CH-3 Evaluating a Firm’s Internal Capabilities – Strategic Management and Competitive Advantage Concepts and Cases : Chapter Notes

3 Evaluating a Firm’s Internal Capabilities The Importance of Internal Analysis By this point in the course, students should have a grasp of the strategic management process and a good understanding of external analysis. Whereas you have taken them through models of external analysis that suggest what a firm should do, you will now be taking them through a model of internal analysis that will suggest what a firm can do. External and internal analyses, considered together, are fundamental building blocks in the strategic management process. The Resource-Based View (RBV) draws upon compelling economic logic to offer a framework for thinking about which, if any, of the firm’s resources and capabilities are likely to lead to competitive advantage. It is important that students understand this logic. They should be able to recognize why the attributes of resources will or won’t lead to competitive advantage. Students need to understand that RBV logic can be applied in two important ways. First, this logic can be used to analyze a firm’s status quo—to form a reasoned opinion as to whether a firm’s existing resources are likely to result in a competitive advantage. Second, and perhaps more importantly, this logic can be used as a planning tool—to help managers see how a firm’s resources should be deployed to gain competitive advantage. Thus, the logic laid out in this chapter is central to the very idea of strategic choice aimed at creating competitive advantage. What Does Internal Analysis Tell Us and Why Does It Matter? Internal analysis makes sense to students who understand one of the main roles of managers, namely organizing and deploying the resources of the firm. One effective way to provide a meaningful context for this class period is to start off with a brief discussion about what managers do.  Teaching Points • Ask students to describe the responsibilities of a CEO. • Students will usually respond with things like making decisions about: hiring and firing people, acquiring other companies, introducing new products, entering new markets, building new factories, etc. • Point out to students that all of these activities are really a matter of organizing and deploying the resources of the firm. • A CEO’s duties can be broadly described as doing just that: organizing and deploying the resources of the firm. • In order to carry out these responsibilities, a CEO needs to understand the resources of the firm and how those resources compare to other firms’ resources. • Internal analysis is a process for helping managers to understand a firm’s resource position. What Does Internal Analysis Tell Us? Internal analysis is a way of looking inside a firm to determine what the firm’s strengths and weaknesses might be. We want to take this look in a comparative sense so that we are clear about strengths and weaknesses as compared to relevant competitors.  Important Point: Students need to understand how internal analysis fits into the strategic management process relative to external analysis. External analysis tells us what the threats and opportunities are in the external environment. Thus, it provides direction about what the firm should do. Internal analysis tells us what the firm can do. Internal analysis builds on external analysis by providing a framework for managers to think about how a firm’s resources can be deployed to best exploit opportunities and neutralize threats in the external environment. Slide 3-2 Emphasize that the strengths and weaknesses of a firm should be considered relative to the strengths and weaknesses of competing firms. Why Does Internal Analysis Matter? The “Big Idea” behind internal analysis is that we are attempting to discover potential sources of competitive advantage. It’s not just that we want to know if the focal firm has better resources than another firm; rather, it’s that we want to know if the focal firm possesses resources that could be deployed in such a way that competitive advantage could be achieved. Internal analysis allows a firm to develop strategy with a reasonable expectation of competitive advantage. Without an internal analysis, firms would just be guessing as to whether a strategy would result in competitive advantage. The following example illustrates the importance of internal analysis.
► Example: Softsoap Enters the Market Softsoap was the brainchild of Minnetonka’s CEO, Robert Taylor. The idea of putting liquid hand soap in a pump container for home use was novel at the time. Taylor knew that the most likely competitors would be large companies like Procter & Gamble who were good at developing and marketing new products for the home and personal care markets. Had Taylor forged ahead without any form of internal analysis he would have rightly developed a great product. He knew the liquid soap would be easy to manufacture and that he could buy the pumps from one or both of the two existing pump manufacturers. Procter & Gamble, and probably others, would have quickly imitated his product and most likely driven him out of business. These other manufacturers were many times larger than Minnetonka. However, Taylor engaged in a form of internal analysis by recognizing that even though these larger companies had a resource advantage when it came to manufacturing and marketing the liquid soap, they had no advantage when it came to the pump bottles. He recognized that if he bought all the pump bottle production of the two manufacturers he would have an advantage over firms much larger than Minnetonka. Taylor bought all the pumps the two manufacturers could produce in a year. He paid more for these orders of pumps than Minnetonka was worth at the time. The strategy worked. He had a 12-18 month lead over his much larger competitors in which he was able to establish the Softsoap brand and capture market share. (Brandenburger & Nalebuff, 1995, The Right Game: Use Game Theory to Shape Strategy, Harvard Business Review.) Slide 3-3 Be sure to tell students that internal analysis is useful in determining whether or not a firm’s current resources are likely to be a source of competitive advantage, but internal analysis is most valuable as a tool for helping firms establish strategy. THE RESOURCE-BASED VIEW The RBV is the theoretical lens through which internal analysis is conducted. A bit of history is in order here. The most popular strategic management theory and thinking before the mid-1980s was based on the Structure-Conduct-Performance Model from industrial organization economics. Recall from Chapter 2 that in this view of economic performance industry characteristics were assumed to be the primary drivers of a firm’s economic performance. In the mid-1980s scholars began to argue that the primary drivers of firm performance may be found at the firm level instead of the industry level. Differences in the resource endowments of firms were viewed as being the root causes of differences in firm performance. This very Ricardian view quickly became known as the Resource-Based View of the firm. This shift in level of analysis from the industry level to the firm level has important implications for management. Where the S-C-P message seemed to be “choose the right industry,” the RBV message seems to be “choose the right resources.” Slide 3-4 Make sure that students understand that the focus of this model is internal to the firm and that this is a very different focus than we took in Chapter 2. Remind them that we are now operating on the assumption that firm-level characteristics are the primary drivers of performance. Scholars began to think about firm-level characteristics to try to answer the question: Why do some firms do better than other firms? The resources a firm possesses or controls provided a natural place to begin looking for answers to this question. Defining a firm’s resources and capabilities is an important step in teaching students about using the RBV to conduct internal analysis. Resources & Capabilities Describe Four Types of Resources and Capabilities • resources are the tangible and intangible assets that a firm controls, which it can use to conceive of and implement its strategies • capabilities are a subset of resources that enable a firm to take full advantage of other resources the firm controls Slide 3-5 Emphasize the point that capabilities are simply a subset of resources.  Important Point: Sometimes students get confused as they try to separate these two concepts. Don’t get too hung up on this issue. Just remember that any asset or ability of a firm is a resource. Capabilities are simply those resources that firms use to combine and deploy other resources. Slide 3-6 Ask students to categorize these firm assets as either resources or capabilities. Machinery is a resource. Collective Product Design skill is a capability. This refers to the ability of the firm, working together, to produce new product designs. Recruiting skill is a firm capability. Engineering skills of individuals are firm resources. Mineral deposits are firm resources. Four Types of Resources • financial—the money available to the firm from whatever source (debt, equity, retained earnings, etc.) • physical—machinery, factories, offices, raw materials, geographic location, technology • human—training, experience, individual intelligence, judgment, work ethic • organizational—reporting structures, reward systems, coordinating systems, relationships, etc. Slide 3-7 Remind students that virtually any firm characteristic they could articulate would fit into one of these categories of resources. The purposes of categorizing resources are: 1) simply to demonstrate that anything and everything may be viewed as a resource, and 2) to show later on that different types of resources may be combined to form the capabilities of the firm. ► Example: Coca-Cola’s Resources and Capabilities Coca-Cola has a distinctive red can with a trademarked white wave image that goes around the can. These are physical resources. Coca-Cola has access to substantial working capital (cash). This is a financial resource. Coca-Cola has talented marketing professionals. These are individual human resources. Coca-Cola also has a well-established set of reporting structures, reward systems, communications systems, and IT systems. These are organizational resources. Coca-Cola has the ability to put these various resources together in an effective marketing campaign. This is a capability. Thus, we would correctly refer to Coca-Cola’s marketing capability as one of its resources right along with its other physical, capital, human, and organizational resources.  Teaching Points • Ask students to name some firms that have resources that clearly make them different from the competition. • Ask students if those differences are due to financial, physical, human, or organizational resources. • Students will usually state that what makes the firm stand out from the rest is a combination of different types of resources. • Point out that the ability to put those resources together in a way that makes the firm different is a capability. Two Assumptions of the Resource-Based View Describe the Critical Assumptions of the Resource-Based View The RBV makes two critical assumptions that set it apart from the industrial organization economics that preceded it. In the IO economics view of the world, any firm differences that may arise would be quickly dissipated through competition. If one firm had a good idea, others would quickly copy it. There would be no enduring differences between firms. The RBV makes two assumptions that directly oppose this idea. Resource Heterogeneity: different firms may possess different resources and capabilities even if they are competing in the same industry. This is an explicit recognition that all firms are not the same. Resource Immobility: some resources may not be moved from firm to firm without substantial cost. It may be more costly for a firm to acquire a desirable resource than what the resource is worth to that firm. Slide 3-8 Explain to students that most of the time it is technically possible for a firm to acquire most any resource. However, resource immobility means that it is so costly to acquire the resource, that it wouldn’t make economic sense. These two assumptions make the notion of enduring firm differences plausible. The idea of enduring firm differences may not be all that novel to students—it seems like common sense. But, if we are to explain why one firm does better economically than another we need to have a logical explanation as to why there are causal differences between the firms.  Important Point: Students must understand these two assumptions before you move on to the VRIO model that follows. In the simplest of terms, these assumptions mean that one firm can be better at something than other firms and that the difference may be enduring. Slide 3-9 Emphasize that existence of differences between firms implies that some firms can be better at something than other firms, i.e., some firms can have a competitive advantage.  Important Point: A firm may possess resources that are similar to the resources of other firms (homogeneous). However, the managers of that firm may employ firm capabilities in such way as to create heterogeneous bundles of resources. In other words, managers can take common resources and create uncommon bundles of resources so that firm differences exist—even if the original basic building blocks (resources) are the same. Slide 3-10 Drive home the point that managers matter in this view because they have the ability to create firm differences even if they are working with resources that are rather common. Also, emphasize that competitive advantage usually comes from several resources bundled in a heterogeneous combination. THE VRIO FRAMEWORK Apply the VRIO Framework to Identify the Competitive Implications of a Firm’s Resources and Capabilities The VRIO Framework is the analysis ‘tool’ of the RBV. This framework is a way of examining resources to determine if a resource is likely to be a source of competitive advantage. Four criteria must be met if a resource is to lead to competitive advantage. These four criteria are represented by questions in the framework. The framework allows us to draw conclusions about competitive advantage based on answers to the four questions. Slide 3-11 Briefly introduce these questions as described below. Four Questions • Value – Does the resource enable the firm to exploit an opportunity or neutralize a threat? The evidence of a positive response to this question is usually that the resource somehow increases revenue or decreases cost. • Rarity – Is the resource rare? Is the resource rare enough that there is still scarcity in the marketplace for this resource? • Imitability – Is the resource costly to imitate? Specifically, is the resource so costly to imitate that no one would try to imitate it? • Organization – Is the firm organized in such a way that the resource can be exploited? If the answer to these four questions is affirmative, then the firm can reasonably expect to achieve a competitive advantage. Of course, there will be many resources that meet some but not all of the criteria. The competitive implication of these resources will be explained as we move along. Slide 3-12 Explain that a firm’s resource(s) must meet all four criteria if an enduring difference is to exist between the focal firm and its competitors. Tell students that the competitive implications of resources that do not meet all four criteria will be explained later. Discussion & Activity This discussion will help students realize why enduring differences are necessary for one firm to have an advantage over other firms. Ask if any students in the class have traveled to Europe or Japan. If some have, ask them if they encountered the appeal of Levi’s jeans in any of the countries they visited. You will usually get a description of outrageous prices that people in some other countries are willing to pay for a pair of new, or even used, Levi’s jeans. If no students have traveled to a country where Levi’s are so highly valued, explain to students that in Russia and Japan there are people who are willing to pay several multiples of the original price for Levi’s jeans. Now ask students why people are willing to pay so much for these jeans. List the reasons on the board. Now ask why other jeans manufacturers haven’t offered the same characteristics in their jeans. The answers will usually boil down to some form of reputation. Point out that any number of competitors could easily manufacture a pair of jeans that looked the same and wore the same. But, there is that difference in reputation and perception that others just don’t have. That difference raises the value of the jeans in the eyes of at least some people. If the difference wasn’t there, we wouldn’t expect to see people willing to pay such a premium for Levi’s jeans. APPLYING THE VRIO FRAMEWORK The VRIO Framework is applied by subjecting one or more resources, bundles of resources, or a capability to each of the four questions.  Important Point: Students must understand that the framework is applied on a resource-by-resource basis and not to the firm as a whole. For example, if a firm sought help in analyzing its proposed introduction of a new personal digital music device, the VRIO Framework might be applied to the firm’s design capability, marketing capability, distribution capability, proposed product per se, etc. This helps to highlight which of these resources, if any, might be sources of competitive advantage. Slide 3-13 Emphasize the point that these questions are asked in a comparative sense, meaning that the competitive context is taken into account. For example: Is the resource valuable in the market where it is being used or where it is planned to be used given the resources that other firms are deploying in that market? Is the resource rare in this market? The Question of Value This is a straightforward question intended to ascertain whether or not the resource is strategically relevant. There is a cost to the firm of carrying any resource and if the firm does not receive some benefit that outweighs the cost, then the firm is at a competitive disadvantage. If the firm receives a benefit that outweighs the carrying cost of the resource, then we would conclude that the resource is valuable, and could, therefore, be a potential source of competitive advantage. Apply Value Chain Analysis to Identify a Firm’s Valuable Resources and Capabilities Using Value Chain Analysis to Identify Potentially Valuable Resources and Capabilities A firm’s value chain is the set of business activities in which it engages to develop, produce, and market its products or services. Each step in the value chain requires the application and integration of different resources and capabilities. A look at figure 3.2 in the text shows us that a number of activities are required to convert crude oil into, say, gasoline and each activity requires specific resources and capabilities. Slide 3-14 Most resources are valuable. However, the important question here is whether the resource is valuable in this specific context. Make sure that students understand that the resource must be valuable in the firm’s intended use for that resource. The Question of Rarity Having established that a resource is valuable, we next turn our attention to the question of rarity. We are interested in whether a resource is rare enough that it creates a difference between the focal firm and its competitors such that the focal firm realizes some advantage from the difference. This question is tied to the assumption of resource heterogeneity. If there is to be any advantage in having a resource, it must create differences between firms.  Important Points: • Some firm resources that are valuable but not rare are still very important to the firm (e.g., telephone systems). • A resource can still be rare even if more than one firm possesses it—the real question is this: Is the resource rare enough that the firm derives some advantage from having the resource? • A resource is considered rare if so few firms possess the resource that nearly perfect competition is not observed. Slide 3-15 Remind students that one good way to tell if a resource is still rare is to see if the firm is able to charge a premium price for the output of that resource. For example, if we examine the reputation of Harley-Davidson Motorcycles we find that they are able to charge a premium for their motorcycles even though other manufacturers of large motorcycles offer similar machines. Implications of Value and Rarity Not valuable. A resource that is not valuable will put the firm at a competitive disadvantage if for no other reason than the carrying costs associated with such a resource. It may also be the case that a resource that is not valuable may actually drive customers and/or employees away. Valuable, but not rare. A resource that is valuable but not rare will lead to competitive parity. This makes sense because it means that the firm is like other firms—no advantage, no disadvantage. Valuable and rare. If a resource is valuable and rare, the firm can reasonably expect a competitive advantage. However, at this point we don’t know if the differences between firms will be enduring so the competitive advantage may only be temporary. Slide 3-16 Go through this slide touching on the implications discussed above. Re-emphasize the point that advantage depends on scarcity or rareness. Then go through the teaching points below.  Teaching Points • Explain to students that a rude concierge could be a resource that is not valuable. Such an employee could actually drive people away from a hotel. • Ask students for examples of resources that are valuable but not rare. They will probably list things like telephones, computers, some common HR practices, raw materials, steel, etc. • Ask students for examples of valuable and rare resources. • Ask students why they think these resources are rare. • Students will usually think of examples because they perceive that the resources have led a firm to have a competitive advantage (e.g., Nike’s marketing capability). • Now ask if the valuable and rare resources are likely to create enduring differences for the respective firms. This provides a segue into a discussion of the question of imitability. The Question of Imitability Describe the Kinds of Resources and Capabilities that Are Likely to Be Costly to Imitate Maintaining the rareness of a resource is the key to having a sustained competitive advantage. If competing firms can acquire a valuable and rare resource, then the advantage of possessing that resource will quickly dissipate. The big issue here is the cost of imitation. A firm can expect to sustain its competitive advantage if other firms face a cost disadvantage in acquiring the valuable and rare resource.  Important Point: A cost disadvantage means that a competing firm would face a cost so high that acquiring the resource would not be worth that cost. Assume a firm faces a cost of $100 to acquire a particular resource and that the firm can expect to sell the output of that resource for only $85. It would be irrational for the firm to attempt to acquire the resource. Slide 3-17 Emphasize the point that intangible resources are usually more difficult to imitate and therefore are more likely to be sources of sustained competitive advantage. Also mention that bundles of resources are more difficult to imitate than a single resource. A sustained competitive advantage does not mean that the firm will have the advantage indefinitely. It means the firm will have the advantage only until the resource is imitated by enough other firms that nearly perfectly competitive competition ensues, at which point the advantage will be gone. Slide 3-18 Explain that firms will vigorously try to imitate resources that are generating competitive advantage for competitors. Managers should anticipate the attempts of others to imitate valuable and rare resources. Costs of Imitation. There are several categories of costs that firms may face as they attempt to imitate valuable and rare resources. These sources of costs are examined with the aim of helping students understand and exploit these costs. If a firm is protected by the high costs of imitation that competitors face, then the firm can expect the competitive advantage to be sustained. Unique Historical Conditions Firms attempting to imitate resources that came about because of unique historical conditions may face substantial cost disadvantages. Two types of cost disadvantages faced by would be imitators are: • First mover advantages – brand loyalty and market share are difficult to overcome. • Path dependency – refers to the fact that the development of a resource may depend heavily on other resources being in place before the desired resource. Slide 3-19 Use the example below to show how unique historical conditions can help create sustained competitive advantage. ► Example: Caterpillar Goes Global During WWII, the U.S. government found a need for heavy construction equipment throughout the world. In most, but not all, cases this equipment was needed to support military operations. Breakdowns could impair important military operations—often with dire consequences. Therefore, the U.S. government had a keen interest in being able to get replacement parts anywhere in the world within 24-48 hours. The government chose to help Caterpillar establish this worldwide capability. The interests of the government were well served during the war. However, after the war there was a continuing need for heavy equipment in rebuilding efforts around the world. Caterpillar was uniquely suited to fill this need. As rebuilding efforts gave way to industrial and infrastructure expansion, Caterpillar continued to enjoy a unique position in the market. The cost faced by competitors in imitating this global capability vastly outweighed the benefit. Caterpillar was the obvious choice for heavy equipment because its service was so reliable. It was a unique set of historical conditions that brought Caterpillar to this point. Causal Ambiguity A firm may face a cost disadvantage in acquiring valuable and rare resources because it is unclear exactly which resources need to be imitated in order to get the desired effect. Southwest Airlines provides an example of causal ambiguity. Southwest does several things that other airlines would love to imitate, but so far, no has been able to imitate them. Competitors know that Southwest has an advantage due to its human resource practices. Even though competitors know the human resource practices of Southwest are creating an advantage, competitors are so far, unable to imitate Southwest because they don’t know exactly what aspect to imitate. Furthermore, there are probably many resources bundled together that make up Southwest’s human resource practices. Slide 3-20 Explain that competitors can easily observe the outcome of the interplay between multiple resources but knowing exactly how to duplicate that interplay may be next to impossible. Social Complexity Social complexity may create a cost disadvantage for a firm attempting to imitate a valuable and rare resource because the desired resource may be the result of a set of complex social relationships. Duplicating these relationships may be extremely costly or even impossible. ► Example: WordPerfect – The Early Days The WordPerfect word processing software was developed by college professor Alan Ashton and Bruce Bastian, a student. Originally these two came together to use a computer to map out and coordinate the movements of the university’s marching band. They continued to work together in creating a word processor for an office on campus. One thing led to another and within a short time, they had developed a software package that was better than anything available on the market at the time. This unique social relationship between Ashton and Bastian led to the early development of the software. It would be virtually impossible to imitate this relationship. However, WordPerfect benefited even more from another form of social complexity. Early on, Ashton and Bastian realized that the programmers were their bread and butter. They allowed the programmers to have the best of everything—offices, bonuses, extremely flexible hours, etc. Soon a set of relationships developed among these programmers such that development efforts aimed at improving the product were naturally well-coordinated. These programmers were able to develop new features in the product that were astonishing for their time, especially for the legal profession. The immense amount of typing done by attorney’s office staffs was greatly reduced and simplified by WordPerfect’s technology. For several years, no other software company was able to match the innovation of WordPerfect. Much of this innovation was the result of the social relationships among the programmers.  Important Point: Some resources and capabilities are generated, in part, from the interaction of two or more individuals. These resources and capabilities are also influenced by organizational surroundings within the firm. Attempting to recreate such a set of social interactions is costly at best, if not strictly impossible. Slide 3-21 Emphasize that even hiring the creators of a resource (like a technology) away from a firm might not be enough to effectively imitate the resource. Furthermore, a would-be imitator might have to pay so much to lure the creators away that the benefits of having the resource would be outweighed by the costs. Patents Patents help to create cost disadvantages for imitators, but they are not an ironclad protection for patent holders. One problem for those seeking a patent is that potentially sensitive information has to be disclosed to get the patent in the first place. This information could prove useful to others attempting to develop a similar product or solution. Another problem for patent holders is that the patent must be enforced if others choose to infringe on the patent. For these reasons, some firms opt for a trade secret instead of a patent. Trade secrets offer a different level of protection, but there is little, if any, a priori disclosure requirement. Slide 3-22 Point out that patents may create a cost disadvantage for imitation, but the holder of the patent may have to expend additional resources to enforce that cost disadvantage. Slide 3-23 The main point with this slide is that unless competitors face a cost disadvantage in acquiring a valuable and rare resource, the focal firm should expect the resource to be imitated. Once the imitation occurs, any competitive advantage is quickly dissipated. Only those resources that are costly to imitate can be sources of sustained competitive advantage. The Question of Organization Describe How a Firm Uses Its Structure, Formal and Informal Control Processes, and Compensation Policy to Exploit Its Resources The logic behind the question of organization is simply that a firm must be appropriately organized to be able to exploit the potential competitive advantage stemming from valuable, rare, and costly-to-imitate resources and capabilities. Conceivably a firm could have a valuable, rare, and costly-to-imitate resource and never realize a competitive advantage because of inadequate organization. 3M is an extremely innovative firm, having developed hundreds of new products based on adhesive and other chemical technologies. The company seems to have a culture focused on innovation. 3M’s organizational structure and reward systems help reinforce this innovative culture. R&D engineers are encouraged to spend time tinkering with new ideas—sometimes completely unrelated to current products. People are rewarded for taking risks in creating and marketing new products. Not every new product is a success, but people are not punished for the occasional failure. As a result of these organizational characteristics, 3M seems to enjoy a sustained competitive advantage.  Teaching Points • Inform students that the ‘organization’ we’re talking about here refers to the firm reporting structures, formal and informal management control systems, hiring and retention policies, compensation policies, etc. of the firm. • These ‘organization’ characteristics of a firm heavily influence the incentives and motivations of employees. • These ‘organization’ characteristics of a firm may not be sources of competitive advantage per se, but they complement other resources and capabilities of the firm. • Point out to students that a reporting structure that allows information to flow from salespeople back to product design engineers may be critical to competitive advantage. For example, a firm could have a set of resources that allowed the firm to offer a product that was comparable to competitors’ products. If that firm had a more efficient reporting structure than competitors, it may be able to alter the resource bundle to offer a superior product. Thus, the reporting structure would complement the other resources of the firm and allow the firm to realize a competitive advantage from its superior product. Slide 3-24 Call attention to the fact that ‘organization’ characteristics allow information to flow and they provide incentives to people. Remind students that in recent large-scale military operations one of the first things an invading army does is disrupt the flow of information and reporting—suggesting the importance of such ‘organization’ characteristics to strategic success. The next two slides have proven quite helpful in getting students to see how the VRIO Framework can be applied.  Important Point: The VRIO Framework can be applied in a descriptive and prescriptive sense. It can help firms analyze their current set of resources and capabilities (descriptive). And, the framework can be applied to help firms formulate strategy (prescriptive). Slide 3-25 Walk the students through each line of the table as suggested below. A resource or capability subjected to VRIO analysis would fall on one of the four lines. • First line: a resource is found not to be valuable. • Competitive Implication: competitive disadvantage. • Second line: a resource is valuable, but not rare. • Competitive Implication: competitive parity. • Third line: a resource that is valuable and rare, but not costly to imitate. • Competitive Implication: temporary competitive advantage. Point out to students that a resource in this category might be something like Razor scooters when they were first introduced. They embodied a cool idea, but they were so simple that others were sure to imitate them in time. Others did imitate them rather quickly. An astute strategic analysis would have revealed that the scooters were valuable and rare, but not costly to imitate—a temporary competitive advantage would have been expected. • Fourth line: a resource is valuable, rare, and costly to imitate. • Competitive Implication: sustained competitive advantage. Now, explain that the question of organization is an adjustment factor. The ‘yes’ at the bottom of the chart indicates that ‘yes’ the firm is organized to exploit the fact that the resource is valuable, rare, and costly to imitate. The ‘no’ near the top of the chart indicates that the firm is not organized to exploit any valuable, rare, and costly-to-imitate qualities of the firm’s resources. Therefore, if it were determined that a firm possessed a resource that was valuable, rare, and costly to imitate, but the firm had only mediocre organization, then we would conclude that the competitive implication would move upward on the chart toward only temporary competitive advantage or parity. Slide 3-26 The economic implications of the various resource characteristics are added on this slide. These implications are based on the logic presented in Chapter 1. A competitive disadvantage would generate below normal returns. Competitive parity would produce a normal economic return. And, a competitive advantage would generate above normal returns. Point out that competitive advantage is expected to produce above normal returns—either temporarily or on a sustained basis COMPETITIVE DYNAMICS OF RESOURCE IMITATION Discuss How the Decision to Imitate or Not Imitate a Firm with a Competitive Advantage Affects the Competitive Dynamics in an Industry Competitive dynamics of imitation are important considerations for both the firms trying to imitate and the firms whose resources are being imitated by other firms. For the firm attempting to imitate, the fundamental question is: Will the benefits of imitating the resource be worth the costs? For the firm who has a resource advantage, the question is: Do other firms face a cost disadvantage in imitating our resources?  Important Point: RBV logic and the VRIO Framework can help firms anticipate the responses of other firms. Sometimes it may be in the interests of the firm possessing the resource advantage to signal to competitors that it would be extremely costly to imitate the resource. Slide 3-27 Use this slide to demonstrate that when firms see that another firm has a resource advantage three general responses are possible: No Change, A Change in Tactics, or A Change in Strategy. A No Change Response. In the face of another firm’s resource advantage, a firm may decide that ‘no response’ is the best response. There may be several compelling reasons for a ‘no response.’ • A firm may decide that it wants to serve a different market or type of customer. For example, a used automobile dealer who exclusively offers four-wheel-drive pickup trucks would probably not respond to resource advantages of the dealer who specializes in Honda Civics. • A firm may recognize that a response could damage its own resource advantage. For example, the used auto dealer that exclusively offers late model Audi’s may decide that it doesn’t make sense to try to match the offerings of a nearby dealer who offers lower priced autos. A few Toyota Corollas and Honda Civics on the lot may send the wrong message. • A firm may simply decide that it doesn’t have the resources necessary to respond to a competitor’s resource advantage. A small, relatively new used auto dealer may decide that offering the same credit terms as the competition down the street exceeds the financial resources currently available to the new dealer. • A firm may choose the ‘no response’ route in an effort to establish tacit collusion in a market. Suppose the four-wheel-drive pickup truck dealer and the late model Audi dealer are on the same street near one another. The truck dealer chooses not to offer late model Audi’s even though he knows he could take some business from the other dealer. In return, the used Audi decides not to offer trucks even though she could gain a few sales by doing so. The used Audi dealer could signal her intent by offering any truck she took as a trade-in to the truck dealer. Both dealers would benefit by maintaining specialization and appealing to specific car buyers. Slide 3-28 Use the auto dealer examples offered above as a way to explain why firms may choose not to respond to a competitor’s resource advantage. Changes in Tactics and Strategies. Firms may decide that changes in either tactics or strategies make sense in response to a resource advantage held by a competitor. There are important differences between changing tactics and changing strategies. Tactics Changes: • refer to changes in the way an overall strategy is carried out. • Example: changes in product characteristics like size, shape, color, etc. The product is still hand soap, for example, and it’s still sold in the same places to the same people. • are typically easy to imitate. When one firm adopts a change in tactics, others can and will quickly follow. • may create temporary advantages until competitors are able to imitate them. • may create an advantage if the firm ‘leap frogs’ the competition like Procter & Gamble did with Tide. • may be a source of advantage for firms that can do them in rapid succession and thereby stay ahead of the competition. Strategy Changes: • refer to fundamental change in the way a firm approaches its business. • Example: Monsanto changed from being a chemical company to being a life sciences company focused on genetic engineering. • mean a firm has altered its theory about how to compete. • usually occur when a firm figures out that its current strategy won’t even produce competitive parity. • can be expected to produce competitive parity if they simply mimic what other firms are doing. • can generate competitive advantage if the VRIO criteria are met. Slide 3-29 Explain that most efforts to ‘copy’ what someone else is doing typically results in competitive parity. One firm realizes an advantage and others quickly imitate it. This is the process of ‘bidding away’ above normal returns. Competitive advantage is reasonably expected only when the change results in a set of resources and capabilities that meet the VRIO criteria. Slides 3-29 and 3-30 are intended to help you make several important points about how external analysis and internal analysis (RBV logic and the VRIO Framework) can be applied to help firms navigate competitive dynamics. Slide 3-30 Use the teaching points below to guide students through this slide.  Teaching Points • Mimetic responses may be necessary to achieve competitive parity but they won’t produce competitive advantage. • Point out that external analysis and internal analysis are used to help firms identify unique competitive space. • Firms should try to find that competitive space in which they can compete and realize a competitive advantage. • Advance the slide to the point where you see the price and quality axes. • Ask students to assume that in the process of doing external and internal analysis for their focal firm, they have found that customers and competitors can be mapped in terms of price and quality. • Advance the slide to show the red stars indicating a cluster of customers who value low price and are willing to accept low quality. • Advance the slide to show that there is a competitor that currently serves that market. • Advance the slide and explain that there is another cluster of customers who demand a little more quality and they are willing to pay for it. • Advance the slide to show that there are two competitors who are already serving that part of the market. • Advance the slide again to show that there is a cluster of customers that value even more quality and they are willing to pay for it. • Tell the students that the analysis reveals that no competitor is currently serving that market. • Advance the slide to show that the focal firm should position itself to serve this high end of the market. • Explain to students that by doing this kind of analysis one can see where the unique space is in a market. • Explain that the focal firm could have chosen to serve the first or second cluster of customers, but unless they were able to serve those customers in a unique way, no competitive advantage would have been expected. • Explain that the assumption we’re making by suggesting that the focal firm serve the high end of the market is that our analysis shows that the focal firm has the necessary resources and capabilities to serve this part of the market. • Competitive advantage can be expected if our analysis shows that the focal firm possesses resources and capabilities that meet the VRIO criteria. Slide 3-31 Use the teaching points below to guide students through this slide.  Teaching Points • Point out to students that changing to a similar strategy may lead to competitive advantage under some circumstances. • Make the point that being a second mover does not necessarily mean that a firm is doomed to settle for competitive parity. • Advance the slide to the price/quality graph and ask students to assume that they have done the same kind of analysis. • This time the analysis did not show that there was a cluster of customers that wanted more quality at a higher price. • Therefore, the focal firm has to decide if it wants to compete in competitive space that seems to be occupied. • Explain to students that the VRIO analysis revealed that the focal firm has resources that will allow it to produce higher quality at a lower cost than competitors can. • Advance the slide to show the focal firm positioned at the lower right of the cluster. • Explain that this firm will be able to attract many customers in this cluster because of the superior quality it will be able to produce. It may not have to charge a lower price, but it could if it needed to because it will have a cost advantage. • Advance the slide to show the point that because of the higher quality and lower cost, the focal firm may achieve a competitive advantage. Discussion & Activity This activity will help the students apply what you have been discussing to this point. Have the students break up in groups. Ask them to assume that they represent one of the firms from the last slide that was already serving the market where the focal firm entered with higher quality and lower cost. Ask the students to come up with a response for their firm. Should it be no response? If so, why? Should it be a change in tactics? If so, why? Should it be a change in strategy? If so, why? Have one or two groups share their answers with the class. Let other students challenge them with questions about why they chose what they did. If other students fail to ask about whether the proposed solutions will result in competitive disadvantage, parity, temporary advantage, or sustained advantage, do so yourself. Press the students by asking if their proposed solutions meet the VRIO criteria. Once again, point out that merely imitating will not result in competitive advantage. Firms must generate a set of resources and capabilities that meet the VRIO criteria if they expect to achieve competitive advantage. Slide 3-32 Put this slide up after the above discussion. Signal to students that this is the review of the days’ topics. See the teaching points below. SUMMARY OF RBV LOGIC At this point, wrap up the session with a brief review of some of the key points of the day. Remind students of the following key points:  Teaching Points • Remind students that the RBV was developed in an effort to answer the question: Why do some firms do better economically than other firms? • The RBV assumes that firm-level phenomena are the primary determinants of economic performance. • The RBV makes two assumptions that distinguished it from previous economic theory: • resource heterogeneity: firms may have different resource endowments • resource immobility: some resources may not be easily transferred or acquired • These assumptions allow for the possibility of enduring firm differences. • Without firm differences, there would be no advantage for any one firm over any other firm. Slide 3-33 Use this slide to highlight, one more time, each element of the VRIO Framework.  Teaching Points • Remind students that the VRIO Framework is to be applied to a specific resource (or bundle of resources) or capability—not to the resources and capabilities of the firm as a whole. • Remind students that the framework can be used to assess what a firm is currently doing, or it can be used to help a firm craft a strategy using the resources and capabilities of the firm. It can be used to answer the question: Is this resource likely to be a source of competitive advantage? • Remind students that each of the four questions (VRIO) should be asked in the context of the market in which the firm operates. • Point out that the most desirable position for a firm is to have a sustained competitive advantage. • A competitive advantage depends on a cost disadvantage for others who would imitate a valuable and rare resource. • A competitive advantage also depends on the focal firm’s organization. It must be able to exploit its resource advantages in order to achieve competitive advantage. Slide 3-34 This slide should be used to put the whole subject of internal analysis in context. Emphasize that internal analysis matters because it offers managers a way to use economic reasoning to formulate an informed opinion about whether a firm’s resources are likely to generate competitive advantage. CONCLUSION Finally, it has proven useful to conclude the class session with a return to the big picture and a final explanation about why internal analysis matters. In a nutshell, the RBV and the VRIO Framework offer us a way to think about the probable results of our strategic decisions.  Important Points: • External analysis only tells half the story. A firm would be hard pressed to formulate an effective strategy using only external analysis. • Internal analysis and external analysis, taken together, allow us to think about positioning firm resources in a way that is likely to lead to competitive advantage and above normal returns. • Internal analysis helps to sharply focus attention on the role of managers. If we accept that managers are responsible for the economic performance of a firm, then the role of managers must be to ‘bundle’ the resources of the firm. • The VRIO Framework is a very effective tool for managers to use as they attempt to position or ‘bundle’ the resources of the firm in the pursuit of competitive advantage. As a final note, we suggest that you point out to students that the principles covered in this session may have very real and relevant application in their personal and professional lives. Encourage students to think about the contributions they can make within their families, communities, and professional circles given their personal ‘resources’ such as talents, abilities, personalities, and interests. In a utilitarian sense, a little VRIO analysis of one’s personal and professional ‘resources’ may go a long way toward helping the individual achieve a measure of competitive advantage on a personal level. Instructor Manual for Strategic Management and Competitive Advantage Concepts and Cases Jay B. Berney, William S. Hesterly 9781292060088, 9781292258041