tho32789_ch03_046-081.indd 46 10/11/16 07:54 PM

CHAPTER 3

Evaluating a Company’s External Environment

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 How to recognize the factors in a company’s broad macro-environment that may have strategic significance.

LO 2 How to use analytic tools to diagnose the competitive conditions in a company’s industry.

LO 3 How to map the market positions of key groups of industry rivals.

LO 4 How to determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability.

© Bull’s Eye/Image Zoo/Getty Images

Final PDF to printer

tho32789_ch03_046-081.indd 47 11/21/16 01:05 PM

No matter what it takes, the goal of strategy is to beat the competition.

Kenichi Ohmae—Consultant and author

There is no such thing as weak competition; it grows all the time.

Nabil N. Jamal—Consultant and author

Sometimes by losing a battle you find a new way to win the war.

Donald Trump—President of the United States and

founder of Trump Entertainment Resorts

Every company operates in a broad “macro-environment”  that comprises six principal components: political factors; economic conditions in the firm’s general environment (local, country, regional, worldwide); sociocultural forces; technologi-cal factors; environmental factors (concerning the natural environment); and legal/regulatory conditions. Each of these components has the potential to affect the firm’s more immediate industry and competitive environment, although some are likely to have a more important effect than others (see Figure 3.2). An analysis of the impact of these factors is often referred to as PESTEL analysis, an acronym that serves as a reminder of the six components involved (political, economic, sociocultural, techno-logical, environmental, legal/regulatory).

THE STRATEGICALLY RELEVANT FACTORS IN THE COMPANY’S MACRO-ENVIRONMENT

LO 1

How to recognize the factors in a company’s broad macro-environment that may have strategic significance.

In order to chart a company’s strategic course wisely, managers must first develop a deep under-standing of the company’s present situation. Two facets of a company’s situation are especially pertinent: (1) its external environment—most nota-bly, the competitive conditions of the industry in which the company operates; and (2) its internal environment—particularly the company’s resources and organizational capabilities.

Insightful diagnosis of a company’s external and internal environments is a prerequisite for managers to succeed in crafting a strategy that is an excellent fit with the company’s situation—the first test of a winning strategy. As depicted in Figure 3.1, strategic thinking begins with an appraisal of the company’s external and internal

environments (as a basis for deciding on a long-term direction and developing a strategic vision), moves toward an evaluation of the most promising alternative strategies and business models, and culminates in choosing a specific strategy.

This chapter presents the concepts and analytic tools for zeroing in on those aspects of a compa-ny’s external environment that should be consid-ered in making strategic choices. Attention centers on the broad environmental context, the specific market arena in which a company operates, the drivers of change, the positions and likely actions of rival companies, and the factors that determine competitive success. In Chapter 4, we explore the methods of evaluating a company’s internal circumstances and competitive capabilities.

Final PDF to printer

48 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 48 10/11/16 07:54 PM

CORE CONCEPT

PESTEL analysis can be used to assess the strategic relevance of the six principal components of the macro-environment: Political, Economic, Social, Technological, Environmental, and Legal/Regulatory forces.

FIGURE 3.1 From Thinking Strategically about the Company’s Situation to Choosing a Strategy

Identifypromisingstrategicoptionsfor the

company

Select thebest

strategyand

businessmodelfor the

company

Form astrategicvision of where thecompanyneeds to

head

Thinkingstrategically

about acompany’s

externalenvironment

Thinkingstrategically

about acompany’s

internalenvironment

Since macro-economic factors affect different industries in different ways and to different degrees, it is important for managers to determine which of these repre-sent the most strategically relevant factors outside the firm’s industry boundaries. By strategically relevant, we mean important enough to have a bearing on the deci-sions the company ultimately makes about its long-term direction, objectives, strat-egy, and business model. The impact of the outer-ring factors depicted in Figure 3.2 on a company’s choice of strategy can range from big to small. But even if those factors change slowly or are likely to have a low impact on the company’s business situation, they still merit a watchful eye.

For example, the strategic opportunities of cigarette producers to grow their businesses are greatly reduced by antismoking ordinances, the decisions of governments to impose higher cigarette taxes, and the growing cultural stigma attached to smoking. Motor vehicle companies must adapt their strategies to cus-tomer concerns about high gasoline prices and to environmental concerns about carbon emissions. Companies in the food processing, restaurant, sports, and fit-ness industries have to pay special attention to changes in lifestyles, eating habits, leisure-time preferences, and attitudes toward nutrition and fitness in fashioning their strategies. Table 3.1 provides a brief description of the components of the macro-environment and some examples of the industries or business situations that they might affect.

As company managers scan the external environment, they must be alert for potentially important outer-ring developments, assess their impact and influence,

and adapt the company’s direction and strategy as needed. However, the factors in a company’s environment having the biggest strategy-shaping impact typically pertain to the company’s immediate industry and competitive environment. Consequently, it is on a company’s industry and competitive environment that we concentrate the bulk of our attention in this chapter.

CORE CONCEPT

The macro-environment encompasses the broad environmental context in which a company’s industry is situated.

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 49

tho32789_ch03_046-081.indd 49 10/11/16 07:54 PM

FIGURE 3.2 The Components of a Company’s Macro-Environment

PoliticalFactors

MACRO-ENVIRONMENT

Economic Conditions

Legal/Regulatory

Factors

EnvironmentalForces

TechnologicalFactors

SocioculturalForces

COMPANY

SubstituteProducts

Suppliers

RivalFirms

NewEntrants

Buyers

Imme

diate Ind

ustry and Competitive Environment

Thinking strategically about a company’s industry and competitive environment entails using some well-validated concepts and analytic tools. These include the five forces framework, the value net, driving forces, strategic groups, competitor analysis, and key success factors. Proper use of these analytic tools can provide managers with the understanding needed to craft a strategy that fits the company’s situation within their industry environment. The remainder of this chapter is devoted to describing how managers can use these tools to inform and improve their strategic choices.

ASSESSING THE COMPANY’S INDUSTRY AND COMPETITIVE ENVIRONMENT

LO 2

How to use analytic tools to diagnose the competitive conditions in a company’s industry.

Final PDF to printer

50 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 50 10/11/16 07:54 PM

Component Description

Political factors Pertinent political factors include matters such as tax policy, fiscal policy, tariffs, the political climate, and the strength of institutions such as the federal banking system. Some political policies affect certain types of industries more than others. An example is energy policy, which clearly affects energy producers and heavy users of energy more than other types of businesses.

Economic conditions

Economic conditions include the general economic climate and specific factors such as interest rates, exchange rates, the inflation rate, the unemployment rate, the rate of economic growth, trade deficits or surpluses, savings rates, and per-capita domestic product. Some industries, such as construction, are particularly vulnerable to economic downturns but are positively affected by factors such as low interest rates. Others, such as discount retailing, benefit when general economic conditions weaken, as consumers become more price-conscious.

Sociocultural forces

Sociocultural forces include the societal values, attitudes, cultural influences, and lifestyles that impact demand for particular goods and services, as well as demographic factors such as the population size, growth rate, and age distribution. Sociocultural forces vary by locale and change over time. An example is the trend toward healthier lifestyles, which can shift spending toward exercise equipment and health clubs and away from alcohol and snack foods. The demographic effect of people living longer is having a huge impact on the health care, nursing homes, travel, hospitality, and entertainment industries.

Technological factors

Technological factors include the pace of technological change and technical developments that have the potential for wide-ranging effects on society, such as genetic engineering, nanotechnology, and solar energy technology. They include institutions involved in creating new knowledge and controlling the use of technology, such as R&D consortia, university-sponsored technology incubators, patent and copyright laws, and government control over the Internet. Technological change can encourage the birth of new industries, such as the connected wearable devices, and disrupt others, such as the recording industry.

Environmental forces

These include ecological and environmental forces such as weather, climate, climate change, and associated factors like water shortages. These factors can directly impact industries such as insurance, farming, energy production, and tourism. They may have an indirect but substantial effect on other industries such as transportation and utilities.

Legal and regulatory factors

These factors include the regulations and laws with which companies must comply, such as consumer laws, labor laws, antitrust laws, and occupational health and safety regulation. Some factors, such as financial services regulation, are industry-specific. Others, such as minimum wage legislation, affect certain types of industries (low-wage, labor-intensive industries) more than others.

TABLE 3.1 The Six Components of the Macro-Environment

The character and strength of the competitive forces operating in an industry are never the same from one industry to another. The most powerful and widely used tool for diagnosing the principal competitive pressures in a market is the five forces frame-work.1 This framework, depicted in Figure 3.3, holds that competitive pressures on

THE FIVE FORCES FRAMEWORK

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 51

tho32789_ch03_046-081.indd 51 10/11/16 07:54 PM

companies within an industry come from five sources. These include (1) competition from rival sellers, (2) competition from potential new entrants to the industry, (3) competition from producers of substitute products, (4) supplier bargaining power, and (5) customer bargaining power.

Using the five forces model to determine the nature and strength of competitive pressures in a given industry involves three steps:

∙ Step 1: For each of the five forces, identify the different parties involved, along with the specific factors that bring about competitive pressures.

FIGURE 3. 3 The Five Forces Model of Competition: A Key Analytic Tool

Buyers

Competitivepressuresstemming

from supplierbargaining

power

Competitive pressurescoming from other firms in

the industry

Competitive pressures coming fromthe threat of entry of new rivals

Competitivepressuresstemmingfrom buyerbargaining

power

PotentialNew Entrants

Firms in OtherIndustries O�eringSubstitute Products

Rivalry amongCompeting

Sellers

Competitive pressures comingfrom the producers of substitute

products

Suppliers

Sources: Adapted from M. E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 57, no. 2 (1979), pp. 137–145; M. E. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review 86, no. 1 (2008), pp. 80–86.

Final PDF to printer

52 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 52 10/11/16 07:54 PM

∙ Step 2: Evaluate how strong the pressures stemming from each of the five forces are (strong, moderate, or weak).

∙ Step 3: Determine whether the five forces, overall, are supportive of high industry profitability.

Competitive Pressures Created by the Rivalry among Competing SellersThe strongest of the five competitive forces is often the rivalry for buyer patronage among competing sellers of a product or service. The intensity of rivalry among competing sellers within an industry depends on a number of identifiable factors. Figure 3.4 summarizes these factors, identifying those that intensify or weaken rivalry among direct competitors in an industry. A brief explanation of why these factors affect the degree of rivalry is in order:

FIGURE 3.4 Factors Affecting the Strength of Rivalry

Suppliers

Rivalry among Competing Sellers

Rivalry increases and becomes a stronger force when:

Rivalry decreases and becomes a weaker force under the oppositeconditions.

Substitutes

New Entrants

Buyers

• Buyer demand is growing slowly.• Buyer costs to switch brands are low.• The products of industry members are commodities or else weakly di�erentiated.• The firms in the industry have excess production capacity and/or inventory.• The firms in the industry have high fixed costs or high storage costs.• Competitors are numerous or are of roughly equal size and competitive strength.• Rivals have diverse objectives, strategies, and/or countries of origin.• Rivals have emotional stakes in the business or face high exit barriers.

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 53

tho32789_ch03_046-081.indd 53 10/11/16 07:54 PM

∙ Rivalry increases when buyer demand is growing slowly or declining. Rapidly expanding buyer demand produces enough new business for all industry members to grow without having to draw customers away from rival enterprises. But in markets where buyer demand is slow-growing or shrinking, companies eager to gain more business are likely to engage in aggressive price discounting, sales pro-motions, and other tactics to increase their sales volumes at the expense of rivals, sometimes to the point of igniting a fierce battle for market share.

∙ Rivalry increases as it becomes less costly for buyers to switch brands. The less costly it is for buyers to switch their purchases from one seller to another, the easier it is for sellers to steal customers away from rivals. When the cost of switch-ing brands is higher, buyers are less prone to brand switching and sellers have protection from rivalrous moves. Switching costs include not only monetary costs but also the time, inconvenience, and psychological costs involved in switching brands. For example, retailers may not switch to the brands of rival manufacturers because they are hesitant to sever long-standing supplier relationships or incur the additional expense of retraining employees, accessing technical support, or testing the quality and reliability of the new brand.

∙ Rivalry increases as the products of rival sellers become less strongly differentiated. When the offerings of rivals are identical or weakly differentiated, buyers have less reason to be brand-loyal—a condition that makes it easier for rivals to convince buy-ers to switch to their offerings. Moreover, when the products of different sellers are virtually identical, shoppers will choose on the basis of price, which can result in fierce price competition among sellers. On the other hand, strongly differentiated product offerings among rivals breed high brand loyalty on the part of buyers who view the attributes of certain brands as more appealing or better suited to their needs.

∙ Rivalry is more intense when industry members have too much inventory or significant amounts of idle production capacity, especially if the industry’s product entails high fixed costs or high storage costs. Whenever a market has excess supply (overproduction relative to demand), rivalry intensifies as sellers cut prices in a des-perate effort to cope with the unsold inventory. A similar effect occurs when a prod-uct is perishable or seasonal, since firms often engage in aggressive price cutting to ensure that everything is sold. Likewise, whenever fixed costs account for a large fraction of total cost so that unit costs are significantly lower at full capacity, firms come under significant pressure to cut prices whenever they are operating below full capacity. Unused capacity imposes a significant cost-increasing penalty because there are fewer units over which to spread fixed costs. The pressure of high fixed or high storage costs can push rival firms into offering price concessions, special discounts, and rebates and employing other volume-boosting competitive tactics.

∙ Rivalry intensifies as the number of competitors increases and they become more equal in size and capability. When there are many competitors in a market, com-panies eager to increase their meager market share often engage in price-cutting activities to drive sales, leading to intense rivalry. When there are only a few com-petitors, companies are more wary of how their rivals may react to their attempts to take market share away from them. Fear of retaliation and a descent into a damaging price war leads to restrained competitive moves. Moreover, when rivals are of comparable size and competitive strength, they can usually compete on a fairly equal footing—an evenly matched contest tends to be fiercer than a contest in which one or more industry members have commanding market shares and substantially greater resources than their much smaller rivals.

Final PDF to printer

54 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 54 10/11/16 07:54 PM

∙ Rivalry becomes more intense as the diversity of competitors increases in terms of long-term directions, objectives, strategies, and countries of origin. A diverse group of sellers often contains one or more mavericks willing to try novel or rule-breaking market approaches, thus generating a more volatile and less predictable competitive environment. Globally competitive markets are often more rivalrous, especially when aggressors have lower costs and are intent on gaining a strong foothold in new country markets.

∙ Rivalry is stronger when high exit barriers keep unprofitable firms from leaving the industry. In industries where the assets cannot easily be sold or transferred to other uses, where workers are entitled to job protection, or where owners are com-mitted to remaining in business for personal reasons, failing firms tend to hold on longer than they might otherwise—even when they are bleeding red ink. Deep price discounting of this sort can destabilize an otherwise attractive industry.

The previous factors, taken as whole, determine whether the rivalry in an industry is relatively strong, moderate, or weak. When rivalry is strong, the battle for mar-ket share is generally so vigorous that the profit margins of most industry members are squeezed to bare-bones levels. When rivalry is moderate, a more normal state, the maneuvering among industry members, while lively and healthy, still allows most industry members to earn acceptable profits. When rivalry is weak, most companies in the industry are relatively well satisfied with their sales growth and market shares and rarely undertake offensives to steal customers away from one another. Weak rivalry means that there is no downward pressure on industry profitability due to this particu-lar competitive force.

The Choice of Competitive WeaponsCompetitive battles among rival sellers can assume many forms that extend well beyond lively price competition. For example, competitors may resort to such market-ing tactics as special sales promotions, heavy advertising, rebates, or low-interest-rate financing to drum up additional sales. Rivals may race one another to differentiate their products by offering better performance features or higher quality or improved customer service or a wider product selection. They may also compete through the rapid introduction of next-generation products, the frequent introduction of new or improved products, and efforts to build stronger dealer networks, establish positions in foreign markets, or otherwise expand distribution capabilities and market pres-ence. Table 3.2 displays the competitive weapons that firms often employ in battling rivals, along with their primary effects with respect to price (P), cost (C), and value (V)—the elements of an effective business model and the value-price-cost framework, discussed in Chapter 1.

Competitive Pressures Associated with the Threat of New EntrantsNew entrants into an industry threaten the position of rival firms since they will compete fiercely for market share, add to the number of industry rivals, and add to the industry’s production capacity in the process. But even the threat of new entry puts added competitive pressure on current industry members and thus functions as an important competitive force. This is because credible threat of entry often prompts industry members to lower their prices and initiate defensive actions in an attempt

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 55

tho32789_ch03_046-081.indd 55 10/11/16 07:54 PM

Types of Competitive Weapons Primary Effects

Discounting prices, holding clearance sales

Lowers price (P), increases total sales volume and market share, lowers profits if price cuts are not offset by large increases in sales volume

Offering coupons, advertising items on sale

Increases sales volume and total revenues, lowers price (P), increases unit costs (C ), may lower profit margins per unit sold (P − C )

Advertising product or service characteristics, using ads to enhance a company’s image

Boosts buyer demand, increases product differentiation and perceived value (V ), increases total sales volume and market share, but may increase unit costs (C) and lower profit margins per unit sold

Innovating to improve product performance and quality

Increases product differentiation and value (V ), boosts buyer demand, boosts total sales volume, likely to increase unit costs (C)

Introducing new or improved features, increasing the number of styles to provide greater product selection

Increases product differentiation and value (V ), strengthens buyer demand, boosts total sales volume and market share, likely to increase unit costs (C)

Increasing customization of product or service

Increases product differentiation and value (V ), increases buyer switching costs, boosts total sales volume, often increases unit costs (C)

Building a bigger, better dealer network

Broadens access to buyers, boosts total sales volume and market share, may increase unit costs (C)

Improving warranties, offering low-interest financing

Increases product differentiation and value (V), increases unit costs (C), increases buyer switching costs, boosts total sales volume and market share

TABLE 3.2 Common “Weapons” for Competing with Rivals

to deter new entrants. Just how serious the threat of entry is in a particular market depends on two classes of factors: (1) the expected reaction of incumbent firms to new entry and (2) what are known as barriers to entry. The threat of entry is low in industries where incumbent firms are likely to retaliate against new entrants with sharp price discounting and other moves designed to make entry unprofitable (due to the expectation of such retaliation). The threat of entry is also low when entry barriers are high (due to such barriers). Entry barriers are high under the following conditions:2

∙ There are sizable economies of scale in production, distribution, advertising, or other activities. When incumbent companies enjoy cost advantages associated with large-scale operations, outsiders must either enter on a large scale (a costly and perhaps risky move) or accept a cost disadvantage and consequently lower profitability.

∙ Incumbents have other hard to replicate cost advantages over new entrants. Aside from enjoying economies of scale, industry incumbents can have cost advantages that stem from the possession of patents or proprietary technology,

Final PDF to printer

56 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 56 10/11/16 07:54 PM

exclusive partnerships with the best and cheapest suppliers, favorable locations, and low fixed costs (because they have older facilities that have been mostly depreciated). Learning-based cost savings can also accrue from experience in performing certain activities such as manufacturing or new product develop-ment or inventory management. The extent of such savings can be measured with learning/experience curves. The steeper the learning/experience curve, the bigger the cost advantage of the company with the largest cumulative pro-duction volume. The microprocessor industry provides an excellent example of this:

Manufacturing unit costs for microprocessors tend to decline about 20 percent each time cumulative production volume doubles. With a 20 percent experience curve effect, if the first 1 million chips cost $100 each, once production volume reaches 2 million, the unit cost would fall to $80 (80 percent of $100), and by a production volume of 4 million, the unit cost would be $64 (80 percent of $80).3

∙ Customers have strong brand preferences and high degrees of loyalty to seller. The stronger the attachment of buyers to established brands, the harder it is for a newcomer to break into the marketplace. In such cases, a new entrant must have the financial resources to spend enough on advertising and sales promotion to overcome customer loyalties and build its own clientele. Establishing brand rec-ognition and building customer loyalty can be a slow and costly process. In addi-tion, if it is difficult or costly for a customer to switch to a new brand, a new entrant may have to offer a discounted price or otherwise persuade buyers that its brand is worth the switching costs. Such barriers discourage new entry because they act to boost financial requirements and lower expected profit margins for new entrants.

∙ Patents and other forms of intellectual property protection are in place. In a number of industries, entry is prevented due to the existence of intellectual property protection laws that remain in place for a given number of years. Often, companies have a “wall of patents” in place to prevent other companies from entering with a “me too” strategy that replicates a key piece of technology.

∙ There are strong “network effects” in customer demand. In industries where buy-ers are more attracted to a product when there are many other users of the product, there are said to be “network effects,” since demand is higher the larger the net-work of users. Video game systems are an example because users prefer to have the same systems as their friends so that they can play together on systems they all know and can share games. When incumbents have a large existing base of users, new entrants with otherwise comparable products face a serious disadvantage in attracting buyers.

∙ Capital requirements are high. The larger the total dollar investment needed to enter the market successfully, the more limited the pool of potential entrants. The most obvious capital requirements for new entrants relate to manufacturing facilities and equipment, introductory advertising and sales promotion campaigns, working capital to finance inventories and customer credit, and sufficient cash to cover startup costs.

∙ There are difficulties in building a network of distributors/dealers or in securing adequate space on retailers’ shelves. A potential entrant can face numerous distribution-channel challenges. Wholesale distributors may be reluctant to take on a product that lacks buyer recognition. Retailers must be recruited and

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 57

tho32789_ch03_046-081.indd 57 10/11/16 07:54 PM

convinced to give a new brand ample display space and an adequate trial period. When existing sellers have strong, well-functioning distributor–dealer networks, a newcomer has an uphill struggle in squeezing its way into existing distribution channels. Potential entrants sometimes have to “buy” their way into wholesale or retail channels by cutting their prices to provide dealers and distributors with higher markups and profit margins or by giving them big advertising and pro-motional allowances. As a consequence, a potential entrant’s own profits may be squeezed unless and until its product gains enough consumer acceptance that dis-tributors and retailers are willing to carry it.

∙ There are restrictive regulatory policies. Regulated industries like cable TV, telecommunications, electric and gas utilities, radio and television broadcast-ing, liquor retailing, nuclear power, and railroads entail government-controlled entry. Government agencies can also limit or even bar entry by requiring licenses and permits, such as the medallion required to drive a taxicab in New York City. Government-mandated safety regulations and environmental pollution standards also create entry barriers because they raise entry costs. Recently enacted banking regulations in many countries have made entry particularly difficult for small new bank startups—complying with all the new regulations along with the rigors of competing against existing banks requires very deep pockets.

∙ There are restrictive trade policies. In international markets, host governments commonly limit foreign entry and must approve all foreign investment applica-tions. National governments commonly use tariffs and trade restrictions (anti-dumping rules, local content requirements, quotas, etc.) to raise entry barriers for foreign firms and protect domestic producers from outside competition.

Figure 3.5 summarizes the factors that cause the overall competitive pressure from potential entrants to be strong or weak. An analysis of these factors can help managers determine whether the threat of entry into their industry is high or low, in general. But certain kinds of companies—those with sizable finan-cial resources, proven competitive capabilities, and a respected brand name—may be able to hurdle an industry’s entry barriers even when they are high.4 For example, when Honda opted to enter the U.S. lawn-mower market in competi-tion against Toro, Snapper, Craftsman, John Deere, and others, it was easily able to hurdle entry barriers that would have been formidable to other newcomers because it had long-standing expertise in gasoline engines and a reputation for qual-ity and durability in automobiles that gave it instant credibility with homeowners. As a result, Honda had to spend relatively little on inducing dealers to handle the Honda lawn-mower line or attracting customers. Similarly, Samsung’s brand reputation in televisions, DVD players, and other electronics products gave it strong credibility in entering the market for smartphones—Samsung’s Galaxy smartphones are now a formidable rival of Apple’s iPhone.

It is also important to recognize that the barriers to entering an industry can become stronger or weaker over time. For example, key patents that had prevented new entry in the market for functional 3-D printers expired in February 2014, open-ing the way for new competition in this industry. Use of the Internet for shopping has made it much easier for e-tailers to enter into competition against some of the best-known retail chains. On the other hand, new strategic actions by incumbent firms to increase advertising, strengthen distributor–dealer relations, step up R&D, or improve product quality can erect higher roadblocks to entry.

Whether an industry’s entry barriers ought to be considered high or low depends on the resources and capabilities possessed by the pool of potential entrants.

High entry barriers and weak entry threats today do not always translate into high entry barriers and weak entry threats tomorrow.

Final PDF to printer

58 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 58 10/11/16 07:54 PM

Competitive Pressures from the Sellers of Substitute ProductsCompanies in one industry are vulnerable to competitive pressure from the actions of companies in a closely adjoining industry whenever buyers view the products of the two industries as good substitutes. For instance, the producers of eyeglasses and con-tact lens face competitive pressures from the doctors who do corrective laser surgery. Similarly, the producers of sugar experience competitive pressures from the producers of sugar substitutes (high-fructose corn syrup, agave syrup, and artificial sweeteners). Internet providers of news-related information have put brutal competitive pressure on the publishers of newspapers.

FIGURE 3.5 Factors Affecting the Threat of Entry

Rivalry among

Competing Sellers

Buyers

Substitutes

Suppliers

Competitive Pressures from Potential Entrants

Threat of entry is a stronger force when incumbents are unlikely to make retaliatory moves against newentrants and entry barriers are low. Entry barriers are high (and threat of entry is low) when:• Incumbents have large cost advantages over potential entrants due to: − High economies of scale − Significant experience-based cost advantages or learning curve e�ects − Other cost advantages (e.g., favorable access to inputs, technology, location, or low fixed costs)• Customers have strong brand preferences and/or loyalty to incumbent sellers.• Patents and other forms of intellectual property protection are in place.• There are strong network e�ects.• Capital requirements are high.• There is limited new access to distribution channels and shelf space.• Government policies are restrictive.• There are restrictive trade policies.

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 59

tho32789_ch03_046-081.indd 59 10/11/16 07:54 PM

As depicted in Figure 3.6, three factors determine whether the competitive pressures from substitute products are strong or weak. Competitive pressures are stronger when:

1. Good substitutes are readily available and attractively priced. The presence of readily available and attractively priced substitutes creates competitive pressure by placing a ceiling on the prices industry members can charge without risking sales erosion. This price ceiling, at the same time, puts a lid on the profits that industry members can earn unless they find ways to cut costs.

2. Buyers view the substitutes as comparable or better in terms of quality, per-formance, and other relevant attributes. The availability of substitutes inevi-tably invites customers to compare performance, features, ease of use, and other attributes besides price. The users of paper cartons constantly weigh the

FIGURE 3.6 Factors Affecting Competition from Substitute Products

Firms in Other Industries O�ering Substitute Products

Competitive pressures from substitutes are stronger when:

• Good substitutes are readily available and attractively priced.• Substitutes have comparable or better performance features.• Buyers have low costs in switching to substitutes.

Competitive pressures from substitutes are weaker underthe opposite conditions.

Suppliers Buyers

Rivalryamong

CompetingSellers

New Entrants

Signs That Competition fromSubstitutes Is Strong

• Sales of substitutes are growing faster than sales of the industry being analyzed.

• Producers of substitutes are moving to add new capacity.

• Profits of the producers of substitutes are on the rise.

Final PDF to printer

60 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 60 10/11/16 07:54 PM

price-performance trade-offs with plastic containers and metal cans, for exam-ple. Movie enthusiasts are increasingly weighing whether to go to movie theaters to watch newly released movies or wait until they can watch the same movies streamed to their home TV by Netflix, Amazon Prime, cable providers, and other on demand sources.

3. The costs that buyers incur in switching to the substitutes are low. Low switch-ing costs make it easier for the sellers of attractive substitutes to lure buyers to their offerings; high switching costs deter buyers from purchasing substitute products.

Before assessing the competitive pressures coming from substitutes, company managers must identify the substitutes, which is less easy than it sounds since it involves (1) determining where the industry boundaries lie and (2) figuring out which other products or services can address the same basic customer needs as those produced by industry members. Deciding on the industry boundaries is nec-essary for determining which firms are direct rivals and which produce substitutes. This is a matter of perspective—there are no hard-and-fast rules, other than to say that other brands of the same basic product constitute rival products and not substitutes.

Competitive Pressures Stemming from Supplier Bargaining PowerWhether the suppliers of industry members represent a weak or strong competitive force depends on the degree to which suppliers have sufficient bargaining power to influence the terms and conditions of supply in their favor. Suppliers with strong bar-gaining power are a source of competitive pressure because of their ability to charge industry members higher prices, pass costs on to them, and limit their opportunities to find better deals. For instance, Microsoft and Intel, both of which supply PC makers with essential components, have been known to use their dominant market status not only to charge PC makers premium prices but also to leverage their power over PC makers in other ways. The bargaining power of these two companies over their cus-tomers is so great that both companies have faced antitrust charges on numerous occa-sions. Prior to a legal agreement ending the practice, Microsoft pressured PC makers to load only Microsoft products on the PCs they shipped. Intel has defended itself against similar antitrust charges, but in filling orders for newly introduced Intel chips, it continues to give top priority to PC makers that use the biggest percentages of Intel chips in their PC models. Being on Intel’s list of preferred customers helps a PC maker get an early allocation of Intel’s latest chips and thus allows the PC maker to get new models to market ahead of rivals.

Small-scale retailers often must contend with the power of manufacturers whose products enjoy well-known brand names, since consumers expect to find these prod-ucts on the shelves of the retail stores where they shop. This provides the manufac-turer with a degree of pricing power and often the ability to push hard for favorable shelf displays. Supplier bargaining power is also a competitive factor in industries where unions have been able to organize the workforce (which supplies labor). Air pilot unions, for example, have employed their bargaining power to increase pilots’ wages and benefits in the air transport industry.

As shown in Figure 3.7, a variety of factors determine the strength of suppliers’ bargaining power. Supplier power is stronger when:

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 61

tho32789_ch03_046-081.indd 61 10/11/16 07:54 PM

∙ Demand for suppliers’ products is high and the products are in short supply. A surge in the demand for particular items shifts the bargaining power to the suppliers of those products; suppliers of items in short supply have pricing power.

∙ Suppliers provide differentiated inputs that enhance the performance of the indus-try’s product. The more valuable a particular input is in terms of enhancing the performance or quality of the products of industry members, the more bargaining leverage suppliers have. In contrast, the suppliers of commodities are in a weak bargaining position, since industry members have no reason other than price to prefer one supplier over another.

∙ It is difficult or costly for industry members to switch their purchases from one supplier to another. Low switching costs limit supplier bargaining power by enabling industry members to change suppliers if any one supplier attempts to raise prices by more than the costs of switching. Thus, the higher the switching costs of industry members, the stronger the bargaining power of their suppliers.

∙ The supplier industry is dominated by a few large companies and it is more con-centrated than the industry it sells to. Suppliers with sizable market shares and strong demand for the items they supply generally have sufficient bargaining power to charge high prices and deny requests from industry members for lower prices or other concessions.

∙ Industry members are incapable of integrating backward to self-manufacture items they have been buying from suppliers. As a rule, suppliers are safe from the

FIGURE 3.7 Factors Affecting the Bargaining Power of Suppliers

Suppliers

Supplier bargaining power is stronger when:• Suppliers’ products and/or services are in short supply.• Suppliers’ products and/or services are di�erentiated.• Industry members incur high costs in switching their purchases to alternative suppliers.• The supplier industry is more concentrated than the industry it sells to and is dominated by a few large companies.• Industry members do not have the potential to integrate backward in order to self-manufacture their own inputs.• Suppliers’ products do not account for more than a small fraction of the total costs of the industry‘s products.• There are no good substitutes for what the suppliers provide.• Industry members do not account for a big fraction of suppliers’ sales.

Supplier bargaining power is weaker under theopposite conditions.

Buyers

Rivalry among

Competing Sellers

New Entrants

Substitutes

Final PDF to printer

62 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 62 10/11/16 07:54 PM

threat of self-manufacture by their customers until the volume of parts a customer needs becomes large enough for the customer to justify backward integration into self-manufacture of the component. When industry members can threaten cred-ibly to self-manufacture suppliers’ goods, their bargaining power over suppliers increases proportionately.

∙ Suppliers provide an item that accounts for no more than a small fraction of the costs of the industry’s product. The more that the cost of a particular part or component affects the final product’s cost, the more that industry members will be sensitive to the actions of suppliers to raise or lower their prices. When an input accounts for only a small proportion of total input costs, buyers will be less sensitive to price increases. Thus, suppliers’ power increases when the inputs they provide do not make up a large proportion of the cost of the final product.

∙ Good substitutes are not available for the suppliers’ products. The lack of readily available substitute inputs increases the bargaining power of suppliers by increas-ing the dependence of industry members on the suppliers.

∙ Industry members are not major customers of suppliers. As a rule, suppliers have less bargaining leverage when their sales to members of the industry constitute a big percentage of their total sales. In such cases, the well-being of suppliers is closely tied to the well-being of their major customers, and their dependence upon them increases. The bargaining power of suppliers is stronger, then, when they are not bargaining with major customers.

In identifying the degree of supplier power in an industry, it is important to rec-ognize that different types of suppliers are likely to have different amounts of bar-gaining power. Thus, the first step is for managers to identify the different types of suppliers, paying particular attention to those that provide the industry with impor-tant inputs. The next step is to assess the bargaining power of each type of supplier separately.

Competitive Pressures Stemming from Buyer Bargaining Power and Price SensitivityWhether buyers are able to exert strong competitive pressures on industry members depends on (1) the degree to which buyers have bargaining power and (2) the extent to which buyers are price-sensitive. Buyers with strong bargaining power can limit industry profitability by demanding price concessions, better payment terms, or addi-tional features and services that increase industry members’ costs. Buyer price sensi-tivity limits the profit potential of industry members by restricting the ability of sellers to raise prices without losing revenue due to lost sales.

As with suppliers, the leverage that buyers have in negotiating favorable terms of sale can range from weak to strong. Individual consumers seldom have much bar-gaining power in negotiating price concessions or other favorable terms with sellers. However, their price sensitivity varies by individual and by the type of product they are buying (whether it’s a necessity or a discretionary purchase, for example). Simi-larly, small businesses usually have weak bargaining power because of the small-size orders they place with sellers. Many relatively small wholesalers and retailers join buying groups to pool their purchasing power and approach manufacturers for better terms than could be gotten individually. Large business buyers, in con-trast, can have considerable bargaining power. For example, large retail chains like

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 63

tho32789_ch03_046-081.indd 63 10/11/16 07:54 PM

Walmart, Best Buy, Staples, and Home Depot typically have considerable bargain-ing power in purchasing products from manufacturers, not only because they buy in large quantities, but also because of manufacturers’ need for access to their broad base of customers. Major supermarket chains like Kroger, Albertsons, Hannaford, and Aldi have sufficient bargaining power to demand promotional allowances and lump-sum payments (called slotting fees) from food products manufacturers in return for stocking certain brands or putting them in the best shelf locations. Motor vehicle manufacturers have strong bargaining power in negotiating to buy original-equipment tires from tire makers such as Goodyear, Michelin, and Pirelli, partly because they buy in large quantities and partly because consumers are more likely to buy replacement tires that match the tire brand on their vehicle at the time of its purchase.

Figure 3.8 summarizes the factors determining the strength of buyer power in an industry. Note that the first five factors are the mirror image of those determining the bargaining power of suppliers, as described next.

Buyer bargaining power is stronger when:

∙ Buyer demand is weak in relation to the available supply. Weak or declining demand and the resulting excess supply create a “buyers’ market,” in which bargain-hunting buyers have leverage in pressing industry members for better deals and special treatment. Conversely, strong or rapidly growing market demand creates a “sellers’

FIGURE 3.8 Factors Affecting the Bargaining Power of Buyers

Buyers

Competitive pressures from buyers increase whenthey have strong bargaining power and are price-sensitive. Buyer bargaining power is stronger when:

• Buyer demand is weak in relation to industry supply.• The industry’s products are standardized or undi�erentiated.• Buyer costs of switching to competing products are low.• Buyers are large and few in number relative to the number of industry sellers.• Buyers pose a credible threat of integrating backward into the business of sellers.• Buyers are well informed about the quality, prices, and costs of sellers.• Buyers have the ability to postpone purchases.

Buyers are price-sensitive and increase competitivepressures when:

• Buyers earn low profits or low income.• The product represents a significant fraction of their purchases.

Competitive pressures from buyers decrease andbecome a weaker force under the oppositeconditions.

Rivalry among

Competing Sellers

Suppliers

Substitutes

New Entrants

Final PDF to printer

64 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 64 10/11/16 07:54 PM

market” characterized by tight supplies or shortages— conditions that put buyers in a weak position to wring concessions from industry members.

∙ Industry goods are standardized or differentiation is weak. In such circumstances, buyers make their selections on the basis of price, which increases price competi-tion among vendors.

∙ Buyers’ costs of switching to competing brands or substitutes are relatively low. Switching costs put a cap on how much industry producers can raise prices or reduce quality before they will lose the buyer’s business.

∙ Buyers are large and few in number relative to the number of sellers. The larger the buyers, the more important their business is to the seller and the more sellers will be willing to grant concessions.

∙ Buyers pose a credible threat of integrating backward into the business of sell-ers. Companies like Anheuser-Busch, Coors, and Heinz have partially integrated backward into metal-can manufacturing to gain bargaining power in obtain-ing the balance of their can requirements from otherwise powerful metal-can manufacturers.

∙ Buyers are well informed about the product offerings of sellers (product features and quality, prices, buyer reviews) and the cost of production (an indicator of markup). The more information buyers have, the better bargaining position they are in. The mushrooming availability of product information on the Internet (and its ready access on smartphones) is giving added bargaining power to consumers, since they can use this to find or negotiate better deals.

∙ Buyers have discretion to delay their purchases or perhaps even not make a pur-chase at all. Consumers often have the option to delay purchases of durable goods (cars, major appliances), or decline to buy discretionary goods (massages, concert tickets) if they are not happy with the prices offered. Business customers may also be able to defer their purchases of certain items, such as plant equipment or main-tenance services. This puts pressure on sellers to provide concessions to buyers so that the sellers can keep their sales numbers from dropping off.

The following factors increase buyer price sensitivity and result in greater competi-tive pressures on the industry as a result: ∙ Buyer price sensitivity increases when buyers are earning low profits or have low

income. Price is a critical factor in the purchase decisions of low-income consum-ers and companies that are barely scraping by. In such cases, their high price sen-sitivity limits the ability of sellers to charge high prices.

∙ Buyers are more price-sensitive if the product represents a large fraction of their total purchases. When a purchase eats up a large portion of a buyer’s budget or represents a significant part of his or her cost structure, the buyer cares more about price than might otherwise be the case.

The starting point for the analysis of buyers as a competitive force is to identify the different types of buyers along the value chain—then proceed to analyzing the bargaining power and price sensitivity of each type separately. It is important to rec-ognize that not all buyers of an industry’s product have equal degrees of bargaining power with sellers, and some may be less sensitive than others to price, quality, or service differences. For example, apparel manufacturers confront significant bargain-ing power when selling to big retailers like Nordstrom, Macy’s, or Bloomingdale’s, but they can command much better prices selling to small owner-managed apparel boutiques.

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 65

tho32789_ch03_046-081.indd 65 10/11/16 07:54 PM

Is the Collective Strength of the Five Competitive Forces Conducive to Good Profitability?Assessing whether each of the five competitive forces gives rise to strong, moderate, or weak competitive pressures sets the stage for evaluating whether, overall, the strength of the five forces is conducive to good profitability. Is any of the competitive forces suf-ficiently powerful to undermine industry profitability? Can companies in this industry reasonably expect to earn decent profits in light of the prevailing competitive forces?

The most extreme case of a “competitively unattractive” industry occurs when all five forces are producing strong competitive pressures: Rivalry among sellers is vigor-ous, low entry barriers allow new rivals to gain a market foothold, competition from substitutes is intense, and both suppliers and buyers are able to exercise considerable leverage. Strong competitive pressures coming from all five directions drive industry profitability to unacceptably low levels, frequently producing losses for many industry members and forcing some out of business. But an industry can be competitively unat-tractive without all five competitive forces being strong. In fact, intense competitive pressures from just one of the five forces may suffice to destroy the conditions for good profitability and prompt some companies to exit the business.

As a rule, the strongest competitive forces determine the extent of the competi-tive pressure on industry profitability. Thus, in evaluating the strength of the five forces overall and their effect on industry profitability, managers should look to the strongest forces. Having more than one strong force will not worsen the effect on industry profitability, but it does mean that the industry has multiple competi-tive challenges with which to cope. In that sense, an industry with three to five strong forces is even more “unattractive” as a place to compete. Especially intense competitive conditions seem to be the norm in tire manufacturing, apparel, and commercial airlines, three industries where profit margins have historically been thin.

In contrast, when the overall impact of the five competitive forces is moderate to weak, an industry is “attractive” in the sense that the average industry member can reasonably expect to earn good profits and a nice return on investment. The ideal com-petitive environment for earning superior profits is one in which both suppliers and customers are in weak bargaining positions, there are no good substitutes, high barri-ers block further entry, and rivalry among present sellers is muted. Weak competition is the best of all possible worlds for also-ran companies because even they can usually eke out a decent profit—if a company can’t make a decent profit when competition is weak, then its business outlook is indeed grim.

Matching Company Strategy to Competitive ConditionsWorking through the five forces model step by step not only aids strategy makers in assessing whether the intensity of competition allows good profitability but also promotes sound strategic thinking about how to better match company strategy to the specific competitive character of the marketplace. Effectively matching a company’s business strategy to prevailing competitive conditions has two aspects:

1. Pursuing avenues that shield the firm from as many of the different competi-tive pressures as possible.

2. Initiating actions calculated to shift the competitive forces in the company’s favor by altering the underlying factors driving the five forces.

CORE CONCEPT

The strongest of the five forces determines the extent of the downward pressure on an industry’s profitability.

A company’s strategy is increasingly effective the more it provides some insulation from competitive pressures, shifts the competitive battle in the company’s favor, and positions the firm to take advantage of attractive growth opportunities.

Final PDF to printer

66 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 66 10/11/16 07:54 PM

But making headway on these two fronts first requires identifying competitive pressures, gauging the relative strength of each of the five competitive forces, and gaining a deep enough understanding of the state of competition in the industry to know which strategy buttons to push.

FIGURE 3.9 The Value Net

Customers

Suppliers

The FirmCompetitors Complementors

(Includes substitutors and

potential entrants)

CORE CONCEPT

Complementors are the producers of complementary products, which are products that enhance the value of the focal firm’s products when they are used together.

Not all interactions among industry participants are necessarily competitive in nature. Some have the potential to be cooperative, as the value net framework demonstrates. Like the five forces framework, the value net includes an analysis of buyers, suppli-ers, and substitutors (see Figure 3.9). But it differs from the five forces framework in several important ways.

First, the analysis focuses on the interactions of industry participants with a par-ticular company. Thus it places that firm in the center of the framework, as Figure 3.9 shows. Second, the category of “competitors” is defined to include not only the focal firm’s direct competitors or industry rivals but also the sellers of substitute products and potential entrants. Third, the value net framework introduces a new category of industry participant that is not found in the five forces framework—that of “complementors.” Complementors are the producers of complementary prod-ucts, which are products that enhance the value of the focal firm’s products when they are used together. Some examples include snorkels and swim fins or shoes and shoelaces.

The inclusion of complementors draws particular attention to the fact that suc-cess in the marketplace need not come at the expense of other industry participants.

COMPLEMENTORS AND THE VALUE NET

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 67

tho32789_ch03_046-081.indd 67 10/11/16 07:54 PM

Interactions among industry participants may be cooperative in nature rather than competitive. In the case of complementors, an increase in sales for them is likely to increase the sales of the focal firm as well. But the value net framework also encour-ages managers to consider other forms of cooperative interactions and realize that value is created jointly by all industry participants. For example, a company’s suc-cess in the marketplace depends on establishing a reliable supply chain for its inputs, which implies the need for cooperative relations with its suppliers. Often a firm works hand in hand with its suppliers to ensure a smoother, more efficient operation for both parties. Newell-Rubbermaid, for example, works cooperatively as a supplier to com-panies such as Kmart and Kohl’s. Even direct rivals may work cooperatively if they participate in industry trade associations or engage in joint lobbying efforts. Value net analysis can help managers discover the potential to improve their position through cooperative as well as competitive interactions.

CORE CONCEPT

Driving forces are the major underlying causes of change in industry and competitive conditions.

INDUSTRY DYNAMICS AND THE FORCES DRIVING CHANGEWhile it is critical to understand the nature and intensity of competitive and coopera-tive forces in an industry, it is equally critical to understand that the intensity of these forces is fluid and subject to change. All industries are affected by new developments and ongoing trends that alter industry conditions, some more speedily than others. The popular hypothesis that industries go through a life cycle of takeoff, rapid growth, maturity, market saturation and slowing growth, followed by stagnation or decline is but one aspect of industry change—many other new developments and emerging trends cause industry change.5 Any strategies devised by management will therefore play out in a dynamic industry environment, so it’s imperative that managers consider the factors driving industry change and how they might affect the industry environ-ment. Moreover, with early notice, managers may be able to influence the direction or scope of environmental change and improve the outlook.

Industry and competitive conditions change because forces are enticing or pressuring certain industry participants (competitors, customers, suppliers, comple-mentors) to alter their actions in important ways. The most powerful of the change agents are called driving forces because they have the biggest influences in reshap-ing the industry landscape and altering competitive conditions. Some driving forces originate in the outer ring of the company’s macro-environment (see Figure 3.2), but most originate in the company’s more immediate industry and competitive environment.

Driving-forces analysis has three steps: (1) identifying what the driving forces are; (2) assessing whether the drivers of change are, on the whole, acting to make the industry more or less attractive; and (3) determining what strategy changes are needed to prepare for the impact of the driving forces. All three steps merit further discussion.

Identifying the Forces Driving Industry ChangeMany developments can affect an industry powerfully enough to qualify as driving forces. Some drivers of change are unique and specific to a particular industry situa-tion, but most drivers of industry and competitive change fall into one of the following categories:

Final PDF to printer

68 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 68 10/11/16 07:54 PM

∙ Changes in an industry’s long-term growth rate. Shifts in industry growth up or down have the potential to affect the balance between industry supply and buyer demand, entry and exit, and the character and strength of competition. Whether demand is growing or declining is one of the key factors influencing the inten-sity of rivalry in an industry, as explained earlier. But the strength of this effect will depend on how changes in the industry growth rate affect entry and exit in the industry. If entry barriers are low, then growth in demand will attract new entrants, increasing the number of industry rivals and changing the competitive landscape.

∙ Increasing globalization. Globalization can be precipitated by such factors as the blossoming of consumer demand in developing countries, the availability of lower-cost foreign inputs, and the reduction of trade barriers, as has occurred recently in many parts of Latin America and Asia. The forces of globalization are sometimes such a strong driver that companies find it highly advantageous, if not necessary, to spread their operating reach into more and more country markets.

∙ Emerging new Internet capabilities and applications. The Internet of the future will feature faster speeds, dazzling applications, and over a billion connected gad-gets performing an array of functions, thus driving a host of industry and com-petitive changes. But Internet-related impacts vary from industry to industry. The challenges are to assess precisely how emerging Internet developments are alter-ing a particular industry’s landscape and to factor these impacts into the strategy-making equation.

∙ Shifts in who buys the products and how the products are used. Shifts in buyer demographics and the ways products are used can greatly alter competitive condi-tions. Longer life expectancies and growing percentages of relatively well-to-do retirees, for example, are driving demand growth in such industries as cosmetic surgery, assisted living residences, and vacation travel. The burgeoning popular-ity of streaming video has affected broadband providers, wireless phone carriers, and television broadcasters, and created opportunities for such new entertainment businesses as Hulu and Netflix.

∙ Technological change and manufacturing process innovation. Advances in tech-nology can cause disruptive change in an industry by introducing substitutes or can alter the industry landscape by opening up whole new industry frontiers. For instance, revolutionary change in self-driving technology has enabled even com-panies such as Google to enter the motor vehicle market.

∙ Product innovation. An ongoing stream of product innovations tends to alter the pattern of competition in an industry by attracting more first-time buyers, reju-venating industry growth, and/or increasing product differentiation, with con-comitant effects on rivalry, entry threat, and buyer power. Product innovation has been a key driving force in the smartphone industry, which in an ever more con-nected world is driving change in other industries. Phillips Company, for example, has introduced a new wireless lighting system (Hue) that allows homeowners to use a smartphone app to remotely turn lights on and off and program them to blink if an intruder is detected. Wearable action-capture cameras and unmanned aerial view drones are rapidly becoming a disruptive force in the digital camera industry by enabling photography shots and videos not feasible with handheld digital cameras.

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 69

tho32789_ch03_046-081.indd 69 10/11/16 07:54 PM

∙ Entry or exit of major firms. Entry by a major firm thus often produces a new ball game, not only with new key players but also with new rules for competing. Similarly, exit of a major firm changes the competitive structure by reducing the number of market leaders and increasing the dominance of the leaders who remain.

∙ Diffusion of technical know-how across companies and countries. As knowledge about how to perform a particular activity or execute a particular manufacturing technology spreads, products tend to become more commodity-like. Knowledge diffusion can occur through scientific journals, trade publications, onsite plant tours, word of mouth among suppliers and customers, employee migration, and Internet sources.

∙ Changes in cost and efficiency. Widening or shrinking differences in the costs among key competitors tend to dramatically alter the state of competition. Declin-ing costs of producing tablets have enabled price cuts and spurred tablet sales (especially lower-priced models) by making them more affordable to lower-income households worldwide. Lower-cost e-books are cutting into sales of cost-lier hardcover books as increasing numbers of consumers have laptops, iPads, Kindles, and other brands of tablets.

∙ Reductions in uncertainty and business risk. Many companies are hesitant to enter industries with uncertain futures or high levels of business risk because it is unclear how much time and money it will take to overcome various technological hurdles and achieve acceptable production costs (as is the case in the solar power industry). Over time, however, diminishing risk levels and uncertainty tend to stimulate new entry and capital investments on the part of growth-minded compa-nies seeking new opportunities, thus dramatically altering industry and competi-tive conditions.

∙ Regulatory influences and government policy changes. Government regulatory actions can often mandate significant changes in industry practices and stra-tegic approaches—as has recently occurred in the world’s banking industry. New rules and regulations pertaining to government-sponsored health insur-ance programs are driving changes in the health care industry. In international markets, host governments can drive competitive changes by opening their domestic markets to foreign participation or closing them to protect domestic companies.

∙ Changing societal concerns, attitudes, and lifestyles. Emerging social issues as well as changing attitudes and lifestyles can be powerful instigators of industry change. Growing concern about the effects of climate change has emerged as a major driver of change in the energy industry. Concerns about the use of chemical additives and the nutritional content of food products have been driv-ing changes in the restaurant and food industries. Shifting societal concerns, attitudes, and lifestyles alter the pattern of competition, favoring those players that respond with products targeted to the new trends and conditions.

While many forces of change may be at work in a given industry, no more than three or four are likely to be true driving forces powerful enough to qualify as the major determinants of why and how the industry is changing. Thus, company strategists must resist the temptation to label every change they see as a driving force. Table 3.3 lists the most common driving forces.

The most important part of driving-forces analysis is to determine whether the collective impact of the driving forces will increase or decrease market demand, make competition more or less intense, and lead to higher or lower industry profitability.

Final PDF to printer

70 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 70 10/11/16 07:54 PM

Assessing the Impact of the Forces Driving Industry ChangeThe second step in driving-forces analysis is to determine whether the prevailing change drivers, on the whole, are acting to make the industry environment more or less attractive. Three questions need to be answered:

• Changes in the long-term industry growth rate • Increasing globalization • Emerging new Internet capabilities and applications • Shifts in buyer demographics • Technological change and manufacturing process innovation • Product and marketing innovation • Entry or exit of major firms • Diffusion of technical know-how across companies and countries • Changes in cost and efficiency • Reductions in uncertainty and business risk • Regulatory influences and government policy changes • Changing societal concerns, attitudes, and lifestyles

TABLE 3.3 The Most Common Drivers of Industry Change

The real payoff of driving-forces analysis is to help managers understand what strategy changes are needed to prepare for the impacts of the driving forces.

1. Are the driving forces, on balance, acting to cause demand for the industry’s product to increase or decrease?

2. Is the collective impact of the driving forces making competition more or less intense?

3. Will the combined impacts of the driving forces lead to higher or lower indus-try profitability?

Getting a handle on the collective impact of the driving forces requires looking at the likely effects of each factor separately, since the driving forces may not all be

pushing change in the same direction. For example, one driving force may be acting to spur demand for the industry’s product while another is working to curtail demand. Whether the net effect on industry demand is up or down hinges on which change driver is the most powerful.

Adjusting the Strategy to Prepare for the Impacts of Driving ForcesThe third step in the strategic analysis of industry dynamics—where the real payoff for strategy making comes—is for managers to draw some conclusions about what strategy adjustments will be needed to deal with the impacts of the driving forces. But taking the “right” kinds of actions to prepare for the industry and competitive changes being wrought by the driving forces first requires accurate diagnosis of the forces driving industry change and the impacts these forces will have on both the indus-try environment and the company’s business. To the extent that managers are unclear

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 71

tho32789_ch03_046-081.indd 71 10/11/16 07:54 PM

Within an industry, companies commonly sell in different price/quality ranges, appeal to different types of buyers, have different geographic coverage, and so on. Some are more attractively positioned than others. Understanding which companies are strongly positioned and which are weakly positioned is an integral part of analyzing an indus-try’s competitive structure. The best technique for revealing the market positions of industry competitors is strategic group mapping.

Using Strategic Group Maps to Assess the Market Positions of Key CompetitorsA strategic group consists of those industry members with similar competitive approaches and positions in the market. Companies in the same strategic group can resemble one another in a variety of ways. They may have comparable product-line breadth, sell in the same price/quality range, employ the same distribution channels, depend on identical technological approaches, compete in much the same geographic areas, or offer buyers essentially the same product attributes or similar services and technical assistance.6 Evaluating strategy options entails examining what strategic groups exist, identifying the companies within each group, and determining if a com-petitive “white space” exists where industry competitors are able to create and capture altogether new demand. As part of this process, the number of strategic groups in an industry and their respective market positions can be displayed on a strategic group map.

The procedure for constructing a strategic group map is straightforward:

∙ Identify the competitive characteristics that delineate strategic approaches used in the industry. Typical variables used in creating strategic group maps are price/quality range (high, medium, low), geographic coverage (local, regional, national, global), product-line breadth (wide, narrow), degree of service offered (no frills, limited, full), use of distribution channels (retail, wholesale, Inter-net, multiple), degree of vertical integration (none, partial, full), and degree of diversification into other industries (none, some, considerable).

∙ Plot the firms on a two-variable map using pairs of these variables. ∙ Assign firms occupying about the same map location to the same strategic group. ∙ Draw circles around each strategic group, making the circles proportional to the

size of the group’s share of total industry sales revenues.

This produces a two-dimensional diagram like the one for the U.S. casual dining industry in Illustration Capsule 3.1.

Several guidelines need to be observed in creating strategic group maps. First, the two variables selected as axes for the map should not be highly correlated; if they are, the circles on the map will fall along a diagonal and reveal nothing more about the relative positions of competitors than would be revealed by comparing the rivals

LO 3

How to map the market positions of key groups of industry rivals.

CORE CONCEPT

Strategic group mapping is a technique for displaying the different market or competitive positions that rival firms occupy in the industry.

CORE CONCEPT

A strategic group is a cluster of industry rivals that have similar competitive approaches and market positions.

about the drivers of industry change and their impacts, or if their views are off-base, the chances of making astute and timely strategy adjustments are slim. So driving-forces analysis is not something to take lightly; it has practical value and is basic to the task of thinking strategically about where the industry is headed and how to prepare for the changes ahead.

STRATEGIC GROUP ANALYSIS

Final PDF to printer

72

tho32789_ch03_046-081.indd 72 10/11/16 07:54 PM

ILLUSTRATION CAPSULE 3.1

Comparative Market Positions of Selected Companies in the Casual Dining Industry: A Strategic Group Map Example

Note: Circles are drawn roughly proportional to the sizes of the chains, based on revenues.

on just one of the variables. For instance, if companies with broad product lines use multiple distribution channels while companies with narrow lines use a single dis-tribution channel, then looking at the differences in distribution-channel approaches adds no new information about positioning.

Second, the variables chosen as axes for the map should reflect important differ-ences among rival approaches—when rivals differ on both variables, the locations of the rivals will be scattered, thus showing how they are positioned differently. Third, the variables used as axes don’t have to be either quantitative or continu-ous; rather, they can be discrete variables, defined in terms of distinct classes and combinations. Fourth, drawing the sizes of the circles on the map proportional to the combined sales of the firms in each strategic group allows the map to reflect the relative sizes of each strategic group. Fifth, if more than two good variables

Few U.S. Locations

Low

Moderate

High

Many U.S. Locations

Geographic Coverage

Pri

ce/S

erv

ice

/Re

sta

ura

nt

Am

bia

nce

International

Maggiano’sLittle Italy,P.F.

Chang’s

Olive Garden,Longhorn

Steakhouse

Hard RockCafé, Outback

Steakhouse

Applebee’s, Chili’s,On the Border,

TGI Friday’s

Cracker Barrel, RedLobster, Golden

Corral

Five Guys, Bu�aloWild Wings, Firehouse

Subs, Moe’sSouthwest Grill

Jason’s Deli,McAlister’sDeli, Fazoli’s

BJ’s Restaurant &Brewery, The

Cheesecake Factory,Carrabba’s Italian

Grille

Corner Bakery Café,Atlanta Bread

Company

PaneraBread

Company

CaliforniaPizza

Kitchen

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 73

tho32789_ch03_046-081.indd 73 10/11/16 07:54 PM

can be used as axes for the map, then it is wise to draw several maps to give differ-ent exposures to the competitive positioning relationships present in the industry’s structure—there is not necessarily one best map for portraying how competing firms are positioned.

The Value of Strategic Group MapsStrategic group maps are revealing in several respects. The most important has to do with identifying which industry members are close rivals and which are distant rivals. Firms in the same strategic group are the closest rivals; the next closest rivals are in the immediately adjacent groups. Often, firms in strategic groups that are far apart on the map hardly compete at all. For instance, Walmart’s clientele, merchandise selection, and pricing points are much too different to justify calling Walmart a close competitor of Neiman Marcus or Saks Fifth Avenue. For the same reason, the beers produced by Yuengling are really not in competition with the beers produced by Pabst.

The second thing to be gleaned from strategic group mapping is that not all posi-tions on the map are equally attractive.7 Two reasons account for why some positions can be more attractive than others:

1. Prevailing competitive pressures from the industry’s five forces may cause the profit potential of different strategic groups to vary. The profit prospects of firms in different strategic groups can vary from good to poor because of differing degrees of competitive rivalry within strategic groups, differing pressures from potential entrants to each group, differing degrees of exposure to competition from substitute products outside the industry, and differing degrees of supplier or customer bargaining power from group to group. For instance, in the ready-to-eat cereal industry, there are significantly higher entry barriers (capital requirements, brand loyalty, etc.) for the strategic group comprising the large branded-cereal makers than for the group of generic-cereal makers or the group of small natural-cereal producers. Differences among the branded rivals versus the generic cereal makers make rivalry stronger within the generic strategic group. In the retail chain industry, the competitive battle between Walmart and Target is more intense (with consequently smaller profit margins) than the rivalry among Prada, Versace, Gucci, Armani, and other high-end fashion retailers.

2. Industry driving forces may favor some strategic groups and hurt others. Likewise, industry driving forces can boost the business outlook for some stra-tegic groups and adversely impact the business prospects of others. In the news industry, for example, Internet news services and cable news networks are gain-ing ground at the expense of newspapers and networks due to changes in tech-nology and changing social lifestyles. Firms in strategic groups that are being adversely impacted by driving forces may try to shift to a more favorably situ-ated position. If certain firms are known to be trying to change their competitive positions on the map, then attaching arrows to the circles showing the targeted direction helps clarify the picture of competitive maneuvering among rivals.

Thus, part of strategic group map analysis always entails drawing conclusions about where on the map is the “best” place to be and why. Which companies/strategic groups are destined to prosper because of their positions? Which companies/strategic groups seem destined to struggle? What accounts for why some parts of the map are better than others?

Strategic group maps reveal which companies are close competitors and which are distant competitors.

Some strategic groups are more favorably positioned than others because they confront weaker competitive forces and/or because they are more favorably impacted by industry driving forces.

Final PDF to printer

74 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 74 10/11/16 07:54 PM

Unless a company pays attention to the strategies and situations of competitors and has some inkling of what moves they will be making, it ends up flying blind into competitive battle. As in sports, scouting the opposition is an essential part of game plan development. Gathering competitive intelligence about the strategic direction and likely moves of key competitors allows a company to prepare defensive coun-termoves, to craft its own strategic moves with some confidence about what mar-ket maneuvers to expect from rivals in response, and to exploit any openings that arise from competitors’ missteps. The question is where to look for such informa-tion, since rivals rarely reveal their strategic intentions openly. If information is not

directly available, what are the best indicators?Michael Porter’s Framework for Competitor Analysis points to four indicators

of a rival’s likely strategic moves and countermoves. These include a rival’s current strategy, objectives, resources and capabilities, and assumptions about itself and the industry, as shown in Figure 3.10. A strategic profile of a rival that provides good clues to its behavioral proclivities can be constructed by characterizing the rival along these four dimensions.

Current Strategy To succeed in predicting a competitor’s next moves, com-pany strategists need to have a good understanding of each rival’s current strategy, as an indicator of its pattern of behavior and best strategic options. Questions to con-sider include: How is the competitor positioned in the market? What is the basis for

Studying competitors’ past behavior and preferences provides a valuable assist in anticipating what moves rivals are likely to make next and outmaneuvering them in the marketplace.

FIGURE 3.10 A Framework for Competitor Analysis

Strategic Moves(actions and reactions)

andOutcomes

ASSUMPTIONS

Held about itself andthe industry

OBJECTIVES

Strategic andperformance objectives

CURRENT STRATEGY

How the company iscompeting currently

Key strengthsand weaknesses

RESOURCES ANDCAPABILITIES

COMPETITOR ANALYSIS

Final PDF to printer

CHAPTER 3 Evaluating a Company’s External Environment 75

tho32789_ch03_046-081.indd 75 10/11/16 07:54 PM

its competitive advantage (if any)? What kinds of investments is it making (as an indicator of its growth trajectory)?

Objectives An appraisal of a rival’s objectives should include not only its finan-cial performance objectives but strategic ones as well (such as those concerning mar-ket share). What is even more important is to consider the extent to which the rival is meeting these objectives and whether it is under pressure to improve. Rivals with good financial performance are likely to continue their present strategy with only minor fine-tuning. Poorly performing rivals are virtually certain to make fresh strategic moves.

Resources and Capabilities A rival’s strategic moves and countermoves are both enabled and constrained by the set of resources and capabilities the rival has at hand. Thus a rival’s resources and capabilities (and efforts to acquire new resources and capabilities) serve as a strong signal of future strategic actions (and reactions to your company’s moves). Assessing a rival’s resources and capabilities involves sizing up not only its strengths in this respect but its weaknesses as well.

Assumptions How a rival’s top managers think about their strategic situation can have a big impact on how the rival behaves. Banks that believe they are “too big to fail,” for example, may take on more risk than is financially prudent. Assessing a rival’s assumptions entails considering its assumptions about itself as well as about the industry it participates in.

Information regarding these four analytic components can often be gleaned from company press releases, information posted on the company’s website (especially the presentations management has recently made to securities analysts), and such public documents as annual reports and 10-K filings. Many companies also have a competi-tive intelligence unit that sifts through the available information to construct up-to-date strategic profiles of rivals. Doing the necessary detective work can be time- consuming, but scouting competitors well enough to anticipate their next moves allows managers to prepare effective countermoves (perhaps even beat a rival to the punch) and to take rivals’ probable actions into account in crafting their own best course of action.

KEY SUCCESS FACTORSAn industry’s key success factors (KSFs) are those competitive factors that most affect industry members’ ability to survive and prosper in the marketplace: the par-ticular strategy elements, product attributes, operational approaches, resources, and competitive capabilities that spell the difference between being a strong competitor and a weak competitor—and between profit and loss. KSFs by their very nature are so important to competitive success that all firms in the industry must pay close attention to them or risk becoming an industry laggard or failure. To indicate the significance of KSFs another way, how well the elements of a company’s strategy measure up against an industry’s KSFs determines whether the company can meet the basic criteria for surviving and thriving in the industry. Identifying KSFs, in light of the prevailing and anticipated industry and competitive conditions, is there-fore always a top priority in analytic and strategy-making considerations. Company strategists need to understand the industry landscape well enough to separate the factors most important to competitive success from those that are less important.

CORE CONCEPT

Key success factors are the strategy elements, product and service attributes, operational approaches, resources, and competitive capabilities that are essential to surviving and thriving in the industry.

Final PDF to printer

76 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 76 10/11/16 07:54 PM

Key success factors vary from industry to industry, and even from time to time within the same industry, as change drivers and competitive conditions change. But regardless of the circumstances, an industry’s key success factors can always be deduced by asking the same three questions:

1. On what basis do buyers of the industry’s product choose between the competing brands of sellers? That is, what product attributes and service characteristics are crucial?

2. Given the nature of competitive rivalry prevailing in the marketplace, what resources and competitive capabilities must a company have to be competitively successful?

3. What shortcomings are almost certain to put a company at a significant competi-tive disadvantage?

Only rarely are there more than five key factors for competitive success. And even among these, two or three usually outrank the others in importance. Managers should therefore bear in mind the purpose of identifying key success factors—to determine which factors are most important to competitive success—and resist the temptation to label a factor that has only minor importance as a KSF.

In the beer industry, for example, although there are many types of buyers (whole-sale, retail, end consumer), it is most important to understand the preferences and buying behavior of the beer drinkers. Their purchase decisions are driven by price, taste, convenient access, and marketing. Thus the KSFs include a strong network of wholesale distributors (to get the company’s brand stocked and favorably displayed in retail outlets, bars, restaurants, and stadiums, where beer is sold) and clever advertis-ing (to induce beer drinkers to buy the company’s brand and thereby pull beer sales through the established wholesale and retail channels). Because there is a potential for strong buyer power on the part of large distributors and retail chains, competi-tive success depends on some mechanism to offset that power, of which advertising (to create demand pull) is one. Thus the KSFs also include superior product dif-ferentiation (as in microbrews) or superior firm size and branding capabilities (as in national brands). The KSFs also include full utilization of brewing capacity (to keep manufacturing costs low and offset the high costs of advertising, branding, and product differentiation).

Correctly diagnosing an industry’s KSFs also raises a company’s chances of crafting a sound strategy. The key success factors of an industry point to those things that every firm in the industry needs to attend to in order to retain custom-ers and weather the competition. If the company’s strategy cannot deliver on the key success factors of its industry, it is unlikely to earn enough profits to remain a viable business.

THE INDUSTRY OUTLOOK FOR PROFITABILITYEach of the frameworks presented in this chapter—PESTEL, five forces analysis, driv-ing forces, strategy groups, competitor analysis, and key success factors—provides a useful perspective on an industry’s outlook for future profitability. Putting them all together provides an even richer and more nuanced picture. Thus, the final step in evaluating the industry and competitive environment is to use the results of each of the analyses performed to determine whether the industry presents the company with

Final PDF to printer

KEY POINTS

Thinking strategically about a company’s external situation involves probing for answers to the following questions:

1. What are the strategically relevant factors in the macro-environment, and how do they impact an industry and its members? Industries differ significantly as to how they are affected by conditions and developments in the broad macro- environment. Using PESTEL analysis to identify which of these factors is strate-gically relevant is the first step to understanding how a company is situated in its external environment.

CHAPTER 3 Evaluating a Company’s External Environment 77

tho32789_ch03_046-081.indd 77 10/11/16 07:54 PM

LO 4

How to determine whether an industry’s outlook presents a company with sufficiently attractive opportunities for growth and profitability.

strong prospects for competitive success and attractive profits. The important factors on which to base a conclusion include:

∙ How the company is being impacted by the state of the macro-environment. ∙ Whether strong competitive forces are squeezing industry profitability to subpar

levels. ∙ Whether the presence of complementors and the possibility of cooperative actions

improve the company’s prospects. ∙ Whether industry profitability will be favorably or unfavorably affected by the

prevailing driving forces. ∙ Whether the company occupies a stronger market position than rivals. ∙ Whether this is likely to change in the course of competitive interactions. ∙ How well the company’s strategy delivers on the industry key success factors.

As a general proposition, the anticipated industry environment is fundamentally attractive if it presents a company with good opportunity for above-average profit-ability; the industry outlook is fundamentally unattractive if a company’s profit pros-pects are unappealingly low.

However, it is a mistake to think of a particular industry as being equally attrac-tive or unattractive to all industry participants and all potential entrants.8 Attrac-tiveness is relative, not absolute, and conclusions one way or the other have to be drawn from the perspective of a particular company. For instance, a favorably posi-tioned competitor may see ample opportunity to capitalize on the vulnerabilities of weaker rivals even though industry conditions are otherwise somewhat dismal. At the same time, industries attractive to insiders may be unattractive to outsiders because of the difficulty of challenging current market leaders or because they have more attractive opportunities elsewhere.

When a company decides an industry is fundamentally attractive and presents good opportunities, a strong case can be made that it should invest aggressively to capture the opportunities it sees and to improve its long-term competitive position in the business. When a strong competitor concludes an industry is becoming less attractive, it may elect to simply protect its present position, investing cautiously—if at all—and looking for opportunities in other industries. A competitively weak company in an unattractive industry may see its best option as finding a buyer, perhaps a rival, to acquire its business.

The degree to which an industry is attractive or unattractive is not the same for all industry participants and all potential entrants.

Final PDF to printer

2. What kinds of competitive forces are industry members facing, and how strong is each force? The strength of competition is a composite of five forces: (1) rivalry within the industry, (2) the threat of new entry into the market, (3) inroads being made by the sellers of substitutes, (4) supplier bargaining power, and (5) buyer bargaining power. All five must be examined force by force, and their collective strength evaluated. One strong force, however, can be sufficient to keep average industry profitability low. Working through the five forces model aids strategy makers in assessing how to insulate the company from the strongest forces, iden-tify attractive arenas for expansion, or alter the competitive conditions so that they offer more favorable prospects for profitability.

3. What cooperative forces are present in the industry, and how can a company har-ness them to its advantage? Interactions among industry participants are not only competitive in nature but cooperative as well. This is particularly the case when complements to the products or services of an industry are important. The value net framework assists managers in sizing up the impact of cooperative as well as competitive interactions on their firm.

4. What factors are driving changes in the industry, and what impact will they have on competitive intensity and industry profitability? Industry and competitive con-ditions change because certain forces are acting to create incentives or pressures for change. The first step is to identify the three or four most important drivers of change affecting the industry being analyzed (out of a much longer list of poten-tial drivers). Once an industry’s change drivers have been identified, the analytic task becomes one of determining whether they are acting, individually and col-lectively, to make the industry environment more or less attractive.

5. What market positions do industry rivals occupy—who is strongly positioned and who is not? Strategic group mapping is a valuable tool for understanding the simi-larities, differences, strengths, and weaknesses inherent in the market positions of rival companies. Rivals in the same or nearby strategic groups are close com-petitors, whereas companies in distant strategic groups usually pose little or no immediate threat. The lesson of strategic group mapping is that some positions on the map are more favorable than others. The profit potential of different strate-gic groups may not be the same because industry driving forces and competitive forces likely have varying effects on the industry’s distinct strategic groups.

6. What strategic moves are rivals likely to make next? Anticipating the actions of rivals can help a company prepare effective countermoves. Using the Framework for Competitor Analysis is helpful in this regard.

7. What are the key factors for competitive success? An industry’s key success fac-tors (KSFs) are the particular strategy elements, product attributes, operational approaches, resources, and competitive capabilities that all industry members must have in order to survive and prosper in the industry. For any industry, they can be deduced by answering three basic questions: (1) On what basis do buyers of the industry’s product choose between the competing brands of sellers, (2) what resources and competitive capabilities must a company have to be competitively successful, and (3) what shortcomings are almost certain to put a company at a significant competitive disadvantage?

8. Is the industry outlook conducive to good profitability? The last step in industry analysis is summing up the results from applying each of the frameworks employed

78 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 78 10/11/16 07:54 PM

Final PDF to printer

in answering questions 1 to 6: PESTEL, five forces analysis, driving forces, stra-tegic group mapping, competitor analysis, and key success factors. Applying mul-tiple lenses to the question of what the industry outlook looks like offers a more robust and nuanced answer. If the answers from each framework, seen as a whole, reveal that a company’s profit prospects in that industry are above-average, then the industry environment is basically attractive for that company. What may look like an attractive environment for one company may appear to be unattractive from the perspective of a different company.

Clear, insightful diagnosis of a company’s external situation is an essential first step in crafting strategies that are well matched to industry and competitive conditions. To do cutting-edge strategic thinking about the external environment, managers must know what questions to pose and what analytic tools to use in answering these questions. This is why this chapter has concentrated on suggesting the right questions to ask, explain-ing concepts and analytic approaches, and indicating the kinds of things to look for.

ASSURANCE OF LEARNING EXERCISES

1. Prepare a brief analysis of the organic food industry using the information pro-vided by the Organic Trade Association at www.ota.com and the Organic Report magazine at theorganicreport.com. That is, based on the information provided on these websites, draw a five forces diagram for the organic food industry and briefly discuss the nature and strength of each of the five competitive forces.

2. Based on the strategic group map in Illustration Capsule 3.1, which casual dining chains are Applebee’s closest competitors? With which strategic group does Cali-fornia Pizza Kitchen compete the least, according to this map? Why do you think no casual dining chains are positioned in the area above the Olive Garden’s group?

3. The National Restaurant Association publishes an annual industry fact book that can be found at imis.restaurant.org/store/detail.aspx?id=FOR2016FB. Based on information in the latest report, does it appear that macro-environmental fac-tors and the economic characteristics of the industry will present industry partici-pants with attractive opportunities for growth and profitability? Explain.

LO 2

LO 3

LO 1, LO 4

EXERCISE FOR SIMULATION PARTICIPANTS

1. Which of the factors listed in Table 3.1 might have the most strategic relevance for your industry?

2. Which of the five competitive forces is creating the strongest competitive pres-sures for your company?

3. What are the “weapons of competition” that rival companies in your industry can use to gain sales and market share? See Table 3.2 to help you identify the various competitive factors.

LO 1, LO 2, LO 3, LO 4

CHAPTER 3 Evaluating a Company’s External Environment 79

tho32789_ch03_046-081.indd 79 10/11/16 07:54 PM

Final PDF to printer

ENDNOTESJournal of Economic Behavior & Organization 15, no. 1 (January 1991).5 For a more extended discussion of the prob-lems with the life-cycle hypothesis, see Porter, Competitive Strategy, pp. 157–162.6 Mary Ellen Gordon and George R. Milne, “Selecting the Dimensions That Define Strate-gic Groups: A Novel Market-Driven Approach,” Journal of Managerial Issues 11, no. 2 (Summer 1999), pp. 213–233.7 Avi Fiegenbaum and Howard Thomas, “Stra-tegic Groups as Reference Groups: Theory, Modeling and Empirical Examination of

1 Michael E. Porter, Competitive Strategy (New York: Free Press, 1980); Michael E. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review 86, no. 1 (January 2008), pp. 78–93.2 J. S. Bain, Barriers to New Competition (Cambridge, MA: Harvard University Press, 1956); F. M. Scherer, Industrial Market Structure and Economic Performance (Chicago: Rand McNally, 1971).3 Ibid.4 C. A. Montgomery and S. Hariharan, “Diversi-fied Expansion by Large Established Firms,”

Industry and Competitive Strategy,” Strategic Management Journal 16 (1995), pp. 461–476; S. Ade Olusoga, Michael P. Mokwa, and Charles H. Noble, “Strategic Groups, Mobility Barriers, and Competitive Advantage,” Journal of Business Research 33 (1995), pp. 153–164.8 B. Wernerfelt and C. Montgomery, “What Is an Attractive Industry?” Management Science 32, no. 10 (October 1986), pp. 1223–1230.

4. What are the factors affecting the intensity of rivalry in the industry in which your company is competing? Use Figure 3.4 and the accompanying discussion to help you in pinpointing the specific factors most affecting competitive inten-sity. Would you characterize the rivalry and jockeying for better market position, increased sales, and market share among the companies in your industry as fierce, very strong, strong, moderate, or relatively weak? Why?

5. Are there any driving forces in the industry in which your company is competing? If so, what impact will these driving forces have? Will they cause competition to be more or less intense? Will they act to boost or squeeze profit margins? List at least two actions your company should consider taking in order to combat any negative impacts of the driving forces.

6. Draw a strategic group map showing the market positions of the companies in your industry. Which companies do you believe are in the most attractive position on the map? Which companies are the most weakly positioned? Which companies do you believe are likely to try to move to a different position on the strategic group map?

7. What do you see as the key factors for being a successful competitor in your industry? List at least three.

8. Does your overall assessment of the industry suggest that industry rivals have suf-ficiently attractive opportunities for growth and profitability? Explain.

80 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch03_046-081.indd 80 10/11/16 07:54 PM

Final PDF to printer

tho32789_ch03_046-081.indd 81 10/11/16 07:54 PM

Final PDF to printer

tho32789_ch04_082-119.indd 82 10/11/16 08:17 PM

CHAPTER 4

Evaluating a Company’s Resources, Capabilities, and Competitiveness

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 How to take stock of how well a company’s strategy is working.

LO 2 Why a company’s resources and capabilities are centrally important in giving the company a competitive edge over rivals.

LO 3 How to assess the company’s strengths and weaknesses in light of market opportunities and external threats.

LO 4 How a company’s value chain activities can affect the company’s cost structure and customer value proposition.

LO 5 How a comprehensive evaluation of a company’s competitive situation can assist managers in making critical decisions about their next strategic moves.

© Ikon Images/Alamy Stock Photo

Final PDF to printer

tho32789_ch04_082-119.indd 83 10/11/16 08:17 PM

Crucial, of course, is having a difference that matters in the industry.

Cynthia Montgomery—Professor and author

If you don’t have a competitive advantage, don’t compete

Jack Welch—Former CEO of General Electric

Organizations succeed in a competitive market-place over the long run because they can do certain things their customers value better than can their competitors.

Robert Hayes, Gary Pisano, and David Upton—

Professors and consultants

Chapter 3 described how to use the tools of indus-try and competitor analysis to assess a company’s external environment and lay the groundwork for matching a company’s strategy to its external situ-ation. This chapter discusses techniques for evalu-ating a company’s internal situation, including its collection of resources and capabilities and the activities it performs along its value chain. Internal analysis enables managers to determine whether their strategy is likely to give the company a signifi-cant competitive edge over rival firms. Combined with external analysis, it facilitates an understand-ing of how to reposition a firm to take advantage of new opportunities and to cope with emerging competitive threats. The analytic spotlight will be trained on six questions:

1. How well is the company’s present strategy working?

2. What are the company’s most important resources and capabilities, and will they give the

company a lasting competitive advantage over rival companies?

3. What are the company’s strengths and weak-nesses in relation to the market opportunities and external threats?

4. How do a company’s value chain activities impact its cost structure and customer value proposition?

5. Is the company competitively stronger or weaker than key rivals?

6. What strategic issues and problems merit front-burner managerial attention?

In probing for answers to these questions, five analytic tools—resource and capability analysis, SWOT analysis, value chain analysis, benchmark-ing, and competitive strength assessment—will be used. All five are valuable techniques for revealing a company’s competitiveness and for helping com-pany managers match their strategy to the compa-ny’s particular circumstances.

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?In evaluating how well a company’s present strategy is working, the best way to start is with a clear view of what the strategy entails. Figure 4.1 shows the key components of a single-business company’s strategy. The first thing to examine is the company’s competitive approach. What moves has the company made recently to attract cus-tomers and improve its market position—for instance, has it cut prices, improved the

LO 1

How to take stock of how well a company’s strategy is working.

Final PDF to printer

84 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 84 10/13/16 07:16 PM

design of its product, added new features, stepped up advertising, entered a new geo-graphic market, or merged with a competitor? Is it striving for a competitive advantage based on low costs or a better product offering? Is it concentrating on serving a broad spectrum of customers or a narrow market niche? The company’s functional strategies in R&D, production, marketing, finance, human resources, information technology, and so on further characterize company strategy, as do any efforts to establish alli-ances with other enterprises.

The three best indicators of how well a company’s strategy is working are (1) whether the company is achieving its stated financial and strategic objectives, (2) whether its financial performance is above the industry average, and (3) whether it is gaining customers and gaining market share. Persistent shortfalls in meeting company performance targets and weak marketplace performance relative to rivals are reliable warning signs that the company has a weak strategy, suffers from poor strategy execu-tion, or both. Specific indicators of how well a company’s strategy is working include:

∙ Trends in the company’s sales and earnings growth. ∙ Trends in the company’s stock price. ∙ The company’s overall financial strength. ∙ The company’s customer retention rate.

FIGURE 4.1 Identifying the Components of a Single-Business Company’s Strategy

E�orts to build competitivelyvaluable partnerships andstrategic alliances with otherenterprises within its industry

Productionstrategy

Supply chainmanagementstrategy

Financestrategy

BUSINESSSTRATEGY(The action plan for managing a single business)

E�orts to expand or narrow geographiccoverage

KE

Y F

UN

CTIO

NA

L STRATEGIES

Humanresourcestrategy

Informationtechnologystrategy

Sales, marketing,and distributionstrategies

Moves to respond to changingconditions in the macro-environmentor in industry and competitiveconditions

R&D, technology, product designstrategy

Initiatives to build competitiveadvantage based on:

Moves to attract customers and outcompete rivals via improved product design, better features, higher quality, wider selection, lower prices, and so on

Superior ability to serve a market niche or specific group of buyers?

A better product o�ering?

Lower costs relative torivals?

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 85

tho32789_ch04_082-119.indd 85 10/11/16 08:17 PM

Sluggish financial performance and second-rate market accomplishments almost always signal weak strategy, weak execution, or both.

∙ The rate at which new customers are acquired. ∙ Evidence of improvement in internal processes such as defect rate, order ful-

fillment, delivery times, days of inventory, and employee productivity.

The stronger a company’s current overall performance, the more likely it has a well-conceived, well-executed strategy. The weaker a company’s financial perfor-mance and market standing, the more its current strategy must be questioned and the more likely the need for radical changes. Table 4.1 provides a compilation of the financial ratios most commonly used to evaluate a company’s financial perfor-mance and balance sheet strength.

TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean

Ratio How Calculated What It Shows

Profitability ratios

1. Gross profit margin

Sales revenues – Cost of goods sold ________________________ Sales revenues

Shows the percentage of revenues available to cover operating expenses and yield a profit.

2. Operating profit margin (or return on sales)

Sales revenues – Operating expenses

_________________________ Sales revenues

or

Operating income

_____________ Sales revenues

Shows the profitability of current operations without regard to interest charges and income taxes. Earnings before interest and taxes is known as EBIT in financial and business accounting.

3. Net profit margin (or net return on sales)

Profits after taxes _____________ Sales revenues Shows after-tax profits per dollar of sales.

4. Total return on assets

Profits after taxes + Interest ____________________ Total assets A measure of the return on total investment in the enterprise. Interest is added to after-tax profits to form the numerator, since total assets are financed by creditors as well as by stockholders.

5. Net return on total assets (ROA)

Profits after taxes _____________ Total assets A measure of the return earned by stockholders on the firm’s total assets.

6. Return on stockholders’ equity (ROE)

Profits after taxes ___________________ Total stockholders’ equity The return stockholders are earning on their capital investment in the enterprise. A return in the 12%–15% range is average.

7. Return on invested capital (ROIC)—sometimes referred to as return on capital employed (ROCE)

Profits after taxes _______________________________ Long-term debt + Total stockholders’ equity A measure of the return that shareholders are earning on the monetary capital invested in the enterprise. A higher return reflects greater bottom-line effectiveness in the use of long-term capital.

Liquidity ratios

1. Current ratio Current assets    _____________ Current liabilities Shows a firm’s ability to pay current liabilities using assets that can be converted to cash in the near term. Ratio should be higher than 1.0.

(continued)

Final PDF to printer

86 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 86 10/11/16 08:17 PM

Ratio How Calculated What It Shows

2. Working capital Current assets – Current liabilities The cash available for a firm’s day-to-day operations. Larger amounts mean the company has more internal funds to (1) pay its current liabilities on a timely basis and (2) finance inventory expansion, additional accounts receivable, and a larger base of operations without resorting to borrowing or raising more equity capital.

Leverage ratios

1. Total debt-to-assets ratio

  Total debt   _________ Total assets Measures the extent to which borrowed funds (both short-term loans and long-term debt) have been used to finance the firm’s operations. A low ratio is better—a high fraction indicates overuse of debt and greater risk of bankruptcy.

2. Long-term debt-to-capital ratio

 Long-term debt _______________________________ Long-term debt + Total stockholders’ equity

A measure of creditworthiness and balance sheet strength. It indicates the percentage of capital investment that has been financed by both long-term lenders and stockholders. A ratio below 0.25 is preferable since the lower the ratio, the greater the capacity to borrow additional funds. Debt-to-capital ratios above 0.50 indicate an excessive reliance on long-term borrowing, lower creditworthiness, and weak balance sheet strength.

3. Debt-to-equity ratio

 Total debt  ___________________ Total stockholders’ equity Shows the balance between debt (funds borrowed both short term and long term) and the amount that stockholders have invested in the enterprise. The further the ratio is below 1.0, the greater the firm’s ability to borrow additional funds. Ratios above 1.0 put creditors at greater risk, signal weaker balance sheet strength, and often result in lower credit ratings.

4. Long-term debt-to-equity ratio

 Long-term debt ___________________ Total stockholders’ equity

Shows the balance between long-term debt and stockholders’ equity in the firm’s long-term capital structure. Low ratios indicate a greater capacity to borrow additional funds if needed.

5. Times-interest-earned (or coverage) ratio

 Operating income

_____________ Interest expenses Measures the ability to pay annual interest charges. Lenders usually insist on a minimum ratio of 2.0, but ratios above 3.0 signal progressively better creditworthiness.

Activity ratios

1. Days of inventory

Inventory __________________ Cost of goods sold ÷ 365

Measures inventory management efficiency. Fewer days of inventory are better.

2. Inventory turnover

Cost of goods sold _____________ Inventory

Measures the number of inventory turns per year. Higher is better.

3. Average collection period

Accounts receivable _______________ Total sales ÷ 365

or

Accounts receivable _______________ Average daily sales

Indicates the average length of time the firm must wait after making a sale to receive cash payment. A shorter collection time is better.

TABLE 4.1 (continued)

(continued)

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 87

tho32789_ch04_082-119.indd 87 10/11/16 08:17 PM

Ratio How Calculated What It Shows

Other important measures of financial performance

1. Dividend yield on common stock

Annual dividends per share

_____________________ Current market price per share A measure of the return that shareholders receive in the form of dividends. A “typical” dividend yield is 2%–3%. The dividend yield for fast-growth companies is often below 1%; the dividend yield for slow-growth companies can run 4%–5%.

2. Price-to-earnings (P/E) ratio

Current market price per share

_____________________ Earnings per share P/E ratios above 20 indicate strong investor confidence in a firm’s outlook and earnings growth; firms whose future earnings are at risk or likely to grow slowly typically have ratios below 12.

3. Dividend payout ratio

Annual dividends per share ___________________ Earnings per share

Indicates the percentage of after-tax profits paid out as dividends.

4. Internal cash flow

After-tax profits + Depreciation A rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, and taxes. Such amounts can be used for dividend payments or funding capital expenditures.

5. Free cash flow After-tax profits + Depreciation – Capital  expenditures – Dividends

A rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, taxes, dividends, and desirable reinvestments in the business. The larger a company’s free cash flow, the greater its ability to internally fund new strategic initiatives, repay debt, make new acquisitions, repurchase shares of stock, or increase dividend payments.

An essential element of deciding whether a company’s overall situation is funda-mentally healthy or unhealthy entails examining the attractiveness of its resources and capabilities. A company’s resources and capabilities are its competitive assets and determine whether its competitive power in the marketplace will be impres-sively strong or disappointingly weak. Companies with second-rate competitive assets nearly always are relegated to a trailing position in the industry.

Resource and capability analysis provides managers with a powerful tool for sizing up the company’s competitive assets and determining whether they can provide the foundation necessary for competitive success in the marketplace. This is a two-step process. The first step is to identify the company’s resources and

QUESTION 2: WHAT ARE THE COMPANY’S MOST IMPORTANT RESOURCES AND CAPABILITIES, AND WILL THEY GIVE THE COMPANY A LASTING COMPETITIVE ADVANTAGE OVER RIVAL COMPANIES?

CORE CONCEPT

A company’s resources and capabilities represent its competitive assets and are determinants of its competitiveness and ability to succeed in the marketplace.

TABLE 4.1 (continued)

Final PDF to printer

88 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 88 10/11/16 08:17 PM

LO 2

Why a company’s resources and capabilities are centrally important in giving the company a competitive edge over rivals.

CORE CONCEPT

A resource is a competitive asset that is owned or controlled by a company; a capability (or competence) is the capacity of a firm to perform some internal activity competently. Capabilities are developed and enabled through the deployment of a company’s resources.

capabilities. The second step is to examine them more closely to ascertain which are the most competitively important and whether they can support a sustainable competitive advantage over rival firms.1 This second step involves applying the four tests of a resource’s competitive power.

Identifying the Company’s Resources and CapabilitiesA firm’s resources and capabilities are the fundamental building blocks of its com-petitive strategy. In crafting strategy, it is essential for managers to know how to take stock of the company’s full complement of resources and capabilities. But

before they can do so, managers and strategists need a more precise definition of these terms.

In brief, a resource is a productive input or competitive asset that is owned or con-trolled by the firm. Firms have many different types of resources at their disposal that vary not only in kind but in quality as well. Some are of a higher quality than others, and some are more competitively valuable, having greater potential to give a firm a competitive advantage over its rivals. For example, a company’s brand is a resource, as is an R&D team—yet some brands such as Coca-Cola and Xerox are well known, with enduring value, while others have little more name recognition than generic products. In similar fashion, some R&D teams are far more innovative and productive than oth-ers due to the outstanding talents of the individual team members, the team’s composi-tion, its experience, and its chemistry.

A capability (or competence)  is the capacity of a firm to perform some inter-nal activity competently. Capabilities or competences also vary in form, quality, and competitive importance, with some being more competitively valuable than others. American Express displays superior capabilities in brand management and market-

ing; Starbucks’s employee management, training, and real estate capabilities are the drivers behind its rapid growth; LinkedIn relies on superior software innova-tion capabilities to increase new user memberships. Organizational capabilities are developed and enabled through the deployment of a company’s resources.2 For example, Nestlé’s brand management capabilities for its 2,000+ food, bever-age, and pet care brands draw on the knowledge of the company’s brand managers, the expertise of its marketing department, and the company’s relationships with retailers in nearly 200 countries. W. L. Gore’s product innovation capabilities in its fabrics and medical and industrial product businesses result from the personal initiative, creative talents, and technological expertise of its associates and the com-pany’s culture that encourages accountability and creative thinking.

Types of Company Resources A useful way to identify a company’s resources is to look for them within categories, as shown in Table 4.2. Broadly speak-ing, resources can be divided into two main categories: tangible and intangible resources. Although human resources make up one of the most important parts of

a company’s resource base, we include them in the intangible category to emphasize the role played by the skills, talents, and knowledge of a company’s human resources.

Tangible resources are the most easily identified, since tangible resources are those that can be touched or quantified readily. Obviously, they include various types of physical resources such as manufacturing facilities and mineral resources, but they also include a company’s financial resources, technological resources, and organi-zational resources such as the company’s communication and control systems. Note

Resource and capability analysis is a powerful tool for sizing up a company’s competitive assets and determining whether the assets can support a sustainable competitive advantage over market rivals.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 89

tho32789_ch04_082-119.indd 89 10/11/16 08:17 PM

that technological resources are included among tangible resources, by convention, even though some types, such as copyrights and trade secrets, might be more logically categorized as intangible.

Intangible resources are harder to discern, but they are often among the most impor-tant of a firm’s competitive assets. They include various sorts of human assets and intellectual capital, as well as a company’s brands, image, and reputational assets. While intangible resources have no material existence on their own, they are often embodied in something material. Thus, the skills and knowledge resources of a firm are embodied in its managers and employees; a company’s brand name is embodied in the company logo or product labels. Other important kinds of intangible resources include a company’s relationships with suppliers, buyers, or partners of various sorts, and the company’s culture and incentive system. A more detailed listing of the various types of tangible and intangible resources is provided in Table 4.2.

Listing a company’s resources category by category can prevent managers from inadvertently overlooking some company resources that might be competitively important. At times, it can be difficult to decide exactly how to categorize certain types of resources. For example, resources such as a work group’s specialized exper-tise in developing innovative products can be considered to be technological assets or human assets or intellectual capital and knowledge assets; the work ethic and drive of a company’s workforce could be included under the company’s human assets or its

Tangible resources

∙ Physical resources: land and real estate; manufacturing plants, equipment, and/or distribution facilities; the locations of stores, plants, or distribution centers, including the overall pattern of their physical locations; ownership of or access rights to natural resources (such as mineral deposits)

∙ Financial resources: cash and cash equivalents; marketable securities; other financial assets such as a company’s credit rating and borrowing capacity

∙ Technological assets: patents, copyrights, production technology, innovation technologies, technological processes

∙ Organizational resources: IT and communication systems (satellites, servers, workstations, etc.); other planning, coordination, and control systems; the company’s organizational design and reporting structure

Intangible resources

∙ Human assets and intellectual capital: the education, experience, knowledge, and talent of the workforce, cumula-tive learning, and tacit knowledge of employees; collective learning embedded in the organization, the intellectual capital and know-how of specialized teams and work groups; the knowledge of key personnel concerning important business functions; managerial talent and leadership skill; the creativity and innovativeness of certain personnel

∙ Brands, company image, and reputational assets: brand names, trademarks, product or company image, buyer loyalty and goodwill; company reputation for quality, service, and reliability; reputation with suppliers and partners for fair dealing

∙ Relationships: alliances, joint ventures, or partnerships that provide access to technologies, specialized know-how, or geographic markets; networks of dealers or distributors; the trust established with various partners

∙ Company culture and incentive system: the norms of behavior, business principles, and ingrained beliefs within the company; the attachment of personnel to the company’s ideals; the compensation system and the motivation level of company personnel

TABLE 4.2 Types of Company Resources

Final PDF to printer

90 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 90 10/11/16 08:17 PM

culture and incentive system. In this regard, it is important to remember that it is not exactly how a resource is categorized that matters but, rather, that all of the com-pany’s different types of resources are included in the inventory. The real purpose of using categories in identifying a company’s resources is to ensure that none of a company’s resources go unnoticed when sizing up the company’s competitive assets.

Identifying Capabilities Organizational capabilities are more complex entities than resources; indeed, they are built up through the use of resources and draw on some combination of the firm’s resources as they are exercised. Virtually all orga-nizational capabilities are knowledge-based, residing in people and in a company’s intellectual capital, or in organizational processes and systems, which embody tacit knowledge. For example, Amazon’s speedy delivery capabilities rely on the knowledge of its fulfillment center managers, its relationship with the United Postal Service, and the experience of its merchandisers to correctly predict inventory flow. Bose’s capa-bilities in auditory system design arise from the talented engineers that form the R&D team as well as the company’s strong culture, which celebrates innovation and beauti-ful design.

Because of their complexity, capabilities are harder to categorize than resources and more challenging to search for as a result. There are, however, two approaches that can make the process of uncovering and identifying a firm’s capabilities more system-atic. The first method takes the completed listing of a firm’s resources as its starting point. Since capabilities are built from resources and utilize resources as they are exer-cised, a firm’s resources can provide a strong set of clues about the types of capabili-ties the firm is likely to have accumulated. This approach simply involves looking over the firm’s resources and considering whether (and to what extent) the firm has built up any related capabilities. So, for example, a fleet of trucks, the latest RFID track-ing technology, and a set of large automated distribution centers may be indicative of sophisticated capabilities in logistics and distribution. R&D teams composed of top scientists with expertise in genomics may suggest organizational capabilities in devel-oping new gene therapies or in biotechnology more generally.

The second method of identifying a firm’s capabilities takes a functional approach. Many capabilities relate to fairly specific functions; these draw on a limited set of resources and typically involve a single department or organizational unit. Capabili-ties in injection molding or continuous casting or metal stamping are manufacturing-related; capabilities in direct selling, promotional pricing, or database marketing all connect to the sales and marketing functions; capabilities in basic research, strate-gic innovation, or new product development link to a company’s R&D function. This approach requires managers to survey the various functions a firm performs to find the different capabilities associated with each function.

A problem with this second method is that many of the most important capabilities of firms are inherently cross-functional. Cross-functional capabilities draw on a num-ber of different kinds of resources and are multidimensional in nature—they spring from the effective collaboration among people with different types of expertise work-ing in different organizational units. Warby Parker draws from its cross-functional design process to create its popular eyewear. Its design capabilities are not just due to its creative designers, but are the product of their capabilities in market research and engineering as well as their relations with suppliers and manufacturing compa-nies. Cross-functional capabilities and other complex capabilities involving numer-ous linked and closely integrated competitive assets are sometimes referred to as resource bundles.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 91

tho32789_ch04_082-119.indd 91 10/11/16 08:17 PM

It is important not to miss identifying a company’s resource bundles, since they can be the most competitively important of a firm’s competitive assets. Resource bundles can sometimes pass the four tests of a resource’s competitive power (described below) even when the individual components of the resource bundle can-not. Although PetSmart’s supply chain and marketing capabilities are matched well by rival Petco, the company has and continues to outperform competitors through its customer service capabilities (including animal grooming and veterinary and day care services). Nike’s bundle of styling expertise, marketing research skills, professional endorsements, brand name, and managerial know-how has allowed it to remain number one in the athletic footwear and apparel industry for more than 20 years.

Assessing the Competitive Power of a Company’s Resources and CapabilitiesTo assess a company’s competitive power, one must go beyond merely identifying its resources and capabilities to probe its caliber.3 Thus, the second step in resource and capability analysis is designed to ascertain which of a company’s resources and capa-bilities are competitively superior and to what extent they can support a company’s quest for a sustainable competitive advantage over market rivals. When a company has competitive assets that are central to its strategy and superior to those of rival firms, they can support a competitive advantage, as defined in Chapter 1. If this advantage proves durable despite the best efforts of competitors to overcome it, then the company is said to have a sustainable competitive advantage. While it may be difficult for a company to achieve a sustainable competitive advantage, it is an important strategic objective because it imparts a potential for attractive and long-lived profitability.

The Four Tests of a Resource’s Competitive Power The competi-tive power of a resource or capability is measured by how many of four specific tests it can pass.4 These tests are referred to as the VRIN tests for sustainable competitive advantage—VRIN is a shorthand reminder standing for Valuable, Rare, Inimitable, and Nonsubstitutable. The first two tests determine whether a resource or capability can support a competitive advantage. The last two determine whether the competi-tive advantage can be sustained.

1. Is the resource or capability competitively Valuable? To be competitively valu-able, a resource or capability must be directly relevant to the company’s strat-egy, making the company a more effective competitor. Unless the resource or capability contributes to the effectiveness of the company’s strategy, it cannot pass this first test. An indicator of its effectiveness is whether the resource enables the company to strengthen its business model by improving its customer value proposition and/or profit formula (see Chapter 1). Companies have to guard against contending that something they do well is necessarily competitively valu-able. Apple’s OS X operating system for its personal computers by some accounts is superior to Microsoft’s Windows 10, but Apple has failed in converting its resources devoted to operating system design into anything more than moderate competitive success in the global PC market.

2. Is the resource or capability  Rare—is it something rivals lack? Resources and capabilities that are common among firms and widely available cannot be a source of competitive advantage. All makers of branded cereals have valuable marketing

CORE CONCEPT

A resource bundle is a linked and closely integrated set of competitive assets centered around one or more cross-functional capabilities.

CORE CONCEPT

The VRIN tests for sustainable competitive advantage ask whether a resource is valuable, rare, inimitable, and nonsubstitutable.

Final PDF to printer

92 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 92 10/11/16 08:17 PM

capabilities and brands, since the key success factors in the ready-to-eat cereal industry demand this. They are not rare. However, the brand strength of Oreo cookies is uncommon and has provided Kraft Foods with greater market share as well as the opportunity to benefit from brand extensions such as Double Stuf Oreos and Mini Oreos. A resource or capability is considered rare if it is held by only a small number of firms in an industry or specific competitive domain. Thus, while general management capabilities are not rare in an absolute sense, they are relatively rare in some of the less developed regions of the world and in some business domains.

3. Is the resource or capability Inimitable—is it hard to copy? The more difficult and more costly it is for competitors to imitate a company’s resource or capabil-ity, the more likely that it can also provide a sustainable competitive advantage. Resources and capabilities tend to be difficult to copy when they are unique (a fantastic real estate location, patent-protected technology, an unusually talented and motivated labor force), when they must be built over time in ways that are difficult to imitate (a well-known brand name, mastery of a complex pro-cess technology, years of cumulative experience and learning), and when they entail financial outlays or large-scale operations that few industry members can undertake (a global network of dealers and distributors). Imitation is also dif-ficult for resources and capabilities that reflect a high level of social complex-ity (company culture, interpersonal relationships among the managers or R&D teams, trust-based relations with customers or suppliers) and causal ambiguity, a term that signifies the hard-to-disentangle nature of the complex resources, such as a web of intricate processes enabling new drug discovery. Hard-to-copy resources and capabilities are important competitive assets, contributing to the longevity of a company’s market position and offering the potential for sus-tained profitability.

4. Is the resource or capability Nonsubstitutable—is it invulnerable to the threat of substitution from different types of resources and capabilities? Even resources that are competitively valuable, rare, and costly to imitate may lose much of their abil-ity to offer competitive advantage if rivals possess equivalent substitute resources. For example, manufacturers relying on automation to gain a cost-based advantage in production activities may find their technology-based advantage nullified by rivals’ use of low-wage offshore manufacturing. Resources can contribute to a sustainable competitive advantage only when resource substitutes aren’t on the horizon.

The vast majority of companies are not well endowed with standout resources or capabilities, capable of passing all four tests with high marks. Most firms have a mixed bag of resources—one or two quite valuable, some good, many satisfactory to mediocre. Resources and capabilities that are valuable pass the first of the four tests. As key contributors to the effectiveness of the strategy, they are relevant to the firm’s competitiveness but are no guarantee of competitive advantage. They may offer no more than competitive parity with competing firms.

Passing both of the first two tests requires more—it requires resources and capa-bilities that are not only valuable but also rare. This is a much higher hurdle that can be cleared only by resources and capabilities that are competitively superior. Resources and capabilities that are competitively superior are the company’s true strategic assets. They provide the company with a competitive advantage over its competitors, if only in the short run.

CORE CONCEPT

Social complexity and causal ambiguity are two factors that inhibit the ability of rivals to imitate a firm’s most valuable resources and capabilities. Causal ambiguity makes it very hard to figure out how a complex resource contributes to competitive advantage and therefore exactly what to imitate.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 93

tho32789_ch04_082-119.indd 93 10/11/16 08:17 PM

CORE CONCEPT

A dynamic capability is an ongoing capacity of a company to modify its existing resources and capabilities or create new ones.

To pass the last two tests, a resource must be able to maintain its competitive supe-riority in the face of competition. It must be resistant to imitative attempts and efforts by competitors to find equally valuable substitute resources. Assessing the availabil-ity of substitutes is the most difficult of all the tests since substitutes are harder to recognize, but the key is to look for resources or capabilities held by other firms or being developed that can serve the same function as the company’s core resources and capabilities.5

Very few firms have resources and capabilities that can pass all four tests, but those that do enjoy a sustainable competitive advantage with far greater profit potential. Costco is a notable example, with strong employee incentive programs and capabilities in supply chain management that have surpassed those of its warehouse club rivals for over 35 years. Lincoln Electric Company, less well known but no less notable in its achievements, has been the world leader in welding products for over 100 years as a result of its unique piecework incentive system for compensating production work-ers and the unsurpassed worker productivity and product quality that this system has fostered.

A Company’s Resources and Capabilities Must Be Managed Dynamically Even companies like Costco and Lincoln Electric cannot afford to rest on their laurels. Rivals that are initially unable to replicate a key resource may develop better and better substitutes over time. Resources and capabilities can depreci-ate like other assets if they are managed with benign neglect. Disruptive changes in technology, customer preferences, distribution channels, or other competitive factors can also destroy the value of key strategic assets, turning resources and capabilities “from diamonds to rust.”6

Resources and capabilities must be continually strengthened and nurtured to sustain their competitive power and, at times, may need to be broadened and deep-ened to allow the company to position itself to pursue emerging market oppor-tunities.7 Organizational resources and capabilities that grow stale can impair competitiveness unless they are refreshed, modified, or even phased out and replaced in response to ongoing market changes and shifts in company strategy. Management’s challenge in managing the firm’s resources and capabilities dynam-ically has two elements: (1) attending to the ongoing modification of existing com-petitive assets, and (2) casting a watchful eye for opportunities to develop totally new kinds of capabilities.

The Role of Dynamic Capabilities Companies that know the impor-tance of recalibrating and upgrading their most valuable resources and capabilities ensure that these activities are done on a continual basis. By incorporating these activities into their routine managerial functions, they gain the experience neces-sary to be able to do them consistently well. At that point, their ability to freshen and renew their competitive assets becomes a capability in itself—a dynamic capability. A dynamic capability is the ability to modify, deepen, or augment the company’s existing resources and capabilities.8 This includes the capacity to improve existing resources and capabilities incrementally, in the way that Toyota aggressively upgrades the company’s capabilities in fuel-efficient hybrid engine technology and constantly fine-tunes its famed Toyota production system. Likewise, management at BMW developed new organizational capabilities in hybrid engine design that allowed the company to launch its highly touted i3 and i8 plug-in hybrids.

A company requires a dynamically evolving portfolio of resources and capabilities to sustain its competitiveness and help drive improvements in its performance.

Final PDF to printer

94 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 94 10/11/16 08:17 PM

A dynamic capability also includes the capacity to add new resources and capabilities to the company’s competitive asset portfolio. One way to do this is through alliances and acquisitions. An example is Bristol-Meyers Squibb’s famed “string of pearls” acquisition capabilities, which have enabled it to replace degraded resources such as expiring patents with new patents and newly acquired capabilities in drug discovery for new disease domains.

LO 3

How to assess the company’s strengths and weaknesses in light of market opportunities and external threats.

SWOT analysis is a simple but powerful tool for sizing up a company’s strengths and weaknesses, its market opportunities, and the external threats to its future well-being.

Basing a company’s strategy on its most competitively valuable strengths gives the company its best chance for market success.

QUESTION 3: WHAT ARE THE COMPANY’S STRENGTHS AND WEAKNESSES IN RELATION TO THE MARKET OPPORTUNITIES AND EXTERNAL THREATS?

In evaluating a company’s overall situation, a key question is whether the company is in a position to pursue attractive market opportunities and defend against external threats to its future well-being. The simplest and most easily applied tool for conduct-ing this examination is widely known as SWOT analysis, so named because it zeros in on a company’s internal Strengths and Weaknesses, market Opportunities, and external Threats. A first-rate SWOT analysis provides the basis for crafting a strategy that capitalizes on the company’s strengths, overcomes its weaknesses, aims squarely

at capturing the company’s best opportunities, and defends against competitive and macro-environmental threats.

Identifying a Company’s Internal StrengthsA strength is something a company is good at doing or an attribute that enhances its competitiveness in the marketplace. A company’s strengths depend on the qual-ity of its resources and capabilities. Resource and capability analysis provides a way for managers to assess the quality objectively. While resources and capabili-ties that pass the VRIN tests of sustainable competitive advantage are among the company’s greatest strengths, other types can be counted among the company’s strengths as well. A capability that is not potent enough to produce a sustainable advantage over rivals may yet enable a series of temporary advantages if used as a basis for entry into a new market or market segment. A resource bundle that fails to match those of top-tier competitors may still allow a company to compete success-fully against the second tier.

Assessing a Company’s Competencies—What Activities Does It Perform Well? One way to appraise the degree of a company’s strengths has to do with the company’s skill level in performing key pieces of its business—such as supply chain management, R&D, production, distribution, sales and market-ing, and customer service. A company’s skill or proficiency in performing different facets of its operations can range from the extreme of having minimal ability to perform an activity (perhaps having just struggled to do it the first time) to the other extreme of being able to perform the activity better than any other company in the industry.

When a company’s proficiency rises from that of mere ability to perform an activ-ity to the point of being able to perform it consistently well and at acceptable cost, it is

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 95

tho32789_ch04_082-119.indd 95 10/11/16 08:17 PM

CORE CONCEPT

A company’s strengths represent its competitive assets; its weaknesses are shortcomings that constitute competitive liabilities.

said to have a competence—a true capability, in other words. If a company’s com-petence level in some activity domain is superior to that of its rivals it is known as a distinctive competence. A core competence is a proficiently performed internal activity that is central to a company’s strategy and is typically distinctive as well. A core competence is a more competitively valuable strength than a competence because of the activity’s key role in the company’s strategy and the contribution it makes to the company’s market success and profitability. Often, core compe-tencies can be leveraged to create new markets or new product demand, as the engine behind a company’s growth. Procter and Gamble has a core competence in brand management, which has led to an ever increasing portfolio of market-leading consumer products, including Charmin, Tide, Crest, Tampax, Olay, Febreze, Luvs, Pampers, and Swiffer. Nike has a core competence in designing and marketing innovative athletic footwear and sports apparel. Kellogg has a core competence in developing, producing, and marketing breakfast cereals.

Identifying Company Weaknesses and Competitive DeficienciesA weakness, or competitive deficiency, is something a company lacks or does poorly (in comparison to others) or a condition that puts it at a disadvantage in the market-place. A company’s internal weaknesses can relate to (1) inferior or unproven skills, expertise, or intellectual capital in competitively important areas of the business; (2) deficiencies in competitively important physical, organizational, or intangible assets; or (3) missing or competitively inferior capabilities in key areas. Company weaknesses are thus internal shortcomings that constitute competitive liabilities. Nearly all companies have competitive liabilities of one kind or another. Whether a company’s internal weaknesses make it competitively vulnerable depends on how much they matter in the marketplace and whether they are offset by the company’s strengths.

Table 4.3 lists many of the things to consider in compiling a company’s strengths and weaknesses. Sizing up a company’s complement of strengths and deficiencies is akin to constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses represent competitive liabilities. Obvi-ously, the ideal condition is for the company’s competitive assets to outweigh its competitive liabilities by an ample margin—a 50–50 balance is definitely not the desired condition!

Identifying a Company’s Market OpportunitiesMarket opportunity is a big factor in shaping a company’s strategy. Indeed, manag-ers can’t properly tailor strategy to the company’s situation without first identify-ing its market opportunities and appraising the growth and profit potential each one holds. Depending on the prevailing circumstances, a company’s opportunities can be plentiful or scarce, fleeting or lasting, and can range from wildly attractive to mar-ginally interesting to unsuitable. Table 4.3 displays a sampling of potential market opportunities.

Newly emerging and fast-changing markets sometimes present stunningly big or “golden” opportunities, but it is typically hard for managers at one company to peer into “the fog of the future” and spot them far ahead of managers at other companies.9

CORE CONCEPT

A competence is an activity that a company has learned to perform with proficiency.

A distinctive competence is a capability that enables a company to perform a particular set of activities better than its rivals.

CORE CONCEPT

A core competence is an activity that a company performs proficiently and that is also central to its strategy and competitive success.

Final PDF to printer

96 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 96 10/11/16 08:17 PM

Potential Strengths and Competitive Assets Potential Weaknesses and Competitive Deficiencies

• Competencies that are well matched to industry key success factors

• Ample financial resources to grow the business • Strong brand-name image and/or company

reputation • Economies of scale and/or learning- and experi-

ence-curve advantages over rivals • Other cost advantages over rivals • Attractive customer base • Proprietary technology, superior technological

skills, important patents • Strong bargaining power over suppliers or buyers • Resources and capabilities that are valuable and

rare • Resources and capabilities that are hard to copy

and for which there are no good substitutes • Superior product quality • Wide geographic coverage and/or strong global

distribution capability • Alliances and/or joint ventures that provide access

to valuable technology, competencies, and/or attractive geographic markets

• No clear strategic vision • No well-developed or proven core competencies • No distinctive competencies or competitively superior

resources • Lack of attention to customer needs • A product or service with features and attributes that

are inferior to those of rivals • Weak balance sheet, insufficient financial resources to

grow the firm • Too much debt • Higher overall unit costs relative to those of key

competitors • Too narrow a product line relative to rivals • Weak brand image or reputation • Weaker dealer network than key rivals and/or lack of

adequate distribution capability • Lack of management depth • A plague of internal operating problems or obsolete

facilities • Too much underutilized plant capacity • Resources that are readily copied or for which there are

good substitutes

Potential Market Opportunities Potential External Threats to a Company’s Future Profitability

• Meeting sharply rising buyer demand for the industry’s product

• Serving additional customer groups or market segments

• Expanding into new geographic markets • Expanding the company’s product line to meet a

broader range of customer needs • Utilizing existing company skills or technological know-

how to enter new product lines or new businesses • Taking advantage of falling trade barriers in attrac-

tive foreign markets • Taking advantage of an adverse change in the for-

tunes of rival firms • Acquiring rival firms or companies with attractive

technological expertise or capabilities • Taking advantage of emerging technological

developments to innovate • Entering into alliances or joint ventures to expand

the firm’s market coverage or boost its competitive capability

• Increased intensity of competition among industry rivals– may squeeze profit margins

• Slowdowns in market growth • Likely entry of potent new competitors • Growing bargaining power of customers or suppliers • A shift in buyer needs and tastes away from the indus-

try’s product • Adverse demographic changes that threaten to curtail

demand for the industry’s product • Adverse economic conditions that threaten critical sup-

pliers or distributors • Changes in technology–particularly disruptive tech-

nology that can undermine the company’s distinctive competencies

• Restrictive foreign trade policies • Costly new regulatory requirements • Tight credit conditions • Rising prices on energy or other key inputs

TABLE 4.3 What to Look for in Identifying a Company’s Strengths, Weaknesses, Opportunities, and Threats

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 97

tho32789_ch04_082-119.indd 97 10/11/16 08:17 PM

But as the fog begins to clear, golden opportunities are nearly always seized rapidly—and the companies that seize them are usually those that have been actively waiting, staying alert with diligent market reconnaissance, and preparing themselves to capi-talize on shifting market conditions by patiently assembling an arsenal of resources to enable aggressive action when the time comes. In mature markets, unusually attractive market opportunities emerge sporadically, often after long periods of relative calm—but future market conditions may be more predictable, making emerging opportuni-ties easier for industry members to detect.

In evaluating a company’s market opportunities and ranking their attractiveness, managers have to guard against viewing every industry opportunity as a company opportunity. Rarely does a company have the resource depth to pursue all avail-able market opportunities simultaneously without spreading itself too thin. Some companies have resources and capabilities better-suited for pursuing some opportu-nities, and a few companies may be hopelessly outclassed in competing for any of an industry’s attractive opportunities. The market opportunities most relevant to a company are those that match up well with the company’s competitive assets, offer the best prospects for growth and profitability, and present the most potential for competitive advantage.

Identifying the Threats to a Company’s Future ProfitabilityOften, certain factors in a company’s external environment pose threats to its profit-ability and competitive well-being. Threats can stem from such factors as the emer-gence of cheaper or better technologies, the entry of lower-cost foreign competitors into a company’s market stronghold, new regulations that are more burdensome to a company than to its competitors, unfavorable demographic shifts, and political upheaval in a foreign country where the company has facilities. Table 4.3 shows a representative list of potential threats.

External threats may pose no more than a moderate degree of adversity (all companies confront some threatening elements in the course of doing business), or they may be imposing enough to make a company’s situation look tenuous. On rare occasions, market shocks can give birth to a sudden-death threat that throws a company into an immediate crisis and a battle to survive. Many of the world’s major financial institutions were plunged into unprecedented crisis in 2008–2009 by the aftereffects of high-risk mortgage lending, inflated credit ratings on sub-prime mortgage securities, the collapse of housing prices, and a market flooded with mortgage-related investments (collateralized debt obligations) whose values suddenly evaporated. It is management’s job to identify the threats to the com-pany’s future prospects and to evaluate what strategic actions can be taken to neu-tralize or lessen their impact.

What Do the SWOT Listings Reveal?SWOT analysis involves more than making four lists. The two most important parts of SWOT analysis are drawing conclusions from the SWOT listings about the com-pany’s overall situation and translating these conclusions into strategic actions to bet-ter match the company’s strategy to its internal strengths and market opportunities, to correct important weaknesses, and to defend against external threats. Figure 4.2 shows the steps involved in gleaning insights from SWOT analysis.

Simply making lists of a company’s strengths, weaknesses, opportunities, and threats is not enough; the payoff from SWOT analysis comes from the conclusions about a company’s situation and the implications for strategy improvement that flow from the four lists.

A company is well advised to pass on a particular market opportunity unless it has or can acquire the resources and capabilities needed to capture it.

Final PDF to printer

98 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 98 10/11/16 08:17 PM

FIGURE 4.2 The Steps Involved in SWOT Analysis: Identify the Four Components of SWOT, Draw Conclusions, Translate Implications into Strategic Actions

Identify companystrengths andcompetitive assets

Identify companyweaknesses andcompetitivedeficiencies

Identify thecompany’s marketopportunities

Identify externalthreats to thecompany’s futurewell-being

Conclusions concerning the company’s overall business situation: Where on the scale from “alarmingly weak” to

“exceptionally strong” does the attractiveness of the company’s situation rank?

What are the attractive and unattractive aspects of the company’s situation?

Implications for improving company strategy: Use company strengths as the foundation for the

company’s strategy. Pursue those market opportunities best suited

to company strengths. Correct weaknesses and deficiencies that impair

pursuit of important market opportunities or heighten vulnerability to external threats.

Use company strengths to lessen the impact of important external threats.

What Can Be Gleaned from theSWOT Listings?

The final piece of SWOT analysis is to translate the diagnosis of the company’s situation into actions for improving the company’s strategy and business prospects. A company’s internal strengths should always serve as the basis of its strategy— placing heavy reliance on a company’s best competitive assets is the soundest route to attracting customers and competing successfully against rivals.10 As a rule, strategies that place heavy demands on areas where the company is weakest or has unproven competencies should be avoided. Plainly, managers must look toward correcting competitive weaknesses that make the company vulnerable, hold down profitability, or disqualify it from pursuing an attractive opportunity. Furthermore, a company’s strategy should be aimed squarely at capturing attractive market opportunities that are suited to the company’s collection of capabilities. How much attention to devote to defending against external threats to the company’s future performance hinges on how vulnerable the company is, whether defensive moves can be taken to lessen their impact, and whether the costs of undertaking such moves represent the best use of company resources.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 99

tho32789_ch04_082-119.indd 99 10/11/16 08:17 PM

Company managers are often stunned when a competitor cuts its prices to “unbeliev-ably low” levels or when a new market entrant introduces a great new product at a surprisingly low price. While less common, new entrants can also storm the market with a product that ratchets the quality level up so high that customers will abandon competing sellers even if they have to pay more for the new product. This is what seems to have happened with Apple’s iPhone 6 and iMac computers; it is what Apple is betting on with the Apple Watch.

Regardless of where on the quality spectrum a company competes, it must remain competitive in terms of its customer value proposition in order to stay in the game. Patagonia’s value proposition, for example, remains attractive to customers who value quality, wide selection, and corporate environmental responsibility over cheaper out-erwear alternatives. Since its inception in 1925, the New Yorker’s customer value proposition has withstood the test of time by providing readers with an amalgam of well-crafted, rigorously fact-checked, and topical writing.

The value provided to the customer depends on how well a customer’s needs are met for the price paid. How well customer needs are met depends on the per-ceived quality of a product or service as well as on other, more tangible attributes. The greater the amount of customer value that the company can offer profitably compared to its rivals, the less vulnerable it will be to competitive attack. For man-agers, the key is to keep close track of how cost-effectively the company can deliver value to customers relative to its competitors. If it can deliver the same amount of value with lower expenditures (or more value at the same cost), it will maintain a competitive edge.

Two analytic tools are particularly useful in determining whether a company’s costs and customer value proposition are competitive: value chain analysis and benchmarking.

The Concept of a Company Value ChainEvery company’s business consists of a collection of activities undertaken in the course of producing, marketing, delivering, and supporting its product or service. All the various activities that a company performs internally combine to form a value chain—so called because the underlying intent of a company’s activities is ultimately to create value for buyers.

As shown in Figure 4.3, a company’s value chain consists of two broad catego-ries of activities: the primary activities foremost in creating value for customers and the requisite support activities that facilitate and enhance the performance of the primary activities.11 The kinds of primary and secondary activities that con-stitute a company’s value chain vary according to the specifics of a company’s business; hence, the listing of the primary and support activities in Figure 4.3 is illus-trative rather than definitive. For example, the primary activities at a hotel operator like Starwood Hotels and Resorts mainly consist of site selection and construction, reservations, and hotel operations (check-in and check-out, maintenance and house-keeping, dining and room service, and conventions and meetings); principal support

QUESTION 4: HOW DO A COMPANY’S VALUE CHAIN ACTIVITIES IMPACT ITS COST STRUCTURE AND CUSTOMER VALUE PROPOSITION?

LO 4

How a company’s value chain activities can affect the company’s cost structure and customer value proposition.

The higher a company’s costs are above those of close rivals, the more competitively vulnerable the company becomes.

The greater the amount of customer value that a company can offer profitably relative to close rivals, the less competitively vulnerable the company becomes.

CORE CONCEPT

A company’s value chain identifies the primary activities and related support activities that create customer value.

Final PDF to printer

100 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 100 10/11/16 08:17 PM

FIGURE 4. 3 A Representative Company Value Chain

Operations DistributionSales andMarketing

ServiceProfit

Margin

Supply Chain

Manage-ment

PrimaryActivities

andCosts

SupportActivities

andCosts

Product R&D, Technology, and Systems Development

Human Resource Management

General Administration

PRIMARY ACTIVITIES

Supply Chain Management—Activities, costs, and assets associated with purchasing fuel, energy, raw materials, parts and components, merchandise, and consumable items from vendors; receiving, storing, and disseminating inputs from suppliers; inspection; and inventory management.

Operations—Activities, costs, and assets associated with converting inputs into final product form (production, assembly, packaging, equipment maintenance, facilities, operations, quality assurance, environmental protection).

Distribution—Activities, costs, and assets dealing with physically distributing the product to buyers (finished goods warehousing, order processing, order picking and packing, shipping, delivery vehicle operations, establishing and maintaining a network of dealers and distributors).

Sales and Marketing—Activities, costs, and assets related to sales force e�orts, advertising and promotion, market research and planning, and dealer/distributor support.

Service—Activities, costs, and assets associated with providing assistance to buyers, such as installation, spare parts delivery, maintenance and repair, technical assistance, buyer inquiries, and complaints.

SUPPORT ACTIVITIES

Product R&D, Technology, and Systems Development—Activities, costs, and assets relating to product R&D, process R&D, process design improvement, equipment design, computer software development, telecommuni- cations systems, computer-assisted design and engineering, database capabilities, and development of computerized support systems.

Human Resource Management—Activities, costs, and assets associated with the recruitment, hiring, training, development, and compensation of all types of personnel; labor relations activities; and development of knowledge-based skills and core competencies.

General Administration—Activities, costs, and assets relating to general management, accounting and finance, legal and regulatory a�airs, safety and security, management information systems, forming strategic alliances and collaborating with strategic partners, and other “overhead” functions.

Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), pp. 37–43.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 101

tho32789_ch04_082-119.indd 101 10/11/16 08:17 PM

activities that drive costs and impact customer value include hiring and training hotel staff and handling general administration. Supply chain management is a cru-cial activity for J.Crew and Boeing but is not a value chain component at Facebook, LinkedIn, or Goldman Sachs. Sales and marketing are dominant activities at GAP and Match.com but have only minor roles at oil-drilling companies and natural gas pipeline companies. Customer delivery is a crucial activity at Domino’s Pizza but insignificant at Starbucks.

With its focus on value-creating activities, the value chain is an ideal tool for examining the workings of a company’s customer value proposition and business model. It permits a deep look at the company’s cost structure and ability to offer low prices. It reveals the emphasis that a company places on activities that enhance dif-ferentiation and support higher prices, such as service and marketing. It also includes a profit margin component, since profits are necessary to compensate the company’s owners and investors, who bear risks and provide capital. Tracking the profit margin along with the value-creating activities is critical because unless an enterprise suc-ceeds in delivering customer value profitably (with a sufficient return on invested capital), it can’t survive for long. Attention to a company’s profit formula in addi-tion to its customer value proposition is the essence of a sound business model, as described in Chapter 1.

Illustration Capsule 4.1 shows representative costs for various value chain activi-ties performed by Boll & Branch, a maker of luxury linens and bedding sold directly to consumers online.

Comparing the Value Chains of Rival Companies Value chain analysis facilitates a comparison of how rivals, activity by activity, deliver value to customers. Even rivals in the same industry may differ significantly in terms of the activities they perform. For instance, the “operations” component of the value chain for a manufacturer that makes all of its own parts and components and assembles them into a finished product differs from the “operations” of a rival producer that buys the needed parts and components from outside suppliers and performs only assembly operations. How each activity is performed may affect a company’s relative cost posi-tion as well as its capacity for differentiation. Thus, even a simple comparison of how the activities of rivals’ value chains differ can reveal competitive differences.

A Company’s Primary and Secondary Activities Identify the Major Components of Its Internal Cost Structure The combined costs of all the various primary and support activities constituting a company’s value chain define its internal cost structure. Further, the cost of each activity contributes to whether the company’s overall cost position relative to rivals is favorable or unfavorable. The roles of value chain analysis and benchmarking are to develop the data for comparing a company’s costs activity by activity against the costs of key rivals and to learn which internal activities are a source of cost advantage or disadvantage.

Evaluating a company’s cost-competitiveness involves using what accountants call activity-based costing to determine the costs of performing each value chain activity.12 The degree to which a company’s total costs should be broken down into costs for specific activities depends on how valuable it is to know the costs of specific activities versus broadly defined activities. At the very least, cost esti-mates are needed for each broad category of primary and support activities, but

A company’s cost-competitiveness depends not only on the costs of internally performed activities (its own value chain) but also on costs in the value chains of its suppliers and distribution-channel allies.

Final PDF to printer

102

tho32789_ch04_082-119.indd 102 10/11/16 08:17 PM

ILLUSTRATION CAPSULE 4.1 The Value Chain for Boll & Branch

© belchonock/iStock/Getty Images

A king-size set of sheets from Boll & Branch is made from 6 meters of fabric, requiring 11 kilograms of raw cotton.

Raw Cotton $ 28.16

Spinning/Weaving/Dyeing   12.00

Cutting/Sewing/Finishing     9.50

Material Transportation     3.00

Factory Fee    15.80

Cost of Goods $ 68.46

Inspection Fees    5.48

Ocean Freight/Insurance    4.55

Import Duties    8.22

Warehouse/Packing    8.50

Packaging    15.15

Customer Shipping    14.00

Promotions/Donations*     30.00

Total Cost $154.38

Boll & Brand Markup About 60%

Boll & Brand Retail Price $250.00

Gross Margin** $ 95.62

Source: Adapted from Christina Brinkley, “What Goes into the Price of Luxury Sheets?” The Wall Street Journal, March 29, 2014, www.wsj.com/articles/SB10001424052702303725404579461953672838672 (accessed February 16, 2016).

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 103

tho32789_ch04_082-119.indd 103 10/11/16 08:17 PM

cost estimates for more specific activities within each broad category may be needed if a company discovers that it has a cost disadvantage vis-à-vis rivals and wants to pin down the exact source or activity causing the cost disadvantage. However, a company’s own internal costs may be insufficient to assess whether its product offering and cus-tomer value proposition are competitive with those of rivals. Cost and price differ-ences among competing companies can have their origins in activities performed by suppliers or by distribution allies involved in getting the product to the final customers or end users of the product, in which case the company’s entire value chain system becomes relevant.

The Value Chain SystemA company’s value chain is embedded in a larger system of activities that includes the value chains of its suppliers and the value chains of whatever wholesale distribu-tors and retailers it utilizes in getting its product or service to end users. This value chain system (sometimes called a vertical chain) has implications that extend far beyond the company’s costs. It can affect attributes like product quality that enhance differentiation and have importance for the company’s customer value proposition, as well as its profitability.13 Suppliers’ value chains are relevant because suppliers perform activities and incur costs in creating and delivering the purchased inputs utilized in a company’s own value-creating activities. The costs, performance fea-tures, and quality of these inputs influence a company’s own costs and product dif-ferentiation capabilities. Anything a company can do to help its suppliers drive down the costs of their value chain activities or improve the quality and performance of the items being supplied can enhance its own competitiveness—a powerful reason for working collaboratively with suppliers in managing supply chain activities.14 For example, automakers have encouraged their automotive parts suppliers to build plants near the auto assembly plants to facilitate just-in-time deliveries, reduce ware-housing and shipping costs, and promote close collaboration on parts design and production scheduling.

Similarly, the value chains of a company’s distribution-channel partners are rel-evant because (1) the costs and margins of a company’s distributors and retail dealers are part of the price the ultimate consumer pays and (2) the activities that distribu-tion allies perform affect sales volumes and customer satisfaction. For these reasons, companies normally work closely with their distribution allies (who are their direct customers) to perform value chain activities in mutually beneficial ways. For instance, motor vehicle manufacturers have a competitive interest in working closely with their automobile dealers to promote higher sales volumes and better customer satisfaction with dealers’ repair and maintenance services. Producers of kitchen cabinets are heav-ily dependent on the sales and promotional activities of their distributors and build-ing supply retailers and on whether distributors and retailers operate cost-effectively enough to be able to sell at prices that lead to attractive sales volumes.

As a consequence, accurately assessing a company’s competitiveness entails scru-tinizing the nature and costs of value chain activities throughout the entire value chain system for delivering its products or services to end-use customers. A typical value chain system that incorporates the value chains of suppliers and forward-channel allies (if any) is shown in Figure 4.4. As was the case with company value chains, the specific activities constituting value chain systems vary significantly from industry to industry. The primary value chain system activities in the pulp and paper industry (timber farming, logging, pulp mills, and papermaking) differ from the primary value

Final PDF to printer

104 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 104 10/11/16 08:17 PM

chain system activities in the home appliance industry (parts and components manu-facture, assembly, wholesale distribution, retail sales) and yet again from the computer software industry (programming, disk loading, marketing, distribution).

Benchmarking: A Tool for Assessing Whether the Costs and Effectiveness of a Company’s Value Chain Activities Are in LineBenchmarking entails comparing how different companies (both inside and outside the industry) perform various value chain activities—how materials are purchased, how inventories are managed, how products are assembled, how fast the company can get new products to market, how customer orders are filled and shipped—and then making cross-company comparisons of the costs and effective-ness of these activities.15 The objectives of benchmarking are to identify the best means of performing an activity and to emulate those best practices.

A best practice is a method of performing an activity or business process that consistently delivers superior results compared to other approaches.16 To qualify as a legitimate best practice, the method must have been employed by at least one enterprise and shown to be consistently more effective in lowering costs, improving quality or performance, shortening time requirements, enhancing safety, or achiev-ing some other highly positive operating outcome. Best practices thus identify a path to operating excellence with respect to value chain activities.

Xerox pioneered the use of benchmarking to become more cost-competitive, quickly deciding not to restrict its benchmarking efforts to its office equipment

rivals but to extend them to any company regarded as “world class” in perform-ing any activity relevant to Xerox’s business. Other companies quickly picked up on Xerox’s approach. Toyota managers got their idea for just-in-time inventory deliver-ies by studying how U.S. supermarkets replenished their shelves. Southwest Airlines reduced the turnaround time of its aircraft at each scheduled stop by studying pit crews on the auto racing circuit. More than 80 percent of Fortune 500 companies reportedly

CORE CONCEPT

Benchmarking is a potent tool for improving a company’s own internal activities that is based on learning how other companies perform them and borrowing their “best practices.”

CORE CONCEPT

A best practice is a method of performing an activity that consistently delivers superior results compared to other approaches.

FIGURE 4.4 A Representative Value Chain System

Supplier-RelatedValue Chains

Activities,costs, andmargins ofsuppliers

Internallyperformedactivities,

costs,and

margins

Activities,costs, andmargins of

forward-channelallies andstrategic partners

Buyer or end-user

value chains

Forward-ChannelValue Chains

A Company’s OwnValue Chain

Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), p. 35.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 105

tho32789_ch04_082-119.indd 105 10/11/16 08:17 PM

use benchmarking for comparing themselves against rivals on cost and other competi-tively important measures.

The tough part of benchmarking is not whether to do it but, rather, how to gain access to information about other companies’ practices and costs. Sometimes bench-marking can be accomplished by collecting information from published reports, trade groups, and industry research firms or by talking to knowledgeable industry ana-lysts, customers, and suppliers. Sometimes field trips to the facilities of competing or noncompeting companies can be arranged to observe how things are done, com-pare practices and processes, and perhaps exchange data on productivity and other cost components. However, such companies, even if they agree to host facilities tours and answer questions, are unlikely to share competitively sensitive cost information. Furthermore, comparing two companies’ costs may not involve comparing apples to apples if the two companies employ different cost accounting principles to calculate the costs of particular activities.

However, a third and fairly reliable source of benchmarking information has emerged. The explosive interest of companies in benchmarking costs and identify-ing best practices has prompted consulting organizations (e.g., Accenture, A. T. Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC) and several associations (e.g., the QualServe Benchmarking Clearinghouse, and the Strategic Planning Institute’s Council on Benchmarking) to gather benchmarking data, distribute information about best practices, and provide comparative cost data without identifying the names of particular companies. Having an independent group gather the information and report it in a manner that disguises the names of individual companies protects competitively sensitive data and lessens the potential for unethical behavior on the part of company personnel in gathering their own data about competitors. Illustration Capsule 4.2 describes benchmarking practices in the cement industry.

Strategic Options for Remedying a Cost or Value DisadvantageThe results of value chain analysis and benchmarking may disclose cost or value dis-advantages relative to key rivals. Such information is vital in crafting strategic actions to eliminate any such disadvantages and improve profitability. Information of this nature can also help a company find new avenues for enhancing its competitiveness through lower costs or a more attractive customer value proposition. There are three main areas in a company’s total value chain system where company managers can try to improve its efficiency and effectiveness in delivering customer value: (1) a com-pany’s own internal activities, (2) suppliers’ part of the value chain system, and (3) the forward-channel portion of the value chain system.

Improving Internally Performed Value Chain Activities Managers can pursue any of several strategic approaches to reduce the costs of internally per-formed value chain activities and improve a company’s cost-competitiveness. They can implement best practices throughout the company, particularly for high-cost activ-ities. They can redesign the product and/or some of its components to eliminate high-cost components or facilitate speedier and more economical manufacture or assembly. They can relocate high-cost activities (such as manufacturing) to geographic areas where they can be performed more cheaply or outsource activities to lower-cost vendors or contractors.

Benchmarking the costs of company activities against those of rivals provides hard evidence of whether a company is cost-competitive.

Final PDF to printer

106

tho32789_ch04_082-119.indd 106 10/11/16 08:17 PM

ILLUSTRATION CAPSULE 4.2

Cement is a dry powder that creates concrete when mixed with water and sand. People interact with con-crete every day. It is often the building material of choice for sidewalks, curbs, basements, bridges, and municipal pipes. Cement is manufactured at billion-dollar contin-uous-process plants by mining limestone, crushing it, scorching it in a kiln, and then milling it again.

About 24 companies (CEMEX, Holcim, and Lafarge are some of the biggest) manufacture cement at 90 U.S. plants with the capacity to produce 110 million tons per year. Plants serve tens of markets distributed across multiple states. Companies regularly benchmark “deliv-ered costs” to understand whether their plants are cost leaders or laggards.

Delivered-cost benchmarking studies typically subdivide manufacturing and logistics costs into five parts: fixed-bin, variable-bin, freight-to-terminal, termi-nal operating, and freight-to-customer costs. These cost components are estimated using different sources.

Fixed- and variable-bin costs represent the cost of making a ton of cement and moving it to the plant’s stor-age silos. They are the hardest to estimate. Fortunately, the Portland Cement Association, or PCA (the cement industry’s association), publishes key data for every plant that features plant location, age, capacity, tech-nology, and fuel. Companies combine the industry data, satellite imagery revealing quarry characteristics, and news reports with the company’s proprietary plant-level financial data to develop their estimates of competitors’ costs. The basic assumption is that plants of similar size utilizing similar technologies and raw-material inputs will have similar cost performance.

Logistics costs (including freight-to-terminal, terminal operating, and freight-to-customer costs) are much easier to accurately estimate. Cement companies use common

carriers to move their product by barge, train, and truck transit modes. Freight pricing is competitive on a per-mile basis by mode, meaning that the company’s per-ton-mile barge cost applies to the competition. By combining the per-ton-mile cost with origin-destination distances, freight costs are easily calculated. Terminal operating costs, the costs of operating barge or rail terminals that store cement and transfer it to trucks for local delivery, represent the smallest fraction of total supply chain cost and typically vary little within mode type. For example, most barge terminals cost $10 per ton to run, whereas rail terminals are less expensive and cost $5 per ton.

By combining all five estimated cost elements, the company benchmarks its estimated relative cost posi-tion by market. Using these data, strategists can identify which of the company’s plants are most exposed to vol-ume fluctuations, which are in greatest need of invest-ment or closure, which markets the company should enter or exit, and which competitors are the most likely candidates for product or asset swaps.

Delivered-Cost Benchmarking in the Cement Industry

© Ulrich Doering/Alamy Stock Photo

Note: Developed with Peter Jacobson.

Source: w w w.cement.org (accessed January 25, 2014).

To improve the effectiveness of the company’s customer value proposition and enhance differentiation, managers can take several approaches. They can adopt best practices for quality, marketing, and customer service. They can reallocate resources to activities that address buyers’ most important purchase criteria, which will have the biggest impact on the value delivered to the customer. They can adopt new tech-nologies that spur innovation, improve design, and enhance creativity. Additional approaches to managing value chain activities to lower costs and/or enhance customer value are discussed in Chapter 5.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 107

tho32789_ch04_082-119.indd 107 10/11/16 08:17 PM

Improving Supplier-Related Value Chain Activities Supplier-related cost disadvantages can be attacked by pressuring suppliers for lower prices, switching to lower-priced substitute inputs, and collaborating closely with suppliers to identify mutual cost-saving opportunities.17 For example, just-in-time deliveries from suppliers can lower a company’s inventory and internal logistics costs and may also allow suppliers to economize on their warehousing, shipping, and production schedul-ing costs—a win–win outcome for both. In a few instances, companies may find that it is cheaper to integrate backward into the business of high-cost suppliers and make the item in-house instead of buying it from outsiders.

Similarly, a company can enhance its customer value proposition through its sup-plier relationships. Some approaches include selecting and retaining suppliers that meet higher-quality standards, providing quality-based incentives to suppliers, and integrating suppliers into the design process. Fewer defects in parts from suppliers not only improve quality throughout the value chain system but can lower costs as well since less waste and disruption occur in the production processes.

Improving Value Chain Activities of Distribution Partners Any of three means can be used to achieve better cost-competitiveness in the forward portion of the industry value chain:

1. Pressure distributors, dealers, and other forward-channel allies to reduce their costs and markups.

2. Collaborate with them to identify win–win opportunities to reduce costs—for example, a chocolate manufacturer learned that by shipping its bulk chocolate in liquid form in tank cars instead of as 10-pound molded bars, it could not only save its candy bar manufacturing customers the costs associated with unpacking and melting but also eliminate its own costs of molding bars and packing them.

3. Change to a more economical distribution strategy, including switching to cheaper distribution channels (selling direct via the Internet) or integrating forward into company-owned retail outlets.

The means to enhancing differentiation through activities at the forward end of the value chain system include (1) engaging in cooperative advertising and promotions with forward allies (dealers, distributors, retailers, etc.), (2) creating exclusive arrange-ments with downstream sellers or utilizing other mechanisms that increase their incen-tives to enhance delivered customer value, and (3) creating and enforcing standards for downstream activities and assisting in training channel partners in business practices. Harley-Davidson, for example, enhances the shopping experience and perceptions of buyers by selling through retailers that sell Harley-Davidson motorcycles exclusively and meet Harley-Davidson standards.

Translating Proficient Performance of Value Chain Activities into Competitive AdvantageA company that does a first-rate job of managing its value chain activities relative to com-petitors stands a good chance of profiting from its competitive advantage. A company’s value-creating activities can offer a competitive advantage in one of two ways (or both):

1. They can contribute to greater efficiency and lower costs relative to competitors. 2. They can provide a basis for differentiation, so customers are willing to pay rela-

tively more for the company’s goods and services.

Final PDF to printer

108 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 108 10/11/16 08:17 PM

Achieving a cost-based competitive advantage requires determined management efforts to be cost-efficient in performing value chain activities. Such efforts have to be ongoing and persistent, and they have to involve each and every value chain activ-ity. The goal must be continuous cost reduction, not a one-time or on-again–off-again effort. Companies like Dollar General, Nucor Steel, Irish airline Ryanair, T.J.Maxx, and French discount retailer Carrefour have been highly successful in managing their value chains in a low-cost manner.

Ongoing and persistent efforts are also required for a competitive advantage based on differentiation. Superior reputations and brands are built up slowly over time, through continuous investment and activities that deliver consistent, reinforcing mes-sages. Differentiation based on quality requires vigilant management of activities for quality assurance throughout the value chain. While the basis for differentiation (e.g., status, design, innovation, customer service, reliability, image) may vary widely among companies pursuing a differentiation advantage, companies that succeed do so on the basis of a commitment to coordinated value chain activities aimed purposefully at this objective. Examples include Cartier (status), Room and Board (craftsmanship), American Express (customer service), Dropbox (innovation), and FedEx (reliability).

How Value Chain Activities Relate to Resources and Capabilities There is a close relationship between the value-creating activities that a company per-forms and its resources and capabilities. An organizational capability or competence implies a capacity for action; in contrast, a value-creating activity initiates the action. With respect to resources and capabilities, activities are “where the rubber hits the road.” When companies engage in a value-creating activity, they do so by drawing on specific company resources and capabilities that underlie and enable the activity. For example, brand-building activities depend on human resources, such as experienced brand managers (including their knowledge and expertise in this arena), as well as organizational capabilities in advertising and marketing. Cost-cutting activities may derive from organizational capabilities in inventory management, for example, and resources such as inventory tracking systems.

Because of this correspondence between activities and supporting resources and capa-bilities, value chain analysis can complement resource and capability analysis as another tool for assessing a company’s competitive advantage. Resources and capabilities that are both valuable and rare provide a company with what it takes for competitive advantage. For a company with competitive assets of this sort, the potential is there. When these assets are deployed in the form of a value-creating activity, that potential is realized due to their competitive superiority. Resource analysis is one tool for identifying competi-tively superior resources and capabilities. But their value and the competitive superiority of that value can be assessed objectively only after they are deployed. Value chain analy-sis and benchmarking provide the type of data needed to make that objective assessment.

There is also a dynamic relationship between a company’s activities and its resources and capabilities. Value-creating activities are more than just the embodi-ment of a resource’s or capability’s potential. They also contribute to the formation and development of capabilities. The road to competitive advantage begins with management efforts to build organizational expertise in performing certain com-petitively important value chain activities. With consistent practice and continuous investment of company resources, these activities rise to the level of a reliable orga-nizational capability or a competence. To the extent that top management makes the growing capability a cornerstone of the company’s strategy, this capability becomes a core competence for the company. Later, with further organizational

Performing value chain activities with capabilities that permit the company to either outmatch rivals on differentiation or beat them on costs will give the company a competitive advantage.

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 109

tho32789_ch04_082-119.indd 109 10/11/16 08:17 PM

learning and gains in proficiency, the core competence may evolve into a distinctive competence, giving the company superiority over rivals in performing an important value chain activity. Such superiority, if it gives the company significant competi-tive clout in the marketplace, can produce an attractive competitive edge over rivals. Whether the resulting competitive advantage is on the cost side or on the differentia-tion side (or both) will depend on the company’s choice of which types of competence-building activities to engage in over this time period.

LO 5

How a comprehensive evaluation of a company’s competitive situation can assist managers in making critical decisions about their next strategic moves.

Using resource analysis, value chain analysis, and benchmarking to determine a company’s competitiveness on value and cost is necessary but not sufficient. A more comprehensive assessment needs to be made of the company’s overall competitive strength. The answers to two questions are of particular interest: First, how does the company rank relative to competitors on each of the important factors that determine market success? Second, all things considered, does the company have a net competi-tive advantage or disadvantage versus major competitors?

An easy-to-use method for answering these two questions involves developing quantitative strength ratings for the company and its key competitors on each industry key success factor and each competitively pivotal resource, capability, and value chain activity. Much of the information needed for doing a competitive strength assessment comes from previous analyses. Industry and competitive analyses reveal the key suc-cess factors and competitive forces that separate industry winners from losers. Bench-marking data and scouting key competitors provide a basis for judging the competitive strength of rivals on such factors as cost, key product attributes, customer service, image and reputation, financial strength, technological skills, distribution capability, and other factors. Resource and capability analysis reveals which of these are com-petitively important, given the external situation, and whether the company’s competi-tive advantages are sustainable. SWOT analysis provides a more comprehensive and forward-looking picture of the company’s overall situation.

Step 1 in doing a competitive strength assessment is to make a list of the industry’s key success factors and other telling measures of competitive strength or weakness (6 to 10 measures usually suffice). Step 2 is to assign weights to each of the measures of competitive strength based on their perceived importance. (The sum of the weights for each measure must add up to 1.) Step 3 is to calculate weighted strength ratings by scoring each competitor on each strength measure (using a 1-to-10 rating scale, where 1 is very weak and 10 is very strong) and multiplying the assigned rating by the assigned weight. Step 4 is to sum the weighted strength ratings on each factor to get an overall measure of competitive strength for each company being rated. Step 5 is to use the overall strength ratings to draw conclusions about the size and extent of the company’s net competitive advantage or disadvantage and to take specific note of areas of strength and weakness.

Table 4.4 provides an example of competitive strength assessment in which a hypo-thetical company (ABC Company) competes against two rivals. In the example, rela-tive cost is the most telling measure of competitive strength, and the other strength measures are of lesser importance. The company with the highest rating on a given measure has an implied competitive edge on that measure, with the size of its edge reflected in the difference between its weighted rating and rivals’ weighted ratings.

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?

Final PDF to printer

110 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 110 10/11/16 08:17 PM

For instance, Rival 1’s 3.00 weighted strength rating on relative cost signals a con-siderable cost advantage over ABC Company (with a 1.50 weighted score on relative cost) and an even bigger cost advantage over Rival 2 (with a weighted score of 0.30). The measure-by-measure ratings reveal the competitive areas in which a company is strongest and weakest, and against whom.

The overall competitive strength scores indicate how all the different strength measures add up—whether the company is at a net overall competitive advantage or disadvantage against each rival. The higher a company’s overall weighted strength rating, the stronger its overall competitiveness versus rivals. The bigger the difference

Competitive Strength Assessment

(rating scale: 1 = very weak, 10 = very strong)

ABC Co. Rival 1 Rival 2

Key Success Factor/Strength Measure

Importance Weight

Strength Rating

Weighted Score

Strength Rating

Weighted Score

Strength Rating

Weighted Score

Quality/product performance

0.10 8 0.80 5 0.50 1 0.10

Reputation/image 0.10 8 0.80 7 0.70 1 0.10

Manufacturing capability

0.10 2 0.20 10 1.00 5 0.50

Technological skills

0.05 10 0.50 1 0.05 3 0.15

Dealer network/distribution capability

0.05 9 0.45 4 0.20 5 0.25

New product innovation capability

0.05 9 0.45 4 0.20 5 0.25

Financial resources

0.10 5 0.50 10 1.00 3 0.30

Relative cost position

0.30 5 1.50 10 3.00 1 0.30

Customer service capabilities

0.15 5 0.75 7 1.05 1 0.15

Sum of importance weights

1.00

Overall weighted competitive strength rating

5.95 7.70 2.10

TABLE 4.4 A Representative Weighted Competitive Strength Assessment

Final PDF to printer

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 111

tho32789_ch04_082-119.indd 111 10/11/16 08:17 PM

A company’s competitive strength scores pinpoint its strengths and weaknesses against rivals and point directly to the kinds of offensive and defensive actions it can use to exploit its competitive strengths and reduce its competitive vulnerabilities.

High-weighted competitive strength ratings signal a strong competitive position and possession of competitive advantage; low ratings signal a weak position and competitive disadvantage.

between a company’s overall weighted rating and the scores of lower-rated rivals, the greater is its implied net competitive advantage. Thus, Rival 1’s overall weighted score of 7.70 indicates a greater net competitive advantage over Rival 2 (with a score of 2.10) than over ABC Company (with a score of 5.95). Conversely, the bigger the difference between a company’s overall rating and the scores of higher-rated rivals, the greater its implied net competitive disadvantage. Rival 2’s score of 2.10 gives it a smaller net competitive disadvantage against ABC Company (with an overall score of 5.95) than against Rival 1 (with an overall score of 7.70).

Strategic Implications of Competitive Strength AssessmentsIn addition to showing how competitively strong or weak a company is relative to rivals, the strength ratings provide guidelines for designing wise offensive and defensive strategies. For example, if ABC Company wants to go on the offensive to win additional sales and market share, such an offensive probably needs to be aimed directly at winning customers away from Rival 2 (which has a lower over-all strength score) rather than Rival 1 (which has a higher overall strength score). Moreover, while ABC has high ratings for technological skills (a 10 rating), dealer network/distribution capability (a 9 rating), new product innovation capability (a 9 rating), quality/product performance (an 8 rating), and reputation/image (an 8 rating), these strength measures have low importance weights—meaning that ABC has strengths in areas that don’t translate into much competitive clout in the marketplace. Even so, it outclasses Rival 2 in all five areas, plus it enjoys substantially lower costs than Rival 2 (ABC has a 5 rating on relative cost posi-tion versus a 1 rating for Rival 2)—and relative cost position carries the highest importance weight of all the strength measures. ABC also has greater competi-tive strength than Rival 3 regarding customer service capabilities (which carries the second-highest importance weight). Hence, because ABC’s strengths are in the very areas where Rival 2 is weak, ABC is in a good position to attack Rival 2. Indeed, ABC may well be able to persuade a number of Rival 2’s customers to switch their purchases over to its product.

But ABC should be cautious about cutting price aggressively to win custom-ers away from Rival 2, because Rival 1 could interpret that as an attack by ABC to win away Rival 1’s customers as well. And Rival 1 is in far and away the best position to compete on the basis of low price, given its high rating on relative cost in an industry where low costs are competitively important (relative cost carries an importance weight of 0.30). Rival 1’s strong relative cost position vis-à-vis both ABC and Rival 2 arms it with the ability to use its lower-cost advantage to thwart any price cutting on ABC’s part. Clearly ABC is vulnerable to any retaliatory price cuts by Rival 1—Rival 1 can easily defeat both ABC and Rival 2 in a price-based battle for sales and market share. If ABC wants to defend against its vulnerability to potential price cutting by Rival 1, then it needs to aim a portion of its strategy at lowering its costs.

The point here is that a competitively astute company should utilize the strength scores in deciding what strategic moves to make. When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense to consider offensive moves to exploit rivals’ competitive weaknesses. When a company has important competitive weaknesses in areas where one or more rivals are strong, it makes sense to consider defensive moves to curtail its vulnerability.

Final PDF to printer

KEY POINTS

There are six key questions to consider in evaluating a company’s ability to compete successfully against market rivals:

1. How well is the present strategy working? This involves evaluating the strategy in terms of the company’s financial performance and market standing. The stron-ger a company’s current overall performance, the less likely the need for radi-cal strategy changes. The weaker a company’s performance and/or the faster the

112 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 112 10/11/16 08:17 PM

The final and most important analytic step is to zero in on exactly what strategic issues company managers need to address—and resolve—for the company to be more finan-cially and competitively successful in the years ahead. This step involves drawing on the results of both industry analysis and the evaluations of the company’s internal situation. The task here is to get a clear fix on exactly what strategic and competitive challenges confront the company, which of the company’s competitive shortcomings need fixing, and what specific problems merit company managers’ front-burner attention. Pinpoint-ing the specific issues that management needs to address sets the agenda for deciding what actions to take next to improve the company’s performance and business outlook.

The “priority list” of issues and problems that have to be wrestled with can include such things as how to stave off market challenges from new foreign com-petitors, how to combat the price discounting of rivals, how to reduce the com-pany’s high costs, how to sustain the company’s present rate of growth in light of slowing buyer demand, whether to correct the company’s competitive deficiencies by acquiring a rival company with the missing strengths, whether to expand into foreign markets, whether to reposition the company and move to a different stra-tegic group, what to do about growing buyer interest in substitute products, and what to do to combat the aging demographics of the company’s customer base. The priority list thus always centers on such concerns as “how to . . . ,” “what to do about . . . ,” and “whether to . . .” The purpose of the priority list is to identify the specific issues and problems that management needs to address, not to figure out what specific actions to take. Deciding what to do—which strategic actions to take and which strategic moves to make—comes later (when it is time to craft the strategy and choose among the various strategic alternatives).

If the items on the priority list are relatively minor—which suggests that the company’s strategy is mostly on track and reasonably well matched to the com-

pany’s overall situation—company managers seldom need to go much beyond fine-tuning the present strategy. If, however, the problems confronting the company are serious and indicate the present strategy is not well suited for the road ahead, the task of crafting a better strategy needs to be at the top of management’s action agenda.

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS MERIT FRONT-BURNER MANAGERIAL ATTENTION?

Compiling a “priority list” of problems creates an agenda of strategic issues that merit prompt managerial attention.

A good strategy must contain ways to deal with all the strategic issues and obstacles that stand in the way of the company’s financial and competitive success in the years ahead.

Final PDF to printer

changes in its external situation (which can be gleaned from PESTEL and industry analysis), the more its current strategy must be questioned.

2. What are the company’s most important resources and capabilities and can they give the company a sustainable advantage over competitors? A company’s resources can be identified using the tangible/intangible typology presented in this chapter. Its capabilities can be identified either by starting with its resources to look for related capabilities or looking for them within the company’s different functional domains.

The answer to the second part of the question comes from conducting the four tests of a resource’s competitive power—the VRIN tests. If a company has resources and capabilities that are competitively valuable and rare, the firm will have a competitive advantage over market rivals. If its resources and capabilities are also hard to copy (inimitable), with no good substitutes (nonsubstitutable), then the firm may be able to sustain this advantage even in the face of active efforts by rivals to overcome it.

3. Is the company able to seize market opportunities and overcome external threats to its future well-being? The answer to this question comes from performing a SWOT analysis. The two most important parts of SWOT analysis are (1) draw-ing conclusions about what strengths, weaknesses, opportunities, and threats tell about the company’s overall situation; and (2) acting on the conclusions to bet-ter match the company’s strategy to its internal strengths and market opportuni-ties, to correct the important internal weaknesses, and to defend against external threats. A company’s strengths and competitive assets are strategically relevant because they are the most logical and appealing building blocks for strategy; inter-nal weaknesses are important because they may represent vulnerabilities that need correction. External opportunities and threats come into play because a good strat-egy necessarily aims at capturing a company’s most attractive opportunities and at defending against threats to its well-being.

4. Are the company’s cost structure and value proposition competitive? One telling sign of whether a company’s situation is strong or precarious is whether its costs are competitive with those of industry rivals. Another sign is how the company compares with rivals in terms of differentiation—how effectively it delivers on its customer value proposition. Value chain analysis and benchmarking are essential tools in determining whether the company is performing particular functions and activities well, whether its costs are in line with those of competitors, whether it is differentiating in ways that really enhance customer value, and whether particu-lar internal activities and business processes need improvement. They comple-ment resource and capability analysis by providing data at the level of individual activities that provide more objective evidence of whether individual resources and capabilities, or bundles of resources and linked activity sets, are competitively superior.

5. On an overall basis, is the company competitively stronger or weaker than key rivals? The key appraisals here involve how the company matches up against key rivals on industry key success factors and other chief determinants of competi-tive success and whether and why the company has a net competitive advantage or disadvantage. Quantitative competitive strength assessments, using the method

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 113

tho32789_ch04_082-119.indd 113 10/11/16 08:17 PM

Final PDF to printer

ASSURANCE OF LEARNING EXERCISES

1. Using the financial ratios provided in Table 4.1 and the financial statement infor-mation presented below for Costco Wholesale Corporation, calculate the follow-ing ratios for Costco for both 2013 and 2014:

a. Gross profit margin b. Operating profit margin c. Net profit margin d. Times-interest-earned (or coverage) ratio e. Return on stockholders’ equity f. Return on assets g. Debt-to-equity ratio h. Days of inventory i. Inventory turnover ratio j. Average collection period

Based on these ratios, did Costco’s financial performance improve, weaken, or remain about the same from 2013 to 2014?

LO 1

presented in Table 4.4, indicate where a company is competitively strong and weak and provide insight into the company’s ability to defend or enhance its mar-ket position. As a rule, a company’s competitive strategy should be built around its competitive strengths and should aim at shoring up areas where it is competi-tively vulnerable. When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense to consider offensive moves to exploit rivals’ competitive weaknesses. When a company has important competi-tive weaknesses in areas where one or more rivals are strong, it makes sense to consider defensive moves to curtail its vulnerability.

6. What strategic issues and problems merit front-burner managerial attention? This analytic step zeros in on the strategic issues and problems that stand in the way of the company’s success. It involves using the results of industry analysis as well as resource and value chain analysis of the company’s competitive situation to iden-tify a “priority list” of issues to be resolved for the company to be financially and competitively successful in the years ahead. Actually deciding on a strategy and what specific actions to take is what comes after developing the list of strategic issues and problems that merit front-burner management attention.

Like good industry analysis, solid analysis of the company’s competitive situation vis-à-vis its key rivals is a valuable precondition for good strategy making.

114 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 114 10/11/16 08:17 PM

Final PDF to printer

Consolidated Income Statements for Costco Wholesale Corporation, 2013–2014 (in millions, except per share data)

2014 2013

Net sales ………………………………………………………………………………… $110,212 $102,870

Membership fees …………………………………………………………………… 2,428 2,286

Total revenue …………………………………………………………………………. 112,640 105,156

Merchandise costs ………………………………………………………………… 98,458 $ 91,948

Selling, general, and administrative …………………………………….. 10,899 10,155

Operating income …………………………………………………………………. 3,220 3,053

Other income (expense) ………………………………………………………..

    Interest expense ………………………………………………………………… (113) (99)

    Interest income and other, net …………………………………………. 90 97

Income before income taxes ………………………………………………… 3,197 3,051

Provision for income taxes ……………………………………………………. 1,109 990

Net income including noncontrolling interests ……………………. 2,088 2,061

Net income attributable to noncontrolling interests …………… (30) (22)

Net income …………………………………………………………………………….. $ 2,058 $ 2,039

    Basic earnings per share ………………………………………………….. $ 4.69 $ 4.68

    Diluted earnings per share ……………………………………………….. $ 4.65 $ 4.63

Source: Costco Wholesale Corporation 2014 10-K.

Consolidated Balance Sheets for Costco Wholesale Corporation, 2013–2014 (in millions, except per share data)

August 31, 2014

September 1, 2013

Assets

Current Assets

Cash and cash equivalents ………………………………………… $ 5,738 $ 4,644

Short-term investments ……………………………………………… 1,577 1,480

Receivables, net …………………………………………………………. 1,148 1,026

Merchandise inventories ……………………………………………. 8,456 7,894

(continued)

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 115

tho32789_ch04_082-119.indd 115 10/11/16 08:17 PM

Final PDF to printer

August 31, 2014

September 1, 2013

Deferred income taxes and other current assets …….. 669 621

Total current assets …………………………………………………….. 17,588 $15,840

Property and Equipment

Land …………………………………………………………………………….. $ 4,716 $ 4,409

Buildings and improvements ……………………………………… 12,522 11,556

Equipment and fixtures ………………………………………………. 4,845 4,472

Construction in progress ……………………………………………. 592 585

22,675 21,022

Less accumulated depreciation and amortization ……. (7,845) (7,141)

Net property and equipment ……………………………………… 14,830 13,881

Other assets ……………………………………………………………….. 606 562

Total assets …………………………………………………………………. $33,024 $30,283

Liabilities and Equity

Current Liabilities

Accounts payable ……………………………………………………….. $ 8,491 $ 7,872

Accrued salaries and benefits …………………………………… 2,231 2,037

Accrued member rewards …………………………………………. 773 710

Accrued sales and other taxes ………………………………….. 442 382

Deferred membership fees ………………………………………… 1,254 1,167

Other current liabilities ……………………………………………….. 1,221 1,089

Total current liabilities ………………………………………………… 14,412 13,257

Long-term debt, excluding current portion ……………….. 5,093 4,998

Deferred income taxes and other liabilities ………………. 1,004 1,016

Total liabilities ……………………………………………………………… 20,509 $19,271

Commitments and Contingencies

Equity

Preferred stock $0.005 par value; 100,000,000 shares authorized; no shares issued and outstanding

0 0

Common stock $0.005 par value; 900,000,000 shares authorized; 436,839,000 and 432,350,000 shares issued and outstanding

2 2

Additional paid-in capital ……………………………………………. $ 4,919 $ 4,670

Accumulated other comprehensive (loss) income …… (76) (122)

(continued)

116 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 116 10/11/16 08:17 PM

Final PDF to printer

August 31, 2014

September 1, 2013

Retained earnings ………………………………………………………. 7,458 6,283

Total Costco stockholders’ equity ……………………………… 12,303 10,833

Noncontrolling interests …………………………………………….. 212 179

Total equity ………………………………………………………………….. 12,515 11,012

Total Liabilities and Equity ……………………………………….. $33,024 $30,283

Source: Costco Wholesale Corporation 2014 10-K.

2. Panera Bread operates more than 1,900 bakery-cafés in more than 45 states and Canada. How many of the four tests of the competitive power of a resource does the store network pass? Using your general knowledge of this industry, perform a SWOT analysis. Explain your answers.

3. Review the information in Illustration Capsule 4.1 concerning Boll & Branch’s average costs of producing and selling a king-size sheet set, and compare this with the representative value chain depicted in Figure 4.3. Then answer the following questions:

a. Which of the company’s costs correspond to the primary value chain activities depicted in Figure 4.3?

b. Which of the company’s costs correspond to the support activities described in Figure 4.3?

c. What value chain activities might be important in securing or maintaining Boll & Branch’s competitive advantage? Explain your answer.

4. Using the methodology illustrated in Table 4.3 and your knowledge as an auto-mobile owner, prepare a competitive strength assessment for General Motors and its rivals Ford, Chrysler, Toyota, and Honda. Each of the five automobile manu-facturers should be evaluated on the key success factors and strength measures of cost-competitiveness, product-line breadth, product quality and reliability, finan-cial resources and profitability, and customer service. What does your competitive strength assessment disclose about the overall competitiveness of each automobile manufacturer? What factors account most for Toyota’s competitive success? Does Toyota have competitive weaknesses that were disclosed by your analysis? Explain.

LO 2, LO 3

LO 4

LO 5

EXERCISE FOR SIMULATION PARTICIPANTS

1. Using the formulas in Table 4.1 and the data in your company’s latest financial statements, calculate the following measures of financial performance for your company:

a. Operating profit margin b. Total return on total assets

LO 1

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 117

tho32789_ch04_082-119.indd 117 10/11/16 08:17 PM

Final PDF to printer

c. Current ratio d. Working capital e. Long-term debt-to-capital ratio f. Price-to-earnings ratio

2. On the basis of your company’s latest financial statements and all the other avail-able data regarding your company’s performance that appear in the industry report, list the three measures of financial performance on which your company did best and the three measures on which your company’s financial performance was worst.

3. What hard evidence can you cite that indicates your company’s strategy is work-ing fairly well (or perhaps not working so well, if your company’s performance is lagging that of rival companies)?

4. What internal strengths and weaknesses does your company have? What external market opportunities for growth and increased profitability exist for your com-pany? What external threats to your company’s future well-being and profitability do you and your co-managers see? What does the preceding SWOT analysis indi-cate about your company’s present situation and future prospects—where on the scale from “exceptionally strong” to “alarmingly weak” does the attractiveness of your company’s situation rank?

5. Does your company have any core competencies? If so, what are they? 6. What are the key elements of your company’s value chain? Refer to Figure 4.3 in

developing your answer. 7. Using the methodology presented in Table 4.4, do a weighted competitive strength

assessment for your company and two other companies that you and your co- managers consider to be very close competitors.

LO 1

LO 1

LO 2, LO 3

LO 2, LO 3LO 4

LO 5

ENDNOTESOrganizations,” California Management Review 44, no. 3 (Spring 2002), pp. 37–54.4 M. Peteraf and J. Barney, “Unraveling the Resource-Based Tangle,” Managerial and Decision Economics 24, no. 4 (June–July 2003), pp. 309–323.5 Margaret A. Peteraf and Mark E. Bergen, “Scanning Dynamic Competitive Landscapes: A Market-Based and Resource-Based Frame-work,” Strategic Management Journal 24 (2003), pp. 1027–1042.6 C. Montgomery, “Of Diamonds and Rust: A New Look at Resources,” in C. Montgom-ery (ed.), Resource-Based and Evolution-ary Theories of the Firm (Boston: Kluwer Academic, 1995), pp. 251–268.7 Constance E. Helfat and Margaret A. Peteraf, “The Dynamic Resource-Based View:

1 Birger Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal 5, no. 5 (September–October 1984), pp. 171–180; Jay Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Manage-ment 17, no. 1 (1991), pp. 99–120.2 R. Amit and P. Schoemaker, “Strategic Assets and Organizational Rent,” Strategic Manage-ment Journal 14 (1993).3 Jay B. Barney, “Looking Inside for Competi-tive Advantage,” Academy of Management Executive 9, no. 4 (November 1995), pp. 49–61; Christopher A. Bartlett and Sumantra Ghoshal, “Building Competitive Advantage through Peo-ple,” MIT Sloan Management Review 43, no. 2 (Winter 2002), pp. 34–41; Danny Miller, Russell Eisenstat, and Nathaniel Foote, “Strategy from the Inside Out: Building Capability-Creating

Capability Lifecycles,” Strategic Management Journal 24, no. 10 (2003).8 D. Teece, G. Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Management,” Stra-tegic Management Journal 18, no. 7 (1997), pp. 509–533; K. Eisenhardt and J. Martin, “Dynamic Capabilities: What Are They?” Strate-gic Management Journal 21, no. 10–11 (2000), pp. 1105–1121; M. Zollo and S. Winter, “Deliber-ate Learning and the Evolution of Dynamic Capabilities,” Organization Science 13 (2002), pp. 339–351; C. Helfat et al., Dynamic Capabili-ties: Understanding Strategic Change in Orga-nizations (Malden, MA: Blackwell, 2007).9 Donald Sull, “Strategy as Active Waiting,” Har-vard Business Review 83, no. 9 (September 2005), pp. 121–126.

118 PART 1 Concepts and Techniques for Crafting and Executing Strategy

tho32789_ch04_082-119.indd 118 10/11/16 08:17 PM

Final PDF to printer

(September–October, 1988), pp. 96–103; Joseph A. Ness and Thomas G. Cucuzza, “Tapping the Full Potential of ABC,” Harvard Business Review 73, no. 4 (July–August 1995), pp. 130–138.13 Porter, Competitive Advantage, p. 34.14 Hau L. Lee, “The Triple-A Supply Chain,” Harvard Business Review 82, no. 10 (October 2004), pp. 102–112.15 Gregory H. Watson, Strategic Benchmarking: How to Rate Your Company’s Performance against the World’s Best (New York: Wiley,

10 M. Peteraf, “The Cornerstones of Competi-tive Advantage: A Resource-Based View,” Stra-tegic Management Journal, March 1993, pp. 179–191.11 Michael Porter in his 1985 best seller Com-petitive Advantage (New York: Free Press).12 John K. Shank and Vijay Govindarajan, Strategic Cost Management (New York: Free Press, 1993), especially chaps. 2–6, 10, and 11; Robin Cooper and Robert S. Kaplan, “Measure Costs Right: Make the Right Deci-sions,” Harvard Business Review 66, no. 5

1993); Robert C. Camp, Benchmarking: The Search for Industry Best Practices That Lead to Superior Performance (Milwaukee: ASQC Quality Press, 1989); Dawn Iacobucci and Christie Nordhielm, “Creative Benchmarking,” Harvard Business Review 78 no. 6 (November–December 2000), pp. 24–25.16 www.businessdictionary.com/definition/best-practice.html (accessed December 2, 2009).17 Reuben E. Stone, “Leading a Supply Chain Turnaround,” Harvard Business Review 82, no. 10 (October 2004), pp. 114–121.

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Competitiveness 119

tho32789_ch04_082-119.indd 119 10/11/16 08:17 PM

Final PDF to printer