Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

Chapter 4 Lecture Note

Evaluation a Company’s Resources, Cost

Position, and Competitive Strength
Chapter Summary

Chapter Four discusses the techniques of evaluating a company’s internal situation, including its
collection of valuable resources and capabilities, its relative cost position, and its competitive strength
versus its rivals. The analytical spotlight will be trained on five questions: (1) How well is the company’s
present strategy working? (2) What are the company’s competitively important resources and
capabilities? (3) Is the company’s cost structure and customer value proposition competitive? (4) Is the
company competitively stronger or weaker than key rivals? (5) What strategic issues and problems merit
front-burner managerial attention? The answers to these five questions complete management’s
understanding of “Where are we now?” and position the company for a good strategy situation fit
required of the “Three Tests of a Winning Strategy.”

Lecture Outline

I. Question 1: How Well is the Company’s Present Strategy Working?

1. The two best empirical indicators are:

a. Whether the company is recording gains in financial strength and profitability.

b. Whether the company’s competitive strength and market standing are improving.

2. Other 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.
 The rate at which new customers are acquired.
 Changes in the company’s image and reputation with customers.
 Evidence of improvement in internal processes such as defect rate, order fulfillment, delivery
times, days of inventory, and employee productivity.

3. The stronger a company’s current overall performance, the less likely the need for radical changes
in strategy. The weaker a company’s financial performance and market standing, the more its
current strategy must be questioned. Weak performance is almost always a sign of weak strategy,

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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

weak execution, or both.

II. Question 2: What are the Company’s Competitively Important Resources and Capabilities?

1. A company’s competitive approach requires a tight fit with a company’s internal situation and is
strengthened when it exploits resources that are competitively valuable, rare, hard to copy, and
not easily trumped by rivals’ equivalent substitute resources. Many companies pursue resource-
based strategies that attempt to exploit company resources in a manner that offers value to
customers in ways rivals are unable to match.

A. Identifying Competitively Important Resources and Capabilities

1. A company’s resources are competitive assets that are owned or controlled by the company and
can either be tangible resources such as plants and distribution or intangible assets such as a
well-known brand or a results-oriented organizational culture.

CORE CONCEPT

A resource is a competitive asset that is owned or controlled by a company; a capability is the

capacity of a company to competently perform some internal activity. Capabilities are
developed and enabled through the deployment of a company’s resources.

2. Table 4.1, Common Types of Tangible and Intangible Resources, gives examples of both types
of resources. These include:

Tangible
a. Physical resources
b. Financial resources
c. Technological resources
d. Organizational resources

Intangible
a. Human assets and intellectual capital
b. Brand image and reputational assets
c. Relationships
d. Company culture

B. Determining the Competitive Power of a Company Resources and Capabilities.

1. What is most telling about company’s aggregate of resources is how powerful they are in the
marketplace.

CORE CONCEPT

The VRIN tests for sustainable competitive advantage ask if a resource or capability is valuable,
rare, inimitable, and non-substitutable.

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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

2. The tests are often referred to as the VRIN tests for sustainable competitive advantage an
acronym for valuable, rare, inimitable, and non-substitutable.

a. Is the resource really competitively valuable?

b. Is the resource strength rare – is it something rivals lack?
c. Is the resource inimitable or hard to copy?
d. Is the resource non-substitutable?

3. Can the resource strength be trumped by substitute resource strengths and competitive
capabilities?

CORE CONCEPT

A core competence is a proficiently performed internal activity that is central to a company’s

strategy and competitiveness. A core competence that is performed with a very high level of
proficiency is referred to as a distinctive competence.

4. Understanding the nature of competitively important resources allows managers to identify

resources or capabilities that that should be further developed to play an important role in the
company’s future strategies.

CORE CONCEPT

Companies that lack a stand-alone resource that is competitively powerful may nonetheless
develop a competitive advantage through resource bundles that enable the superior
performance of important cross-functional capabilities.

C. The Importance of Dynamic Capabilities in Sustaining Competitive Advantage

1. Resources and capabilities must be continually strengthened and nurtured to sustain their
competitive power.

2. A dynamic capability is the ability to modify, deepen, or reconfigure the company’s existing
resources and capabilities in response to its changing environment or market opportunities.

CORE CONCEPT

A dynamic capability is developed when a company has become proficient in modifying,

upgrading, or deepening the company’s resources and capabilities to sustain its competitiveness
and prepare it to seize future market opportunities and nullify external threats to its well-being.

D. Are Company Resources and Capabilities Sufficient to Allow It to Seize Market Opportunities
and Nullify External Threats?

1. Appraising a company’s resource strengths and weaknesses and its external opportunities and
threats, commonly known as SWOT analysis, provides a good overview of whether its overall
situation is fundamentally healthy or unhealthy.

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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

CORE CONCEPT

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

2. A first-rate SWOT analysis provides the basis for crafting a strategy that capitalizes on the
company’s strengths, aims squarely at capturing the company’s best opportunities, and defends
against the threats to its well-being.

3. Table 4.2, Factors to Consider When Identifying a Company’s Strengths, Weaknesses,

Opportunities, and Threats, provides a detailed list of potential strengths and competitive
assets, potential weaknesses and competitive deficiencies, potential market opportunities, and
potential external threats to a company’s future profitability.

4. The Value of a SWOT Analysis - A SWOT analysis involves more than making four lists. The most
important parts of SWOT analysis are:

a. Drawing conclusions from the SWOT listings about the company’s overall situation.
b. Translating these conclusions into strategic actions to better match the company’s strategy to
its strengths and market opportunities, correcting problematic weaknesses, and defending
against worrisome external threats.

III. Question 3: Are the Company’s Costs Structure and Value Proposition Competitive?

1. One of the most telling signs of whether a company’s business position is strong or precarious is
whether its prices and costs are competitive with industry rivals.

2. Price-cost comparisons are especially critical in a commodity-product industry where the price
competition is typically the ruling force.

3. Two analytical tools are particularly useful in determining whether a company’s prices and costs
are competitive and thus conducive to winning in the marketplace: value chain analysis and
benchmarking.

A. Company Value Chains

1. All of 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 to do things that ultimately
create value for buyers.

CORE CONCEPT

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

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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

2. Figure 4.1, A Representative Company Value Chain, depicts the linked set of value creating
activities.

3. The value chain consists of two broad categories of activities:

a. Primary activities: foremost in creating value for customers

b. Support activities: facilitate and enhance the performance of primary activities

4. The value chain also includes a profit margin component; profits are necessary to compensate
the company’s owners/shareholders and investors, who bear risks and provide capital.

5. Illustration Capsule 4.1, The Value Chain for KP MacLane, a Producer of Polo Shirts, shows
representative costs for various activities performed by the producers and marketers of apparel.

Concepts & Connections - 4.1, The Value Chain for KP MacLane, a Producer of Polo Shirts

Discussion Question: What are the total costs associated with production and shipping a polo
shirt to the retailer? Why is having this knowledge important to such a company?

Answer: According to the information provided in the table, the total costs to deliver a men’s
polo shirt to the retailer is $29.57 with a whole sale price of $65.00. This provides the producer
with an operating profit of $35.43. With this information, the producer can establish a
competitive price point with the wholesaler with the intention of increasing market share. The
producer can also carefully examine each cost category and determine if further cost reductions
can be found to include outsourcing opportunities or vender selection.

B. Benchmarking: A Tool for Assessing Whether a Company’s Value Chain Activities are
Competitive

1. Benchmarking entails how different companies perform various value chain activities, how
customer orders are billed and shipped, and how maintenance is performed—and then making
cross-company comparison of the costs and effectiveness of these activities.

2. The objectives of benchmarking are to identify the best practices in performing an activity and
to emulate these best practices when they are possessed by others.

3. The tough part of benchmarking is not whether to do it, but how to gain access to information
about other companies’ practices and costs.

CORE CONCEPT

Benchmarking is a potent tool for learning which companies are best at performing particular
activities and then using their techniques (or “best practices”) to improve the cost and
effectiveness of a company’s own internal activities.

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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

C. The Value Chain System for an Entire Industry

1. Accurately assessing a company’s competitiveness requires that company managers understand

the entire value chain system for delivering a product or service to end-users, not just the
company’s own value chain.

2. Figure 4.2, A Representative Value Chain for an Entire Industry, explores a value chain for an
entire industry.

3. Suppliers’ value chains are relevant because suppliers perform activities and incur costs.

4. Forward channel and customer value chains are relevant because:

a. The costs and margins of a company’s distribution allies are part of the price the end user
pays.
b. The activities that distribution allies perform affect the end user’s satisfaction.

D. Strategic Options for Remedying a Cost or Value Disadvantage

1. There are three main areas in a company’s overall value chain where important differences
between firms in costs and value can occur: a company’s own internal activities, the suppliers’
part of the industry value chain, and the forward channel portion of the industry chain.

2. Remedying an Internal Cost Disadvantage - If the source of a firm’s cost disadvantage is internal;
managers can use any of the following eight strategic approaches to restore cost parity:

a. Implement the use of best practices throughout the company, particularly for high-cost
activities.
b. Try to eliminate some cost-producing activities altogether by revamping the value chain.
c. Relocate high-cost activities to geographic areas where they can be performed more
cheaply.
d. See if certain internally performed activities can be outsourced from vendors or performed
by contractors more cheaply than they can be done internally.
e. Invest in productivity-enhancing, cost-saving technological improvements.
f. Find ways to detour around the activities or items where cost is high.
g. Redesign the product so that it can be manufactured or assembled quickly and more
economically.
h. Try to make up the internal cost disadvantage by achieving savings in the other two parts of
the value chain system.

3. Rectifying a weakness in a company’s customer value proposition - This can be accomplished by

applying one or more of the following approaches:

a. mplement the use of best practices throughout the company

b. Adopt best practices for marketing, brand management, and customer relationship
management to improve brand image and customer loyalty.
c. Reallocate resources to activities having a significant impact on value delivered to customers
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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

4. Improving Supplier-Related Cost Disadvantage - Supplier-related cost disadvantages can be

attacked by:

a. Pressuring suppliers for lower prices

b. Switching to lower-priced substitute inputs
c. Collaborating closely with suppliers to identify mutual cost-saving opportunities.
d. A company can also enhance its customer value proposition through its supplier
relationships.

5. Improving Value Chain Activities of Forward Channel Allies - There are three main ways to
combat a cost disadvantage in the forward portion of the industry value chain:

a. Pressure dealer-distributors and other forward channel allies to reduce their costs and
markups so as to make the final price to buyers more competitive with the prices of rivals.
b. Work closely with forward channel allies to identify win-win opportunities to reduce costs.
c. Change to a more economical distribution strategy, including switching to cheaper
distribution channels or perhaps integrating forward into company-owned retail outlets.
d. A company can improve its customer value proposition through the activities of forward
channel partners.

E. How Value Chain Activities Relate to Resource and Capabilities

1. A close relationship exists between the value-creating activities that a company performs and
its resources and capabilities.

2. Because of the linkage between activities and enabling resources and capabilities, value chain
analysis complements resource and capability analysis as another tool for assessing a
company’s competitive advantage.

IV. Question 4: What is the Company’s Competitive Strength Relative to Key Rivals?

1. An additional component of evaluating a company’s situation is developing a comprehensive

assessment of the company’s overall competitive strength.

2. Making this determination requires answers to two questions:

a. How does the company rank relative to competitors on each of the important factors that
determine market success?
b. All things considered, does the company have a net competitive advantage or disadvantage
to major competitors?

3. The followings are steps for compiling a competitive strength assessment:

a. Make a list of the industry’s key success factors and most telling measures of competitive
strength or weakness.
b. Assign a weight to each measure of competitive strength.
c. Rate the firm and its rivals on each factor.
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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

d. Sum the strength ratings on each factor to get an overall measure of competitive strength for
each company being rated.
e. 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
strengths and weaknesses.

4. Interpreting the Competitive Strengths Assessment

a. Competitive strength assessments provide useful conclusions about a company’s competitive

situation.
b. The overall competitive strength scores indicate whether the company is at a net competitive
advantage or disadvantage against each rival.
c. Table 4.3, Illustration of a Competitive Strength Assessment, provides an example of a
Competitive Strength Assessment

V. Question 5: What Strategic Issues and Problem Must Be Addressed by Management?

1. The final and most important analytical step is to zero in on exactly what strategic issues that
company managers need to address.

2. This step involves drawing on the results of both industry and competitive analysis and the
evaluations of the company’s own competitiveness.

3. Pinpointing the precise things that management needs to worry about sets the agenda for
deciding what actions to take next to improve the company’s performance and business
outlook.

4. Managers need to differentiate between major and minor worry lists. Dominantly minor issue
lists are an indicator of solid planning and execution, while dominantly major issue lists are an
indicator of significant challenges.

Assurance of Learning Exercises

1. Using the financial ratios provided in the Appendix and the financial statement information Macy’s,
Inc., below, calculate the following ratios for Macy’s for both 2011 and 2012.

a. Gross profit margin

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

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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

Based on these ratios, did Macy’s financial performance improve, weaken, or remain about the
same from 2011 to 2012?

Answer - The student should prepare the following analysis:

a. Gross profit margin - Gross profit margin equals (sales – cost of goods sold) divided by (sales).
For Macy’s, this is represented in the following equations:

2011 ($26,405M – $15,738M) / ($26,405M) = 0.4039 or 40.39%

2012 ($27,6862M – $16,538M) / ($27,6862M) = 0.4026 or 40.26 % [neutral, slight decrease but
essentially flat]

b. Operating profit margin - Operating profit margin equals (operating income) divided by (sales).
For Macy’s, this is represented in the following equations:

2011 ($2,411M) / ($26,405M) = 0.0913 or 9.13%

2012 ($2,661M) / ($27,6862M) = 0.0961 or 9.61% [neutral, increase but slight]

c. Net profit margin - Net profit margin equals (profits after taxes) divided by (sales). For Macy’s,
this is represented in the following equations:

2011 ($1,256M) / ($26,405M) = 0.0476 or 4.76 %

2012 ($1,335M) / ($27,6862M) = 0.0482 or 4.82 % [neutral, increase but slight]

d. Times-interest-earned (coverage) ratio - Times-interest-earned equals (operating income)

divided by (interest expense). For Macy’s, this is represented in the following equations:

2011 ($2,411M) / ($0.447M) = 5.39

2012 ($2,661M) / ($0.425M) = 6.26 [upward trend is favorable]

e. Return on shareholders’ equity - Return on stockholders’ equity equals (profits after taxes)
divided by (total stockholders’ equity). For Macy’s, this is represented in the following
equations:

2011 ($1,256M) / ($5,933M) = 0.2117 or 21.17%

2012 ($1,335M) / ($6,051M) = 0.2206 or 22.06% [favorable, increase]

f. Return on assets - Return on total assets equals (profits after taxes + interest) divided by (total
assets). For Macy’s, this is represented in the following equations:

2011 ($1,256M + $0.447M) / ($22,095M) = 0.0770 or 7.70 %

2012 ($1,335M + $0.425M) / ($20,991M) = 0.0838 or 8.38 % [favorable, increase]

g. Debt-to-equity ratio - Debt-to-equity equals (total debt) divided by (total stockholders’ equity).
For Macy’s, this is represented in the following equations:

2011 ($16,362M) / ($5,933M) = 2.757

2012 ($14,940M) / ($6,051M) = 2.469 [favorable decrease]
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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

h. Days of inventory - Days of inventory equals (inventory) divided by (Cost of goods sold divided
by 365). For Macy’s, this is represented in the following equations:

2011 ($5,117M) / ($15,738M/365 days) = 117.15 days

2012 ($5,308M) / ($16,538M/365 days) = 118.67 days [neutral, slight increase; trend of fewer
days of inventory is better]

i. Inventory turnover ratio - Inventory turnover ratio equals (Cost of goods sold) divided by
(inventory). For Macy’s, this is represented in the following equations:

2011 ($15,738M) / ($5,117M) = 3.07 turns per year

2012 ($16,538M) / ($5,308M) = 3.11 turns per year (neutral, increase but slight)

The student should identify that overall, Macy’s financial performance is slightly up from 2011 but
performance is flat in most areas. The most significant changes are the improvements in ROA and
ROE as they indicate a potential increase in efficiency and utilization of assets. One are of concern is
the relatively low inventory turns ratio and the relatively high days of inventory. Higher inventory
levels and slow moving inventory can require the firm to maintain more cash in order to provide
adequate liquidity, while at the same time increasing the costs associated with maintaining the
inventory.

2. Panera Bread operates more than 1,600 bakery-cafés in 44 states and Canada. How many of the four
tests of the competitive power of a resource does the store network pass? Explain your answer.

Answer:

The student should identify the following:

1. Is the resource or capability competitively valuable – Is it directly relevant to the company’s

strategy. The combination of product and the experience provided by the store are the most
essential components of Panera Bread’s value proposition.

2. Is the resource or capability rare – Is it something rivals lack. – Other companies are able to copy
many features of the store but few have the quantity of stores or are able to provide the same
high quality product.

3. Is the resource or capability hard to copy – Is it built over time or unique – As stated, the
product and the experience provided by Panera Bread copied. It is however cost prohibitive and
therefore ‘hard to copy’.

4. Can the resource or capability be trumped by different types of resources or capabilities. – Are
good substitutes available for the resource or capability. – For someone looking for a predictable
‘specialty food’ experience few substitutes exist.

3. Review the information in Concepts & Connections 4.1 concerning the value chain average costs of
producing and selling an upscale polo shirt and compare this with the representative value chain
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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

depicted in Figure 4.1. Then answer the following questions:

a. Which of the company’s primary value chain activities account for the largest percentage of its
operating expenses?

b. What support activities described in Figure 4.1 would be necessary at KP MacLane?

c. What value chain activities might be important in securing or maintaining a competitive

advantage for a producer of upscale, branded shirts like KP MacLane?

Answer:

The student should use the following costs to conduct their analysis:

1. Cotton-blend fabric from France $ 6.80

2. Fabric for placket and vent $ 0.99
3. 4 buttons, including 1 extra $ 0.12
4. Thread $ 0.09
5. Labels $ 1.10
6. Hang tag $ 0.40
7. Waste fabric $ 0.85
8. Labor $ 11.05
9. Packing materials $ 0.17
10. Shipping materials to factory; shirt to store $ 5.00
11. Hand-embroidered linen bag $ 3.00
12. Total company costs $ 29.57
13. Wholesale markup over company costs (company operating profit) $ 35.43
14. Wholesale price $ 65.00
15. Retailer’s markup $ 90.00
16. Retail price $155.00

a. The student should identify that the example provided illustrates a complex value chain which
includes a separate manufacturer and retailer. From the perspective of the manufacturer with a
wholesale price of $65.00, the costs are:

Cost of Goods Sold (Operations) - 33%

Shipping and Packaging (Distribution) - 13%

However, when the perspective is changed to focus on the final retail price of $155.00, the cost
allocations change:

Cost of Goods Sold (Operations) - 14%

Shipping and Packaging (Distribution) - 5%
Retailer Markup (Sales & Marketing) - 58%

Therefore, when the entire value chain is analyzed, the retailer presents the highest percentage of
operating expenses at 58%. This extended analysis might point to a weakness in the firm’s
business model that would not come to light if the focus was only on internal operations.
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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

b. The student should examine the information provided to identify all of the support activities
highlighted to include:

Research & Development for new products

Human Resource Management for employees
General Administration

c. The student should explain that first, strong research and development are critical to keeping the
right products in the marketing mix. Second, a strong marketing plan will be necessary in order to
maintain and grow brand equity. The cost analysis above might point to issues in the distribution
and sales chain that should be examined further.

4. Using the methodology illustrated in Table 4.3 and your knowledge as an automobile owner, prepare
a competitive strength assessment for General Motors and its rivals Ford, Chrysler, Toyota, and
Honda. Each of the five automobile manufacturers should be evaluated on the key success
factors/strength measures of: cost competitiveness, product line breadth, product quality and
reliability, financial 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.

Answer:

1. The student should identify Key Success Factors in the automotive industry sector being
evaluated, which include:

 Quality / Product Performance

 Reputation / Image
 Product Portfolio
 Manufacturing Capability
 Technological Skills
 Dealer Network / Distribution Capability
 New Product Innovation Capability
 Financial Resources
 Relative Cost Position

2. The Key Success Factors should be assigned weights based on how important they feel the
factor is relative to other factors. The total of all weights should equal 1 (100%).

3. Each company should be graded from 0- 10 for each factor and that grade should be multiplied
by the weight for the factor score.

4. The total of all weighted scores will be the relative Competitive Strength of the company.

5. The student should use published data included annual reports and industry watchdog reports
to develop their grades in each factor. The grading must be consistent for each company in

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Chapter 4 - Evaluating a Company’s Resources, Capabilities, and Competitiveness

order for the results to have validity. The student should be provided with latitude in
determining factors and weights that they feel are relevant to success in the industry. The
condition should be that they can substantiate their selections.

6. Table 4.3 provides an example of what an automotive industry Competitive Strength

Assessment should look like.

7. The student should be able to determine numerically any specific areas where Toyota has
competitive weaknesses when compared to the other competitors. Further, the student should
be able to identify which competitors have an advantage over Toyota as related to specific Key
Success Factors. In this way, the student can determine the basis of competition between
specific competitors and Toyota.

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