Department of Management

College of Business and Economics

Addis Ababa University

Strategic Management
Short Note

Yohannes Neda
[email protected]

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 Chapter Four
Internal Environmental
Analysis
Chapter Objectives Contents

At the end of this unit students will be able to:  The nature of an internal audit
 Define the internal environment  Identifying internal resources and capabilities
 Explain the nature of internal audit  The Value Chain analysis
 Identify firm’s resources and capabilities

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Outcomes From External & Internal The Nature of Internal Analysis

Environmental Analyses

 As Shown in the diagram an analysis of the internal environment

By Studying the External By Studying the enables an organization determine what it can do- that is, the
Environment, firms Internal Environment, actions permitted by its unique resources, capabilities and core
identify: firms identify: competencies.
 The proper matching of what a firm can do with what it might do
allows the development of strategic intent, the pursuit of
• What they might choose to strategic mission and formulation of strategies.
do? • What they can do?  The internal audit requires gathering and assimilating information
about the firm’s management, marketing, finance/accounting,
production/operations, research and development (R&D), and
management information systems operations.
 Key factors should be prioritized so that the firm’s most
Examine unique important strengths and weaknesses can be determined
collectively.
resources,  a task force of managers from different units of the organization,
Examine supported by staff, should be charged with determining the 10 to
opportunities & capabilities &
20 most important strengths and weaknesses that should
threats competencies influence the future of the organization
 A key to organizational success is effective coordination and
understanding among managers from all functional business
areas.
 Through involvement in performing an internal strategic-
management audit, managers from different departments and
 Before an organization can begin strategy formulation, it divisions of the firm come to understand the nature and effect of
must scan the external environment to identify possible decisions in other functional business areas in their firm.
opportunities and threats and its internal environment  Knowledge of these relationships is critical for effectively
for strengths and weaknesses. establishing objectives and strategies.
 Environmental Analysis involves the monitoring,
evaluation, and dissemination of information from
the external and internal environments to key people
within the corporation.

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 Chapter Four: Internal Environmental Analysis

Resources, Capabilities and Core Competencies

 Resources, capabilities and core competencies are the centers of

any organizations internal audit/internal analysis Capabilities
 A firm to identify its strengths and weaknesses, it needs to make
analysis of resources, capabilities and core competencies related
to each functional area.  Capabilities refer to the firm's ability to utilize its
resources effectively. An example of a capability is the
ability to bring a product to market faster than
Resources competitors.
 Are the firm’s capacity to deploy resources that have been
purposely integrated to achieve a desired end state.
 Resources are the firm-specific assets useful for creating a cost or  Emerge over time through complex interactions among
differentiation advantage and that few competitors can acquire easily. tangible and intangible resources
The following are some examples of such resources:  Often are based on developing, carrying and exchanging
information and knowledge through the firm’s human
capital
Patents and trademarks
Proprietary know-how
Installed customer base
Reputation of the firm
Brand equity

Tangible resources
• Financial resources Intangible resources
• Physical resources • Human Talent
• Technological resources • innovation resources
• Organizational resources • Reputation resources

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Core Competencies Why core competencies might become core

rigidities?
 The firm's resources and capabilities together form its core According to William Cohen
competencies.
 These competencies enable innovation, efficiency, quality, and  “A firm that continues to employ a previously successful
customer responsiveness, all of which can be leveraged to create a strategy eventually & inevitably falls victim to a competitor.”
cost advantage or a differentiation advantage i.e. core competencies Then, core competencies can become core rigidities
serve as sources of competitive advantage.  Strategic myopia & inflexibility on the part of the firm’s
managers eventually will result in core rigidities.
 Core rigidities generate inertia & stifle innovation.
Resources & Capabilities: four criteria
Examples of Core Rigidities:
Not all of a firm’s resources & capabilities have the potential to be
the basis for competitive advantage. This potential can be − Core rigidity that may be centered on existing routines
realized when resources & capabilities are:
− Core rigidity that may be related to old technology
 Valuable: Allow the firm to exploit opportunities or neutralize
threats in its external environment Preventing Core Competencies from Becoming Core
 Rare: Possessed by few, if any, current & potential competitors Rigidities
 Costly to imitate: When other firms cannot obtain them or must
obtain them at a much higher cost  Realizing that a previous successful strategy might not lead to
 Non-substitutable: The firm is organized appropriately to obtain success
the full benefit of the resources in order to realize a competitive  Realizing that success might not lead to success indefinitely
advantage  Continually evaluating whether the current core competencies
fit / match with the firm’s environment
When the four criteria are met, resources & capabilities become
core competencies.  In order to build core competencies, two conceptual tools or
frameworks might be available as firms search for competitive
In some cases, when a firm fails to keep on working on its core advantage:
competencies, they can become core rigidities
 Value chain analysis, which is a framework for determining
which value creating competencies should be maintained,
upgraded, & developed and which should be outsourced.
 Determining which of the firm’s resources & capabilities are
core competencies using the four criteria: valuable, rare,
inimitable, non-substitutable

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Competitive Advantage
 When a firm sustains profits that exceed the average for its Generic Building Blocks of Competitive Advantage
industry, the firm is said to possess a competitive advantage
over its rivals. The goal of much of business strategy is to
achieve a sustainable competitive advantage.
 Michael Porter identified two basic types of competitive
advantage:
 cost advantage
 differentiation advantage
 A competitive advantage exists when the firm is able to
deliver the same benefits as competitors but at a lower cost
(cost advantage), or deliver benefits that exceed those of
competing products (differentiation advantage). Thus, a
competitive advantage enables the firm to create superior
value for its customers and superior profits for itself.

Value Creation
 Value consists of the performance characteristics and
attributes provided by companies in the form of goods or
services for which customers are willing to pay.
 The firm creates value by performing a series of activities
that Porter identified as the value chain. In addition to the
firm's own value-creating activities, the firm operates in a
value system of vertical activities including those of
upstream suppliers and downstream channel members.
 Superior efficiency - the quantity of inputs that it takes to produce a
Categories of value 
given output
Superior quality - customer-perceived value in the attributes of
products/services, reliability etc.
 Value is low price  Superior innovation - anything new or novel, uniqueness
 Value is what is wanted  Superior customer responsiveness - identifying & satisfying the needs
 Value is the quality received for the price paid of customers, customization

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Value Chain Analysis

 The value chain was described and popularized by Michael

Porter in his 1985 Competitive Advantage: Creating and
Sustaining Superior Performance.
 A value chain is a systematic way of viewing the series of
activities a firm performs to provide a product to its
customers.
 It allows the firm to understand the parts of its operations
that create value & those that do not.
 It is a template that firms use to understand their cost
position & identify multiple means of implementation for a
chosen business-level strategy
 The value chain categorizes the generic value-adding
activities of an organization
 The "primary activities" Represent the sequence of bringing
materials into the business, converting them into final
products, making it available to the customers and proving
after sale support to the consumer.
 I.e. they include: inbound logistics, production, outbound
logistics, sales and marketing, and after sales service.
 The "support activities" include: firm infrastructure
management, HRM, R&D, and procurement.
 The most important thing is that the cost & value drivers
should be identified for each value activity
 Thus, the ultimate goal is to maximize value creation while
minimizing costs.
 Each of an organization’s product lines has its own distinctive value
chain. Because most organizations make several different products
or services, an internal analysis of the firm involves analyzing a
series of different value chains.
 The systematic examination of individual value activities can lead
to a better understanding of an organization’s strengths and
weaknesses.

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Analyzing Functional Resources SWOT Analysis (Internal

and Capabilities
Environment)
SWOT analysis of the internal environment focuses on
 The simplest way to begin an analysis of a corporation’s strengths and weaknesses.
value chain is by carefully examining its traditional
functional areas for potential strengths and weaknesses.
Strengths:
 Functional resources and capabilities include not only the
financial, physical, and human assets in each area but  Strength is a resource, skill, or other advantage relative to
also the ability of the people in each area to formulate competitors and the needs of the markets a firm serves or expects to
and implement the necessary functional objectives, serve.
strategies, and policies.
 It is a distinctive competence that gives the firm a comparative
 These resources and capabilities include the knowledge of advantage in the market place.
analytical concepts and procedural techniques common to
each area as well as the ability of the people in each area  Strengths may exist with regard to financial resources, image,
to use them effectively. market leadership, buyer/supplier relations etc.

 If used properly, these resources and capabilities serve as

strengths to carry out value-added activities and support
strategic decisions.
Weaknesses:
 In addition to the usual business functions of marketing,
finance, R&D, operations, human resources, and
 Weakness is a limitation or deficiency in resource, and capabilities that
information systems/technology, we also discuss structure
seriously impedes a firm’s effective performance.
and culture as key parts of a business corporation’s value
chain.  Lack of facilities, financial resources, management capabilities,
marketing skills, and brand image can be source of weaknesses.

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The SWOT Matrix (Implication of SWOT Analysis for Strategy Formulation)

 A firm should not necessarily pursue the more lucrative  S-O strategies pursue opportunities that
opportunities. Rather, it may have a better chance at developing a
competitive advantage by identifying a fit between the firm's are a good fit to the company's strengths.
strengths and upcoming opportunities.
 In some cases, the firm can overcome a weakness in order to  W-O strategies overcome weaknesses to
prepare itself to pursue a compelling opportunity. pursue opportunities.
 To develop strategies that take into account the SWOT profile, a
matrix of these factors can be constructed. The SWOT matrix is  S-T strategies identify ways that the firm
shown below:
can use its strengths to reduce its
vulnerability to external threats.
Strengths Weaknesses
 W-T strategies establish a defensive plan to
prevent the firm's weaknesses from making
it highly susceptible to external threats.
S-O W-O
Opportunities strategies strategies

Threats S-T W-T

strategies strategies

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