Strategy – Chapter 5

Key elements

We have shifted the focus of our attention from the external environment of the firm to its internal
environment. We have observed that internal resources and capabilities offer a sound basis for
building strategy.

Indeed, when a firm’s external environment is in a state of flux, internal strengths are likely to
provide the primary basis upon which it can define its identity and its strategy.

In this chapter we have followed a systematic approach to identifying the resources and capabilities
that an organization has access to and then have appraised these resources and capabilities in terms
of their potential to offer a sustainable competitive advantage and, ultimately, to generate profit.

Having built a picture of an organization’s key resources and capabilities and having identified areas
of strength and weakness, we can then devise strategies through which the organization can exploit
its strengths and minimize its vulnerability to its weaknesses. Figure 5.10 summarizes the main stages
of our analysis.

In the course of the chapter, we have encountered a number of theoretical concepts and
relationships; however, the basic issues of resource and capability analysis are intensely practical. At
its core, resource and capability analysis asks what is distinctive about a firm in terms of what it can
do better than its competitors and what it cannot. This involves not only analysis of balance sheets,
employee competencies, and benchmarking data, but also insight into the values, ambitions, and
traditions of a company that shape its priorities and identity.

I- The role of Resources and Capabilities in strategy formulation

Basing strategy on Resources and Capabilities

1990: New theory on strategy emerges, it is called the resource-based view of the firm.

Why resource-based view had a major impact on strategy?

Let’s go back to the starting point: at first, we asked “what is our business” which was answered by
“who are our customers” and “which of their needs we are looking to serve”.
But we are in a world where preferences are volatile, so a market focused strategy wouldn’t give a
lot of consistency to have a long term strategy.

The emphasis on resources and capabilities has been popularized by C.K. Prahalad and Gary Hamel,
in “The core competence of the Corporation”
In general, the greater the rate of change in a firm’s external environment, the more likely it is that
internal resources and capabilities rather than external market focus will provide a secure foundation
for long-term strategy.

In fast moving, technology-based industry, basing strategy upon capabilities can help firms to outlive
the lifecycle of their initial product.
{Ex: Microsoft, Apple: They have a core product (OS/PC System/Hardware/Software…) and succeed in
developing into other sectors, like Microsoft Office, or MP3 (iPod), Smartphones (iPhones), Tablet
computers (iPad) and so on.}

On the other hand, those who wanted to keep focusing on their main market struggled in a fast-
paced changing industry, with technology.

{Ex: Kodak: Forced to bankruptcy after trying to develop digital technologies and digital imaging
products.

Successive technological waves have caused market leaders to falter and have allowed new entrants
to prosper.

Resources and Capabilities as Sources of Profit

Establishing competitive advantage through the development and deployment of resources and
capabilities, rather than seeking shelter from the storm of competition, has become the primary goal
of strategy.

The distinction between industry

attractiveness and competitive
advantage (based
on superior resources) as sources of a
firm’s profitability corresponds to
economists’
distinctions between different types
of profit (or rent). The profits arising
from mar-
ket power are referred to as
monopoly rents; those arising from
superior resources
are Ricardian rents
The distinction between industry attractiveness and competitive advantage (based on superior
resources) as sources of a firm’s profitability corresponds to economists’ distinctions between
different types of profit (or rent).
The profits arising from market power are referred to as monopoly rents; those arising from superior
resources are Ricardian rents

Ricardian rent is the return earned by a scarce resource over and above the cost of using the
resource. (Rente gagnée par l’exploitation d’une valeur rare d’une entreprise dont l’offre est limitée).

When the primary concern of strategy was industry selection and positioning, companies tended to
adopt similar strategies. The resource-based view, by contrast, recognizes that each company
possesses a unique collection of resources and capabilities; the key to profitability is not doing the
same as other firms but rather exploiting differences. Establishing competitive advantage involves
formulating and implementing a strategy that exploits a firm’s unique strengths.

II- Identifying Resources and capabilities

Identifying Resources
3 main types of a firm’s resources: tangible, intangible, human.

1- Tangible: financial resources and physical assets that are valued in a firm’s balance sheet.

The primary goal of resource analysis is not to value a company’s tangible resources but to
understand their potential for generating profit. We need the balance sheet, but also their
composition and characteristics.

2 routes to create additional value from a firm’s tangible resources.

A- What opportunities exist for economizing on their use? Can we use fewer resources to support the
same level of business or use the existing resources to support a larger volume of business?

B- Can existing assets be deployed more profitably?

{Ex: Disneyland growth with the use of their considerable resource base}

2- Intangible: For most companies, intangible resources are more valuable than tangible resources.
Yet, in companies’ balance sheets, intangible resources tend to be either undervalued or omitted
altogether

A firm’s relationships can also be considered resources. They provide a firm with access to
information, know-how, inputs, and a wide range of other resources that lie beyond the firm’s
boundaries. These are referred as “network resources”.

Organizational resources can also be considered intangible resources: organizational culture is a

critically important resource in most firms: it exerts a strong influence on the capabilities an
organization develops and the effectiveness with which they are exercised.

3- Human resources: Human resources comprise the skills and productive effort offered by an
organization’s employees. They don’t appear in the balance sheet, but it is here as the company
purchases their services under contracts.

Identifying Organizational Capabilities

An organizational capability is a “firm’s capacity to deploy resources for a desired end result.
To identify a firm’s organizational capabilities, 2 approaches are commonly used:

A functional analysis identifies organizational capabilities within each of the firm’s functional areas
(operations, purchasing, logistics/supply chain management, design, engineering, new product
development, marketing, sales and distribution, customer service, finance, human resource
management, legal, information systems, government relations, communication and public relations,
and HSE (health, safety, and environment)

A value chain analysis identifies a sequential chain of the main activities that the firm undertakes.
Michael Porter’s generic value chain distinguishes between primary activities (those involved with
the transformation of inputs and interface with the customer) and support activities.

The problem of both approaches is that, despite providing a comprehensive view of an organization’s
capabilities, they may fail to identify those idiosyncratic capabilities that are truly distinctive and
critical to an organization’s competitive advantage

In reviewing an organization’s successes and failures over time, do patterns emerge and what do
these patterns tell us about the capabilities that the organization possesses?

At the basis of every organizational

capability is coordinated behavior
among
organizational members. This is what
distinguishes an organizational
capability
from an individual skill
At the basis of every organizational capability is coordinated behavior among organizational
members. This is what distinguishes an organizational capability from an individual skill.

{Ex: Apple: Success can’t be described by the functional or value chain analysis, it’s a combination of
coordinated behavior}

The capabilities of an organization may be viewed as a hierarchical system in which lower-level

capabilities are integrated to form higher-level capabilities.

{Ex: Toyota “lean production” -> Integrate multiple capabilities, and higher-level capabilities tend to
be cross-functional (integrate marketing, finance, tech etc.)

III- Appraising Resources and capabilities

Appraising the Strategic importance of Resources and capabilities
Strategically important resources and capabilities are those with the potential to generate substantial
streams of profit for the firm that owns them.

This depends on three factors:

1- Their potential to establish a competitive advantage: 2 conditions must be present: Relevance

and Scarcity

Relevance: A resource or capability must be relevant to the key success factors in the market, in
particular, it must be capable of creating value for customers.

Scarcity: If a resource or capability is widely available within the industry, it may be necessary in
order to compete, but it will not be an adequate basis for competitive advantage

2- Sustaining competitive advantage: 3 characteristics of resources and capabilities determine the

sustainability of the competitive advantage they offer:

Durability: The more durable a resource, the greater its ability to support a competitive advantage
over the long term. (With the quickening pace of technological innovation, it reduces the life spans of
old resources, Brands on the other hand last a long time)

Transferability: Competitive advantage is undermined by competitive imitation. If resources and

capabilities are transferable between firms—i.e., if they can be bought and sold, then any
competitive advantage that is based upon them will be eroded.
Most resources, including most human resources, can be bought and sold with little difficulty.
Other resources and most capabilities are immobile and not easily transferred.
Some resources are specific to certain locations and cannot be relocated.

Another barrier to transferability is limited information regarding resource quality. In the case of
human resources, hiring decisions are typically based on very little knowledge of how the new
employee will perform.

Sellers of resources have better information about the performance characteristics of resources than
buyers do. This creates a problem of adverse selection for buyers.

Replicability: If a firm cannot buy a resource or capability, it must build it.

In financial services, most new product innovations can be imitated easily by competitors. In
retailing, too, competitive advantages that derive from store layout, point-of-sale technology, and
marketing methods are easy to observe and easy to replicate.

Capabilities based on complex organizational routines are less easy to copy.

Even when resources and capabilities can be copied, imitators are typically at a disadvantage to
initiators

3- To appropriate the returns from the competitive advantage: Who gains the returns generated by
superior resources and capabilities? Typically, the owner of that resource or capability. But
ownership may not be clear-cut. Are organizational capabilities owned by the employees who
provide skills and effort or by the firm which provides the processes and culture?

It will depend on property rights, relative bargaining power and embeddedness

{Ex: Goldman Sachs -> It’s an all (Brand company, employee, IT Infrastructure, corporate reputation),
it seems that it is employee that wins.
Ex: Sports -> Star players wins also}

Appraising the relative strength of a firm’s Resources and capabilities

How a firm measures up relative to its competitors, making an objective appraisal of a company’s
resources and capabilities relative to its competitors’ is difficult.

Benchmarking the process of comparing one’s processes and performance to those of other
companies offers an objective and quantitative way for a firm to assess its resources and capabilities
relative to its competitors’

IV- Developing Strategy Implication

Identifying resources and capabilities and appraising them in terms of strategic importance and
relative strength—can be summarized in the form of a simple display.

Exploiting Key strengths

{Ex: Disney -> Key strengths -> Brand, affection of Disney world and characters. Parc themes are
available on 6 locations, but they should open more parcs on other locations which have adequate
market potential}

{Ex: Newspaper (Le Monde, New York times, the Guardian), should maybe develop in Business
Intelligence to supplement their declining revenues from newspaper sales}

If a company has few key strengths, this may suggest adopting a niche strategy. (Focusing on one
thing, as for example Brand identity)
Managing key weaknesses

converting weakness into strength is

likely to be a long-term task for most
compa-
nies. In the short to medium term, a
company is likely to be stuck with
the resources
and capabilities that it has inherited
Converting weakness into strength is likely to be a long-term task for most companies. In the short to
medium term, a company is likely to be stuck with the resources and capabilities that it has inherited.

The most decisive, and often most successful, solution to weaknesses in key functions is to
outsource. (It is the case for the automobile industry for example)

{Ex: Consider once more Harley-Davidson. It cannot compete with Honda, Yamaha, and BMW on
technology. The solution? It has made a virtue out of its outmoded technology and traditional
designs. Harley-Davidson’s old-fashioned, push-rod engines, and recycled designs have become
central to its retro-look authenticity.}

What about superfluous strengths?

In the same way that companies can turn apparent weaknesses into competitive strengths, so it is
possible to develop innovative strategies that turn apparently inconsequential strengths into key
strategy differentiators.

{Ex: Edward Jones’ network of brokerage offices and 8000-strong sales force looked increasingly
irrelevant in an era when brokerage transactions were going online. However, by emphasizing
personal service, trustworthiness, and its traditional, conservative investment virtues, Edward Jones
has built a successful contrarian strategy based on its network of local offices}

The industry context of resource analysis

Appraising resources and capabilities on the basis of strategic importance and relative strength is
highly sensitive to how we define the competitive environment of the focal firm the results of any
resource and capability analysis depend critically upon how broadly or narrowly an industry is
defined.

More generally, as with all strategy frameworks, we need to be alert to the limitations of resource
and capability analysis. Not only are our criteria of strategic importance and relative strength
context-dependent but also individual resources and capabilities are themselves multidimensional
aggregations.
{Ex: Usually, the key success factor in the airline business is providing safe, reliable transportation
between city pairs at a competitive price.
Iceland air, needs a precise way to operate and be profitable, strength in location (Iceland), but they
are too small to support international airline. To achieve efficient scale, they have to collaborate with
the gov, and develop tourism in Iceland.
They then have to make a stop at Reykjavik, which is a competitive hub operated by the major US
and EU airlines. -> To achieve this, they need to use their key strengths which are Human Resources,
and Iceland as a stopover (Reykjavik).}