Evaluating a Firm’s Internal Capabilities Chapter 3

Evaluating a Evaluating a Firm’sFirm’sInternal Internal CapabilitiesCapabilities

Chapter 3Chapter 3

Evaluating a Firm’s Internal CapabilitiesEvaluating a Firm’s Internal Capabilities

Copyright © 2006 Pearson Prentice Hall. All rights reserved. Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & HesterlyStrategic Management & Competitive Advantage - Barney & Hesterly

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What Does Internal Analysis Tell Us?

Internal analysis provides a comparative look at a firm’s capabilities

• what are the firm’s strengths?

• what are the firm’s weaknesses?

• how do these strengths & weaknesses compareto competitors?



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Why Does Internal Analysis Matter?

• establish strategies that will exploit any sourcesof competitive advantage

• determine if its resources and capabilities arelikely sources of competitive advantage

Internal analysis helps a firm:



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The Theory Behind Internal Analysis

The Resource-Based View

• developed to answer the question: Why do some firms achieve better economic performancethan others?

• assumes that a firm’s resources and capabilitiesare the primary drivers of competitive advantageand economic performance

• used to help firms achieve competitive advantageand superior economic performance



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Resources and Capabilities

Resources:

• tangible and intangible assets of a firm» tangible: factories, products intangible: reputation

• used to conceive of and implement strategies

Capabilities:

• a subset of resources that enable a firm totake full advantage of other resources» marketing skill, cooperative relationships



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Resources and Capabilities

Firm Assets:

Machinery

Collective Product Design Skill

Recruiting Skill

Engineering Skill of Individuals

Mineral Deposits

Are these resourcesor capabilities?

?

?

?

?

?



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Four Categories of Resources

• Financial (cash, retained earnings)

• Physical (plant & equipment, geographic location)

• Human (skills & abilities of individuals)

• Organizational (reporting structures, relationships)



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Two Critical Assumptions of the RBV

• Resource Heterogeneity

» different firms may have different resources

• Resource Immobility

» it may be costly for firms without certainresources to acquire or develop them

» some resources may not spread from firm tofirm easily



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What do these assumptions really mean?

• if one firm has resources that are valuableand other firms don’t, and…

• if other firms can’t imitate these resourceswithout incurring high costs, then…

• the firm possessing the valuable resourceswill likely gain a sustained competitive advantage



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• heterogeneity of resources typically occurs as the result of ‘bundling’ the resources and capabilitiesof a firm (bundles of HR practices, p. 90)

Resource Heterogeneity

• managers of a firm could take resources that seemhomogeneous and ‘bundle’ them to createheterogeneous combinations

• competitive advantage typically stems from severalresources and capabilities ‘bundled’ together



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The Internal Analysis Tool

The VRIO Framework

Four Important Questions:

• Value

• Rarity

• Imitability

• Organization



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The VRIO Framework

If a firm has resources that are:

• valuable,

• rare, and

• costly to imitate, and…

• the firm is organized to exploit these resources,

then the firm can expect to enjoy a sustainedcompetitive advantage.



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The VRIO Framework

• a resource or bundle of resources is subjected toeach question to determine the competitiveimplication of the resource

Applying the Tool

• each question is considered in a comparativesense (competitive environment)



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Porter’s Generic Internal Value Chain

• Primary Activities– Inbound Logistics– Production– Warehousing & Distribution– Sales & Marketing– Dealer Support & Customer Service

• Support Activities– Procurement– Infrastructure– Technology: R&D– Human Resource Management



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Applying the VRIO Framework

The Question of Value

• in theory: Does the resource enable the firmto exploit an external opportunity or neutralizean external threat?

• the practical: Does the resource result in anincrease in revenues, a decrease in costs, orsome combination of the two? (Levi’s reputationallows it to charge a premium for its Docker’s pants)



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The Question of Rarity

• a resource must be rare enough that perfect competition has not set in

• if a resource is not rare, then perfect competitiondynamics are likely to be observed (i.e., nocompetitive advantage, no above normal profits)

• thus, there may be other firms that possess theresource, but still few enough that there is scarcity (several pharmaceuticals sell cholesterol-loweringdrugs, but the drugs are still scarce—look at prices)



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Valuable and Rare

If a firm’s resources are: The firm can expect:

Not Valuable Competitive Disadvantage

Valuable, but Not Rare Competitive Parity

Valuable and RareCompetitive Advantage

(at least temporarily)



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The Question of Imitability

• the temporary competitive advantage of valuableand rare resources can be sustained only if competitors face a cost disadvantage in imitatingthe resource

» intangible resources are usually morecostly to imitate than tangible resources(Harley-Davidson’s styles may be easilyimitated, but its reputation cannot)



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• if there are high costs of imitation, then the firmmay enjoy a period of sustained competitiveadvantage

» a sustained competitive advantage will lastonly until a duplicate or substitute emerges

if a firm has a competitive advantage, otherswill attempt to imitate it (Razor scooterswere a big hit and others quickly imitated them)



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Costs of Imitation

Unique Historical Conditions (Caterpillar)

• first mover advantages

• path dependence



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Costs of Imitation

Causal Ambiguity (Southwest Airlines – HR)

• causal links between resources and competitive advantage may not be understood

• bundles of resources fog these causallinks



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Costs of Imitation

Social Complexity (WordPerfect)

• the social relationships entailed in resources may be so complex thatmanagers cannot really manage themor replicate them



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Costs of Imitation

Patents

• patents may be a two-edged sword

• offer a period of protection if the firm isable to defend its patent rights

• required disclosure may actually decreasethe cost of imitation, and the timing



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Value, Rarity, & Imitability

If a firm’s resources are: The firm can expect:

Valuable, Rare, butnot Costly to Imitate

TemporaryCompetitive Advantage

Valuable, Rare, and Costly to Imitate

SustainedCompetitive Advantage

(if Organized appropriately)



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The Question of Organization

• a firm’s structure and control mechanismsmust be aligned so as to give people abilityand incentive to exploit the firm’s resources

• examples: formal and informal reporting structures,management controls, compensation policies,relationships, etc.

• these structure and control mechanisms complementother firm resources—taken together, they can help a firm achieve sustained competitive advantage(3M Company)



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The VRIO Framework

Valuable? Rare?Costly toImitate?

Exploited byOrganization?

CompetitiveImplications

No

Yes

Yes

Yes

Yes

Yes Yes Yes

No

No

No Disadvantage

Parity

TemporaryAdvantage

SustainedAdvantage



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The VRIO Framework

Valuable? Rare?Costly toImitate?

Exploited byOrganization?

CompetitiveImplications

No

Yes

Yes

Yes

Yes

Yes Yes Yes

No

No

No Disadvantage

Parity

TemporaryAdvantage

SustainedAdvantage

EconomicImplications

BelowNormal

Normal

AboveNormal

AboveNormal



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Entrepreneurial and InternationalApplication of the VRIO Framework

The Logic Remains the Same

• small firms and start-ups can apply the VRIOframework to their resources and capabilities

» competitive advantage vis-à-vis largerfirms can often be identified

recognizing if and why larger firmsface high costs of imitation can becritical to small firm success



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The International Context

Two Reasons for International Expansion:

1) to exploit current resource and capabilityadvantages in a new market

2) to develop new resources and capabilities ina foreign market



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Critical Caveat:

• resources and capabilities that generatean advantage in one market may or maynot generate an advantage in a new market

Firms should re-apply the VRIO frameworkwhen entering new markets!!



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As a firm enters a new market:

• a disciplined learning mentality is imperativefor success

» what resources and capabilities meetthe VRIO criteria in the new market?

» what can the firm learn from partners inthe new market? (GM learned from Toyotain the NUMMI alliance)



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Competitive Dynamics of Resource Imitation

Competitive Dynamics:

• the strategic decisions and actions of firms inresponse to the strategic decisions and actionsof other firms

Firm A(strategy decisionslead to competitive

advantage)

Firm B’s Possible Responses

No Response

Change Tactics

Change Strategy



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Competitive Dynamics

• the other firm is serving a different market

A firm may decide to take no action because:

• a response may hurt its own competitive advantage

• it does not have the resources and capabilitiesto mount an effective response

• it wants to reduce or manage rivalry in themarket through tacit collusion

“No Action” Response (Rolex Casio)

The roles of tacit cooperation and tacit collusion



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No Response

• Tacit cooperation– Small number of competing firms– Homogeneous products and costs– Market Share Leader– High Barriers to Entry

• Tacit collusion



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“Change” Responses

Tactics (Tide) Strategy (Monsanto)

• specific actions

» tweaking productcharacteristics

• usually imitated soquickly that there isno advantage

• a ‘leap frog’ movemay create advantage

• a fundamental changein a firm’s theory

• may be necessary if current strategybecomes obsolete

• a mimetic change mayachieve parity, but notadvantage



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Imitation will seldom lead to competitive advantage

• firms should use resources and capabilities to fillunique competitive space

CustomerNeeds

CompetitorOfferings

Price

Quality

Focal FirmOffering



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Similar strategies may lead to competitive advantage

• some firms can achieve competitive advantage evenif they are second movers

CustomerNeeds

CompetitorOfferings

Price

Quality

Focal FirmOffering

» higher quality/lower costoffering maylead to advantage



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Internal Analysis

Assumes:

• determinates of economic performance arefirm-level characteristics (resources & capabilities)

» firms may be different (heterogeneity)

» differences may be enduring (immobility)

• competitive advantage stems from resourcesand capabilities that meet the VRIO criteria



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Resources &Capabilities

CompetitiveAdvantage

• Valuable

• Rare

• Costly to Imitate

• Organized to Exploit

CA will be sustained if:

• other firms’ costs of imitation are greaterthan benefit of imitation

• the firm is organizedto exploit advantages



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Managers’ Job:

• bundle resources and capabilities to achieve competitive advantage

Internal Analysis

Tells us:

• what the firm should do, given the relativestrengths and weaknesses of resources andcapabilities

VRIO Framework Helps Managers RecognizeSources of Competitive Advantage



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Managerial Implications

• Competitive advantage is every employee’s responsibility.

• Imitation cannot lead to a competitive advantage.

• Socially complex resources can be a source of competitive advantage.

• International business activities enable a firm to exploit current resources and to develop new resources and capabilities.

Documents

Evaluating a Firm’s Internal Capabilities Chapter 3