Chapter 3
The Internal Organization: Resources, Capabilities, Core
Competencies, and Competitive Advantages
CHAPTER OVERVIEW
LEARNING OBJECTIVES
LECTURE NOTES
3-1 ANALYZING THE INTERNAL ORGANIZATION
3-2 RESOURCES, CAPABILITIES, AND CORE COMPETENCIES
3-2a Resources
3-2b Capabilities
3-4 OUTSOURCING
3-5 COMPETENCIES, STRENGTHS, WEAKNESSES AND STRATEGIC
DECISIONS
Chapter 3: The Internal Organization
CHAPTER OVERVIEW
Now that students understand the importance of studying a firm’s external environment to
identify opportunities (Chapter 2), they can turn their attention to studying a firm’s
internal organization to identify its core competencies. Matching opportunities with core
competencies leads to strategic competitiveness and above-average returns.
Next, core competencies are discussed in more detail. Effectively managing core
competencies requires careful analysis of the firm’s tangible and intangible resources,
which are inputs to the production process, and capabilities, which are resources that have
been purposely integrated to achieve specific tasks. Perhaps the most significant capability
In the next section, students learn more about value chain analysis, which can be used to
identify and evaluate the competitive potential of resources and capabilities. By studying their
skills relative to those associated with value chain activities and support functions, firms can
understand their cost structure and identify the activities that will enable them to create value.
This concept leads to the next section on outsourcing, which is an option that should be
considered when a firm cannot create value in either a value chain activity or support function.
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3
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.
Lecture Notes
Chapter Introduction: As indicated in Chapter 1, firms follow two competing models to
generate the inputs needed to formulate and implement strategies. Chapter 2 focused on
OPENING CASE
Large Pharmaceutical Companies, Big Data Analytics, Artificial Intelligence, and
Core Competencies: A Brave New World
Many large pharmaceutical companies are trying to develop a core competence in terms of
big data analytics and artificial intelligence. Big pharma firms capable of forming BDA as
Chapter 3: The Internal Organization
4
Teaching Note
Big Pharma is just beginning to develop data analytics as a core competence. There are
Teaching Note
Numerous firms such as Coca-Cola, McDonald’s, and Subway have implemented
value-creating strategies using their unique resources, capabilities, and core
competencies. In particular, they have developed unique capabilities related to the
management of their brands.
The ultimate goal of such strategies is for the firms to achieve a sustainable competitive
advantage that will enable them to earn above-average returns.
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
The sustainability of a competitive advantage is a function of three factors:
Chapter 3: The Internal Organization
• The imitability of the core competence (or the abilities of competitors to develop the same
core competence)
To sustain a competitive advantage, firms must manage current core competencies while
simultaneously developing new competencies. In other words, strategists must
Teaching Note
It is important to stress that the outcomes of the external and internal analyses of a
firm’s environment must be linked. Analyzing the external environment enables
strategists to identify opportunities that the firm can choose to pursue if it is capable of
3-1 ANALYZING THE INTERNAL ORGANIZATION
3-1a 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
Chapter 3: The Internal Organization
Analysis of the firm’s internal environment requires that evaluators examine the firm’s
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
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
Figure Note
Figure 3.1 illustrates the relationships among the components of an internal strategic
analysis—resources, capabilities, and core competencies—and competitive advantages
and shows how their integrated use can lead to strategic competitiveness. This is a very
helpful figure as it ties together much of the material in the chapter.
FIGURE 3.1
Components of an Internal Analysis
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.
Chapter 3: The Internal Organization
• These capabilities (teams or bundles of resources) represent sources of core competencies.
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. At one time, firms considered strategic management research to be a tool for
3-1b Creating Value
Some thoughts on “value”:
• Firms create value by exploiting core competencies and meeting the standards of global
competition.
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3-1c The Challenge of Analyzing the Internal Organization
Correctly identifying, developing, deploying, and protecting firm resources, capabilities,
and core competencies require managers to make difficult decisions. In part, these
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 characteristics of the firm’s general and industry environments
and customer’s needs.
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
Chapter 3: The Internal Organization
Complexity is increased because of the uncertain nature of interrelationships among the
characteristics of the external environment and the related challenge regarding how to
Intraorganizational 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
Thus, managers that must make decisions under conditions of uncertainty, complexity,
and intraorganizational conflict must exercise judgment, a capacity for making a
successful decision in a timely manner when no correct model is available or when
relevant data are unreliable or incomplete.
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3-2 RESOURCES, CAPABILITIES, AND CORE
COMPETENCIES
3-2a 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.
STRATEGIC FOCUS
Tangible and Intangible Resources as the Base for Core Competencies
All firms possess both tangible and intangible resources, but intangible resources, such as
knowledgeable human capital, are critically important in service-based organizations, such
Teaching Note
Ask students to identify other companies and how they have been able to develop
capabilities from either tangible or intangible resources. Be sure to address a mix of
different types of businesses and industries.
Tangible Resources
Tangible resources are assets that can be observed or quantified, such as a firm’s physical
11
TABLE 3.1
Tangible Resources
A firm’s tangible resources generally can be placed into one of four categories:
• Financial resources, such as borrowing capacity
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
A firm’s intangible resources may be less visible, but they are no less important. In fact,
they may be more important as a source of core competencies. Intangible resources are
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 found that
Chapter 3: The Internal Organization
Table Note
Three classifications of intangible resources are presented in Table 3.2.
TABLE 3.2
Intangible Resources
A firm’s intangible resources can be classified as:
• Human resources, such as knowledge, trust, and the ability to collaborate with others
Teaching Note
Remind students of the relationships illustrated in Figure 3.2. Resources are the source
of firm capabilities, capabilities are the source of core competencies, and core
competencies are the foundation for achieving a competitive advantage and strategic
competitiveness.
Because they cannot be quantified, touched, or seen, and are more difficult to explain,
Teaching Note
One can report to the class that two surveys asked managers to identify the source of
their firms’ competitive advantage or overall success. In both instances, one intangible
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
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
However, cost-cutting is not the only strategy that can be used to safeguard a
brand.
• For companies whose brand names are expected to thrive and continue to
provide a competitive advantage (such as Nike or Hanes), their challenge is to
Chapter 3: The Internal Organization
• For companies whose brands are troubled, because the brands are no longer a
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.
Note: It is important to remember that resources, both tangible and intangible,
represent the primary sources that enable a firm to establish capabilities, the
capacity for a set or bundle of unique resources to perform a task or activity
4
Define capabilities and discuss their development.
3-2b 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.
Capabilities develop over time as a result of complex interactions that take advantage of
Chapter 3: The Internal Organization
Teaching Note
As discussed in the chapter, the strategic value of resources is increased when they are
integrated or combined. Unique combinations of the firm’s tangible and intangible
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
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
Chapter 3: The Internal Organization
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
TABLE 3.3
Example of Firms’ Capabilities
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.
5
Describe four criteria used to determine if resources and
capabilities are core competencies.
3-2c 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
Teaching Note
Remember, resources and capabilities serve as the foundation on which firms formulate
and implement value-creating strategies so that the firm can achieve strategic
Chapter 3: The Internal Organization
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
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
areas in which the firm is weak compared to competitors. Thus, some resources or
capabilities may stifle or prevent the development of a core competence.
When the firm’s resources and capabilities result in a core competence, the firm will be
3-3 BUILDING CORE COMPETENCIES
This section discusses two conceptual tools/frameworks firms can use to identify
competitive advantages:
3-3a The 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
Table 3.4 describes the four criteria for determining strategic capabilities. These criteria
Chapter 3: The Internal Organization
TABLE 3.4
The Four Criteria of Sustainable Strategic Capabilities
Before they can be sources of competitive advantage, capabilities must be:
valuable rare costly-to-imitate nonsubstitutable
It is important to understand that a firm’s capabilities must meet all four of the criteria
noted earlier before they can be core competencies and enable the firm to achieve a
Valuable
Valuable capabilities help a firm exploit opportunities and/or neutralize threats in the
external environment. Valuable capabilities allow a firm to develop and implement
strategies that create customer value.
Rare
Rare capabilities are possessed by few, if any, current or potential competitors. If many
firms have the same capabilities, the same value-creating strategies will be selected. As a
Costly to Imitate
Costly-to-imitate capabilities are ones that other firms are unable to develop, except at a
cost disadvantage relative to firms that already have them. This usually is a result of one
or a combination of three conditions:
1. Unique historical conditions can make duplication of capabilities costly. For example,
Chapter 3: The Internal Organization
Teaching Note
This may explain why such companies as IBM and General Motors, whose cultures
developed early in each company’s history—and during relatively calm or stable
2. Causal ambiguity also may prevent competitors from perfectly imitating a competency if
the link between a firm’s capabilities and core competencies is not identified or
understood. Competitors may not be able to identify or determine how a firm uses its
competencies to achieve a sustainable competitive advantage.
3. Social complexity means that a firm’s capabilities are the product of complex social
Nonsubstitutable
Nonsubstitutable capabilities do not have strategic equivalents. Firm resources are
strategically equivalent when each can be separately exploited to implement the same
Table Note
Table 3.5 summarizes the relationship between the characteristics of firm capabilities,
TABLE 3.5
Outcomes from Combinations of the Criteria for Sustainable Competitive Advantage