Chapter
Three
Internal
Analysis:
Distinctive
Competencies,
Competitive
Advantage,
and
Profitability
“In preparing for battle I have
always found that plans are
useless, but planning is
indispensable.”
- Dwight D.
Eisenhower
Copyright © Houghton Mifflin Company. All rights reserved.
© RoyaltyFree/ Stockdisc/ Getty Images
3|2
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
Copyright © Houghton Mifflin Company. All rights reserved.
3|3
Internal Analysis:
Strengths and Weaknesses
Internal analysis - along with the external analysis of
the company’s environment - gives managers the
information to choose the strategies and business
model to attain a sustained competitive advantage.
Strengths
Weaknesses
Of the enterprise
are assets that
boost
profitability
Of the enterprise
are liabilities that
lead to lower
profitability
Copyright © Houghton Mifflin Company. All rights reserved.
3|4
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
Copyright © Houghton Mifflin Company. All rights reserved.
3|5
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.
Copyright © Houghton Mifflin Company. All rights reserved.
3|6
Profitability in the
Computer Industry, 1998-2003
Dell has achieved a sustained competitive advantage over its rivals.
Data Source: Value Line Investment Survey
Copyright © Houghton Mifflin Company. All rights reserved.
3|7
Strategy, Resources,
Capabilities, and Competencies
Figure 3.1
Copyright © Houghton Mifflin Company. All rights reserved.
3|8
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
Copyright © Houghton Mifflin Company. All rights reserved.
3|9
Distinctive Competencies
to Gain Competitive Advantage
Distinctive Competencies
Firm-specific strengths allow a company to
differentiate its products and/or achieve
substantially lower costs than its rivals in
order to gain a competitive advantage.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 10
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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 11
Value Creation per Unit
Figure 3.2
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 12
Value Creation
and Pricing Options
There is a dynamic
relationship among utility,
pricing, demand, and costs.
Copyright © Houghton Mifflin Company. All rights reserved.
Figure 3.3
3 | 13
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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 14
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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 15
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



Copyright © Houghton Mifflin Company. All rights reserved.
3 | 16
 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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 17
 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
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 18
A Quality Map for Automobiles
Figure 3.7
When customers
evaluate the quality of a
product, they commonly
measure it against two
kinds of attributes:
1. Quality as Excellence
2. Quality as Reliability
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 19
 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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 20
 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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 21
Competitive Advantage:
The Value Creation Cycle
Figure 3.8
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 22
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
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 23
Definitions of
Basic Accounting Terms
Table 3.1
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 24
Drivers of Profitability (ROIC)
Figure 3.9
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 25
Ways to Increase ROIC
Increase Company’s Return on Sales
 Increase sales revenue more than costs
 Reduce cost of goods sold
 Reduce spending on SG&A

Sales, Marketing, General & Administrative Expenses
 Reduce R&D expenses
Research & Development




Increase Capital Turnover
 Reduce the amount of working capital

Inventory, Accounts Receivable, Payables
 Reduce the amount of fixed capital
PPE - Property, Plant & Equipment
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 26
Comparing Wal-Mart to Target
Figure 3.10
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 27
“Sears ignored us in the early
years and in the end we simply
blew right by them.”
- Sam Walton
Chairman,
Wal-Mart
Copyright © Houghton Mifflin Company. All rights reserved.
www.walmart.com
3 | 28
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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 29
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.
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 30
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
Copyright © Houghton Mifflin Company. All rights reserved.
3 | 31
“Developing a sound and
healthy organization requires
understanding the environment
as much as understanding the
organization.”
- Gary Hamel
Copyright © Houghton Mifflin Company. All rights reserved.
© RoyaltyFree/ Stockdisc/ Getty Images
3 | 32