Chapter 4—The Internal Organization

Competing for Advantage

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CHAPTER SUMMARY

This chapter focuses on the firm's internal organization and what it can do, showing how
firms use the strategic management process to create value and to earn high returns by effectively
leveraging their unique core competencies to take advantage of opportunities in the external
environment.
The role of firm resources, capabilities, and core competencies to provide a foundation
for creating strategies and the relationship amongst these concepts in developing sustainable
competitive advantage are discussed.
The value chain concept, outsourcing, and four criteria to evaluate core competencies are
presented as tools of internal resource analysis that aid firms in building the sustainability of
competitive advantages with higher performance potential.
The chapter closes with an examination of performance dimensions from stakeholder
perspectives and the strategic importance of considering the broader socially-responsible role that
organizations are now expected to fill within their communities.

CHAPTER OUTLINE

Internal Analysis and Value Creation

Conditions Influencing Internal Analysis
Creating Value
Resources, Capabilities, and Core Competencies
Resources
Capabilities

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Core Competencies
Building Core Competencies
Four Criteria of Sustainable Competitive Advantage
Value Chain Analysis
Outsourcing
When Core Competencies Lose Their Value
Firm Performance
Stakeholder Objectives and Power
Measures of Firm Performance
Balancing Stakeholder Performance
Sustainable Development
Summary
Ethics Questions

KNOWLEDGE OBJECTIVES

1. Explain the need to study and understand the internal organization.

2. Define value creation and discuss its importance.
3. Describe the differences between tangible and intangible resources.
4. Define capabilities and discuss their development.
5. Describe four criteria used to determine whether resources and capabilities are or
are not core competencies.
6. Explain how value chain analysis is used to identify and evaluate resources and
capabilities.
7. Define outsourcing and discuss the reasons for its use.
8. Discuss why firms should prevent their core competencies from becoming core
rigidities.
9. Explain several methods to measure firm performance and how firms can use
multiple measures to balance stakeholder interests and enhance value creation.

LECTURE NOTES

The Internal Organization – This opening section launches a discussion of looking at the
actions that are permitted by a firm's unique bundle of resources, capabilities, and core
competencies and what happens to a firm's competitive advantage over time in today's rapidly
changing environment.

See slide 1. Competing for Advantage

Introduction PART II: STRATEGIC ANALYSIS
Chapter 4: Internal Organization:
Resources, Capabilities, and Core Competencies

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See slide 2. The Strategic Management Process – Overview

Figure 1.6
Strategic Analysis – highlights the two key sources of information-
based inputs to the strategic management process which prepare the firm
to develop its strategic direction and the specific strategies it will use to
create a competitive advantage.
• From the external environment – opportunities and threats
• Internally – strengths and weaknesses derived collectively from
the firm’s resources, capabilities, and core competencies
The strategic management process helps a firm successfully identify and
use sources of competitive advantage over time. The key is to form and
leverage unique core competencies to take advantage of opportunities in
the external environment.

See slide 3. The Internal Organization – Firm resources provide a foundation for
Introduction developing and implementing strategies. Due to rapidly developing
technology, increasing globalization, and economic volatility, the
strategic reality is that it is increasingly difficult to create and sustain a
competitive advantage. This means turning to inimitable intangible
resources as a source of competitive advantage.

Example: Intel’s brand name and R&D processes

Discussion points:
- Possessing a unique bundle of resources puts a firm in a strong
position to develop competitive advantages which can create
value for stakeholders.
- But, all competitive advantages have a limited life.
- In general, the sustainability of a competitive advantage is a
function of three factors.
o The rate of core competence obsolescence caused by
environmental change
o The availability of substitutes for the core competence
o The imitability of the core competence
- Requires managers to keep an eye on developing new core
competencies, even as they are effectively managing current
core competencies.

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See slide 4. Outcomes from Internal Organizational Analysis – In Chapter 3, we

Figure 4.1 looked outside of the firm to examine general, industry, and competitor
environments. In this chapter, we look inside the firm.

Discussion points:
- What the firm can do is the actions permitted by its unique
resources, capabilities, and core competencies.
- By matching what the firm can do with what it might do, the
firm gains insights required for wise selection and
implementation of strategies.

Internal Analysis and Value Creation – This section presents the challenge of making decisions
related to an organization's resources, capabilities, and core competencies.

See slide 5. Internal Analysis and Value Creation – Making decisions related to
Discussion an organization's resources, capabilities, and core competencies creates
challenges for the managers of an organization.

Resource Decision Pitfalls – These decisions significantly influence

firm performance.

Discussion points:
- Resource-related decisions involve identifying, developing,
deploying, and nurturing key organizational resources,
capabilities, and core competencies.
- Decision success is difficult and increasingly linked to
international considerations.

- Pressure to pursue only short-term performance targets can

reduce the firm’s ability to achieve long-term organizational
potential.
- Recognizing a firm’s core competencies is essential before the
firm can make important strategic decisions.
- Admitting mistakes and taking corrective action can have a
positive effect on future efforts to create a competitive
advantage.

1. What types of strategic decisions should not be made before

recognizing the firm’s core competencies?
a. To enter or exit key markets
b. To invest in new technologies
c. To build new or additional manufacturing capacity

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d. To form strategic partnerships

Conditions Influencing Internal Analysis – This section highlights the impact that an emerging
global economy has had on the sources of competitive advantage for businesses and other
conditions that influence how firms make effective strategic decisions.

See slide 6. Key Terms

Key Terms ▪ Global mind-set - ability to study an internal environment in
ways that do not depend on the assumptions of a single country,
culture, or context

Conditions Influencing Internal Analysis – Traditional sources of

competitive advantage (such as labor costs, access to financial resources
or raw material, and protected or regulated markets) can be duplicated
by rivals using an international strategy, and the relatively free flow of
resources across economic borders facilitates the effect. Environmental
context now expands beyond any one national or cultural set of
boundaries. Consequently, the adoption of a global mind set, is
necessary for strategic leaders tasked with analyzing the firm’s internal
organization.

Example: Japanese automobile manufacturers

See slide 7. Conditions Influencing Internal Analysis – An emerging global

Discussion economy and other conditions have had a great impact on the sources of
competitive advantage for businesses and influence how firms make
effective strategic decisions. Global considerations, the pace of
environmental change, and a seemingly-permanent state of economic
volatility significantly affect strategic thinking.

2. How can firms and their strategic leaders combat these

influences?
a. Manage the tendency to deny or resist the need for
change – involve more and diverse individuals in the
strategic process to prevent inertia
b. Establish organizational settings which foster
experimentation and learning – promote responsiveness
to the need for change
c. Rethink earlier concepts of the firm and competition
Example: Kodak

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d. Hire and reward managers with the attributes and skills

necessary for the challenge – confidence, boldness,
integrity, the capacity to handle uncertainty and
complexity, and willingness to hold people accountable
e. Define strategies in terms of unique (exclusive) and
viable competitive positions beyond the demands of the
external environment

See slide 8. Conditions Affecting Managerial Decisions about Resources,

Figure 4.2 Capabilities, and Core Competencies – Managerial decisions about
resources, capabilities, and core competencies are characterized by three
conditions: uncertainty, complexity, and intraorganizational conflict.

Discussion points:
- Managers face uncertainty from a number of sources, including
new proprietary technologies, economic and political volatility,
transformations in societal values, and shifts in customer
demands.
- Biases about how to cope with uncertainty may affect decisions
about the resources and capabilities that will become the
foundation of the firm’s competitive advantage. (Chapter 2
examined several biases that influence the quality of strategic
decisions.)
- Complexity results from the dependence firms have on one
another and on the sheer number of factors that influence firm
performance.

- Environmental uncertainty increases the complexity and range

of issues the firm needs to examine when studying its internal
organization.
- Intraorganizational conflicts often surface when decisions are
made about which core competencies to nurture as well as how
to nurture them.

See slide 9. Resource Perspective – suggests that a firm possesses at least some
Discussion resources and capabilities that other companies do not, at least not in the
same combination

See slide 10. Resources, Capabilities, and Core Competencies

Discussion
Discussion points:
- Are not inherently valuable, but they create value when the firm
uses them to perform certain activities that result in a
competitive advantage

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- Should be used to simultaneously achieve operational

effectiveness and uniqueness
- Operational effectiveness – able to do what competitors do, but
better – signals that the firm is using its resources and
capabilities efficiently relative to competitors
- Unique strategic position – creates value by doing things
differently or by doing different things than competitors –
implementing a strategy which takes advantage of that position
is required to consistently create value for stakeholders over the
long-term

3. What are some measures of operational effectiveness?

a. Productivity
b. Quality
c. Speed

4. What types of management techniques are available in the quest

for operational effectiveness?
a. TQM
b. Benchmarking
c. Time-based competition
d. Re-engineering

See slide 11. Components of Internal Analysis Leading to Competitive

Figure 4.3 Advantage and Value Creation – illustrates the relationships among
resources, capabilities, and core competencies and shows how firms use
the four criteria of sustainable competitive advantage and value chain
analysis to identify sources of value and ultimately competitive
advantage and strategic competitiveness – provides an outline of topics
for much of the rest of this chapter

Combinations of resources and capabilities are managed to create core

competencies. This can begin a discussion to define and provide
examples of these building blocks of competitive advantage.

Creating Value – This section discusses the idea of exploiting core competencies and meeting
global standards of competition to create superior value for customers.

See slide 12. Key Terms

Key Terms ▪ Value - measured by a product's performance characteristics and
by its attributes for which customers are willing to pay

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Creating Value – for customers and other stakeholders by exploiting

core competencies and meeting demanding standards of global
competition

Discussion points:
- The type of value a firm intends to create for customers affects
its choice of business-level strategy and the organizational
structure it will use to implement the strategy. These concepts
are explained further in Chapter 5.
- Today, core competencies, in combination with product-market
positions, are recognized as the firm’s most important sources
of competitive advantage.
- By emphasizing core competencies when formulating strategies,
companies learn to compete primarily on the basis of firm-
specific resources that differ from their competitors’ resources.

Resources, Capabilities, and Core Competencies – This section discusses the evolution of the
strategic management process into a broader, comprehensive theory which identifies the
importance of both adaptation and enactment in strategy formulation.

Resources – This section outlines and describes both tangible and intangible types of resources.

See slide 13. Key Terms

Key Terms ▪ Tangible resources - assets that can be observed and quantified
▪ Intangible resources - assets that typically are rooted deeply in
the firm's history and have accumulated over time
▪ Organizational routines - complex patterns of social interactions
that allow firms to accomplish much of what they do

Resources – broad in scope, covering a spectrum of individual, social,

and organizational phenomena

Discussion points:
- It is in the unique bundling of resources that a competitive
advantage is created.
Example: Nike
- Because intangible resources are embedded in unique patterns
of routines, they are relatively difficult for competitors to
analyze, understand, purchase, imitate, or substitute for.

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See slide 14. Tangible Resources – visible assets, the value of which is usually
Table 4.1 recorded in financial statements

The value of tangible resources is constrained because they can be

difficult to leverage for additional business or value.
Example: Airplane

See slide 15. Intangible Resources – invisible assets, the value of which is rarely
Table 4.2 captured entirely by financial records

Discussion points:
- A superior and more potent source of competitive advantage
- Explains why firms are increasing efforts to nurture and develop
employees
- The more unobservable the resource, the more sustainable its
competitive advantage
- Less able to be analyzed, understood, purchased, imitated, or
substituted for by competitors
- Can be leveraged – the larger the network of users, the greater
the potential benefit to each party
Example: Shared knowledge leveraged to create additional
knowledge

5. What are some examples of intangible resources?

a. Knowledge
b. Trust between managers and employees
c. Ideas
d. Capacity for innovation
e. Managerial capabilities
f. Organizational routines
g. Scientific capabilities
h. Company reputation
i. Manner of interactions with stakeholders
j. Capacity for learning
k. Proprietary processes
l. Quality
m. Intellectual capabilities
n. Systems capabilities
o. Creativity
p. Speed

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See slide 16. Key Terms

Key Terms ▪ Social capital - relationships with other organizations that
contribute to the creation of value
▪ Strategic value of resources - degree to which resources can
contribute to the development of capabilities, core
competencies, and ultimately, competitive advantage

Discussion points:
- Reputation
o Level of awareness built with stakeholders
o An important source of competitive advantage
Examples: Coke, Google, Southwest Airlines
- Brand name
o Powerful measure of an organization’s ability to create real
and lasting value for shareholders
Examples: Apple, Google, IBM, McDonald’s, Microsoft
- Social capital
o Provides access to external resources to complement or
supplement those of the firm

- Strategic value of resources

Example: Value affiliated with a tangible resource such as a
distribution facility

Capabilities – This section highlights that the foundation of many capabilities lies in the skills
and knowledge of a firm's employees and their functional expertise. The value of human capital
in developing and collectively using capabilities is emphasized.

See slide 17. Key Terms

Key Terms ▪ Capabilities - firm's capacity to deploy resources that have been
purposely integrated to achieve a desired end state

Capabilities – As a source of capabilities, tangible and intangible

resources are a critical part of the pathway to developing a competitive
advantage.

Knowledge possessed by human capital is among the most significant of

an organization’s capabilities and may ultimately be at the root of all
competitive advantages. But firms must also be able to utilize the
knowledge that they have and transfer it among their operating
businesses.

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Discussion points:
- The glue binding an organization together
- Emerge over time through complex interactions between
resources
- Often based on developing, carrying, and exchanging
information and knowledge through the firm’s human capital
- A knowledge base, grounded in organizational actions, which
may not be explicitly understood
- Many founded on the skills and functional expertise of
employees
- Value of human capital cannot be overstated
- Challenge to create an environment where knowledge is
successfully shared to leverage the collective value of
intellectual assets embedded in the employee base
- CLO’s being employed to manage the firm’s knowledge
resources, which traditionally have not been actively managed
or measured

See slide 18. Examples of Firm’s Capabilities – Capabilities are often developed in
Table 4.3 specific functional areas or in a part of a functional area (for example,
advertising within the marketing department). Research suggests that a
relationship exists between capabilities developed in particular
functional areas and the firm’s financial performance at both the
corporate and business-unit levels, suggesting the need to develop
capabilities at all levels.

The capabilities included in this table satisfy the Four Criteria of

Sustainable Competitive Advantage discussed on Slides 21 and 22.

Core Competencies – This section discusses how core competencies distinguish a company
competitively and reflect its personality.

See slide 19. Key Terms

Key Terms ▪ Core competencies - resources and capabilities that serve as a
source of competitive advantage for a firm over its rivals

Core Competencies – Core competencies distinguish a company

competitively from its rivals and reflect the personality of the
organization.

Discussion points:

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Chapter 4—The Internal Organization

- Emerge over time through the organizational process of

accumulating and learning to deploy resources and capabilities
- The “crown jewels of a company” – activities the firm performs
especially well compared with competitors
- Strategic assets – resources and capabilities with a competitive
value and potential to provide a competitive advantage
- Success comes from identifying opportunities in the
environment that can be exploited through core competencies,
while avoiding competition in areas of weakness

See slide 20. Example: Walmart

Discussion

Building Core Competencies – This section develops two tools for identifying and building core
competencies that will create and sustain competitive advantages.

See slide 21. Tools for Building Core Competencies – Two tools are commonly
Tools used to identify and build core competencies that create and sustain
competitive advantages.

Four Criteria of Sustainable Competitive Advantage – to determine

whether resources are or have the potential to be core competencies

Value Chain Analysis – to select the value-creating competencies that

should be maintained, upgraded, or developed and those which should
be outsourced

Four Criteria of Sustainable Competitive Advantage – This section outlines and discusses
each of the four criteria that qualify capabilities as core competencies and ultimately establish
competitive advantages for firms.

See slide 22. Four Criteria of Sustainable Competitive Advantage – Only

Introduction capabilities that satisfy these four criteria are core competencies.

See slide 23. Key Terms

Key Terms ▪ Valuable capabilities - allow the firm to exploit opportunities or
neutralize threats in its external environment
▪ Rare capabilities - possessed by few, if any, current or potential
competitors
▪ Costly-to-imitate capabilities - cost for other firms to develop is
prohibitive, cannot easily be developed by other firms

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▪ Nonsubstitutable capabilities - do not have strategic equivalents

Four Criteria of Sustainable Competitive Advantage – These four

criteria are used to qualify capabilities as core competencies and to
ultimately establish competitive advantages for firms.

See slide 24. Four Criteria for Determining Core Competencies – A sustainable
Table 4.4 competitive advantage is achieved only when competitors have failed in
efforts to duplicate the benefits of a firm’s strategy.

Discussion points:
- The length of time a firm can expect to maintain its competitive
advantage is a function of how quickly competitors can imitate
it.
- Two valuable firm resources are strategically equivalent if they
can each be separately exploited to implement the same
strategies.

See slide 25. Costly-to-Imitate Capabilities – three reasons capabilities are costly to
Discussion imitate

Discussion points:
- Capabilities were developed because of unique historical
conditions. As firms evolve, they pick up skills, abilities, and
resources that are unique to them, reflecting their particular path
through history.
Examples: McKinsey & Company and UPS
- Capabilities have a causally ambiguous link to competitive
advantage. Competitors are unable to understand how the firm
uses its capabilities as the foundation for a competitive
advantage.
Examples: Southwest Airlines and Lincoln Electric
- Capabilities are socially complex, or are the product of complex
social phenomenon.
Examples: Trust, interpersonal relationships, friendships among
managers and employees, and firm’s reputation with suppliers
and customers

See slide 26 Core Competencies as a Strategic Capability – distinguishing

Figure 4.4 between strategic capabilities and non-strategic capabilities

Strategic capabilities meet the four criteria of sustainable competitive

advantage and have strategic relevance.

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They are valuable and nonsubstitutable from the customer’s

point of view.
They are unique and inimitable from the competitor’s point of
view.

See slide 27 Outcomes from Combinations of the Criteria for Sustainable

Figure 4.5 Competitive Advantage – shows the competitive consequences and
performance implications resulting from combinations of the four
criteria of sustainability – helps managers determine the strategic value
of the firm's capabilities

Discussion points:
- Capabilities that fall into the first row of the table should not be
emphasized.
- Capabilities yielding competitive parity and either temporary or
sustainable competitive advantage should be supported.

Value Chain Analysis – This section introduces an internal analysis tool to help managers
understand the parts of their operations that create value and those that do not. This template can
be used to identify a firm's cost position and the means that might be used to facilitate
implementation of a chose business-level strategy.

See slide 28. Key Terms

Key Terms ▪ Value chain activities - activities or tasks involved with the
production of a firm’s product, the sale and distribution of
products to buyers, and after-sales services in ways that create
value for the customer
▪ Support functions - activities or tasks which support the firm’s
work required to make, sell, distribute, and service its products

Value Chain Analysis – This is an internal analysis tool used to help

managers understand the parts of their operations that create value and
those that do not. This template can be used to identify a firm's cost
position and the means that might be used to facilitate implementation
of a chosen business-level strategy.

See slide 29. Value Chain Model – The value chain shows how a product moves
Figure 4.5 through the stages of supply-chain management to follow-up
service/support.

Discussion points:

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- The essential idea is to add as much value as possible as cheaply

as possible and to capture that value.
- Value chain activities that are considered during a value chain
analysis:
o Inbound logistics
o Operations
o Outbound logistics
o Marketing and sales
o Service
- Support functions that are considered during a value chain
analysis:
o Procurement
o Technological development
o Human resource management
o Firm infrastructure
- In a globally competitive economy, the most valuable links on
the chain tend to belong to people who have knowledge about
customers.

- It has become increasingly necessary to develop value-adding

knowledge processes to compensate for the value and margin
stripped from physical processes by the Internet.
- Determining or rating a firm’s capability to execute value chain
activities and support functions is challenging.
Example: Sony
- Judgment is necessary for value chain analysis as no known
accurate model or rule is available to help in the process.

See slide 30. Creating Value Through Value Chain Activities – Figures 4.6 and 4.7
Figure 4.6 list the items to consider when assessing the value-creating potential of
value chain activities and support functions, respectively. The purpose
of examining these activities and functions is to determine areas where
the firm has the potential to create and capture value. All activities in
both tables should be evaluated relative to competitors’ capabilities.

See slide 31. Creating Value Through Support Functions – Figures 4.6 and 4.7 list
Figure 4.7 the items to consider when assessing the value-creating potential of
value chain activities and support functions, respectively. The purpose
of examining these activities and functions is to determine areas where
the firm has the potential to create and capture value. All activities in
both tables should be evaluated relative to competitors’ capabilities.

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See slide 32. Sources of Competitive Advantage – To be a source of competitive

Discussion advantage, two conditions must be met by a resource or capability.
Only under these conditions does a firm create value for customers and
have opportunities to capture that value.

Discussion points:
- Start-up firms are known to create value by uniquely
reconfiguring or recombining parts of the value chain.
Example: FedEx
- The Internet has changed several aspects of the value chain for
many firms.
Examples: Amazon and Twitter

Outsourcing – This section defines the practice of going outside of a firm to acquire value-
creating activities, when it is a viable option to do so, and why this trend continues to increase at
a rapid pace.

See slide 33. Key Terms

Key Terms ▪ Outsourcing - the purchase of a value-creating activity from an
external supplier

Outsourcing – the practice of going outside of a firm to acquire value-

creating activities when the firm lacks capabilities linked to competitive
success and when it is a viable option to internal competency
development

Outsourcing is a trend which continues to increase at a rapid pace,

especially in global industries.
Example: Pharmaceutical industry

In some industries, virtually all firms seek value that can be captured
through effective outsourcing.
Examples: Automobile manufacturing and consumer
electronics

See slide 34. Benefits of Outsourcing

Benefits

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See slide 35. Outsourcing Viability – Outsourcing value-creating activities can be a

Viability viable option for a firm.

Discussion points:
- Few companies can afford to internally develop all of the
technologies that might create a competitive advantage.
- By nurturing a smaller number of capabilities, firms increase the
probability of developing a competitive advantage.
- Outsourcing allows the company to fully concentrate on areas
where it can truly create value.
- Intermediaries are available to facilitate the process.
Example: Outsourcing Institute
- Critics argue that too much outsourcing can decrease a firm’s
ability to innovate.
- Taking advantage of mutually dependent supplier relationships
or making unrealistic demands can encourage suppliers to
integrate forward and become direct competitors.

See slide 36. Essential Skills for Outsourcing – Outsourcing does not work
Key Skills effectively without the managers who administer these programs having
extensive internal capabilities to effectively coordinate external sourcing
with internal core competencies.

Discussion points:
- Understand whether and how outsourcing creates competitive
advantage within the firm
- Be able to secure rights from external providers that internal
managers can fully use
- Complete effective outsourcing transactions
- Be able to oversee and appropriately govern relationships with
outsourcing partners and service providers
- Understand that outsourcing can significantly change how an
organization operates
- Be able to resolve employee resistance to change

When Core Competencies Lose Their Value – This section discusses conditions that are
created externally as well as internally to the organization which diminish the value of core
competencies.

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See slide 37. When Core Competencies Lose Their Value – Internal and external
Discussion conditions can diminish the value of core competencies over time.

6. What external events may contribute to core competencies

becoming core rigidities?
a. When new competitors figure out a better way to serve
the firm’s customers
b. When new technologies emerge
c. When political or social events substantially shift the
environment

Firm Performance – This section identifies high performance results as the primary objective of
using the tools of internal analysis and addresses the multidimensional nature of firm
performance measurements. Additionally, stakeholder expectations and their response to firm
performance are discussed.

Stakeholder Objectives and Power – This section evaluates the varying dependencies between
firms and their stakeholders, the factors that influence firms' positions relative to the perceived
power of stakeholders, and the resulting priorities and trade-offs for firms.

See slide 38. Key Terms

Key Terms ▪ Economic power - comes from the ability to withhold economic
support from the firm
▪ Political power - results from the ability to influence others to
withhold economic support or to change the rules of the game
▪ Formal power - involves laws or regulations that specify the
legal relationship existing between a firm and a particular
stakeholder group

Firm Performance – High performance results are the primary

objective of using the tools of internal analysis. Firm performance
measurements are multidimensional in nature, and must take into
account stakeholder expectations and stakeholder response to firm
performance.

Stakeholders continue to support a firm when its performance meets or

exceeds their expectations. The dependency and influence of

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stakeholders vary, but top managers tend to give shareholder needs a

high priority when making decisions and taking strategic actions.

Stakeholder Objectives and Power – Effective managers must find

ways to either accommodate or insulate the organization from the
demands of stakeholders controlling critical resources. With various
and sometimes conflicting stakeholder objectives to consider, managers
must carefully prioritize the needs and desires of important stakeholders
because the firm’s resources are finite at any set point in time. They
must set priorities and make trade-offs to ensure the firm’s short-term
success and long-term survival.

Discussion points:
- Short-term enhancement of shareholder wealth can negatively
affect the firm’s future competitive capability.
- Stakeholder power, or level of influence, is the most critical
criterion managers use to prioritize stakeholders.
- Economic – such as investment funds which not only can sell a
significant share of their stockholdings to reduce the value of
the firm, but can persuade others to withdraw their support
- Political – such as special interest groups which lobby
government bodies for legal changes
- Formal – such as legal obligations firms have to shareholders or
to follow government regulations
- Stakeholders can enjoy multiple sources of power.
- Firms may give priority to a particular stakeholder group
because of its strategic importance to future plans.
Example: Community relations where the firm hopes to build a
new plant

See slide 39. Returns and Stakeholders – The levels of financial returns earned by
Discussion firms affect their efforts to satisfy multiple stakeholder expectations.

Discussion points:
- When firms earn high economic returns, the challenge of
balancing stakeholder interests is lessened substantially – a firm
can more easily satisfy multiple stakeholders simultaneously.
- When firms earn average economic returns, the objective
becomes one of at least minimally satisfying each stakeholder,
and trade-off decisions are made in light of how dependent the
firm is on the support of its stakeholder groups.
- When firms earn below-average returns, the managerial
challenge is to minimize the amount of support withdrawn by
dissatisfied stakeholders.

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Measures of Firm Performance – This section categorizes firm performance into three types of
measurements (based on three primary stakeholder groups) and presents the needs of other key
stakeholders that are important to the success of the firm. The reconciliation of risk levels and
expected returns is also discussed.

See slide 40. Measures of Firm Performance – dimensions of firm performance

Introduction from the perspective of all stakeholders – measuring is an essential
component of internal analysis

See slide 41. Firm Performance from a Capital Market Perspective – Table 4.6
Table 4.6 shows examples of measures that are highly relevant to capital market
stakeholders, measures that can be used to assess risk and to adjust
shareholder returns.

Capital market stakeholders, shareholders, and lenders expect a firm to

preserve and enhance the wealth they have entrusted to the firm.

Shareholders are particularly interested in receiving high returns for the

investment they have made in a company’s stock. Those returns can be
compared with the average return of all stocks in the market as a whole
or in a designated industry for a particular period.

Discussion points:
- Capital market stakeholders are concerned about the growth of
the firm because growth is so closely associated with other
measures of performance.
- Capital market stakeholders are concerned when liquidity
becomes too low or debt levels grow too high, because these
factors can influence the ability of a company to remain solvent.
- Capital market stakeholders are interested in firm efficiency
because of its influence on future profitability. Consequently,
measures like asset or inventory turnover and days receivable
are also relevant.
- Both shareholders and lenders anticipate returns that are
commensurate with the degree of risk accepted for those
investments (that is, lower returns are expected for low-risk
investments, and higher returns are expected for high-risk
investments). See Slide 42 for discussion of risk.
o To calculate risk-adjusted returns, shareholders can deduct
the average or market return for a particular period from the
return that was actually received and then divide the result
by the standard deviation of returns or beta.
o Comparing the risk-adjusted return to the risk-adjusted
return of other firms provides a better sense of how well the
stock is performing relative to the amount of risk the
shareholder is assuming.

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o Lenders are interested in risk measures such as standard

deviation or beta because they are one indication of the
financial stability of the firm.

See slide 42. Key Terms

Key Terms ▪ Risk - investor uncertainty about the economic gains or losses
that will result from a particular investment

Risk – Strategic leaders must assess the risks involved in pursuing

various courses of action. Decisions that lead to lower variance in
returns can enhance the value of an organization from the perspective of
capital market stakeholders. See Table 4.6 or Slide 41 which contain a
few common examples of measures that can be used to assess risk.

See slide 43. Other Measures of Firm Performance – The needs and desires of
Table 4.7 other key stakeholders are also important to the success of the firm, so
managers should also establish measures that reflect how well the firm
is responding to them. Table 4.7 contains a few examples of the types
of measures firms might use.

Discussion points:
- Stakeholder expectations are conflicting in nature, and resources
expended to satisfy one stakeholder group can reduce resources
available for others. Optimal value creation requires a balance
of stakeholder interests.
- It is in the interest of all stakeholders that a firm provides a
steady and high return to shareholders to reduce the cost of
capital for the firm.
- Prosperity means that more resources are available for all
stakeholders.
- Even advocates of maximizing shareholder wealth recognize the
importance of other stakeholder interests.
- Traditional financial measures may not reflect the full amount
of value the firm is creating and may not identify when
stakeholder groups receive a disproportionate share of the firm’s
value.

Balancing Stakeholder Performance – This section re-emphasizes the conflicting nature of

stakeholder expectations and that optimal value creation requires a balance of stakeholder
interests.

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Sustainable Development – This section adds social responsibility to the discussion of internal
strategic considerations for firms and discusses the need for firms to exceed legal and moral
requirements to find ways for value-creating activities to benefit society.

See slide 44. Key Terms

Key Terms ▪ Sustainable development - business growth that does not deplete
the natural environment or damage society

Sustainable Development – A broader perspective of social

responsibility is often added to the discussion of internal strategic
considerations for firms. While pursuing stakeholder satisfaction makes
the beginnings of a socially responsible firm, firms need to exceed legal
and moral requirements while performing value-creating activities to
benefit society.

Today, stakeholders and global communities are demanding more of

“corporate citizens” with respect to environmental sustainability.
Sustainability has become a competitive necessity in today’s
marketplace.

7. Describe some corporate activities which demonstrate a

commitment to sustainability.
a. McDonald’s – pork supplier requirements
b. Walmart – zero waste program
c. Novo Nordisk A/S – triple bottom line focus

Ethical Questions – Recognizing the need for firms to effectively interact with stakeholders
during the strategic management process, all strategic management topics have an ethical
dimension. A list of ethical questions appears after the Summary section of each chapter in the
textbook. The topic of ethics is best covered throughout the course to emphasize its prevalence
and importance. We recommend posing at least one of these questions during your class time to
stimulate discussion of ethical issues relevant to the chapter material that you are covering. (See
slides 45-51.)

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