Internal Analysis 1 Why does firm performance differ?
Updated: 30 Aug. 2006 Scott Gallagher 2004
Internal Analysis
Earlier we explained differences in firm performance as being a function of their external
environment. However, this is only part of the story. Obviously, each firm has some unique
aspects. Internal analysis is an attempt to explain how and why these internal differences
explain
differences in firm performance.
Resources and Capabilities.
Economics generally models firms as generic black boxes that
transform inputs into outputs in an efficient manner. Edith Penrose (1950) is generally
credited
with being the first person to model firms as unique bundles of resources. Some
individuals like
to make distinctions between resources, what companies have, versus capabilities, things
companies can do. A classic example might be my personal computer. As a resource it is
more
powerful than the original computer on the Space Shuttle, however, I could not land the
Space
Shuttle with it. So in this case I have a superior resource but an inferior capability.
Resources and capabilities can take many different forms. Literally anything an
organization
possesses can be considered a resource. Examples include financial resources, plants,
equipment, technology, reputation, brands, and organizational expertise. In short there is
no
potential constraint on what can be considered a firms resources or capabilities.
VRIO Analysis
Given that almost anything a firm possesses can be considered a resource or capability
how
should you attempt to narrow down the ones that explain why firm performance differs? In
order
to lead to a sustainable competitive advantage a resource or capability should be Valuable,
Rare,
Inimitable (including non-substitutable), and Organized. This VRIO framework is the
foundation for internal analysis.
If you ask a business person why their firm does well while others do poorly, a common
answer
is likely to be “our people.” But this is really not an answer, it may be the start of an
answer, but
you need to probe deeper, what is it about “our people” that are especially valuable? Why
dont
competitors have similar people? Cant competitors hire our people away? Or is it that there
something special about the organization that brings out the best in people? These kinds of
questions form the basis of VRIO and get to the heart of why some resources help firms
more
than others.
Valuable.
A resource is valuable if it helps the organization meet an external threat or exploit an
opportunity. While it may not help the firm outperform its competitors, it can still be
labeled a
strength. One good way to think about valuable resources is to ask how they help the
company.
Common competitive foundations (a.k.a. the generic building blocks) for firms are
