Building Competitive Advantage Through Internal Analysis

(1)

Chapter Three

p04-2

Internal Analysis:

Distinctive

Competencies, Competitive Advantage,

and

Profitability

(2)

3 | 2

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

useless, but planning is indispensable.”

- Dwight D.

Eisenhower

(3)

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

(4)

3 | 4

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.

Strengths

Of the enterprise are assets that

boost profitability

Weaknesses

Of the enterprise are liabilities that

lead to lower

profitability

(5)

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

(6)

3 | 6

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 Strategy

is to achieve a

Sustained Competitive Advantage

which in turn results in

Superior Profit and Profit Growth.

(7)

Profitability in the

Computer Industry, 1998-2003

Dell has achieved a sustained competitive advantage over its rivals.

Data Source: Value Line Investment Survey

(8)

3 | 8

Strategy, Resources,

Capabilities, and Competencies

Figure 3.1

(9)

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

(10)

3 | 10

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.

(11)

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:

(12)

3 | 12

Value Creation per Unit

Figure 3.2

(13)

Value Creation and Pricing Options

There is a dynamic relationship among utility, pricing, demand, and costs.

Figure 3.3

(14)

3 | 14

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

(15)

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

(16)

3 | 16

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

(17)

 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.

(18)

3 | 18

 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 attributes

Form, features, performance, durability, reliability, style, design

Quality products are goods and services that are:

(19)

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 Excellence 2. Quality as Reliability

Figure 3.7

(20)

3 | 20

 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.

(21)

 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 support

Superior 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

(22)

3 | 22

Competitive Advantage:

The Value Creation Cycle

Figure 3.8

(23)

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 =

(24)

3 | 24

Definitions of Basic Accounting Terms

Table 3.1

(25)

Drivers of Profitability (ROIC)

Figure 3.9

(26)

3 | 26

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













(27)

Comparing Wal-Mart to Target

Figure 3.10

(28)

3 | 28

“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

(29)

The Durability of Competitive Advantage

1. Barriers to Imitation

Making 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 Dynamism

Ability 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.

(30)

3 | 30

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.

(31)

Avoiding Failure:

Sustaining Competitive Advantage

1. 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 Learning

Recognize the importance of continuous learning within the organization

3. Track Best Practices and Use Benchmarking

Measure against the products and practices of the most efficient global competitors

4. Overcome Inertia

Overcome 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}

(32)

3 | 32

“Developing a sound and

healthy organization requires

understanding the environment

as much as understanding the organization.”

- Gary Hamel