Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability

Chapter 3

Internal Analysis: Identifying Strengths and Weaknesses

Managers must understand– The role of resources, capabilities, and

distinctive competencies in the process by which companies create value and profit

– The importance of superior efficiency, innovation, quality, and responsiveness to customers

– The sources of their company’s competitive advantage (strengths and weaknesses)

Distinctive Competences and Competitive Advantage

• Distinctive competencies– Firm-specific strengths that allow a company

to gain competitive advantage by differentiating its products and/or achieving lower costs than its rivals

– Arise from unique application of resources and acquisition of capabilities

The Role of Resources

• Resources– Capital or financial, physical, social or human,

technological, and organizational factor endowments• Tangible and intangible

• A firm-specific and difficult to imitate resource is likely to lead to distinctive competency

• A valuable resource that creates strong demand for a firm’s products may lead to distinctive competency

The Role of Capabilities

• Capabilities– A company’s skills at coordinating and using

its resources

• Capabilities are the product of organizational structure, processes, and control systems

• We must add people, particularly leadership in building the structure, etc.

Strategy, Resources, Capabilities, and Competencies

A Critical Distinction

• If a firm has firm-specific and valuable resources, it must also have the capability to use them effectively to create distinctive competency

• A firm can create distinctive competency without firm-specific and valuable resources if it has unique capabilities

Competitive Advantage, Value Creation, and Profitability

• Profitability factors– Amount of value customers place on the

company’s products– Price charged– Costs of creating the value

Value Creation and Pricing Options

Comparing Toyota and General Motors

Differentiation and Cost Structure: Roots of Competitive

Advantage

The Value Chain

• A company is a chain of activities for transforming inputs into outputs that customers value

• The transformation process is composed of primary and support activities that add value to the product

The Value Chain: Primary and Support Activities

The Generic Building Blocks of Competitive Advantage

Exercise

• Strategy in Action 3.2: Southwest Airlines

• What portions of the value chain does Southwest Airlines work on to create value for its customers?

• Why these portions rather than the more significant costs like fuel?

Efficiency

• The quantity of inputs it takes to produce a given output. Usually measured as outputs over inputs; examples of latter– No. of employees– Capital investment

• Productivity leads to greater efficiency and lower costs– Employee productivity– Capital productivity

Quality

• Superior quality = customer perception of greater value in a specific product’s attributes– Form, features, performance, durability,

reliability, style, design

• Quality products = goods and services that are reliable and that are differentiated by attributes that customers perceive to have higher value

Quality (cont’d)

• The impact of quality on competitive advantage– High-quality products increase the value of

(differentiate) the products in customers’ eyes– Greater efficiency and lower unit costs are

associated with reliable products

A Quality Map for Automobiles

Innovation

• The act of creating new, commercially viable products or processes– Product innovation

• Creates products that customers perceive as more valuable, increasing the company’s pricing options

– Process innovation• Creates value by lowering production costs

• Perhaps the most important building block of competitive advantage

Responsiveness to Customers

• Doing a better job than competitors of identifying and satisfying customers’ needs– Superior quality and innovation are integral to

superior responsiveness to customers– Customizing goods and services to the unique

demands of individual customers or customer groups

Responsiveness to Customers (cont’d)

• Sources of enhanced customer responsiveness– Customer response time, design, service,

after-sales service and support

• Differentiates a company’s products; leads to brand loyalty and premium pricing

Value Creation per Unit

Analyzing Competitive Advantage and Profitability

• Benchmarking company performance against that of competitors and the company’s own historic performance

• Return on invested capital

capital InvestedprofitNet ROIC

• Net profit = Total revenues – Total costs

Definitions of Basic Accounting Terms

Drivers of Profitability (ROIC)

Ways to Increase ROIC

• Increase the company’s return on sales– Reduce cost of goods sold– Reduce spending on sales force, marketing,

general, and administrative expenses– Reduce R&D spending– Increase sales revenue more than costs

• Increase sales revenues from invested capital– Reduce the amount of working capital– Reduce amount of fixed capital

The Durability of Competitive Advantage

• Barriers to Imitation– Imitating Resources– Imitating Capabilities

• Capability of Competitors– Strategic commitment– Absorptive capacity

• Industry Dynamism

Why Companies Fail

• Inertia– Companies find it difficult to change their strategies

and structures

• Prior strategic commitments– Limit a company’s ability to imitate and cause

competitive disadvantage

• The Icarus paradox– A company can become so specialized based on past

success that it loses sight of market realities– Craftsmen, builders, pioneers, salesmen