Internal Analysis

By putting internal resources and capabilities to good use and meeting the demanding standards of global competition, firms create value for customers (Buckley & Carter, 2000; McEvily & Chakravarthy, 2002). Value is measured by a product’s performance characteristics and by its attributes for which customers are willing to pay (Hindle, 2008, p. 165). Those particular bundles of resources and capabilities that provide unique advantages to the firm are considered core competencies (Prahlad & Hamel, 1990). 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 the “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 (Hafeez et al, 2002; Prahalad & Hamel, 1990).

While Amazon excels in logistics, innovation, and an extensive product range, it can be argued that its main core competency is its customer-centricity. By consistently investing in advanced technology, such as automation, data analytics, and AI, Amazon achieves operational efficiency and elevates the customer experience. Prioritizing customer satisfaction, evident through services like Amazon Prime and personalized recommendations, cultivates loyalty and encourages repeat business. In addition, Amazon’s expansive marketplace, complemented by a diverse community of third-party sellers, in conjunction with its own products and services, provides customers with an unmatched selection of choices (Twin, 2023).

During the past several decades, the SMP 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. (See the I/O Model for AAR from Chapter 1: What Is Strategic Management?) This emphasis on industry characteristics and competitive strategy may have understated the role of the firm’s resources and capabilities in developing competitive advantage. (See the Resource-based Model for AAR from Chapter 1.)

In the current competitive landscape, core competencies, in combination with product-market positions, are the firm’s most important sources of competitive advantage (Hitt et al., 1999). In addition to analysis of its general, industry, and competitor environments, the core competencies of a firm 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” (Christensen, 2001, p. 109).

Resources and Capabilities

Broad in scope, the term resource covers a spectrum of individual, social, and organizational phenomena (Eisenhardt & Martin, 2000; Michalisin et al., 2000). Typically, resources alone do not yield a competitive advantage (Chi, 1994; Deeds et al., 2000; West & DeCastro, 2001). In fact, the core competencies that yield a competitive advantage are created through the unique bundling of several resources and/or capabilities (Berman et al., 2002).

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 (Feldman, 2000; Knott & McKelvey, 1999).

The four types of tangible resources are (1) financial, (2) organizational, (3) physical, and (4) technological. The three types of intangible resources are (1) human, (2) innovation, and (3) reputational.

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 and AARs. 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, goes beyond the balance sheet and is grounded in a variety of factors, such as proximity to raw materials and customers, as well as the way workers integrate their actions internally and with suppliers and customers (Coff, 1999; Gavetti & Levinthal, 2000; Marsh & Ranft, 1999).

Capabilities are the firm’s capacity to deploy resources that have been purposely integrated to achieve a desired end state (Helfat & Raubitschek, 2000). As the glue that holds an organization together, capabilities emerge through complex interactions among tangible and intangible resources guided by strategic decisions over time based on the organization’s values and priorities. They can be tangible, like a business process that is automated, but most of them tend to be intangible. Critical to forming competitive advantages, capabilities are often based on developing, carrying, and exchanging information and knowledge through the firm’s human capital (Hitt et al., 2000; Hitt et al., 2001; Hoopes & Postrel, 1999; Quinn, 1992). 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.

Core Competency

The foundation of many capabilities lies in a firm’s employees and 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 their boss” (“Thoughts,” 1999, p. 352).

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 businesses (Argote & Ingram, 2000). 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” (Dess & Picken, 1999, p. 26). 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 (Coy, 2002, p. 24).

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” (Baldwin & Danielson, 2000, p. 5). In general, these firms should manage knowledge in ways that will support its efforts to create value for customers (Hansen et al., 1999; Kuratko et al., 2001).

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, The Competitive Advantage (1985), is a useful tool for taking stock of organizational capabilities. A value chain is a series of activities. In a value chain, some activities are deemed to be primary value chain activities, in the sense that these activities add direct value. In Figure 4.3, primary activities are logistics (inbound and outbound), marketing, and service. Support value chain activities, also referred to as secondary activities, include how the firm is organized (infrastructure), human resources, technology, and procurement.

Products or services pass through all activities of the value 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 secondary 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 when they are a source of competitive advantage.

It is important not to mix the concept of value with the costs incurred during the value chain activities. Consider a diamond cutter as an example. The cutting activity may have a low cost, but the activity adds most of the value in the end product, since a rough diamond is worth significantly less than a cut and polished one. Research suggests a relationship between capabilities developed in functional areas and the firm’s financial performance at both the corporate and business-unit levels, suggesting the need to develop capabilities at both levels (Hitt, Ireland, & Palia, 1982; Hitt, Ireland, & Stadter, 1982; Hitt & Ireland, 1985; Hitt & Ireland, 1986; Snow & Hrebiniak, 1980).

Starbucks’ value chain involves sourcing high-quality coffee beans through ethical and sustainable practices, operating coffee roasting facilities to create consistent blends, distributing products through retail stores and efficient supply chain management, marketing efforts focused on brand image and customer experience, delivering excellent customer service through well-trained baristas, and supporting activities like infrastructure development and employee training. By effectively managing these activities, Starbucks stands out in the market by offering a premium coffee experience, driven by its commitment to sustainability and customer satisfaction (Bajpai, 2023).

Value Creation

Let’s step away from describing how a core competency is developed and put value creation in context of the activities that a firm and its related stakeholders perform to create value within an entire industry. Value chain analysis (VCA) is a formal process where a firm identifies and distinguishes the primary activities that add value to its product or service from supporting activities.

Sourcing raw materials and resolving customer complaints are vastly different types of activities—indeed, they are opposite ends of the value chain. As discussed in Chapter 1: What Is Strategic Management? on the I/O Model of AAR, the industry in which a firm competes accounts for about 20% of profitability. Some firms will choose to control as much of the value chain (known as vertical integration, discussed in Chapter 6: Corporate-level Strategy) while others will use value chain analysis to decide which ones to perform internally and which to outsource (Figure 4.4).

Outsourcing is the act of contracting an internal activity out to a third party with better expertise or greater scale that allows them to perform the same activity for less money or to do more things for the same cost. Typically, these third parties are higher up the value chain (toward the extraction of raw materials) or lower down (in the direction of end customers) in the same industry or in an adjacent industry. The firm that is outsourcing its work still gets the task completed but at a lower cost than if they had executed it themselves. For example, most online retailers distribute their product through a third party such as United Parcel Service, FedEx, or the United State Postal Service; shipping is a necessary part of selling in e-commerce, but buying planes and trucks and hiring drivers is specialized and expensive.

Importantly, a firm will not outsource an activity that it considers a core competency. As a result, many primary value chain activities are kept internal to maximize control while support activities are often candidates for outsourcing. Firms use benchmarking to compare their internal performance to industry leaders and rival competitors in areas of quality, profitability, customer satisfaction, and operational efficiency.

The challenge of making effective strategic decisions to improve, integrate, or outsource are implied by evidence suggesting that one-half of organizational decisions fail (Sengupta et al., 2015). Sometimes, mistakes are made when the firm analyzes conditions in its internal organization (Holahan et al., 2014; Schilke, 2014). If a firm fails to continually invest in and upgrade its core competencies, those capabilities may lose their attractiveness. The opposite is true as well. Imagine the problems that arise when management thinks it has identified a core competency when it really hasn’t—needless investment and inefficient operations that might be better handled by a third party.

Next, we’ll explore an analytical model that helps firms understand which of their activities are core competencies and where they have weaknesses in their firm-level value chain.

Toolkit: VRIO Analysis

While VCA aims to sort primary and support value chain activities within an organization to identify cost drivers and value—adding activities, VRIO analysis identifies core competencies by determining those primary activities that are valuable, rare, inimitable, and organized to capture value to determine the sustainability of competitive advantage (Figure 4.5).

Given that almost anything a firm possesses or does can be considered a resource or capability, how should we attempt to narrow down the ones that lead to competitive advantage and AARs? To lead to an SCA and differentiate one firm from its competitors, a resource or capability should meet all four of the VRIO requirements. That is, it must be (1) valuable in the eyes of its customers, (2) rare in that only one or a few firms possess it, (3) there must be no or few substitutes (inimitable) or is costly to imitate in terms of money or time, and (4) the firm is organized in such a manner that it is able to capture the resource’s value-creating potential. This VRIO^[1] framework is the foundation for such an internal analysis (Wernerfelt, 1984).

If you ask managers why their firms do well while others do poorly, a common answer is likely to be “our people.” This may be the start of an answer, but it is incomplete. We need to probe deeper—what is it about “our people” that is especially valuable? Why don’t competitors have similar people? Why haven’t competitors hired your people away? Or is it that there is something special about the organization—rewards, culture, or structure—that brings out the best in people? These kinds of questions are part of VRIO and get to the heart of why some resources help firms more than others.

Moreover, your ability to identify whether an organization has VRIO resources or capabilities will also likely explain their competitive position. In Table 4.1, you can see that a firm’s performance relative to industry peers is likely to vary according to the level to which resources, capabilities, and ultimately, core competences satisfy VRIO criteria.

The table shows the four VRIO criteria—Valuable, Rare, Inimitable, and Organized—and their combinations leading to different performance outcomes. The table lists combinations of “Yes” or “No” across the columns, with corresponding performance levels (e.g., Below Normal, Above Normal) and competitive implications like “Competitive Disadvantage” or “Sustained Competitive Advantage.”

The VRIO Factors

Valuable: A resource or capability is said to be valuable if it allows the firm to exploit opportunities or negate threats in the environment. If a resource does not allow a firm to minimize threats or seize opportunities, it does not enhance the competitive position of the firm. In fact, some scholars suggest that owning resources that do not meet the VRIO test of value puts the firm at a competitive disadvantage (Barney, 1991).

Despite being a well-established brand in the hygiene industry, Colgate continues to explore strategies to maintain its market share. The company’s R&D team identified a concern: Some customers were not using their toothbrushes and toothpaste correctly. In response, Colgate acted by developing products that encourage proper use and emphasized this aspect in their marketing efforts. This proactive approach demonstrates that even companies with a substantial customer base must continually add value to ensure ongoing success. By addressing customer needs and promoting proper product usage, Colgate aims to enhance customer satisfaction and secure its position in the market (Tendayi, 2019).

Key value questions:

1. Which activities lower the cost of production without decreasing perceived customer value?
2. Which activities increase product or service differentiation and perceived customer value?
3. Has the organization ever won an award or been recognized as the best in something?
4. Does the firm have access to scarce raw materials or those hard to get in the distribution channel?
5. Does the organization have a relationship with their suppliers?
6. Does the firm have employees with unique skills and capabilities?
7. Does the organization have a brand reputation for quality, innovation, and/or customer experience?
8. Does the firm have any other strengths compared to rivals?

Rare: A resource is rare if it is not widely possessed by other competitors. Of all the VRIO criteria, this is probably the easiest to judge. For example, Coke’s brand name is valuable, but most of Coke’s competitors (Pepsi, 7Up, RC) also have widely recognized brand names, making it not that rare. While Coke’s brand may be the most recognized brand in the world, that makes its brand more valuable, not rarer.

A firm that possesses valuable resources that are not rare is not in a position of advantage relative to competitors. Rather, valuable resources that are commonly held by many competitors simply allow firms to be at par with competitors. However, when a firm maintains possession of valuable resources that are rare in the industry, they are in a position of competitive advantage over firms that do not possess the resource. They may be able to exploit opportunities or negate threats in ways that those lacking the resource will not be able to do.

How rare do the resources need to be for a firm to have a competitive advantage? In practice, this is a difficult question to answer unequivocally. At the two extremes (i.e., only one firm possesses the resource or all firms possess it), the concept is intuitive. If only one firm possesses the resource, it has significant advantages over all other competitors. However, meeting the condition of rarity does not always require exclusive ownership. When only a few firms possess the resource, they will have an advantage over the remaining competitors.

For instance, Toyota and Honda both have the capabilities to build cars of high quality at relatively low cost (Dyer et al., 2004). Their products regularly beat rival firms’ products in both short-term and long-term quality ratings (Dyer & Hatch, 2004). Thus, the criterion of rarity requires that the resource not be widely possessed in the industry. It also suggests that the more exclusive a firm’s access to a particularly valuable resource, the greater the benefit for having it.

Key rarity questions:

1. How many other organizations own the resources or can perform the capability in the same way as the firm can?
2. Can a resource be easily bought in the market by one of their competitors?
3. Can competitors obtain the resource or capability soon?

Inimitable: An inimitable (the opposite of imitable) resource is difficult to imitate or to create ready substitutes for. If a resource is valuable and rare and responsible for a market leader’s competitive advantage, it is likely that competitors lacking the resources or capability will do all they can to obtain the resource or capability themselves. The concept of imitation includes any form of acquiring the lacking resource or substituting a similar resource that provides equivalent benefits.

Tablet computers have existed for some time, but with the introduction of the iPad, the market started to truly flourish. Apple’s design and innovation have been so exceptional that imitating it successfully proved to be a daunting task. This is evident from the multitude of knockoffs and imitation products of Apple’s iPod, iPad, and MacBook, which have failed to capture significant market share (Penn, 2021).

As strategy researcher Scott Gallagher notes:

This is probably the toughest criterion to examine because given enough time and money almost any resource can be imitated. Even patents only last 17 years and can be invented in even less time. Therefore, one way to think about this is to compare how long you think it will take for competitors to imitate or substitute something else for that resource and compare it to the useful life of the product.

Another way to help determine if a resource is inimitable is why/how it came about. Inimitable resources are often a result of historical, ambiguous, or socially complex causes. For example, the U.S. Army paid for Coke to build bottling plants around the world during World War II. This is an example of history creating an inimitable asset. Generally, intangible (also called tacit) resources or capabilities, like corporate culture or reputation, are very hard to imitate and therefore inimitable (S. Gallagher, personal communication, January 30, 2009).

Key imitability questions:

1. Can competitors easily duplicate a resource?
2. Can competitors easily develop a substitute resource?
3. Does the firm have patents, trademarks, or copyrights?
4. Is a resource or capability socially complex?
5. Is it hard to identify the processes, tasks, or other factors that form the resource?

Organized to capture value: The fourth and final VRIO criterion acknowledges that mere possession or control of a capability or resource is insufficient to gain an advantage; the firm must also employ it. That is, the firm must actively exploit the V-R-I resource or capability for it to become a core competency.

DriveScale was founded in 2013 to provide dynamically composed server systems and storage (i.e., big data systems) and developed a DriveScale Adapter product to use ethernet and cloud storage. They were acquired by Twitter in 2021 when they were outmaneuvered by two competitors in their very specialized market niche. While they were successful at creating a viable tool, their market capitalization prevented them from achieving the scale of their two rivals. They had created a valuable, rare, and inimitable product that they were unsuccessful at exploiting in the market (Mellor, 2021).

The question of organized to capture value is broad and encompasses many facets of a firm but essentially means that the firm can capture any value that the resource or capability might generate. This concept spans such firm characteristics as control systems, reporting relationships, compensation policies, and management interface with both customers and value-adding functions in the firm.

While being organized to capture value addresses a firm’s current readiness to leverage existing resources, firms also must consider dynamic capabilities. This is the ability to adapt, integrate, and reconfigure its resources in response to a changing environment. Dynamic capabilities are about future readiness.

Key organized to capture value questions:

1. Does the organization have an effective SMP?
2. Are there effective motivation and reward systems in place?
3. Does the culture reward innovative ideas?
4. Is the organizational structure designed to use the resources?
5. Are there excellent management and control systems in place?
6. What makes the firm uniquely positioned to exploit this capability or resource?

Summarizing VRIO

A valuable but widely held resource only leads to competitive parity for a firm if they also possess the capabilities to exploit the resource. Likewise, a firm that possesses a valuable and rare resource will not gain a competitive advantage unless it can put that resource to effective use.

Many firms have valuable and rare resources that they fail to exploit. For instance, Intel has long been a powerhouse in the integrated circuits business but that advantage has become less robust. While possessing resources that are valuable, they are “one of only a handful of American companies able to produce the best chips at scale” (Acton & Chazan, 2024) that are also rare—only Taiwan’s TSMC had similar capabilities—organizational inefficiencies prevented the company from full exploiting these advantages as of 2024. They found themselves scrambling to restructure and retool. In the face of national security concerns, the U.S. government considered buying a stake in Intel in 2025 to provide the capital investment necessary to break its reliance on Chinese technology (Foley, 2025).

Toolkit: SWOT Analysis

While VRIO core competencies are necessary, they are by definition quite rare, and it is not uncommon for successful firms to simply be combinations of a large number of just V-R-O or even just V-O resources and capabilities. Let’s apply an old business school standby analytical tool, SWOT, to strategy decisions where we’ll see that even a V-O resource can be considered a strength under a traditional SWOT analysis (Figure 4.8).

Strengths and Weaknesses

In general, good strategies take advantage of strengths and minimize the disadvantages posed by weaknesses. Michael Jordan, for instance, was an excellent all-around athlete; he excelled in baseball and golf, but his athletic skills showed best in basketball. As with Jordan, when we identify a certain strength that sets an organization apart from actual and potential competitors, that strength is considered a source of competitive advantage even if it doesn’t satisfy the VRIO criteria for core competency.

Opportunities and Threats

An understanding of the external environment is a critical input for strategy. Opportunities comprise the external attractive factors that represent the reason for a business to exist and prosper. That is, what are the opportunities that exist in the firm’s market, or in the external environment, from which managers might hope the organization will benefit? Threats include factors beyond the firm’s control that could place the strategy, or the business, at risk.

In a nutshell, SWOT analysis helps identify strategic alternatives that address the following questions:

1. Strengths and Opportunities (SO) – How can you use your strengths to take advantage of the opportunities?
2. Strengths and Threats (ST) – How can you take advantage of your strengths to avoid real and potential threats?
3. Weaknesses and Opportunities (WO) – How can you use your opportunities to overcome the weaknesses you are experiencing?
4. Weaknesses and Threats (WT) – How can you minimize your weaknesses and avoid threats?

Most importantly, a SWOT analysis needs to both draw a set of concrete conclusions from the firm’s specific situation and identify a set of strategic actions to address each factor. The ultimate goal is to match the company’s resource strengths with market opportunities, correct important weaknesses, and defend against external threats.

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