Chapter 3: The Internal Organization: Resources, Capabilities, Core Competencies, and Competitive Advantages

3-1 Understanding the Firm’s Internal Environment

• Firms achieve strategic competitiveness and earn above-average returns by acquiring, bundling, and leveraging resources to take advantage of opportunities in the external environment, creating value for customers.
• Competitors will eventually learn how to duplicate the benefits of a firm’s value-creating strategy; thus, all competitive advantages have a limited life.

3-2 Creating Value and Its Importance

• Value is measured by a product’s performance characteristics and by its attributes for which customers are willing to pay.
• Firms create value by innovatively building and leveraging their resources to form capabilities and core competencies.
• Creating value for customers is the source of above-average returns for a firm.
• Strategic decisions about the internal organization are:
  • nonroutine
  • have ethical implications
  • significantly influence the firm’s ability to earn above-average returns

3-3 Resources, Tangible and Intangible

• The foundations of competitive advantage are:
  • Resources
  • Capabilities
  • Core competencies
• Resources are bundled to create organizational capabilities.
• Capabilities are the source of a firm’s core competencies, which are the basis of establishing competitive advantages.
• Resources span a broad spectrum of individual, social, and organizational phenomena.
• By themselves, resources do not create value for customers or above-average returns; they must be combined into capabilities.
• Some resources are tangible; others are intangible.
• Four primary categories of tangible resources:
  • Financial
  • Organizational
  • Physical
  • Technological
• Intangible resources are assets rooted in the firm’s history, accumulate over time, and are difficult for competitors to analyze and imitate. Three primary categories:
  • Human
  • Innovation
  • Reputational
• Tangible versus intangible (summary):
  • Tangible resources are observable and quantifiable and can be hard to leverage for ongoing value.
  • Intangible resources are less visible, harder to substitute or imitate, and often form the foundation for capabilities.

3-4 Capabilities and Core Competencies

• Capabilities:

  • Created by combining individual tangible and intangible resources.
  • Used to complete the organizational tasks required to produce, distribute, and service the firm’s offerings.
  • Foundation for building core competencies and competitive advantages.
  • Often based on developing, carrying, and exchanging information and knowledge through the firm’s human capital.
  • Strategic human capital enables a firm to develop capabilities by matching employees’ knowledge, skills, and abilities to strategic objectives.

• Table 3.3 Example of Firms’ Capabilities (illustrative examples across functional areas)

  • Distribution: Effective use of logistics management techniques (e.g., Walmart)
  • Human Resources: Motivating, empowering, and retaining employees (e.g., Microsoft)
  • Management Information Systems: Effective and efficient control of inventories through point-of-purchase data collection methods (e.g., Walmart)
  • Marketing: Effective promotion of brand-name products; strong customer service; innovative merchandising (e.g., Procter & Gamble; Ralph Lauren Corp.; McKinsey & Co.; Nordstrom Inc.; Crate & Barrel)
  • Management: Ability to envision the future of clothing (e.g., Hugo Boss; Zara)
  • Manufacturing: Design and production skills yielding reliable products; product and design quality; miniaturization of components (e.g., Komatsu; Witt Gas Technology; Sony)
  • Research & Development: Innovative technology; development of sophisticated elevator control solutions; rapid transformation of technology into new products (e.g., Caterpillar; Otis Elevator; Chaparral Steel; Thomson Consumer Electronics)

• Core competencies:

  • Capabilities that serve as a source of competitive advantage for a firm over rivals.
  • Distinguish the company competitively and reflect its personality.
  • Emerge over time through organizational learning and accumulating/deploying resources and capabilities.
  • The activities the company performs especially well compared to competitors.
  • The activities through which the firm adds unique value to its goods or services.

• Building Core Competencies:

  • Two tools help firms identify core competencies:
  • The four criteria of sustainable competitive advantage
  • Value chain analysis

3-5 The Four Criteria of Sustainable Competitive Advantage

• Core competencies satisfy all four criteria: valuable, rare, costly to imitate, and nonsubstitutable.

• If a capability fails to satisfy any one criterion, it is not a core competence (though every core competence is a capability).

• In customer terms:

  • A core competence must be valuable and unique from the customer’s perspective.
  • To be a potential source of competitive advantage, it must be inimitable and nonsubstitutable.

• The four criteria, when combined, determine the sustainability and strength of competitive advantage.

• Summary phrasing: $ext{Core Competence} \equiv (\text{Valuable} \land \text{Rare} \land \text{Costly-to-imitate} \land \text{Nonsubstitutable})$

• Table 3.4 The Four Criteria of Sustainable Competitive Advantage (conceptual)

  • Valuable: Helps neutralize threats or exploit opportunities
  • Rare: Not possessed by many others
  • Costly-to-Imitate: Includes factors like historical conditions, ambiguous causes, social complexity
  • Nonsubstitutable: No strategic equivalent

• Table 3.5 Outcomes from Combinations of the Criteria for Sustainable Competitive Advantage (conceptual framing)

  • If any criterion is not met, outcomes range from competitive parity to competitive disadvantage.
  • Only when all four criteria are satisfied is the outcome a sustainable competitive advantage (above-average returns).
  • Note: The exact mapping of all 16 combinations is shown in the source table; the key takeaway is the all-four-criteria condition yields sustainable competitive advantage.

3-6 Value Chain Analysis

• Value chain analysis helps the firm understand which parts of its operations create value and which do not.
• Important because the firm earns above-average returns only when value created exceeds costs.
• The value chain is a template used to analyze cost positions and identify means to implement chosen strategies.
• Figure 3.3: A Model of the Value Chain (conceptual)
• Porter’s Value Chain (original source: Porter, 1985)
• Value chain activities vs. support functions:
  • Value chain activities: tasks the firm completes to produce, sell, distribute, and service products in ways that create value for customers.
  • Support functions: activities that support the value chain activities.
• A firm can develop a capability or core competence in any value chain activity or support function.
• All items in the value chain should be evaluated relative to competitors’ capabilities and core competencies.
• To become a core competence and a source of competitive advantage, a capability must either:
  • Perform an activity in a manner that provides value superior to competitors, or
  • Perform a value-creating activity that competitors cannot perform.
• Value chain analysis helps managers determine which activities hold the most potential for developing a capability.
• Value chain analysis can also reveal deficiencies in the organization that hinder value creation; viewing the firm as a value creation system emphasizes interdependencies among parts of the system.
• Building strong social capital with stakeholders (e.g., trust) is important for value creation and pursuing strategies.

3-7 Outsourcing

• Outsourcing is the purchase of a value-creating activity or a support function from an external supplier.
• Reasons to outsource:
  • When the firm cannot create value in a value chain activity or support function.
  • Outsourcing increases flexibility, mitigates risks, and reduces capital investments.
  • Outsourcing should be used only for activities where the firm cannot create value or is at a substantial disadvantage compared to competitors.
• Outsourcing is effective because few or no firms possess the resources and capabilities required to achieve competitive superiority in every value chain activity and support function.
• By nurturing a smaller number of capabilities, a firm can increase the probability of developing core competencies and achieving a competitive advantage, while avoiding overextension.
• Concerns about outsourcing:
  • Potential loss of a firm’s ability to innovate.
  • Potential loss of jobs within the focal firm.
• Firms can sometimes enhance their own innovation capabilities by studying how their outsourcing partners complete activities.

3-8 Competencies, Strengths, Weaknesses, and Strategic Decisions

• By analyzing the internal organization, firms identify their strengths and weaknesses as reflected by resources, capabilities, and core competencies.
• If a firm has weak capabilities or lacks core competencies in areas needed to achieve a competitive advantage, it must acquire those resources and build the needed capabilities and competencies.
• Having a significant quantity of resources is not the same as having the right resources.
  • The right resources are those with the potential to form core competencies as the foundation for creating value and competitive advantages.
• The ability of a core competence to provide a permanent competitive advantage cannot be assumed; core competencies can become core rigidities that generate inertia and stifle innovation.

Discussion Activity 3-6 Debrief (Key Takeaway)

• Trust can be instrumental in accomplishing organizational goals.
• Organizations we trust are more likely to be frequented and recommended, which builds social capital for the company.
• Organizations with social capital have greater potential to grow, expand, and reach new markets.

Additional Notes and Concepts

• The internal organization should be analyzed with a global mind-set, avoiding dependence on a single country, culture, or context.
• Matching a firm’s unique bundle of resources and capabilities with external opportunities helps determine viable strategies (the “can do” vs. “might do” framework).
• Judgment plays a significant role in decision-making under conditions of uncertainty, complexity, and potential intra-organizational conflicts; cognitive biases (e.g., overconfidence) should be considered, and intelligent risk-taking is often involved.
• Core competencies emerge from organizational learning and the continual development of capabilities tied to strategic objectives and human capital.