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Lesson 4: Evaluating a Firms Internal Capabilities

What does Internal Analysis tell us?

Internal analysis provides a comparative look at a firms capabilities
What are the firms strengths/weaknesses/compared to
Internal analysis helps a firm:
Determine if its resources and capabilities are likely sources of
competitive advantage
Establish strategies that will exploit any sources of competitive
Resource-Based View
Answer Why do some firms achieve better economic performance
than others?
Help firms achieve competitive advantage and superior economic
Assumes a firms resources and capabilities are the primary divers
of competitive advantage and economic performance
Resources: tangible and intangible assets of
a firm (factories, products, reputation)
- Financial (cash, retained earnings)
- Physical (Plant and Equipment, geographic
- Human (skills and abilities of individuals)
- Organisational (reporting structures,
Capabilities: a subset of resources that
enable a firm to take full advantage of other
resources (marketing skills, cooperative relationships)
2 Critical assumptions of RBV
1 Resource Heterogeneity: Different firms may have different
resources (as a result of bundling the resources and capabilities
of a firm)
2 Resource Immobility: Costly for firms without certain resources to
acquire or develop them; some resources may not spread from
firm to firm easily
*The Internal Analysis Tool
- Determinates of economic performance are firm-level
characteristics (resources and capabilities)
- Firms may be different (heterogeneity) and differences may be
enduring (immobility)
- Competitive advantage stems from resources and capabilities
that meet the VRIO criteria
The VRIO Framework: (4 important questions considered in a
comparative sense)

- Value
- Rarity
- Imitability
- Organisation
If a firm has resources that are valuable, rare, costly to imitate and
the firm is organized to exploit these resources, then the firm can
expect to enjoy a sustained competitive advantage
- Theory: Does the resource enable the firm to exploit an external
opportunity or neutralize an external threat?
- Practical: Does the resource result in an increase in revenue,
decrease in costs or combination of the two?
- If a resource is not rare, then perfect competition dynamics are
likely to be observed (no competitive advantage, no above
normal profits)
- A resource must be rare enough that perfect competition has not
set in
Not Valuable -> Competitive Disadvantage, Valuable + Not Rare ->
Competitive Parity, Valuable + Rare -> Competitive Advantage (at least
- The temporary competitive advantage of valuable and rare
resources can be sustained only if competitors face a cost
disadvantage in imitating the resource
- Intangible -> costlier to imitate than tangible resources
- High cost of imitation, firm may enjoy a period of sustained
competitive advantage (last until a duplicate or substitute
- If a firm has competitive advantage, others will attempt to
imitate it
- Cost of Imitation:
1. Unique historical conditions (first mover advantages, path
2. Causal ambiguity (causal links between resources and
competitive advantage may not be understood; bundles of
resources fog these causal links)
3. Social complexity (social relationships entailed in resources
may be so complex that managers cannot really manage them
or replicate them)
4. Patents (offer a period of protection if the firm is able to
defend its patent rights; required disclosure may actually
decrease the cost of imitation and the timing)
Valuable, Rare but not costly to imitate -> Temporary competitive
Valuable, Rare and costly to imitate -> Sustained competitive advantage
(if organized appropriately)

A firms structure and control mechanisms must be aligned so as

to give people ability and incentive to exploit the firms resources
(e.g. formal and informal reporting structures, management
controls, compensation policies, relationships)

Competitive Dynamics of Resource Imitation

Competitive Dynamics: The strategic decisions and actions of firms in
response to the strategic decisions and actions of other firms
Possible responses when faced with competitors strategy decisions that
led to competitive advantage: (no response/change tactics/change
1. No Response
A firm may decide to take no action because:
- Other firm is serving different market
- Response may hurt its own competitive advantage
- Firm does not have resources and capabilities to mount an
effective response
- Wants to reduce or manage rivalry in the market through tacit
2. Change Tactics
- Specific actions (tweak product
- usually imitated so quickly that
there is no advantage
- a leap frog move may create

3. Change Strategy
- fundamental change in a
firms theory
- may be necessary if current
strategy becomes obsolete
- a mimetic change may
achieve parity, but not

Imitation will seldom lead to competitive advantage, firms should use

resources and capabilities to fill unique competitive space.
Similar strategies may lead to competitive advantage; some firms can
achieve competitive advantage even if they are second movers.

Internal analysis tells us
- What the firm should do, given the relative strengths and
weaknesses of resources and capabilities
Managers Job
- Bundle resources and capabilities to achieve competitive
VRIO Framework helps managers recognize sources of competitive

Cost Leadership
Business Level Strategies:
1. Cost Leadership: generate economic value by having lower costs
than competitors
2. Product Differentiation: generate economic value by offering a
product than customers prefer over competitors product
Why Cost Leadership matters?
- To enjoy above normal economic returns (competitive advantage)
- Managers need to understand who has the cost advantage in
their market
- Focal firm develop strategy to exploit the advantage
- Competitor develop strategy to either capture the advantage or
compete on some other basis
Sources of Cost Advantage
- Economies of Scale
o Average cost per unit falls as quantity increases until MES
is reached
o Cost advantage because competitors may not be able to
match the scale because of capital requirements (BTEs)
o International expansion may allow a firm to have enough
sales to justify investing in additional capacity to capture
- Diseconomies of Scale
o Advantage for those who do not have diseconomies of
o Occurs when firms become too large and bureaucratic
o Are a risk of international expansion
- Learning Curve Economics
o A firm gets more efficient at a process with experience
o The more complicated/technical the process, the greater
the experience advantage
o International expansion may propel a firm down the
experience curve because of higher volumes
- Differential Low-Cost Access to Productive Inputs
o Result from:
1. History bring in the right place at the right time
2. See slides
3. See slides
4. See slides
- Technology Independent of Scale:
o May allow small firms to become cost competitive
o Advantage typically accrues to the owner of the
technology may or may not be the ones who actually
use the technology