“Save for a few additions, these lecture notes are entirely based on Ehlers & Lazenby (2010:109-133)

Learning Outcomes
After completing this study unit you should be able to:
 Discuss the importance and challenges of internal environment analysis
 Apply SWOT analysis and explain its importance in environment analysis
 Identify all the important resources and capabilities in an organisation and discuss their
importance in the resource-based view with regard to internal environmental analysis
 Describe value chain analysis as a method for performing internal environmental analysis
 Apply the functional approach in internal factor evaluation matrix as a method of doing an
internal audit

Introduction
Organizations try to build their capacity as a source of competitive advantage through their
resources and capabilities. This is done through identifying and evaluating their strengths and
weaknesses. A key ingredient of a successful strategy is that it should place realistic requirements
on the organization’s resources. SWOT analysis, the resource-based view, value chain analysis,
functional approach and the internal factor evaluation matrix will be discussed.

The importance and challenge of internal analysis

An organization cannot decide on a specific strategic direction to follow if it does not know what
it can and cannot do, and what assets it has and does not have. When an organization is able to
match what it can do-with what it might do, this allows it to develop its vision or strategic intent,
pursue its strategic mission and select and implement its strategies. There is a link between the
organization’s visions and the internal environment. Even if the results of an internal assessment
are favourable, if there is no challenging and exciting vision the organisation will not achieve
strategic excellence. The outcome of an internal analysis will determine what an organization

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 can do, while the outcome of external environmental analysis will identify what it may choose to
do.

In the past, factors such as low labor costs, access to financial resources were regarded as the
only sources of competitive advantage. This is no longer the case. It is now important for
organizations to develop the ability to change and, and to foster an organizational setting in which
continuous organizational learning is expected and promoted, so that they are able to make the
most effective strategic decisions.. In order to devise the most appropriate strategy, organization
should know what they can do well and what resources it has. It is not only the organisations’s
ability to change that will make it successful, it is also critical that managers should view the
organization as a bundle of resources, capabilities and core competencies that can be used to
create an exclusive position in the market. This implies that the organisation has some resources
and capabilities that other organizations do not have. The presence of these resources and
capabilities leads to strategic competitiveness when an organisation is able to use them to satisfy
the demands of its external environment

The process of identifying, developing and deploying resources, capabilities and core
competencies is difficult and challenging. The recognition of core competencies is essential
before any strategic management decision can be taken. Some managers may select, as the
organization’s core competencies, resources and capabilities that do not really create
competitive advantage. This stresses the importance of the challenge of identifying the resources
and capabilities that really contribute to the competitive advantage of the organisation.

1. SWOT ANALYSIS
SWOT is an acronym for strengths, weaknesses, opportunities and threats, and provides a
framework for analyzing these elements in the organization’s external and internal environment.
It is one of the best known techniques for doing an environmental analysis. SWOT analysis
highlights the specific conditions in the oganisation’s environment for environmental analysis.
Environmental analysis is about the internal and external assessment of the organisation – what
the organisation has or does not have in terms of resources and capabilities, and what is
happening in the external environment. The success of a new strategy for the organization
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 depends on the strategic fit between the internal and the external conditions. The objective of a
good strategy is to increase the strengths and optimize the opportunities, and to decrease the
influence of internal weaknesses and external threats.

What is strength?
It is a resource or a capability that the organization has which is an advantage relative to what
competitors have. A resource or capability can only be strength if it offers a distinctive
competence that gives the organization a competitive advantage. There may however, be other
resources and capabilities that do not necessarily give the organization a competitive advantage
but contribute to its sustainability, and should therefore be nurtured and reinforced.
Examples of Strengths - Skilful employees, large financial reserves, a quality product or service,
strong reputation, economies of scale.

What is a weakness?
It refers to the lack or deficiency of a resource that represents a relative disadvantage to an
organization in comparison to what competitors have. These deficiencies prevent the organization
from developing a competitive position in the market (industry).
Examples of Weaknesses – Limited financial resources, poor marketing skills, poor after-sales
service, negative organizational culture etc

What is an opportunity?
This term refers to a favorable situation in the organization’s external environment (market &
macro). A decrease in interest rate can be seen as an opportunity for an organisation that still has
a loan obligation.

What is a threat?
This is an unfavorable situation in the organization’s external environment. An organisation does
not have any control over what is happening in the external environment, but, for instance, an
increase in the interest rate is a major threat for the cash flow of an organisation with a big loan.
Although managers rely on SWOT analysis to stimulate discussions on how to improve their
organizations and position them for success, it has its limitations.
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 Limitations of SWOT analysis
 SWOT analysis cannot show the organisation how to achieve competitive advantage. More
in-depth analysis is needed.
 The SWOT analysis is a static approach and is also sometimes focused on only a single
dimension. The focus on external environment may be too narrow.
 It is perhaps a static assessment - a one-shot view of a moving target.
 The strengths that are identified may not necessarily lead to an advantage.
 It may lead to overemphasis of a single feature or strength and disregard other important
factors that may lead to competitive success.

INTERNAL ANALYSIS FOR EFFECTIVE STRATEGY DEVELOPMENT

In order to develop the most effective and efficient strategy, it is important to analyse the
organizations internally, that is to look more closely at the organisation’s resources, capabilities
and core competencies, in order to gain an informed understanding of its current situation. The
following methods are used for conducting an internal analysis.

INTERNAL ENVIRONMENTAL
ANALYSIS TECHNIQUES

RESOURCE
BASED VIEW
 Tangible Resources VALUE CHAIN
 Intangible Resources
ANALYSIS
 Organisational Capabilities
 Primary Activities
 Secondary Activities FUNCTIONAL
APPROACH
INTERNAL FACTOR
EVALUATION MATRIX

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 2. THE RESOURCE BASED VIEW
Resources, capabilities and competencies are the foundation characteristics that make up the
Competitive Advantage of an organisation. Organisational resources have an impact on the
management capabilities of the organization, which in turn are the sources of core competencies
that may ultimately lead to a competitive advantage.

Basic Assumptions of the Resource Based View

1. An organization’s resources are more important than the industry structure in achieving and
keeping its competitive advantage.
2. Organizations are different in terms of their collections of assets and organizational
capabilities - no two organizations are similar, because they have different experiences,
different assets and capabilities and different organizational cultures.
3. It is resources and capabilities that will determine how efficiently and effectively the
organisation is functioning.
4. The main concerns for competitive advantage are organizational resources and capabilities
5. It is important for resources & capabilities to be unique and distinctive and capable of leading
to a sustainable advantage. They must be difficult to create, buy, replace or imitate – they
must have the quality of inimitability.
6. There are three types of resources that will lead to distinctive competencies and therefore to
competitive advantage as follows:

Types of Resources
Resources include all the financial, physical, human and intangible assets that are used by an
organization to develop, manufacture and deliver products to customers. These include:
1. Tangible assets
2. Intangible assets
3. Organizational capabilities

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 Resource Examples Indicator
Tangible resources  What is the organization’s financial situation - its cash  Cash flow
include reserves?  Profitability
 Financial,  What physical resources does the organization have - perhaps  Solvency
 Physical & an excellent location, technically advanced equipment,  Liquidity
 Technological reserves of raw materials?  Market value of assets
resources  Stock of technology such as trademarks and copyrights? For  Capital equipment
example Coca-Cola's formula or KFC’s recipe
Intangible resources  Intellectual property,  Patents and copyrights
include  Knowledge & skills of employees, reputation with customers,  Brand recognition
 Human  Brand names and  Corporate reputation
 Innovation &  Perception of product/service quality and delivery, for Brand equity
 Reputation example Coke's brand name & Pick n Pay’s reputation
resources
1. Tangible assets – are easy to identify because an organisation’s location and the status of its
building and equipment are visible. The value of many tangible resources can be determined
by looking at the financial statements, especially the balance sheet. It is, however, important
to remember that these statements do not account for the real value of the assets, because they
do not reflect market value. A good location is a tangible asset or resource, but the real value
is only visible if an organisation is successful at that location.
2. Intangible assets – Are assets that one cannot touch, but they are often the critical assets that
create the real competitive advantage. Intangible resources are a superior and more potent
source of core competencies. The advantage of intangible assets is that they are less visible
and thus more difficult for competitors to understand, purchase, imitate or replace. This is the
reason why organizations rely more on intangible resources for creating core competencies
and competitive advantage. The reputation and brand name of Coca-Cola is the reason why it
has a competitive advantage over Pepsi.
3. Capabilities – These are the complex network of processes and skills that determine how
efficiently and effectively the inputs will be transformed into outputs. Strategic success is
only possible if the organisation has the necessary capabilities in place. By themselves
resources are not productive – they must be processed or use in some way to draw the value
out of them. for example – Coke’s formula is not valuable unless someone knows how to use
it and produce coke. The foundation of many organizations’ capabilities therefore lies in the
skills and knowledge of the employees and their functional expertise. The essence of

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 capabilities is the human capital of the organisation. As employees do their work, combining
the tangible and intangible resources within the structure of the organizational processes, they
actually accumulate knowledge and experience about how to create value from the resources
for the organization and turn them into possible core competencies or distinctive
organizational capabilities. This is why organizations should invest in their employees’
continuous development. Knowledge of the employees also known as human capital is one
of the most significant capabilities of the organisation and may contribute, together with
resources, to competitive advantage. The organization should create an organizational
environment that allows employees to fit all their knowledge together to the advantage of the
organization.
The majority of capabilities are developed in specific functional areas – for example –
motivation & empowerment skills in the HR, effective promotion of brand names & customer
service in Marketing Dept, Product and design quality in the Production Dept etc. Organisational
capabilities must also be developed at top management level
Considering that organizations are confronted with a dynamic and complex environment and
therefore the competencies that are capable of leading the organisation to a competitive position
today may not continue to do so as conditions and competitors change. It is thus better to think in
terms of dynamic capabilities.
Dynamic capabilities – refers to the organization’s ability to build, integrate and restructure
capabilities to address the rapidly changing environment. To be a successful organization requires
demonstrating timely responsiveness, rapid and flexible product innovation and also management
expertise in coordinating and deploying organizational resources and capabilities.
For a resource and capability to become real sources of competitive advantage, they must be truly
distinctive and also contribute to the development of the organization’s core competencies.
Distinctive capabilities are special and unique that distinguishes an organization from its
competitors. It is so important to identify, develop and leverage them.
"What are the distinguishing aspects between capabilities and core competencies? Core
competencies are only possessed by those organizations whose performance is superior to the
industry average. They make a significant contribution to the perceived benefits of the product
and are difficult for competitors to imitate. They also add greater value than general
competencies or capabilities, and are based on superior organizational skills and knowledge. For
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 example – BMW has core competencies in design and engine technology which are the
company’s reputation for high quality and high performance cars.

According to the RBV It is important for resources & capabilities to be unique and distinctive
and capable of leading to a sustainable advantage. They must be difficult to create, buy, replace
or imitate – they must have the quality of inimitability. If competitors can copy a specific
resource, then there is no way that an organization can develop a sustainable competitive
advantage. A resource should be of real value for it to be able to add to the competitive advantage

Characteristics/Guidelines that make a resource valuable

Characteristics
Description
(Guidelines)
An organizational resource is valuable if it adds value
A resources is valuable if it helps the organization to exploit the external
Value opportunities or if it can be used to cope with and neutralize negative external threats.
Skilled employees are an example of organizational resources that fulfils both these
requirements.
If the resource is superior to those of the competitor, and if it fulfils a customer’s need
better, then the resource is superior and valuable
Superior For example– Two equally sized supermarkets offer the same range of products &
resources
pricing structure but is more successful than the other because of its convenience in
location
If a resource is in short supply and ideally no other organization possesses it, then it
Scarcity becomes a distinctive competence for the organization. The resource should also be
sustainable and valuable through fulfilling the needs of customers.
If the resource is hard to imitate, it is likely to be a long term competitive advantage
for the organisation. Hard to imitate resources generate revenues that will probably
continue to flow in. Imitation by competitors can happen in at least two ways:
duplication & substitution. Duplicating a resource is where the same kind of resource
Inimitability is built, whereas Substitution of a resource involves replacing it with an alternative
resource that achieves the same results.
Difficult to imitate resources include, for example, reputation/goodwill, a good
location, a patented product & organizational culture. KFC’s difficult to imitate
recipe is a good example
Capacity to If an organization does not have the capacity or ability to exploit the resource, then
Exploit the the resource cannot create a competitive advantage. Some resources may need large
Resource capital investments to be exploited. This will enhance the inimitability of a resource.

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 The characteristics mentioned above are important indicators of the changes of a specific
resource to be a source of competitive advantage. The unique resources identified through the
RBV must be sustainable in order to give a sustainable competitive advantage to an organization.

3. VALUE CHAIN ANALYSIS

The assumption behind the value chain is that customer wants and actually demands value when
they buy products. Every organization has a chain of activities through which the inputs are
transformed into the outputs. When the value chain is examined as a method of internal analysis,
the chain of activities is looked at to determine where value is really added to the product or
service. Value added to a product or service is the difference in the monetary value of the
finished product.

The following are the three aspects of resources that create value for customers.
1. The product is unique and or different (differentiation).
2. The product is cheaper than that of competitors( low cost)
3. The organization has the ability to respond to the customer's needs very quickly.

Value chain analysis (VCA) is a systematic method of determining how the organization’s
various activities contribute to creating value for the customer. This means that VCA views the
organization as a sequential process which includes all the value-creating activities in the
organization. The VCA views the organisation as a sequential process which includes all the
value creating activities in the organisation.

Value chain analysis helps to identify where the most value is added especially where the is
potential to add more value. In an analysis of the chain of activities, one can identify where the
organisation is doing things well and really adding value for the customer (this will be its
strengths) and where there is potential for improvement (perhaps weaknesses). If an activity is to
be regarded as a source of competitive advantage, the organisation must be able to perform that
activity in a manner that is superior to the way in which competitors are performing it (then it is a
strength) and in such a way that it is difficult to competitors to imitate.

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 Value added to a product is the difference in the monetary value of the finished product compared
to the inputs. Value is the amount of money that customers are willing to pay for what the
organization is providing them. The more value they perceive that they are receiving, the higher
the amount they are willing to pay. In competitive terms, then, it can be said that an organisation
is more profitable if this amount exceeds the total costs involved in creating the product or
service. Organisations will only receive high returns if it is successful in creating value. The
activities of the VCA are the building blocks of competitive advantage.

Value Chain Activities

The activities in VCA are grouped into two categories namely primary and secondary activities.
The activities in VCA can be grouped into two categories, namely primary activities and support
activities. Primary activities are those that create the physical product and customer value,
whereas the support activities provide support and thus add value throughout the process.
Activity Type Description
Is associated with the receiving, storing and distributing of inputs to the
Input product. Is there a materials control system? How, effectively and efficiently,
Logistics are the raw materials handled and warehoused?

Includes all those activities associated with the transformation of the inputs
into the final product; Questions to answer in this regard are: How efficient is
Operations the layout of the manufacturing plant? Is a production control system in place
and how effective and efficient is it? What is the level of automation?
Refers to all the issues related to the distribution of the product to the
Primary Activities

Output customers. How effectively and efficiently are products and services delivered
Logistics to customers? How effectively & efficiently are the finished products handles
in and warehoused?
Refers to the methods used to persuade customers to make the purchases.
What is the level of marketing and competency in terms of sales? Is the
marketing research effective in identifying customer’s needs? What is the
Marketing situation regarding and effectiveness of the marketing strategy in terms of the
four Ps? How successful is the organization in creating brand loyalty to the
customers?
These are activities that the organization must undertake to make sure that the
value of the product is maintained, such as installation, repair, training and the
Customer supply of parts and perhaps product adjustment. How effective and efficient
Service are the customer services that the organisation provides? What guarantees
and warrantee are offered to the customers? Does the organisation listen to
customers’ complaints and the act on them?
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 This activity refers to the function of purchasing inputs. There is an
overlap between this activity and the primary activity known as input
logistics. However, this support activity refers to the actions that can be
Procurement taken to optimize the quality and speed of the procurement of inputs, and
not to the inputs themselves. Are the resources procured at the lowest
possible cost and acceptable quality levels? Are sound relationships being
established with suppliers?
Technology is important for all activities and includes the different
processes and equipment used throughout the entire value chain. What is
Technological the level and quality of technological development? To what extent can the
Development
technological activities meet the critical deadlines? Does the organisation
Secondary Activities

have a culture of enhancing creativity and innovation?

This activity affects all levels of the organisation. The aspects that are
Human important for this activity include the following: How effective are the
Resources human resources management procedures? What is the level of employee
Management
motivation? What can be done to ensure a quality working environment?
It is important for the organization to achieve its overall goals. That is why
there must be a general administration and organizational infrastructure in
General place. The issues that should be addressed are: Are all the value chain
Administration activities coordinated and integrated throughout the organizational value
&
chain? What are the relationships with all the stakeholders of the
Infrastructure
organisation? What systems are in place to ensure a good public image
and reputation?
Sound financial practices should be in place throughout the value chain. All
activities must adhere to effective financial recording and control. The
Financial issues that should be addressed are: Are all the value activities recorded
Management according to sound financial principles as described in GAAP (Generally
Accepted Accounting Practices)? What systems are in place to ensure
effective financial recording?
If there are no efficient management systems in place in all the activities in the value chain, an
organization will experience problems such as inventory shortages, ineffective marketing and sales, slow
responsive to competitor’s actions and perhaps also inefficiency in its operations. All these activities are
important and if these activities are viewed as part of an interconnected process it will be possible to
optimize value and profit. Value chain activities should support the current strategy of the organization. If
the organization is following a low- cost strategy, then the activities in the value chain must be organized
to support the strategy of minimizing costs. If the strategy is based on high quality, then all activities must
be configured to ensure the high quality of products or services.

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 4. FUNCTIONAL APPROACH
Internal environmental analysis can be done through conducting an internal audit using a
functional approach. Internal audit can be done by analyzing the organizations functional
activities such marketing, production, Human Resources management etc. The premise of the
internal audit is that it can be conducted by analyzing the organisation’s functional activities. The
premise of the internal audit is that every organisation has specific functions that it must perform.
Therefore an internal audit can be regarded as an assessment of the various functional areas of the
organisation. The major objective of the internal audit is to determine how well or poorly these
functions are being performed and what resources these functional areas actually need to perform
effectively. The disadvantage of this approach is, however, that the attention is focused entirely
on the functional areas, while there is no determination of whether a specific functional area
makes an important contribution to the organisation’s competitive advantage.
Examples of Internal Audit Question Regarding Functional Areas
 What is the organization’s position with regard to profitability?
Financing &


Accounting

What is the organization’s position with regard to its solvency?

 What is the organization’s position with regard to its liquidity?
 What is the organization’s position with regard to its cash flow situation?
 What is the organization’s position with regard to its working capital position?
 Is the organization able to raise long-term and short-term capital?
 What is the organization’s position with regard to its overall marketing strategy?
 What is the organization’s position with regard to its pricing strategy?
Marketing

 What is the organization’s position with regard to its promotion strategy?

 What is the organization’s position with regard to its distribution strategy?
 What is the organization’s position with regard to new products & services?
 What is the organization’s position with regard to its marketing, planning and control techniques and tools?
 What is the organization’s position with regard to its facilities, offices, machinery and equipment?
 What is the organization’s position with regard to its quality assessment of products?
Production

 What is the organization’s position with regard to effective and efficient inventory control policies and procedures?
 What are the specific competencies in the area of production?
 What is the organization’s position with regard to its production capacity?

 What is the organization’s position with regard to its research and development facilities?
Development
Research &

 What is the organization’s position with regard to its culture of creativity and innovativeness?
 What is the organization’s position with regard to its inclination towards new products?
 What is the organization’s position with regard to the appropriateness of research and development tools and
techniques?
 What is the organization’s position with regard to the competency levels of its employees?
Resource
Human

 What is the organization’s position with regard to its overall human resources management (recruitment, selection,
training, etc.) procedures and policies?
 What is the organization’s position with regard to the morale of its employees?
 What is the organization’s position with regard to the level of employee turnover?
What is the organization’s position with regard to applying self-managing work teams?

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 The Internal Factor Evaluation Matrix
A method that can be used to conduct an internal audit is through the construction of an Internal
Factor Evaluation Matrix (IFE Matrix). This evaluates the major strengths and weaknesses in the
different functional areas. It could also be regarded as a summary of the internal factors identified
in previous internal analysis methods. The answers to the questions asked in the table above will
provide the starting point for this matrix. It is far more important to understand why the internal
factor is selected as strengths and weaknesses than to rely solely on the actual number that is
arrived at.

Steps used to complete the summary of the internal audit in the IFE Matrix:
The following five steps are used to complete the summary of the internal audit in the IFE
Matrix:
1. List the 10 to 15 most important internal factors that are identified in the internal audit. The
factors are both strengths & weaknesses. These factors can be listed in the first column of the
table below - first the strengths and then the weaknesses.
2. In the next column a weight can be assigned to a given factor that will indicate the relative
importance of the factor in terms of the success of the organization in its specific industry.
The higher the weight, the more important the factor is for the current and future success of
the organisation. The sum of the weights must always be equal to 1,00. If the factor is not
important, it will receive a low weight, e.g. 0,10. If it is an important factor that may
contribute, for example, to 80 percent of the current and future success of the organization, it
will receive a weight of 0,80.
3. In the third column a rating out of 5 can be used to rate these factors. These ratings are based
on the company's response to that specific factor. If the factor is an outstanding strength it
will receive a 5, above, average a 4 and average a 3. If the factor is a major weakness, it will
receive a 1 and if it is a minor weakness it will receive a 2.
4. In the last column the weight is multiplied by the rating of the factor to get the weighted
score. The sum of these scores will range from 5,00 (outstanding) to 1,00 (poor), with 3,00 as
the average.
5. Sometimes it can be useful to include some comments in an additional column for a better
understanding of the selected factors.
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 Internal factor Weight Rating Score
Internal strengths
Professional team 5
0.15 0.75
Integrity of personnel 4
0.10 0.40
Hardworking personnel 5
0.10 0.50
Good reputation 4
0.15 0.60
Excellent administrative systems 4
0.15 0.20

Internal Weaknesses
No transformation 0.05 1 0.05
Overloading personnel 0.10 1 0.10
No motivation of personnel 0.05 2 0.10
Poor marketing 0.10 3 0.30
Shortage of personnel 0.05 1 0.05
1.0 3.05

The important principle to remember is that the weights must always add up to a total of 1,00. As
already indicated, the average score is 3,00. When an organization scores higher than 3,00, it
means that it is above average in its overall internal analysis in relation to other organizations in
that specific industry. If an internal factor is both strength and a weakness, it must be included
twice in the matrix. The total weighted score of 3,05 indicates that the firm is above average
(above 3,00) in its overall internal strength. This matrix can also be used to com- are
organizations with one another. This makes comparison more meaningful and relevant. All the
information provided through this evaluation matrix will help the organization to develop more
effective and relevant strategies.

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