Evaluating a Firm’s Internal
Capabilities
Chapter 3
Learning Objectives
• Be able to describe the critical assumptions
of the resource-base view.
• Describe resources & capabilities.
• Understand how to use SWOT analysis.
• Understand how value chain analysis is used
to improve a firm’s operations & identify
valuable resources & capabilities.
• Understand how to apply the VIRO
framework.
What Does Internal Analysis Tell Us?
• Internal analysis provides a comparative look
at a firm’s capabilities
– what are the firm’s strengths?
– what are the firm’s weaknesses?
– how do these strengths & weaknesses compare
– to competitors?
Why Does Internal Analysis Matter?
Internal analysis helps a firm:
• Determine if its resources and capabilities are
likely sources of competitive advantage.
• Establish strategies that will exploit any
sources of competitive advantage.
SWOT Analysis
Internal
Strengths
Weaknesses
External
Opportunities
Threats
SWOT
• Strengths (Internal Focus) – What does the firm do
well?
• Weaknesses (Internal Focus) – Where is the firm
vulnerable?
• Opportunities (External Focus) – What opportunities
can the firm take advantage of given its resource
bundle.
• Threats (External Focus) – What does the company
have to monitor and/or address.
Focus: Opportunities/Threats
• Companies scan their external environment
looking for valuable information, e.g., new
factors and trends.
• What is happening in the general
environment that may affect the company in
the short- and/or long-term?
SWOT Example:
• Strengths
– First mover advantage
– Low labor cost
– Creative employees
• Weaknesses
– Inexperienced new
company
– No proprietary
information
• Opportunities
– Demand for electronic
phone books
– Sudden growth in use of
digital technology
• Threats
– Easily duplicated product
– Market power of
incumbent firms
Limitations of SWOT Analysis
• SWOT Analysis is a starting point for
discussion and cannot show how to
achieve a competitive advantage.
• Strengths may not lead to a competitive
advantage.
Limitations of SWOT Analysis
• SWOT Analysis’ focus on the external
environment is too narrow.
• SWOT Analysis is a snapshot of a dynamic
environment.
• SWOT Analysis overemphasizes a single
dimension of strategy.
Dess, Lumpkin, & Taylor (2007) p. 78
The Theory Behind Internal Analysis
The Resource-Based View:
• Developed to answer the question: Why do some
firms achieve better economic performance than
others?
• Used to help firms achieve competitive advantage
and superior economic performance.
• Assumes that a firm’s resources and capabilities are
the primary drivers of competitive advantage and
economic performance.
The Resource-Based View
• Resources:
• Tangible and intangible assets of a firm used
to conceive of and implement strategies.
Capabilities:
• A subset of resources that enable a firm to
take full advantage of other resources.
The Resource-Based View
Four Categories of Resources
• Financial (cash, retained earnings)
• Physical (plant & equipment, geographic
location)
• Human (skills & abilities of individuals)
• Organizational (reporting structures,
relationships)
The Resource-Based View
Two Critical Assumptions of the RBV
• Resource Heterogeneity
• Resource Immobility
The Resource-Based View
Resource Heterogeneity
• Heterogeneity of resources typically occurs
as the result of ‘bundling’ the resources and
capabilities of a firm.
• Managers of a firm could take resources that
seem homogeneous and ‘bundle’ them to
create heterogeneous combinations.
• Competitive advantage typically stems from
several resources and capabilities ‘bundled’
together.
Support
Activities
The Chain of Value
Inbound
Logistics
General Administration
Human Resource Management
Technology Development
Procurement
Marketing
Outbound
Operations
&
Logistics
Sales
Primary Activities
(Dess, Lumpkin, & Eisner p. 77).
Service
Inbound Logistics
• Receiving, Storing, & Distributing Inputs, e.g.,
material handling, warehousing, inventory
control, scheduling, & returns.
• Just-in-Time Inventory Control saves
companies money.
Operations
• Includes the activities that transform raw
materials into the finished product. This
includes processing, machining, packaging,
assembly, equipment, testing, printing, and
facility operations.
Outbound Logistics
• Activities that handle the finished product
including collecting, storing, and distributing
the product/service to the customer.
Marketing & Sales
• These departments are responsible for
activities associated with making the
market aware of the product/ service and
turning potential customers into
customers.
• When channel customers are involved the
marketing and sales force must convince
them that their product should be carried.
Service
• Primarily responsible for handling customer
problems associated with enhancing or
maintain the product/ service. This may
include installing, repairing, training,
supplying parts, and adjusting the product.
Support Activities
• General Administration – Responsible for
firm’s overall welfare.
• Human Resources Management –
Responsible for providing the best employees
possible as well as managing those important
resources.
Support Activities
• Technology Development – Responsible for
providing the firm with state of art future
products/services as well as ensuring the company
has the resources to support this environment.
• Procurement – Responsible for procuring raw
material inputs and creating systems that ensure
the firm has access to best resources.
The Internal Analysis Tool
• If a firm’s resources are:
– Valuable
– Rare
– Costly to Imitate
– Organized to Exploit these Resources …
• Then the firm can expect to gain a sustained
competitive advantage.
Applying the VRIO Framework
The Question of Value:
• In theory: Does the resource enable the firm
to exploit an external opportunity or neutralize
an external threat?
• The practical: Does the resource result in an
increase in revenues, a decrease in costs, or
some combination of the two? (Levi’s
reputation allows it to charge a premium for
its Docker’s pants)
Applying the VRIO Framework
The Question of Rarity
• If a resource is not rare, then perfect
competition dynamics are likely to be
observed (i.e., no competitive advantage, no
above normal profits).
• A resource must be rare enough that perfect
competition has not set in.
Applying the VRIO Framework
The Question of Imitability
• The temporary competitive advantage of
valuable and rare resources can be sustained
only if competitors face a cost disadvantage
in imitating the resource.
• If there are high costs of imitation, then the
firm may enjoy a period of sustained
competitive advantage.
Applying the VRIO Framework
The Question of Organization
• A firm’s structure and control mechanisms
must be aligned so as to give people ability
and incentive to exploit the firm’s resources.
• These structure and control mechanisms
complement other firm resources—taken
together, they can help a firm achieve
competitive advantage. (3M Company)
The VRIO Framework
Costly to Exploited by Competitive
Valuable? Rare? Imitate? Organization? Implications
No
No
Disadvantage
No
Parity
Yes
Yes
No
Temporary
Advantage
Yes
Yes
Yes
Yes
Yes
Sustained
Advantage
The VRIO Framework
Costly to
Valuable? Rare? Imitate?
No
Exploited
By Org?
No
Competitive
Implics.
Economic
Implics.
Disadvantage Below
Normal
No
Parity
Yes
Yes
No
Temporary
Advantage
Above
Normal
Yes
Yes
Yes
Sustained
Advantage
Above
Normal
Yes
Yes
Normal
Entrepreneurial Application of the VRIO
Framework
The Logic Remains the Same:
• Small firms and start-ups can apply the VRIO
framework to their resources and capabilities.
– Competitive advantage vis-à-vis larger firms can
often be identified.
– Recognizing if and why larger firms face high
costs of imitation can be critical to small firm
success.
International Application of the VRIO
Framework
Two Reasons for International Expansion:
1. Exploit current resource and capability
advantages in a new market.
2. Develop new resources and capabilities in a
foreign market
Competitive Dynamics of Resource
Imitation
Competitive Dynamics:
• The strategic decisions and actions of firms
in response to the strategic decisions and
actions of other firms.
Firm B’s Possible Responses
Firm A
(strategy decisions
lead to competitive
advantage)
No Response
Change Tactics
Change Strategy
Competitive Dynamics
• A firm may decide to take no action because:
• the other firm is serving a different market.
• A response may hurt its own competitive
advantage.
• It does not have the resources and
capabilities to mount an effective response.
• It wants to reduce or manage rivalry in the
market through tacit collusion.
“No Action” Response (Rolex
Casio)
Competitive Dynamics
“Change” Responses
Tactics (Tide)
• specific actions
»tweaking product
characteristics
• usually imitated so
quickly that there is
no advantage
• a ‘leap frog’ move
may create advantage
Strategy (Monsanto)
• a fundamental change
in a firm’s theory
• may be necessary if
current strategy
becomes obsolete
• a mimetic change may
achieve parity, but not
advantage
Competitive Dynamics
• Imitation will seldom lead to competitive
advantage.
• Firms should use resources and capabilities
to fill unique competitive space.
Price
Focal Firm
Offering
Competitor
Offerings
Customer
Needs
Quality
Competitive Dynamics
• Similar strategies may lead to competitive
advantage.
• Some firms can achieve competitive
advantage even if they are second movers
Price
Focal Firm
Offering
» higher quality/
lower cost
offering may
lead to advantage
Competitor
Offerings
Customer
Needs
Quality
Wrapping it Up
Internal Analysis Assumes:
• Determinates of economic performance are
firm-level characteristics (resources &
capabilities).
– firms may be different (heterogeneity)
– differences may be enduring (immobility)
• competitive advantage stems from resources
and capabilities that meet the VRIO criteria
Wrapping it Up: The Resource-Based View
Resources &
Capabilities
Competitive
Advantage
• Valuable
CA will be sustained if:
• Rare
1.Other firms’ costs of
• Costly to Imitate
imitation are greater
• Organized to Exploit than benefit of imitation.
2.The firm is organized
to exploit advantages
The Resource-Based View
What do these assumptions really mean?
• If one firm has resources that are valuable
and other firms don’t, and…
• If other firms can’t imitate these resources
without incurring high costs, then…
• The firm possessing the valuable resources
will likely gain a sustained competitive advantage.