Week 3 Analyzing Firm Capabilities

Analyzing Firm
Capabilities
Image Credit: By Aero Icarus from Zürich, Switzerland [CC BY‐SA 2.0
(http://creativecommons.org/licenses/by‐sa/2.0)], via Wikimedia Commons
This slide handout was created by the University of Virginia Darden School of Business and is provided to support your learning while taking this
course. Please do not share or distribute it. 1
The Fundamental Principle
of Business Strategy
“If everyone can do it, it’s difficult to
create and capture value from it.”
or, alternatively
“In a perfectly competitive market, no
firm realizes economic profits (rents).”
Two Perspectives on Rents

Monopoly Rents Ricardian Rents
(Industrial Organization View) (Resource Based View)
S
MC1 MC2 AC2
S’
P P
AC1
Q q1 q2
•Barriers to entry •Barriers to imitation

•Industry structure matters •Firm structure matters
The Role of Firm Capabilities
• The Resource Based Perspective:

 Premise that firm capabilities MC1 MC2 AC2
matter most
 Economic rents due to barriers to
imitation (i.e. Ricardian rents) P
AC1
 Some firms are more profitable
than others
q1 q2
Cost vs. Demand Advantage
COST ADVANTAGE DEMAND ADVANTAGE
MC1 MC2
AC2 MC
P2 AC
P P1
AC1
q1 q2 q1 q2
Analyzing Capabilities
• Identifying the value chain and specific

resources and capabilities
• Assessing the alignment of capabilities
both internally and externally
• Determining the degree to which any
capability advantage is sustainable
over time
Value Chain

over time

over time
The Value Chain
Supplier Manufacturer Distributor Buyer

Service
Service
Service
Service
The Value Chain
Firm Infrastructure
Secondary Human Resource Management

Activities
Technological Development
Procurement
Service…
Service
Operations
Marketing
Outbound
Logistics
Logistics
Inbound
& Sales
Primary
Activities
Resources to Capabilities
Tangible Intangible
Cash Brands
People/ Physical Plant Reputation
Assets Patents Technical Expertise
Talent Loyalty
Systems/ Contracts/Alliances Positive Culture

Processes IT Systems Talent Acquisition
Alignment

over time
Alignment
• Internal Alignment
 Are our processes, people, and
systems aligned with each other?
 Do they reinforce each other to build
capability?
• External Alignment
 Are capabilities aligned with the value
proposition?
 The “value” in a VRIN analysis
− Valuable Rare Inimitable Non-Substitutable
Alignment: Nucor Steel
Image Credit: Goodwin Steel Castings, https://www.flickr.com/photos/55810025@N06/5206502448

Human Resource Management
• Performance incentives at all levels
• Non-unionized
• Flat hierarchy, limited status
• Participatory decision making
Operating Efficiency High Utilization
Value Proposition:
Low Cost Per Ton
Rapid Expansion
• Little R&D, rely on suppliers
• Steady investment / upgrading
Capital Efficiency • Financed with retained earnings
Capital Resource Management • Kept debt to <30%
• Built in low cost, rural areas • Required 25% ROA within 5 years
• Acted as general contractor
• Design plant as built (to save time)
• Design plant with expansion in mind
• “Tiger team” to start plant
• Hired construction workers for plant
Image Credit: Goodwin Steel Castings, https://www.flickr.com/photos/55810025@N06/5206502448
Sustainability:
Imitation

over time
Sustainability
• The degree to which a competitive

advantage is captured and sustained
 Imitability
 Durability
Sustainability
• Imitability
 Can others do what we do?
 Rarity and inimitability conditions of a
VRIN analysis
Barriers to Imitation
• Legal barriers present
• Control scarce supply
• Developed over unique historical path
• Capabilities are socially complex
• Value derives from tight combinations
• Credibly commit a firm to a course of action
 Can they be used to keep others from exploiting
expanding opportunities?
− Scalable
 Are they limited to this purpose?
− Specificity
Sustainability:
Durability

over time
Sustainability
• The degree to which a competitive

advantage is captured and sustained
 Imitability
 Durability
Sustainability
• Durability
 Can we maintain our capabilities
over time?
 Will they degrade or become obsolete?
Challenges to Durability
• Human and physical assets tend to
degrade over time
• Core capabilities may become core
rigidities
 Success breeds complacency, risk
aversion, myopia
• Valuable capabilities today may be
obsolete tomorrow
• Some assets may be more valuable to
others and thus are worth selling!
Building Capabilities

over time
How Do You Build Capabilities?
• Alternative 1: Acquired from others
 Resource markets
(e.g. labor, technology, patents)
 Mergers & acquisitions
 Alliances, associations, corporate venture
capital
• Limitations:
 Only viable if these factor markets (markets
for things that firms buy) are imperfect!
 Firm must have either superior information or
pre-existing complementary capabilities (or
luck)
Information vs.
Complementarities
Value
Leader
Laggard
Performance
How Do You Build Capabilities?
• Alternative 2: Developed internally
over time
 New product development and internal
Research & Development
 Knowledge management, training
 Superior leadership
• Limitations: Firm still must have either
 Superior information (know-why)
 Pre-existing complementary capabilities
(know-how)
 Luck!
Module Lessons
Module Lessons
• Capability analysis helps identify a firm’s value-
creating activities (i.e., strengths and
weaknesses).
• Capabilities arise through the interaction of
people, processes, and systems.
• To provide a sustainable competitive advantage,
capabilities must by well aligned internally and
externally, durable, and hard to imitate.
• Superior capabilities are either acquired or built
and required superior know-why or know-how (or
luck!).
The Strategist’s
Toolkit: Capabilities
Analysis
The Strategist’s Toolkit:
Capability Analysis
CAPABILITIES 1. ______ 2. ______ 3. ______ 4. ______
Processes
People
Systems
Alignment
Sustainability

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Analyzing Firm

Two Perspectives on Rents

•Barriers to entry •Barriers to imitation

• The Resource Based Perspective:

Cost vs. Demand Advantage

COST ADVANTAGE DEMAND ADVANTAGE

• Identifying the value chain and specific

• Identifying the value chain and specific

• Identifying the value chain and specific

The Value Chain

Supplier Manufacturer Distributor Buyer

Secondary Human Resource Management

Systems/ Contracts/Alliances Positive Culture

• Identifying the value chain and specific

Alignment: Nucor Steel

• Identifying the value chain and specific

• The degree to which a competitive

• Identifying the value chain and specific

• The degree to which a competitive

• Identifying the value chain and specific

CAPABILITIES 1. ______ 2. ______ 3. ______ 4. ______

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CAPABILITIES 1. 2. 3. 4.