Chapter 3Examining the Internal Context of Strategy

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OBJECTIVES

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2

3

4

5

Explain the internal context of strategy

Identify a firm’s resources and capabilities and explain their role in its performance

Define dynamic capabilities and explain their role in both strategic change and a firm’s performance

Explain how value‑chain activities are related to firm performance and competitive advantage

Explain the role of managers with respect to resources, capabilities, and value‑chain activities

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COMPARATIVE INDUSTRY REFORMANCE

How dosuch differences in profitability materialize?

ROA

ROS

Grocery Store

Global AutoSemiconductor

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TWO THEORIES FOR HOW AND WHY SOME FIRMS PERFORM BETTER THAN OTHERS

A firm’s resources and capabi-lities determine performance

Success issues from fundamental differences in what firms own and what they can do

A firm’s activities determine performance

Success is driven by a firm’svalue chain activities:How it configures these activities to add more valuethan competitors

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RESOURCES, CAPABILITIES, AND MANAGERIAL DECISIONS

StrategyCompetitive advantage/disadvantage

Management strategic decision making

Capabilities

Managers

Resources

Performance

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RESOURCES AND CAPABILITIES: FUNDAMENTAL BUILDING BLOCKS OF STRATEGY

The inputs that firms use to create goods and services• Undifferentiated or firms-specific • Tangible or intangible• Easy to acquire or difficult

A firm’s skill in using its resources to create goods and services. The combination of procedures and expertise that the firm relies on to engage in distinct activities in the process of producing goods and services

Capabilities

(competencies

)

Resources

Strategy

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EXAMPLES OF CAPABILITIES

1: Stalk, Evans, and Shulman, 19922: Makadok, 2003

Capability Result

Logistics -- distributing vast amounts of goods quickly and efficiently to remote locations

An extraordinarily frugal system for delivering the lowest cost structure in the mutual fund industry, using both techno-logical leadership and economies of scale

Generating new ideas then turning those ideas into new, profitable products

200,000-percent return to share-holders during first 30 years since IPO1

25,000-percent return to share-holders during the 30-plus year tenure of CEO John Connelly.2

As for ongoing expenses, share-holders in Vanguard equity funds pay, on average, just $30 per $10,000, vs. a $159 industry average. With bond funds, the bite is just $17 per $10,000

30 percent of revenue from products introduced within the past four years

Company

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THE VRINE MODEL

Performance implicationTest Competitive implication

Valuable? Does the resource or capability allow the firm to meet a market demand or protect the firm from market uncertainties?

If so, it satisfies the value require-ment. Valuable resources are needed just to compete in the indus-try, but value by itself does not convey an advantage

Valuable resources and capabilities convey the potential to achieve “normal profits” (i.e., profits which cover the cost of all inputs including the cost of capital)

Rare? Assuming the resource or capability is valuable, is it scarce relative to demand? Or, is it widely possessed by most competitors?

Valuable resources which are also rare convey a competitive advant-age, but its relative permanence is not assured. The advantage is likely only temporary

A temporary competitive advantage conveys the potential to achieve above normal profits, at least until the competitive advantage is nullified by other firms

Inimitable and non-substitut-able?

Assuming a valuable and rare resource, how difficult is it for com-petitors to either imitate the resource or capability or substitute for it with other resources and capabilities that accomplish similar benefits?

Valuable resources and capabilities which are difficult to imitate or substitute provide the potential for sustained competitive advantage

A sustained competitive advantage conveys the potential to achieve above normal profits for extended periods of time (until competitors eventually find ways to imitate or substitute or the environment changes in ways that nullify the value of the resources)

Exploit-able?

For each step of the preceding steps of the VRINE test, can the firm actually exploit the resources and capabilities that it owns or controls?

Resources and capabilities that satisfy the VRINE requirements but which the firm is unable to exploit actually result in significant opportu-nity costs (other firms would likely pay large sums to purchase the VRINE resources and capabilities). Alternatively, exploitability unlocks the potential competitive and perfor-mance implications of the resource or capability

Firms which control unexploited VRINE resources and capabilities generally suffer from lower levels of financial performance and depressed market valuations relative to what they would otherwise enjoy (though not as depressed as firms lacking resources and capabilities which do satisfy VRINE)

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Value: A resource or capability is valuable if it allows a firm to take advantage of opportunities or to fend off threats in its environment

THE VRINE MODEL: VALUE

Union Pacific Railroad’s rail system is a tangible resource that allows UP to compete with other carriers in the long-haul transportation of a variety of goods

• Maintain an extensive network of rail-line property and equipment on the U.S. Gulf cost

• Operates in the western two-third of the United States serving 23 states, linking every major West Coast and Gulf Coast port, and reaching east through major gateways in Chicago, St.Louis, Memphis, and New Orleans

• Also operates in key north-south corridors

• The only U.S. railroad serving all six gateways to Mexico

• Interchanges traffic with Canadian rail systems

Example

Definition

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THE VRINE MODEL: RARITY

Example

When McDonald’s signs an agreement to build a restaurant inside a Wal-Mart store, it has an intangible advantage over Burger King that is valuable and rare

A useful resource or capability that is scarce relative to demand.

Valuable resources that are available to most competitors (i.e., that are not rare) simply allow firms to achieve parity

Definition

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Example

THE VRINE MODEL: INIMITABILITY AND NON-SUBSTITUTABILITY

Barnes & Noble’s large store network gave it access to customers and purchasing power that was inimitable …

… but Amazon.comfound a substitute

Definition

• A resource or capability is inimitable if competitors cannot acquire the valuable and rare resource quickly, or face a disadvantage in doing so

• It is non-substitutable if a competitor cannot achieve the same benefit using different combinations of resources and capabilities

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TANGIBLE AND INTANGIBLE ADVANTAGES

=

=

=

Intangible

Location selection

Brand

Tangible

Rural real-estate

High traffic real-estate

+

+

+

Wal-Mart

McDonald’s

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THE VRINE MODEL: EXPLOITABLITY

Novell: “I walk down Novell hallways and marvel at the incredible potential for innovation here, but Novell has had a difficult time in the past turning innovation into product in the market place”

- CEO Eric Schmidt

Xerox: Xerox invented the laser printer, Ethernet, graphical-interface software and computer mouse but could not capitalize on these

Example

A resource of capability that the organization has the capability to exploit (i.e., the capability to generate value from)

Definition

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HOW WOULD YOU DO THAT?

Inimitable andnon-substitutable?

Can competitors imitate?Can they substitute?

Exploitable? Can Pfizer exploit?

Rare? Do Pfizer's patents provide “rarity”?

Valuable?Do patents on Zoloft ®provide value?

Pfizer’sZoloft ®

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STOCK AND FLOW OF CAPABILITIES

Capability

Stock

Flow

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DYNAMIC CAPABILITIES

Mail Boxes Etc. franchise

Value

Dynamic capability: how we integrate recon-figure, acquire, or divest resources for competitiveadvantage?

Mail boxes, etc., has developed the ability to

combine resources better

than the competition

Start-up plans

People

Brand

Location

Processes

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VALUE CHAIN: INTERNET STARTUP EXAMPLE

Inbound shipment of top titles

Warehousing

Server operations

Billing

Collections

Picking and shipment of top titles from warehouse

Shipment of other titles from third- party distributors

Pricing

Promotions

Advertising

Product information and reviews

Affiliations with other websites

Returned items

Customer feedback

CDsShipping

ComputersTelecom lines

Shipping services

Media

Inventory system

Site software

Pick & pack procedures

Site look & feelCustomer research

Return procedures

Financing, legal support, accounting

Recruiting, training, incentive system, employee feedback

Procurement

TechnologyDevelopment

HumanResources

FirmInfrastructure

SupportActivities

InboundLogistics

Operations OutboundLogistics

Marketing& Sales

After-Sales Service

Primary Activities

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USING VALUE CHAINS TO GAIN COMPETITIVE ADVANTAGE

Identical DifferentiatedFind a different way to perform activities

Find a better way to perform the same activities

Longer-lasting advantage

Shorter-term advantage (competitors catch up)

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TRADE OFF PROTECTION YOUR RIVALS CHOOSE NOT TO COPY YOU

Selected difference between Southwest and large Airlines

Southwest made choices so that competitors did not copy - because copying would require them to abandon activities essential to their strategies

Technologyand design

Operations

Marketing

Southwest

• Single aircraft

• Short segment flights

• Smaller markets and secondaryairports in major markets

• No baggage transfers to others airlines

• No meals

• Single class of service

• No seat assignments

• Limited use of travel agents

• Word of mouth

Major Airlines

• Multiple types of aircrafts

• Hub and spoke system

• Meals

• Seat assignments

• Multiple classes of service

• Baggage transfer to other airlines

• Extensive use of travel agents

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RESULTS OF TRADE OFF PROTECTION

Airline

AirTran

Alaska

American

AmericaWest

Continental

Delta

JetBlue

Northwest

Southwest

United

US Air

2004 Revenue($000,000)

279

656

4,541

579

2,397

3,641

334

2,753

1,655

3,988

1,660

2004 Cost of Available Seat Miles (CASM)

8.42

10.03

9.72

7.81

9.49

10.23

6.03

10.31

7.77

10.16

11.34

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INNOVATION AND INTEGRATION OF THE VALUE CHAIN

  

Transferred assembly and delivery to the consumer

Choose an entirely direct distribution model (rather than through retailers) and outsourced component manufacturing

IKEA

Dell

Source

Assemble

Deliver

Area of innovation

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STRATEGIC LEADERSHIP

“Companies that overlook the role of leadership in the early phases of strategic planning often find themselves scrambling when it’s time to execute. No matter how thorough the plan, with-out the right leaders it is unlikely to succeed”

– McKinsey & Company

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SENIOR VS. MIDDLE MANAGERS

Senior

Middle

Decide how to use other resources and capabilities, configure their firm’s value-chain activities, and set the context which determines how front-line and middle managers can add value

Are better positioned than senior managers to contribute to competitive advantage and firm success in four areas• Entrepreneurship• Communications• Psychoanalyst• Tightrope walker

Source: Quy Nguyen Huy

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SUMMARY

1

2

3

4

5

Explain the internal context of strategy

Identify a firm’s resources and capabilities and explain their role in its performance

Define dynamic capabilities and explain their role in both strategic change and a firm’s performance

Understand how value‑chain activities are related to firm performance and competitive advantage

Explain the role of managers with respect to resources, capabilities, and value‑chain activities

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BLANK SLIDE

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