Chapter 3: The Internal Organization
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Chapter 3
The Internal Organization:
Resources, Capabilities, Core Competencies, and Competitive
Advantages
LEARNING OBJECTIVES
1. Explain why firms need to study and understand their internal organization.
2. Define value and discuss its importance.
3. Describe the differences between tangible and intangible resources.
4. Define capabilities and discuss their development.
5. Describe four criteria used to determine whether resources and capabilities are
core competencies.
6. Explain how firms analyze their value chain for the purpose of determining where
they are able to create value when using their resources, capabilities, and core
competencies.
7. Define outsourcing and discuss reasons for its use.
8. Discuss the importance of identifying internal strengths and weaknesses.
9. Discuss the importance of avoiding core rigidities.
CHAPTER OUTLINE
Opening Case: Data analytics, Large pharmaceutical companies, and core
competencies.
ANALYZING THE INTERNAL ORGANIZATION
The Context of Internal Analysis
Creating Value
The Challenge of Analyzing the Internal Organization
Resources, Capabilities, Core Competencies
Strategic Focus Emphasis on Value Creation through Tangible (Kinder Morgan) and
Intangible (Coca-Cola Inc.) Resources
Strategic Focus Superdry and its performance problems.
Building Core Competencies
Value Chain Analysis
Outsourcing
Competencies, Strengths, Weaknesses, and Strategic Decisions
SUMMARY
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LECTURE NOTES
OPENING CASE
Big Pharma: The use of data analytics as a business strategy.
The idea of using data strategically remains somewhat novel in some organizations.
However, the reality of “big data” and “big data analytics” (which is “the process of
examining big data to uncover hidden patterns, unknown correlations and other useful
Teaching Note
Big Pharma is just beginning to develop data analytics as a core competence. There
are many reasons why this could work to their advantage. Ask students how data
analytics can help companies be competitive. Ask students what the challenges are to
developing new analytical tools to assess their business strategy.
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Competitive advantages are often strongly related to the resources firms hold and how they
are managed. Resources are the foundation for strategy and these can generate competitive
advantages leading to wealth creation when they are bundled together uniquely.
People are an especially critical resource for producing innovation and gaining a competitive
advantage. Even if they are not as critical in some industries, they are necessary for the
development and implementation of firms’ strategies.
To sustain a competitive advantage, firms must manage current core competencies while
simultaneously developing new competencies. In other words, strategists must continuously
make investments that will enhance the value of current competencies while striving to
develop new ones (discussed further in Chapter 5).
This chapter represents the next phase in the strategy development process: what a firm can
do. It is linked to the understanding that managers gain by assessing the external environment
to determine what the firm might do, or to identify opportunities that might be pursued.
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of doing so. This capability is determined by a careful analysis of the firm’s internal
environment, or by determining whether or not it has the resources, capabilities, and
core competencies that will enable it to successfully implement value-creating
strategies that fit with its vision and mission (previously discussed in Chapter 1).
1
Explain the need for organizations to study and understand their
internal organization.
ANALYZING THE INTERNAL ORGANIZATION
The Context of Internal Analysis
In the global economy, traditional factors such as labor costs, access to financial resources
and raw materials, and protected or regulated markets continue to be sources of competitive
Teaching Note
It might be appropriate at this point in the discussion to remind students of the
primary differences between the I/O and resource-based models. The I/O model
presumes that resources and capabilities are distributed homogeneously among firms
and freely move between them; the primary determining factor is how firms react to
changes in the external environment. The resource-based model presumes a
heterogeneous distribution of resources and capabilities and assumes that they do not
move freely between firms.
By using or exploiting their core competencies, firms are in a position to develop and
perform value-creating strategies better than their competitors or to create and perform value-
creating strategies that competitors either are unable or unwilling to imitate.
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Teaching Note
Although it will be discussed in detail in Chapter 4, it is appropriate to provide
students with some introductory remarks on value at this point. Value represents a
concept of the relationship between a product’s features (such as quality) and its price
FIGURE 3.1
Components of Internal Analysis Leading to Competitive Advantage and Strategic
Competitiveness
As illustrated in Figure 3.1:
• A firm’s tangible and intangible resources (for example, its facilities and corporate culture,
respectively) represent sources of capabilities
Teaching Note
The importance of a firm’s internal characteristics – represented by its resources and
capabilities – highlights a shift in the priorities and prescriptions of strategic
management research. The field has evolved or developed from a position that
understanding industry characteristics and then positioning the firm to take advantage
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2
Define value and discuss its importance.
CREATING VALUE
Some thoughts on “value”:
• Firms create value by exploiting core competencies and meeting the standards of global
competition.
• Value is measured by the product’s performance and by its attributes for which customers
are willing to pay.
The Challenge of Analyzing the Internal Organization
Figure Note: Suggest that students refer to Figure 3.2 during your discussion of the
three conditions that characterize important strategic decisions.
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FIGURE 3.2
Conditions Affecting Managerial Decisions about Resources, Capabilities, and Core
Competencies
The conditions or decision characteristics presented in Figure 3.2 are:
• Uncertainty regarding the assessment of the general and industry environments,
assessments, and predictability of competitive actions, and customer preferences.
Teaching Note
The descriptions of uncertainty, complexity, and intraorganizational conflict (see
below) expand on the material presented in the text. This should help you explain
these concepts in greater depth, if you should choose to do so.
Uncertainty is present because of the inherent difficulty in identifying, assessing, and
predicting changes and trends in characteristics of the external environment. Among these
external environment that can be exploited successfully to achieve a competitive advantage.
Intra-organizational conflicts often develop as a result of uncertainty and complexity. When
managers make decisions regarding the identification of the firm’s capabilities and choose to
nurture them (with resources) to develop core competencies that can be exploited to achieve
a competitive advantage, they must make these important decisions without absolute
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certainty that the decision is correct. And, such decisions may result in changes or shifts in
power and interrelationships among individuals and groups within the firm. When this
occurs, there may be conflict as those who are affected adversely – or perceive that they will
be so affected – may resist these changes. In some cases, managers faced with decisions that
may have unpleasant consequences or are uncomfortable often experience denial, an
unconscious coping mechanism used to block out and not initiate major changes that may
have some pain associated with them.
Significant changes in the value-creating potential of a firm’s resources and capabilities can
occur in a rapidly changing global economy. Because these changes affect a company’s
power and social structure, inertia or resistance to change may surface. Even though these
reactions may happen, decision makers should not deny the changes needed to assure the
firm’s strategic competitiveness. By denying the need for change, difficult experiences can
be avoided in the short run.
3
Describe the differences between tangible and intangible resources.
RESOURCES, CAPABILITIES, AND CORE COMPETENCIES
Resources
Resources represent inputs into a firm’s production process, such as capital equipment, the
skills of individual employees, brand names, financial resources, and talented managers.
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STRATEGIC FOCUS
Emphasis on Value Creation through Tangible (Kinder Morgan) and Intangible
(Coca-Cola Inc.) Resources
The Strategic Focus profiles two companies, Kinder Morgan and Coca-Cola, and
describes some of the ways in which they have used resources to create value for
Teaching Note
The point should be obvious that competitive advantage can be achieved through
a number of different means. Rather than focusing strictly on the two companies
mentioned in the Strategic Focus, ask students to identify other companies and
how they have been able to develop capabilities from either tangible or intangible
resources.
Tangible Resources
TABLE 3.1
Tangible Resources
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• Physical resources, such as location
• Technological resources, such as patents and trademarks
Teaching Note
One statement made in the chapter deserves special attention. Paraphrased slightly,
the authors declare that the value of tangible resources is constrained because they are
Intangible Resources
Teaching Note
It is interesting to note that tangible resources may be less valuable today than they
were in the past. To support this conclusion, economist John Kendrick has found that
Table Note
Three classifications of intangible resources are presented in Table 3.2.
TABLE 3.2
Intangible Resources
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Because tangible resources are those that can be seen (such as plants), touched (such as
equipment), documented (such as contracts with suppliers of raw materials), or quantified
(such as the value of a specific asset), they generally do not, by themselves, represent
capabilities that serve as sources of core competencies. However, they still have value and
will contribute to the development of capabilities and core competencies.
Because they cannot be quantified, touched, or seen, and are more difficult to explain,
intangible resources are more likely to be sources of sustainable competitive advantage.
And, if they also are difficult for competitors to identify and/or understand, they also may
represent the most likely source(s) of a firm’s capabilities, core competencies, and sustained
competitive advantage.
Teaching Note
The Value of Brands: A Mini-Lecture
One intangible resource that may enable a firm to create a reputation and serve as a
source of competitive advantage is a brand name. Specifically, what a brand name
communicates to customers about the performance characteristics or attributes of a
firm’s product(s) represents a direct link to a firm’s reputation with its customers.
When the brand name communicates positive characteristics of a product (for
example, superior performance, high quality, or superior value), consumers will tend
to purchase the brand name product rather than similar products offered by competing
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that value through consistent advertising messages.
When a firm has a brand name that serves as a foundation for competitive advantage,
the firm often will try to leverage the power of that brand name. Using an example in
the chapter, Harley-Davidson’s name now adorns a limited edition Barbie doll, a
popular restaurant in New York City, and a line of L’Oreal cologne. Moreover,
Harley-Davidson Motorclothes generates over $100 million in revenue for the firm
each year, and the Harley brand adorns many clothing items, from black leather
jackets to fashions for tots.
The value of a brand name can be lessened or reduced by competitive actions that the
firm either does not recognize or to which it fails to respond. In the consumer goods
segment, national brands are under attack by private label store brands. And some
appear to be losing the battle as customer preferences are shifting toward private labels
source of competitive advantage, the challenge is even greater: they must identify
and develop new bundles of resources and capabilities and nurture them to establish
a new source of competitive advantage.
• Firms also may choose to package their brand as a way to differentiate themselves
from competitors, as Century 21 Real Estate has done by using technology to make
its offices virtual home stores by offering many discounted home services,
including cable service, appliances, insurance, and mortgages.
• Other firms (e.g., Procter & Gamble, General Motors, and Philip Morris) support
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other words, individual resources alone, while they may have value, will contribute to
the development of capabilities only when they are put together in unique
combinations to provide the foundation for core competencies and the establishment
of competitive advantage. Examples include a firm’s information-based tangible
resources (Table 3.1) and/or its intangible resources (Table 3.2).
4
Define capabilities and discuss their development.
Capabilities
As implied in the definition, a firm’s capabilities represent its capacity to integrate individual
firm resources to achieve a desired objective, though this ability does not emerge overnight.
Teaching Note
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Teaching Note
A number of firms have gone so far as to hire a Chief Learning Officer (CLO) to find
ways for the organization to acquire, internalize, and share knowledge in
competitively relevant ways. Managing knowledge is critical since enterprises view
this as their primary source of competitive advantage and believe it should be used in
ways that will create value for customers.
Teaching Note
Firms use a variety of methods to nurture the value of their human capital. For
example, Microsoft contends its best asset is the intellectual potential of its
employees. To support the trend, the firm strives to hire people who are more talented
than the current set of employees in hopes of defending and extending the domain of
its intellectual property. It is not uncommon for prospective employees to be asked
Table Note: Table 3.3 illustrates the value-creating potential of functional areas for a
broad array of firms in a variety of industries. Rather than going over the table item
by item, students should be asked to discuss why a particular firm’s capabilities serve
as a source of competitive advantage. In other words, involve students in a discussion
of why one firm’s functional activity is being performed better than that of its
competitors. For example, ask students to compare and contrast the marketing
approaches of Procter & Gamble and Polo Ralph Lauren Company or the
manufacturing capabilities of Komatsu and Sony.
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Table 3.3 provides examples of functional areas, capabilities, and firm examples across a
variety of industries. It indicates that a number of functional area capabilities have the
potential to serve as the foundation for a firm’s competitive advantage.
STRATEGIC FOCUS
Strengthening the Superdry Brand
lines.
5
Describe four criteria used to determine whether resources and
capabilities are core competencies.
Core Competencies
Once a firm has identified its resources and capabilities, it is ready to identify its core
competencies, the resources and capabilities that are a source of competitive advantage for
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Thus, firms not only are challenged to scan the external environment to identify
opportunities that can be exploited, but also to have an in-depth understanding of their
resources and capabilities. This enables the firm to develop strategies to exploit
external opportunities while it also avoids competing in areas where the firm’s
resources and capabilities are inadequate.
Not all of a firm’s resources and capabilities are strategic assets – that is, assets that have
competitive value and the potential to serve as a source of competitive advantage. Some
resources and capabilities may result in incompetence, because they represent competitive
BUILDING CORE COMPETENCIES
This section discusses two conceptual tools/frameworks firms can use to identify competitive
advantages:
• Four criteria determine which of the firm’s resources and capabilities are core
competencies.
• Value chain analysis, a tool for determining which value-creating competencies should be
maintained, upgraded, and developed and which should be outsourced.
Four Criteria for Sustainable Competitive Advantage
Four criteria should be used to determine whether or not a firm’s capabilities are core
competencies and can be a source of competitive advantage.
Table Note