CHAPTER 3

The Internal Environment:

Resources, Capabilities,
STRATEGIC and Core Competencies
MANAGEMENT
INPUTS

Strategic Management
Competitiveness and Globalization:
PowerPoint Presentation by Charlie Cook
Concepts and Cases Seventh edition
The University of West Alabama
© 2007 Thomson/South-Western.
All rights reserved. Michael A. Hitt • R. Duane Ireland • Robert E. Hoskisson
KNOWLEDGE OBJECTIVES

Studying this chapter should provide you with the strategic

management knowledge needed to:
1. Explain the need for firms to study and understand their
internal environment.
2. Define value and discuss its importance.
3. Describe the differences between tangible and
intangible resources.
4. Define capabilities and discuss how they are
developed.
5. Describe four criteria used to determine whether
resources and capabilities are core competencies.

© 2007 Thomson/South-Western. All rights reserved. 3–2

KNOWLEDGE OBJECTIVES (cont’d)

Studying this chapter should provide you with the strategic

management knowledge needed to:
6. Explain how value chain analysis is used to identify and
evaluate resources and capabilities.
7. Define outsourcing and discuss the reasons for its use.
8. Discuss the importance of identifying internal strengths
and weaknesses.

© 2007 Thomson/South-Western. All rights reserved. 3–3

Competitive Advantage (cont’d)
• Sustainability of a competitive advantage is a
function of:
 The rate of core competence obsolescence due to
environmental changes.
 The availability of substitutes for the core
competence.
 The difficulty competitors have in duplicating or
imitating the core competence.

© 2007 Thomson/South-Western. All rights reserved. 3–4

External Analyses’ Outcomes

Opportunities
and threats

By studying the external environment, firms

identify what they might choose to do.
© 2007 Thomson/South-Western. All rights reserved. 3–5
Internal Analyses’ Outcomes

Unique resources,
capabilities, and
competencies
(required for sustainable
competitive advantage)

By studying the internal environment,

firms identify what they can do

© 2007 Thomson/South-Western. All rights reserved. 3–6

The Context of Internal Analysis
• Global Economy
 Traditional sources of advantages can be overcome
by competitors’ international strategies and by the
flow of resources throughout the global economy.
• Global Mind-Set
 The ability to study an internal environment in ways
that are not dependent on the assumptions of a single
country, culture, or context.
• Analysis Outcome
 Understanding how to leverage the firm’s bundle of
heterogeneous resources and capabilities.

© 2007 Thomson/South-Western. All rights reserved. 3–7

 FIGURE 3.1 Components of Internal Analysis Leading to
Competitive Advantage and Strategic Competitiveness

© 2007 Thomson/South-Western. All rights reserved. 3–8

Creating Value
• By exploiting their core competencies or
competitive advantages, firms create value.
• Value is measured by:
 Product performance characteristics
 Product attributes for which customers are willing to
pay

• Firms create value by innovatively bundling and

leveraging their resources and capabilities.
• Superior value  Above-average returns

© 2007 Thomson/South-Western. All rights reserved. 3–9

Creating Competitive Advantage
• Core competencies, in combination with product-
market positions, are the firm’s most important
sources of competitive advantage.
• Core competencies of a firm, in addition to its
analysis of its general, industry, and competitor
environments, should drive its selection of
strategies.

© 2007 Thomson/South-Western. All rights reserved. 3–10

The Challenge of Internal Analysis
• Strategic decisions in terms of the firm’s
resources, capabilities, and core competencies:
 Are non-routine.
 Have ethical implications.
 Significantly influence the firm’s ability to earn above-
average returns.

© 2007 Thomson/South-Western. All rights reserved. 3–11

The Challenge of Internal Analysis (cont’d)
• To develop and use core competencies,
managers must have:
 Courage
 Self-confidence
 Integrity
 The capacity to deal with uncertainty and complexity
 A willingness to hold people (and themselves)
accountable for their work

© 2007 Thomson/South-Western. All rights reserved. 3–12

 FIGURE 3.2 Conditions Affecting Managerial Decisions about
Resources, Capabilities, and Core Competencies

Source: Adapted from R. Amit & P. J. H. Schoemaker, 1993, Strategic

assets and organizational rent, Strategic Management Journal, 14: 33.
© 2007 Thomson/South-Western. All rights reserved. 3–13
Resources, Capabilities and Core Competencies
• Resources
Discovering Core  Are the source of a firm’s
Competencies capabilities.
 Are broad in scope.
Core  Cover a spectrum of
Competencies individual, social and
organizational
Capabilities phenomena.
 Alone, do not yield a
Resources competitive advantage.
•Tangible
•Intangible

© 2007 Thomson/South-Western. All rights reserved. 3–14

Resources
• Resources • Types of Resources
 Are a firm’s assets,  Tangible resources
including people and • Financial resources
the value of its brand
• Physical resources
name.
• Technological
 Represent inputs into a resources
firm’s production • Organizational
process, such as: resources
• Capital equipment
• Skills of employees
 Intangible resources
• Brand names • Human resources
• Financial resources • Innovation resources
• Talented managers • Reputation resources

© 2007 Thomson/South-Western. All rights reserved. 3–15

TABLE 3.1 Tangible Resources

Financial Resources • The firm’s borrowing capacity

• The firm’s ability to generate internal
funds
Organizational Resources • The firm’s formal reporting structure
and its formal planning, controlling, and
coordinating systems
Physical Resources • Sophistication and location of a firm’s
plant and equipment
• Access to raw materials
Technological Resources • Stock of technology, such as patents,
trademarks, copyrights, and trade
secrets

Sources: Adapted from J. B. Barney, 1991, Firm resources and sustained competitive advantage, Journal of
Management, 17: 101; R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge, U.K.: Blackwell Business, 100–
102.
© 2007 Thomson/South-Western. All rights reserved. 3–16
TABLE 3.2 Intangible Resources

Human Resources • Knowledge

• Trust
• Managerial capabilities
• Organizational routines
Innovation Resources • Ideas
• Scientific capabilities
• Capacity to innovate
Reputational Resources • Reputation with customers
• Brand name
• Perceptions of product quality,
durability, and reliability
• Reputation with suppliers
• For efficient, effective, supportive, and
mutually beneficial interactions and
relationships
Sources: Adapted from R. Hall, 1992, The strategic analysis of intangible resources, Strategic Management Journal,
13: 136–139; R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge, U.K.: Blackwell Business, 101–104.
© 2007 Thomson/South-Western. All rights reserved. 3–17
Resources, Capabilities and Core Competencies
• Capabilities
Discovering Core  Represent the capacity to deploy
Competencies resources that have been
purposely integrated to achieve a
desired end state
Core  Emerge over time through complex
Competencies
interactions among tangible and
intangible resources
Capabilities
 Often are based on developing,
carrying and exchanging
Resources information and knowledge through
•Tangible the firm’s human capital
•Intangible

© 2007 Thomson/South-Western. All rights reserved. 3–18

Resources, Capabilities and Core Competencies
• Capabilities (cont’d)
Discovering Core  The foundation of many
Competencies capabilities lies in:
• The unique skills and
knowledge of a firm’s
Core employees
Competencies
• The functional expertise of
those employees
Capabilities
 Capabilities are often
developed in specific
Resources functional areas or as part
•Tangible
•Intangible of a functional area.

© 2007 Thomson/South-Western. All rights reserved. 3–19

TABLE 3.3 Examples of Firms’ Capabilities

Functional Areas Capabilities

Distribution Effective use of logistics management techniques
Human resources Motivating, empowering, and retaining employees
Management Effective and efficient control of inventories through
information systems point-of-purchase data collection methods
Marketing Effective promotion of brand-name products
Effective customer service
Innovative merchandising
Management Ability to envision the future of clothing
Effective organizational structure
Manufacturing Design and production skills yielding reliable products
Product and design quality
Miniaturization of components and products
Research & Innovative technology
development Development of sophisticated elevator control solutions
Rapid transformation of technology into new products and
processes
Digital technology
© 2007 Thomson/South-Western. All rights reserved. 3–20
Resources, Capabilities and Core Competencies
• Four criteria for
Discovering Core determining strategic
Competencies capabilities:
 Value
Core
Competencies  Rarity
 Costly-to-imitate
Capabilities
 Nonsubstitutability
Resources
•Tangible
•Intangible

© 2007 Thomson/South-Western. All rights reserved. 3–21

Resources, Capabilities and Core Competencies
• Core Competencies
Discovering Core  Resources and capabilities that
Competencies
are the sources of a firm’s
competitive advantage:
Core • Distinguish a company
Competencies competitively and reflect its
personality.
Capabilities
• Emerge over time through an
organizational process of
Resources
•Tangible accumulating and learning
•Intangible how to deploy different
resources and capabilities.
© 2007 Thomson/South-Western. All rights reserved. 3–22
Resources, Capabilities and Core Competencies
• Core Competencies
Discovering Core  Activities that a firm performs
Competencies
especially well compared to
competitors.
Core  Activities through which the firm
Competencies adds unique value to its goods
or services over a long period of
Capabilities time.

Resources
•Tangible
•Intangible

© 2007 Thomson/South-Western. All rights reserved. 3–23

Building Core Competencies
• Four Criteria of
Discovering Core Sustainable Competitive
Competencies Advantage
 Valuable capabilities
Four Criteria of
Sustainable  Rare capabilities
Advantages
 Costly to imitate
 Nonsubstituable
• Valuable
• Rare
• Costly to imitate
• Nonsubstitutable

© 2007 Thomson/South-Western. All rights reserved. 3–24

TABLE 3.4 The Four Criteria of Sustainable Competitive Advantage

Valuable Capabilities • Help a firm neutralize threats or

exploit opportunities
Rare Capabilities • Are not possessed by many
others
Costly-to-Imitate Capabilities • Historical: A unique and a
valuable organizational culture or
brand name
• Ambiguous cause: The causes
and uses of a competence are
unclear
• Social complexity:
Interpersonal relationships, trust,
and friendship among managers,
suppliers, and customers
Nonsubstitutable Capabilities
© 2007 Thomson/South-Western. All rights reserved. • No strategic equivalent 3–25
Building Sustainable Competitive Advantage
• Valuable capabilities
Discovering Core  Help a firm neutralize
Competencies threats or exploit
opportunities.
Four Criteria of • Rare capabilities
Sustainable  Are not possessed by
Advantages
many others.

• Valuable
• Rare
• Costly to imitate
• Nonsubstitutable

© 2007 Thomson/South-Western. All rights reserved. 3–26

Building Sustainable Competitive Advantage
• Costly-to-Imitate Capabilities
Discovering Core  Historical
Competencies • A unique and a valuable
organizational culture or brand
name
Four Criteria of  Ambiguous cause
Sustainable
• The causes and uses of a
Advantages
competence are unclear
 Social complexity
• Valuable • Interpersonal relationships,
• Rare trust, and friendship among
• Costly to Imitate managers, suppliers, and
• Nonsubstitutable
customers

© 2007 Thomson/South-Western. All rights reserved. 3–27

Building Sustainable Competitive Advantage
• Nonsubstitutable
Discovering Core Capabilities
Competencies
 No strategic equivalent
• Firm-specific knowledge
Four Criteria of • Organizational culture
Sustainable
Advantages • Superior execution of the
chosen business model

• Valuable
• Rare
• Costly to imitate
• Nonsubstitutable

© 2007 Thomson/South-Western. All rights reserved. 3–28

 Outcomes from Combinations
of the Four Criteria

?
?

le
te

b
ita

ta
Im

u
tit
?

to

bs
le

Competitive Performance
tly
ab

su
e?
os
lu

on
Consequences Implications
ar
Va

N
R

No No No No Competitive Below Average

Disadvantage Returns

Yes No No Yes/ Competitive Average Returns

No Parity

Yes Yes No Yes/ Temporary Com- Above Average to

No petitive Advantage Average Returns

Yes Yes Yes Yes Sustainable Com- Above Average

petitive Advantage Returns

© 2007 Thomson/South-Western. All rights reserved. 3–29

Table 3.5 Outcomes from Combinations of the Criteria for
Sustainable Competitive Advantage

© 2007 Thomson/South-Western. All rights reserved. 3–30

Value Chain Analysis
• Allows the firm to understand the parts of its
operations that create value and those that do
not.
• A template that firms use to:
 Understand their cost position.
 Identify multiple means that might be used to facilitate
implementation of a chosen business-level strategy.

© 2007 Thomson/South-Western. All rights reserved. 3–31

Value Chain Analysis (cont’d)
• Primary activities involved with:
 A product’s physical creation
 A product’s sale and distribution to buyers
 The product’s service after the sale

• Support Activities
 Provide the assistance necessary for the primary
activities to take place.

© 2007 Thomson/South-Western. All rights reserved. 3–32

Value Chain Analysis (cont’d)
• Value Chain
 Shows how a product moves from the raw-material
stage to the final customer.
• To be a source of competitive advantage, a
resource or capability must allow the firm:
 To perform an activity in a manner that is superior to
the way competitors perform it, or
 To perform a value-creating activity that competitors
cannot complete

© 2007 Thomson/South-Western. All rights reserved. 3–33

 FIGURE 3.3

The Basic Value

Chain

© 2007 Thomson/South-Western. All rights reserved. 3–34

Table 3.6 Examining the Value-Creating Potential of Primary Activities

Inbound Logistics
Activities, such as materials handling, warehousing, and inventory control, used to receive, store, and
disseminate inputs to a product.
Operations
Activities necessary to convert the inputs provided by inbound logistics into final product form.
Machining, packaging, assembly, and equipment maintenance are examples of operations activities.
Outbound Logistics
Activities involved with collecting, storing, and physically distributing the final product to customers.
Examples of these activities include finished goods warehousing, materials handling, and order
processing.
Marketing and Sales
Activities completed to provide means through which customers can purchase products and to induce
them to do so. To effectively market and sell products, firms develop advertising and promotional
campaigns, select appropriate distribution channels, and select, develop, and support their sales force.
Service
Activities designed to enhance or maintain a product’s value. Firms engage in a range of service-
related activities, including installation, repair, training, and adjustment.
Each activity should be examined relative to competitors’ abilities. Accordingly, firms rate each
activity as superior, equivalent, or inferior.

Source: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive
Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, pp. 39–40, Copyright © 1985, 1998 by Michael E. Porter.
© 2007 Thomson/South-Western. All rights reserved. 3–35
Table 3.7 Examining the Value-Creating Potential of Support Activities

Procurement
Activities completed to purchase the inputs needed to produce a firm’s products. Purchased inputs include
items fully consumed during the manufacture of products (e.g., raw materials and supplies, as well as
fixed assets—machinery, laboratory equipment, office equipment, and buildings).
Technological Development
Activities completed to improve a firm’s product and the processes used to manufacture it. Technological
development takes many forms, such as process equipment, basic research and product design, and
servicing procedures.
Human Resource Management
Activities involved with recruiting, hiring, training, developing, and compensating all personnel.
Firm Infrastructure
Firm infrastructure includes activities such as general management, planning, finance, accounting, legal
support, and governmental relations that are required to support the work of the entire value chain.
Through its infrastructure, the firm strives to effectively and consistently identify external opportunities and
threats, identify resources and capabilities, and support core competencies.

Each activity should be examined relative to competitors’ abilities. Accordingly, firms rate each
activity as superior, equivalent, or inferior.

Source: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive
Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, pp. 40–43, Copyright © 1985, 1998 by Michael E.
Porter.
© 2007 Thomson/South-Western. All rights reserved. 3–36
The Value-Creating Potential of Primary
Activities
• Inbound Logistics
 Activities used to receive, store, and disseminate
inputs to a product
• Operations
 Activities necessary to convert the inputs provided by
inbound logistics into final product form
• Outbound Logistics
 Activities involved with collecting, storing, and
physically distributing the product to customers

© 2007 Thomson/South-Western. All rights reserved. 3–37

The Value-Creating Potential of Primary
Activities (cont’d)
• Marketing and Sales
 Activities completed to provide the means through
which customers can purchase products and to
induce them to do so.
• Service
 Activities designed to enhance or maintain a product’s
value
• Each activity should be examined relative to competitor’s
abilities and rated as superior, equivalent or inferior.

© 2007 Thomson/South-Western. All rights reserved. 3–38

The Value-Creating Potential of Primary
Activities: Support
• Procurement
 Activities completed to purchase the inputs needed to
produce a firm’s products.
• Technological Development
 Activities completed to improve a firm’s product and
the processes used to manufacture it.
• Human Resource Management
 Activities involved with recruiting, hiring, training,
developing, and compensating all personnel.

© 2007 Thomson/South-Western. All rights reserved. 3–39

The Value-Creating Potential of Primary
Activities: Support (cont’d)
• Firm Infrastructure
 Activities that support the work of the entire value chain
(general management, planning, finance, accounting,
legal, government relations, etc.)
• Effectively and consistently identify external
opportunities and threats
• Identify resources and capabilities
• Support core competencies
 Each activity should be examined relative to
competitor’s abilities and rated as superior, equivalent
or inferior.

© 2007 Thomson/South-Western. All rights reserved. 3–40

 Figure 3.4

Prominent
Applications of
the Internet in
the Value Chain

Source: Reprinted by permission

of Harvard Business Review from
“Strategy and the Internet” by
Michael E. Porter, March 2001,
p. 75. Copyright © 2001 by the
Harvard Business School
Publishing Corporation; all rights
reserved.

© 2007 Thomson/South-Western. All rights reserved. 3–41

Outsourcing
• The purchase of a value-creating activity from an
external supplier
 Few organizations possess the resources and
capabilities required to achieve competitive superiority
in all primary and support activities.
• By performing fewer capabilities:
 A firm can concentrate on those areas in which it can
create value.
 Specialty suppliers can perform outsourced
capabilities more efficiently.

© 2007 Thomson/South-Western. All rights reserved. 3–42

Outsourcing Decisions
A firm may outsource
all or only part of one
M
or more primary and/or g in ar
gi
ar n
support activities. M

Technological Development
Human Resource Mgmt.
Service
Support Activities

Firm Infrastructure
Marketing and Sales

Procurement
Outbound Logistics

Operations

Inbound Logistics

Primary Activities
© 2007 Thomson/South-Western. All rights reserved. 3–43
Strategic Rationales for Outsourcing
• Improving business focus
 Helps a company focus on broader business issues
by having outside experts handle various operational
details.
• Providing access to world-class capabilities
 The specialized resources of outsourcing providers
makes world-class capabilities available to firms in a
wide range of applications.

© 2007 Thomson/South-Western. All rights reserved. 3–44

Strategic Rationales for Outsourcing (cont’d)
• Accelerating re-engineering benefits
 Achieves re-engineering benefits more quickly by
having outsiders—who have already achieved world-
class standards—take over process.
• Sharing risks
 Reduces investment requirements and makes firm
more flexible, dynamic and better able to adapt to
changing opportunities.
• Freeing resources for other purposes
 Redirects efforts from non-core activities toward those
that serve customers more effectively.

© 2007 Thomson/South-Western. All rights reserved. 3–45

Outsourcing Issues
• Seeking greatest value
 Outsource only to firms possessing a core
competence in terms of performing the primary or
supporting the outsourced activity.
• Evaluating resources and capabilities
Do not outsource activities in which the firm itself
can create and capture value.
• Environmental threats and ongoing tasks
Do not outsource primary and support activities that
are used to neutralize environmental threats or to
complete necessary ongoing organizational tasks.

© 2007 Thomson/South-Western. All rights reserved. 3–46

Outsourcing Issues (cont’d)
• Nonstrategic team resources
Do not outsource capabilities critical to the firm’s
success, even though the capabilities are not actual
sources of competitive advantage.
• Firm’s knowledge base
Do not outsource activities that stimulate the
development of new capabilities and competencies.

© 2007 Thomson/South-Western. All rights reserved. 3–47

Cautions and Reminders
• Never take for granted that core competencies will
continue to provide a source of competitive advantage.
• All core competencies have the potential to become core
rigidities—former core competencies that now generate
inertia and stifle innovation.
• Determining what the firm can do through continuous and
effective analyses of its internal environment will increase
the likelihood of long-term competitive success.

© 2007 Thomson/South-Western. All rights reserved. 3–48