Idea Strategy

Chapter 3
Evaluating a
Firms
Internal
Capabilities
Copyright 2006 Pearson Prentice Hall. All rights reserved.

Evaluating a Firms Internal Capabilities
What Does Internal Analysis Tell Us?

Internal analysis provides a comparative look at
a firms capabilities
what are the firms strengths?
what are the firms weaknesses?
how do these strengths & weaknesses compare

to competitors?

3-2
Why Does Internal Analysis Matter?
Internal analysis helps a firm:
determine if its resources and capabilities are

likely sources of competitive advantage
establish strategies that will exploit any sources

of competitive advantage

3-3
The Theory Behind Internal Analysis
The Resource-Based View
developed to answer the question: Why do some

firms achieve better economic performance
than others?
used to help firms achieve competitive advantage

and superior economic performance
assumes that a firms resources and capabilities

are the primary drivers of competitive advantage
and economic performance
3-4

Resources and Capabilities
Resources:
tangible and intangible assets of a firm
tangible: factories, products intangible: reputation
used to conceive of and implement strategies

Capabilities:
a subset of resources that enable a firm to
take full advantage of other resources
marketing skill, cooperative relationships

3-5

Resources and Capabilities
Are these resources
Firm Assets: or capabilities?
Machinery ?
Collective Product Design Skill ?
Recruiting Skill ?
Engineering Skill of Individuals ?
Mineral Deposits ?

3-6
Four Categories of Resources
Financial (cash, retained earnings)
Physical (plant & equipment, geographic location)
Human (skills & abilities of individuals)
Organizational (reporting structures, relationships)

3-7
Two Critical Assumptions of the RBV
Resource Heterogeneity
different firms may have different resources
Resource Immobility
it may be costly for firms without certain

resources to acquire or develop them
some resources may not spread from firm to
firm easily
3-8
What do these assumptions really mean?

if one firm has resources that are valuable
and other firms dont, and
if other firms cant imitate these resources

without incurring high costs, then
the firm possessing the valuable resources

will likely gain a sustained competitive advantage

3-9
Resource Heterogeneity
heterogeneity of resources typically occurs as the

result of bundling the resources and capabilities
of a firm (bundles of HR practices, p. 90)
managers of a firm could take resources that seem

homogeneous and bundle them to create
heterogeneous combinations
competitive advantage typically stems from several

resources and capabilities bundled together
3-10
The Internal Analysis Tool
The VRIO Framework
Four Important Questions:

Value
Rarity
Imitability
Organization

3-11
The VRIO Framework
If a firm has resources that are:

valuable,
rare, and
costly to imitate, and
the firm is organized to exploit these resources,
then the firm can expect to enjoy a sustained
competitive advantage.

3-12
The VRIO Framework
Applying the Tool
a resource or bundle of resources is subjected to

each question to determine the competitive
implication of the resource
each question is considered in a comparative

sense (competitive environment)

3-13
Applying the VRIO Framework
The Question of Value
in theory: Does the resource enable the firm

to exploit an external opportunity or neutralize
an external threat?
the practical: Does the resource result in an

increase in revenues, a decrease in costs, or
some combination of the two? (Levis reputation
allows it to charge a premium for its Dockers pants)

3-14
The Question of Rarity

if a resource is not rare, then perfect competition
dynamics are likely to be observed (i.e., no
competitive advantage, no above normal profits)
a resource must be rare enough that perfect
competition has not set in
thus, there may be other firms that possess the

resource, but still few enough that there is scarcity
(several pharmaceuticals sell cholesterol-lowering
drugs, but the drugs are still scarcelook at prices)
3-15
Valuable and Rare
If a firms resources are: The firm can expect:
Not Valuable Competitive Disadvantage
Valuable, but Not Rare Competitive Parity
Competitive Advantage
Valuable and Rare
(at least temporarily)

3-16
The Question of Imitability
the temporary competitive advantage of valuable

and rare resources can be sustained only if
competitors face a cost disadvantage in imitating
the resource
intangible resources are usually more
costly to imitate than tangible resources
(Harley-Davidsons styles may be easily
imitated, but its reputation cannot)

3-17
if there are high costs of imitation, then the firm

may enjoy a period of sustained competitive
advantage
a sustained competitive advantage will last
only until a duplicate or substitute emerges
if a firm has a competitive advantage, others

will attempt to imitate it (Razor scooters
were a big hit and others quickly imitated them)

3-18

Costs of Imitation
Unique Historical Conditions (Caterpillar)
first mover advantages

path dependence

3-19

Costs of Imitation
Causal Ambiguity (Southwest Airlines HR)

causal links between resources and
competitive advantage may not be
understood
bundles of resources fog these causal
links

3-20

Costs of Imitation
Social Complexity (WordPerfect)
the social relationships entailed in

resources may be so complex that
managers cannot really manage them
or replicate them

3-21

Costs of Imitation
Patents
patents may be a two-edged sword
offer a period of protection if the firm is
able to defend its patent rights
required disclosure may actually decrease
the cost of imitation, and the timing
3-22
Value, Rarity, & Imitability
If a firms resources are: The firm can expect:
Valuable, Rare, but Temporary

not Costly to Imitate Competitive Advantage
Sustained
Valuable, Rare, and
Competitive Advantage
Costly to Imitate
(if Organized appropriately)

3-23
The Question of Organization

a firms structure and control mechanisms
must be aligned so as to give people ability
and incentive to exploit the firms resources
examples: formal and informal reporting structures,
management controls, compensation policies,
relationships, etc.
these structure and control mechanisms complement
other firm resourcestaken together, they can help a
firm achieve sustained competitive advantage
(3M Company)
3-24
The VRIO Framework

Costly to Exploited by Competitive
Valuable? Rare? Imitate? Organization? Implications
No No Disadvantage
Yes No Parity
Temporary
Yes Yes No Advantage
Sustained
Yes Yes Yes Yes
Advantage

3-25
The VRIO Framework

Costly to Exploited by Competitive Economic
Valuable? Rare? Imitate? Organization? Implications Implications
No No Disadvantage Below
Normal
Yes No Parity Normal
Temporary Above
Yes Yes No Advantage Normal
Sustained Above
Yes Yes Yes Yes
Advantage Normal

3-26
Entrepreneurial and International

Application of the VRIO Framework
The Logic Remains the Same
small firms and start-ups can apply the VRIO

framework to their resources and capabilities
competitive advantage vis--vis larger
firms can often be identified
recognizing if and why larger firms
face high costs of imitation can be
critical to small firm success

3-27

The International Context
Two Reasons for International Expansion:
1) to exploit current resource and capability

advantages in a new market
2) to develop new resources and capabilities in

a foreign market

3-28

Critical Caveat:
resources and capabilities that generate

an advantage in one market may or may
not generate an advantage in a new market
Firms should re-apply the VRIO framework

when entering new markets!!

3-29

As a firm enters a new market:
a disciplined learning mentality is imperative
for success
what resources and capabilities meet

the VRIO criteria in the new market?
what can the firm learn from partners in

the new market? (GM learned from Toyota
in the NUMMI alliance)
3-30
Competitive Dynamics of Resource Imitation
Competitive Dynamics:
the strategic decisions and actions of firms in
response to the strategic decisions and actions
of other firms
Firm Bs Possible Responses
Firm A No Response
(strategy decisions
Change Tactics
lead to competitive
advantage) Change Strategy

3-31
Competitive Dynamics
No Action Response (Rolex Casio)

A firm may decide to take no action because:
the other firm is serving a different market

a response may hurt its own competitive
advantage
it does not have the resources and capabilities
to mount an effective response
it wants to reduce or manage rivalry in the
market through tacit collusion
3-32
Change Responses
Tactics (Tide) Strategy (Monsanto)
specific actions a fundamental change
tweaking product in a firms theory
characteristics may be necessary if
usually imitated so current strategy
quickly that there is becomes obsolete
no advantage a mimetic change may
a leap frog move achieve parity, but not
may create advantage advantage
3-33
Imitation will seldom lead to competitive advantage

firms should use resources and capabilities to fill
unique competitive space

3-34
Similar strategies may lead to competitive advantage

some firms can achieve competitive advantage even
if they are second movers

3-35
Internal Analysis
Assumes:
determinates of economic performance are

firm-level characteristics (resources & capabilities)
firms may be different (heterogeneity)
differences may be enduring (immobility)
competitive advantage stems from resources

and capabilities that meet the VRIO criteria

3-36
Resources & Competitive

Capabilities Advantage
Valuable CA will be sustained if:

Rare other firms costs of
Costly to Imitate imitation are greater
than benefit of imitation
Organized to Exploit
the firm is organized
to exploit advantages

3-37
Internal Analysis
Tells us:
what the firm should do, given the relative
strengths and weaknesses of resources and
capabilities
Managers Job:
bundle resources and capabilities to

achieve competitive advantage
VRIO Framework Helps Managers Recognize

Sources of Competitive Advantage
3-38

Idea Strategy

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Chapter 3

Copyright 2006 Pearson Prentice Hall. All rights reserved.

What Does Internal Analysis Tell Us?

what are the firms strengths?

what are the firms weaknesses?

how do these strengths & weaknesses compare

Copyright 2006 Pearson Prentice Hall. All rights reserved.

Why Does Internal Analysis Matter?

Internal analysis helps a firm:

determine if its resources and capabilities are

establish strategies that will exploit any sources

Copyright 2006 Pearson Prentice Hall. All rights reserved.

The Theory Behind Internal Analysis

The Resource-Based View

developed to answer the question: Why do some

used to help firms achieve competitive advantage

assumes that a firms resources and capabilities

The Resource-Based View

used to conceive of and implement strategies

Copyright 2006 Pearson Prentice Hall. All rights reserved.

The Resource-Based View

Collective Product Design Skill ?

Engineering Skill of Individuals ?

Copyright 2006 Pearson Prentice Hall. All rights reserved.

The Resource-Based View

Four Categories of Resources

Financial (cash, retained earnings)

Physical (plant & equipment, geographic location)

Human (skills & abilities of individuals)

Organizational (reporting structures, relationships)

Copyright 2006 Pearson Prentice Hall. All rights reserved.

The Resource-Based View

Two Critical Assumptions of the RBV

it may be costly for firms without certain

The Resource-Based View

What do these assumptions really mean?

if other firms cant imitate these resources

the firm possessing the valuable resources

Copyright 2006 Pearson Prentice Hall. All rights reserved.

The Resource-Based View

heterogeneity of resources typically occurs as the

managers of a firm could take resources that seem

competitive advantage typically stems from several

The Internal Analysis Tool

The VRIO Framework

Four Important Questions:

Copyright 2006 Pearson Prentice Hall. All rights reserved.

The VRIO Framework

If a firm has resources that are:

Copyright 2006 Pearson Prentice Hall. All rights reserved.

The VRIO Framework

Applying the Tool

a resource or bundle of resources is subjected to

each question is considered in a comparative

Copyright 2006 Pearson Prentice Hall. All rights reserved.

Applying the VRIO Framework

The Question of Value

in theory: Does the resource enable the firm

the practical: Does the resource result in an

Copyright 2006 Pearson Prentice Hall. All rights reserved.

Applying the VRIO Framework

The Question of Rarity

thus, there may be other firms that possess the