chapter three internal analysis: distinctive competencies, competitive advantage, and profitability

Chapter ThreeInternal

Analysis: Distinctive

Competencies, Competitive

Advantage, and

Profitability

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“In preparing for battle I have always found that plans are

useless, but planning is indispensable.”

- Dwight D. Eisenhower

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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

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.

Building and sustaining a competitive advantage requires a company to achieve superior:

• Efficiency• Quality

• Innovations• Responsiveness to customers


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.

StrengthsOf the enterprise are assets that

boost profitability

Weaknesses Of the enterprise are liabilities that

lead to lower profitability


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 Quality

3. Analyze the sources of the company’s competitive advantage. Strengths – that are driving profitability Weaknesses – opportunities for improvement

Innovation Responsiveness to Customers


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 Strategyis to achieve a Sustained Competitive Advantagewhich in turn results in Superior Profit and Profit Growth.


Profitability in the Computer Industry, 1998-2003

Dell has achieved a sustained competitive advantage over its rivals.

Data Source: Value Line Investment Survey


Strategy, Resources, Capabilities, and Competencies

Figure 3.1


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


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.


Competitive Advantage, Value Creation, and Profitability

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.

How profitable a company becomes depends on three basic factors:


Value Creation per UnitFigure 3.2


Value Creation and Pricing Options

There is a dynamic relationship among utility,

pricing, demand, and costs.

Figure 3.3


Comparing Toyota and General Motors

Superior value creation requires that the gap between perceived utility (U) and costs of production (C)

be greater than that obtained by competitors.

Figure 3.4


The Value Chain

A company is a chain of activities for transforming inputs into outputs that customers value –

including the primary and support activities.

Figure 3.5


Building Blocks of Competitive Advantage

The Generic Distinctive Competencies

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

Figure 3.6


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.


Quality

• 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 attributesForm, features, performance, durability, reliability, style, design

Quality products are goods and services that are:


A Quality Map for Automobiles

When customers evaluate the quality of a product, they commonly measure it against two kinds of attributes:1. Quality as Excellence2. Quality as Reliability

Figure 3.7


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.


Responsiveness to Customers

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 supportSuperior responsiveness to customers

differentiates a company’s products and services and leads to brand loyalty and premium pricing.

Identifying and satisfying customers’ needs – better than the competitors


Competitive Advantage: The Value Creation Cycle

Figure 3.8


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)• Net profit Net income after tax

Capital invested Equity + Debt to creditors

• Net Profit

Net Profit = Total revenues – Total costs

= ROIC =


Definitions of Basic Accounting Terms

Table 3.1


Drivers of Profitability (ROIC)

Figure 3.9


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


Comparing Wal-Mart to Target

Figure 3.10


“Sears ignored us in the early years and in the end we simply blew right by them.”

- Sam Walton Chairman, Wal-Mart

www.walmart.com


The Durability of Competitive Advantage

1.Barriers to ImitationMaking 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 DynamismAbility of an industry to change rapidly

The DURABILITY of a company’s competitive advantage over its competitors depends on:

Competitors are also seeking to develop distinctive competencies that will give them a competitive edge.


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.


Avoiding Failure: Sustaining Competitive Advantage1. 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 LearningRecognize the importance of continuous learning within the organization

3. Track Best Practices and Use BenchmarkingMeasure against the products and practices of the most efficient global competitors

4. Overcome InertiaOvercome the internal forces that are barriers to change

Luck may play a role in success, so always exploit a lucky break - but remember:

“The harder I work, the luckier I seem to get.” J P Morgan


“Developing a sound and healthy organization requires understanding the environment

as much as understanding the organization.”

- Gary Hamel

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chapter three internal analysis: distinctive competencies, competitive advantage, and profitability

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