Chapter ThreeInternal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability

Copyright Houghton Mifflin Company. All rights reserved.3 | *Internal Analysis includes an assessment of:Quantity and quality of a companys resources and capabilitiesWays of building unique skills and company-specific or distinctive competencies

Internal AnalysisThe purpose of internal analysis is to pinpoint the strengths and weaknesses of the organization. Strengths lead to superior performance. Weaknesses lead to inferior performance.

Copyright Houghton Mifflin Company. All rights reserved.3 | *Internal Analysis: Strengths and WeaknessesInternal analysis - along with the external analysis of the companys environment - gives managers the information to choose the strategies and business model to attain a sustained competitive advantage.Strengths

Of the enterprise are assets that boost profitabilityWeaknesses

Of the enterprise are liabilities that lead to lower profitability

Copyright Houghton Mifflin Company. All rights reserved.3 | *Internal Analysis: A Three-Step Process Understand the process by which companies create value for customers and profit for themselves.ResourcesCapabilitiesDistinctive competenciesUnderstand the importance of superiority in creating value and generating high profitability.EfficiencyQualityAnalyze the sources of the companys competitive advantage.Strengths that are driving profitabilityWeaknesses opportunities for improvement Innovation Responsiveness to Customers

Copyright Houghton Mifflin Company. All rights reserved.3 | *Competitive Advantage Competitive AdvantageA firms profitability is greater than the average profitability for all firms in its industry. Sustained Competitive AdvantageA firm maintains above average and superior profitability and profit growth for a number of years.The Primary Objective of Strategyis to achieve a Sustained Competitive Advantagewhich in turn results in Superior Profit and Profit Growth.

Copyright Houghton Mifflin Company. All rights reserved.3 | *Strategy, Resources, Capabilities, and CompetenciesFigure 3.1

Copyright Houghton Mifflin Company. All rights reserved.3 | *Competitive Advantage, Value Creation, and Profitability

VALUE or UTILITY the customer gets from owning the productPRICE that a company charges for its productsCOSTS of creating those productsConsumer surplus is the excess utility a consumer captures beyond the price paid.Basic Principle: the more utility that consumers get from a companys products or services, the more pricing options the company has.How profitable a company becomes depends on three basic factors:

Copyright Houghton Mifflin Company. All rights reserved.3 | *Value Creation per UnitFigure 3.2

Copyright Houghton Mifflin Company. All rights reserved.3 | *Value Creation and Pricing OptionsThere is a dynamic relationship among utility, pricing, demand, and costs.Figure 3.3

Copyright Houghton Mifflin Company. All rights reserved.3 | *Comparing Toyota and General MotorsSuperior value creation requires that the gap between perceived utility (U) and costs of production (C) be greater than that obtained by competitors.Figure 3.4

Copyright Houghton Mifflin Company. All rights reserved.3 | *The Value ChainA company is a chain of activities for transforming inputs into outputs that customers value including the primary and support activities.Figure 3.5

Copyright Houghton Mifflin Company. All rights reserved.3 | *Building Blocks of Competitive AdvantageThe Generic Distinctive Competencies Allow a company to: Differentiate product offering Offer more utility to customer Lower the cost structure regardless of the industry, its products, or its services Figure 3.6

Copyright Houghton Mifflin Company. All rights reserved.3 | * EfficiencyMeasured by the quantity of inputs it takes to produce a given output: Efficiency = Outputs / InputsProductivity leads to greater efficiency and lower costs:Employee productivityCapital productivitySuperior efficiency helps a company attain a competitive advantage through a lower cost structure.

Copyright Houghton Mifflin Company. All rights reserved.3 | * QualityReliable and Differentiated by attributes that customers perceive to have higher value The impact of quality on competitive advantage:High-quality products differentiate and increase the value of the products in customers eyes.Greater efficiency and lower unit costs are associated with reliable products.Superior quality = customer perception of greater value in a products attributesForm, features, performance, durability, reliability, style, designQuality products are goods and services that are:

Copyright Houghton Mifflin Company. All rights reserved.3 | *A Quality Map for AutomobilesWhen customers evaluate the quality of a product, they commonly measure it against two kinds of attributes:

1. Quality as Excellence

2. Quality as ReliabilityFigure 3.7

Copyright Houghton Mifflin Company. All rights reserved.3 | * Innovation Innovation is the act of creating new products or new processesProduct innovationCreates products that customers perceive as more valuable and Increases the companys pricing optionsProcess innovationCreates value by lowering production costs

Successful innovation can be a major source of competitive advantage by giving a company something unique, something its competitors lack.

Copyright Houghton Mifflin Company. All rights reserved.3 | * Responsiveness to Customers

Superior quality and innovation are integral to superior responsiveness to customers.Customizing goods and services to the unique demands of individual customers or customer groups.Enhanced customer responsiveness Customer response time, design, service, after-sales service and support

Superior responsiveness to customers differentiates a companys products and services and leads to brand loyalty and premium pricing.Identifying and satisfying customers needs better than the competitors

Copyright Houghton Mifflin Company. All rights reserved.3 | *Competitive Advantage: The Value Creation CycleFigure 3.8

Copyright Houghton Mifflin Company. All rights reserved.3 | *Analyzing Competitive Advantage and Profitability Competitive AdvantageWhen a companies profitability is greater than the average of all other companies in the same industry that compete for the same customers BenchmarkingComparing company performance against that of competitors and the companys historic performance

Measures of Profitability

Return On Invested Capital (ROIC) Net profit Net income after tax Capital invested Equity + Debt to creditors

Net Profit Net Profit = Total revenues Total costs

= ROIC=

Copyright Houghton Mifflin Company. All rights reserved.3 | *Definitions of Basic Accounting TermsTable 3.1

Copyright Houghton Mifflin Company. All rights reserved.3 | *Drivers of Profitability (ROIC)Figure 3.9

Copyright Houghton Mifflin Company. All rights reserved.3 | *Comparing Wal-Mart to TargetFigure 3.10

Copyright Houghton Mifflin Company. All rights reserved.3 | *The Durability of Competitive AdvantageBarriers to ImitationMaking it difficult to copy a companys distinctive competenciesImitating ResourcesImitating CapabilitiesCapability of CompetitorsStrategic commitment Commitment to a particular way of doing businessAbsorptive capacityAbility to identify, value, assimilate, and use knowledgeIndustry DynamismAbility of an industry to change rapidlyThe DURABILITY of a companys competitive advantage over its competitors depends on:Competitors are also seeking to develop distinctive competencies that will give them a competitive edge.

Copyright Houghton Mifflin Company. All rights reserved.3 | *Why Companies Fail InertiaCompanies find it difficult to change their strategies and structures Prior Strategic CommitmentsLimit a companys ability to imitate and cause competitive disadvantage The Icarus ParadoxA company can become so specialized and inner directed based on past success that it loses sight of market realitiesCategories of rising and falling companies: Craftsmen Builders Pioneers SalespeopleWhen a company loses its competitive advantage, its profitability falls below that of the industry. It loses the ability to attract and generate resources. Profit margins and invested capital shrink rapidly.

Copyright Houghton Mifflin Company. All rights reserved.3 | *Avoiding Failure: Sustaining Competitive AdvantageFocus on the Building Blocks of Competitive Advantage Develop distinctive competencies and superior performance in:Efficiency Quality Innovation Responsiveness to CustomersInstitute Continuous Improvement and LearningRecognize the importance of continuous learning within the organizationTrack Best Practices and Use BenchmarkingMeasure against the products and practices of the most efficient global competitorsOvercome InertiaOvercome the internal forces that are barriers to change

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