Chapter 3 Examining the Internal Context of Strategy OBJECTIVES 1 Explain the internal context of strategy 2 Identify a firm s resources and capabilities and explain their role in its performance 3 Define dynamic capabilities and explain their role in both strategic change and a firm s performance 4 Explain how value chain activities are related to firm performance and competitive advantage 5 Explain the role of managers with respect to resources capabilities and value chain activities 2 COMPARATIVE INDUSTRY REFORMANCE ROA Global Auto Semiconductor ROS Grocery Store How do such differences in profitability materialize 3 TWO THEORIES FOR HOW AND WHY SOME FIRMS PERFORM BETTER THAN OTHERS A firm s resources and capabilities determine performance A firm s activities determine performance Success issues from fundamental differences in what firms own and what they can do Success is driven by a firm s value chain activities How it configures these activities to add more value than competitors 4 RESOURCES AND CAPABILITIES FUNDAMENTAL BUILDING BLOCKS OF STRATEGY Strategy Resou rces The inputs that firms use to create goods and services Undifferentiated or firm specific Tangible or intangible Easy to acquire or difficult ie s t i l i b a Cap cies n e t e comp A firm s skill in using its resources to create goods and services The combination of procedures and expertise that the firm relies on to engage in distinct activities in the process of producing goods and services 5 EXAMPLES OF CAPABILITIES Company Capability Result Logistics distributing vast amounts of goods quickly and efficiently to remote locations 200 000 percent return to shareholders during first 30 years since IPO1 An extraordinarily frugal system for delivering the lowest cost structure in the mutual fund industry using both technological leadership and economies of scale 25 000 percent return to share holders during the 30 plus year tenure of CEO John Connelly 2 As for ongoing expenses shareholders in Vanguard equity funds pay on average just 30 per 10 000 vs a 159 industry average With bond funds the bite is just 17 per 10 000 Generating new ideas then turning those ideas into new profitable products 30 percent of revenue from products introduced within the past four years 1 Stalk Evans and Shulman 1992 2 Makadok 2003 6 THE VRINE MODEL Test Competitive implication Performance implication Valuable Does the resource or capability allow the firm to meet a market demand or protect the firm from market uncertainties If so it satisfies the value requirement Valuable resources are needed just to compete in the industry but value by itself does not convey an advantage Valuable resources and capabilities convey the potential to achieve normal profits i e profits which cover the cost of all inputs including the cost of capital Rare Assuming the resource or capability is valuable is it scarce relative to demand Or is it widely possessed by most competitors Valuable resources which are also rare convey a competitive advantage but its relative permanence is not assured The advantage is likely only temporary A temporary competitive advantage conveys the potential to achieve above normal profits at least until the competitive advantage is nullified by other firms Inimitable and nonsubstitutable Assuming a valuable and rare resource how difficult is it for competitors to either imitate the resource or capability or substitute for it with other resources and capabilities that accomplish similar benefits Valuable resources and capabilities which are difficult to imitate or substitute provide the potential for sustained competitive advantage A sustained competitive advantage conveys the potential to achieve above normal profits for extended periods of time until competitors eventually find ways to imitate or substitute or the environment changes in ways that nullify the value of the resources Exploitable For each step of the preceding steps Resources and capabilities that Firms which control unexploited VRINE of the VRINE test can the firm actually satisfy the VRINE requirements but resources and capabilities generally exploit the resources and capabilities that itwhich the firm is unable to exploit suffer from lower levels of financial owns or controls actually result in significant opportuperformance and depressed market nity costs other firms would likely valuations relative to what they would pay large sums to purchase the otherwise enjoy though not as VRINE resources and capabilities depressed as firms lacking resources and Alternatively exploitability unlocks capabilities which do satisfy VRINE the potential competitive and performance implications of the resource or capability 7 THE VRINE MODEL VALUE Example Union Pacific Railroad s rail system is a tangible resource that allows UP to compete with other carriers in the long haul transportation of a variety of goods Definition Value A resource or capability is valuable if it allows a firm to take advantage of opportunities or to fend off threats in its environment Maintain an extensive network of rail line property and equipment on the U S Gulf cost Operates in the western two third of the United States serving 23 states linking every major West Coast and Gulf Coast port and reaching east through major gateways in Chicago St Louis Memphis and New Orleans Also operates in key north south corridors The only U S railroad serving all six gateways to Mexico Interchanges traffic with Canadian rail systems 8 THE VRINE MODEL RARITY Example When McDonald s signs an agreement to build a restaurant inside a Wal Mart store it has an intangible advantage over Burger King that is valuable and rare Definition A useful resource or capability that is scarce relative to demand Valuable resources that are available to most competitors i e that are not rare simply allow firms to achieve parity UNLV has world s oldest janitor Is this rare Phelan Lewin concept of value rarity 9 THE VRINE MODEL INIMITABILITY AND NON SUBSTITUTABILITY Example Barnes Noble s large store network gave it access to customers and purchasing power that was inimitable Definition A resource or capability is inimitable if competitors cannot acquire the valuable and rare resource quickly or face a disadvantage in doing so It is non substitutable if a competitor cannot achieve the same benefit using different combinations of resources and capabilities but Amazon com found a substitute What makes things difficult to imitate Property