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

(34th President of the United States from 1953 until 1961. He was a five-star general in the United States Army during World War II and served as Supreme Commander of the Allied Forces in Europe)

Need for Internal Analysis

• Within a given industry, why some companies do better than others

• Internal Analysis helps to explore the basis of competitive advantage at the level of the individual company

Internal Analysis

“…pinpoints the strengths and weaknesses of the organization. It includes assessments of:

• Firm’s resources & capabilities• Distinctive competencies

• Building/sustaining a competitive advantage requires a company to achieve superior performance in:• Efficiency• Quality• Innovations• Responsiveness to customers

Strengths and Weaknesses

• “…gives managers the information to choose the strategies and business model to attain a sustained competitive advantage.

• Strengths: Assets that boost profitability

• Weaknesses: Liabilities that depress profitability

Competitive Advantage

Competitive Advantage- firm’s profitability is greater than the average profitability for all firms in its industry.

Sustained Competitive Advantage- firm maintains above average and superior profitability and profit growth over a number of years.

Distinctive Competencies

• “…firm-specific strengths that allow a company to differentiate its products from those offered by rivals, and/or achieve substantially lower costs….”

Resources“…assets of a company.” - refer to the

financial, physical, human, technological, and organizational resources of the company.

Tangible (physical entities) Ex: land, buildings, equipment, inventory, & money

Intangible (nonphysical entities created by managers & other employees)

Ex: brand names, company reputation, employee knowledge & experience, intellectual property

Resources …

• Resources that are firm specific and difficult to imitate (barriers to imitation) are unique. Resources that create a strong demand for the firm’s products are valuable.

• Unique and valuable resources lead to a distinctive competency.

Capabilities

• “…a company’s skills at coordinating its resources and putting them to productive use.”

– These skills reside in the way a company makes decisions and manages its internal processes e.g. rules, routines, and procedures.

– Capabilities are, by definition, intangible. They reside not so much in individuals as in the way individuals interact, cooperate, and make decisions within the context of an organization.

Strategy, Resources, Capabilities, and Competencies

Competitive Advantage, Value Creation, and Profitability

How profitable a company becomes depends on three basic factors:

1. Value/utility customers place on products2. Price company charges for products

Consumer surplus = “excess” utility consumer captures beyond price paid

3. Costs of creating product

Basic Principle“More utility consumers get from company’s products or services, the more pricing options company has.”

Value Creation per Unit

Value Creation and Pricing Options

Value Creation and Pricing Options• Under Option 1, a company can make the product more attractive, raising costs

(C) but also raising utility (U). Customers are then willing to pay a higher price (P increases). (Product differentiation)

• Under Option 2, a company can lower its price (P), creating a higher utility (U), more demand, and increased volume of sales. (Low cost)– Economies of scale realized because of the increased volume

• Low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry.

• Competitive advantage (and higher profits) goes to those companies that can create superior value

• To create superior value is to drive down the cost structure of the business and/or differentiate the product in some way so that consumers value it more and are prepared to pay a premium price.

The Value Chain

• It is a sequence of interrelated activities for transforming inputs into outputs that customers value.

• The process consists of a number of primary activities and support activities, each of which can add value to the product

The Value Chain Activities

Primary Activities• R & D = design and production• Production = creation of good/service• Marketing = brand positioning & advertising• Customer Service = after-sales service & support

Support Activities• Materials Mgmt. = transmission of materials• HR = ensures right mix of skilled people• I. S. = managing, tracking• Infrastructure = context in which all other activities take

place

Building Blocksof Competitive Advantage

• Efficiency – fewer inputs to produce given output Efficiency = Outputs / Inputs

• Quality – customers perceive product’s attributes provide higher utility in excellence & reliability

• Innovation (Successful innovation gives a company something unique that its competitors lack )• Product• Process

• Customer Responsiveness – customers attribute more utility by creating differentiation with competitive advantage

More on customer responsiveness• A company give its customers exactly what they want when they want it.

It involves doing everything possible to identify customer needs and to satisfy those needs.

1. improve the efficiency of production processes and the quality of products.

2. develop new products that have features currently not incorporated in existing products.

3. customize goods and services to the unique demands of individual customers.

4. reduce customer response time, or the amount of time it takes for a good to be delivered or a service to be performed.

Building Blocks of Competitive Advantage

Competitive Advantage& Value Creation Cycle

Analyzing Competitive Advantage and Profitability

Competitive Advantage- Profitability greater than average of all companies in same industry

Benchmarking- Comparing performance against competitors & historic performance

Measures of Profitability: Return on Invested Capital; Profit margin

Net Profit = Total Revenues – Total Costs

Drivers of Profitability (ROIC)SG&A- Selling, General & AdministrativePPE – property, plant & equipment

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– Reduce R&D expenses

• Increase Capital Turnover – Reduce the amount of working capital – Reduce the amount of fixed capital

Durability of Competitive Advantage

1. Barriers to Imitation- difficulty to copy distinctive competencies• Resources – tangible and intangible • Capabilities

2. Capability of Competitors• Strategic commitment• Absorptive capacity

3. Industry Dynamism- ability to change rapidly

Competitors also seeking distinctive competencies that give them a competitive edge

Why Companies Fail• Inertia- difficult to adapt strategies & structures to changing

conditions

• Prior Strategic Commitments- limit ability to imitate & cause competitive disadvantage

• Icarus Paradox- so specialized/inner-directed by past success lose sight of market realities

• Rising/Falling industries: • Craftsmen • Builders • Pioneers •Salespeople

• When company loses competitive advantage, profitability falls below the industry. – Loses ability to attract/generate resources. – Profit margins invested capital shrink rapidly.

Avoiding Failure: Sustaining Competitive Advantage

1.Focus on Building Blocks • Efficiency • Quality • Innovation • Responsiveness to Customers

2.Institute Continuous Improvement & Learning3.Track Best Practice/Use Benchmarking4.Overcome Inertia