Chapter 3: The Internal Environment

Chapter 3
The Internal Organization:
Resources, Capabilities, Core Competencies and
Competitive Advantages
KNOWLEDGE OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
8.

Explain the need for firms to study and understand their internal organization.
Define value and discuss its importance.
Describe the differences between tangible and intangible resources.
Define capabilities and discuss how their development.
Describe four criteria used to determine whether resources and capabilities are core competencies.
Explain how value-chain analysis is used to identify and evaluate resources and capabilities.
Define outsourcing and discuss the reasons for its use.
Discuss the importance of identifying internal strengths and weaknesses.

CHAPTER OUTLINE
Opening Case Managing the Tension Between Innovation and Efficiency
THE CONTENT OF INTERNAL ANALYSIS
The Context of Internal Analysis
Creating Value
The Challenge of Analyzing the Internal Organization
RESOURCES, CAPABILITIES, AND CORE COMPETENCIES
Resources
Strategic Focus Hyundai Cars: The Quality Is There, So Why Arent the Cars Selling?
Capabilities
Core Competencies
BUILDING CORE COMPETENCIES
Four Criteria of Sustainable Competitive Advantage
Value Chain Analysis
OUTSOURCING
COMPETENCIES, STRENGTHS, WEAKNESSES, AND STRATEGIC DECISIONS
SUMMARY
REVIEW QUESTIONS
EXPERIENTIAL EXERCISES
NOTES

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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 the
external environment, which is the foundation of the I/O model. The emphasis in Chapter 3 is
on internal resources and their potential to create competitive advantage for the firm, which
falls in line with the resource-based model. This orientation is perhaps best captured by the
elements of Figure 3.1, which should be emphasized.
OPENING CASE
Managing the Tension between Innovation and Efficiency
For decades, 3M, the widely-diversified technology company with six business segments, was a model of
successful corporate innovation. The firms commitment to innovation, and the importance innovation had
to its competitive actions, is suggested by its slogan: The Spirit of Innovation. Thats 3M. In a practical,
everyday sense, innovations importance is signaled by 3Ms famous intention of generating at least onethird of its annual sales from products introduced to the marketplace in the most recent five years. 3M has
relied on its skill-base of scientists and engineers to meet this goal and to maintain a continual inflow of
innovative products. The company developed over thirty core competencies which have been the
foundation for more than 55,000 products sold worldwide.
But things have begun to change at 3M. As recently as mid-2007, sales of products introduced in the last
five years have dropped to only one-fourth of total sales. This shortfall represents nearly a 25 percent
deficiency in actual performance versus goal. What are possible root-causes of this decline? Could it be
that 3M was spending less money on R&D? A number of Wall Street analysts felt this was the reason that
2006 profits were below expectations. Other people feel that the introduction of the Six Sigma program
into the 3M culture was, not only a diversion of peoples attention, but also a deterrent to innovation. Six
Sigma is a widely-used series of management techniques designed to decrease production defects and
increase efficiency. Focusing on work processes, Six Sigma techniques help spot problems and use
rigorous measurements to reduce production variations and eliminate defects.
Using techniques such as Six Sigma is completely appropriate in that reducing waste and
increasing efficiency contribute to a firms profitability. The issue is that innovation generating and
efficient quality focused actions can be at odds with each other. In an analysts words: When (Six
Sigma) types of initiatives become ingrained in a companys culture, as they did at 3M, creativity
(and innovation that results from it) can easily get squelched. Your students may have some
creative ideas as to how innovation and conformity can co-exist.

Teaching Note: Firms such as Coca-Cola, Goldman Sachs, Sony Corporation, Nike, and
McDonalds 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.
To achieve strategic competitiveness and earn above-average returns, firms must
leverage their core competencies to exploit opportunities in the external environment.
However, a competitive advantage does not always last, because value-creating
strategies may be successfully imitated or duplicated by competitors.

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Several features of the global economy, such as technological changes, can result in the erosion of the
competitive advantage of established competitors. For example, the Internet is undermining the competitive
advantage of brick-and-mortar rivals.
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.
The sustainability of a competitive advantage is a function of three factors:
the obsolescence of a core competencethe basis of value creationas a result of environmental changes
the availability of substitutes for the core competence (or the extent to which competitors can use different
core competencies to overcome value created by the original core competence)
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 continuously make investments that will both
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.
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 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).

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 advantage, but to a lesser degree
(mostly because the advantages created by these more traditional sources can be overcome by competitors
through an international strategy and by the flow of resources throughout the global economy).
Increasingly, those analyzing their firms internal environment should use a global mind-set (i.e., the ability to
study an internal environment in ways that are not dependent on the assumptions of a single country, culture, or
context).
Analysis of the firms internal environment requires that evaluators examine the firms portfolio of resources
and the bundles of heterogeneous resources and capabilities managers have created. Understanding how to

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leverage the firms unique bundle of resources and capabilities is a key outcome decision makers seek when
analyzing the internal environment.
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.
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
relative to those offered by competitors. As will be discussed in Chapter 4, value can be
provided by low cost, high differentiation of product features, or a combination of low cost and
differentiated features.
Figure Note: Relationships between the components of an internal strategic analysis
resources, capabilities, and core competenciesand a sustainable competitive advantage
and strategic competitiveness are illustrated in Figure 3.1. This is a very helpful figure as it
ties together much of the material in the chapter.
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
these capabilities (teams or bundles of resources) represent sources of core competencies
when exploited and nurtured (and valuable, costly to imitate, rare, and non-substitutable), core competencies
are potential sources of competitive advantage
if a firm is able to use its core competencies to achieve a competitive advantage, it will achieve strategic
competitiveness and earn above-average returns so long as competitors are unable or unwilling to imitate
them successfully

Teaching Note: The importance of a firm's internal characteristicsrepresented by its

resources and capabilitieshighlights 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 of
industry characteristics relative to competitors was of primary importance to recognizing that
it is a firm's resources and capabilities (which represent sources of core competencies) that
should serve as the foundation for firm strategy. This shift recognizes that industry
attractiveness is not dependent only on industry characteristics. Industry attractiveness is
ultimately determined by both industry characteristics (which can be translated into
opportunities and threats) or what a firm might do and its internal strengths (its resources,

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capabilities, and core competencies) which determine what a firm is capable of doing to take
advantage of (or exploit) external opportunities.

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 products performance and by its attributes for which customers are willing to pay.
Firms must provide value to customers which is superior to the value provided by competitors in order to
create a competitive advantage.
Customers perceive higher value in global rather than domestic-only brands.
Firms create value by innovatively bundling and leveraging their resources and capabilities.
Ultimately, value is the foundation for earning above-average profits.
Core competencies, combined with product-market positions, are the most important sources of advantage.
The core competencies of a firm, in addition to analysis of its general, industry, and competitor
environments, should drive its selection of strategies.
The Challenge of Analyzing the Internal Organization
Correctly identifying, developing, deploying, and protecting firm resources, capabilities, and core competencies
requires managers to make difficult decisions. In part, these challenges are a result of characteristics of both the
internal and external environments of the firm. This challenge is multiplied because of three conditions that
characterize important strategic decisionsuncertainty, complexity, and intraorganizational conflict.
Figure Note: Suggest that students refer to Figure 3.2 during your discussion of the three
conditions that characterize important strategic decisions.
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
Complexity regarding the nature of any interrelatedness of the causes of change in the environment and how
the environments are perceived, especially regarding decisions as to which of the firms resources and
capabilities might serve as the foundation for competitive advantage
Intraorganizational conflicts among managers making decisions about which core competencies are to be
nurtured and about how the nurturing should take place

Teaching Note: The descriptions of uncertainty, complexity, and intraorganizational conflict

(see below) expand upon the material presented in the text. This should help you to 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 characteristics are correctly predicting the
extent, direction, and timing of changes in the general environment, such as those resulting from societal values,

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political and economic conditions, customer preferences, and emerging technologies from other industries (and
how they might ultimately affect the firm).
Complexity is increased because of the uncertain nature of interrelationships among the characteristics of the
external environment and the related challenge regarding how to assess the effects of changes in one set of
characteristics on other characteristics. The issue becomes more complex when managers must relate the
complex external environment to their assessment of the firm's internal environment and thus affects decisions
regarding the firm's resources, capabilities, and core competencies, and their relationship to opportunities in the
external environment that can be exploited successfully to achieve a competitive advantage.
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 exploited to achieve a competitive advantage, they must make these
important decisions without absolute 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 adverselyor 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.
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.
When exercising judgment, decision makers often take intelligent risks. In the current competitive landscape,
executive judgment can be a particularly important source of competitive advantage. One reason is that, over
time, effective judgment allows a firm to build a strong reputation and retain the loyalty of stakeholders whose
support is linked to above-average returns.
Significant changes in the value-creating potential of a firms resources and capabilities can occur in a rapidly
changing global economy. Because these changes affect a companys 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 firms strategic competitiveness. By denying the need for change, difficult
experiences can be avoided in the short run.
STRATEGIC FOCUS
Hyundai Cars: The Quality is There, So Why Arent the Cars Selling?
Once defined as cheap, tin-pot vehicles, Hyundai automobiles suffered from multiple manufacturing
defects. But in a move to reposition itself in a very competitive business, Hyundai Motor Company
became intent on establishing a new image of producing high-quality vehicles. In a 2007 study done by a
well-known market research and auto-industry consulting firm, Hyundai held leadership positions in five
different categories (including large car, minivan, and small SUV). A J.D. Powers study supported these
findings. These evaluations supported Hyundais goal of establishing a brand that stood for quality.
Hyundais quality ratings exceeded Toyotas ratings and were exceeded only by those of Lexus and
Porsche.
With quality endorsements by highly respected third parties, Hyundai felt that its quality efforts
had been validated and that it was in a position to become a new player in a market dominated by
Japanese and European quality automakers. Unfortunately for Hyundai, the market has yet to
recognize it as a manufacturer of high-quality vehicles. Is this an example of having one chance
to make a first impression? What suggestions do students have for Hyundai to recreate itself and
establish an image of quality?

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Later in this chapter, students will be reminded of the power of a brand. You might want to refer
back to this case, asking if there is a handicap associated with branding.

Describe the differences between tangible and intangible resources.

RESOURCES, CAPABILITIES, AND CORE COMPETENCIES

This section develops the background and relationships between resources, capabilities, and core competencies
that represent potential sources upon which a firm can build the foundation for a competitive advantage.
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.
By themselvesor individuallyresources generally will not enable a firm to achieve a competitive advantage.
They must be combined or integrated with other firm resources to establish a capability. When these capabilities
are identified and nurtured, they can result in core competencies, which may lead to a competitive advantage. A
firm's resources can be classified either as tangible or intangible.
Tangible Resources
Tangible resources are assets that can be seen or quantified, such as a firm's physical assets (e.g., its plant and
equipment). Tangible resources are classified in one of four ways, as illustrated in Table 3.1.

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
Organizational resources, such as its formal reporting structure and systems
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 difficult to leverage: it is hard to derive more business or additional value
from a tangible resource. For example, an airplane is a tangible resource or asset, but it can
only be used on one route at a time, and it is equally impossible to put the same crew on five
different routes at the same time. This is also true for the financial investment made in the
airplane, but intangible assets such as a new innovation in manufacturing processes can be
applied to many assembly lines. These dynamics are considered next.
Intangible Resources

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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 range from innovation resources, such as
knowledge, trust, and organizational routines, to the firm's people-dependent or subjective resources of knowhow, networks, organizational culture, to the firm's reputation for its goods and services and the way it interacts
with others (such as employees, suppliers, or customers).
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
intangible assets to have contributed increasingly to U.S. economic growth since the early
1900s. The ratio of intangible business capital to tangible business capital in 1929 was 30
percent to 70 percent, but that ratio was 63 percent to 37 percent in 1990.
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 managerial capabilities
Innovation resources, such as scientific capabilities and capacity to innovate
Reputational resources, such as the firm's reputation with customers or suppliers

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 will not, by themselves, represent capabilities that will serve as sources of core
competencies. However, they still have value and will contribute to the development of capabilities and core
competencies.
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, 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: 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 asset was identified as the most important: Company Reputation/Reputation for
Quality. As time permits, you may want to have the class discuss what makes a company's
reputation. This also can be assigned as a "thought-provoking" question for an outside
assignment or for future class discussion.

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STRATEGIC FOCUS
Seeking to Repair a Tarnished Brand Name
In this case, PepsiCo and other soft drink manufacturers operating within India are accused of having
unsafe levels of pesticides (per European standards) in their respective products. These accusations, made
by a highly respected Indian private research and advocacy group, resulted in the public reacting in a
predictable fashion by buying 30 to 40 percent fewer PepsiCo products. Pepsi refuted the accusations.
Tests conducted by an Indian government agency support PepsiCos claim that Indian-produced PepsiCo
products meet European and American content standards.
So who is the public to believe? Critics are now leveling charges against all soft-drink manufacturers in
India, claiming that they are using excessive amounts of groundwater to manufacture their products. Now
critics have refocused their claims from using pesticide-infested water to using too much water. In an effort
to restore its name as a good corporate citizen and demonstrate sensitivity to the Indian culture and its
respect for water, PepsiCo is undertaking various actions within India including digging wells in villages
for the local citizenry, harvesting rainwater, and teaching better techniques for growing rice and tomatoes.
PepsiCo has been trying to do the right thing as a good corporate neighbor. It faced claims of
producing unhealthy product followed by allegations of using an excessive amount of precious
water. It appears that PepsiCo is always in the defensive mode. Why is PepsiCo a popular or
easy target for environmentalists? PepsiCos CEO is an Indian woman. Is this a consideration
in this case?

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 firms. Thus, it is important that companies with
strong brand names nurture the core competencies that provide the brand name with value and
continually communicate 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 LOreal
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, which 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 that may be perceived as providing more value than the
national brands. In many cases, national brands have reacted to such threats by cutting prices.
However, cost-cutting is not the only strategy that can be used to safeguard a brand.

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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 nurture and exploit the resources,
capabilities, and core competencies that are the source of competitive advantage.
For companies whose brands are under fire (such as Marlboro or Budweiser), the challenge is to reestablish the value of the brand. They must reconfigure their existing bundle of resources,
capabilities, and core competencies to renew them as sources of competitive advantage.
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.
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, mortgages.
Other firms (e.g., Procter & Gamble, General Motors, and Philip Morris) support their brand-name
products through heavy advertising expenditures.
It is important to remember that resourcesboth tangible and intangiblerepresent 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 integratively. In 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 firms information-based
tangible resources (Table 3.1) and/or its intangible resources (Table 3.2).

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.
Capabilities develop over time as a result of complex interactions that take advantage of the interrelationships
between a firm's tangible and intangible resources that are based on the development, transmission, and
exchange or sharing of information and knowledge as carried out by the firm's employees (its human capital).
A firm's ability to achieve a competitive advantage is thus reflected in its knowledge base and the ability of its
human capital to successfully exploit firm capabilities. Thus, human capital is of significant value in the firm's
ability to develop capabilities and core competencies to achieve strategic competitiveness.
Teaching Note: As discussed in the chapter, the strategic value of resources is increased
when they are integrated or combined. Unique combinations of the firms tangible and
intangible resources can be molded into capabilitieswhat the firm can do when it deploys
teams of resources working together. You can use a firm like Microsoft to illustrate this point.
The knowledge possessed by the firm's human capital may be one of the most significant sources of a firm's
competitive advantage because it represents everything that the firm has learned, and thus everything that it
knows about successfully linking or bundling sets of individual resources to develop capabilities as a foundation
for developing core competencies and, ultimately, to achieve a competitive advantage.

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Teaching Note: A number of firms have gone so far as to hire Chief Learning Officers (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.
Establishing and nurturing the skills and abilities of the workforce is of critical importance to a firm's ability not
only to establish, but to sustain a competitive advantage by acquiring new knowledge and developing new skills
that will enhance existing capabilities and core competencies, as well as aid in the development of new ones.
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 questions like, Why are manhole
covers round? (The answer: A round cover cannot fall into the hole no matter which way it is
turned.) Such questions may seem silly, but the goal is to identify people with powerful
reasoning skills, and thus (conceivably) the capacity to generate outstanding software
solutions.
Firms also have functional area capabilities they have nurtured and are now considered as core competencies.
As a result, these core competencies provide the foundation for the firms competitive advantage.
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 firms capabilities serve as a source of
competitive advantage. In other words, involve your students in a discussion of why one
firms functional activity is being performed better than that of its competitors. For example,
ask students to compare and contrast the marketing approaches of Proctor & Gamble and
Polo Ralph Lauren Company or the manufacturing capabilities of Komatsu and Sony.
TABLE 3.3
Examples 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 firms
competitive advantage.

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 the firm over its competitors. Core
competencies emerge over time through an organizational process of accumulating and learning how to deploy
different resources and capabilities. As the capacity to take action, core competencies are the crown jewels of

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a company, the activities the company performs especially well compared with competitors and through which
the firm adds unique value to its goods or services over a long period.
Teaching Note: Remember, resources and capabilities serve as the foundation upon which
firms formulate and implement value-creating strategies so that the firm can achieve strategic
competitiveness and earn above-average returns. However, if a firm has a deficiency in some
of its resources, it may not be able to achieve strategic competitiveness. For example,
insufficient financial resources may prevent a firm from implementing the processes or
integrating the activities required to add superior value by limiting its ability to hire workers
with the necessary skills or to invest in the capital assets (facilities and equipment) that are
needed.
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 firms resources and capabilities are strategic assetsthat 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 able to produce goods or
services with features and characteristics that are valued by customers. This implies that firms can implement
value-creating strategies only when its capabilities and resources can be combined to form core competencies.
The question is asked: "How many core competencies are required for a competitive advantage?" McKinsey &
Company recommends that firms identify 3 or 4 competencies around which to frame their strategic actions.
Teaching Note: In support of the McKinsey Rule, it is interesting to note that McDonalds
has four main competencies (in real estate, restaurant operations, marketing, and its global
infrastructure). Also, with the actual manufacturing of automobiles and trucks expected to
become a declining part of its operations, Ford Motor Company is framing its twenty-first
century competitive success around competencies in the areas of design, branding, sales,
and service operations.
BUILDING CORE COMPETENCIES
This section discusses two conceptual tools/frameworks firms can use to identify competitive advantages:
Four criteria determine which of the firms 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 firms 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 will be discussed in more detail following the table.

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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 sustainable competitive advantage.
However, a short-term competitive advantage is available when firm capabilities are valuable, rare, and nonsubstitutable. The length of time that a firm possessing such capabilities can expect to sustain a competitive
advantage depends on how long it takes for competitors to successfully imitate the value-creating activity or
process, or reproduce valued features or characteristics of the product or service.
Thus, the ability to sustain a competitive advantage is dependent on firm capabilities being valuable, rare, nonsubstitutable, and costly to imitate.
Valuable
Capabilities that are valuable 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
Capabilities are rare when they 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 result, none of the firms
will be able to achieve a sustainable competitive advantage. A competitive advantage will be achieved by firms
that develop and exploit capabilities that are different from those held by other firms.
Costly-to-Imitate
Capabilities are costly to imitate when other firms are unable to develop them 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, establishing facilities
in a key location that can preempt competition when no other locations have similar value-related
characteristics or developing a unique organizational culture in the early stages of the organization's life may
not be cheap to duplicate by firms that are developing theirs at a different time.
A unique culture may not only serve as a source of competitive advantage, but also can be a source of
competitive disadvantage. The latter may be the case when a firm's culture prevents it from recognizing or
successfully adapting to changes in a turbulent environment.
Teaching Note: This may explain why such companies as IBM and General Motors, whose
cultures developed early in each company's historyand during relatively calm or stable
environmentswere able to rely on formal controls and multiple approvals of strategies and
be successful. However, their respective cultures, grounded in rigidity and bureaucracy, may

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have prevented them from successfully adapting to rapid environmental change in a fastpaced global environment.
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 phenomena such as
interpersonal relationships within the firm (e.g., how managers and subordinates at Hewlett-Packard work with
each other) or a firms reputation with its customers and suppliers.
Nonsubstitutable
A firm's capabilities are nonsubstitutable when they do not have strategic equivalents. Firm resources are
strategically equivalent when they each can be separately exploited to implement the same strategies. If
capabilities are invisible, it is even more difficult for competitors to identify viable substitutes. Examples of
capabilities that can be difficult to identify or to find suitable substitutes for include firm-specific knowledge
and trust-based working relationships.
Table Note: Table 3.5 summarizes the relationship between the characteristics of firm
capabilities, sustainability of competitive advantage, and performance implications. Rather
than repeating the table in a lecture, students should be advised to refer to it as needed.
TABLE 3.5
Outcomes from Combinations of the Criteria for Sustainable Competitive Advantage
Highlights from Table 3.5 are:
Resources and capabilities that are neither valuable, rare, costly-to-imitate, nor nonsubstitutable mean that
the firm will be at a competitive disadvantage and will earn below-average returns.
Resources and capabilities that are valuable, but are neither rare nor costly to imitate and may or may not be
nonsubstitutable mean that the firm can achieve competitive parity and earn average returns.
Resources and capabilities that are both valuable and rare, but are not costly to imitate and may or may not
be nonsubstitutable, may enable the firm to achieve a temporary competitive advantage and will earn aboveaverage to average returns.
Resources and capabilities that are valuable, rare, costly-to-imitate, and nonsubstitutable will enable the firm
to achieve a sustainable competitive disadvantage and earn above-average returns.

Teaching Note: Given the criteria for the sustainability of a competitive advantage, ask
students if The Gaps Old Navy concept (or another case with which they are likely to be
personally familiar) represents a source of competitive advantage that can be sustained over
time. One likely interpretation using the criteria set out in Table 3.5 is that The Gaps
competitive advantage in the Old Navy concept can only be sustained until competitors
successfully imitate or duplicate the value created. Thus, the Old Navy concept represents a
temporary competitive advantage. This will enable The Gap to earn above-average returns
until the value created is successfully imitated by competitors.

Explain how value-chain analysis is used to identify and

evaluate resources and capabilities.

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Value Chain Analysis
A framework that firms can use to identify and evaluate the ways in which their resources and capabilities can
add value is value chain analysis. This framework is useful because it enables firms to understand which parts
of their operations or activities create value by segmenting the value chain into primary and secondary activities
as illustrated in Figure 3.3.
Figure Note: Students should refer to Figure 3.3 and Tables 3.6 and 3.7 during your
explanation of the value chain concept. Tables 3.6 and 3.7 develop the criteria for examining
the value-creating potential of the firm's primary and secondary activities, respectively, after
these terms are introduced in Figure 3.3.

FIGURE 3.3
The Basic Value Chain
Figure 3.3 illustrates how the value-creating activities performed by the firm can be separated into primary and
secondary activities.
Primary activities represent traditional line activities such as inbound logistics, operations, outbound logistics,
marketing and sales, and service.
Support activities are represented by a firm's staff activities and include its financial infrastructure, human
resource management practices, technological development, and procurement activities.

Table Note: The first step in value chain analysis is to carefully examine each of the firm's
primary activities to assess the potential for creating or adding value (see Table 3.6).
TABLE 3.6
Examining the Value-Creating Potential of Primary Activities
Table 3.6 presents value-creating issues to be addressed for each primary activity. Activities are rated as
superior, equivalent, or inferior (relative to competitors). Students can refer to this table during your discussion.
Inbound logistics: Examine all activities related to the receipt, control, warehousing, inventory, and
distribution of raw materials or component parts into the production process.
Operations: Activities to be examined are all of those necessary to convert the inputs (raw materials or
components) available as a result of inbound logistics into finished products. Examples include machining,
assembly, equipment maintenance, and packaging.
Outbound logistics: This category represents the firm's activities involved with the collection, storage, and
physical distribution of products to customers. Examples include warehousing or storage of finished
products, material handling, and order processing.
Marketing and sales: Several marketing and sales activities must be completed to both induce customers to
purchase products and ensure that products are available. Activities include developing advertising and
promotion campaigns; selecting and developing distribution channels; and selecting, training, developing,
and supporting a sales force.

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Service: These are the activities that a firm offers to enhance or maintain a product's value, including
installation, product use training, adjustment, repair, and warranty services.

Table Note: The next step in the value chain analysis process is to examine the firm's
support activities to determine any value-creating potential in those activities (see Table 3.7).
TABLE 3.7
Examining the Value-Creating Potential of Support Activities
Table 3.7 presents value-creating issues to be addressed for each support activity. Activities are rated as
superior, equivalent or inferior, relative to competitors. Students can refer to this table during your discussion.
Procurement: These are activities that are completed to purchase the inputs needed to produce a firm's
products, including items consumed or used in the manufacturing process (such as raw materials or
component parts), supplies, and fixed assets (machinery, equipment and facilities).
Technological development: All activities that are completed to either improve a firm's products or its
production processes. This includes basic research, process and equipment design, product design, and
servicing procedures.
Human resource management: These activities are related to the recruiting, hiring, training, developing,
and compensating (including performance assessment and reward systems) of a firm's employees.
Firm infrastructure: These activities support the activities performed in the firm's value chain, including
general management practices, planning, finance, accounting, legal, and government relations. By
performing its infrastructure-related activities, a firm identifies external opportunities and threats, and
internal strengths and weaknesses related to firm resources and capabilities, and supports or nurtures its core
competencies.

Using the value chain framework enables managers to study the firm's resources and capabilities in relationship
to the primary and support activities performed to design, manufacture, and distribute products, and to assess
them relative to competitors' capabilities. For these activities to be sources of competitive advantage, a firm
must be able to:
perform primary or support activities in a manner superior to the ways that competitors perform them
perform a primary or support activity that no competitor is able to perform to create superior value for
customers and achieve a competitive advantage
This implies that, given that individual firms are comprised of unique or heterogeneous bundles of activities,
reconfiguring the value chainor rebundling resources and capabilitiesmay enable a firm to develop unique
value-creating activities.
Figure Note: The potential to configure the value chain to create a core competency and
achieve competitive advantage is illustrated in Figure 3.4, and with a great deal of detail.
FIGURE 3.4
Prominent Application of the Internet in the Value Chain

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This is a very involved figure, but it helps to illustrate the vast potential of the Internet to change the way
managers think about the value chain. Explaining the ins-and-outs of the figure will take a good bit of time, but
it is worth the investment.

The managerial challenge is that the value-creation process is difficult and there is no one best way to assess a
firm's primary and support activities or to evaluate the value-creating potential of those activities either within
the firm or relative to competitors, because of incomplete or ambiguous data.
By being objective, managers may be able to use the value chain framework to identify new, unique ways to
combine resources and capabilities to create value that are difficult for competitors to recognize, understand, or
imitate. The longer a firm is able to keep competitors "in the dark" as to how resources and capabilities have
been combined to create value, the longer a firm will be able to sustain a competitive advantage.
Firms can use outsourcing as an alternative to identify primary or support activities for which its resources and
capabilities are not core competencies and do not enable the firm to add superior value and achieve competitive
advantage.

Define outsourcing and discuss the reasons for its use.

OUTSOURCING
Outsourcing describes a firm's decision to purchase a value-creating activity from an external supplier.
Outsourcing has become importantand may become more important in the futurefor two reasons:
There are limits to the abilities of firms to possess all of the bundles of resources and capabilities that are
required to achieve superior performance (relative to competitors) in all its primary and support activities.
With limited resources and capabilities, firms can increase their ability to develop resources and capabilities
to form core competencies and achieve competitive advantage by nurturing a few core competencies.
Firms engaging in outsourcing can increase their flexibility, mitigate risks, and reduce their capital investment.
Teaching Note: When outsourcing, a firm seeks the greatest value. In other words, a
company wants to outsource only to firms possessing a core competence in terms of
performing the primary or support activity that is being outsourced. This was the case
between Nissan and IBM. In fact, the firms services division, the group to which Nissan
outsourced some of its computer operations, was the fastest-growing part of IBM. A few years
back, IBM sold its Global Network division to AT&T at a price of $5 billion. As part of this
transaction, IBM agreed to pay AT&T Solutions $5 billion to run its global telecom network
through 2004, a deal that allows AT&T and IBM to concentrate their efforts on different
operations (those in which the companies have core competencies).
Other research suggests that outsourcing does not work effectively without extensive internal capabilities to
coordinate external sourcing as well as core competencies.
To ensure that the appropriate primary and support activities are outsourced, four skills are essential for
managers involved in outsourcing programs:
strategic thinking understanding whether/how outsourcing creates competitive advantage within the
company
deal making able to secure rights from external providers that can be fully used by internal managers
partnership governance able to oversee and govern appropriately the relationship with the company to
which the services were outsourced

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change management because outsourcing can significantly change how an organization operates, managers
administering these programs must also be able to manage that change, including resolving employee
resistance that accompanies any significant change effort
Teaching Note: Outsourcing can take several forms, depending on a firm's strategic
objectives. Examples of outsourcing strategies that, while different, enable outsourcing firms
to achieve their strategic objectives while changing the face of college campuses include:
Universities and colleges outsourcing the management of college bookstores to Follett
College Stores and Barnes & Noble
Food Service management companies such as ARA and Marriott licensing with Burger
King to establish national chain restaurants on college campuses
Colleges in the U.S. contracting with private firms to manage or build on-campus housing

Discuss the importance of identifying internal strengths and

weaknesses.

COMPETENCIES, STRENGTHS, WEAKNESSES, AND STRATEGIC DECISIONS

Tools such as outsourcing help the firm focus on its core competencies as the source of its competitive
advantages. However, evidence shows that the value-creating ability of core competencies should never be
taken for granted. Moreover, the ability of a core competence to be a permanent competitive advantage cant be
assumed.
All core competencies have the potential to become core rigidities. As Leslie Wexner, CEO of The Limited,
Inc., says: Success doesnt beget success. Success begets failure because the more that you know a thing
works, the less likely you are to think that it wont work. When youve had a long string of victories, its harder
to foresee your own vulnerabilities. Thus, each competence is a strength and a weaknessa strength because it
is the source of competitive advantage and, hence, strategic competitiveness, and a weakness because, if
emphasized when it is no longer competitively relevant, it can sow the seeds of organizational inertia.
Events occurring in the firms external environment create conditions through which core competencies can
become core rigidities, generate inertia, and stifle innovation. According to one observer, Often the flip side,
the dark side, of core capabilities is revealed due to external events when new competitors figure out a better
way to serve the firms customers, when new technologies emerge, or when political or social events shift the
ground underneath.
In the final analysis, changes in the external environment do not cause core competencies to become core
rigidities; rather, strategic myopia and inflexibility on the part of managers are the cause. Thus, nurturing
existing competencies must be balanced by efforts to encourage the development of new competencies.

ANSWERS TO REVIEW QUESTIONS

1.

Why is it important for a firm to study and understand its internal environment? (p. 71-72)

As they analyze their internal environment, a manager should think of the firm as a bundle of heterogeneous
resources and capabilities that can be used to create an exclusive market position. This means that firms should
no longer focus only on the traditional sources of competitive advantage (e.g., labor costs, access to capital, and
raw materials) as these advantages can be overcome through an international strategy and the relative free flow
of global resources. Instead, firms should seek out those resources and capabilities that other firms do not
have, at least not in the same combinations. A firm's resources are the source of its capabilities, some of which

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can lead to core competencies that enable a firm to perform value-creating activities better than its competitors
or that its competitors cannot duplicate.
2.

What is value? Why is it critical for a firm to create value? How does it do so? (pp. 72-73)

Value is represented by the bundle of performance characteristics and attributes that a firm provides to
customers in the form of goods or services for which customers are willing to pay. Broadly speaking, value can
be provided by a product's/service's low cost, highly-differentiated features, or a combination of the two (when
these strategies are superior to those offered by competitors).
Ultimately, it is critical that a firm be able to create customer value since it is the source of a firm's potential to
earn above-average returns. Therefore, in the rapidly changing environments of the 21st-century competitive
landscape, firms must evaluate continuously the degree to which their core competencies create customer value.
What the firm intends to do to create value affects its choice of business-level strategy and its organizational
structure
3. What are the differences between tangible and intangible resources? Why is it important for decision
makers to understand these differences? Are tangible resources linked more closely to the creation of
competitive advantages than are intangible resources, or is the reverse true? Why? (pp. 76-78)
Tangible resources are represented by assets which can be seen and quantified. They are not only represented
by the firm's physical resources (such as plant and equipment), but also by other assets, such as the firm's
borrowing capacity, the skills and attributes of its staff, and its technological capacities. Intangible resources
(because they are less visible and more embedded in the firm's history) are more difficult for competitors to
understand and imitate. These include such resources as scientific capabilities, knowledge within the firm,
organizational routines, or the firm's reputation for quality.
Resources are the source of a firm's capabilities. Capabilities are the source of a firm's core competencies,
which are the basis of competitive advantages. Intangible resources (as compared to tangible resources) are a
superior and more potent source of core competencies. In fact, in the global economy, intellectual and systems
capabilities are more important to the success of a corporation than are its physical assets, and the capacity to
manage human intellect is now a critical executive skill. Intangible resources are less visible and more difficult
for competitors to understand, purchase, imitate, or substitute, and thus firms prefer to rely on these resources as
the foundation for their capabilities and core competencies. Therefore, unobservable (i.e., intangible) resources
provide a better platform for competitive advantage than do tangible resources. And unlike tangible resources,
the use of intangible resources can be leveraged for even greater benefits to firm performance.
4.

What are capabilities? What must firms do to create capabilities? (p. 80)

Capabilities represent the firm's capacity or ability to successfully integrate sets of firm resources and deploy
these resources to achieve some desired end. Capabilities evolve or develop over time through interactions
among and between tangible and intangible resources. It is also critical to recognize that capabilities are based
on the development, carrying, and exchange of information and knowledge by the firm's human capital. Thus, a
firm's capabilities are a reflection of its knowledge base: the skills and knowledge of its employees and (often)
their functional expertise.
Global business leaders increasingly support the view that the knowledge possessed by human capital is among
the most significant of an organizations capabilities and may ultimately be at the root of all competitive
advantages. But firms must also be able to utilize the knowledge that they have and transfer it among their
business units. Given this reality, the firms challenge is to create an environment that allows people to
integrate their individual knowledge with that held by others in the firm so that, collectively, the firm has
significant organizational knowledge.
5. What are the four criteria used to determine which of a firms capabilities are core competencies?
Why is it important for these criteria to be used? (pp. 81-84)

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Capabilities are a firm's core competencies when they satisfy the four criteria of sustainable competitive
advantage: they must be valuable, rare, costly to imitate, and nonsubstitutable. A capability is valuable when it
helps a firm exploit opportunities or neutralize threats in its external environment. A capability that is rare is
possessed by few, if any, current or potential competitors. Capabilities are costly to imitate when other firms
cannot develop them except at a cost disadvantage relative to firms that already possess them. (This can be the
case when the capabilities derive from unique historical conditions, are causally ambiguous, or socially
complex.) Finally, capabilities are non-substitutable when they do not have strategic equivalents.
It is important for these criteria to be used because a competitive advantage is sustainable over time only when
competitors are unsuccessful at duplicating the benefits of the firm's strategy or when they are unable to imitate
the strategy.
6.

What is value chain analysis? What does a firm gain when it successfully uses this tool? (pp. 84-87)

The value chain is a template that the firm uses to understand its cost position and to identify the multiple means
that might be used to facilitate the implementation of its business-level strategy. Managers would use value
chain analysis to examine the firm's resources and capabilities in relationship to the activities performed in the
design, manufacture, and distribution of products. Specifically, this framework differentiates primary activities
(those involved with a product's physical creation, its sale and distribution to buyers, and its service after the
sale) from support activities (which provide the support necessary for the primary activities to take place).
Managers should scrutinize and assess activities and capabilities with competitors' capabilities in mind because
the firm must be able to either perform an activity in a manner that provides value superior to or better than any
competitor or identify and perform value-adding activities that competitors are unable to perform, if these
capabilities are to be a source of competitive advantage. Nonetheless, it is important to remember that value
chain analysis is a highly subjective process. Just as identifying and valuing a firm's resources and capabilities
requires judgment, so does the process of assessing the relative value added by activities performed. Studying
the value chain will enable managers to better understand their cost structure and the activities in which they
can create and capture value.
7. What is outsourcing? Why do firms outsource? Will outsourcing's importance grow in the 21st
century? If so, why? (pp. 87-88)
Outsourcing is the purchase of a value-creating activity from an outside supplier that can provide the greatest
value. A firm is likely to engage in outsourcing when it identifies primary and support activities in which its
resources and capabilities are neither sources of competence nor of sustainable competitive advantage. In such
instances, firms should consider purchasing these activities from firms that can add value to the activity
(relative to the firm's competitors).
Outsourcing has several advantages for firms but also carries some important risks as well. Outsourcing can
potentially reduce costs and increase the quality of the activities outsourced. In this way, it adds value to the
product provided to consumers. Thus, outsourcing can contribute to a firms competitive advantage and its
ability to create value for its stakeholders. However, the risk of the outsourcing partners learning the
technology and becoming a competitor is very real and should be taken seriously.
Outsourcing is important to firms competing in the 21st-century landscape because few, if any firms possess all
of the resources and capabilities that are necessary for them to achieve competitive superiority in all necessary
primary and support activities. By outsourcing activities in which it lacks the competence to create value and
by nurturing a few core competencies, a firm increases its probability of developing a sustainable competitive
advantage. To maximize value, firms should scan the entire globe to locate the source (supplier or performer)
of the to-be-outsourced activity to locate the best producer in the world of the activity that is being outsourced.
Given the increasing complexity of products/services offered (e.g., based on combined, sophisticated
technologies), firms looking forward should anticipate that even more outsourcing of non-strategic activities is
likely to be necessary.

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8. How do firms identify internal strengths and weaknesses? Why is it vital that firms base their
strategy on such strengths and weaknesses? (pp. 88-90)
By completing the internal analysis, firms can (must) identify their strengths and weaknesses in resources,
capabilities, and core competencies. For example, if they have weak capabilities or do not have core
competencies in areas required to achieve a competitive advantage, they must acquire those resources and build
the capabilities and competencies needed. Alternatively, they could decide to outsource a function or activity
where they are weak in order to improve the value that they provide to customers.
Firms need to have the appropriate resources and capabilities to develop the desired strategy and create value
for customers and shareholders as well. Having many resources does not necessarily lead to success. Firms
must have the right ones and the capabilities needed to produce superior value to customers. Undoubtedly,
having the appropriate and strong capabilities required for achieving a competitive advantage is a primary
responsibility of top-level managers. These important leaders must focus on both the firms strengths and
weaknesses.

EXPERIENTIAL EXERCISES
Exercise 1: Dot com boom and bust
The focus of this chapter is on understanding how firm resources and capabilities serve as the cornerstone
for competencies, and, ultimately, a competitive advantage. Strategists have long understood the
importance of internal analysis: for example, Porters value chain model was introduced in 1985, more than
twenty years ago. How, then, can a large number of prominent firms create strategies while apparently
disregarding the importance of internal analysis?
The late 1990s saw the launch of thousands of Internet start-ups, often supported by venture capital. These
new businesses were heralded as part of the new economy and were characterized as having a superior
business model compared to models being used by traditional bricks and mortar firms. The collapse of
the dot com bubble had global economic ramifications. Some of the more prominent e-business failures
include:

Webvan.com
Kosmo.com
Cyberrebate.com
Go.com
Boo.com
Kibu.com

Pets.com
Zap.com
Flooz.com
Digiscents.com
eToys.com
Yadayada.com

As a group, select a failed dot com business. You may choose one of the companies from the above list, or
another dot com that you identify on your own. Using library and Internet resources, prepare a brief
PowerPoint presentation that covers these questions:
How did the company describe its value proposition i.e., how did the firm plan to create value
for its customers?
Describe the resources, capabilities, and competencies that supported this value proposition.
Why do you think the firm failed? Was it a poor concept, or a sound concept that was not well
executed? Apply the concepts of value, rarity, imitation and sustainability when preparing your
answer.

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Are there presently other firms that use a similar approach to creating value for their customers?
If so, what makes them different from the failed company that you studied?

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Chapter 3: The Internal Environment

Exercise 2: Competitive advantage and pro sports
What makes one team successful while another team struggles? At first glance, a National Football League
franchise or womens National Basketball Association team may not seem like a typical business.
However, professional sports have been around for a long time: pro hockey in the United Stated emerged
around World War I, and pro basketball shortly after World War II; both could be considered newcomers
relative to the founding of baseball leagues. Pro sports are big business as well, as evidenced by David
Beckhams 2007 multi-million dollar contract with Major League Soccer.
With this exercise, we will use tools and concepts from the chapter to analyze factors underlying the
success or failure of different sports teams. Working as a group, pick two teams that play in the same
league. For each team, address the following questions:
How successful are the two teams you selected? How stable has their performance been over
time?
Make an inventory of the characteristics of the two teams. Characteristics you might choose to
identify include reputation, coaching, fan base, playing style and tactics, individual players, and so
on. For each characteristic you describe,
o

Decide if it is best characterized as a tangible, intangible, or capability.

Apply the concepts of value, rarity, imitation and sustainability to analyze its valuecreating ability.

Is there evidence of bundling i.e., the combination of different resources and capabilities?
What would it take for these two teams to substantially change their competitive position over
time? For example, if a team is a leader, what types of changes in resources and capabilities might
affect it negatively? If a team is below average, what changes would you recommend to its
portfolio of resources and capabilities?

INSTRUCTOR'S NOTES FOR

EXPERIENTIAL EXERCISES

Exercise 1: Dot com boom and bust

The goal of this exercise is to use the dot com bubble to analyze the role of resources and capabilities in
building a competitive advantage. Working in groups, students are asked to select a failed dot com and
develop a PowerPoint presentation which answers the following questions:
How did the company describe its value proposition i.e., how did they plan to create value for
their customers?
Describe the resources, capabilities, and competencies that supported this value proposition.
Why do you think the firm failed? Was it a poor concept, or a sound concept that was not well
executed? Apply the concepts of value, rarity, imitation and sustainability in your answer.
Are there presently other firms which use a similar approach to creating value for their customers?
If so, what makes them different from the failed company that you studied?

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Michael Porters Strategy and the Internet article (Harvard Business Review, March 2001) is an excellent
complement to this assignment. Porter discusses how the exuberance associated with the Internet led to a
number of adverse outcomes, including the adoption of strategies that hurt both individual firms and entire
industries, as well as the creation of many businesses that were fundamentally unsustainable.
The instructor should distribute copies of Porters article when the exercise is assigned. Following is a
recommended teaching plan for discussing the exercise in class:
Ask two or three student teams to share their presentations with the class. To obtain variety in the
presentations, ask several questions before selecting teams. For instance:
What firm did you pick?
What is the reason for failure? Who thought the idea was sound, but poorly executed? Who thought the
basic idea was flawed? How severe were the failures? Who studied firms that came and went quickly?
Who studied firms that lasted for awhile before going under?
Next, discuss how these failures relate to concepts in Porters article. Some of the relevant topics from the
article include:
distorted market signals
effects on industry structure
first mover issues
competitive advantage
value chain
If there is sufficient time available, business models can be included as a topic in the discussion. Porter is
highly critical of this term, which was popularized during the Internet boom as a shorthand term for how a
firm creates revenue. Porter notes that the business model approach to management becomes an invitation
to faulty thinking and self-delusion (2001: 12). Elsewhere, Michael Lewis noted that the term business
model was used during the boom to justify all manner of half-baked plans.
A good discussion question is to ask whether Porters critique is overly harsh. Joan Magrettas article Why
Business Models Matter (Harvard Business Review May 2002) offers a good counterpoint to Porters
negative assessment.
Exercise 2: Competitive advantage and professional sports
The intent of this exercise is to frame the discussion of resources, capabilities, and competitive advantage
in a familiar topic professional sports. Student teams are asked to pick two teams that compete in the
same league and answer the following questions:
How successful are the two teams you selected? How stable has their performance been over
time?
Make an inventory of the characteristics of the two teams. For example, reputation, coaching, fan
base, playing style and tactics, individual players, and so on. For each of the features that you
describe,
o

Decide if they are best characterized as a tangible, intangible, or capability.

Apply the concepts of value, rarity, imitation and sustainability each of the resources and
capabilities you identified.

Is there evidence of bundling i.e., the combination of different resources and capabilities?

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What would it take for these two teams to substantially change their competitive position over
time? For example, if a team is a leader, what types of changes in resources and capabilities might
affect them negatively? If a team is below average, what changes would you recommend to their
portfolio of resources and capabilities?
To debrief this exercise in class, ask students which teams they chose for analysis. Focus on the league
with the greatest number of teams represented. Draw on the results of the team analyses to fill in the
following table.
For each team, identify no more than four characteristics that students believe are important to that teams
success. If more than four items are offered, have students rank order the different components. For each
of the items:
Classify the type as T, I, or C, for Tangible, Intangible, or Capability.
Evaluate each item whether it adds value, is rare, is free from imitation, and is sustainable.
Next, discuss whether multiple characteristics are bundled together for a particular team. Assign a score of
1 for no bundling, 2 for some bundling, and 3 for extensive bundling.
Finally, ask what would be necessary for a firm to substantially change their competitive position over
time.
Team

Key
Characteristics

Type
(I,T,
or C)

Is It
Valuable

Rare

Team
1

Team
2

Team
3

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Imitable

Bundling
(1,2, or 3)
Sustainable

Keys to
Change

Chapter 3: The Internal Environment

ADDITIONAL QUESTIONS AND EXERCISES

The following questions and exercises can be presented for in-class discussion or assigned as homework.
Application Discussion Questions
1. Several companies use their brand as a competitive advantage. Ask the class, given their knowledge about
the global economy, which brands they believe have the strongest likelihood of remaining a source of
advantage in the twenty-first century? Why? What effects do they believe the Internets capabilities will
have on this brand, and what should the owner of the brand do in light of them?
2. Students should visit the manager of a local store to obtain the following information. Using the definition
presented in the chapter, define value for the manager. Ask the manager if the definition is consistent with
how her or his firm thinks of value. If there is a difference, ask the manager to assess why the difference
exists.
3. Have the students consider a group (e.g., a fraternity or sorority, Toastmasters, or a volunteer organization)
in which they hold membership. Using the categories shown in Tables 3.1 and 3.2, list what are perceived as
the groups tangible and intangible resources. Show the list to another member of the group. Does the person
agree with your assessment of the groups resources? If not, what might account for the differences? If
differences do exist between you and your colleague, what is the meaning of such differences in terms of
trying to form the groups capabilities?
4. Refer to the third question. Ask the students if it was easier to list the tangible or the intangible resources?
Why? How confident are they with their assessments?
5. What competitive advantage do the individual students feel that the university or college possesses? What
evidence can they provide to support this opinion? Does the class as a whole agree with the assessments? If
not, why not?
6. Ask the students what effects they believe the Internet will have on the university or college within the next
five years as it seeks to develop new competitive advantages? In their view, do the strategic decision makers
in your educational institution understand the Internets capabilities? If not, why not?
7. Trust is identified in the chapter as a potential source of competitive advantage. Ask the students if they have
ever been involved in a situation in which trust was instrumental in accomplishing an organizations goals?
If so, what outcomes were made possible because of trust?
Ethics Questions
1. Can efforts to develop sustainable competitive advantages result in employees using unethical practices? If
so, what unethical practices might be used to compare a firms core competencies with those held by rivals?
How do the Internets capabilities affect actions taken to form competitive advantages that will help the firm
in efforts to outperform its rivals?
2. Do ethical practices affect a firms ability to develop brand as a source of competitive advantage? If so, how
does this happen? Can you think of brands that are a source of competitive advantage at least in part because
of the firms ethical practices?
3. What is the difference between exploiting a firms human capital and using that capital as a source of
competitive advantage? Are there situations in which the exploitation of human capital can be a source of
advantage? If so, can you name such a situation? If the exploitation of human capital can be a source of
competitive advantage, is this a sustainable advantage? Why or why not?
4. Are there any ethical dilemmas associated with outsourcing? If so, what are they? How would you deal with
outsourcing ethical dilemmas you believe exist?
5. What ethical responsibilities do managers have if they determine that a set of employees has skills that are
valuable only to a core competence that is becoming a core rigidity?
6. Through the Internet, firms sometimes make a vast array of data, information, and knowledge available to
competitors as well as to customers and suppliers. What ethical issues, if any, are involved when the firm
finds competitively relevant information on a competitors Web site?

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Chapter 3: The Internal Environment

7. Firms are aware that competitors read information that is posted on their Web sites. Given this reality, is it
ethical for a firm to include false information, for example, about its sources of competitive advantage on its
Web site in hopes that the information will influence competitors to take certain actions as a result of
viewing it?
Internet Exercise
A fairly recent global development in the automobile industry has been the mergers and acquisitions going on
among firms. These include the coupling of Daimler-Benz with Chrysler; VW with Audi, Rolls Royce, and
Bentley; GM with Saab; and Fords acquisition of Volvo. The new partnerships have allowed firms to combine
resources and capabilities to build a new breed of universal car. Explore the Websites of these firms. Is there
still a specific brand identification associated with each type of car? How important will branding be in the
future for these products?
*e-project: Imagine that you are able to purchase your dream car from among the current years models. Before
buying, though, you would like to learn something about how the car is produced. (For example, is your
Rolls Royce being assembled alongside a Beetle?) Using Internet sources, attempt to trace the origins of
the cars major components, technology, and performance-testing resources, as well as the production
and advertising or marketing facilities.

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