Chapter 3 Internal Capabilities What Does Internal Analysis
Chapter 3 Internal Capabilities
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 compare to competitors? 3 -2
Why Does Internal Analysis Matter? Internal analysis helps a firm: • determine if its resources and capabilities are likely sources of competitive advantage • establish strategies that will exploit any sources of competitive advantage 3 -3
The Theory Behind Internal Analysis The Resource-Based View • Developed to answer the question: Why do some firms achieve better economic performance than others? • Used to help firms achieve competitive advantage and superior economic performance • Assumes that a firm’s resources and capabilities are the primary drivers of competitive advantage and economic performance 3 -4
The Resource-Based View 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 to take full advantage of other resources » marketing skill, cooperative relationships 3 -5
The Resource-Based View Resources and Capabilities Firm Assets: Are these resources or capabilities? Machinery ? Collective Product Design Skill ? Recruiting Skill ? Engineering Skill of Individuals ? Mineral Deposits ? 3 -6
The Resource-Based View Four Categories of Resources • Financial (cash, retained earnings) • Physical (plant & equipment, geographic location) • Human (skills & abilities of individuals) • Organizational (reporting structures, relationships) 3 -7
The Resource-Based View Two Critical Assumptions of the RBV • Resource Heterogeneity » different firms may have different resources • Resource Immobility » it may be costly for firms without certain resources to acquire or develop them » some resources may not spread from firm to firm easily 3 -8
The Resource-Based View What do these assumptions really mean? • if one firm has resources that are valuable and other firms don’t, and… • if other firms can’t imitate these resources without incurring high costs, then… • the firm possessing the valuable resources will likely gain a sustained competitive advantage 3 -9
The Resource-Based View Resource Heterogeneity • heterogeneity of resources typically occurs as the result of ‘bundling’ the resources and capabilities of a firm • managers of a firm could take resources that seem homogeneous and ‘bundle’ them to create heterogeneous combinations • competitive advantage typically stems from several resources and capabilities ‘bundled’ together 3 -10
Application: The Internal Analysis Tool The VRIO Framework Four Important Questions: • Value • Rarity • Imitability • Organization 3 -11
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 sustained competitive advantage. 3 -12
Segment 2 VRIO Application 3 -14
The VRIO Framework Applying the Tool • a resource or bundle of resources is subjected to each question to determine the competitive implication of the resource • each question is considered in a comparative sense (competitive environment) 3 -15
Applying the VRIO Framework The Question of Value • in theory: Does the resource enable the firm to exploit an external opportunity or neutralize an external threat? • the practical: Does the resource result in an increase in revenues, a decrease in costs, or some combination of the two? (Levi’s reputation allows it to charge a premium for its Docker’s pants) 3 -16
Applying the VRIO Framework The Question of Rarity • if a resource is not rare, then perfect competition dynamics are likely to be observed (i. e. , no competitive advantage, no above normal profits) • a resource must be rare enough that perfect competition has not set in • thus, there may be other firms that possess the resource, but still few enough that there is scarcity (several pharmaceuticals sell cholesterol-lowering drugs, but the drugs are still scarce—look at prices) 3 -17
Applying the VRIO Framework 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 Rare Competitive Advantage (at least temporarily) 3 -18
Applying the VRIO Framework The Question of Imitability • the temporary competitive advantage of valuable and rare resources can be sustained only if competitors face a cost disadvantage in imitating the resource » intangible resources are usually more costly to imitate than tangible resources (Harley-Davidson’s styles may be easily imitated, but its reputation cannot) 3 -19
Applying the VRIO Framework The Question of Imitability • if there are high costs of imitation, then the firm may enjoy a period of sustained competitive advantage » a sustained competitive advantage will last only until a duplicate or substitute emerges w if a firm has a competitive advantage, others will attempt to imitate it (Razor scooters were a big hit and others quickly imitated them) 3 -20
Applying the VRIO Framework The Question of Imitability Costs of Imitation Unique Historical Conditions (Caterpillar) • first mover advantages • path dependence 3 -21
Applying the VRIO Framework The Question of Imitability Costs of Imitation Causal Ambiguity (Southwest Airlines – HR) • causal links between resources and competitive advantage may not be understood • bundles of resources fog these causal links 3 -22
Applying the VRIO Framework The Question of Imitability Costs of Imitation Social Complexity (Word. Perfect) • the social relationships entailed in resources may be so complex that managers cannot really manage them or replicate them 3 -23
Applying the VRIO Framework The Question of Imitability Costs of Imitation Patents • patents may be a two-edged sword • offer a period of protection if the firm is able to defend its patent rights • required disclosure may actually decrease the cost of imitation, and the timing 3 -24
Applying the VRIO Framework Value, Rarity, & Imitability If a firm’s resources are: The firm can expect: Valuable, Rare, but not Costly to Imitate Temporary Competitive Advantage Valuable, Rare, and Costly to Imitate Sustained Competitive Advantage (if Organized appropriately) 3 -25
Applying the VRIO Framework The Question of Organization • a firm’s structure and control mechanisms must be aligned so as to give people ability and incentive to exploit the firm’s resources • examples: formal and informal reporting structures, management controls, compensation policies, relationships, etc. • these structure and control mechanisms complement other firm resources—taken together, they can help a firm achieve sustained competitive advantage (3 M Company) 3 -26
The VRIO Framework Valuable? Rare? Costly to Imitate? No Exploited by Organization? No Competitive Implications Disadvantage No Parity Yes No Temporary Advantage Yes Yes Yes Sustained Advantage 3 -27
End Unit 2 3 -29
Section 3 Competitive Dynamics 3 -30
Competitive Dynamics of Resource Imitation Competitive Dynamics: • the strategic decisions and actions of firms in response to the strategic decisions and actions of other firms Firm B’s Possible Responses Firm A (strategy decisions lead to competitive advantage) No Response Change Tactics Change Strategy 3 -31
Competitive Dynamics “No Action” Response (Rolex Casio) A firm may decide to take no action because: • the other firm is serving a different market • a response may hurt its own competitive advantage • it does not have the resources and capabilities to mount an effective response • it wants to reduce or manage rivalry in the market through tacit collusion 3 -32
Competitive Dynamics “Change” Responses Tactics (Tide) • specific actions » tweaking product characteristics • usually imitated so quickly that there is no advantage • a ‘leap frog’ move may create advantage Strategy (Monsanto) • a fundamental change in a firm’s theory may be necessary if current strategy becomes obsolete • a mimetic change may achieve parity, but not advantage 3 -33
Competitive Dynamics Similar strategies may lead to competitive advantage • some firms can achieve competitive advantage even if they are second movers Price Focal Firm Offering » higher quality/ lower cost offering may lead to advantage Competitor Offerings Customer Needs Quality 3 -35
Internal Analysis Assumes: • determinates of economic performance are firm-level characteristics (resources & capabilities) » firms may be different (heterogeneity) » differences may be enduring (immobility) • competitive advantage stems from resources and capabilities that meet the VRIO criteria 3 -36
End Segment 3 3 -37
Segment 4 How to find resources 3 -38
Assessing a Company’s Resources and Capabilities: The Case of Ole Miss RESOURCES Importance UM’s relative strength CAPABILITIES Importance UM’s Relative Strength R 1. Finances 6 6 C 1. Student recruitment 9 4 R 2. Location 7 5 C 2 Course development 7 5 R 3. Brands 8 8 C 3 Teaching 7 9 C 4 Student placement 8 4 C 5 Alumni relations 6 9 C 6 Corporate relations 4 4 C 7 Research 7 4 C 8 Administration 4 8 Both scales range from 1 to 10 (1= very low, 10= very high) Note: Don’t get all defensive on any of these numbers, they are drawn at random 3 -39
Appraising UM’s Resources and Capabilities (Hypothetical only) 10 Key Strengths Superfluous Strengths Relative Strength C 3 R 3 C 8 R 1 R 2 C 2 5 C 6 Zone of Irrelevance 1 1 C 4 C 1 C 7 C 5 Key Weaknesses 5 10 Strategic Importance 3 -40
Appraising the Capabilities of a Business School (illustrative only) IMPORTANCE + Superfluous strength + Key strength R 1, R 3, C 3 C 8 RELATIVE STRENGTH Inconsequential weaknesses Key weaknesses C 1, C 4, C 5, C 7 C 6 3 -41
Honda Technical Research Institute founded The Evolution of Honda Motor Company motorcycle: 98 cc, 2 -cycle Dream D 4 cycle engine 1 st gasoline-powered car to meet US Low Emission Vehicle Standard Portable generator 1 st 1946 1950 4 -cylinder 750 cc motorcycle Competes in Isle of Man TT motorcycle races Power products: ground tillers, marine engines, generators, pumps, chainsaws snowblowers 405 cc motor cycle 1955 1960 The 50 cc Supercub 1965 1970 1975 1980 Enters Formula 1 Gran Prix racing Civic GS (natural gas powered) 1985 1990 1995 Acura Car division N 360 mini car Honda Civic First product: Model A clip-on engine for bicycles Civic Hybrid (dual gasoline/ electric) 1000 cc Goldwing touring motor cycle 2000 Home cogeneration system Enters Indy car racing Honda FCX fuel cell car 3 -42
Internal Analysis Tells us: • what the firm should do, given the relative strengths and weaknesses of resources and capabilities Managers’ Job: • bundle resources and capabilities to achieve competitive advantage VRIO Framework Helps Managers Recognize Sources of Competitive Advantage 3 -43
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