Unit 3

Strategy

Unit 3

Competing with Capabilities

Prepared by Anjali Bakhru with Pauline Gleadle

Masters

THE COURSE TEAMAnjali Bakhru (Course Team Co-Chair and Author) Howard Viney (Course Team Co-Chair and Author) Dev K (Roshan) Boojihawon (Author) Prof Susan Segal-Horn (Author) Sally Brown (Course Manager) Emir Forken (Accessibility Adviser) Richard Frost (AL Representative and Author, support items) Pauline Gleadle (Author, Finance) Ken Littlewood (AL Representative and Author, support items) Grant Miller (ICT ) Bronagh Power (RM Representative) Kathy Reay (Course Team Assistant) Tony Stapleton (Author, Case Studies) Kelvin Street (Library Liaison)

Course ProductionSylvan Bentley (Picture Researcher) Martin Brazier (Graphic Designer) Jenny Edwards (OUBS Production and Quality) Julie Fletcher (Media Project Manager, LTS ) Barbara Fraser (Contracts Executive) Diane Hopwood (Compositor) Edwina Jones (Editor) Roy Lawrance (Graphic Artist) Katie Meade (Contracts Executive) John ODwyer (Editor) Winifred Power (Editor) Iris Widdows (OUBS Production Administrator)

External AssessorProfessor John McGee, Warwick University Business School

Published by The Open University, Walton Hall, Milton Keynes MK7 6AA First published 2005 Copyright # 2010 The Open University All rights reserved. No part of this work may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without either the prior written permission of the publishers or a licence permitting restricted copying issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published, without the prior consent of the publishers. Edited and designed by The Open University. Typeset in India by Alden Prepress Services, Chennai. Printed in the United Kingdom by Hobbs the Printers Limited, Brunel Road, Totton, Hampshire SO40 3WX. ISBN 978 1 8487 3425 8 Further information on Open University Business School courses may be obtained from OUBS Information Team, The Call Centre, The Open University, PO Box 724, Milton Keynes MK7 6ZS (Telephone: +44 (0) 8700 100311). Or visit www.oubs.open.ac.uk For materials available for purchase through OU Worldwide, visit the webshop at www.ouw.co.uk 2.1

CONTENTS1 Introduction 1.1 Learning outcomes of this unit 5 6 7 8 11 14 18 23 24 27 35 44 47 47 49 53 53 56 58 69 70 73

2 What is a resource-based approach to strategy? 2.1 2.2 2.3 2.4 Does industry matter? Resources and capabilities as a source of advantage Understanding superior performance Value appropriation

3 Undertaking a resource-based analysis 3.1 3.2 3.3 3.4 Resource audit Value chain analysis Starbucks: looking inside Benchmarking

4 Linking the RBV to knowledge and learning 4.1 4.2 Knowledge-based view The role of organisational routines

5 Sustainability of competitive advantage 5.1 5.2 5.3 The changing basis of advantage Competing in new markets Competing flexibly

6 Summary References Acknowledgements

1 INTRODUCTION

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INTRODUCTION

In this unit, we are effectively progressing from strategic thinking at the industry or sector level to strategic thinking at the level of the organisation. In Unit 2, our focus was on conducting an analysis of the external environment and identifying those factors that might pose an opportunity or a threat to the organisation, either now or in the future. The focus of this unit is on the next stage of the analysis process. Our intention here is to conduct an internal analysis of the organisation and thereby identify those factors that are considered to be its principal strengths or weaknesses. In conducting an internal analysis of the organisation, we adopt a resource-based approach. As we will show, the resource-based view is a theoretical approach which assumes that organisations differ in respect of the resources that they possess and the capabilities that they have developed. This view asserts that it is these differences that account for the variation in performance between organisations. If resources and capabilities are considered to be the key source of inter-firm performance differentials, we argue that a resource-based approach to conducting an internal analysis of the organisation is a useful one. Our aim is to identify the key resources and capabilities of an organisation and assess the implications of these for the organisation concerned, both now and in the future. As in Unit 2, we recognise the dynamic context within which organisations operate. A key issue for organisations is to address the implications of this for the sustainability of the organisations valuable resources and capabilities. While sustainability of competitive advantage is often advocated as the consummate objective of organisations, it is increasingly unlikely that the sources of value underlying competitive advantage are themselves sustainable. A dynamic approach to strategy thinking is advanced, and it is shown that organisational success is increasingly linked to an organisations ability to acquire the resources and develop the capabilities required for success at any one point in time. Further, the importance of capabilities in determining the choice of markets served highlights the importance of choosing and then committing to long-term paths or trajectories of capability development (Teece et al., 1997). We emphasise that an organisations strategic flexibility both now and in the future is effectively bound by the strategic paths already taken, i.e. path dependency.

To study this unit you need:

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UNIT 3 COMPETING WITH CAPABILITIES

1.1

LEARNING OUTCOMES OF THIS UNIT

After studying the unit, you should:l

have a theoretical understanding of the resource-based view, appreciating that it can be considered complementary to an industry structure/market positioning approach be able to practically apply the resource-based view through conducting an internal analysis of the organisation, including analysis of the organisations financial resources be able to show a basic understanding of how the resourcebased view relates to knowledge and learning understand the notion of sustainability of competitive advantage appreciate the need to consider resources and capabilities within a dynamic framework, including discussion of dynamic capabilities and how the strategic value of capabilities can change over time.

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This unit is about strategy at the level of the organisation. Section 2 considers the apparently straightforward observation why are there differences in performance between organisations in the same sector? The section introduces a resource-based approach to explaining competitive advantage. Section 3 illustrates how an assessment of an organisations resources and capabilities (using Starbucks, a US coffee chain, as our example) can be an effective approach to conducting an internal strategic analysis. Section 4 highlights how the knowledge-based view relates to a resourcebased approach. Finally, Section 5 addresses the issue of sustainability of competitive advantage and discusses whether the term sustainable is a misnomer given the rate of change in the external environment.

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2 WHAT IS A RESOURCE-BASED APPROACH TO STRATEGY?

2

WHAT IS A RESOURCE BASED APPROACH TO STRATEGY?

The resource-based view (RBV) has emerged as an approach which explores an important set of ideas about how organisations achieve competitive success. The popularisation of the RBV is due in large part to Prahalad and Hamel (1990) and their notion of core competence (their article The core competence of the corporation is available in full in the Course Reader). They argue that in the short run, an organisations competitiveness derives from the price/ performance attributes of current products. In the long run, however, competitiveness depends on an organisations ability to develop a core competence around a key skill or set of interrelated skills, e.g. Sonys capacity to miniaturise or Philips optical-media expertise. The notion of core competence was influential in focusing strategists attention on the characteristics that distinguish the success of one organisation relative to another. However, in the last fifteen or so years, the resource-based perspective has developed as a result of growing interest from practitioners as well as researchers. Increasingly, the focus is less on the contribution of a single or core capability to an organisations success than on the complementary set of resources and capabilities which allow a firm to pursue a particular strategy over the long term. Further, while a plethora of terms and definitions have emerged since 1990, there is increasing agreement over the use of terms, with capability serving as a common and simplified replacement for other terms such as competence and distinctive competence. At the core of the RBV is the assumption that the critical difference between organisations, irrespective of whether they are in the same industry or sector, is the bundle of assets that they possess and the way they make use of these assets. The implication is that it is an approach to strategy that emphasises the role of managers in determining how well or not they use the assets which their organisations possess. As such, it is an approach which is as applicable to the public and not-for-profit (NFP) sectors as it is to the private sector. In a departure from traditional (neo-classical) economics, this approach assumes that organisations are intrinsically different from one another, i.e. firms are heterogeneous rather than homogeneous. In order to assess the sources of heterogeneity, we need to look inside the organisation by focusing our attention on the firms assets, i.e. its resources and its ability to co-ordinate and manage them (capabilities). Attention is given not only to the tangible and intangible assets that organisations possess but to the skills and know-how that are often taken for granted. We argue that an

In this unit, a firms resources and capabilities are often more generally referred to as a firms assets, since they are considered to underlie its competitive advantage according to the RBV.

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increasingly valuable source of competitive advantage is bound up in the processes through which organisations combine and co-ordinate assets. The implication is that organisational capabilities are assumed to play an increasingly important role in organisational success. The relationship between resources, capabilities and competitive advantage can be depicted as in Figure 2.1.

Industry key success factors

Competitive advantage

Strategy

Organisational capabilities

Tangible Financial Physical

Resources Intangible Human Technology Skills/know-how Reputation Capacity for communication Culture and collaboration Motivation

Figure 2.1

The link between resources, capabilities and competitive advantage (Grant, 2005, p. 139)

2.1

DOES INDUSTRY MATTER?

If the central challenge facing managers is to generate competitive advantage, then it is crucial to understand the sources of competitive advantage. As we stated in Unit 2, the fundamental determinant of an organisations profitability is industry structure according to the market positioning school. This view was dominant within the strategic management field throughout the 1980s, and the significance of the resource-based view is that it was the first serious challenge to the dominance of the industry structure approach. As discussed in Unit 2, Porters industry structure perspective considers the source of profitability to be based on industry characteristics and the organisations market position within an industry. Studies show, however, that an industry structure approach cannot fully explain intra-industry profit differentials (i.e. between companies in the same industry) which are typically far greater than inter-industry (i.e. different industries) profit differentials. Key support for the RBV was provided by Rumelts (1991) research which showed that industry effects accounted for only 8 per cent of the variance in firm performance, while business unit effects accounted for around 47 per cent. (Rumelts article is available and may be read in full in the Course Reader.) The implication of Rumelts findings is that, if profit differentials are greater among organisations in the same sector than across industries, then industry-level factors cannot be wholly responsible for explaining the differences in performance across organisations. So does industry matter? The answer is8


only in a very small number of cases. Rumelt estimated that only one in every forty industries will have genuinely important proportions of their return-on-assets determined by industry effects. Later work by McGahan and Porter (1997) challenged Rumelts findings. While they found that industry effects accounted for only 19 per cent of the variance in firm profits against 32 per cent accounted for by business unit effects, they argue that the level of environmental turbulence and, hence, industry stability can affect the level of firm profitability. For example, the effect of industry structure on firm profitability is less in more stable sectors, such as manufacturing, and greater in more turbulent sectors, such as in the entertainment and service sectors. The debate is an ongoing one; research has produced mixed findings that are less than conclusive (see, for example, Hawawini et al., 2003, and Adner and Helfat, 2003). The results do suggest, nevertheless, that industry effects cannot account for all the variation in performance between firms. Other factors must account for non-industry effects. This is where the resource-based view provides explanatory power. Its proponents argue that the resources and capabilities of an organisation are the main source of its competitive advantage. The further suggestion is, therefore, that the role of the manager is significant since strategy can make a difference. Organisations are not trapped in an industry-driven mould. As well as reacting to changes in their external environment, organisations can also be pro-active in the strategic decisions they make.

ACTIVITY 2.1With respect to your own industry, or one with which you are familiar, are there performance differences between firms? If differences exist, are these substantial or not? Why do you think these performance differences exist? (0N.B. You must bear in mind that the nature of performance, performance measures and performance differences will often vary across industries and sectors most obviously between for-profit and NFP organisations).

DISCUSSIONThe intention here is to develop your understanding of the principles underlying industry structure and resource-based explanations of competitive advantage. In Unit 2 we suggested that the blurring of industry boundaries, particularly in information-based businesses, along with the changing structure of industries suggests that an assessment of industry attractiveness is less useful as an analytical framework for predicting organisational success. However, by considering the magnitude of any performance differences between organisations in an industry or sector with which you are familiar, we are asking you to evaluate the two approaches for yourself.

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For example, the greater the magnitude of performance differences between firms, the more likely it is that a resource-based explanation is superior to an industry structure explanation. The converse could be true given fewer performance differences between firms. If there are clusters of performance-differentiated firms, this might point to the existence of strategic groups (see Unit 2). You are further asked to consider more specifically the causes of any performance differences. If the pattern suggests the existence of strategic groups, you might be able to identify the key characteristics of the main industry groupings. Otherwise, are there specific characteristics that you think might cause some firms to perform better than others? For example, resources such as access to a cheap or talented labour pool, a reputation for the quality of goods or services, a physical network of branches or even the quality of its leadership or management. Additionally, you might be able to point to differences in capabilities between organisations such as their logistics capability or service quality.

We have shown in Unit 2 that Porters Five Forces model is useful as a framework with which to assess industry attractiveness as part of an analysis of the external environment. Here, we advocate a resource-based approach to undertaking an internal analysis. However, the importance of the latter is that we believe the RBV provides a superior explanation of the success of one organisation over another. From a resource-based perspective, it is competitive advantage rather than the external environment that is assumed to be the source of profit differentials between organisations. Nevertheless, it is important to emphasise that the resource-based view should be considered to be complementary to a market positioning view. Firms compete in terms of Porters generic strategies on the basis of cost or differentiation (see Section 5, Unit 2). However, the magnitude of competitive advantage of a resource depends on the extent to which it reduces the cost structure of an organisation or to which it differentiates the organisations offering relative to competitors. As the example of Nissan (Box 2.1) demonstrates, Nissans ability to compete on the basis of price (derived from cost advantages) is due to the efficiency of its underlying capabilities such as those in welding, painting and assembly.

BOX 2.1 NISSANJapanese auto manufacturer, Nissan, is known for the price competitiveness of its vehicles, which it owes, in turn, to its productive efficiency and the capabilities which enable this.

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For example, in its Body Shop, the firm is able to weld the bodies of different models of cars and trucks using the same machines. Computer-controlled robots quickly adjust the weld points required. In its Paint Shop, all the firms plants have highly automated processes to paint all kinds of vehicles one after another with no time needed for re-configuration. Even its assembly workers are able to stand on a lineside limousine, which moves them, their tools, and parts along with the car. This eliminates having to walk back and forth to the parts bins and tool racks.Source: adapted from BusinessWeek, 22 December 2003

The continued and current research interest in a resource-based approach to strategy since its development in the early 1990s is testimony to the explanatory power that the approach offers. However, one of the main criticisms of the approach is that it is difficult to identify those resources and capabilities which are considered to be valuable given that this requires both a detailed look inside an organisation and an ability to untangle the complexity of resources and their interaction.

2.2

RESOURCES AND CAPABILITIES AS A SOURCE OF ADVANTAGEResources comprise the tangible and intangible assets of the firm. Capabilities are the processes through which resources are combined and co-ordinated. In this unit we also more generally refer to the resources and capabilities of the firm as the assets or the strategic assets of the firm (see also the article by Amit and Schoemaker (1993) in the Course Reader).

Central to a resource-based perspective is the assumption that an organisations resources and capabilities contribute to the organisation gaining competitive advantage in product and market activities. Resources comprise the tangible and intangible assets of the organisation, where tangible assets include the physical assets such as buildings and equipment as well as financial assets, and intangible assets include the organisations reputation, its brand and even its organisational culture. While there is a wide variety of definitions with respect to organisational capability, including the use of terms such as competence, competencies and distinctive competence, it is defined here (and stated in Unit 2) as an organisations capacity for undertaking a particular productive activity. An organisations capabilities combine and co-ordinate its resources through its functional capabilities, such as those in marketing, operations and distribution, to produce its outputs in the form of the organisations products or services. The example of a web design firm in Figure 2.2 illustrates how the organisations resources are combined through its capabilities to produce not only websites for customers but also to offer additional services in the form of web hosting and project management. Two assumptions are fundamental to the resource-based view (RBV0): 1 organisations differ from each other in respect of their resource and capability endowments

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Products and services

Client websites

Project management services

Website hosting services

Capabilities

Sales and marketing

Web design

Development (software)

Consultancy

Hosting

Resources

Management team

Sales team

Developers

Graphic designers

Integrated PC systems

Specialist software

Figure 2.2 Linking resources and capabilities to products and services in a web design firm

2 these productive resources and capabilities cannot easily be transferred from organisation to organisation without cost, i.e. they are sticky (Barney, 1991; Szulanksi, 2003). According to Barney, while firms may be lucky in terms of being able to acquire the right resources at the right time and the right price, the role of managerial discretion is emphasised within the RBV. In other words, the managerial role in resource acquisition and co-ordination is an important one that typically should not be left to chance. The implication is that not all firms are equally good at producing goods and services, and there are differences in their respective resources, including both tangible assets as well as intangible assets, and their ability to co-ordinate them (capabilities). Such differences are perpetuated given that it is not possible to trade many of these resources and capabilities between firms since markets dont exist for the less transparent and, hence, more valuable intangible assets and capabilities. Lets consider the case of the Disney brand. Disney, the US film and entertainments company, has a valuable resource in its brand (see Table 3.2 on p. 26). However, it would be difficult for another organisation to make use of the Disney brand without first acquiring the company or entering into some type of licensing arrangement. Even if this were possible, it is likely that the brand would retain value only in relation to its current uses at least, in the short term. Building additional resources cannot usually be done immediately (except if they are obtained by acquisition and, even then, it still takes time to absorb the acquired resources effectively into the organisation). Where a retail chain has the financial resources to expand the number of its outlets or stores, it still takes time to identify potential outlet locations and to acquire or physically build new outlets. We are suggesting that stocks of assets or strategic assets (both resources and capabilities) have to be built over time and cannot be adjusted instantaneously. Given the complexity of

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the co-ordination processes through which capabilities are developed, there is further likely to be ambiguity as to which factors are responsible for superior performance. This is the notion of causal ambiguity (Lippman and Rumelt, 1982).

BOX 2.2 YAHOO!Yahoo!, the US internet portal, is known for its capability in developing alliances with other organisations. It is likely, nevertheless, that Yahoo! would have difficulty in identifying and articulating the specific steps through which this strategic capability has been developed.

The example of Yahoo! in Box 2.2 illustrates that the value of capabilities lies in the fact that they are difficult to replicate, thereby acting as a barrier to imitation by other organisations. Firms might further find that they even have difficulties in replicating their own existing capabilities, such as within a new subsidiary or through overseas expansion.

ACTIVITY 2.2With respect to your own organisation, or one with which you are familiar, list some of its key tangible and intangible assets. Which of these do you think are the most sticky (p. 12) and why?

DISCUSSIONThis aim of this activity is to develop your understanding of the immobility or stickiness of resources. While physical assets such as a companys buildings might be immobile in the physical sense, they are less likely to be sticky. Buildings can be traded (bought and sold), or they can be replicated by competitors in a different location. Only if the location of such assets contributes to their value would their stickiness be enhanced (e.g. the specific location of beautiful scenery at a leisure resort or precious metals that can be mined only in particular countries). In contrast, intangible assets like the organisations brand, its reputation, and its culture are more likely to be sticky since they are both difficult to trade as well as being difficult to imitate by competitors.

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2.3

UNDERSTANDING SUPERIOR PERFORMANCE

A resource must be valuable if it is to contribute to competitive advantage. Barney (1991) argues that valuable resources must be:l l l

rare imperfectly imitable non-substitutable.

It follows, therefore, that the most valuable resources are those that combine these three qualities (rare, imperfectly imitable and non-substitutable) and, thus, the implication is that superior resources are inherently limited in supply.

RarityAll resources and capabilities have the potential to contribute to superior performance, where they are limited in supply (Peteraf, 1993). This does not imply that common but valuable resources are not important, although they are unlikely to be a source of competitive advantage for any one firm as the example of internet service providers (ISPs) shows (Box 2.3).

BOX 2.3 ISPsInternet access services offered by internet service providers (ISPs) have become increasingly standardised or even commoditised. Consequently, the technological capabilities that underlie the ability of an ISP to provide internet access services to its retail customers are unlikely to differ significantly across different ISPs. While these capabilities are valuable in that they are essential for firm survival, they cannot be a source of competitive advantage for any one firm since they are not rare but standard within firms across the industry.

Where resources are in limited supply, the critical issue is whether rarity can be preserved, either permanently or for long periods. If resources are rare for only very short periods of time, the differences between firms will also be very short-lived. If there is a nationwide shortage of nurses, then it can take time to expand their supply given the time lag required to attract and train nurses. Organisations could, alternatively, recruit suitably trained nurses from overseas to overcome the shortfall of supply in the near term. Other resources are permanently rare, such as potential sites for businesses requiring a specific or premium location, i.e. for a seaside hotel or a high street retailer.

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Imitability and substitutabilityIn order for resources to be durable, they must be hard to imitate (or copy) and difficult to substitute. Dell has constructed its value chain operations in a way that is difficult for competitors to reproduce. Similarly, Kssbohrer, a German vehicle manufacturer, has developed a capability around its customer service operations which it believes is difficult for competitors to imitate (see Box 2.4).

BOX 2.4 KSSBOHRER ALL-TERRAIN VEHICLESKssbohrer (Germany) makes the E290,000 PistenBully 300 Polar, a specialist vehicle used to groom or maintain the surface of ski trails and slopes. While the company has a reputation for the quality of its vehicles, it also has an unmatched reputation for the quality of its customer service it guarantees customers that it will despatch spare parts or a repair person within 24 hours.Source: adapted from BusinessWeek, 26 January 2004

Given the existence of causal ambiguity, potential imitators do not know exactly what to imitate. In particular, capabilities which develop and accumulate within an organisation from the interconnectedness of the resources which contribute to them will be hard to imitate. These are capabilities which have a large tacit dimension and are socially complex. Capabilities, thus, rely on complex processes of organisational learning, which are themselves contingent upon earlier stages and levels of learning, investment and development. Organisations have followed certain pathways of development to arrive at the complex resource bundle they now possess (path dependency). Valuable resources are sticky and are not easily traded. This may take many forms. A resource may be tradable, but be more valuable within the current organisation than elsewhere. A football player who is a star with one team and a particular set of team mates may never perform as well at another club. Less obvious is the example of a highly specialised marketing executive moving from one firm to another, where part of the value of this individual may lie with the skills developed around the specific organisational processes of the first firm. Other resources are not tradable because they only have relevance to a specific organisation. Examples include the fixtures and fittings that have been created specifically for a retail outlet or office, or even an industrial plant that has been designed for a specific use. (See Box 2.5.)

Tacit knowledge is that knowledge which is less easily written down. Grant (2002, p. 177) states that the knowledge underlying some skills is largely tacit in nature and, hence, is difficult to articulate and more easily expressed through performance, such as the know-how required to ride a bicycle.

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BOX 2.5 MOBILITY OF RESOURCESIn the nineteenth century and earlier, most factors of production were immobile across frontiers; differentiated, branded products were very rare; and traders dealing in commodity products were the norm. Most resources were therefore tied to a specific geographic location. By the second half of the twentieth century, different factors of production which were mobile and not locationspecific had become critical. Old immobile resourcesl l l

New mobile resourcesl l l l

land labour capital

technology information brands open international financial markets

Organisations once derived advantage from manufacturing or producing at a given location because of that locations particular features, such as access to roads or ports or especially fertile soil or a raw material. Labour also used to be tied to location and provided special local skills or low-cost labour. However, modern communication technologies have made many aspects of specialised labour available and accessible without physically moving people. The development of new communication technologies, such as the internet, further minimises the constraints of space and time. Hence, the dramatic rise in software companies in India, where skilled programmers are available to multinational companies at a fraction of the salary levels in Europe, Japan or North America. There is also a further advantage staff living within a complementary time zone. That means that the Indian workforce working during the day can effectively process data for a European company overnight.

Another source of limited mobility is what Teece (1982) calls co-specialised assets. These are specialised resources which are not productive separate from the firm, but must be combined to create value. Consider the example of a specialist in particle physics who can only conduct further research with equipment that costs millions of dollars to provide. Only three or four laboratories in the world provide such conditions. Alternatively, think of rich oil and mineral deposits in the deep parts of the oceans or under the polar ice caps. These mineral resources can be accessed only if combined with highly specialised and expensive equipment, often specially designed for that specific project and requiring immense technical knowledge to use properly. Because immobile resources are not easily traded, their value is likely to stay with the current organisation in the long term.

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The characteristics of valuable resources apply equally to different types of organisations. For example, a key resource of NFP organisations, such as Mdecins sans Frontires (Box 2.6) is their brands, which are often critical in attracting the funding necessary to meet their requirements.

BOX 2.6 MDECINS SANS FRONTIRES (MSF OR DOCTORS WITHOUT BORDERS)

MSF, a private NFP founded in 1971, delivers emergency aid to victims of armed conflict, epidemics, and natural and manmade disasters, and to others who lack health care due to social or geographical isolation. MSF is an international network with sections in 18 countries. Each year, more than 2,500 volunteer doctors, nurses, other medical professionals, logistics experts, water/sanitation engineers, and administrators join 15,000 locally hired staff to provide medical aid in more than 80 countries. While foundations, corporations, other not-for-profit organizations, and the U.S. and other governments also provide financial support, MSF relies primarily on private funding from individuals, thereby affording MSF the independence to set its operational priorities and to speak out without hindrance.Source: www.doctorswithoutborders.org/aboutus/

In the Course Reader article by Amit and Schoemaker entitled Strategic assets and organizational rents, they argue that uncertainty, complexity and conflict, both inside and outside the organisation, constitute the normal conditions under which managers have to manage. The implication is that there is room for discretionary managerial decisions on strategy crafting. In other

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words, it is precisely such uncertainties that create the opportunity for heterogeneity between organisations to develop, often as a result of better or worse decision making by managers about the external environment or the internal resource mix. The article suggests that the challenge facing managers is to identify a set of strategic assets directly arising from the organisations resources and capabilities. These will be developed as the basis for creating and protecting their organisations sustainable sources of advantage. The ideas presented here can be applied to both single-business strategy and multi-business corporate strategy to show some of the implications for managers of resource-based strategy. At the single-business level this analysis may help managers distinguish between resources which form the basis of a potential advantage and therefore attract investment and other resources which do not. Clarity about imitability of key resources which the organisation possesses should help decide whether and for how long a resource can be protected. This in turn should influence the decision on, for example, how rapidly to license out an innovation. The degree to which an organisation can or should protect its valuable resources is addressed in the next section.

2.4

VALUE APPROPRIATION

If the importance of an organisations resources and capabilities is ultimately linked to their ability to generate value for the organisation, then it is critical that an organisation is able to appropriate or benefit from the value created. (Value is discussed further in Unit 4.) We make a distinction between value creation and value appropriation given that successful firms are also likely to be those best able to appropriate the value created. As we discussed in the previous section, valuable resources include those which are non-imitable. Some resources are protected by knowledge barriers such as the inability of competitors to imitate a firms processes given the existence of causal ambiguity. Other resources are protected by property rights, such as patents or copyright. The aim here is to examine the use of property rights as a barrier to imitation. The rationale behind the existence of property rights is the idea that innovation can be encouraged only by ensuring that innovators are able to benefit from innovation through establishing property rights, i.e. rewarding effort. Intellectual property is typically protected through the use of the following:l

Patents exclusive rights to a new and useful product, process, substance or design. (Length of patents are increasingly becoming standardised across countries it is 20 years from the time of filing the patent in many countries including the USA and the UK) Copyright exclusive production, publication, or sales rights to the creators of artistic, literary, dramatic or musical works

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Trademarks these are words, symbols or other marks used to distinguish the goods or services supplied by a firm. Trademarks provide the basis for brand identification.

The importance of patents lies in their ability to protect the valuable knowledge assets of the firm, where the protection of an organisations intellectual capital is itself considered to form part of the organisations intangible assets. While patents are widely used in respect of products, a recent development has been the use of patents in respect of an organisations business processes, such as the one-click ordering process of Amazon.com. Patents instead of copyrights are also increasingly used to protect property rights in respect of software, as the example in Box 2.7 shows.

BOX 2.7 SOFTWARE PATENTSTraditionally, the software industry has been regulated by the copyright system. The advantage of using copyright is that it is an automatic law and, hence, is not subject to any time delays. A major disadvantage of the time delay in receiving patent approval is that it becomes difficult, if not impossible, for competitors to avoid patent infringement given that a patent may not be publicly viewable until twelve months after it has been applied for or even eighteen months in the US.Source: adapted from BusinessWeek, 1 December 2003

It is paradoxical that, as there are more demands to own ideas and gain cheaper access to ideas, it is becoming harder to enforce their protection. Globalisation has made it easier for intellectual property to spread to parts of the world with a weaker protection of ideas or intellectual property rights (IPR), while technological change has made it harder to protect ideas. The difficulty of protecting intellectual property given the development of new technologies is exemplified by the case of Napster.com, a US digital media company, with its peer-to-peer (P2P) file-sharing technology. Napster.com operated a centralised repository P2P model, i.e. the music or MP3 files were not stored on a central server given the significant storage and bandwidth requirements. Instead, Napster. com kept track of which of its users held which music files, placing the requesting user in touch with the source to permit a direct exchange of files between users. The software developed by Napster.com simply scanned the hard drive for MP3 files and then sent a list of files the user was willing to share to Napsters online directory. Napster.com had approximately 21 million users at its peak before a legal decision was made that Napsters file-sharing technology violated music copyrights (see Box 2.8).

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BOX 2.8 COPYRIGHT AND THE MUSIC INDUSTRYContent digitization, compression technologies and P2P file-sharing systems present the music industry with its biggest ever challenge. Latest estimates put the number of P2P users at 57 million in the US alone. Individuals who obtain copyright music files licensed to others through such P2P systems infringe the copyright in that music. The difficulty the industry has is how to stop such use. The US music industry (and recently the movie industry too) has gone on a major legal offensive in response to digitization and P2P. After a US court required Napster to remove copyright material notified to it by the record companies from its central file sharing index (followed by the eventual closure of its service) it seemed that the music industry had overcome the challenge. The music industrys victory was short-lived. In April 2003, a US district court ruled that P2P software providers KaZaA, Grokster and Morpheus were not liable for copyright infringements by users of their P2P software. Although these P2P systems facilitated the same infringement as Napster, it appears that the type of software architecture used in P2P is key to determining whether an operation is legal. For the time being at least, record and movie companies cannot stop file sharing at the root. The music industrys response is to announce that it will track and sue individual infringers a pretty aggressive move considering that each of the 57 million infringers could be their customers. But it doesnt have to be this way and, ultimately, the music industry would prefer a solution which would gain the approval of consumers. One only has to look back to the advent of digital recording devices to see that the current aggressive stance could well amount to tough posturing before a commercial compromise is worked out. In the late 1980s when the first digital audio tape recorders were introduced, the record companies threatened to sue the manufacturers for copyright infringement. Instead of legal proceedings, the device manufacturers and the music industry agreed a compromise which formed the basis of the US 1992 Audio Home Recording Act. The Act provided that, first, the devices should incorporate a special chip that allowed users to copy the original work, but not copies of that work; second, a small royalty fee levied on digital recording devices and all recording media used in such devices should be collected from the manufacturers and distributed to copyright owners; and, third, in return copyright owners would waive their right to sue individuals for the copies they made using such devices for their personal use. Given that a compromise was reached in the 1980s there are subtle indications that both content owners and P2P software providers may once again be looking for a compromise. For example, major music companies have recently licensed a large part of their catalogue to Apples iTunes Music Store on terms

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that allow Apple, a US computer company, to license to users with considerably more flexibility than their own on-line distribution channels. Apples simple 99 cents per song business model allows users to do almost everything they could do with a song obtained on CD except, it seems, file share with the rest of the world.Source: adapted from Evans (2003)

ACTIVITY 2.3It appears that the use of long-term property rights such as patents is increasing. Why do you think that is? Can you outline some of the advantages and disadvantages of this trend?

DISCUSSIONWhile the preceding discussion has not explicitly discussed the reasons why there has been an increase in the use of intellectual property rights (IPR), the resource-based view highlights the growing importance of intangible assets and capabilities in organisational success. Hence, organisations are likely to want to prevent competitors from imitating their intellectual property, whether it is in the form of intangible assets or bound up in the organisations business processes. They will also attempt to ensure that value appropriation accrues to the innovating organisation. In an assessment of the advantages and disadvantages of the growing use of IPR, a key issue is that the advantage of providing an incentive for innovators must be weighed against the fact that patents might constrain innovation if they spread protection too broadly. For example, the use of patents, which provide long-term property rights, is arguably defensible in the pharmaceutical and biotech sectors given the long development times and high sunk costs involved. The Tufts Center for the Study of Drug Development in the US currently estimates that it costs more than $800 million to develop a new prescription drug. You should also consider the impact of the growing use of patents on business processes and software. Will this ultimately have the opposite effect on overall levels of innovation, acting as a disincentive to innovate?

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3 UNDERTAKING A RESOURCE-BASED ANALYSIS

3

UNDERTAKING A RESOURCE-BASED ANALYSIS

We argue that a critical source of difference (or heterogeneity) between firms is the resources and capabilities that they possess. Further, since we argue that it is an organisations resources and capabilities that contribute to its potential competitive advantage, then we need to assess the value of these strategic assets. In Unit 2, we showed that the external environment can be analysed at different levels. In this section, we will show that there are multiple and complementary ways to conduct an internal analysis of an organisation, focusing on the use of a resource audit and value chain analysis. Our aim here is to identify key resources and capabilities and assess the extent to which these act as a strength or a weakness of the organisation.

ACTIVITY 3.1You must now read the article in the Course Reader by Grant (1991) entitled, The resource-based theory of competitive advantage: implications for strategy formulation. With respect to Grants article, why is the identification of the organisations key resources and capabilities so important to strategy formulation?

DISCUSSIONWe know that, according to a resource-based perspective, it is an organisations resources and capabilities that contribute to competitive advantage. Grant argues that those resources and capabilities which are durable, difficult to identify and understand, imperfectly transferable, and not easily replicated should be regarded as the organisations most important assets or crown jewels. They play a pivotal role in the firms competitive strategy, and the essence of strategy formulation is to design a strategy that makes the most effective use of them. For example, he shows that Harley-Davidson, a US motorcycle manufacturer, designed a strategy that leveraged the firms sole durable, non-transferable, and irreplicable asset, i.e. the firms image and the loyalty that accompanies that image. The firm, therefore, decided to focus on traditional design and extend its marketing effort away from its existing customers to more affluent, professional types.

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3.1

RESOURCE AUDIT

A resource audit permits the identification and evaluation of an organisations resources. The approach taken here is based on Grants work (2002, p. 139), where a firms resources are considered to comprise its tangible, intangible and human resources. Central to this approach is an appreciation of the fact that the value of a resource is not simply a calculation of its intrinsic financial worth (if this can be measured at all) but, importantly, an estimate of its contribution to the competitive advantage of the organisation. Given that organisations are unlikely to formally document their resources, with the exception of financial and physical assets in their balance sheets, it is useful to first classify their resources as in Table 3.1. Table 3.1TangibleFinancial Physical

Classifying resources (Grant, 2002)IntangibleTechnology Brand/reputation Culture

HumanSkills/know-how Capacity for communication and collaboration Motivation

Tangible resourcesAn organisations tangible resources include its financial and physical assets, such as its buildings and equipment. While the value of an organisations assets is stated in its balance sheet, it should be recognised that this valuation is specific to a point in time. It further does not always portray accurately the financial situation of an organisation since financial instruments, such as derivatives, are often accounted for off-balance sheet and, hence, mask the true financial position of the organisation. While it is important to consider financial valuations, they cannot on their own provide any indication of the potential of these resources to contribute to competitive advantage, as the case of the Hilton hotel chain illustrates (Box 3.1).

BOX 3.1 HILTON HOTELSIn the balance sheet of Hilton, an international hotel chain, property and equipment is valued in excess of $3.9 billion. The usefulness of this information for our purposes is limited. It does not tell us anything about the age or condition of the hotel groups properties. It does not provide any information on resource utilisation, although occupancy rates are voluntarily reported separately. Finally, the

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balance sheet does not provide any detail on the location of the properties, a potentially important factor in the success of hotels and one that can itself be considered to be a physical resource. In other words, the concept of value in relation to valuing an organisations resources involves more than a consideration of value in the accounting sense.Source: adapted from www.hilton.com

Intangible resourcesIntangible assets such as a firms intellectual property rights, its reputation and its organisational culture are considered to be increasingly valuable assets. The great advantage of intangible assets or invisible assets over tangible assets is that they can be used in more than one area simultaneously without reducing their value in other areas (Itami, 1987). If we return to the example of the Disney brand, we can appreciate how it has been used to extend the firms product/service offering without reducing its value in existing product/service markets. Similarly, Chinas Baosteel is able to leverage its existing reputation as a leading manufacturer of steel to develop new product markets with international partners (Box 3.2).

BOX 3.2 BAOSTEELBaosteel, based in Shanghai, is Chinas leading manufacturer of steel. Since it was founded in 1978, Baosteel has focused on using the latest technology which has allowed it to develop more profitable products like cold-rolled steel and hot-rolled galvanised sheets. As the company faces growing domestic competition, it continues to develop new products to serve new markets, such as developing steel products for the automotive market with the Chinese partners of General Motors (US), Volkswagen (Germany) and Nissan (Japan).Source: adapted from BusinessWeek, 26 January 2004

However, in spite of the perception that intangible assets are valuable, they are difficult to value, especially given that accounting standards have been developed without their inclusion. Under valued or unvalued intangible assets are increasingly thought to account for the disparity between balance sheet valuations (book values) and stock market valuations, and their value is often realised only through the purchase of goodwill arising on acquisition. The financial amounts in question are often significant as can be seen in the valuation of brands in Table 3.2.

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Table 3.2Rank1 2 3 4 5 6 7 8 9 10

Top ten global brandsBrandCoca-Cola Microsoft IBM GE Intel Nokia Disney McDonalds Marlboro Mercedes

Brand value ($ billions)70.45 65.17 51.77 42.34 31.11 29.44 28.04 24.70 22.18 21.37

(Source: based on BusinessWeek, 2003)

Human resourcesHuman resources are the productive services that humans offer to the firm in terms of their skills, knowledge, reasoning and decisionmaking abilities. Despite their importance in co-ordinating the other tangible and intangible assets of the organisation, human resources are perhaps the most difficult resources to value and are not accounted for on an organisations balance sheet. In any assessment of their contribution to competitive advantage, account should be taken of the context-specific factors in which they operate. For example, the effect of different types of organisational culture can be to reinforce (or not) certain competences, skills and behaviours as the example of Vitra shows (Box 3.3).

BOX 3.3 VITRAVitra, the Swiss maker of retail and office furniture, has built its reputation on the quality of its design. The company established itself in the 1950s by marketing chairs designed by the legendary Charles and Ray Eames from the US into Europe. The company has arguably maintained its leading position in design by fostering a culture of creativity it always hires top designers from outside, whilst ensuring that they have the freedom to design whatever they want.Source: adapted from www.vitra.com

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Our next step in the analysis process is to identify the key resources within each of these categories and appraise their strategic value by evaluating the relative importance and contribution of these resources to the organisations current strategy. It is further important to consider the implications of these resources for the organisations future strategy. Table 3.3 (overleaf ) provides a checklist of some additional and measurable indicators that can be used in appraising the value of an organisations key resources. As part of a resource audit, you can also use some of the skills you have learned previously in calculating financial ratios. We will use this approach in looking at the Starbucks case in Section 3.3. However, when doing this you will have to remember the limitations inherent in ratio analysis even when looking at tangible resources. Of course, these problems become even more of an issue when thinking about intangible resources, although these are often vital to a firms success.

3.2

VALUE CHAIN ANALYSIS

You might already be familiar with Porters value chain model, which highlights the different value-adding activities of an organisation (Figure 3.1). Primary activities contribute to the provision of goods or services for customers, while support activities are those activities which allow the primary activities to take place, such as the role of infrastructure, human resources and IT/Technology.

Support activities Firm infrastructure

Human resource management

Technology development

Procurement

Inbound logistics

Operations

Outbound logistics

Marketing and sales

Service

Primary activities

Figure 3.1

Porters value chain (Porter, 1985)

At its simplest, a value chain is an activity path through an organisation. It tells you what the organisation does and the order in which it does it. It should also tell you something about how it does it. A value chain can be a very helpful tool for understanding the difference between two organisations which appear to be

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Table 3.3ResourceTangible resources

Classifying and assessing the firm s resourcesRelevant characteristicsFinancial resources The firms borrowing capacity and its internal funds generation determine its resilience and capacity for investment. Physical resources constrain the firms set of production possibilities and impact its cost position. Key characteristics include: the size, location, technical sophistication, and flexibility of plant and equipment; location and alternative uses for land and buildings; reserves of raw materials. Intellectual property: patent portfolio, copyright, trade secrets. Resources for innovation: research facilities, technical and scientific employees. Reputation with customers through the ownership of brands and trademarks; established relationships with customers; the reputation of the firms products and services for quality and reliability. The reputation of the company with suppliers (including component suppliers, banks and financiers, employees and potential employees), with government and government agencies, and with the community. The education, training and experiences of employees determine the skills available to the firm. The adaptability of employees contributes to the strategic flexibility of the firm. The social and collaborative skills of employees determine the capacity of the firm to transform human resources into organisational capabilities. The commitment and loyalty of employees determine the capacity of the firm to attain and maintain competitive advantage.

Key indicatorsDebt/equity ratio Operating cash flow/free cash flow Credit rating Market values of fixed assets Age of capital equipment Scale of plants Flexibility of fixed assets

Physical resources

Intangible resources

Technological resources Reputation

Number and significance of patents Revenue from licensing patents and copyright R&D staff as a percentage of total employment Number and location of research facilities Brand recognition Brand equity Percent of repeat buying Objective measures of comparative product performance (e.g. Consumers Associations ratings). Surveys of corporate reputation (e.g. BusinessWeek)

Human resources

Educational, technical and professional qualifications of employees Compensation relative to industry Percentage of days lost through stoppages and industrial disputes Absentee rates Employee turnover rate

(Source: Grant, 2002, p. 140)

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functioning in similar ways, in a similar sector. That is because organisations can construct their value chains in very different ways. The value chain of Italian clothes manufacturer and retailer, Benetton, clearly illustrates the way in which Benetton has designed its business processes (Figure 3.2). As a result of its particular value chain (or the particular way in which it has designed its business), Benetton secures specific advantages such as 20 per cent lower production costs than the industry average, and fast response times to actual customer preferences for types of fashion items in their shops. This business model has more recently been matched and even improved upon by a competitor, Zara, the Spanish fashion retailer, with its rapid time-to-market for new designs.Value chain Technology Knitting Cutting Dyeing Product design (External) Material sourcing Wool thread fabrics Knitting/ cutting process Assembly Finishing Dyeing (100% internal) Distribution to shops

Sources of advantage Computerised Computer knitting transfer of machines design to knitting or Computerised cutting cutting turning out 15,000 garments in 8 hours, less than 15% cloth wastage

Economies of scale in wool thread Centralised purchasing activities

Decentralised External to production take advantage Control of of Italian equipment law centrally Economies Total of scale production costs 20% below Europe and Far East manufacturers

Main distinctive product feature under in-house control Keeps 1520% of stock grey until colour trends determined Flexibility

External Labourintensive work kept out of house

Robotised warehouse Controlled to allow product to be placed directly on display Minimises shop inventory

Figure 3.2

Manufacturing value chain for Benetton

The importance of the value chain for our purposes is that the primary and support activities of the organisation represent its core functional activities and, hence, provide identification of its organisational capabilities in relation to each of the functional areas (Figure 3.1). Put simply, the value chain provides a framework for the analysis of an organisations capabilities. It permits consideration of which functional activities add value relative to others and/or which might be considered core to the firm, such as the marketing capability of Procter and Gamble, a US consumer goods firm, or the logistics capability of Federal Express, a US express courier. Value chain analysis is useful since it focuses our attention on what we think an organisation does well and what it does less well. If we consider the structure of capabilities, we can further assess activities at various levels within the organisation as Figure 3.3 shows. Broad functional areas (or value chain activities) can be considered to consist of one or more specialist capabilities and, in turn, the tasks of which these comprise (Grant, 2002, p. 149). Thus,

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customer service might be a specialist capability within the sales function and, in turn, the handling of complaints might be a task within the customer service function.

Cross-functional capabilities

e.g. Customer support

Functional capabilities

e.g. Marketing and sales

Specialist capabilities

e.g. Customer service (sales)

Single-task capabilities

e.g. Customer complaints handling

Individuals specialised knowledge

Figure 3.3

The hierarchical structure of capabilities

Similarly, it may be important to evaluate cross-functional capabilities, where these consist of more than one functional capability, i.e. the customer support capability in Figure 3.3. Given the complexity and level of integration required in developing cross-functional capabilities such as new product development, these capabilities are often an important source of advantage to organisations relative to their competitors. For example, Yahoo!s capability in developing alliances (as stated in Section 2.2) or 3Ms (a US materials firm) strength in new product development. While the value chain highlights the sequential order of activities of the organisation, it does not indicate how the functions interact with each other. A firms business model, which is a description of the main product, service and information flows, can better illustrate this, as in the example of online share dealing (Figure 3.4). The emergence of many new online business models in existing business sectors can be viewed as changing the nature of the interaction between individual value chain activities. Within online

Increasing price and level of personal service Advisory services Face to face Telephone Clients

Exchange

Broker

Non-advisory services

Telephone/touch-tone Internet

Clients (new, old) Increasing (real-time) convenience

Figure 3.430

Online broking: a new business model (Brown and Bakhru, 2004)


share dealing, customers deal on a non-advisory basis, accessing research via the website and undertaking their own investment decisions instead of dealing with, and on the advice of, a personal broker. We have shown that a value chain approach can be used to identify key organisational capabilities. Consideration must also be given, however, to the financial implications of supporting particular activities, such as R&D or sales, as will be discussed in the next section.

3.2.1 Value chain analysis from a financial perspectiveAccording to Ghemawat (2001), differences across firms in activities, i.e. differences in what firms do on a day-to-day basis, produce disparities in cost and so they dictate added value. Accordingly, by analysing a firm activity by activity, managers can:l l l

understand why the firm does or does not have added value spot opportunities to improve a firms added value foresee future shifts in added value.

Porters value chain, which distinguishes between primary activities that directly generate a product or service and support activities that make this possible, is a useful starting point. However, as Ghemawat notes, any generic templates need to be adapted to the situation in question. Value chain analysis usually involves three broad steps: 1 Managers examine the costs associated with each activity, using their understanding of this to explore also how and why their costs differ from those of the competition. Managers then analyse how each activity generates customer willingness to pay, again studying differences in activities to see how and why customers are willing to pay more or less for the goods or services of the competition. Finally, managers consider changes in the firms activities in order to identify those that will widen the margin between costs and willingness to pay.

2

3

Note that, although value chain analysis can be decomposed into these three discrete steps, in practice, managers will find it necessary to adopt an iterative approach. Accordingly, they may find it necessary to go from Step 3 back to Steps 1 and 2 in order to conduct a really useful analysis of the value chain of their organisation.

Step 1 Examination of the c osts associated with each activityNote that when reviewing costs, it is important to focus on detailed individual activities and not just differences in total costs. This is because different organisations will usually have different31


cost structures related to their quite distinctive competitive positions. Good cost analysis will tend to concentrate on cost categories that:l

pick up on major differences across competitors or strategic options correspond to technically separable activities OR, are large enough to influence significantly, the overall cost position.

l l

Cost drivers should only be explored in depth if these vary significantly from the competition or in terms of strategic options being considered. Sensitivity analysis is vital because relative cost analysis will involve a large number of assumptions.

Step 2

Examination of c ustomers willingness to pay

Note that according to Caves and Ghemawat (1992), differences in willingness to pay account for more of the variation in profitability amongst competitors than do disparities in cost levels. Step 2 is therefore vital. Points to bear in mind include the following:l

The most obvious activities in a value chain affecting willingness to pay include such product characteristics as quality, performance, special features and aesthetics. In many cases, therefore, willingness to pay will also depend on intangible factors. At this point, it is further important to consider whether there are features that customers are not willing to pay for. Consumers tastes as well as their expectations can change. For example, the car industry illustrates how a feature such as ABS (automatic braking system), which at one time might have been considered to be an extra that customers were willing to pay for, is now expected to be included in the price of the basic model. It is helpful for managers to work out who the real buyer is. In the case of a Barbie doll for example, the immediate purchaser will be a toyshop or supermarket whilst the ultimate consumer is usually a young girl. However, the so-called pivotal decision maker is probably the parent who chooses amongst various brands. Managers need to gain an understanding of what the buyer or buyers want. In the case of the Barbie doll, the retailer will be most interested in factors like trade margins, turnover, customer recognition of the brand etc. However, the parent is more likely to be interested in aspects such as price, likely durability of appeal to the child and safety angles such as whether the toy contains small parts that might be swallowed by the child or by a younger sibling. Importantly, market research will need to be undertaken to establish not only what customers want, but also what they are willing to pay for. Note that pricing processes, which can be incredibly complex, can be regarded as a dynamic capability. (We will discuss the concept of dynamic capabilities further in Section 5.) Dutta, Zbaracki and Bergen (2003) show that, in

l

l

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addition to creating value, a firm must also set the right prices to capture value. Central to any pricing decision is the pricing capability, i.e. the systems and processes that managers at a firm choose in addressing the tension between the desire to change prices and the constraints on changing prices, such as uncertainty about the price elasticity of demand and the relative profitability of different groups of customers.

BOX 3.4 ESCADAA dynamic capability in pricing is likely to be important for fashion houses which cater to different market segments through their designer and diffusion ranges. For example, Escada (a German fashion house) has its main designer range which it prices differently from its diffusion range, Laurel. A dynamic capability in pricing includes the ability to price relatively to other brands managed internally, as well as to competitor brands.

l

A further step involves an assessment of how successful the firm and competitors are at fulfilling customer needs. Accordingly, managers can estimate how much extra customers may be willing to pay for certain product characteristics. In the example of the Barbie doll, parents might be enthusiastic about a doll that was sold with its own sturdy case that could be used to hold and so tidy away all Barbies tiny accessories. Success in meeting customer needs can then be related back to company activities. In the case of a bakery, a high customer preference for freshness could be related back to the firms procurement, manufacturing and delivery activities without which freshness cannot be achieved.

l

Step 3 Exploring different strategic options and making choicesStep 3 is the final step in exploring cost and willingness to pay in order to find ways of widening this margin. Unlike Steps 1 and 2, this is more of a creative process so that it is difficult to lay down rigid rules for exploring different strategic options. However, Ghemawat (2001) suggests the following:l

Try to establish what drives each of your competitors. In the case of a bakery, one competitor might differentiate itself on the basis of the freshness of its products. However, you may decide that if you can offer a still fresher product, customers might be willing to pay even more, thereby creating substantial added value. Think about likely responses to your moves from the competition. In the bakery example above, the competitor might cut its prices in reaction to your moves. What would be your response?

l

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l

Make sure you think about the full range of ways in which your activities create added value. Often it is helpful to explore also the value chains of your customers and suppliers. In the case of one laundry firm, managers found that hotel sub-managers as customers really appreciated the way the laundry firm drivers carefully stacked the clean laundry in the correct places in the hotel linen store. By doing this, the laundry firm saved the hotel concierges a lot of time and so this was regarded as a valuable service by the hotel.

In rapidly changing markets, companies such as 3M will often pay particular attention to the needs of especially demanding customers if this group is felt to predict the needs of the larger market as a whole (von Hippel et al., 1999). When 3M was trying to develop a surgical dressing that would withstand significant wear and tear by patients, 3M managers thought of who would be the most demanding patients. Somebody within 3M hit on the idea of testing the bandages on animals who had been treated by the vet. Animals are particularly demanding patients since they often have poor personal hygiene habits, they cannot express their needs directly, and they will try to chew off the dressings. Once 3M had found a dressing that survived largely intact with this group of patients, they were able to market successfully this particularly durable dressing. Although value chain analysis has involved separating and analysing the firm into its constituent parts or activities, Ghemawat cautions that competitive advantage arises from an integrated set of choices about the whole of the organisations product or service offering. Accordingly, Teece et al. (1994) argue that coherence is important in multi-product firms. Ghemawat sees that such competitive advantage will depend on driving a wider wedge between customer willingness to pay and the firms costs than that achieved by the competition. This is likely to happen when the firm offers something that is perceived as unique and valuable. Note that the complexity or otherwise of the value chain will affect which financial or marketing measures are used interactively by senior management. If value chains are stable and well understood, simple input and output measures can be used. These include brand volumes and market share. However, for an organisation such as 3M that is involved in product innovation in multiple markets, then value creation is complex. Interactive control is therefore likely to be based at least partly around profit planning systems rather than brand volumes. Understanding the complexity of the value chain is therefore an important issue for many different reasons. Finally, we need to combine the results of our resource audit and value chain analysis and put them all together as in Grants (2002, p. 175) framework for analysing resources and capabilities (Figure 3.5). This framework shows that identification of the organisations key resources and capabilities is an important step prior to selecting a strategy that exploits these relative to opportunities and threats in the external environment. Note also that Figure 3.5 differs from Grants earlier version in the34


Course Reader article. Figure 3.5 emphasises that the organisation is not a closed system and that resources and capabilities can be developed outside the firm through outsourcing, for example.

4 Develop strategy implications: (a) In relation to strengths How can these be exploited more effectively and fully? (b) In relation to weaknesses Identify opportunities to outsource activities that can be better performed by other organisations How can weaknesses be corrected through acquiring and developing resources and capabilities?

Strategy

3 Appraise the firms resources and capabilities in terms of: (a) strategic importance (b) relative strength

Potential for sustainable competitive advantage

2 Explore the linkages between resources and capabilities

Capabilities

1 Identify the firms resources and capabilities

Resources

Figure 3.5

A framework for analysing resources and capabilities (Grant 2002, p. 175)

3.3

STARBUCKS: LOOKING INSIDE

In this section, we are going to apply our analytical tools and undertake an internal analysis of Starbucks, the US coffee retail chain.

Coffee is the second most traded commodity in the world

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ACTIVITY 3.2Read the case in Box 3.5 on Starbucks, the US coffee retail chain. Consider the statement: Starbucks formula is firmly based in its coffee, its employees, its merchandising, its ownership philosophy, its real-estate approach, its image, and its innovativeness. To what extent do you agree with this statement? What do you consider to be the key strengths or weaknesses of Starbucks?

BOX 3.5 STARBUCKSStarbucks is a seller of speciality coffee. Its strategy was stated as follows in its 1996 Annual Report: We have firmly established our leadership position, ending fiscal 1996 with more than 1,000 retail locations in 32 markets throughout North America and two new stores in Tokyo, Japan. With more than 20,000 dedicated partners (employees), we are creating opportunities every day for millions of customers around the world to enjoy the Starbucks Experience. From selecting the finest Arabica beans to hiring the most talented people, we are committed to applying the highest standards of quality in everything we do ... When you walk into a Starbucks store, when you open a mail order package, when you drink our coffee on United Airlines (a US airline), it is our goal to offer more than just a great cup of coffee we want to offer a memorable experience ... We are excited about the global possibilities as more new customers embrace our business, and we know that we have many brand-building opportunities ahead of us ... We look forward to the positive reception of bottled Frappuccino ... We know that we have developed a platform for bigger product innovations. During fiscal 1996, we installed proprietary, state-of-the-art roasting and manufacturing equipment ... Our Speciality sales and marketing team has continued to develop new channels of distribution ... Our direct response group launched a new America Online Caf Starbucks Store ... We continue to work towards our long-term goal of becoming the most recognised and respected brand of coffee in the world ... We believe more strongly than ever that at the heart of our continuing success lies the companys two cornerstones, coffee and our people ... 25 years from now, when we look back, if we can say that we grew our company with the same values and guiding principles that we embrace today, then we will know that we have succeeded. The firms main functional activities could be considered to comprise the following: Sourcing Coffee is the second most traded commodity after oil. It is divided into two categories: speciality coffee and basic coffee. Speciality coffee companies deal directly with the coffee exporters given that about a third of coffee farms in the world are less than

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three acres in size. Starbucks sourced approximately 50% of its beans from Latin America, 35% from the Pacific Rim, and 15% from East Africa. Having a diversified portfolio allowed Starbucks to offer a greater palette of coffees while being able to maintain a hedged position. It maintained close relationships with its exporters by working directly with them and providing them with training. Mary Williams, Senior Vice-President of Coffee at Starbucks, described what it took to be considered an official Starbucks exporter: If I am working with a dealer who has sold me 5,000 bags of Guatemalan for Januarys shipment and he knows that he is not going to be able to deliver, I dont want to hear about it in January. I want him to call me in September and ask how we can work this problem out. If I have a quality problem, I expect to be able to say sorry, but I have to reject this as it doesnt meet our standards. Both the customer service and consistency are the things we look for over time. To ensure quality, Starbucks extracted three different samples of coffee from every shipment of 250 bags. Sample one was an offer sample sent by an exporter trying to make a sale to Starbucks. Sample two was taken just before the shipment was due to be sent. Sample three was extracted from the shipment, which arrived at the coffee roasting plant. At every stage, Starbucks reserved the right to reject the coffee if it was not up to standard. Starbucks hoped to double volumes over the next three years. This could make the ability to find coffees that would meet its quantity/quality requirements difficult. Starbucks needed to offer an increasing number of blends to deal with its increasing volumes, since blends provide more flexibility around components. Despite Starbucks large supply needs, growing its own, high-quality coffee was an option that was never seriously considered. Roasting and blending Roasting was a combination of time and temperature, although how a coffee was roasted could change its entire taste. Recipes were put together by the coffee department once all the components had been tested and were up to standard. Despite computerised roasters which guaranteed consistency, roasting was not a complete science. People roasting the coffee had to understand the properties of the roasting process, i.e. managing temperature as well as being able to roast coffees along different roast curves. Supply chain operations (SCO) This part of the companys operations claims it has the best transportation rates in the industry, a complex bakery distribution model, a forecasting process, strong inventory turns for the speciality coffee market, and a fully integrated manufacturing and distribution process that protected coffee beans from oxygen from the time beans were roasted to the time they were packaged (closed loop system). Starbucks had developed these skills and benefits because it benchmarked against its competitors, hired experts, and believed strongly in the concept of integrated supply. Its SCO were designed to eliminate redundancy and maximise efficiency. They served four business units: the retail store units,

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the speciality sales and wholesale channels, the mail order business and the grocery channel. Ted Garcia, Executive Vice President of SCO, stated that the greatest challenge to its SCO was the phenomenal growth in the business units:Supporting four business units in an integrated, effective, efficient, cost-effective method, is a challenge. We are trying new and innovative things. We are not afraid to enter into agreements or challenge our suppliers such as United Parcel Service (a US express courier service) to do things in new and innovative ways. Retail sales The retail outlet has been Starbucks fundamental growth vehicle. For many customers, Starbucks was not only a place to drink coffee but also an experience. Howard Schultzs (CEO) vision for Starbucks was a place that offered interesting coffee-related drinks in a theatrical kind of atmosphere, which pivoted around an espresso machine. You get more than the finest coffee when you visit Starbucks. You get great people, first-rate music, a comfortable and upbeat meeting place, and sound advice on brewing excellent coffee at home. At home youre part of a family. At work youre part of a company. And somewhere in between theres a place where you can sit back and be yourself. Thats what Starbucks store is to many of its customers a kind of third place where they can escape, reflect, read, chat or listen. Employees Starbucks store employees (baristas) tended to be either in college or university. They received a great deal of training and were able to talk about a variety of different coffees and processes. Having baristas that had a strong coffee education was essential because Starbucks consumers were becoming more and more knowledgeable about coffee. Developing coffee knowledge and service expertise demanded a great deal of effort from employees and, as Starbucks grew, finding enough good people that could replicate the values, culture and service experiences was an ongoing challenge.Source: adapted from Starbucks, A Case Study (1997), Richard Ivey School of Business

DISCUSSIONOur aim here is to undertake an internal strategic analysis of Starbucks using tools such as a resource audit and value chain analysis in an attempt to narrow down the sources of competitive advantage through identifying the organisations key resources and capabilities. The importance of the statement is that it suggests that Starbucks success is built upon a combination of its resources and capabilities acting together. While our aim is to identify specific resources and capabilities and assess their relative importance to the organisation, it is worth emphasising that an organisations assets are ultimately not productively valuable in isolation, but only in productive combinations.

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Exhibit 1: Starbucks ANALYSIS OF UNIT ECONOMIC TRENDS (US$ thousands)1994Cash Investment Store Build Out1 Pre-opening Beginning Inventory Total Cash Investment Average Sales/Store2

1995357 23 20 400 820 2.1x 17.5% 144 36.0%

1996315 21 24 360 850 2.4x 16.5% 140 39.0%

1997E310 20 20 350 825 2.4x 18.0% 150 43.0%

1998E305 20 20 345 790 2.3x 17.8% 141 41.0%

1999E300 20 20 340 765 2.3x 17.6% 135 40.0%

330 16 17 363 820 2.3x 18.9% 155 43.0%

Average Sales/Investment EBIT Margin3 EBIT ROI (EBIT/Cash Invested)1

Estimated investment per store opened during the fiscal year; 2Estimated average sales and earnings before interest and tax (EBIT) for units open at least one year; 3EBIT includes marketing and field level overhead expenses.

Exhibit 2: Starbucks INCOME STATEMENT/PROFIT & LOSS (US$ thousands)1994Net Revenues Retail Speciality Sales Direct Response Total Net Revenues Store Operating Expenses Other Operating Expenses Cost of Sales and Related Occupancy Costs Operating Income Other Expenses Earnings Before Income Taxes Income Taxes Net Earnings Preferred Stock Dividends Accrued/Preference Dividends Net Earnings Available to Common Shareholders 248,453 26,498 9,972 284,923 90,087 8,698 162,840 23,298 -5,544 17,754 7,548 10,206 -270 9,936 402,874 47,917 14,422 465,213 148,757 13,932 262,408 40,116 3,027 43,143 17,041 26,102 0 26,102 600,367 78,702 17,412 696,481 210,693 19,787 409,008 56,993 11,508 68,501 26,373 42,128 0 42,128 57,700 84,900 113,000 827,003 110,331 22,066 959,400 296,200 24,200 548,800 90,200 3,600 93,800 36,100 57,700 1,053,796 148,612 25,792 1,228,200 368,700 31,800 687,000 140,700 -2,600 138,100 53,200 84,900 1,276,840 193,552 30,008 1,500,400 441,800 40,200 827,700 190,700 -7,000 183,700 70,700 113,000

1995

1996

1997E

1998E

1999E

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Net Earnings Per Share (Net EPS)3 Weighted Average Shares Outstanding Average Share Price Price Earnings Ratio (PER)1

0.172 57,575 25 148

0.36 71,909 15 42

0.471 80,831 24 51

0.70 88,600

1.00 89,500

1.30 90,400

51

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The $0.47 EPS in 1996 excludes the gains from the sale of Noahs Bagels; 2The $0.17 EPS in 1994 would be $0.22 without the one-time charges associated with the acquisition of Coffee Connection; 3On December 1, 1995, the company recorded a 2 for 1 stock split to holders of record on November 1,1995. Net earnings per share for all years have been restated to reflect the stock split.

Exhibit 3: Starbucks BALANCE SHEET (US$ thousands)1994Assets Current Assets Cash and Cash Equivalents Accounts Receivable/Debtors Inventories/Stock Other Current Assets Total Current Assets Property and Equipment, Net Other Assets Total Assets 8,394 5,394 56,064 14,728 84,580 140,754 6,087 231,421 20,944 9,852 123,657 50,897 205,350 244,728 18,100 468,178 126,215 17,621 83,370 112,335 339,541 369,477 17,595 726,613 128,900 24,300 122,500 12,500 288,200 496,700 43,100 828,000 53,200 31,100 149,600 16,100 250,000 617,600 78,100 945,700 21,000 38,000 178,100 19,600 256,700 733,600 121,100 1,111,400

1995

1996

1997E

1998E

1999E

Liabilities and Shareholders Equity Current Liabilities Accounts Payable/Creditors Other Current Liabilities Total Current Liabilities Other Liabilities Shareholders Equity Common Stock/Ordinary Share Capital Retained Earnings Total Shareholders Equity Total Liabilities 89,861 20,037 109,898 231,421 265,679 46,552 312,231 468,178 361,309 90,351 451,660 726,613 828,000 945,700 1,111,400 519,400 604,300 717,200 9,128 31,290 40,418 81,105 28,668 42,378 71,046 84,901 38,034 63,057 101,091 173,862 134,100 165,800 198,100

(Source: Starbucks Corporation Annual Report and William Blair and Company)

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A resource audit can be used to identify the organisations key tangible, intangible and human resources. In respect of the organisations physical resources, it is likely that you will have identified Starbucks international retail infrastructure, its high quality raw mate

Unit 3

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