Chapter

Three
Internal
Analysis:
Distinctive
Competencies,
Competitive
Advantage,
and
Profitability

Internal Analysis
The purpose of internal analysis is to pinpoint the
strengths and weaknesses of the organization.
Strengths lead to superior performance.
Weaknesses lead to inferior performance.
Internal Analysis includes an assessment of:
Quantity and quality of a companys
resources and capabilities
Ways of building unique skills
and company-specific or
distinctive competencies

Building and sustaining a competitive advantage

requires a company to achieve superior:
Efficiency Innovations
Quality

Responsiveness to customers

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Internal Analysis:
Strengths and Weaknesses
Internal analysis - along with the external analysis of
the companys environment - gives managers the
information to choose the strategies and business
model to attain a sustained competitive advantage.

Strengths

Weaknesses

Of the enterprise
are assets that
boost
profitability

Of the enterprise
are liabilities that
lead to lower
profitability

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Internal Analysis:
A Three-Step Process
1. Understand the process by which companies
create value for customers and profit for
themselves.
Resources
Capabilities
Distinctive competencies

2. Understand the importance of superiority in

creating value and generating high profitability.
Efficiency Innovation
Responsiveness to Customers
Quality

3. Analyze the sources of the companys

competitive advantage.
Strengths that are driving profitability
Weaknesses opportunities for improvement
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Competitive Advantage
Competitive Advantage
A firms profitability is greater than the average
profitability for all firms in its industry.

Sustained Competitive Advantage

A firm maintains above average and superior
profitability and profit growth for a number of
years.

The Primary Objective of Strategy

is to achieve a

Sustained Competitive Advantage

which in turn results in

Superior Profit and Profit Growth.

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Strategy, Resources,
Capabilities, and Competencies
Figure 3.1

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Competitive Advantage,
Value Creation, and Profitability
How profitable a company becomes
depends on three basic factors:
1. VALUE or UTILITY the customer gets from
owning the product
2. PRICE that a company charges for its
products
3. COSTS of creating those products
Consumer surplus is the excess utility a
consumer captures beyond the price paid.
Basic Principle: the more utility that consumers
get from a companys products or services, the
more pricing options the company has.
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Value Creation per Unit

Figure 3.2

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Value Creation
and Pricing Options
There is a dynamic
relationship among utility,
pricing, demand, and costs.

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Figure 3.3

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Comparing Toyota
General Motors

and
Figure 3.4

Superior value creation requires that the gap between

perceived utility (U) and costs of production (C)
be greater than that obtained by competitors.
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The Value Chain

Figure 3.5

A company is a chain of activities for transforming

inputs into outputs that customers value
including the primary and support activities.

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Building Blocks
of Competitive Advantage
The Generic
Distinctive Competencies

Figure 3.6

Allow a company to:

Differentiate product offering
Offer more utility to customer
Lower the cost structure
regardless of the industry,
its products, or its services

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 Efficiency
Measured by the quantity of inputs it
takes to produce a given output:
Efficiency = Outputs / Inputs
Productivity leads to greater efficiency
and lower costs:

Employee productivity
Capital productivity

Superior efficiency helps a company

attain a competitive advantage
through a lower cost structure.
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 Quality
Quality products are goods and services that are:
Reliable and
Differentiated by attributes that customers
perceive to have higher value

The impact of quality on competitive

advantage:

High-quality products differentiate and increase

the value of the products in customers eyes.
Greater efficiency and lower unit costs are
associated with reliable products.

Superior quality = customer perception

of greater value in a products attributes
Form, features, performance, durability, reliability, style, design
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A Quality Map for Automobiles

Figure 3.7
When customers
evaluate the quality of a
product, they commonly
measure it against two
kinds of attributes:
1. Quality as Excellence
2. Quality as Reliability

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 Innovation
Innovation is the act of creating

new products or new processes

Product innovation

Creates products that customers

perceive as more valuable and
Increases the companys pricing options

Process innovation
Creates value by lowering production costs

Successful innovation can be a major

source of competitive advantage
by giving a company something unique,
something its competitors lack.
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 Responsiveness to Customers
Identifying and satisfying customers
needs better than the competitors

Superior quality and innovation are integral to

superior responsiveness to customers.
Customizing goods and services to the unique
demands of individual customers or customer
groups.

Enhanced customer responsiveness

Customer response time, design,

service, after-sales service and support

Superior responsiveness to customers

differentiates a companys products and services
and leads to brand loyalty and premium pricing.
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Competitive Advantage:
The Value Creation Cycle
Figure 3.8

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Analyzing Competitive
Advantage and Profitability
Competitive Advantage
When a companies profitability is greater than the average of all
other companies in the same industry that compete for the same
customers

Benchmarking
Comparing company performance against that of competitors and
the companys historic performance

Measures of Profitability
Return On Invested Capital (ROIC)

ROIC

Net profit

Equity + Debt to creditors

Net income after tax

Capital invested

Net Profit
Net Profit = Total revenues Total costs

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Definitions of
Basic Accounting Terms
Table 3.1

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Drivers of Profitability (ROIC)

Figure 3.9

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Comparing Wal-Mart to Target

Figure 3.10

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The Durability of Competitive

Advantage
The DURABILITY of a companys competitive advantage over
its competitors depends on:

1.Barriers to Imitation

Making it difficult to copy a companys distinctive competencies

Imitating Resources
Imitating Capabilities

1.Capability of Competitors
Strategic commitment

Commitment to a particular way of doing business

Absorptive capacity

Ability to identify, value, assimilate, and use knowledge

2.Industry Dynamism

Ability of an industry to change rapidly

Competitors are also seeking to develop distinctive

competencies that will give them a competitive edge.
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Why Companies Fail

Inertia
Companies find it difficult to change their
strategies and structures

Prior Strategic Commitments

Limit a companys ability to imitate and
cause competitive disadvantage

The Icarus Paradox

A company can become so specialized and inner directed
based on past success that it loses sight of market realities
Categories of rising and falling companies:
Craftsmen Builders Pioneers Salespeople

When a company loses its competitive advantage,

its profitability falls below that of the industry.

It loses the ability to attract and generate resources.

Profit margins and invested capital shrink rapidly.
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Avoiding Failure:
Sustaining Competitive Advantage
1. Focus on the Building Blocks of Competitive
Advantage
Develop distinctive competencies and superior performance in:
Efficiency
Quality
Innovation
Responsiveness to Customers

1. Institute Continuous Improvement and Learning

Recognize the importance of continuous learning within the organization

1. Track Best Practices and Use Benchmarking

Measure against the products and practices of the most efficient global
competitors

1. Overcome Inertia
Overcome the internal forces that are barriers to change

Luck may play a role in success,

so always exploit a lucky break - but remember:

The harder I work, the luckier I seem to get.

J P Morgan

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