Internat Situation Analysis:Evaluating a Company'sResources, Costand Competitive

Positio n,Stre n gth

Chapter Learning Objectives

LOl. Understand how to evaluate a company's internal situation, inctudingits collection of competitively vatuabte resources and capabilities.

LOz. Grasp how and why activities performed internally by a company and

those performed externally by its supptiers and fonryard channel alliesdetermine a company's cost structure and abitity to competesuccessfully.

LO3. Learn how to evatuate a company's competitive strength relative tokey rivals.

LO4. Understand the role and importance of industry and competitiveanalysis and internat situation analysis in identifuing strategic issuescompany managers must address.

Chapter 4, Internal S¡tuation Analysis

In Chapter 3 we described how to use the tools of industry and competitiveanalysis to assess a company's external environment and lay the groundworkfor matching a company's strategy to its external situation. In this chapter wediscuss the techniques of evaluating a company's internal srtuation, includingits collection of valuable resources and capabilities, its relative cost position,and its competitive strength versus its rivals. The analytical spotlight will betrained on five questions:

1. How well is the company's shategy working?

2. What are the company's competitively important resources andcapabilities?

3. Are the companv's prices and costs competitive?

4. Is the company competitively stronger or weaker than key rivals?

5. What strategic issues and problems merit front-burner managerialattention?

The answers to these five questions complete management's understandingof "Where are we nozu?" and position the company for a ¡;ood strategy situ-ation fit required of t}:te "Three Tests of a Winning Strategy" (see Chapter 1,

page 9).

Question r: How Wett ls the Compant'sStrategry Working?The two best indicators of how well a company's strategy is working are(1) whether the company is achieving its stated financial and strategic objec-tives and (2) whether the company is an above-average industry performer.Persistent shortfalls in meeting company performance targets and -,t'eak per-formance relative to rivals a¡e ¡eliable warning signs that the company suffersfrom poor strategy making, less-than-competent strategy execution, or both.Other indicators of how n,ell a company's strategy is working include:

. Trends in the cornpany's sales and earnings growth.

. Trends in the company's stock price.o The company's overall financial strength.. The company/s customer retention rate.

. The rate at which new customers are acquired.

. Changes in the company's image and reputation with customers.

. Evidence of improvement in internal processes such as defect rate, orderfulfillrnent, delivery times, davs of inventory, and employee productivity.

The stronger a company's current overall performance, the less likely theneed for radical changes in strategy. The n'eaker a company's financial per-formance and market standing, the more its current strategy must be ques-tioned. (A compilation of financial ratios most commonly used to evaluate a

company/s financial performance and balance sheet strength is presented inthe Appendix on pages 240-247).

Core ConceDts and AnalvticaI Tools

Question z: What Are the CompanfsCompetitively lmportant Resourcesand Capabitities?As discussed in Chapter 1. a company's business model and strategy mustbe well-matched to its collection of resources and capabilities. An attemptby management to create and deliver customer value in a manner that

depends on resources or capabilities that are deficient

A resource-based strategy uses a company's and cannot be readily acquired is unr'r'ise and posi-valuable and rare resources and competitive tions the comPany for failure. A company's compcti-capabilities to deliver value to customers in tive approach requires a tight fit n'ith a company'sways rivals frnd it diffrcult to match. internal situation and is strengthened when it expkrits

resources that are competitively valuable, rare, hardto copy, and not easily trumped by rivals' equivalent substitute resources. Infact, many companies pursue resource-based strategies thnL nttentpt to exploitcompmul resources in a mnnner that offers onlue to cLtstofircrs in unys rianls are

tmable to ¡natch.t

For example, a company pursuing a cost-based advantage might investirr super-efficient distribution centers that give it the capability to distributeits products at a lower cost than rivals. Walmart is well-known for its low-cost distribution anci its distribr-rtior-r efficiencv is one factor in its abilit_v tounderprice rivals. Over a period of more than a decade, Dell has put consider-able time and money into cultivating relationshíps with its key suppliers thatgive it unmatchcd supply chain capabiLities. Real-time information sharingbetween Dell and its suppliers allows many Dell plants to operate with onlvseveral hours'inventory of certain parts and components because the sup-pliers have online access to Dell's daily production scheclule. Competitivelyvaluable resources and capabilities can also facilitate differentiation in themarkctplacc. Bccause Fox News and CNN have the capability to devote moreair time to breaking news storics and gct rcportcrs on the scenc vcry quicklycompared to the major networks like ABC, NBC, and CBS, manv vievt,ers turnto the cable networks when a major news event occurs.

'ln the past decade, thereb been considerable research into the role a companV's resourcesand competitive capabilities play in crafting strategy and in determining company profitab¡llty.The findings and conclusions have coaLesced into what is caLted the resource-based view of thefirm. Among the most insightful publications on the topic are Birger Wernerfelt, 'A Resource-

Based View of the Firm," Strateg¡c Monagement lournd¿ Septem ber-October 1984, pp. 1/1-180;lay Barney, "Firm Resources and Sustained Competitive Advantage," lournol of Monagenent 17,

no. r (199r), pp. 99 1,2oi Margaret A. Peteraf, "The Cornerstones of Competitive Advantage: AResource Based View," Strategic Monogement Journdl, March ry93, pp. r7g-rgt¡ EirgerWernerfelt, "The Resource-Based View of the Firm: Ten Years After," Strotegic Monogement

Journal 16 (r99S), pp. 171-77 + )ay B. Barney, "Looking Inside for Competitive Advantage,"Academy of Management Executive 9, no. 4 (Novembet \995J, pp.49 ó1; Christopher A. Bartlettand Sumantra Ghoshal, "Building Competitive Advantage through People," MIT Sloon Monoge-ment Review 43, no 2, (Winter zooz), pp.34-411 Danny MilLer, Russell Eisenstat, and Nathan¡elFoote, "Strategy from the Inside 0ut: Buitding CapabiLity-Creating 0rganizations," CalifornioMonogement Review 44, no. 3 (Spring zooz), pp. )7-54; and Jay B. Barney and DeLwyn N. CLark,

Resource-Based Theory: Creoting and Susta¡n¡n9 Competitive Advontage (New York: OxfordUn¡versity Press, 2oo7).

Situation Analysis

ldentiffing Com petitively lmportantResources and CapabilitiesCommon types of valuable resources and competitive capabilities that man-agement should consider when crafting strategy include :

. A skill, specialized expertise, or competitiaely important capability----examplesinclude skills in low-cost operations, proven capabilities in creating andintroducing innovative products, cutting-edge supply chain managementcapabilities, expertise in getting ¡gw products to rnarket quickly, andexpertise in providing consistently good customer service.

. Valuable physical assets-such as state-of-the-art plants and equipment,attractive real estate locations, or ownership of valuable natural resourcedeposits.

. Valuable human assets and intellectual capital-an experienced and capableworkforce, talented employees in key areas, collective learning embeddedin the organization, or proven managerial know-how.2

. Valuable organizational assefs-proven quality control systems, proprietarytechnology, key patents, and a strong network of distributors or retaildealers.

. Valuable intangible nssets-a powerful or well-known brand name orstrong buyer loyalty.

. Competitiz¡ely uahtable alliances or cooperatiue aentures-alliances or jointventures that provide access to valuable technologies, specialized know-how, or geographic markets.

Determining the Competitive Powerof a Company Resource

What is most telling about a company's aggregation of resources is howpowerful they are in the marketplace. The competitive power of a resource ismeasured by how many of the following four tests it can pass:3

'1. ls the resource really competitiaely oaluable? Al1 companies possess a collec-lion of resources and capabilities-some have the potential to contributeto a competitive advantage while others may not. Apple's operating

'Many business organizations are coming to view cutting-edge knowledge and the intellectuairesources of company personne[ as a valuable competitive asset and have concLuded that explicitlymanaging these assets is an essential part of their strategy. See Michael H. Zack, "Devetoping aKnowledge Strategy," Col¡forn¡a Monagement Review 47, no. 3 (Spring 1.99qD, pp. r25-r45i andShaker A. Zahra, Anders P. Nielsen, and William C. Bogner, "Corporate Entrepreneursh¡p, KnowLedge,

and Competence Development," Entrepreneurship Theory and Proct¡ce, Spring ry99, pp. 169-189.r See Jay B. Barney, "Firm Resources and Sustained Competitive Advantage,' Journol of Manoge-

ment 17, no. r (rgqr), pp. ro5-ro9; and lay B. Barney and DeLwyn N. Clark, Resourre-Bosed

Theory: Crcoting and Susta¡ning Compet¡tive Advantdge (New York: Oxford University Press,

2oo7). Atso see M. A. Peteraf, "The Cornerstones of Competit¡ve Advantage: A Resource-Based

view," Stroteg¡c Monagement lournol q 09gi, pp.77g 797i and David J. Cotlis and Cynthia A.

Montgomery "Compet¡ng on Resources: Strategy in the r99os," Horvord Business Review 73,no. 4 oufy-August 1995), pp. r2o-123.

and Analytica I Tools

system for its Maclntosh PCs is by most accounis a world beater(compared to Windows Vista) but Apple has failed miserably in convert-íng its resource strength in operating system design into competitivesuccess in the global PC market.

2. ls the resoLLlce rnre is it something riuals Inck? Companies have to guardagainst pridefully bclieving that thcir collcction of rcsourccs and compcti-tive capabilities is more powerful than that of their rivals. Who can reallysay whether Coca-Cola's consumer marketing prowess is better thanPepsi-Cola's or whether the Mercedes-Benz brand name is more powerfulthan that of BMW or Lexus? Although many retailers clarm to be quite pro-ficient in product selection and in-store merchandising, a number nur intotrouble in the markeplace because they encounter rivals whose capabili-ties in product selection and in-store merchandising are equal to or betterthan theirs.

3. Is the resolrrce hard to copy or imitate? The more difficult and more expensiveit is to imitate a company's resource or capability, the greater its potentialcompetitive value. Resources tend to be difficult to copy when they areunique (a fantastic real estate location, patent protection), when they mustbe built over time (a brand name, a strategy suppi;rtive organizational cul-ture), and when thev carrv big capital requirements (a cost-effective plantto manufacture cutting-edge microprocessors). Walmart's competitorshave failed miserably in their attempts over the past two decades to matchits state-of-the-art dishibution capabilities.

4. Cnn the resource be trumped b'r¡ substitute resource strengths and competitíaecnpnbilities? Resources that a¡e competitively valuable, rare, and costly toimitate lose their ability to offer competitive advantage if rivals possessequivalent substitute resources. For example, manufacturers relying onautomation to gain a cost-bascd advantagc in production activitie s mayfind their technology-based advantage nullified by rivals' use of low-rn age offshore manufacturing. Resources can contribute to a competitiveaclvantage only u'hen resource substitutes don't exist.

Understanding the nature of competitively important resources allowsmanagers to id.entify resources or capabilities that should be further de"'el-oped to play an important role in the company's future strategies. In addition,management may determine thai it doesn't possess a resource that indepen-dently passes all four tests Listed here with high marks, but does have a bundleof resources that can be leveraged to support its business model and strategy.Although Nike's resources dedicated to research and development, marketingresearch, and product design are matched relatively well by rival adidas, itscross-functional design process allows it to set the pace for innovation in ath-letic apparel and footwear and consistently outperform adidas and other rivalsin the marketplace. Nike's footwear designers get ideas for new performancefeatures from the professional athletes who endorse its products and thenwork alongside footwear materials researchers, consumer trend analysts, colordesigners, and marketers to design new models that are presented to a reviewcommittee. Nike's review committee is made up of hundreds of i¡rdividualswho evaluate protolvpe details such as shoe proportions and color designs,

ChapteFl lnternal Situation Anatysis

the size of the s\ 'oosh, stitching patterns, sole color and tread pattern, andinsole design. About 400 models are approved by the committee each year,which are sou¡ced from contract manufacturers andmarketed in more than 180 countries. The bundling of Comoanies that lack a stand-atone resourceNike's professional endorsements, R&D activities, that is compeütively powerful may nonethelessmarketing research efforts, styling expertise, and man- develop a competitive advantage through

agerial know-how has become an important source of bundled resources.

the company's competitive advantage ar-rd has allowedit to remain number one in the athletic footwear and apparel industry for morethan 20 years.

Resource-based strategies can also be directed at eroding or at least neutral-izing the competitive potency of a particular rival's resourccs and capabiliticsby ídentifying and developing substitute resources to accomplish the samepurpose. For examplc, Amazon.com lacks a big netr,r'ork of retail stores to com-pctc with those operated by rival Barnes & Noble, but Amazon's much larger,readily accessible, and searchable book inventory-coupled with its shortdeliverv times and free shipping on o¡ders over $25-are more attractive to many busy consume¡s than visit- Rather than try to match the resources anding a big-box bookstore. In other words, Amazon has capabilities possessed by a rival company, a

carefully and consciously developecl a set of competi- company may develop entirely different

trvely valuable resources that are proving to be effec- resources and capabil¡ties that substitute for

tive substitutes for competing head-to-head against the sbengths of the rival.

Barnes and Noble without having to invest in hundredsof brick-and-mortar retail stores. Whereas manv cosmetics companies sell theirproducts through department stores and specialty retailers, Avon and MaryKay Cosmetics have substituted for the lack of a retail dealer netr'r'ork byassembling a direct sales force numbering in the hundreds of thousancls-theirsales associates can personally demonstrate products to interested buyersin their homes or at parties, take orders on the spot, and deliver the items tobuvers'homes.j

Resources and Capabilities as the Foundationof Competitive AdvantageOne of the most important aspects of identifying resources and capabilitiesthat can become the basis for competitive advantage has to do with a compa-nv's competence level in performing key pieces of its business-such as sup-ply chain management, R&D, production, distribution, sales and markcting,and customcr service. A company's proficiency in conducting different facetsof its operations can range from merely the abilit¡r to perform an activity to acompetence, core competence, or distinctive competence:

'1. A competence is an internal activity an organization performs with pro-ficiency. Some competencies relate to fairly specific skills and expertise(like just-in-time inventory control or picking locations for new stores)and may be performed in a single department or organizational unit.

4 For a more detailed discussion, see George Stalk, Philip Evans, and Lawrence E. Schulman,"Competing on Capabitities: The New Rules of Corporate Strategy," Horvord Business Review 7o,no. z (March-April ry92), pp. 57-69.

A competence is an activity that a company

oerforms well.

A core competence is a competitivelyimportant activity that a company performs

better than other internal activit¡es.

Part One: Section B: Core Conceots and Analvtical Tools

Other competencies, hon'ever, are inherently rnultidisciplinary andcross-functional. A competence in continuous product innovation, for

example, comes from the bundled efforts of peopleand groups with expertise in market research, newproduct R&D, design and engineering, cost-effectivemanufacturing, and market testing.

2. A core competence is a proficiently performed internal acti",ity thatís central to a company's strategy and competitiveness. A core competenceis a highly valuable capability because of the contribution it makes to thecompany's success in the marketplace. A company may have more thanone core competence in its resource portfolio, but rare is the company thatcan legitimately claim more than tw-o or three core competencies. Most

often, a clre cofitpeteflce is kttowledge-hased, residing íttpeople nnd in n company's intellectual capitnl and not in itsnsscts ott tlrc balance sfte¿1. Moreovet a core competenccis morc likely to bc groundcd in cross-departmcntcombinations of knowledge and expertise rather than

being the product of a single department or r,r'ork group. Facebook has acore competence in anticipating features that will appeal to Internet userswho maintain social netu'orking sites. The ability of Internet users toshare information, photos, videos, and interesting news stories withfriends and others made Facebook the world's largest social net\4.orkingsite as of 2009 with more than 90 million unique visitors each month.

3. A distinctive competence is a competitively valuable activity that a com-pany performs better than its riaals. Bccause a distinctivc competcncc rcprc-sents a uniquely strong capability relative to rival companies, it has

significant competitive advantage potential This is particularly true whenthe distinctive comDetence enables a comDanv to deliver standout value to

customers (in the form oilo*"r prices or better prod-

A distinctive competence is a competitively uct Performance or suPerior service). Toyota has

important activity that a company performs worked diligently over several decades to establish a

better than its rivals-therefore offering the distinctive comPetence in low-cost, high-quality man-potenüal for competitive advantage. ufacturing of motor vehicles; its "lean production"

system is far superior to that of any other automaker'sand the company is pushing the boundaries of its production advantagewith a new Global Body assembly line. Toyota's Global Body assemblyline costs 50 percent less to install and can be changed to accommodate a

new model for 70 percent less than its previous production system.5 Theconceptual differences between a competence, a core competence, and adistinctive competence draw attention to the fact that a company'sresources and competitive capabilities are not all equal.n Strme capabilities

5 George Stalk, lr and Rob Lachenauer, "Hard BalL: Five Killer Strategies for Trouncing the

Competition," HoNotd Eusiness Review 82, no. 4 (April zood, p. 65.6 For a more extensive discussion of how to identifu and evaluate the comDetitive oower of acompany's capabilities, see David W. Birchall and George Tovstiga, "The Strateg¡c Potential of a

Firm's Knowledge Portfol¡o," Journal of General Management 25, no. 1 (Autumn 1'999), pp. r-16;and David Teece, "Capturing Value from Knowledge Assets: The New Economy, Markets for Know-

How, and Intangibl€ Assels," Califomio Manoqement Review 4o, no. 3 (Spring 1998), pp. 55 79.

Chapter 4, Internal Situation Analysis

and competencies merely enable marke t survival because most rivals havethem. Core competencies are competitiaely more important than competen-cies because they add power to the company's strategy and have a biggerpositive impact on its market position and profitability. Distinctive compe-tencies are even more competitively important. A distinctive competence is

competitivelv potent for three reasons: (1) It gives a company comPeti-tively valuable capability that is unmatchetl by rivals, (2) it has potentialfor being the cornerstone of the company's strategy, and (3) it can producea competitive edge in the marketplace.

Taking Inventory of a Compant's lnternal ResourceStrenglhs and Weaknesses and lts ExternalOpportunities and Threats

An appraisal of a company's resource strengths and weaknesses can be cou-pled with a listing of external opportunities and threats to provide an ovcr-view of the company's overall situation. Such an

assessment, commonly known as SWOT analysis, SWOT analysis is a simple but powerful tool

provides the basis for crafting a strategy that capital- gths

izes on the company's strengths, aims squarcly at cap-

turing the company/s best opportunities, and defends lls

againit the threats io its well-being. future wellóeing'

IDENTIFYING COMPANY RESOURCE STRE\GTHS ANI) CORICOI\'ll'L I E\CIES A company's resource strengths reprcsent its competi-ti\-e assets and determine whether its competitivc Power in the marketplacern il1 be impressivelv strong or disappointingly weak. A company that is well-endowed with potent resource strengths and core competencies normallyhas considerable competitive powcr-especially when its management teamskillfully utilizes the company's resources in ways that build sustainablecompetitive advantagc. Companies with modest or weak competitive assets

nearly always are relegated to a trailing position in the industry. Table 4.1 liststhe kinds of factors to consider in compiling a company's resource strengthsand weaknesses.

II)FNTTFYINC CON,IPA\JY RISOURCE IVEAKNESSES AI\D CON4-f't.TITIVI DLf ICIINCIES A resource weakness or competititte liobility is

something a companv lacks or does poorly or a condition that puts it ata disadvantage in the marketplace. As a rule, strategies that place heavydemands on areas where the company is weakest or has unproven abilityare suspect and should be avoided. A companY's resource 'it'eaknesses canrelate to:

. lnferior or unproven skills, expertise, or intellectual capital in competi-tively important areas of the business.

. Deficiencies in competitively important physical, organizational, or intan-gible assets.

. Missing or competitively inferior capabilities in key areas.

Part One: Section Core Conceots and Analvtical Tools

Table 4.1

Potential Resource Strengths and Competitive Capabilities. Core competencies in _. A strong frnancial condition; amplc frnancial resources to grow the business.. Strong brand name image/company reputation.. Economy of scale and/or learning and experience curve advantages over rivals.o Proprietary technology/superior technological skills/important patents.. CLr5t ddvanldg,es t.rver riv¿ls.. Product innovation caoabilities.. Proven capabrlitics rn improving production processes.. Cood supply chain management capabilities.. Cood customer service capabilities.. Better product quality relatrve to rivals.. Wide geographic covcrage and/or strong global distribution capabiliry.. Alliances/ioint ventures with other lirms that provide access to valuable

technology, competencies, and/or attractive geographic markets.

Potential Market Opportunities. Serving additional customer groups or market segments.. Expanding ¡nto new geographic markets.. Expanding the company's product Iine to meet a broader range of customer

needs.. UtilizinB existing companv skills or technological know-how to enter ncw product

lines or new businesses.. Falling trade barncrs in attract¡ve foreign markets.. Acquiring rival firms or companies rvith attractive technological expertise or

capatril¡t¡es.

Potential Resource Weaknesses and Competitive Defi ciencies. No clear stratesic d¡rcction.o No lvell-develóped or proven core compelencies.. A lveak balance sheeq burdened rvith tc-¡o much debt.. Higher overall uniI costs relative to key compet¡tors.. A produc/serv¡ce w¡th features and attributes that are inferior to thosc of rivals.. Too narrow a product line relative to rivals,. Weak brand image or rcputation.. Weakcr dealer network than key rivals.o Behind on product quality, R&D, and/or technological know-how.. Lack of management depth.. Short on financial resources to gro$,the business and pursue promising in¡ti¿t¡ves.

Potential ExternalTh¡eats to a Company's Future Prospectso Increasing intensity of compet¡tion among industry rivals-may squeeze profit

marSrns.. Slowdowns in market growth.. Likely entry oÍ potent new compct¡tors.o Crowing bargaining power of customers or suppliers.o A shift in buyer needs and tastes away from the industry's product.. Adverse demographic changes that threaten to curta¡l demand for the industry's

prooucL. Vulnerability to unfavorable industry drivrng iorces.. Restrictivc trade policies on the part of ioreign governments.o (lostl,v new regulatory requirements.

Nearly all companies have competitive liabilities of one kind or another.Whether a company's resource weaknesses make it competitively vulnera-blc depends on hon' much they matter in the market-place and whether they are offset by the company's A company's resource strengths representresource strengths. Sizing up a company's comple- Cqmpet¡tive assets; its resource weaknessesment of resource capabilities and deficiencies is akin represent competit¡ve liab¡l¡ties.

tcr constructin g a strntegic bnlance sheet , where resourcestrengths represent competitiae assels and resource weaknesses representcompet itiT)e I inb il ities.

lD[\TIFYING A CON'IPANY'S N'IARKFT OPPORTUNITIES Marketopportunity is a big factor in shaping a company's stuategy. Indeed, man-agers can't properly tailor strategy to the company's situation without firstidentifying its market opportunities and appraising thc growth and profitpotential each one holds. (See Table 4.1, under "Potential Market Opportu-nities.") Depending on the prevailing circurnstances, a company's oppor-tunities can be plentiful or scarce and can range from wildly attractive tounsuitable.

In evaluating the attractiveness of a company's market opportunities, man-agers have to ¡;uard against viewing every irrdustry opportunity as a suitableopportunity. Not every company is equipped with the resources to success-

fully pursue each opportunity that exists in its industrv. Some companies aremore capable of going after particular opportunities than others. The market

opportunities most releuant to c company are those thnt match up uell with the com-

pnny's financial and organizntional resources and cnpabilities, ffir the best growthand profitability, and present the ntost potential for competitiae aduantage.

IDENTIFYING THI{EATS IO A CON4PA\IY'S FUTURE PROFITABILITYOften, certain factors in a company's external environment pose ¡Ll*edfs to itsprofitability and competitive well-being. Threats can stem from the emergenceof cheaper or better technologies, rivals' introduction of new or improvedproducts, the entry of lower-cost foreign compctitors into a company's marketstronghold, new regulations that are more burdensome to a company thanto its competitors, vulnerability to a rise in interest rates, the potential of ahostile takeover, unfavorable demographic shifts, or adverse changes in for-eign exchange rates. (See Table 4.1, under "Potential External Threats to a

Company's Future Prospects. ")External threats may pose no more than a moderate dcgree of adversity

or thev may be so imposing as to make a company's situation and outlookquite tenuous. On rarc occasions, market shocks can throw a company intoan immediate crisis and battle to survive. Many of the world's major airlineshave been plunged into unprecedented financial crisis because of a combina-iion of factors: rising prices for jet fuel, a global economic slowdown that hasaffected business and leísure travel, mounting competition from low-fare car-riers, shifting travelcr prefcrences for low fares as opposed to lots of in-flightamenities, and "out-of-control" labor costs. lt is management's job to identifythe threats to the company's future prospects and to evaluate what strategicactions can be taken to neutralize or lessen thei¡ imoact.

Part One: Section B: Core Concepts and Anatytical Tools

THE VALUE OI A 5\.{OT ANALYSIS A SWOT analysis involvcs morcthan making four lists. The most important parts of SWOT analysis are:

lSimply making lists of a company's strengths,

weaknesses, opportunities, and threats is not Z.enough; the payoff from SWOT analysis comes

from the conclusions about a company's

sifuation and the implications for strategy¡morovement that flow from the four lists.

I)rawing conclusions from the SWOT listingsabout the company's overall situation.

Translating thcsc conclusions into strategic actionsto better match the company's strategy to itsresource stren¡;ths and market opportunities,correcting problematic weaknesses, and defend-ing against worrisome exte¡nal threats.

Question 3: Are the Company's Costsand Prices Competitive?Company managers are often stunned r¡'hen a competitor cuts its prices to"unbelievably low" Ievels or when a new market entrant comes on strongwith a vcty low pricc. The competitor may not, however, be buying its wayinto the market with super-low prices that are below its costs-it may sim-ply have substantially lower costs. One of the most telling signs of whether a

company's business position is strong or precarious is whether its prices andcosts are competitive with industry rivals.

Price and cost comparisons are especiallv critical in indnstries where pricecompetition is typicallv the ruling market force. But even in industries whereproducts are differentiated, rival companies have to keep their costs in iinewith rivals offering a similar mix of differentiating featurcs. Tvr'o analyticaltools are particularly useful in determining u,hether a company's prices andcosts are competitive: value chain analysis and benchmarking.

Company Value ChainsEvery company's business consists of a collection of activities undertaken inthe course of designing, producing, marketin¡J, delivering, and supporting its

product or service. All of the various activities that a

A company's value chain identrfies the primary comPany performs internally combine to form a valueactiviües that create customer value and related chain, so-called because the rurderlying intent of a

support activities. company's activities is to do things that ulttmatelv cre-nte aalue for buyers. A company's value chain also

includes an allowance for profit bccausc it is customarily part of the pricc (ortotal cost) borne by buyers.

As shown rn Figure 4.1, a company's value chain consists of two broad cat-egories of activities: the primnry actiztities that are foremost in creating val-refor customers and the requisite support actiaities that facilitate and enhancethe performance of the primary activities.T For example, the primary activitiesfor a big box retailcr include me¡chandise selection and buying, store layoutand product display, advertising, and customer serwice; its support activities

/The value chain concept was developed and aftrculated bv professor M¡chael Porter at theHarvard Business SchooL and is descrlbed at greater length in Mich¿eL E. Pofte\ Compet¡t¡veAdvontoge (New York: Free Press, 1985), Chapters z and 3.

Chapter 4 Internal Situation Anatysis 8$

FI(;Ull

Pr¡maryArtiY¡ties

andCosts

SupportActiviiies

anoCosG

PRIMARY ACÍIVITIES

. Supply Chain Manat€ment-Act¡vities, costs, and assets associated with purchasing fuel, energy, ra$¿ mater¡als, parts and

components, merchandise, and consumable ¡tems from vendors; receiving, storing, and dissem¡nat¡ng inputs from suppliers;inspection; and inventory management.

. Opelations-Activ¡ties, costs, and assets assoclated with convert¡ng inputs into final product form (production, assembly,packaging, equipment ma¡ntenance, fac¡l¡ties, operations, quality assurance, environmental protection).

. Distributlon -Act¡v¡ties, costs, and assets deaL¡ng with physically distributing the product to buyers (finished goods

warehous¡ng, order processing, order picking and packing, sh¡pping, delivery vehicle operations, estabt¡shing and

maintain¡ng a network of dealers and d¡stributors).

. Sales and Market¡ng-Act¡vit¡es, costs, and assets related to sales fofce efforts, advertising and promotion, marketresearch and planning, and dealer/distr¡butor support.

. Service-Activities, costs, and assets associated with prov¡ding assistance to buyers, such as ¡nstatlat¡on, spare pans

delivery, ma¡ntenance and repa¡r, technical assistance, buyer inquiries, and compla¡nts.

SUPPORT ACTIVITIES

. Product R&D, Technology, and Systems Development Act¡vities, costs, and assets relating to ploduct R&D, process

R&D, process design improvement, equipmen¡ des¡gn, computer software development, telecommunications systems,computer-assisted design and engineering, database capab¡lities, and development of computer¡zed support systems.

. Human Resources Management Act¡v¡t¡es, costs, and assets associated with the recru¡tment, hiring, training,development, and compensation of all types of personnel; [abor relations activities; and development of knowledge-basedskills and core competencies.

. General Admin¡strat¡on-Activities, .osts, and assets relating to general management, accounting and f¡nance, legal and

regulatory affa¡rs, safety and security, management information systems, forming strategic alliances and collaborat¡ngwith strategic partners, and other "overhead" functions.

Source: tsased on the discussion n fi4rch¿el E. PotIet, Co¡tpet¡i¡ve Advontoge (NcN York: Free Press, 1985), pp 37-43.

include sitc selection, hiring and training, store mainten¿rnce, plLls the r-rsr-ral

assortmc.nt of admlnistrativc activities. A hotel chain's primarv aciivities an!-l

costs are mainlv comprised of reservations and hotel oPeratiolls (check-tnand check-out, maintenance and housekeeping, dining and roorn service, and

Part One: Section B: Core Conceots and Analvticat Tools

conventions and meetings); principal support activities include accounting,hiring and training hotel staff, and general administration. Supply chain man-agement is a crucial activrty for Nissan, L.L. Bean, and Petsmart but is not a

value chain component at Google or Bank of America. Sales and marketing aredominant activities at Proctcr & Camble and Sony but have minor roles at oildrilling companies and natural gas pipelinc companics. Whether an activityis classified as primarv or supporting varies with each company's businessmodel and strategy, so it is important to view the listing of the primary andsupport activities in Figure 4.1 as illustrative rather than definitive.

Benchmarking: A Too[ for Assessing Whethera Company's Value Chain Activities Are CompetitiveBenchmarking entails comparing how different companies perform various valuechain activities how materials are purchased, how inventories are managed,how products arc assembled, hort'customer orders are filled and shipped, andhow maintenance is performed and thcn rnaking cross-company comparisonsof the costs and effectiveness of these activities.E Thc objcctives of benchmark-ing are to identify the best practices in performing an activity and to emulatethose best practices when they are possessed by others.

Xerox became one of the first companies to use benchmarking in 1979 n henfapanese manufacturers began selling miclsize copiers in the United States for$9,600 each-iess than Xerox's production costs.e Xerox management sent ateam of linc managers and its head of manufacturing to Japan to study com-petitors' business processes and costs. With the aid of Xerox's joínt venturepartner in fapan (Fuii-Xerox), who knew the competitors n'ell, the tcam found

that Xerox's costs were excessive due to gross ineffi-

Benchmarking ¡s a potent tool for learning which ciencies in the company's manufacturing processes

companies are best at performing partic;lar and business practices The findings triggered a majoractivities and then using their techniques (or "best internal effort at Xerox to become cost-comPetitive andpractices") to improve the cost and effectiveness prompted Xerox to begin benchmarking 67 of its keyof a company's own internal activities. n'ork processes. Xerox quickly decided not to restrict

its benchmarking efforts to its officc cquipmcnt rivaisbut to extend them to any company regarded as "world class" in pcrformingnny acLixity relevant to Xerox's business. Other companies quickly picked upon Xerox's approach. Toyota managers got their idea for iust-in-time inven-tory deLiveries by studying how U.S. supermarkets replenished their shelves.Southwcst Airlines reduced the turnaround time of its aircraft at each sched-uled stop by studying pit crews on the auto racing circuit. Over 80 percent ofFortune 500 companies reportedly usc bcnchmarking for comparing them-selves against rivals on cost and other compctitivclv important measLlres.

3 For more details, see Gregory H. Watson, Stroteg¡c Benchmorking: How to Rote Your Compony'sPerformonce Against the World's Best (New York: john WiLey, 1993); Robert C. Camp, Benchnork-¡ng: The Seorch for lndustry Best Practices Thot Leod to Super¡or Performonce (Milwaukee: ASQC

Quality Press, 1989); Christopher E. Bogan and Michael I. English, Benchmark¡ng lor Best Prac-tices: Winning through lnnovative Adoptotrcn (New York: lvlccraw-H¡ll, t994); and Dawn lacobucc¡

and Christie Nordhielm, "Creatrve Benchmatking," Harvord Bus¡ness Rev¡ew 28, no. 6 (November-

December zooo), pp. z4-25-t leremy Main, "How to Steal the Best ldeas Atound," Forfune, October 19, 1992, pp. ro2 1oj.

Chapter 4 Internal Situation Analysis EJ

The tough part of benchmarking is not whether to do it, but rather how togain access to information about other companies' practices and costs. Some-times benchmarking can be accomplished by collecting information from pub-lished reports, trade groups, and industry research firms and by talking toknowledgeable industry anaiysts, customers, and suppliers. Sometimes fieldtrips to the facilities of competing or noncompeting companies canbe arrangedto observe hon'things are done, cornpare practices and processes,, and perhapsexchange data on productivitv and other cost components. However, suchcompanies, even if they agree to host facilitics tours and ans\ ¡er questions,are unlikely to share compctitivcly sensitive cost information. Furthermore,comparing trvo companies'costs may not involve comparing apples to applesif thc two companies cmploy different cost accounting principles to calculatethe costs of particular activities.

Hon,ever, a fairly reliable source of benchmarking information has emerged.The explosive interest of companíes in benchmarking costs and identifyingbest practices has prompted cor-rsulting organizations (e.g., Accenture, A. T.

Kearney, Benchnet-The Benchmarking Exchange, Towers Perrin, and BcstPractices, LLC) and several councils and associations (e.g., the APQC, the

Qualservc Bcnchmarking Clearinghouse, and the Strategic Planning Institute'sCouncil on Benchmarking) to ¡;ather benchmarking data, distribute informa-tion about best practices, and provide comparative cost data without identify-ing the names of particular companies. Having an independent group gatherthe information and report rt rn a rnarurer that disguises the names of indi-vidual comp-rames avords the disclosure of competitively sensitive data andlessens the potential for unethicai behavior on the part of company personnelin gathering their own data about compctitors.

The Value Chain System for an Entire IndustryA company's value chain is cmbedded in a larger svstem of activities thatincludes the value chains of its suppliers ancl the value chains of u.hateverdistribution channel allies it utilizes ín getting its product or service to endusers.r(' The value chains of fonva¡d channel partnersare relevant because (1) the costs and margins of a A company's cosfcompetitiveness depends notcornpany's distributors and retail dealers are part of on! on the costs of internally performed

the price the consumer ultimately pays, and (2) the activities (its own company value chain), but also

activities that distribution allies pcrform affect cus- on costs in the value chains of its suppliers and

tomer satisfaction. For these reasons, companies nor- forward channel allies.

mally rvork ckrsely w,ith their suppliers and forwardchannel allies to perforrn value chain activities in mutually beneficial ways.For instance, motor vehlcle manufacturers work closely lvith their forwardchannel allies (local automobile dealers) to ensurc that owners are satisfiedwith dealers' repair and maintenancc scrvices.I' Also, many automotive parts

- PofteL Compet¡ttve Advontage, p. 34." M. Hegert and D. lvlorris, 'Accounting Data for Value Chain Analysis," Strateg¡c Management

Journol rc (rS8S), p- r8o; Robin Cooper and Robert S. Kaplan, "Measure Costs Right: Make the

R¡ght Dec¡sions," Horvard Business Review 66, no. 5 (September October 1988), pp. 96 ro3; and

John K. Shank and Viiay Govindarajan, Strategic Cost Monogement (New York: Free Press, 1993),

especial[y Chapters 2 ó, 10.

B: Core Concepts and Analytical Tools

FIGURE 4,.2 Representátlve vslue chain for an Entlre IndustrySourc€¡ Eased ¡n part on

the single'industry value€hain displayed in M¡chael

E. Poleí Compet¡tiveAdvantoge (New York:Free Press, 1985), p. 35.

Supplier-Related A Company's OwnValue Chains Value Chain

Forward ChannelValue Chains

suppliers have built plants near the auto assembly plants they supply tofacilitate just-in-time deliveries, reduce warehousing and shipping costs, andpromote close collaboration on parts design and production scheduling.Irrigation equipment companies, suppliers of grape-harvesting and wine-making equipment, and firms making barrels, wine bottles, caps, corks, andlabels all have facilities in the California wíne country to be close to the nearly700 winemakers they supply.l'Z The lesson here is that a company's valuechain activities are often closely linked to the value chains of their suppliersand the forward allies.

As a consequence, accurately assessing a company's competitioeness requiresthat company managers understand an industry's entire ualue chain system for delio-ering a product or setnice to custonters, not just the company's own aalue chain. Atypical industry value chain that incorporates the activities, costs, and mar-gins of suppliers and forward channel allies (if any) is shown in Figure 4.2.

However, industry value chains vary significantly by industry. For example,the primary value chain activities in the bottled water industry (spring opera-tion or water purification, processing of basic ingredients used in flavored orvitamin-enhanced water, bottling, wholesale distribution, advertising, andretail merchandising) differ from those for the computer software industry(programming, disk loading, marketing, distribution). Producers of bath-room and kitchen faucets depend heavily on the activities of wholesale dis-tributors and building supply retailers in winning sales to homebuildersand do-it-yourselfers but producers of papermaking machines intemalizetheir distribution activities by selling directly to the operators of paper plants.Concepts & Connections 4.1 shows representative costs for various activitiesperformed by the producers and marketers of music CDs.

Strategic Options for Remedying a Cost DisadvantageThere are three main areas in a company's overall value chain where importantdiffe¡ences in the costs of competing firms can occur: a company's own inter-nal activities, the suppliers' part of the industry value chain, and the forwardchannel portion of the industry chain.

" For more on how and why the clustering of suppliers and other support organizations matter toa company's costs and co m p etit iveness, see Michael E. Porter, "Clusters and the New Economicsof Competition," Horuord Bus¡ness Review 76, no. 6 (November-December ry98), pp- 7l-go.

Chapter 4, Internal Situat¡on Analysis

ESTIMATED CO5T5 FOR VATUE CHAII{ ACTIVITIES IN THE RECORDING INDUSTRY

The table below presents the representative costs and music CD retailing for $r5 in music stores (as opposed tomarkups associated with producing and distributing a Internet sources).

Value Chain Activities and Cosb ¡n Prcducing and Distributing a CD

l. Record company direct production costs:

Artists and reperto¡re

Pressing of CD and packaging

2. Royalties

3. Record company marketing expenses

4. Record company overhead

5. Total record company costs

6. Record company's operating profit7. Record companyt selling pricc to distributor/wholcsaierB. Average wholesale d¡stributor markup to cover distribution activities and

profit marg¡ns

9. Average wholesale price charged to retailer

10. Average retail markup over wholesale cost

1 ] AveraBe price to consumer at retail

s0.7s

I Of

9 2.40

$r s.00

.99

1.50

1.50

6.39

1.86

8.2 5

1.50

9.75

5 .25

Soüne¡ Developed ftom infomation in "Fight the Power," a case study prepared by Adrian Ateyne, Babson College, 1999.

REMEDYING AN INTERNAL COST DISADVANTAGE Whenacom-pany's cost disadvantage stems from performing internal value chain activi-ties at a higher cost than key rivals, then managers can pursue any of severalstrategic approaches to restore cost parity:13

l. lmplement the use of best practices throughout the company, particularly forhigh-cost activities.

2. Try to eliminate some cost-producing actiuities altogether by revamping thevalue chain. Many retailers have found that donating returned items tocharitable organizations and taking the appropriate tax deduction resultsin a smaller loss than incurring the costs of the value chain activitiesinvolved in reverse logistics.

3. Relocate high-cost actiuities (such as manufacturing) to geographic areas likeChina, Latin America, or Eastem Europe where they can be performedmore cheaply.

4, See if certain internally performed actittities ütn be outsourced from vendors orperformed by contractors more cheaply than they can be done in-house.

5, lnuest in productiuitt¡ mhnncing, cost-saoing technological improaemeru fs (robotics,flexible manufacfuring techniques, state-of-the-art electronic networking).

'r Some of these options are discussed in more detail in Pofie\ Compet¡t¡ve Advantage, Chapter 3.

B: Core Concepts and Analytical Tools

,7

Find wnys to detour around the actiaities or items whue costs are hígh----compluler

chip makers regularly design around the patents held by others to avoidpaying royalties; automakers have substituted lower-cost plasfic for metal atmany exterior body locations.

Redesign the product and/or some of íts components to facilitate speedierand more economical manufacture or assembly.

Try to make up the internal cost disadvantage by reducing costs in thesupplier or forward channel portions of the industry value chain-usuallya last resort.

REMEDYING A SUPPLIEIT.I{ELATED COST DISAD\ANTAGESupplier-related cost disadvantages can be attacked by pressuring suppliersfor lower prices, switching to lower-priced substitute inputs, and collaborat-ing closely with suppliers to identify mutual cost-saving opportunities.r¡ Forexample, just-in-time deliveries from suppliers can lower a company's inven-tory and internal logistics costs, eliminate capital expenditures for additionalwarehouse space, and improve cash flow and financial ratios by reducingaccounts payable. In a few instances, companies may find that it is cheaper tointegrate backward into the business of high-cost suppliers and make the itemin-house instead of buying it from outsiders.

REMEDYING A COST DISAD\ANTACE ASSOCIATED WITHACTIVITIES PERFORMED BY FORIVARD CHANNEL ALLIESThere are three main ways to combat a cost disadvantage in the forward por-tion of the industry value chain: (1) Pressure dealer-distributors and other for-ward channel allies to reduce their costs and markups; (2) work closely withforward channel allies to identify win-win opportunities to reduce costs-forexample, a chocolate manufacturer learned that by shipping its bulk choco-late in liquid form in tank cars instead of 1O-pound molded bars, it could notonly save its candy bar manufacturing customers the costs associated withunpacking and melting but also eliminate its own costs of molding bars andpacking them; and (3) change to a more economical distribution strategy orperhaps integrate forward into company-owned retail outlets. Dell Computerhas eliminated all activities, costs, and margins of forward channel allies byadopting a direct sales business model that allows buyers to purchase custom-ized PCs directly from the manufacturer. The direct sales model allows Dell toeasily match competitors' prices, while earning larger profit margins.

Question 4: What ls the Compant's CompetitiveStrength Relative to Key Rivats?An additional component of evaluating a company's situation is developinga comprehensive assessment of the company's overall competitive strength.Making this determination requires answers to tvvo questions:

'4 An exampte of how Whirlpool Corporat¡on transformed ¡ts supply chain from a competitive Liab¡l-

ity to a competitive asset is discussed in Reuben E. Stone, "Leading a Supply Chain Turnaround,"

Horvord Bus¡ness Review 82, no. ro (October zoo4), pp. tt4-tzt.

Chapter,l, Internal SituationAnalysis

1. Hou' does the company rank relative to competitors on each of iheimportant factors that determine market success?

2. All things considered, does the company have a net competitive advan-tage or disadvantage versus major competitors?

Step 1 in doing a competitive strength assessment is to make a list of theindustry's key success facto¡s and other telling measures of competitivestrength or weakness (6 to 10 measures usually suffice). Step 2 is to assign a

weight to each measure of competitive strength based on its perceived impor-tance in shaping competitive success. (The sum of the weights for each mea-sure must add up to 1.0.) Step 3 is to calculate weighted strength ratings byscoring each competitor on each strength measure (using a 1 to 10 rating scalewhere 1 is very weak and 10 is verv strong) and multiplying the assignedrating by the assigned weight. Step 4 is to sum the weighted strength ratingson each factor to get an overall measure of competitive strength for each com-pany being rated. Step 5 is to use the overall strength ratings to draw conclu-sions about the size and extent of the company's net competitive advantageor disadvantage and to take specific note of areas of strength and weakness.Table 4.2 provides an example of a competitive strength assessment, using thehypothetical ABC Company against four rivals. ABC's total score of 5.95 sig-nals a net competitive advantage over Rival 3 (with a score of 2.10) and Rival4 (t+'ith a score of 3.70\, but indicates a net competitive disadvantage againstRival 1 (r,'ith a score of 7. 70) and Rival 2 (with an overall score of 6.85).

I nterp reti n g th e Com petitive Stren gth Assessm entsCompetitive strength assessments provide useful conclusions about a com-pany's competitive situation. The ratings show hor','l a companv comparesagainst rir.als, factor by factor or capability bv capability, thus revealing whereit is stron¡;est and weakest. Moreover, the overall competitive strength scoresindicate whethe¡ the company is at a net competitive advantage or disadvan-tage against each rival.

In addition, the strength ratings provide guidelines for designing wiseoffensive and defensive strategies. For example, consider the ratings andweighted scores in Table 4.2. If ABC Co. wants to go on the offensive to winadditional sales and market share, such an offensiveprobabl¡r needs to be aimed directly at winning cus- A company's competitive strength scorestomers away from Rivals 3 and 4 (n,hich have lower pinpoint its strengths and weaknesses againstoverall strength scores) rather than Rivals 1 and 2 rivals and point to offensive and defensive(which have higher overall strength scores). ABC's skategies capable of producing lirsfrate results.

advantages over Rival 4 tends to be in areas that aremoderately important to competitive success in the indusfry, but ABC out-cLasses Rival 3 on the two most heavily weightcd strength factors relativecost position and customer service capabilities. Therefore, Rival 3 should bcviewed as the primarv target of ABC's offensive strate¡;ies, with Rival 4 beinga secondary tar8et.

The point hcre is that a competitively astute company should utilize thestrength scores in deciding what strategic moves to make. I\¡hen a company hasimportant competitivc strengths in areas where one or more rivals are weak,

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Chapter + InternaI Situation AnaLysis

it makes sense to consider offensive moves to exploit rivals' competitiveweaknesses. When a company has competitive weaknesses in important areaswhere one or more rivals are strong, it makes sense to consider defensivemoves to curtail its vulnerability.

Question 5: What Strategic lssues and ProblemsMust Be Addressed by Management?The final and most important analytical step is to zero in on exactly what stra-tegic issues company managers need to address. This step involves drawingon the results of both industry and competitive analysis and the evaluations ofthe company's internal situation. The task here is toget a clear fix on exactly what industry and cornpeti-tive challenges confront the company, which of thecompany's internal weaknesses need fixing, and whatspecific problems merit front-bumer attention by com-

an agenda for managerial strategy

pany managerl Pinpointing the precise things that management needs to worryabout sets the agenda for deciding what actions to take next to improae the company'sperformance and business outlook.

If the items on management's "worry list" are relatively minor, which sug-gests the company's strategy is mostly on track and reasonably well matched tothe company's overall sifuation, company managers seldom need to go muchbeyond fine-tuning the present strategy. If, however, the issues and problemsconfronting the company are serious and indicate the present strategy is notwell suited fo¡ the road ahead, the task of crafting a better strategy has got togo to the top of management's action agenda.

Kev PointsThere a¡e five key questions to consider in analyzing a company's own particular com-petitive circumstances and its competitive position vis-á-vis key rivals:

l. How well is the present strntegy working? This involves evaluating the strategy froma qualitative standpoint (completeness, intemal consistency. rationale, and suit-abilify to the situation) and also from a quantitative standpoint (the strategic andfinancial results the strategy is producing). The stronger a company's currentoverall performance, the less likely the need for radical strategy changes. Theweaker a company's performance and/or the faster the changes in its extemalsituation (which can be gleaned from industry and cornpetitive analysis), themore its current strategy must be questioned.

2. What are the coffipany's competitiuely important rcsources and cnpabilities? Acompany's resources, competitive capabilities, and core competencies arestrategically relevant because they are the most logical and appealing

a fuorry lisf of problems and issues

building blocks for strategy. In fact, many companies pursue resource'based

strategics that attempt to exploit comPany resources in a manner that offersvalue to customers in ways rivals are unable to match. The most Potentresource-based strategies exploit resources which are competitioelY aaluable,

rarc, hard to copy or imitate, and are not easily trumped by substitute rcsources

ASWOT analysls is a simple but powerful tool for sizing up a comPany'sresource strengths and comPetitive deficiencies, its market opportunities, andthe extemal threats to its future well-being. Resource weaknesses are impor-tant because they may represent vulnerabilities that need correction. Externalopportunities and threats come into play because a good strategy necessarily

aims at capturing a company's most attractive opPortunities and at defendingagainst th¡eats to its well-being.

3. Are the company's prices and costs competitiae? One telling sign of whether acompany's situation is strong or precarious is whether its prices and costs are

competitive with those of industry rivals. Value chain analysis and bench-marking a¡e essential tools in determining whether the company is perform-ing particular functions and activities cost-effectively, learning whether itscosts are in line with comPetitors, and deciding which internal activitiesand business processes need to be scrutinized for improvement. Value chainanalysis teaches that how competently a company manages its value chainactivities relative to rivals is a key to building a comPetitive advantage based

on either better cornpetencies and competitive capabilities or lower costs

than rivals.

4. ls the company competitiuely stronger or zaeaku than key rioalsT The key appraisals

here involve how the company matches up agairst key rivals on industry keysuccess factors and other chief determinants of competitive success and whetherand why the company has a competitive advantage or disadvantage. Quantita-tive competitive süength assessments, using the method presented in Table 4.2,

indicate where a company is competitively shong and weak and provide insightinto the company's ability to defend or enhance its market position. As a rule a

company's competitive st¡ategy shouJd be built around its competitive strengths

and should aim at shoring up areas where it is competitively vulnerable. When a

company has important competitive strengths in areas where one or more rivalsare weak, it makes sense to consider offensive moves to exploit rivals' comPeti-tive weaknesses. VVhen a company has important comPetitive weaknesses inareas where one or mote rivals are strong, it makes sense to consider defensivemoves to curtail its vulnerability.

5. What strategic issues and problems merit f'ront-burner managerial attention? Tlisanalytical step zeros in on the st¡ategic issues and problems that stand in the

way of the company's success. It involves using the results of both industryand competitive analysis and comPany situation analysis to identify a "worrylist" of issues to be resolved in order for the company to be financially andcompetitively successful in the years ahead. Actually deciding upon a shaFegy and what specific actions to take is what comes after the list of strategicissues and problems that merit front-burner management attention has beendeveloped.

Good company situation annlysis,like good industry and competitiae analysís, is a oaluable

precondition for good strategy making.

LOI 1. Using the financial ratios provided in the Appendix and the financial statementinformation for Avon Products below, calculate the following ratios fo¡ Avon forboth 2007 and 2008:

a. Gross profit margin

b. Operating profit margin

c. Net profit margin

d. Times interest eamed coverage

e. Retum on shareholders' equity

f. Retum on assets

B. Debt-to-equityratio

h. Days of inventory

i. Inventory tumover ratioj. Average collection period

Based on these ratios, did Avon's financial performance improve, weaken, o¡ remainabout the same from 2007 to 2008?

CONSOTIDATED STATEMENTS OF INCOME FORAVON PRODUCTS, tNC., 2007-2008(in millions, except per share data)

Years ended December 31

Assuranceof Learning

Exercises

Net sales

Other revenue

Total revenue

Costs, expenses and other:Cost oi sales

Selling, general and administratire expenses

Operating profitInterest cxpcnscIntcrcst Income

Othcr expense, net

Total other expenses

lncome before t¿xes and minority nterest

Income taxes

lncome before rninority interest

Minority interest

Net incomeEarnings per share:

Bas¡c

Diluted\teighted-average shares outstandi n g:

B¿s i(

Dilufed

$ 1 0,588.9101,2

1 0,690. r

j,949.1

5,401 7

1,339 l100 4

lt7.1)377

101.01,238.3

362.7875.6

(0 3)

$ 875.3

$ 205$ 2.04

426.36429.53

$ 9,84s.2I3.-5

9,9i8.7

3,941 .2

5,124.8872.7112.2(42 -2)

6.676.6

796.1

262.8533.3

12.6J

$ 530.7

$ 1.22

$ 1 .21

433.47436.89

CONSOLIDATED BALANCE SHEETS TORAVON PRODUCTS, rNC., 2007-2008(in millions, except per share data)

Decembe¡ 31

Assets

Current assets

Cash, including cash equivalents of $704.8 anrl $492.iAccounts rece¡vable (less allowances of $1 2 7.9 and $ 141 .1 )

tnventone5

Prepaid expenses and otherTotal current assets

Property, plant and equipment, at cost

Land

Buildings and improvements

Equipment

Less accumulated depfeciation

Other assets

Total assets

[iabilities and Shareholders' Equity

Current liabilitiesDebt maturing within one year

Accounts payableAccrued compensationOther accrued liabilitiesSales and taxes other than incomc

lncome taxes

Total current l¡abilit¡esLong-term debtEmployee benefit plans

LonB-term income taxes

Other liabrlities (inr:luding minority ¡nterest of $37.4 and $38.2)Total liabilities

Comm¡tments and ( ontinSencies (Notes I 3 and I 5)

Shareholders'equityCommon stock, par value $.25 - aufhrrrized 1,500 shares; issued739.4 and 736.3 sharcs

Additional pa id-in capitalReta¡ned earn¡n8s

Accumulated other comprchensive loss

Treasury stock, at cost 313.1 and 308.6 shares

Total shareholders' equityTotal liabilities and shareholders' equity

$ 1 ,1 04.7687 .8

1 ,OO7 9

756_5

$ 963.4795.O

1 ,041 .8

71 5.2

l,5 t 5.4

71 .B

972.71,3't7.9

2,362.4

t1,084.2)1 ,27 8.2

922.6

$ s,716.2

$ 929.5800.l285.8717.2

222.3102.3

3,053.41,167.9

3 88.7208.7185.9

$ s,004.6

s 184 .7

1 ,7 21.6

3,586.5

\417.O)(,4,367 .2)

$ 71 1.6

$ s,716.2

3,5 5 6.9

85.31,OO0.7

r,353.92,439.9

(1,096.0)

1,34i.91 ,17 7.2

s 6,074.0

$ l,0l r .4

724.1

214.4581 .9

212.)128.0

2,912.2't,456.2

665.41 68.9"t96_4

$ 5,399.1

$ 185.6

1 ,874.14,1 1 8.9

(965.9)

(4,537.8)

$ 6749$ 6,0740

Sou'te! Avon Products. lnc. 2oo8. ro-K.

LOZ Z. Review the information in Concepts & Connecüons 4.1 concerning the costs ofthe different value chain activities associated with recording and distributingmusic CDs through traditional brick-and-mortar retail outlets. Then answer thefollowing questions:

a. Does the growing popularity of downloading music from the Intemet giverise to a new music industry value chain that differs considerably from thet¡aditional value chain? Explain why or why not.

b. What costs would be cut out of the t¡aditional value chain or bypassed in theevent recording studios sell downloadable files of artists' recordings direct toonline buyers?

c. What happens to the traditional value chain if mo¡e and more consurlersuse peer-to-peer file-sharing software to dor,lrrload music f¡om the Intemetrather than purchase CDs or downloadable files?

LOI 1.

102LO3

2.

What hard evidence can you cite that indicates your company's skategy is work- : ,-.8ing fairly well (or perhaps not working so well, if your company's perforrranceis lagging that of rival companies)? ' :.

What external market opportunities for growth and increasedfor your company? What extemal threats to your company's futu¡eand profitability do you and your co-managers see? What doesSWOT analysis indicate about your company's present situationprospects-where on the scale from "exceptionally sbong" to "does the attractiveness of your company's sifuation rank?

3. Does your company have any core competencies? If so, what are they?

4. What are the key elements of your company's value chain? Refer to Figue 4.1 indeveloping your answer,

5. Using the methodology presented in Táble 4.2, prepare a competitive süengthassessrnent for your company and two other companies that you and yourco-managers consider to be very close competitors,