, or substitute, and thus firms prefer to rely on these resources as the foundation for their capabilities and core competencies. Therefore, unobservable (i.e., intangible) resources provide a better platform for competitive advantage than do tangible resources. And unlike tangible resources, the use of intangible resources can be leveraged for even greater benefits to firm performance. 4. What are capabilities? What must firms do to create capabilities? (p. 80)

Capabilities represent the firm's capacity or ability to successfully integrate sets of firm resources and deploy these resources to achieve some desired end. Capabilities evolve or develop over time through interactions among and between tangible and intangible resources. It is also critical to recognize that capabilities are based on the development, carrying, and exchange of information and knowledge by the firm's human capital. Thus, a firm's capabilities are a reflection of its knowledge base: the skills and knowledge of its employees and (often) their functional expertise. Global business leaders increasingly support the view that the knowledge possessed by human capital is among the most significant of an organizations 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 business units. Given this reality, the firms challenge is to create an environment that allows people to integrate their individual knowledge with that held by others in the firm so that, collectively, the firm has significant organizational knowledge. 5. What are the four criteria used to determine which of a firms capabilities are core competencies? Why is it important for these criteria to be used? (pp. 81-84) Capabilities are a firm's core competencies when they satisfy the four criteria of sustainable competitive advantage: they must be valuable, rare, costly to imitate, and nonsubstitutable. A capability is valuable when it helps a firm exploit opportunities or neutralize threats in its external environment. A capability that is rare is possessed by few, if any, current or potential competitors. Capabilities are costly to imitate when other firms cannot develop them except at a cost disadvantage relative to firms that already possess them. (This can be the case when the capabilities derive from unique historical conditions, are causally ambiguous, or socially complex.) Finally, capabilities are non-substitutable when they do not have strategic equivalents. It is important for these criteria to be used because a competitive advantage is sustainable over time only when competitors are unsuccessful at duplicating the benefits of the firm's strategy or when they are unable to imitate the strategy. 6. What is value chain analysis? What does a firm gain when it successfully uses this tool? (pp. 84-87)

The value chain is a template that the firm uses to understand its cost position and to identify the multiple means that might be used to facilitate the implementation of its business-level strategy. Managers would use value chain analysis to examine the firm's resources and capabilities in relationship to the activities performed in the design, manufacture, and distribution of products. Specifically, this framework differentiates primary activities (those involved with a product's physical creation, its sale and distribution to buyers, and its service after the sale) from support activities (which provide the support necessary for the primary activities to take place). Managers should scrutinize and assess activities and capabilities with competitors' capabilities in mind because the firm must be able to either perform an activity in a manner that provides value superior to or better than any competitor or identify and perform value-adding activities that competitors are unable to perform, if these

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Chapter 3: The Internal Environment capabilities are to be a source of competitive advantage. Nonetheless, it is important to remember that value chain analysis is a highly subjective process. Just as identifying and valuing a firm's resources and capabilities requires judgment, so does the process of assessing the relative value added by activities performed. Studying the value chain will enable managers to better understand their cost structure and the activities in which they can create and capture value. 7. What is outsourcing? Why do firms outsource? Will outsourcing's importance grow in the 21st century? If so, why? (pp. 87-88) Outsourcing is the purchase of a value-creating activity from an outside supplier that can provide the greatest value. A firm is likely to engage in outsourcing when it identifies primary and support activities in which its resources and capabilities are neither sources of competence nor of sustainable competitive advantage. In such instances, firms should consider purchasing these activities from firms that can add value to the activity (relative to the firm's competitors). Outsourcing has several advantages for firms but also carries some important risks as well. Outsourcing can potentially reduce costs and increase the quality of the activities outsourced. In this way, it adds value to the product provided to consumers. Thus, outsourcing can contribute to a firms competitive advantage and its ability to create value for its stakeholders. However, the risk of the outsourcing partners learning the technology and becoming a competitor is very real and should be taken seriously. Outsourcing is important to firms competing in the 21st-century landscape because few, if any firms possess all of the resources and capabilities that are necessary for them to achieve competitive superiority in all necessary primary and support activities. By outsourcing activities in which it lacks the competence to create value and by nurturing a few core competencies, a firm increases its probability of developing a sustainable competitive advantage. To maximize value, firms should scan the entire globe to locate the source (supplier or performer) of the to-be-outsourced activity to locate the best producer in the world of the activity that is being outsourced. Given the increasing complexity of products/services offered (e.g., based on combined, sophisticated technologies), firms looking forward should anticipate that even more outsourcing of non-strategic activities is likely to be necessary. 8. How do firms identify internal strengths and weaknesses? Why is it vital that firms base their strategy on such strengths and weaknesses? (pp. 88-90) By completing the internal analysis, firms can (must) identify their strengths and weaknesses in resources, capabilities, and core competencies. For example, if they have weak capabilities or do not have core competencies in areas required to achieve a competitive advantage, they must acquire those resources and build the capabilities and competencies needed. Alternatively, they could decide to outsource a function or activity where they are weak in order to improve the value that they provide to customers. Firms need to have the appropriate resources and capabilities to develop the desired strategy and create value for customers and shareholders as well. Having many resources does not necessarily lead to success. Firms must have the right ones and the capabilities needed to produce superior value to customers. Undoubtedly, having the appropriate and strong capabilities required for achieving a competitive advantage is a primary responsibility of top-level managers. These important leaders must focus on both the firms strengths and weaknesses.

EXPERIENTIAL EXERCISES
Exercise 1: Dot com boom and bust The focus of this chapter is on understanding how firm resources and capabilities serve as the cornerstone for competencies, and, ultimately, a competitive advantage. Strategists have long understood the

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Chapter 3: The Internal Environment importance of internal analysis: for example, Porters value chain model was introduced in 1985, more than twenty years ago. How, then, can a large number of prominent firms create strategies while apparently disregarding the importance of internal analysis? The late 1990s saw the launch of thousands of Internet start-ups, often supported by venture capital. These new businesses were heralded as part of the new economy and were characterized as having a superior business model compared to models being used by traditional bricks and mortar firms. The collapse of the dot com bubble had global economic ramifications. Some of the more prominent e-business failures include: Webvan.com Kosmo.com Cyberrebate.com Go.com Boo.com Kibu.com Pets.com Zap.com Flooz.com Digiscents.com eToys.com Yadayada.com

As a group, select a failed dot com business. You may choose one of the companies from the above list, or another dot com that you identify on your own. Using library and Internet resources, prepare a brief PowerPoint presentation that covers these questions: How did the company describe its value proposition i.e., how did the firm plan to create value for its customers? Describe the resources, capabilities, and competencies that supported this value proposition. Why do you think the firm failed? Was it a poor concept, or a sound concept that was not well executed? Apply the concepts of value, rarity, imitation and sustainability when preparing your answer. Are there presently other firms that use a similar approach to creating value for their customers? If so, what makes them different from the failed company that you studied?

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Chapter 3: The Internal Environment Exercise 2: Competitive advantage and pro sports What makes one team successful while another team struggles? At first glance, a National Football League franchise or womens National Basketball Association team may not seem like a typical business. However, professional sports have been around for a long time: pro hockey in the United Stated emerged around World War I, and pro basketball shortly after World War II; both could be considered newcomers relative to the founding of baseball leagues. Pro sports are big business as well, as evidenced by David Beckhams 2007 multi-million dollar contract with Major League Soccer. With this exercise, we will use tools and concepts from the chapter to analyze factors underlying the success or failure of different sports teams. Working as a group, pick two teams that play in the same league. For each team, address the following questions: How successful are the two teams you selected? How stable has their performance been over time? Make an inventory of the characteristics of the two teams. Characteristics you might choose to identify include reputation, coaching, fan base, playing style and tactics, individual players, and so on. For each characteristic you describe, o o Decide if it is best characterized as a tangible, intangible, or capability. Apply the concepts of value, rarity, imitation and sustainability to analyze its valuecreating ability.

Is there evidence of bundling i.e., the combination of different resources and capabilities? What would it take for these two teams to substantially change their competitive position over time? For example, if a team is a leader, what types of changes in resources and capabilities might affect it negatively? If a team is below average, what changes would you recommend to its portfolio of resources and capabilities?

INSTRUCTOR'S NOTES FOR EXPERIENTIAL EXERCISES

Exercise 1: Dot com boom and bust The goal of this exercise is to use the dot com bubble to analyze the role of resources and capabilities in building a competitive advantage. Working in groups, students are asked to select a failed dot com and develop a PowerPoint presentation which answers the following questions: How did the company describe its value proposition i.e., how did they plan to create value for their customers? Describe the resources, capabilities, and competencies that supported this value proposition. Why do you think the firm failed? Was it a poor concept, or a sound concept that was not well executed? Apply the concepts of value, rarity, imitation and sustainability in your answer. Are there presently other firms which use a similar approach to creating value for their customers? If so, what makes them different from the failed company that you studied?

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Michael Porters Strategy and the Internet article (Harvard Business Review, March 2001) is an excellent complement to this assignment. Porter discusses how the exuberance associated with the Internet led to a number of adverse outcomes, including the adoption of strategies that hurt both individual firms and entire industries, as well as the creation of many businesses that were fundamentally unsustainable. The instructor should distribute copies of Porters article when the exercise is assigned. Following is a recommended teaching plan for discussing the exercise in class: Ask two or three student teams to share their presentations with the class. To obtain variety in the presentations, ask several questions before selecting teams. For instance: What firm did you pick? What is the reason for failure? Who thought the idea was sound, but poorly executed? Who thought the basic idea was flawed? How severe were the failures? Who studied firms that came and went quickly? Who studied firms that lasted for awhile before going under? Next, discuss how these failures relate to concepts in Porters article. Some of the relevant topics from the article include: distorted market signals effects on industry structure first mover issues competitive advantage value chain If there is sufficient time available, business models can be included as a topic in the discussion. Porter is highly critical of this term, which was popularized during the Internet boom as a shorthand term for how a firm creates revenue. Porter notes that the business model approach to management becomes an invitation to faulty thinking and self-delusion (2001: 12). Elsewhere, Michael Lewis noted that the term business model was used during the boom to justify all manner of half-baked plans. A good discussion question is to ask whether Porters critique is overly harsh. Joan Magrettas article Why Business Models Matter (Harvard Business Review May 2002) offers a good counterpoint to Porters negative assessment. Exercise 2: Competitive advantage and professional sports The intent of this exercise is to frame the discussion of resources, capabilities, and competitive advantage in a familiar topic professional sports. Student teams are asked to pick two teams that compete in the same league and answer the following questions: How successful are the two teams you selected? How stable has their performance been over time? Make an inventory of the characteristics of the two teams. For example, reputation, coaching, fan base, playing style and tactics, individual players, and so on. For each of the features that you describe, o o Decide if they are best characterized as a tangible, intangible, or capability. Apply the concepts of value, rarity, imitation and sustainability each of the resources and capabilities you identified.

Is there evidence of bundling i.e., the combination of different resources and capabilities?

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What would it take for these two teams to substantially change their competitive position over time? For example, if a team is a leader, what types of changes in resources and capabilities might affect them negatively? If a team is below average, what changes would you recommend to their portfolio of resources and capabilities? To debrief this exercise in class, ask students which teams they chose for analysis. Focus on the league with the greatest number of teams represented. Draw on the results of the team analyses to fill in the following table. For each team, identify no more than four characteristics that students believe are important to that teams success. If more than four items are offered, have students rank order the different components. For each of the items: Classify the type as T, I, or C, for Tangible, Intangible, or Capability. Evaluate each item whether it adds value, is rare, is free from imitation, and is sustainable. Next, discuss whether multiple characteristics are bundled together for a particular team. Assign a score of 1 for no bundling, 2 for some bundling, and 3 for extensive bundling. Finally, ask what would be necessary for a firm to substantially change their competitive position over time. Team Key Characteristics Type (I,T, or C) Is It Valuable Rare Imitable Sustainable Bundling (1,2, or 3) Keys to Change

Team 1

Team 2

Team 3

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ADDITIONAL QUESTIONS AND EXERCISES

The following questions and exercises can be presented for in-class discussion or assigned as homework. Application Discussion Questions 1. Several companies use their brand as a competitive advantage. Ask the class, given their knowledge about the global economy, which brands they believe have the strongest likelihood of remaining a source of advantage in the twenty-first century? Why? What effects do they believe the Internets capabilities will have on this brand, and what should the owner of the brand do in light of them? 2. Students should visit the manager of a local store to obtain the following information. Using the definition presented in the chapter, define value for the manager. Ask the manager if the definition is consistent with how her or his firm thinks of value. If there is a difference, ask the manager to assess why the difference exists. 3. Have the students consider a group (e.g., a fraternity or sorority, Toastmasters, or a volunteer organization) in which they hold membership. Using the categories shown in Tables 3.1 and 3.2, list what are perceived as the groups tangible and intangible resources. Show the list to another member of the group. Does the person agree with your assessment of the groups resources? If not, what might account for the differences? If differences do exist between you and your colleague, what is the meaning of such differences in terms of trying to form the groups capabilities? 4. Refer to the third question. Ask the students if it was easier to list the tangible or the intangible resources? Why? How confident are they with their assessments? 5. What competitive advantage do the individual students feel that the university or college possesses? What evidence can they provide to support this opinion? Does the class as a whole agree with the assessments? If not, why not? 6. Ask the students what effects they believe the Internet will have on the university or college within the next five years as it seeks to develop new competitive advantages? In their view, do the strategic decision makers in your educational institution understand the Internets capabilities? If not, why not? 7. Trust is identified in the chapter as a potential source of competitive advantage. Ask the students if they have ever been involved in a situation in which trust was instrumental in accomplishing an organizations goals? If so, what outcomes were made possible because of trust? Ethics Questions 1. Can efforts to develop sustainable competitive advantages result in employees using unethical practices? If so, what unethical practices might be used to compare a firms core competencies with those held by rivals? How do the Internets capabilities affect actions taken to form competitive advantages that will help the firm in efforts to outperform its rivals? 2. Do ethical practices affect a firms ability to develop brand as a source of competitive advantage? If so, how does this happen? Can you think of brands that are a source of competitive advantage at least in part because of the firms ethical practices? 3. What is the difference between exploiting a firms human capital and using that capital as a source of competitive advantage? Are there situations in which the exploitation of human capital can be a source of advantage? If so, can you name such a situation? If the exploitation of human capital can be a source of competitive advantage, is this a sustainable advantage? Why or why not? 4. Are there any ethical dilemmas associated with outsourcing? If so, what are they? How would you deal with outsourcing ethical dilemmas you believe exist? 5. What ethical responsibilities do managers have if they determine that a set of employees has skills that are valuable only to a core competence that is becoming a core rigidity? 6. Through the Internet, firms sometimes make a vast array of data, information, and knowledge available to competitors as well as to customers and suppliers. What ethical issues, if any, are involved when the firm finds competitively relevant information on a competitors Web site?

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Chapter 3: The Internal Environment 7. Firms are aware that competitors read information that is posted on their Web sites. Given this reality, is it ethical for a firm to include false information, for example, about its sources of competitive advantage on its Web site in hopes that the information will influence competitors to take certain actions as a result of viewing it? Internet Exercise A fairly recent global development in the automobile industry has been the mergers and acquisitions going on among firms. These include the coupling of Daimler-Benz with Chrysler; VW with Audi, Rolls Royce, and Bentley; GM with Saab; and Fords acquisition of Volvo. The new partnerships have allowed firms to combine resources and capabilities to build a new breed of universal car. Explore the Websites of these firms. Is there still a specific brand identification associated with each type of car? How important will branding be in the future for these products? *e-project: Imagine that you are able to purchase your dream car from among the current years models. Before buying, though, you would like to learn something about how the car is produced. (For example, is your Rolls Royce being assembled alongside a Beetle?) Using Internet sources, attempt to trace the origins of the cars major components, technology, and performance-testing resources, as well as the production and advertising or marketing facilities.

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