STRATEGIC MANAGEMENTCHAPTER-3

Internal Analysis: Distinctive Competencies, Competitive Advantage and Profitability

Internal AnalysisIt’s a 3 step process:1. Managers must understand the process by which companies create value for customers and profit for themselves, and they need to understand the role of resources, capabilities, and distinctive competencies in this process; 2. They need to understand how important superior efficiency, innovation, quality, and customer responsiveness are in creating value and generating high profitability; and 3. They must be able to analyze the sources of their company’s competitive advantage to identify what is driving the profitability of their enterprise and where opportunities for improvement might lie.

The Roots of Competitive Advantage

Distinctive Competencies: Competitive advantage is based on distinctive

competencies. Distinctive competencies are firm-specific strengths that allow a company to differentiate its products from those offered by rivals and/or achieve substantially lower costs than its rivals.

Distinctive competencies arise from two complementary sources: resources and capabilities.

Resources refer to the assets of a company. A company’s resources can be divided into two types: tangible and intangible resources.

Capabilities refer to a company’s skills at coordinating its resources and putting them to productive use.

The Roots of Competitive Advantage

The distinction between resources and capabilities is critical to understanding what generates a distinctive competency.

For a company to have a distinctive competency, it must at a minimum have either a firm-specific and valuable resource and the capabilities

(skills) necessary to take advantage of that resource or a firm-specific capability to manage resources.

A company’s distinctive competency is strongest when it possesses both firm-specific and valuable resources and firm-specific capabilities to manage those resources.

The Roots of Competitive Advantage

The Role of Strategy: Distinctive competencies shape the strategies that a

company pursues, which lead to competitive advantage and superior profitability.

However, it is also very important to realize that the strategies a company adopts can build new resources and capabilities or strengthen the existing resources and capabilities of the company, thereby enhancing the distinctive competencies of the enterprise.

Thus, the relationship between distinctive competencies and strategies is not a linear one; rather, it is a reciprocal one in which distinctive competencies shape strategies, and strategies help to build and create distinctive competencies.

Relationship of a company’sstrategies, distinctive competencies, and competitive advantage

Competitive Advantage, Value Creation, and Profitability

Competitive advantage leads to superior profitability.

How profitable a company becomes depends on three factors: 1. The value customers place on the

company’s products; 2. The price that a company charges for its

products; and 3. The costs of creating those products.

Competitive Advantage, Value Creation, and Profitability

The value customers place on a product reflects the utility they get from a product.

Utility must be distinguished from price. It is a function of the attributes of the product, such

as its performance, design, quality, and point-of-sale and after-sale service.

The price a company charges for goods or service is typically less than the utility value placed on goods or service by the customer.

It is because the customer captures some of that utility in the form of what economists call a consumer surplus.

The Value Chain The term value chain refers to the idea

that a company is a chain of activities for transforming inputs into outputs that customers value. The transformation process involves a number of primary activities and support activities that add value to the product.

Primary Activities Primary activities have to do with the

design, creation, and delivery of the product, its marketing, and its support and after-sales service. The primary activities are broken down into four functions: research and development, production, marketing and sales, and customer service.

Support Activities The support activities of the value

chain provide inputs that allow the primary activities to take place. These activities are broken down into four functions: materials management (or logistics), human resources, information systems, and company infrastructure.

Durability of Competitive advantage

What is the Durability of competitive advantage , given that other companies are also seeking to develop distinctive competencies that will give them a competitive advantage ?

The answer depends on 3 factors • Barriers to imitation• Capability of competitors • Dynamism of the industry environment

Barriers to Imitation It is a primary determinant of speed of imitation. Barriers are factors that make it difficult for a competitor

to copy a company’s distinctive competencies. It differs depending on whether rivals are imitating

resources or capabilities. Resources- Tangible resources ( buildings, plant,

equipment) Intangible resources ( brand name, marketing and

technological know-how) Capabilities: They are invisible in nature and rarely

reside in a single individual; hence it is difficult to imitate.

2. Capability of Competitors

• The major determinant of the capability of competitors to imitate a company's competitive strategy rapidly is the nature of the competitors prior strategic commitments

• Example : Us automobile industry from 1945 to 1975

• Absorptive capacity : refers to the ability of an enterprise to identify , value , assimilate , and use new knowledge .

• Example : Toyota

3 .Industry Dynamism

• Dynamic industry environment is one that is changing rapidly .

• Dynamic industries tend to be those with a high rate of product innovation .

• Example : Consumer electronic industry and

personal electronic industry

CASE: COMPARING WALMART AND TARGET For the year financial year ending Jan 2008, the

ROIC(Return on Invested Capital) for: 1.) Walmart = 14.1% 2.) Target = 10.6%

Walmart has a lower ROS(Return on Sales) than target since its COGS(Cost of Goods Sold) as a percentage of sales(76.5%) is higher than Target’s(66.1%) i.e. its profit margin on each item sold is lower.

By reducing spending on sales promotions and by operating with a flat organization structure Walmart reduces its SG&A/sales ratio.

Walmart has a lower working capital/sales ratio(-2.90%) than Target(11.24%) i.e. Walmart doesn’t need any capital to finance its day-to-day operations.

Walmart has a significantly lower PPE/sales ratio(25.9%) than Target(35.02%).This is because:

1.) Many Walmart stores are still located in small towns where land is cheap.

2.) Walmart turns its inventory over so rapidly , hence does not need to devote as much space in stores to storing inventory.

3.) Store traffic is higher at Walmart.

Avoiding Failure and Sustaining

Competitive Advantage

Why Companies Fail? Inertia

The inertia argument says that companies find it difficult to change their strategies and structures when adapting to changing competitive conditions.

eg: IBM

Why do Companies Fail? Prior Strategic Commitments

A company’s prior strategic commitments not only limit its ability to imitate rivals but may also cause competitive disadvantage.

Why do Companies Fail?

The Icarus Paradox

Many companies become dazzled by the early success and get over specialized and inner-directed.

They loose the sight of market realities and the fundamental requirements for achieving a competitive advantage.

Step to Avoid Failure Focus on Building Blocks of

Competitive Advantage. Efficiency Quality Innovation Responsiveness

Avoid imbalance with respect to attention to equal importance to each of these blocks.

Step to Avoid Failure Institute Continuous Improvement

and Learning Maintain competitive advantage through

continually improve: Efficiency Quality Innovation Responsiveness to the customers

Step to Avoid Failure Track Best Industrial Practices and

Use Benchmarking Identify and develop distinct competencies

that contribute to superior Efficiency Quality Innovation Responsiveness to customer

Track the best practices followed by the other companies in the industry or segment.

Step to Avoid Failure Overcome Inertia

Overcoming the internal forces that are a barrier to change within an organization is of the key requirements for maintaining a competitive advantage.

Once this is achieved, implementing the change requires. Good Leadership Judicious Use of Power Appropriate Changes in Organizational Structure and

Control System

Step to Avoid Failure The Role of Luck

There’s nothing called as luck. To sustain in a competitive environment,

leaving the company’s strategy in the hands of luck is the ultimate suicidal move.

Thank You