Chapter
Three
Internal
Analysis:
Distinctive
Competencies,
Competitive
Advantage,
and
Profitability
Internal Analysis
The purpose of internal analysis is to pinpoint the
strengths and weaknesses of the organization.
Strengths lead to superior performance.
Weaknesses lead to inferior performance.
Internal Analysis includes an assessment of:
 Quantity and quality of a company’s
resources and capabilities
 Ways of building unique skills
and company-specific or
distinctive competencies
Building and sustaining a competitive advantage
requires a company to achieve superior:
• Efficiency • Innovations
• Quality
• Responsiveness to customers
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Competitive Advantage
 Competitive Advantage
• A firm’s profitability is greater than the average
profitability for all firms in its industry.
 Sustained Competitive Advantage
• A firm maintains above average and superior
profitability and profit growth for a number of years.
The Primary Objective of Strategy
is to achieve a
Sustained Competitive Advantage
which in turn results in
Superior Profit and Profit Growth.
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Internal Analysis:
A Three-Step Process
1. Understand the process by which companies
create value for customers and profit for
themselves.
 Resources
 Capabilities
 Distinctive competencies
2. Understand the importance of superiority in
creating value and generating high profitability.
 Efficiency  Innovation
 Quality
 Responsiveness to Customers
3. Analyze the sources of the company’s
competitive advantage.
 Strengths – that are driving profitability
 Weaknesses – opportunities for improvement
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Distinctive Competencies and
Role of Resources and Capabilities
Resources
• Tangible (physical) and intangible (non-physical)
• Allow a company to create value for its customers
• Must have skills to take advantage of the resources
• Firm-specific and difficult-to-imitate resources
as well as valuable resources that create strong
demand for a company’s products lead to
distinctive competencies
Capabilities
• Coordinating resources & putting to productive use
• Skills reside in the organization’s rules, routines
and procedures
• Product of its organization, processes & controls
• Firm-specific capabilities to manage its resources
lead to distinctive competencies
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Competitive Advantage,
Value Creation, and Profitability
How profitable a company becomes
depends on three basic factors:
1. VALUE or UTILITY the customer gets from
owning the product
2. PRICE that a company charges for its
products
3. COSTS of creating those products
 Consumer surplus is the “excess” utility a
consumer captures beyond the price paid.
Basic Principle: the more utility that consumers
get from a company’s products or services, the
more pricing options the company has.
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Value Creation per Unit
Figure 3.2
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Comparing Toyota
General Motors
and
Figure 3.4
Superior value creation requires that the gap between
perceived utility (U) and costs of production (C)
be greater than that obtained by competitors.
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The Value Chain
Figure 3.5
A company is a chain of activities for transforming
inputs into outputs that customers value –
including the primary and support activities.
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Building Blocks
of Competitive Advantage
The Generic
Distinctive Competencies

Figure 3.6
Allow a company to:
• Differentiate product offering
• Offer more utility to customer
• Lower the cost structure
regardless of the industry,
its products, or its services



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 Efficiency
 Measured by the quantity of inputs it
takes to produce a given output:
Efficiency = Outputs / Inputs
 Productivity leads to greater efficiency
and lower costs:
•
•
Employee productivity
Capital productivity
Superior efficiency helps a company
attain a competitive advantage
through a lower cost structure.
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 Quality
Quality products are goods and services that are:
• Reliable and
• Differentiated by attributes that customers
perceive to have higher value
The impact of quality on competitive
advantage:
• High-quality products differentiate and increase
the value of the products in customers’ eyes.
• Greater efficiency and lower unit costs are
associated with reliable products.
Superior quality = customer perception
of greater value in a product’s attributes
Form, features, performance, durability, reliability, style, design
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 Innovation
Innovation is the act of creating
new products or new processes
• Product innovation
» Creates products that customers
perceive as more valuable and
» Increases the company’s pricing options
• Process innovation
» Creates value by lowering production costs
Successful innovation can be a major
source of competitive advantage –
by giving a company something unique,
something its competitors lack.
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 Responsiveness to Customers
Identifying and satisfying customers’
needs – better than the competitors


Superior quality and innovation are integral to
superior responsiveness to customers.
Customizing goods and services to the unique
demands of individual customers or customer
groups.

Enhanced customer responsiveness
Customer response time, design,
service, after-sales service and support
Superior responsiveness to customers
differentiates a company’s products and services
and leads to brand loyalty and premium pricing.
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Analyzing Competitive
Advantage and Profitability
 Competitive Advantage
• When a companies profitability is greater than the average of all
other companies in the same industry that compete for the same
customers
 Benchmarking
• Comparing company performance against that of competitors and
the company’s historic performance
 Measures of Profitability
• Return On Invested Capital (ROIC)
•
ROIC
=
Net profit
Capital invested
=
Net income after tax
Equity + Debt to creditors
• Net Profit
Net Profit = Total revenues – Total costs
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The Durability of Competitive
Advantage
The DURABILITY of a company’s competitive advantage over
its competitors depends on:
1.Barriers to Imitation
Making it difficult to copy a company’s distinctive competencies
 Imitating Resources
 Imitating Capabilities
2.Capability of Competitors
 Strategic commitment
Commitment to a particular way of doing business
 Absorptive capacity
Ability to identify, value, assimilate, and use knowledge
3.Industry Dynamism
Ability of an industry to change rapidly
Competitors are also seeking to develop distinctive
competencies that will give them a competitive edge.
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Why Companies Fail
 Inertia
• Companies find it difficult to change their
strategies and structures
 Prior Strategic Commitments
• Limit a company’s ability to imitate and
cause competitive disadvantage
 The Icarus Paradox
• A company can become so specialized and inner directed
based on past success that it loses sight of market realities
• Categories of rising and falling companies:
• Craftsmen • Builders • Pioneers • Salespeople
When a company loses its competitive advantage,
its profitability falls below that of the industry.
 It loses the ability to attract and generate resources.
 Profit margins and invested capital shrink rapidly.
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Avoiding Failure:
Sustaining Competitive Advantage
1. Focus on the Building Blocks of Competitive
Advantage
Develop distinctive competencies and superior performance in:
 Efficiency
 Quality
 Innovation
 Responsiveness to Customers
2. Institute Continuous Improvement and Learning
Recognize the importance of continuous learning within the organization
3. Track Best Practices and Use Benchmarking
Measure against the products and practices of the most efficient global
competitors
4. Overcome Inertia
Overcome the internal forces that are barriers to change
Luck may play a role in success,
always exploit a lucky break - but remember:
so
“The harder I work, the luckier I seem to get.”
J P Morgan
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