Lesson 4 Analyzing The Internal Organization PDF

STRATM1 LESSON 4: The Internal Environment: Resources, Capabilities, Core Competencies, and Competitive Advantage Objective Describe the differences between tangible and intangible resources; and Use the VRIN model in determining if resources and capa...

STRATM1 LESSON 4: The Internal Environment: Resources, Capabilities, Core Competencies, and Competitive Advantage Objective Describe the differences between tangible and intangible resources; and Use the VRIN model in determining if resources and capabilities of a firm are a source of sustainable competitive advantage.  The Internal Environment Even if the firm develops and manages resources in ways that create core competencies and competitive advantages, competitors will eventually learn how to duplicate the benefits of any firm’s value- creating strategy; thus, all competitive advantages have a limited life. Because of this, the question of duplication of a competitive advantage i not if it will happen, but when. In general, a competitive advantage’s sustainability is a function of three factors: 1. The rate of core competence obsolescence because of environmental changes. 2. The availability of substitutes for the core competence. 3. The imitability of the core competence.  The Internal Environment For all firms, the challenge is to effectively manage current core competencies while simultaneously developing new ones. Only when firms are able to do this can they expect to achieve strategic competitiveness, earn above-average returns, and remain ahead of competitors in both the short and long term. By analyzing its internal organization, a firm determines what it can do. Matching what a firm can do (a function of its resources, capabilities, and core competencies in the internal organization) with what it might do (a function of opportunities and threats in the external environment) is a process that yields insights that the firm requires to select strategies from.  The Internal Environment We begin this module by briefly describing conditions associated with analyzing the firm’s internal organization. We then discuss the roles of resources and capabilities in developing core competencies, which are the sources of the firm’s competitive advantages. Included in this discussion are the techniques firms use to identify and evaluate resources and capabilities and the criteria for identifying core competencies from among them. Resources by themselves typically are not competitive advantages. In fact, resources create value when the firm uses them to form capabilities, some of which become core competencies, and hopefully competitive advantages.  The Internal Environment Because of the relationship among resources, capabilities, and core competencies, we also discuss the value chain and examine four criteria that firms use to determine if their capabilities are core competencies and, as such, sources of competitive advantage. The chapter closes with comments about outsourcing as well as the need for firms to prevent their core competencies from becoming core rigidities. The existence of core rigidities indicates that the firm is too anchored to its past, a situation that prevents it from continuously developing new capabilities and core competencies.  Analyzing the Internal Organization The Context of Internal Analysis One of the conditions associated with analyzing a firm’s internal organization is the reality that in today’s global economy, some of the resources that were traditionally critical to firms’ efforts to produce, sell, and distribute their goods or services, such as labor costs, access to financial resources and raw materials, and protected or regulated markets, although still important, are now less likely to be the source of competitive advantages. An important reason for this is that an increasing number of firms are using their resources to form core competencies through which they successfully implement an international strategy as a means of overcoming the advantages created by these more traditional resources.  Analyzing the Internal Organization The Context of Internal Analysis Given the increasing importance of the global economy, those analyzing their firm’s internal organization should use a global mind- set to do so. A global mind-set is the ability to analyze, understand, and manage an internal organization in ways that are not dependent on the assumptions of a single country, culture, or context. Because they are able to span artificial boundaries, those with a global mind- set recognize that their firms must possess resources and capabilities that allow understanding of and appropriate responses to competitive situations that are influenced by country-specific factors and unique cultures. Using a global mind-set to analyze the internal organization has the potential to significantly help the firm in its efforts to outperform rivals.  Analyzing the Internal Organization The Context of Internal Analysis Analyzing the firm’s internal organization requires that evaluators examine the firm’s entire portfolio of resources and capabilities. This perspective suggests that individual firms possess at least some resources and capabilities that other companies do not—at least not in the same combination. Resources are the source of capabilities, some of which lead to the development of core competencies; in turn, some core competencies may lead to a competitive advantage for the firm. Understanding how to leverage the firm’s unique bundle of resources and capabilities is a key outcome decision makers seek when analyzing the internal organization. Figure 3.1 illustrates the relationships among resources, capabilities, core competencies, and competitive advantages and shows how their integrated use can lead to strategic competitiveness. As we discuss next, firms use the resources in their internal organization to create value for customers. Analyzing the Internal Organization Analyzing the Internal Organization Creating Value Firms use their resources as the foundation for producing goods or services that will create value for customers. Value is measured by a product’s performance characteristics and by its attributes for which customers are willing to pay. Firms create value by innovatively bundling and leveraging their resources to form capabilities and core competencies. Firms with a competitive advantage create more value for customers than do competitors. Walmart uses its “every day low price” approach to doing business (an approach that is grounded in the firm’s core competencies, such as information technology and distribution channels) to create value for those seeking to buy products at a low price compared to competitors’ prices for those products. The stronger these firms’ core competencies, the greater the amount of value they’re able to create for their customers. Analyzing the Internal Organization Creating Value Ultimately, creating value for customers is the source of above-average returns for a firm. What the firm intends regarding value creation affects its choice of business-level strategy and its organizational structure. Business-level strategies denote that value is created by a product’s low cost, by its highly differentiated features, or by a combination of low cost and high differentiation compared to competitors’ offerings. A business- level strategy is effective only when it is grounded in exploiting the firm’s capabilities and core competencies. Thus, the successful firm continuously examines the effectiveness of current capabilities and core competencies while thinking about the capabilities and competencies it will require for future success. Analyzing the Internal Organization Creating Value At one time, firms’ efforts to create value were largely oriented toward understanding the characteristics of their industry in which they competed and, in light of those characteristics, determining how they should be positioned relative to competitors. This emphasis on industry characteristics and competitive strategy underestimated the role of the firm’s resources and capabilities in developing core competencies as the source of competitive advantages. In fact, core competencies, in combination with product-market positions, are the firm’s most important sources of competitive advantage. A firm’s core competencies, integrated with an understanding of the results of studying the conditions in the external environment, should drive the selection of strategies. Analyzing the Internal Organization Creating Value As Clayton Christensen noted, “successful strategists need to cultivate a deep understanding of the processes of competition and progress and of the factors that undergird each advantage. Only thus will they be able to see when old advantages are poised to disappear and how new advantages can be built in their stead.” By emphasizing core competencies when selecting and implementing strategies, companies learn to compete primarily on the basis of firm-specific differences. However, while doing so they must be simultaneously aware of changes in the firm’s external environment. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization The strategic decisions managers make about the internal organization are nonroutine, have ethical implications, and significantly influence the firm’s ability to earn above- average returns. These decisions involve choices about the resources the firm needs to collect and how to best manage and leverage them. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization Making decisions involving the firm’s assets—identifying, developing, deploying, and protecting resources, capabilities, and core competencies—may appear to be relatively easy. However, this task is as challenging and difficult as any other with which managers are involved; moreover, the task is increasingly internationalized. Some believe that the pressure on managers to pursue only decisions that help the firm meet anticipated quarterly earnings makes it difficult to accurately examine the firm’s internal organization. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization The challenge and difficulty of making effective decisions are implied by preliminary evidence suggesting that one-half of organizational decisions fail. Sometimes, mistakes are made as the firm analyzes conditions in its internal organization. Managers might, for example, think a capability is a core competence when it is not. This may have been the case at Polaroid Corporation as decision makers continued to believe that the capabilities it used to build its instant film cameras were highly relevant at the time its competitors were developing and using the capabilities required to introduce digital cameras. In this instance, Polaroid’s decision makers may have concluded that superior manufacturing was a core competence, as was the firm’s ability to innovate in terms of creating value-adding features for its instant cameras. If a mistake is made when analyzing and managing a firm’s resources, such as appears to have been the case some years ago at Polaroid, decision makers must have the confidence to admit it and take corrective actions. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization A firm can improve by studying its mistakes; in fact, the learning generated by making and correcting mistakes can be important to efforts to create new capabilities and core competencies.35 One capability that can be learned from failure is when to quit. Polaroid should have obviously changed its strategy earlier than it did, and by doing so it may have been able to avoid more serious failure. Three conditions—uncertainty, complexity, and intraorganizational conflict—affect managers as they analyze the internal organization and make decisions about resources (see Figure 3.2). Analyzing the Internal Organization Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization When studying the internal organization, managers face uncertainty because of a number of issues, including those of new proprietary technologies, rapidly changing economic and political trends, transformations in societal values, and shifts in customers’ demands. Environmental uncertainty increases the complexity and range of issues to examine when studying the internal environment. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization Consider how uncertainty affects how to use resources at coal companies such as Peabody Energy Corp. and Murray Energy Corp. Peabody is the world’s largest private coal sector producer. The firm’s coal products fuel approximately 10 percent of all U.S. electricity generation and 2 percent of worldwide electricity. But this firm and others competing in its industry face a great deal of uncertainty, particularly political uncertainty. As a result, there are questions about how Peabody and its competitors might best allocate their resources today to prepare for success tomorrow. Viewing coal as a “dirty fuel” and its production as environmental unfriendly, the U.S. Environmental Protection Agency (EPA) announced in 2014 and described in greater detail in 2015 new regulations. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization Focusing on carbon emissions, the EPA’s carbon regulations “call for a 30 percent cut in power-plant carbon emissions by 2030 based on emissions levels in 2005.” Coal producers such as Peabody, Arch Coal, and Murray Energy to name only a few, believe that the regulations are too strict and that moreover, the EPA misinterpreted the Clean Air Act when developing them. Time is required for the parties to sort through all of these issues, some of which will be decided by various courts given lawsuits filed by states (such as West Virginia) and firms (such as Murray Energy Corp.) The issue though is that the decision makers in these energy firms face a great deal of uncertainty as they examine the resources, capabilities, and core competencies that form their firms’ internal organization. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization Biases regarding how to cope with uncertainty affect decisions made about how to manage the firm’s resources and capabilities to form core competencies. Additionally, intraorganizational conflict may surface when decisions are made about the core competencies a firm should develop and nurture. Conflict might surface in the energy companies mentioned above about the degree to which resources and capabilities should be used to form new core competencies to support newer “clean technologies.” Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization In making decisions affected by these three conditions, judgment is required. Judgment is the capability of making successful decisions when no obviously correct model or rule is available or when relevant data are unreliable or incomplete. In such situations, decision makers must be aware of possible cognitive biases, such as overconfidence. Individuals who are too confident in the decisions they make about how to use the firm’s resources may fail to fully evaluate contingencies that could affect those decisions. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization When exercising judgment, decision makers often take intelligent risks. In the current competitive landscape, executive judgment can become a valuable capability. One reason is that, over time, effective judgment that decision makers demonstrate allows a firm to build a strong reputation and retain the loyalty of stakeholders whose support is linked to above-average returns. Finding individuals who can make the most successful decisions about using the organization’s resources is challenging. Being able to do this is important because the quality of leaders’ decisions regarding resources and their management affect a firm’s ability to achieve strategic competitiveness. Individuals holding these key decision- making positions are called strategic leaders. Analyzing the Internal Organization The Challenge of Analyzing the Internal Organization Next, consider the relationships among a firm’s resources, capabilities, and core competencies. While reading these sections, keep in mind that organizations have more resources than capabilities and more capabilities than core competencies. Resources, Capabilities & Core Competencies Resources, capabilities, and core competencies are the foundation of competitive advantage. Resources are bundled to create organizational capabilities. In turn, capabilities are the source of a firm’s core competencies, which are the basis of establishing competitive advantages. These relationships are shown in Figure 3.1. Resources, Capabilities & Core Competencies Resources Broad in scope, resources cover a spectrum of individual, social, and organizational phenomena. By themselves, resources do not allow firms to create value for customers as the foundation for earning above-average returns. Indeed, resources are combined to form capabilities. For example, As its sole distribution channel, the Internet is a resource for Amazon.com. The firm uses the Internet to sell goods at prices that typically are lower than those offered by competitors selling the same goods through more costly brick-and- mortar storefronts. Resources, Capabilities & Core Competencies Resources By combining other resources (such as access to a wide product inventory), Amazon has developed a reputation for excellent customer service. Amazon’s capability in terms of customer service is a core competence as well in that the firm creates unique value for customers through the services it provides to them. Amazon also uses its technological core competence to offer AWS (Amazon Web Services), services through which businesses can rent computing power from Amazon at a cost of pennies per hour. Much smaller than AWS, Rackspace seeks to leverage its core competence of “economies of expertise” as it competes against its larger rival. Resources, Capabilities & Core Competencies Resources Some of a firm’s resources (defined in module 1 as inputs to the firm’s production process) are tangible while others are intangible. Tangible resources are assets that can be observed and quantified. Production equipment, manufacturing facilities, distribution centers, and formal reporting structures are examples of tangible resources. Its stock of oil and gas pipelines are a key tangible resource for energy giant Kinder Morgan. Intangible resources are assets that are rooted deeply in the firm’s history, accumulate over time, and are relatively difficult for competitors to analyze and imitate. Resources, Capabilities & Core Competencies Resources Because they are embedded in unique patterns of routines, intangible resources are difficult for competitors to analyze and imitate. Knowledge, trust between managers and employees, managerial capabilities, organizational routines (the unique ways people work together), scientific capabilities, the capacity for innovation, brand name, the firm’s reputation for its goods or services and how it interacts with people (such as employees, customers, and suppliers), and organizational culture are intangible resources. Intangible resources require nurturing to maintain their ability to help firms engage in competitive battles. Resources, Capabilities & Core Competencies Resources For each analysis, tangible and intangible are grouped into categories. The four primary categories of tangible resources are financial, organizational, physical, and technological (see Table 3.1). The three primary categories of intangible resources are human, innovation, and reputational (see Table 3.2). Resources, Capabilities & Core Competencies Resources, Capabilities & Core Competencies Tangible Resources. As tangible resources, a firm’s borrowing capacity and the status of its physical facilities are visible. The value of many tangible resources can be established through financial statements, but these statements do not account for the value of all of the firm’s assets because they disregard some intangible resources. The value of tangible resources is also constrained because they are hard to leverage—it is difficult to derive additional business or value from a tangible resource. Resources, Capabilities & Core Competencies Tangible Resources. For example, an airplane is a tangible resource, but “you can’t use the same airplane on five different routes at the same time. You can’t put the same crew on five different routes at the same time. And the same goes for the financial investment you’ve made in the airplane.” Although production assets are tangible, many of the processes necessary to use them are intangible. Thus, the learning and potential proprietary processes associated with a tangible resource, such as manufacturing facilities, can have unique intangible attributes, such as quality control processes, unique manufacturing processes, and technologies that develop over time. Resources, Capabilities & Core Competencies Intangible Resources. Compared to tangible resources, intangible resources are a superior source of capabilities and subsequently, core competencies. In the global economy, a firm’s intellectual capital often plays a more critical role in corporate success than do physical assets. Because of this, being able to effectively manage intellectual capital is an increasingly important skill for today’s leaders to develop. Resources, Capabilities & Core Competencies Intangible Resources. Since intangible resources are less visible and more difficult for competitors to understand, purchase, imitate, or substitute for, firms prefer to rely on them rather than on tangible resources as the foundation for their capabilities. The more unobservable (i.e., intangible) a resource is, the more valuable that resource is to create capabilities. Another benefit of intangible resources is that, unlike most tangible resources, their use can be leveraged. For instance, sharing knowledge among employees does not diminish its value for any one person. To the contrary, two people sharing their individualized knowledge sets often can be leveraged to create additional knowledge that, although new to each individual, contributes potentially to performance improvements for the firm. Resources, Capabilities & Core Competencies Intangible Resources. Reputational resources (see Table 3.2) are important sources of a firm’s capabilities and core competencies. Indeed, some argue that a positive reputation can even be a source of competitive advantage. Earned through the firm’s actions as well as its words, a value- creating reputation is a product of years of superior marketplace competence as perceived by stakeholders. A reputation indicates the level of awareness a firm has been able to develop among stakeholders and the degree to which they hold the firm in high esteem. Resources, Capabilities & Core Competencies Capabilities The firm combines individual tangible and intangible resources to create capabilities. In turn, capabilities are used to complete the organizational tasks required to produce, distribute, and service the goods or services the firm provides to customers for the purpose of creating value for them. As a foundation for building core competencies and hopefully competitive advantages, capabilities are often based on developing, carrying, and exchanging information and knowledge through the firm’s human capital. Hence, the value of human capital in developing and using capabilities and, ultimately, core competencies cannot be overstated. Resources, Capabilities & Core Competencies Capabilities In fact, it seems to be “well known that human capital makes or breaks companies.” At pizza-maker Domino’s, human capital is critical to the firm’s efforts to change how it competes. Describing this, CEO Patrick Doyle says that, in many ways, Domino’s is becoming “a technology company … that has adapted the art of pizza-making to the digital age.” As illustrated in Table 3.3, capabilities are often developed in specific functional areas (such as manufacturing, R&D, and marketing) or in a part of a functional area (e.g., advertising). Table 3.3 shows a grouping of organizational functions and the capabilities that some companies are thought to possess in terms of all or parts of those functions. Resources, Capabilities & Core Competencies Resources, Capabilities & Core Competencies Core Competencies As defined in Lesson 1, core competencies are capabilities that serve as a source of competitive advantage for a firm over its rivals. Core competencies distinguish a company competitively and reflect its personality. Core competencies emerge over time through an organizational process of accumulating and learning how to deploy different resources and capabilities. As the capacity to take action, core competencies are the “crown jewels of a company,” the activities the company performs especially well compared to competitors and through which the firm adds unique value to the goods or services it sells to customers. Thus, if a big pharma company (such as Pfizer) developed big data analytics as a core competence, one could conclude that the firm had formed capabilities through which it was able to analyze and effectively use huge amounts of data in a competitively- superior manner. Resources, Capabilities & Core Competencies Core Competencies Innovation is thought to be a core competence at Apple. As a capability, R&D activities are the source of this core competence. More specifically, the way Apple has combined some of its tangible (e.g., financial resources and research laboratories) and intangible (e.g., scientists and engineers and organizational routines) resources to complete research and development tasks creates a capability in R&D. By emphasizing its R&D capability, Apple is able to innovate in ways that create unique value for customers in the form of the products it sells, such as the iWatch, suggesting that innovation is a core competence for Apple. Resources, Capabilities & Core Competencies Core Competencies Excellent customer service in its retail stores is another of Apple’s core competencies. In this instance, unique and contemporary store designs (a tangible resource) are combined with knowledgeable and skilled employees (an intangible resource) to provide superior service to customers. A number of carefully developed training and development procedures are capabilities on which Apple’s core competence of excellent customer service is based. The procedures that are capabilities include specification of how employees are to interact with customers, carefully written training manuals to describe on-site tech support that is to be provided to customers, and deep thinking about every aspect of the store’s design including music that is played. Building Core Competencies Two tools help firms identify their core competencies. The first consists of four specific criteria of sustainable competitive advantage that can be used to determine which capabilities are core competencies. Because the capabilities shown in Table 3.3 have satisfied these four criteria, they are core competencies. The second tool is the value chain analysis. Firms use this tool to select the value- creating competencies that should be maintained, upgraded, or developed and those that should be outsourced. Building Core Competencies The Four Criteria of Sustainable Competitive Advantage (VRIN Model) Capabilities that are valuable, rare, costly to imitate, and nonsubstitutable are core competencies (see Table 3.4). In turn, core competencies can lead to competitive advantages for the firm over its rivals. Capabilities failing to satisfy the four criteria are not core competencies, meaning that although every core competence is a capability, not every capability is a core competence. In slightly different words, for a capability to be a core competence, it must be valuable (V) and unique or rare (R) from a customer’s point of view. For a core competence to be a potential source of competitive advantage, it must be inimitable (I) and nonsubstitutable (N) by competitors. Building Core Competencies The Four Criteria of Sustainable Competitive Advantage (VRIN Model) A sustainable competitive advantage exists only when competitors are unable to duplicate the benefits of a firm’s strategy or when they lack the resources to attempt imitation. For some period of time, the firm may have a core competence by using capabilities that are valuable and rare, but imitable. Building Core Competencies Building Core Competencies Valuable. Valuable capabilities allow the firm to exploit opportunities or neutralize threats in its external environment. By effectively using capabilities to exploit opportunities or neutralize threats, a firm creates value for customers. For example, Groupon created the “daily deal” marketing space; the firm reached $1 billion in revenue faster than any other company in history. In essence, the opportunity Groupon’s founders pursued when launching the firm in 2008 was to create a marketplace through which businesses could introduce their goods or services to customers who would be able to experience them at a discounted price. Restaurants, hair and nail salons, and hotels are examples of the types of companies making frequent use of Groupon’s services. Building Core Competencies Rare. Rare capabilities are capabilities that few, if any, competitors possess. A key question to be answered when evaluating this criterion is “how many rival firms possess these valuable capabilities?” Capabilities possessed by many rivals are unlikely to become core competencies for any of the involved firms. Instead, valuable but common (i.e., not rare) capabilities are sources of competitive parity. Competitive advantage results only when firms develop and exploit valuable capabilities that become core competencies and that differ from those shared with competitors. Building Core Competencies Rare. The central problem for Groupon is that its capabilities to produce the “daily deal” reached competitive parity quickly. Similarly, Walmart has developed valuable capabilities that it uses to engage in green practices; but, as mentioned previously, Target seeks to develop sustainability capabilities through which it can duplicate Walmart’s green practices. Target’s success in doing so, if this happens, would suggest that Walmart’s green practices are valuable but not rare. Building Core Competencies Costly to Imitate. Costly-to-imitate capabilities are capabilities that other firms cannot easily develop. Capabilities that are costly to imitate are created because of one reason or a combination of three reasons (see Table 3.4). First, a firm sometimes is able to develop capabilities because of unique historical conditions. As firms evolve, they often acquire or develop capabilities that are unique to them. A firm with a unique and valuable organizational culture that emerged in the early stages of the company’s history “may have an imperfectly imitable advantage over firms founded in another historical period;” one in which less valuable or less competitively useful values and beliefs strongly influenced the development of the firm’s culture. Building Core Competencies Costly to Imitate. An organizational culture is a source of advantage when employees are held together tightly by their belief in it and the leaders who helped to create it. Historically, emphasizing cleanliness, consistency, and service and the training that reinforces the value of these characteristics created a culture at McDonald’s that some thought was a core competence and a competitive advantage for the firm. However, McDonald’s recent performance is worrying investors. One of the actions the firm is taking to address this matter is to change its organizational structure in its U.S. operations, largely for the purpose of giving “leaders in its 22 U.S. regions more autonomy in making local menu and marketing decisions.” Hopefully, a different organizational structure will facilitate McDonald’s efforts to reinvigorate its historically unique culture as a core competence. Building Core Competencies Costly to Imitate. A second condition of being costly to imitate occurs when the link between the firm’s core competencies and its competitive advantage is causally ambiguous. In these instances, competitors aren’t able to clearly understand how a firm uses its capabilities that are core competencies as the foundation for competitive advantage. As a result, firms are uncertain about the capabilities they should develop to duplicate the benefits of a competitor’s value-creating strategy. For years, firms tried to imitate Southwest Airlines’ lowcost strategy, but most have been unable to do so, primarily because they can’t duplicate this firm’s unique culture. Building Core Competencies Costly to Imitate. Social complexity is the third reason that capabilities can be costly to imitate. Social complexity means that at least some, and frequently many, of the firm’s capabilities are the product of complex social phenomena. Interpersonal relationships, trust, friendships among managers and between managers and employees, and a firm’s reputation with suppliers and customers are examples of socially complex capabilities. Southwest Airlines is careful to hire people who fit with its culture. This complex interrelationship between the culture and human capital adds value in ways that other airlines cannot, such as jokes on flights by the flight attendants or the cooperation between gate personnel and pilots. Building Core Competencies Nonsubstitutable. Nonsubstitutable capabilities are capabilities that do not have strategic equivalents. This final criterion “is that there must be no strategically equivalent valuable resources that are themselves either not rare or imitable. Two valuable firm resources (or two bundles of firm resources) are strategically equivalent when they each can be separately exploited to implement the same strategies.” In general, the strategic value of capabilities increases as they become more difficult to substitute. The more intangible, and hence invisible, capabilities are, the more difficult it is for firms to find substitutes and the greater the challenge is to competitors trying to imitate a firm’s value-creating strategy. Building Core Competencies Nonsubstitutable. Firm-specific knowledge and trust-based working relationships between managers and nonmanagerial personnel, such as has existed for years at Southwest Airlines, are examples of capabilities that are difficult to identify and for which finding a substitute is challenging. However, causal ambiguity may make it difficult for the firm to learn and may stifle progress because the firm may not know how to improve processes that are not easily codified and thus are ambiguous. Building Core Competencies Nonsubstitutable. In summary, only using valuable, rare, costly-to-imitate, and nonsubstitutable capabilities has the potential for the firm to create sustainable competitive advantages. Table 3.5 shows the competitive consequences and performance implications resulting from combinations of the four criteria of sustainability. The analysis suggested by the table helps managers determine the strategic value of a firm’s capabilities. The firm should not emphasize capabilities that fit the criteria described in the first row in the table (i.e., resources and capabilities that are neither valuable nor rare and that are imitable and for which strategic substitutes exist). Building Core Competencies Nonsubstitutable. Capabilities yielding competitive parity and either temporary or sustainable competitive advantage, however, should be supported. Some competitors such as Coca-Cola and PepsiCo and Boeing and Airbus may have capabilities that result in competitive parity. In such cases, the firms will nurture these capabilities while simultaneously trying to develop capabilities that can yield either a temporary or sustainable competitive advantage. Building Core Competencies Building Core Competencies Value Chain Analysis Value chain analysis allows the firm to understand the parts of its operations that create value and those that do not. Understanding these issues is important because the firm earns above-average returns only when the value it creates is greater than the costs incurred to create that value. The value chain is a template that firms use to analyze their cost position and to identify the multiple means that can be used to facilitate implementation of a chosen strategy. Today’s competitive landscape demands that firms examine their value chains in a global rather than a domestic-only context. Building Core Competencies Value Chain Analysis In particular, activities associated with supply chains should be studied within a global context. A model of the value chain in Figure 3.3 depicts a firm’s value chain which is segmented into value chain activities and support functions. Value chain activities are activities or tasks the firm completes in order to produce products and then sell, distribute, and service those products in ways that create value for customers. Building Core Competencies Building Core Competencies Support functions include the activities or tasks the firm completes in order to support the work being done to produce, sell, distribute, and service the products the firm is producing. A firm can develop a capability and/or a core competence in any of the value chain activities and in any of the support functions. When it does so, it has established an ability to create value for customers. In fact, as shown in Figure 3.3, customers are the ones firms seek to serve when using value chain analysis to identify their capabilities and core competencies. When using their unique core competencies to create unique value for customers that competitors cannot duplicate, firms have established one or more competitive advantages. Building Core Competencies Support functions As shown in Figure 3.3, customers are the ones firms seek to serve when using value chain analysis to identify their capabilities and core competencies. When using their unique core competencies to create unique value for customers that competitors cannot duplicate, firms have established one or more competitive advantages. Building Core Competencies Building Core Competencies The activities associated with each part of the value chain are shown in Figure 3.4, while the activities that are part of the tasks firms complete when dealing with support functions appear in Figure 3.5. All items in both figures should be evaluated relative to competitors’ capabilities and core competencies. To become a core competence and a source of competitive advantage, a capability must allow the firm to either 1. Perform an activity in a manner that provides value superior to that provided by competitors. 2. Perform a value-creating activity that competitors cannot perform. Only under these conditions does a firm create value for customers and have opportunities to capture that value. Building Core Competencies Building Core Competencies Evaluating a firm’s capability to execute its value chain activities and support functions is challenging. Earlier in the chapter, we noted that identifying and assessing the value of a firm’s resources and capabilities requires judgment. Judgment is equally necessary when using value chain analysis because no obviously correct model or rule is universally available to help in the process. What should a firm do about value chain activities and support functions in which its resources and capabilities are not a source of core competence? Outsourcing is one solutions to consider. Outsourcing Concerned with how components, finished goods, or services will be obtained, outsourcing is the purchase of a value-creating activity or a support function activity from an external supplier. Not-for-profit agencies as well as for-profit organizations actively engage in outsourcing. Firms engaging in effective outsourcing increase their flexibility, mitigate risks, and reduce their capital investments. In multiple global industries, the trend toward outsourcing continues at a rapid pace. Outsourcing Moreover, in some industries virtually all firms seek the value that can be captured through effective outsourcing. However, as is the case with other strategic management process decisions, careful analysis is required before the firm decides to outsource. And if outsourcing is to be used, firms must recognize that only activities where they cannot create value or where they are at a substantial disadvantage compared to competitors should be outsourced. Outsourcing Outsourcing is the purchase of a value-creating activity or a support function activity from an external supplier. Outsourcing can be effective because few, if any, organizations possess the resources and capabilities required to achieve competitive superiority in each value chain activity and support function. For example, research suggests that few companies can afford to internally develop all the technologies that might lead to competitive advantage. By nurturing a smaller number of capabilities, a firm increases the probability of developing core competencies and achieving a competitive advantage because it does not become overextended. In addition, by outsourcing activities in which it lacks competence, the firm can fully concentrate on those areas in which it has the potential to create value. Outsourcing There are concerns associated with outsourcing. Two significant ones are the potential loss in a firm’s ability to innovate and the loss of jobs within the focal firm. When evaluating the possibility of outsourcing, firms should anticipate possible effects on their ability to innovate in the future as well as the impact of losing some of their human capital. On the other hand, firms are sometimes able to enhance their own innovation capabilities by studying how the companies to which they’ve outsourced complete those activities. Because a focal firm likely knows less about a foreign company to which it chooses to outsource, concerns about potential negative outsourcing effects in these cases may be particularly acute, requiring careful study and analysis as a result. Deciding to outsource to a foreign supplier is commonly called offshoring. Competencies, Strengths, Weaknesses, & Strategic Decisions By analyzing the internal organization, firms identify their strengths and weaknesses as reflected by their resources, capabilities, and core competencies. If a firm has weak capabilities or does not have core competencies in areas required to achieve a competitive advantage, it must acquire those resources and build the needed capabilities and competencies. Alternatively, the firm could decide to outsource a function or activity where it is weak in order to improve its ability to use its remaining resources to create value. Competencies, Strengths, Weaknesses, & Strategic Decisions In considering the results of examining the firm’s internal organization, managers should understand that having a significant quantity of resources is not the same as having the “right” resources. The “right” resources are those with the potential to be formed into core competencies as the foundation for creating value for customers and developing competitive advantages as a result of doing so. Interestingly, decision makers sometimes become more focused and productive when seeking to find the right resources when the firm’s total set of resources is constrained. Competencies, Strengths, Weaknesses, & Strategic Decisions Tools such as outsourcing help the firm focus on its core competencies as the source of its competitive advantages. However, evidence shows that the value-creating ability of core competencies should never be taken for granted. Moreover, the ability of a core competence to be a permanent competitive advantage can’t be assumed. The reason for these cautions is that all core competencies have the potential to become core rigidities. Typically, events occurring in the firm’s external environment create conditions through which core competencies can become core rigidities, generate inertia, and stifle innovation. “Often the flip side, the dark side, of core capabilities is revealed due to external events when new competitors figure out a better way to serve the firm’s customers, when new technologies emerge, or when political or social events shift the ground underneath.”