Chapter 3 Examining the Internal Context of Strategy

1. Chapter 3Examining the Internal Context of Strategy

2. OBJECTIVES 1 • Explain the internal context of strategy • Identify a firm’s resources and capabilities and explain their role in its performance 2 • Define dynamic capabilities and explain their role in both strategic change and a firm’s performance 3 • Explain how value‑chain activities are related to firm performance and competitive advantage 4 • Explain the role of managers with respect to resources, capabilities, and value‑chain activities 5

3. COMPARATIVE INDUSTRY REFORMANCE ROA Global Auto ROS • Semiconductor Grocery Store How dosuch differences in profitability materialize?

4. TWO THEORIES FOR HOW AND WHY SOME FIRMS PERFORM BETTER THAN OTHERS • A firm’s resources and capabi-lities determine performance • A firm’s activities determine performance • Success issues from fundamental differences in what firms own and what they can do • Success is driven by a firm’svalue chain activities:How it configures these activities to add more valuethan competitors

5. RESOURCES AND CAPABILITIES: FUNDAMENTAL BUILDING BLOCKS OF STRATEGY • The inputs that firms use to create goods and services • Undifferentiated or firm-specific • Tangible or intangible • Easy to acquire or difficult Strategy Capabilities (competencies) Resources A firm’s skill in using its resources to create goods and services. The combination of procedures and expertise that the firm relies on to engage in distinct activities in the process of producing goods and services

6. EXAMPLES OF CAPABILITIES Company Capability Result Logistics -- distributing vast amounts of goods quickly and efficiently to remote locations 200,000-percent return to share-holders during first 30 years since IPO1 An extraordinarily frugal system for delivering the lowest cost structure in the mutual fund industry, using both techno-logical leadership and economies of scale 25,000-percent return to share-holders during the 30-plus year tenure of CEO John Connelly.2 As for ongoing expenses, share-holders in Vanguard equity funds pay, on average, just $30 per $10,000, vs. a $159 industry average. With bond funds, the bite is just $17 per $10,000 Generating new ideas then turning those ideas into new, profitable products 30 percent of revenue from products introduced within the past four years 1: Stalk, Evans, and Shulman, 1992 2: Makadok, 2003

7. Valuable? Does the resource or capability allow the firm to meet a market demand or protect the firm from market uncertainties? If so, it satisfies the value requirement. Valuable resources are needed just to compete in the industry, but value by itself does not convey an advantage Valuable resources and capabilities convey the potential to achieve “normal profits” (i.e., profits which cover the cost of all inputs including the cost of capital) Rare? Assuming the resource or capability is valuable, is it scarce relative to demand? Or, is it widely possessed by most competitors? Valuable resources which are also rare convey a competitive advantage, but its relative permanence is not assured. The advantage is likely only temporary A temporary competitive advantage conveys the potential to achieve above normal profits, at least until the competitive advantage is nullified by other firms Inimitable and non-substitut-able? Assuming a valuable and rare resource, how difficult is it for competitors to either imitate the resource or capability or substitute for it with other resources and capabilities that accomplish similar benefits? Valuable resources and capabilities which are difficult to imitate or substitute provide the potential for sustained competitive advantage A sustained competitive advantage conveys the potential to achieve above normal profits for extended periods of time (until competitors eventually find ways to imitate or substitute or the environment changes in ways that nullify the value of the resources) Exploit-able? For each step of the preceding steps of the VRINE test, can the firm actually exploit the resources and capabilities that it owns or controls? Resources and capabilities that satisfy the VRINE requirements but which the firm is unable to exploit actually result in significant opportu-nity costs (other firms would likely pay large sums to purchase the VRINE resources and capabilities). Alternatively, exploitability unlocks the potential competitive and performance implications of the resource or capability Firms which control unexploited VRINE resources and capabilities generally suffer from lower levels of financial performance and depressed market valuations relative to what they would otherwise enjoy (though not as depressed as firms lacking resources and capabilities which do satisfy VRINE) THE VRINE MODEL Test Competitive implication Performance implication

8. THE VRINE MODEL: VALUE Example Union Pacific Railroad’s rail system is a tangible resource that allows UP to compete with other carriers in the long-haul transportation of a variety of goods Definition • Maintain an extensive network of rail-line property and equipment on the U.S. Gulf cost • Operates in the western two-third of the United States serving 23 states, linking every major West Coast and Gulf Coast port, and reaching east through major gateways in Chicago, St.Louis, Memphis, and New Orleans • Also operates in key north-south corridors • The only U.S. railroad serving all six gateways to Mexico • Interchanges traffic with Canadian rail systems Value: A resource or capability is valuable if it allows a firm to take advantage of opportunities or to fend off threats in its environment

9. THE VRINE MODEL: RARITY UNLV has world’s oldest janitor! Is this rare? Phelan/Lewin concept of value/rarity Example When McDonald’s signs an agreement to build a restaurant inside a Wal-Mart store, it has an intangible advantage over Burger King that is valuable and rare Definition A useful resource or capability that is scarce relative to demand. Valuable resources that are available to most competitors (i.e., that are not rare) simply allow firms to achieve parity

10. Definition • A resource or capability is inimitable if competitors cannot acquire the valuable and rare resource quickly, or face a disadvantage in doing so • It is non-substitutable if a competitor cannot achieve the same benefit using different combinations of resources and capabilities THE VRINE MODEL: INIMITABILITY AND NON-SUBSTITUTABILITY What makes things difficult to imitate? Property rights Cost Time Causal Ambiguity Example Barnes & Noble’s large store network gave it access to customers and purchasing power that was inimitable … … but Amazon.comfound a substitute

11. TANGIBLE AND INTANGIBLE ADVANTAGES Intangible Tangible + = Location selection + Rural real-estate = Wal-Mart High traffic real-estate + = Brand McDonald’s

12. THE VRINE MODEL: EXPLOITABLITY Example Novell: “I walk down Novell hallways and marvel at the incredible potential for innovation here, but Novell has had a difficult time in the past turning innovation into product in the market place” - CEO Eric Schmidt Xerox: Xerox invented the laser printer, Ethernet, graphical-interface software and computer mouse but could not capitalize on these Definition A resource of capability that the organization has the capability to exploit (i.e., the capability to generate value from)

13. HOW WOULD YOU DO THAT? Do patents on Zoloft ®provide value? Valuable? Do Pfizer's patents provide “rarity”? Rare? Pfizer’sZoloft ® Inimitable andnon-substitutable? Can competitors imitate? Can they substitute? Exploitable? Can Pfizer exploit?

14. STOCK AND FLOW OF CAPABILITIES Capability Flow Stock

15. RESOURCE PICKING OR CAPABILITY BUILDING ? • Resource Picking • Is about acquiring rare resources on the “strategic factor market” for less than they are worth • Requires luck or superior information • Railroad example • Capability Building • Some assets can’t be traded on the strategic factor market, they have to be developed over time • Even humdrum resources can be developed into a competitive advantage • If this is true, then these assets can be very difficult to copy • - Reputation, brand name, R&D skill, know-how, teamwork, trust • - Time compression diseconomies • - English country garden example • - Samurai sword example (tacit knowledge)

16. Value DYNAMIC CAPABILITIES Mail Boxes Etc. franchise Start-up plans People Brand Location Processes Dynamic capability: how we integrate recon-figure, acquire, or divest resources for competitiveadvantage? Mail boxes, etc., has developed the ability to combine resources better than the competition

17. Inventory system Site software Pick & pack procedures Site look & feel Return procedures Customer research CDs Shipping Computers Telecom lines Shipping services Media VALUE CHAIN: INTERNET STARTUP EXAMPLE Firm Infrastructure Financing, legal support, accounting Support Activities Recruiting, training, incentive system, employee feedback HumanResources Technology Development Procurement Inbound shipment of top titles Server operations Billing Collections Picking and shipment of top titles from warehouse Shipment of other titles from third- party distributors Pricing Promotions Advertising Product information and reviews Affiliations with other websites Returned items Customer feedback Warehousing • Inbound • Logistics • Operations • Outbound • Logistics • Marketing • & Sales • After-Sales Service Primary Activities

18. USING VALUE CHAINS TO GAIN COMPETITIVE ADVANTAGE Identical Differentiated Find a different way to perform activities Longer-lasting advantage Shorter-term advantage (competitors catch up) Find a better way to perform the same activities

19. Southwest Major Airlines Technologyand design • Single aircraft • Multiple types of aircrafts Operations • Short segment flights • Smaller markets and secondaryairports in major markets • No baggage transfers to others airlines • No meals • Single class of service • No seat assignments • Hub and spoke system • Meals • Seat assignments • Multiple classes of service • Baggage transfer to other airlines Marketing • Limited use of travel agents • Word of mouth • Extensive use of travel agents TRADE OFF PROTECTION: YOUR RIVALS CHOOSE NOT TO COPY YOU Selected difference between Southwest and large Airlines Southwest made choices so that competitors did not copy - because copying would require them to abandon activities essential to their strategies

20. RESULTS OF TRADE OFF PROTECTION 2004 Revenue($000,000) 2004 Cost of Available Seat Miles (CASM) Airline AirTran 279 8.42 Alaska 656 10.03 American 4,541 9.72 AmericaWest 579 7.81 Continental 2,397 9.49 Delta 3,641 10.23 JetBlue 334 6.03 Northwest 2,753 10.31 Southwest 1,655 7.77 United 3,988 10.16 US Air 1,660 11.34

21. INNOVATION AND INTEGRATION OF THE VALUE CHAIN Area of innovation Assemble Source Deliver IKEA Transferred assembly and delivery to the consumer Dell Choose an entirely direct distribution model (rather than through retailers) and outsourced component manufacturing

22. STRATEGIC LEADERSHIP “Companies that overlook the role of leadership in the early phases of strategic planning often find themselves scrambling when it’s time to execute. No matter how thorough the plan, with-out the right leaders it is unlikely to succeed” – McKinsey & Company

23. SENIOR VS. MIDDLE MANAGERS Decide how to use other resources and capabilities, configure their firm’s value-chain activities, and set the context which determines how front-line and middle managers can add value Senior • Are better positioned than senior managers to contribute to competitive advantage and firm success in four areas • Entrepreneurship • Communications • Psychoanalyst • Tightrope walker Middle Source: Quy Nguyen Huy

24. SUMMARY • 1 • Explain the internal context of strategy • Identify a firm’s resources and capabilities and explain their role in its performance • 2 • Define dynamic capabilities and explain their role in both strategic change and a firm’s performance • 3 • Understand how value‑chain activities are related to firm performance and competitive advantage • 4 • Explain the role of managers with respect to resources, capabilities, and value‑chain activities • 5

25. GROUP ACTIVITIES • PART 1 • Choose a company with which you are familiar: • Analyze the value chain of the firm and its rivals • are there activities that this firm performs differently from its rivals? • Do any of the value-chain activities give the firm (or their rivals) a competitive advantage? • If so, why don’t others imitate these activities? • What resources and capabilities does your focal firm possess? • How do your focal organization’s resources and capabilities fare relative to rivals? • Use VRINE to determine the source of your firm’s performance difference with rivals • Use the same analysis on the UNLV College of Business compared with its rivals. • Do we have a competitive advantage? • PART 2 • What is the role of luck in gaining possession of a particular resource or capability? • Can you think of any particular examples? (MS-DOS is one) • Can a firm manage luck? • How much luck is there in the simulation game? Is this more or less than the real world?