Chapter Four

Business Environment Analysis and Environmental Scanning:

Internal Environment Assessment

4.1 Introduction
This chapter focuses on identifying and evaluating a firm’s strengths and
weaknesses in the functional areas of business, including management, marketing,
finance, production and operations, research and development (R&D), accounting,
information systems (MIS). Internal scanning often referred to as organizational
analysis is concerned with identifying and developing an organization’s resources
and competencies.
4.2 The Nature of an Internal Audit
Internal environment provides an organization with the capability to capitalize on
the opportunities or protect itself from the threats that are present in the external
environment. Analysts must look within the corporation itself to identify internal
strategic factors critical strengths and weaknesses that are likely to determine
whether a firm will be able to take advantage of opportunities while avoiding
threats. Ultimately, the fit takes place between the external and the internal
environment that enable an organization to formulate its strategy.
Internal environmental analysis is all about identifying strength and weaknesses,
which the organization may have. All organizations have strengths and weaknesses
in the functional areas of business. No enterprise is equally strong or weak in all
areas. Internal strengths and weaknesses, coupled with external opportunities and
threats and clear vision and mission statements, provide the basis for establishing
objectives and strategies. Objectives and strategies are established with the
intention of capitalizing on internal strengths and overcoming weaknesses.
Key Terminology in Internal Environment Analysis
Resources, capabilities, and core competencies provide the foundation of
competitive advantage.
1. Resources: are an organization’s assets thus the basic building blocks of the
organization. Resources represent inputs into a firm’s production process.
Resources are the foundation for strategy and unique bundles of resources
generate competitive advantages leading to wealth creation. A company’s
resources can be divided into two types: tangible and intangible. Tangible
resources are physical entities, such as land, buildings, plant, equipment,
inventory, and money. Intangibleresources 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 intellectual
property protected through 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. .
2. Capabilities refer to a corporation’sability to exploit its resources. They
consist of business processes and routines that manage the interaction
among resources to turn inputs into outputs. For example, acompany’s
marketing capability can be based on the interaction among its marketing
specialists, distribution channels, and sales people. A capability is
functionallybased and is resident in a particular function. Thus, there are
 marketing capabilities, manufacturing capabilities, and human resource
management capabilities. Whenthese capabilities are constantly being
updated and reconfigured to make them more adaptive to an uncertain
environment, they are called dynamic capabilities.

3. Competency: It is a cross-functional integration and coordination of

capabilities. For example, a competency in new product development in one
division of a corporation may be the consequence of integrating management of
information systems (MIS) capabilities, marketing capabilities, R&D capabilities,
and production capabilities within the division.
4. Core competency: is a collection of competencies that crosses divisional
boundaries, is widespread within the corporation. 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. Thus, new product development is a core competency if it goes
beyond one division. Three criteria that distinguishes a core competence from a
competence; a core competence must contribute significantly to customer
benefit from a product, a core competence should be competitively unique, must
be difficult for competitors to imitate and finally, a core competence should
provide potential access to a wide variety of markets. Capabilities are formed by
the integration of resources whereas core competencies are formed by the
integration of capabilities.
5. Distinctive competencies: A firm’s strengths that cannot be easily matched or
imitated by competitors are called distinctive competencies. Building
competitive advantages involves taking advantage of distinctive competencies.
Strategies are designed in part to improve on a firm’s weaknesses, turning them
into strengths and maybe even into distinctive competencies. Thismeans all
firms should continually strive to improve on their weaknesses, turning them into
 strengths, and ultimately developing distinctive competencies that can provide
the firm with competitive advantages over rival firms.
6. Sustainable competitive advantage is an advantage over competitors that
cannot easily be imitated.
Four Criteria of Sustainable Competitive Advantage
Core competencies are sources of competitive advantage for the firm over its rivals.
Capabilities failing to satisfy the four criteria of sustainable competitive advantage
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 and unique, from a
customer’s point of view. For the competitive advantage to be sustainable, the core
competence must be inimitable and non-substitutable, from a competitor’s point of
view. Sustained competitive advantage is achieved only when competitors cannot
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 earn a competitive
advantage by using capabilities that are, for example, valuable and rare, but
imitable. Sustainable competitive advantage results only when all four criteria are
satisfied.
1. Valuable: Valuable capabilities allow the firm to exploit opportunities or
neutralize threats in its external environment. By effectively using capabilities to
exploit opportunities, a firm creates value for customers.
2. Rare: Rare capabilities are capabilities that fewcompetitors 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 be sources of competitive advantage for any one of them. Instead,
valuable but common (i.e., not rare) resources and capabilities are sources of
competitive parity. Competitive advantage results only when firms develop and
exploit valuable capabilities that differ from those shared with competitors.
3. 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.
 First, a firm sometimes is able to develop capabilities because of unique
historical conditions. “As firms evolve, they pick up skills, abilities and resources
that are unique to them, reflecting their particular path through history.” 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.
 A second condition of being costly to imitate occurs when the link between the
firm’s capabilities and its competitive advantage is causally ambiguous. In these
instances, competitors cannot clearly understand how a firm uses its capabilities
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.
 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.
4. Non-substitutable:non-substitutable capabilities are capabilities that do not
have strategic equivalents. This final criterion for a capability to be a source of
competitive advantage “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 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. Firm-specific knowledge and trust-based
working relationships between managers and non-managerial personnel are
examples of capabilities that are difficult to identify and for which finding a
substitute is challenging.
Figure 4.1Components of Internal Analysis Leading to
Competitive Advantage and Strategic Competitiveness

4.3 The Process of Performing an Internal Audit

The internal audit requires gathering and assimilating information about the firm's
management, marketing, finance/accounting, production/operations, research and
development (R&D), and computer information systems operations. To perform an
internal audit companies may follow the following steps
1. Gather information on functional areas: RepresentativeManagers and
employees from throughout the firm need to be involved in determining a firm’s
strengths and weaknesses. The internal audit requires gathering and
assimilating information about the firm's management, marketing,
finance/accounting, production/operations, research and development (R&D),
and information systems.
2. Assimilation and evaluation: Once information is gathered from different
functional areas in the organization, it should be assimilated and evaluated. A
meeting or series of meetings of functional managers is needed to collectively
identify the most important strength and weakness the firm have. Key factors
should be prioritized as so that the firm’s most important strengths and
weaknesses can be determined collectively
3. Communicate and distribute key internal strength and weakness: A final
list of the most important key strengths and weakness should be communicated
and distributed widely in the organization.
4.4 Relationship among the Functional Areas of Business
Functional Areas of Business
Strategic management is a highly interactive process that requires effective
coordination among management, marketing, finance and accounting, production
and operations, R&D, and MIS managers. It is not possible in a strategic-
management text to review in depth all the material presented in courses such as
marketing, finance, accounting, management, management information systems,
and production and operations; there are many subareas within these functions,
such as customer service, warranties, advertising, packaging, and pricing under
marketing. However, strategic planning must include a detailed assessment of how
the firm is doing in all internal areas. For different types of organizations, such as
hospitals, universities, and government agencies, the functional business areas, of
course, differ. In a hospital, for example, functional areas may include cardiology,
hematology, nursing, maintenance, physician support, and receivables. Functional
areas of a university can include athletic programs, placement services, housing,
fund-raising, academic research, counseling, and intramural programs. Within large
organizations, each division has certain strengths and weaknesses.
1) Management
The functions of management consist of five basic activities: planning, organizing,
staffing, leading, and controlling.
Planning- Planning consists of all those managerial activities related to preparing
for the future. Specific tasks include forecasting, establishing objectives, devising
strategies, developing policies, and setting goals. Planning is most important at
strategy formulation stage of strategic-management process.
Organizing- Organizing includes all those managerial activities that result in a
structure of task and authority relationships. Organizing is most important at
strategy implementation stage of strategic-management process.
Staffing- Staffing activities are centered on personnel or human resource
management. Staffing is most important at strategy implementation stage of
strategic-management process
Leading –leading involves efforts directed toward shaping human behavior.
Leading is most important at strategy implementation stage of strategic-
management process
Controlling- Controlling refers to all those managerial activities directed toward
ensuring that actual results are consistent with planned results. Controlling is most
important at strategy evaluation stage of strategic-management process
2) Accounting / Finance
Financial condition is often considered the single best measure of a firm's
competitive position and overall attractiveness to investors. Determining an
organization's financial strengths and weaknesses is essential to formulating
strategies effectively. A firm's liquidity, leverage, working capital, profitability, asset
utilization, cash flow, and equity can eliminate some strategies as being feasible
alternatives. Financial factors often alter existing strategies and change
implementation plans. Financial ratio analysis is the most widely used method for
determining an organization's strengths and weaknesses in the investment,
financing, and dividend areas. This includes investment decision, capital budgeting,
the financing decision and dividend decisions
3) Production/Operations
The production/operations function of a business consists of all those activities that
transform inputs into goods and services. Production/operations management
deals with inputs, transformations, and outputs that vary across industries and
markets. A manufacturing operation transforms or converts inputs such as raw
materials, labor, capital, machines, and facilities into finished goods and services.
4) Marketing
Marketing can be described as the process of defining, anticipating, creating, and
fulfilling customers' needs and wants for products and services. There are seven
basic functions of marketing: There are seven basic functions of marketing: (1)
customer analysis, (2) selling products/services, (3) product and serviceplanning,
(4) pricing, (5) distribution, (6) marketing research, and (7) opportunity analysis.
Understanding these functions helps strategists identify and evaluate marketing
strengths and weaknesses.
5) Management Information Systems
Billions of bits of information are now “in the cloud.” Information ties all business
functions together and provides the basis for all managerial decisions. It is the
cornerstone of all organizations. Information represents a major source of
competitive management advantage or disadvantage. Assessing a firm’s internal
strengths and weaknesses in information systems is a critical dimension of
performing an internal audit. A MIS’s purpose is to improve the performance of an
enterprise by improving the quality of managerial decisions. An effective
information system thus collects, codes, stores, synthesizes, and presents
information in such a manner that it answers important operating and strategic
questions.
A management information system (MIS) receives raw material from both the
external and internal evaluation of an organization. It gathers data about marketing,
finance, production, and personnel matters internally, and social, cultural,
demographic, environmental, economic, political, governmental, legal,
technological, and competitive factors externally. Data are integrated in ways
needed to support managerial decision-making. Data becomes information only
when it is evaluated, filtered, condensed, analyzed, and organized for a specific
purpose, problem, individual, or time.
6) Research and Development
The fifth major area of internal operations that should be examined for specific
strengths and weaknesses is research and development (R&D). Many firms today
conduct no R&D, and yet many other companies depend on successful R&D
activities for survival. Firms pursuing a product development strategy especially
need to have a strong R&D orientation. The purpose of research and development
are as follows: Development of new products before competition, improving product
quality and improving manufacturing processes to reduce costs. Thus, a key to
organizational success is effective coordination and understanding among
managers from all functional business areas. Through involvement in performing an
internal strategic-management audit, managers from different departments and
divisions of the firm come to understand the nature and effect of decisions in other
functional business areas in their firm. Knowledge of these relationships is critical
for effectively establishing objectives and strategies.
7) Human resource management: Human resource management (HRM) is an
integrative general management that involves identifying the organization’s
demand for human resources with particular skills and abilities. As for the
introduction of the new products or services, it is necessary for HRM department
to know about it. Once the new products or services are introduced, marketing
has the responsibility to inform the HRM department punctually and sufficiently.
The information for HRM department should be concerned with the new skills
and experience needed for the new workers at present.
4.5 The Value Chain Analysis
Value is the extent to which a good or service is perceived by its customer to meet
his or her needs or wants, measured by a product’s performance characteristics and
by its attributes for which customers are willing to pay. 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 with competitors’ offerings.
Value=Benefits = Functional benefits + emotional benefits_______________
Costs Monetary costs + time costs + energy costs + psychic
costs

It commonly depends more on the customer's perception of the worth of

the product than on its intrinsic value. Firms must provide value to a customer that
is superior to the value provided by competitors in order to create a competitive
advantage. 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.
Value chain is the processes or activities a company performs to design, produce,
and market, deliver and support its product. The value chain analysis describes
the activities the organization performs and links them to the organizations
competitive position.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. According to Porter,
the business of a firm can best be described as a value chain, in which total
revenues minus total costs of all activities undertaken to develop and market a
product or service yields value
Value chain analysis (VCA) refers to the process whereby a firm determines the
costs associated with organizational activities from purchasing raw materials to
manufacturing product(s) to marketing those products
The value chain is a template that firms use to understand their cost position and to
identify the multiple means that might be used to facilitate implementation of a
chosen business-level strategy. As shown in Figure 4.1, a firm’s value chain is
segmented into primary and supportive activities.
Primary activities: are involved with a product’s physical creation, its sale and
distribution to buyers, and its service after the sale. Supportive activities: provide
the assistance necessary for the primary activities to take place. The value chain
shows how a product moves from the raw-material stage to the final customer. For
individual firms, the essential idea of the value chain is to create additional value
without incurring significant costs while doing so and to capture the value that has
been created. In a globally competitive economy, the most valuable links on the
chain are people who have knowledge about customers. This locus of value creating
possibilities applies just as strongly to retail and service firms as to manufacturers.

Figu
re 4.2 the value chain analysis
Moreover, for organizations in all sectors, the effects of e-commerce make it
increasingly necessary for companies to develop value-adding knowledge processes
to compensate for the value and margin that the Internet strips from physical
processes.Table 4.2 lists the items that can be evaluated to determine the value-
creating potential of primary activities. In Table 4.3, the items for evaluating
support activities are shown. All items in both tables should be evaluated relative to
competitors’ capabilities. To be a source of competitive advantage, a resource or
capability must allow the firm (1) to perform an activity in a manner that provides
value superior to that provided by competitors, or (2) to perform a value-creating
activity that competitors cannot complete. Only under these conditions does a firm
create value for customers and have opportunities to capture that value.
Table 4.1 Examining the Value-Creating Potential of Primary Activities
Inbound Activities, such as materials handling, warehousing, and inventory
Logistics 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 Activities involved with collecting, storing, and physically distributing
Logistics the final product to customers. Examples of these activities include
finished goods warehousing, materials handling, and order
processing.
Marketing Activities completed to provide means through which customers can
and Sales 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.
Each activity should be examined relative to competitors’ abilities.
Accordingly, firms rate each activity as superior, equivalent, or inferior.

Table 4.2 Examining the Value-Creating Potential of Support Activities

Procurement Activities completed to purchase the inputs needed toproduce 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 Activities completed to improve a firm’s product and the
Development processes used to manufacture it. Technological development
takes many forms, such as process equipment, basic research
and product design, and servicing procedures.
Human Activities involved with recruiting, hiring, training, developing, and
Resource compensating all personnel.
Management
Firm Firm infrastructure includes activities such as general
Infrastructure 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.