MODULE 3

Strategic Management

SESSION TOPIC 3: Internal Analysis

LEARNING OUTCOMES:
The following specific learning objectives are expected to be realized at the end of the session:
1. To discuss the source of competitive advantage
2. To explain the concept of the value chain

KEY POINTS

Distinctive Value chain

competencies

CORE CONTENT
Introduction:
This module focuses on internal analysis, which is concerned with identifying the strengths and weaknesses of
the company. Internal analysis, coupled with an analysis of the company’s external environment, gives managers the
information they need to choose the strategy and business model that will enable their company to attain a sustained
competitive advantage and threats.

THE ROOTS OF COMPETITIVE ADVANTAGE

The primary objective of strategy is to achieve a sustained competitive advantage, which in turn will result in superior
profitability and profit growth. What are the sources of competitive advantage?

Distinctive Competencies
Competitive advantage is based upon distinctive competencies. Distinctive competencies are firm-specific strengths that
allow a company to differentiate its products from those offered by rivals, and/or achieve substantially lower costs than its
rivals. Distinctive competencies arise from two complementary sources: resources and capabilities.

 Resources Resources refer to the assets of a company. A company’s resources can be divided into two types:
tangible and intangible resources. Tangible resources are physical entities, such as land, buildings,
manufacturing plants, equipment, inventory, and money. Intangible resources are nonphysical entities that are
created by managers and other employees, such as brand names, the reputation of the company, the knowledge
that employees have gained through experience, and the intellectual property of the company, including patents,
copyrights, and trademarks. Resources are particularly valuable when they enable a company to create strong
demand for its products, and/or to lower its costs. Valuable resources are more likely to lead to a sustainable
competitive advantage if they are rare, in the sense that competitors do not possess them, and difficult for rivals
to imitate; that is, if there are barriers to imitation. For example, the software code underlying Windows is rare
because only Microsoft has full access to it. The code is also difficult to imitate. A rival cannot simply copy the
software code underlying Windows and sell a repackaged version of Windows because copyright law protects the
code, and reproducing it is illegal
 Capabilities Capabilities refer to a company’s resource-coordinating skills and productive use. These skills reside
in an organization’s rules, routines, and procedures, that is, the style or manner through which it makes decisions
and manages its internal processes to achieve organizational objectives. More generally, a company’s capabilities
are the product of its organizational structure, processes, control systems, and hiring strategy. They specify how
and where decisions are made within a company, the kind of behaviors the company rewards, and the company’s
cultural norms and values. Capabilities are intangible. They reside not in individuals, but in the way individuals
interact, cooperate, and make decisions within the context of an organization.

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Distinctive competencies shape the strategies that the company pursues, which lead to competitive advantage and
superior profitability. However, it is also very important to realize that the strategies a company adopts can build new
resources and capabilities or strengthen the existing resources and capabilities of the company, thereby enhancing the
distinctive competencies of the enterprise. Thus, the relationship between distinctive competencies and strategies is not a
linear one; rather, it is a reciprocal one in which distinctive competencies shape strategies, and strategies help to build
and create distinctive competencies

THE VALUE CHAIN

All of the functions of a company—such as production, marketing, product development, service, information
systems, materials management, and human resources—have a role in lowering the cost structure and increasing the
perceived value of products through differentiation. The term value chain refers to the idea that a company is a chain of
activities that transforms inputs into outputs that customers value. The transformation process involves both primary
activities and support activities that add value to the product.

PRIMARY ACTIVITIES
Primary activities include the design, creation, and delivery of the product, the product’s marketing, and its support and
after-sales service. The primary activities are broken down into four functions: research and development, production,
marketing and sales, and customer service.

Research and Development Research and development (R&D)

refers to the design of products and production processes. Although
we think of R&D as being associated with the design of physical
products and production processes in manufacturing enterprises,
many service companies also undertake R&D. For example, banks
compete with each other by developing new financial products and
new ways of delivering those products to customers. Online banking
and smart debit cards are two examples of the fruits of new product
development in the banking industry. Earlier examples of innovation
in the banking industry included ATM machines, credit cards, and
debit cards. By creating superior product design, R&D can increase

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the functionality of products, making them more attractive to customers, and thereby adding value. R&D function can help
to lower costs or raise the utility of a product and permit a company to charge higher prices.

Production Production refers to the creation process of a good or service. For physical products, this generally means
manufacturing. For services such as banking or retail operations, “production” typically takes place while the service is
delivered to the customer, as when a bank makes a loan to a customer. By performing its activities efficiently, the
production function of a company helps to lower its cost structure. For example, the efficient production operations of
Honda and Toyota help those automobile companies achieve higher profitability relative to competitors such as General
Motors. The production function can also perform its activities in a way that is consistent with high product quality, which
leads to differentiation (and higher value) and lower costs.
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Marketing and Sales There are
several ways in which the marketing
and sales functions of a company can
help to create value. Through brand
positioning and advertising, the
marketing function can increase the
value that customers perceive to be
contained in a company’s product
(and thus the utility they attribute to
the product). Marketing and sales can
also create value by discovering
customer needs and communicating
them back to the R&D function of the
company, which can then design
products that better match those
needs.

Customer Service The role of the service function of an enterprise is to provide aftersales service and support. This
function can create superior utility by solving customer problems and supporting customers after they have purchased the
product.

SUPPORT ACTIVITIES
The support activities of the value chain provide inputs that allow the primary activities to take place. These activities are
broken down into four functions: materials management (or logistics), human resources, information systems, and
company infrastructure.

Materials Management (Logistics) The materials-management (or logistics) function controls the transmission of
physical materials through the value chain, from procurement through production and into distribution. The efficiency with
which this is carried out can significantly lower cost, thereby creating more profit.
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Human Resources There are numerous
ways in which the human resource
function can help an enterprise to create
more value. This function ensures that
the company has the right combination of
skilled people to perform its value
creation activities effectively. It is also the
job of the human resource function to
ensure that people are adequately
trained, motivated, and compensated to
perform their value creation tasks. If the
human resources are functioning well,

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employee productivity rises (which lowers costs) and customer service improves (which raises utility), thereby enabling
the company to create more value.

Information Systems Information systems are, primarily, the electronic systems for managing inventory, tracking sales,
pricing products, selling products, dealing with customer service inquiries, and so on. Information systems, when coupled
with the communications features of the Internet, are holding out the promise of being able to improve the efficiency and
effectiveness with which a company manages its other value creation activities.

Company Infrastructure Company infrastructure is the companywide context within which all the other value creation
activities take place: the organizational structure, control systems, and company culture. Because top management can
exert considerable influence upon shaping these aspects of a company, top management should also be viewed as part
of the infrastructure of a company. Indeed, through strong leadership, top management can shape the infrastructure of a
company and, through that, the performance of all other value creation activities that take place within it.

WHY COMPANIES FAIL

When a company loses its competitive advantage, its profitability falls. The company does not necessarily fail; it may just
have average or below-average profitability and can remain in this mode for a considerable time, although its resource
and capital base is shrinking. Failure implies something more drastic. A failing company is one whose profitability is
substantially lower than the average profitability of its competitors; it has lost the ability to attract and generate resources
and its profit margins and invested capital are rapidly shrinking.

There are three related reasons for failure: inertia, prior strategic commitments, and the Icarus paradox.
1. Inertia The inertia argument states that companies find it difficult to change their strategies and structures in order
to adapt to changing competitive conditions. One reason companies find it so difficult to adapt to new
environmental conditions is the role of capabilities in causing inertia. Organizational capabilities—the way a
company makes decisions and manages its processes—can be a source of competitive advantage, but they are
often difficult to change. Power struggles and the hierarchical resistance associated with trying to alter the way in
which an organization makes decisions and manages its process—that is, trying to change its capabilities—bring
on inertia. This is not to say that companies cannot change. However, those who feel threatened by change often
resist it; change in most cases is induced by a crisis.
2. Prior Strategic Commitments A company’s prior strategic commitments not only limit its ability to imitate rivals
but may also cause competitive disadvantage.
3. The Icarus Paradox Danny Miller has postulated that the roots of competitive failure can be found in what he
termed the “Icarus paradox.” Icarus is a figure in Greek mythology who used a pair of wings, made for him by his
father, to escape from an island where he was being held prisoner. He flew so well that he climbed higher and
higher, ever closer to the sun, until the heat of the sun melted the wax that held his wings together, and he
plunged to his death in the Aegean Sea. The paradox is that his greatest asset, his ability to fly, caused his
demise. Miller argues that the same paradox applies to many once-successful companies. According to Miller,
many companies become so dazzled by their early success that they believe more of the same type of effort is
the way to future success. As a result, they can become so specialized and myopic that they lose sight of market
realities and the fundamental requirements for achieving a competitive advantage. Sooner or later, this leads to
failure.

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IN-TEXT ACTIVITY
Distinctive competencies
Distinctive competence is a set of unique capabilities that certain firms possess allowing them to make inroads into
desired markets and to gain advantage over the competition; generally, it is an activity that a firm performs better than its
competition. To define a firm's distinctive competence, management must complete an assessment of both internal and
external corporate environments. When management finds an internal strength that both meets market needs and gives
the firm a comparative advantage in the marketplace, that strength is the firm's distinctive competence. Taking advantage
of an existing distinctive competence is essential to business strategy development.

Value chain
A value chain is used to describe all the business activities it takes to create a product from start to finish (e.g., design,
production, distribution, etc.)

SESSION SUMMARY
Distinctive competencies are the firm-specific strengths of a company. Valuable distinctive competencies enable a
company to earn a profit rate that is above the industry average. The distinctive competencies of an organization arise
from its resources (its financial, physical, human, technological, and organizational assets) and capabilities (its skills at
coordinating resources and putting them to productive use).

SELF-ASSESSMENT
Assignment:
Analyze the competitive position of your business school in the market for business education. Then answer the following
questions:
1. Does your school have a competitive advantage?
2. If so, upon what is this advantage based, and is this advantage sustainable?
3. If your school does not have a competitive advantage in the market for education, identify the inhibiting factors that are
holding it back.
4. How might the Internet change the way in which education is delivered?
5. Does the Internet pose a threat to the competitive position of your school in the market for education, or is it an
opportunity for your school to enhance its competitive position?

Case study:
Your friend manages a retailer that has a history of superior profitability. She believes that one of the principal sources of
competitive advantage for her enterprise are low labor costs. The low labor costs are due to her hiring of minimum-wage
workers, the decision not to give them any benefits (such as health benefits), and her consistent opposition to unionization
at the company (the workforce is not unionized). Although she acknowledges that this approach does lead to high
employee turnover, she argues that the jobs are low skilled, and that it is easy to replace someone who leaves. Is your
friend’s approach to doing business ethical? Are there ways of achieving low labor costs that do not rely upon the hiring of
minimum-wage workers? Would you counsel your friend to use an alternative approach?

REFERENCES
Refer to the references listed in the syllabus of the subject.

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