Internal Analysis

By exploiting internal resources and capabilities and meeting the demanding standards of global competition, firms create value for customers.^[1] Value is measured by a product’s performance characteristics and by its attributes for which customers are willing to pay.^[2] Those particular bundles of resources and capabilities that provide unique advantages to the firm are considered core competencies.^[3] Core competencies are resources and capabilities that serve as a source of a firm’s competitive advantage over rivals. Core competencies distinguish a company competitively and reflect its personality. Core competencies emerge over time through an organizational process of accumulating and learning how to deploy different resources and capabilities. As the capacity to take action, core competencies are “crown jewels of a company,” the activities the company performs especially well compared to competitors and through which the firm adds unique value to its goods or services over a long period of time.^[4]

During the past several decades, the strategic management process was concerned largely with understanding the characteristics of the industry in which the firm competes and, in light of those characteristics, determining how the firm should position itself relative to competitors. This emphasis on industry characteristics and competitive strategy may have understated the role of the firm’s resources and capabilities in developing competitive advantage. In the current competitive landscape, core competencies, in combination with product-market positions, are the firm’s most important sources of competitive advantage.^[5] The core competencies of a firm, in addition to its analysis of its general, industry, and competitor environments, should drive its selection of strategies. As Clayton Christensen noted, “Successful strategists need to cultivate a deep understanding of the processes of competition and progress and of the factors that undergird each advantage. Only thus will they be able to see when old advantages are poised to disappear and how new advantages can be built in their stead.”^[6] By drawing on internal analysis and emphasizing core competencies when formulating strategies, companies learn to compete primarily on the basis of firm-specific differences, but they must be aware of how things are changing as well.

Resources and Capabilities

Resources

Broad in scope, the term resources covers a spectrum of individual, social, and organizational phenomena.^[7] Typically, resources alone do not yield a competitive advantage.^[8] In fact, the core competencies that yield a competitive advantage are created through the unique bundling of several resources.^[9]

Some of a firm’s resources are tangible while others are intangible. Tangible resources are assets that can be seen and quantified. Production equipment, manufacturing plants, and formal reporting structures are examples of tangible resources. Intangible resources typically include assets that are rooted deeply in the firm’s history and have accumulated over time. Because they are embedded in unique patterns of routines, intangible resources are relatively difficult for competitors to analyze and imitate. Knowledge, trust between managers and employees, ideas, the capacity for innovation, managerial capabilities, organizational routines (the unique ways people work together), scientific capabilities, and the firm’s reputation for its goods or services and how it interacts with people (such as employees, customers, and suppliers) are all examples of intangible resources.^[10] The four types of tangible resources are financial, organizational, physical, and technological. The three types of intangible resources are human, innovation, and reputational.

As a manager or entrepreneur, you will be challenged to understand the strategic value of your firm’s tangible and intangible resources. The strategic value of resources is indicated by the degree to which they can contribute to the development of core competencies, and, ultimately, competitive advantage. For example, as a tangible resource, a distribution facility is assigned a monetary value on the firm’s balance sheet. The real value of the facility, however, is grounded in a variety of factors, such as its proximity to raw materials and customers, but also in intangible factors such as the manner in which workers integrate their actions internally and with other stakeholders, such as suppliers and customers.^[11]

Capabilities

Capabilities are the firm’s capacity to deploy resources that have been purposely integrated to achieve a desired end state.^[12] As the glue that holds an organization together, capabilities emerge over time through complex interactions among tangible and intangible resources. They can be tangible, like a business process that is automated, but most of them tend to be tacit and intangible. Critical to forming competitive advantages, capabilities are often based on developing, carrying, and exchanging information and knowledge through the firm’s human capital.^[13] Because a knowledge base is grounded in organizational actions that may not be explicitly understood by all employees, repetition and practice increase the value of a firm’s capabilities.

The foundation of many capabilities lies in the skills and knowledge of a firm’s employees and, often, their functional expertise. Hence, the value of human capital in developing and using capabilities and, ultimately, core competencies cannot be overstated. Firms committed to continuously developing their people’s capabilities seem to accept the adage that “the person who knows how will always have a job. The person who knows why will always be his boss.”^[14]

Global business leaders increasingly support the view that the knowledge possessed by human capital is among the most significant of an organization’s capabilities and may ultimately be at the root of all competitive advantages. But firms must also be able to use the knowledge that they have and transfer it among their operating businesses.^[15] For example, researchers have suggested that “in the information age, things are ancillary, knowledge is central. A company’s value derives not from things, but from knowledge, know-how, intellectual assets, and competencies—all of it embedded in people.”^[16] Given this reality, the firm’s challenge is to create an environment that allows people to fit their individual pieces of knowledge together so that, collectively, employees possess as much organizational knowledge as possible.^[17]

To help them develop an environment in which knowledge is widely spread across all employees, some organizations have created a new upper-level managerial position of chief learning officer (CLO). Establishing a CLO position highlights a firm’s belief that “future success will depend on competencies that traditionally have not been actively managed or measured—including creativity and the speed with which new ideas are learned and shared.”^[18] In general, these firm should manage knowledge in ways that will support its efforts to create value for customers.^[19]

Capabilities are often developed in specific functional areas (such as manufacturing, R&D, and marketing) or in a part of a functional area (for example, advertising). The value chain, popularized by Michael Porter’s book, Competitive Advantage, is a useful tool for taking stock of organizational capabilities. A value chain is a chain of activities. In the value chain, some of the activities are deemed to be primary, in the sense that these activities add direct value. In the preceding figure, primary activities are logistics (inbound and outbound), marketing, and service. Support activities include how the firm is organized (infrastructure), human resources, technology, and procurement. Products pass through all activities of the chain in order, and at each activity, the product gains some value. A firm is effective to the extent that the chain of activities gives the products more added value than the sum of the costs at each step. While both primary and support activities add to a firm’s cost structure, due to their enabling nature, support activities are often candidates for outsourcing. Distinguishing between the two types of activities is a critical first step in understanding the firm’s value chain. Firms do not outsource primary activities if they are a source of competitive advantage.

It is important not to mix the concept of the value chain with the costs occurring throughout the value chain activities. A diamond cutter can be used as an example of the difference. The cutting activity may have a low cost, but the activity adds to much of the value of the end product, since a rough diamond is significantly less valuable than a cut, polished diamond. Research suggests a relationship between capabilities developed in particular functional areas and the firm’s financial performance at both the corporate and business-unit levels,^[20] suggesting the need to develop capabilities at both levels.