Southwest airlines tangible and intangible resources

The Internal Organization: Resources, Capabilities, Core Competencies, and Competitive Advantages

· Chapter Introduction

· 3-1 Analyzing the Internal Organization

· 3-1a The Context of Internal Analysis

· 3-1b Creating Value

· 3-1c The Challenge of Analyzing the Internal Organization

· 3-2 Resources, Capabilities, and Core Competencies

· 3-2a Resources

· 3-2b Capabilities

· 3-2c Core Competencies

· 3-3 Building Core Competencies

· 3-3a The Four Criteria of Sustainable Competitive Advantage

· 3-3b Value Chain Analysis

· 3-4 Outsourcing

· 3-5 Competencies, Strengths, Weaknesses, and Strategic Decisions

· Chapter Review

· Summary

· Key Terms

· Review Questions

· Mini-Case Is Strengthening the Superdry Brand a Foundation to Strategic Success?

Chapter Introduction
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Learning Objectives
Studying this chapter should provide you with the strategic management knowledge needed to:

· 3-1Explain why firms need to study and understand their internal organization.

· 3-2Define value and discuss its importance.

· 3-3Describe the differences between tangible and intangible resources.

· 3-4Define capabilities and discuss their development.

· 3-5Describe four criteria used to determine if resources and capabilities are core competencies.

· 3-6Explain how firms analyze their value chain to determine where they are able to create value when using their resources, capabilities, and core competencies.

· 3-7Define outsourcing and discuss reasons for its use.

· 3-8Discuss the importance of identifying internal strengths and weaknesses.

· 3-9Describe the importance of avoiding core rigidities.

Large Pharmaceutical Companies, Big Data Analytics, Artificial Intelligence and Core Competencies: A Brave New World
To date, and perhaps surprisingly, the idea of using data strategically remains somewhat novel in some organizations. However, the reality of “big data” and “big data analytics” (which is “the process of examining big data to uncover hidden patterns, unknown correlations, and other useful information that can be used to make better decisions”) is becoming increasingly popular in business. Indeed, in the current competitive landscape, most businesses must use big data analytics (BDA) across all customer channels (mobile, Web, e-mail, and physical stores) throughout their supply chain to help them become more innovative.

This is the situation for large pharmaceutical companies (the firms often called “big pharma”) in that many have been working to develop a core competence in BDA. (We define and discuss core competencies in this chapter.) There are several reasons they are doing this. In addition to the vast increases in the amounts of data that must be studied and interpreted for competitive purposes, “health care reform and the changing landscape of health care delivery” systems throughout the world are influencing these firms to think about developing BDA as a core competence.

AI can help analyze data on clinical trials, health records, genetic profiles, and preclinical studies. China has a goal to become the world leader in AI.

A photo shows a female health care professional pointing at a laptop screen and explaining to a woman next to her.

Creativa Images/ Shutterstock.com

Many benefits can accrue to big pharma firms that develop BDA as a core competence. For example, having BDA as a core competence can help a firm quickly identify trial candidates and accelerate their recruitment, develop improved inclusion and exclusion criteria to use in clinical trials, and uncover unintended uses and indications for products. In terms of customer functionality, superior products can be provided at a faster pace as a foundation for helping patients live better and healthier lives.

In developing their BDA capabilities, many of the big pharma companies are investing in artificial intelligence (AI). AI provides the capability to analyze many different sets of information. For example, AI can help analyze data on clinical trials, health records, genetic profiles, and preclinical studies. AI can analyze and integrate these data to identify patterns in the data and suggest hypotheses about relationships. A new drug generally requires a decade of research and $2.6 billion of investment. And only about 5 percent of the drugs that enter experimental research make it to the market and are successful. Eventually, it is expected that the use of AI could reduce the early research development time from 4-6 years to 1 year, not only greatly reducing the time of development but also the costs.

As we discuss in this chapter, capabilities are the foundation for developing core competencies. There are several capabilities big pharma companies need for BDA to be a core competence. Supportive architecture, the proper mix of data scientists, and “technology that integrates and manages new types and sources of data flexibility and scalability while maintaining the highest standards of data governance, data quality, and data security” are examples of capabilities that big pharma need if they wish to develop BDA as a core competence. Of course, using artificial intelligence provides strong support for the application of BDA.

Having a strong BDA competence could be critical for pharmaceutical firms in the future. Most Chinese pharmaceutical firms are medium-sized and sell generic drugs and therapeutic medicines, investing in R&D at only about 25% of the amount invested by big pharma in developed countries. However, China has a plan to develop large, competitive pharmaceutical firms by 2025. In 2017, for example, China’s second largest class of investments was biopharma. Interestingly, the largest Chinese investment that year was in information systems, including AI. China has a goal to become the world leader in AI.

In recent years, big pharma has been earning mediocre returns of about 3 percent ROI, down from 10 percent a decade earlier. Thus, big pharma executives feel pressure especially with the initial costs of developing BDA and AI. Hopefully, they soon will be able to reduce their costs and experience higher rates of success in the development of new drugs. Until then, however, analysts are predicting record numbers of mergers and acquisitions in the pharmaceutical industry, with big pharma acquiring successful medium-sized pharmaceuticals and biotechnology firms.

Sources: S. Mukherjee, 2018, How big pharma is using AI to make better drugs, Fortune, fortune.com, March 19: Z. Torrey, 2018, China prepares for big pharma, thediplomat.com, March 14; E. Corbett, 2018, European mid-sized pharma companies-biotechs and big pharma? The Pharmaletter, www.thepharmaletter.com, March 9; M. Jewel, 2018, Signs that 2018 will be a record year for pharma M&A, The Pharmaletter, www.thepharmaletter.com, March1; B. Nelson, 2018, Why big pharma and biotech are betting big on AI, NBC News, www.nbc.news, March 1; Big data analytics: What it is & why it matters, 2015, SAS, www.sas.com, April 2; Big data for the pharmaceutical industry, Informatica, www.informatica.com, March 17; B. Atkins, 2015, Big data and the board, Wall Street Journal Online, www.wsj.com, April 16; S. F. DeAngelis, 2014, Pharmaceutical big data analytics promises a healthier future, Enterrasolutions, www.enterrasolutions.com, June 5; T. Wolfram, 2014, Data analytics has big pharma rethinking its core competencies, Forbes Online, www.forbes.com, December 22.

As discussed in the first two chapters, several factors in the global economy, including the rapid development of the Internet’s capabilities and globalization in general, are making it difficult for firms to develop competitive advantages. Increasingly, innovation appears to be a vital path to efforts to develop competitive advantages, particularly sustainable ones. Innovative actions are required by big pharma companies, and they need to develop new drugs more quickly and at lower costs while improving the success of the drugs that they develop. As the Opening Case shows, they are trying to use artificial intelligence to help develop capabilities in big data analytics that hopefully can become a core competence.

As is the case for big pharma companies, innovation is critical to most firms’ success. This means that many firms seek to develop innovation as a core competence. We define and discuss core competencies in this chapter and explain how firms use their resources and capabilities to form them. As a core competence, innovation has long been critical to Boeing’s success, too. Today, however, the firm is focusing on incremental innovations as well as developing new technologies that are linked to major innovations and the projects they spawn, such as the 787 Dreamliner. The first delivery of the 787-10 Dreamliner was made to Singapore Airlines on March 26, 2018. Boeing believes its incremental innovations enable the firm to deliver reliable products to customers more quickly and at a lower cost. As we discuss in this chapter, firms and organizations—such as those we mention here—achieve strategic competitiveness and earn above-average returns by acquiring, bundling, and leveraging their resources for the purpose of taking advantage of opportunities in the external environment in ways that create value for customers.

Even if the firm develops and manages resources in ways that create core competencies and competitive advantages, competitors will eventually learn how to duplicate the benefits of any firm’s value-creating strategy; thus, all competitive advantages have a limited life. Because of this, the question of duplication of a competitive advantage is not if it will happen, but when. In general, a competitive advantage’s sustainability is a function of three factors:

1. The rate of core competence obsolescence because of environmental changes

2. The availability of substitutes for the core competence

3. The imitability of the core competence

For all firms, the challenge is to effectively manage current core competencies while simultaneously developing new ones. Only when firms are able to do this can they expect to achieve strategic competitiveness, earn above-average returns, and remain ahead of competitors in both the short and long term.

We studied the general, industry, and competitor environments in Chapter 2. Armed with knowledge about the realities and conditions of their external environment, firms have a better understanding of marketplace opportunities and the characteristics of the competitive environment in which those opportunities exist. In this chapter, we focus on the firm. By analyzing its internal organization, a firm determines what it can do. Matching what a firm can do (a function of its resources, capabilities, and core competencies in the internal organization) with what it might do (a function of opportunities and threats in the external environment) yields insights for the firm to select strategies from among those we discuss in Chapters 4, 5, 6, 7, 8, and 9.

We begin this chapter by briefly describing conditions associated with analyzing the firm’s internal organization. We then discuss the roles of resources and capabilities in developing core competencies, which are the sources of the firm’s competitive advantages. Included in this discussion are the techniques firms use to identify and evaluate resources and capabilities and the criteria for identifying core competencies from among them. Resources alone typically do not provide competitive advantages. Instead, resources create value when the firm uses them to form capabilities, some of which become core competencies, and hopefully competitive advantages. Because of the relationship among resources, capabilities, and core competencies, we also discuss the value chain and examine four criteria that firms use to determine if their capabilities are core competencies and, as such, sources of competitive advantage. The chapter closes with comments about outsourcing as well as the need for firms to prevent their core competencies from becoming core rigidities. The existence of core rigidities indicates that the firm is too anchored to its past, a situation that prevents it from continuously developing new capabilities and core competencies.

3-1Analyzing the Internal Organization
3-1aThe Context of Internal Analysis
One of the conditions associated with analyzing a firm’s internal organization is the reality that in today’s global economy, some of the resources that were traditionally critical to firms’ efforts to produce, sell, and distribute their goods or services—such as labor costs, access to financial resources and raw materials, and protected or regulated markets—although still important, are now less likely to be the source of competitive advantages. An important reason for this is that an increasing number of firms are using their resources to form core competencies through which they successfully implement an international strategy (discussed in Chapter 8) as a means of overcoming the advantages created by more traditional resources.

Given the increasing importance of the global economy, those analyzing their firm’s internal organization should use a global mind-set to do so. A global mind-set is the ability to analyze, understand, and manage an internal organization in ways that are not dependent on the assumptions of a single country, culture, or context. Because they are able to span artificial boundaries, those with a global mind-set recognize that their firms must possess resources and capabilities that allow understanding of and appropriate responses to competitive situations that are influenced by country-specific factors and unique cultures. Using a global mind-set to analyze the internal organization has the potential to significantly help the firm in its efforts to outperform rivals.

Finally, analyzing the firm’s internal organization requires that evaluators examine the firm’s entire portfolio of resources and capabilities. This perspective suggests that individual firms possess at least some resources and capabilities that other companies do not—at least not in the same combination. Resources are the source of capabilities, some of which lead to the development of core competencies; in turn, some core competencies may lead to a competitive advantage for the firm. Understanding how to leverage the firm’s unique bundle of resources and capabilities is a key outcome decision makers seek when analyzing the internal organization. Figure 3.1 illustrates the relationships among resources, capabilities, core competencies, and competitive advantages and shows how their integrated use can lead to strategic competitiveness. As we discuss next, firms use the resources in their internal organization to create value for customers.

Figure 3.1Components of an Internal Analysis

Figure 3.1 shows us the components of an internal analysis. The components are represented in boxes. Ascending from left to right, resources both tangible and intangible lead to capabilities that in turn lead to core competencies leading to discovering core competencies. Discovering core competencies leads to competitive advantage which in turn leads to strategic competitiveness. Discovering core competencies also forms a triangle with two other boxes that appear below it. Branching off of it on the bottom left is a box that reads four criteria of sustainable advantages. Branching off of it on the right is a box that reads value chain analysis. Below the Four criteria of sustainable advantages are listed valuable, rare, costly to imitate, and non-substitutable. Below Value chain analysis outsource is listed.

3-1bCreating Value
Firms use their resources as the foundation for producing goods or services that will create value for customers. Value is measured by a product’s performance characteristics and by its attributes for which customers are willing to pay. Firms create value by innovatively bundling and leveraging their resources to form capabilities and core competencies. Firms with a competitive advantage create more value for customers than do competitors. Walmart uses its “every day low price” approach to doing business (an approach that is grounded in the firm’s core competencies, such as information technology and distribution channels) to create value for those seeking to buy products at a low price compared to competitors’ prices for those products. The stronger these firms’ core competencies, the greater the amount of value they’re able to create for their customers.

Ultimately, creating value for customers is the source of above-average returns for a firm. What the firm intends regarding value creation affects its choice of business-level strategy (see Chapter 4) and its organizational structure (see Chapter 11). In Chapter 4’s discussion of business-level strategies, we note that value is created by a product’s low cost, by its highly differentiated features, or by a combination of low cost and high differentiation compared to competitors’ offerings. A business-level strategy is effective only when it is grounded in exploiting the firm’s capabilities and core competencies. Thus, the successful firm continuously examines the effectiveness of current capabilities and core competencies while thinking about the capabilities and competencies it will require for future success.

At one time, firms’ efforts to create value were largely oriented toward understanding the characteristics of the industry in which they competed and, in light of those characteristics, determining how they should be positioned relative to competitors. This emphasis on industry characteristics and competitive strategy underestimated the role of the firm’s resources and capabilities in developing core competencies as the source of competitive advantages. In fact, core competencies, in combination with product-market positions, are the firm’s most important sources of competitive advantage. A firm’s core competencies, integrated with an understanding of the results of studying the conditions in the external environment, should drive the 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.” By emphasizing core competencies when selecting and implementing strategies, companies learn to compete primarily on the basis of firm-specific differences. However, while doing so they must be simultaneously aware of changes in the firm’s external environment.

3-1cThe Challenge of Analyzing the Internal Organization
The strategic decisions managers make about the internal organization are nonroutine, have ethical implications, and significantly influence the firm’s ability to earn above-average returns. These decisions involve choices about the resources the firm needs to collect and how to best manage and leverage them.

Making decisions involving the firm’s assets—identifying, developing, deploying, and protecting resources, capabilities, and core competencies—may appear to be relatively easy. However, this task is as challenging and difficult as any other with which managers are involved; moreover, the task is increasingly internationalized. Some believe that the pressure on managers to pursue only decisions that help the firm meet anticipated quarterly earnings makes it difficult to accurately examine the firm’s internal organization.

The challenge and difficulty of making effective decisions are implied by preliminary evidence suggesting that one-half of organizational decisions fail. Sometimes, mistakes are made as the firm analyzes conditions in its internal organization. Managers might, for example, think a capability is a core competence when it is not. This may have been the case at Polaroid Corporation, as decision makers continued to believe that the capabilities it used to build its instant film cameras were highly relevant at the time its competitors were preparing to introduce digital cameras. In this instance, Polaroid’s decision makers may have concluded that superior manufacturing was a core competence, as was the firm’s ability to innovate in terms of creating value-adding features for its instant cameras. If a mistake is made when analyzing and managing a firm’s resources, decision makers must have the confidence to admit it and take corrective actions.

At one time, Polaroid’s cameras created a significant amount of value for customers. Poor decisions may have contributed to the firm’s subsequent inability to create value and its initial filing for bankruptcy in 2001.

A photo shows a Polaroid camera. There is a photo attached on the top that shows a man giving the ‘peace’ sign, and women with glasses standing next to him.

Gene Blevins/Polaris/Newscom

A firm can improve by studying its mistakes; in fact, the learning generated by making and correcting mistakes can be important in the creation of new capabilities and core competencies. One capability that can be learned from failure is when to quit. Polaroid should have obviously changed its strategy earlier than it did, so it could have been able to avoid demise. Another potential example concerns News Corp.’s Amplify unit (founded 2011), which was created to change the way children are taught. As of mid-2015, the firm had invested over $1 billion in the unit, which makes tablets, sells online curricula, and offers testing services. In 2014, Amplify generated a $193 million loss, facing competition from well-established textbook publishers enhancing their own ability to sell similar digital products. In September 2015, News Corp. decided to sell Amplify to a team of managers and private investors, incurring a significant loss.

As we discuss next, three conditions—uncertainty, complexity, and intraorganizational conflict—affect managers as they analyze the internal organization and make decisions about resources (see Figure 3.2).

Figure 3.2Conditions Affecting Managerial Decisions about Resources, Capabilities, and Core Competencies

When studying the internal organization, managers face uncertainty because of a number of issues, including those of new proprietary technologies, rapidly changing economic and political trends, transformations in societal values, and shifts in customers’ demands. Environmental uncertainty increases the complexity and range of issues to examine when studying the internal environment. Consider how uncertainty affects the ways to use resources at coal companies such as Peabody Energy Corp. and Murray Energy Corp. Coal companies have been suffering in the last decade or more with significant regulations and the competition from cleaner forms of energy such as natural gas. They have been aided some by the reduction of regulations by the Trump administration, but the competition from cleaner and cheaper forms of energy remains. Thus, they still have to deal with a complex and uncertain environment.

Biases regarding how to cope with uncertainty affect decisions made about how to manage the firm’s resources and capabilities to form core competencies. Additionally, intraorganizational conflict may surface when decisions are made about the core competencies a firm should develop and nurture. Conflict might surface in the energy companies mentioned above about the degree to which resources and capabilities should be used to form new core competencies to support newer “clean technologies.”

In making decisions affected by these three conditions, judgment is required. Judgment is the capability of making successful decisions when no obviously correct model or rule is available or when relevant data are unreliable or incomplete. In such situations, decision makers must be aware of possible cognitive biases, such as overconfidence. Individuals who are too confident in the decisions they make about how to use the firm’s resources may fail to fully evaluate contingencies that could affect those decisions.

When exercising judgment, decision makers often take intelligent risks. In the current competitive landscape, executive judgment can become a valuable capability. One reason is that, over time, effective judgment that decision makers demonstrate allows a firm to build a strong reputation and retain the loyalty of stakeholders whose support is linked to above-average returns.

Finding individuals who can make the most successful decisions about using the organization’s resources is challenging, and important. The quality of decisions regarding resources and their management affect a firm’s ability to achieve strategic competitiveness. Individuals holding such key decision-making positions are called strategic leaders. Discussed fully in Chapter 12 and for our purposes in this chapter, we can think of strategic leaders as individuals with an ability to examine the firm’s resources, capabilities, and core competencies and make effective choices about their use.

Next, we consider the relationships among a firm’s resources, capabilities, and core competencies. While reading these sections, keep in mind that organizations have more resources than capabilities and more capabilities than core competencies.

3-2Resources, Capabilities, and Core Competencies
Resources, capabilities, and core competencies are the foundation of competitive advantage. Resources are bundled to create organizational capabilities. In turn, capabilities are the source of a firm’s core competencies, which are the basis of establishing competitive advantages. We show these relationships in Figure 3.1 and discuss them next.

3-2aResources
Broad in scope, resources cover a spectrum of individual, social, and organizational phenomena. By themselves, resources do not allow firms to create value for customers as the foundation for earning above-average returns. Indeed, resources are combined to form capabilities. For example, Subway links its fresh ingredients with several other resources, including the continuous training it provides to those running the firm’s fast food restaurants, as the foundation for customer service as a capability; customer service is also a core competence for Subway.

As its sole distribution channel, the Internet is a resource for Amazon.com. The firm uses the Internet to sell goods at prices that typically are lower than those offered by competitors selling the same goods through more costly brick-and-mortar storefronts. By combining other resources (such as access to a wide product inventory), Amazon has developed a reputation for excellent customer service. Amazon’s capability in terms of customer service is a core competence as well in that the firm creates unique value for customers through the services it provides to them.

Some of a firm’s resources (defined in Chapter 1 as inputs to the firm’s production process) are tangible while others are intangible. Tangible resources are assets that can be observed and quantified. Production equipment, manufacturing facilities, distribution centers, and formal reporting structures are examples of tangible resources. For energy giant Kinder Morgan, its stock of oil and gas pipelines are a key tangible resource. Intangible resources are assets that are rooted deeply in the firm’s history, accumulate over time, and are relatively difficult for competitors to analyze and imitate. Because they are embedded in unique patterns of routines, intangible resources are difficult for competitors to analyze and imitate. Knowledge, trust between managers and employees, managerial capabilities, organizational routines (the unique ways people work together), scientific capabilities, the capacity for innovation, brand name, the firm’s reputation for its goods or services and how it interacts with people (such as employees, customers, and suppliers), and organizational culture are intangible resources.

Intangible resources require nurturing to maintain their ability to help firms engage in competitive battles. For example, brand has long been a valuable intangible resource for Coca-Cola Company. The same is true for “logo-laden British brand Superdry,” a case highlighted at the end of the chapter. As you will read, SuperGroup PLC, the owner of Superdry, encountered problems a few years ago in its efforts to maintain and enhance the value of the Superdry brand. New management and a new approach are attempting to renew the Superdry brand.

As noted in the Strategic Focus, intangible resources may be even more important in the development of core competencies. Of course, three of the firms described in the Strategic Focus—Fainsbert Mase Brown & Susmann, Genpact, and Document Security Systems—were service firms, which commonly base their core competencies on their human capital. However, even Hecla Mining Company, which has significant investments in specialized mining equipment, must also have valuable human capital for its core competence in “high grade, narrow-vein underground mining.”

For each analysis, tangible and intangible resources are grouped into categories. The four primary categories of tangible resources are financial, organizational, physical, and technological (see Table 3.1). The three primary categories of intangible resources are human, innovation, and reputational (see Table 3.2).

Table 3.1

Tangible Resources
Financial Resources

· The firm’s capacity to borrow

· The firm’s ability to generate funds through internal operations

Organizational Resources

· Formal reporting structures

Physical Resources

· The sophistication of a firm’s plant and equipment and the attractiveness of its location

· Distribution facilities

· Product inventory

Technological Resources

· Availability of technology-related resources such as copyrights, patents, trademarks, and trade secrets

Sources: Adapted from J. B. Barney, 1991, Firm resources and sustained competitive advantage, Journal of Management, 17: 101; R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge: U.K.: Blackwell Business, 100–102.

Table 3.2

Intangible Resources
Human Resources

· Knowledge

· Trust

· Skills

· Abilities to collaborate with others

Innovation Resources

· Ideas

· Scientific capabilities

· Capacity to innovate

Reputational Resources

· Brand name

· Perceptions of product quality, durability, and reliability

· Positive reputation with stakeholders such as suppliers and customers

Sources: Adapted from R. Hall, 1992, The strategic analysis of intangible resources, Strategic Management Journal, 13: 136–139: R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge: U.K.: Blackwell Business, 101–104.

Strategic Focus

Tangible and Intangible Resources as the Base for Core Competencies
While tangible resources are important, intangible resources are perhaps even more important in the development of firms’ core competencies. Understandably, most professional service firms have few tangible resources but can have high market value primarily because of their intangible resources. For example, Fainsbert Mase Brown & Susmann, LLP is a premier law firm located in Los Angeles, California. Obviously, its goal is to provide superior legal services to its clients. Within this broad frame, however, there is a core competence. The firm provides legal advice and support on significant real estate, business, and corporate transactions for large institutions, high net-worth individuals, and privately owned businesses. For example, in 2018 the firm provided the legal services to conclude the negotiations for the Industrial Realty Group’s purchase of the 3.1 million square foot IBM technology campus in Rochester, Minnesota. This complex transaction required more than one year to negotiate with a multi-level corporate legal team.

Likewise, other major service firms are heavily dependent on their intangible assets. For example, Genpact requires highly knowledgeable human capital for its core competence. Genpact provides solutions to major process problems for its clients. Genpact describes its competence as providing “digital-led innovation and digitally enabled intelligent operations” for clients. The firm solves clients’ problems using data analytics, helping its clients transform their operations. Another technology-based service firm is Document Security Systems, Inc. (DSS). DSS has a core competence in the development of anti-counterfeit, authentication, and diversion software that protects organizations against Internet fraud and theft. And it tries to remain a leader in this field through continued investment in research and new technology. In 2018, it announced an agreement to partner with the Hong Kong R&D Center for Logistics and Supply Chain to develop the next generation of protection products using blockchain technology.