Chapter 4

Strategy: Core Concepts and Analytical Approaches
Arthur A. Thompson, The University of Alabama 7th Edition, 2022-2023

An e-book marketed by McGraw Hill Education
Chapter 4
Evaluating a Company’s
Resources and Ability to
Compete Successfully
Before executives can chart a new strategy, they must reach common understanding of the company’s
current position.
—W. Chan Kim and Rene Mauborgne
Organizations succeed in a competitive marketplace 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
A new strategy nearly always involves acquiring new resources and capabilities.
—Laurence Capron and Will Mitchell
C
hapter 3 described how to use the tools of industry and competitive analysis to assess a company’s
external environment and lay the groundwork for matching a company’s strategy to its external
situation. This chapter discusses techniques for evaluating a company’s internal situation, with
emphasis on its collection of resources and capabilities, the competitiveness of its prices and internal
operating costs, and its competitive strength versus rivals. The analytical spotlight is trained on six questions:
1. How well is the company’s present strategy working?
2. What are the company’s important resources and capabilities, and do they have enough competitive
power to produce a competitive advantage over rival companies?
3. What are the company’s competitively important strengths and weaknesses and how well-suited
are they to capturing its best market opportunities and defending against the external threats to its
future well-being?
4. Are the company’s prices and costs competitive with those of key rivals, and does it have an
appealing customer value proposition?
5. Is the company competitively stronger or weaker than key rivals?
70
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Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully 71
6. What strategic issues and problems does top management need to address in crafting a strategy to
fit the company's situation?
In probing for answers to these questions, five analytical tools—resource and capability analysis, SWOT
analysis, value chain analysis, benchmarking, and competitive strength assessment—are used. All five are
valuable techniques for revealing a company’s ability to compete successfully and for helping company
managers match their strategy to the company’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, one must start with a clear view of what the
strategy is. 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
customers and improve its market position—for instance, has it cut prices, improved the design of its product,
added new features, stepped up advertising, entered a new foreign or domestic geographic market, or
merged with a competitor? Is it striving for a competitive advantage based on low costs or an appealingly
different or 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
competitively valuable alliances or partnerships with other enterprises.
FIGURE 4.1 Identifying the Components of a Single-Business Company’s Strategy
Actions to respond to important Planned, proactive moves to attract

changes in the macro-environment customers and out-compete rivals via
or in industry and competitive more appealing product attributes,
conditions better product quality, wider selection,
lower prices, superior service, and so on
Initiatives to build competitive

advantage based on:
R&D, technology, • Lower costs and prices
product design BUSINESS relative to rivals?
strategy STRATEGY • A different or better
The actions and product offering?
Supply chain approaches crafted • Superior ability to serve
management to compete successfully a market niche or specific
strategy in a particular group of buyers?
business
Production Efforts to expand or
strategy narrow geographic
coverage
Sales, marketing,
and distribution Efforts to build competitively
strategies valuable partnerships and
Information strategic alliances with other
technology enterprises
strategy
Human
resources Finance
strategy strategy

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 the company is an above-average industry
performer, and (3) whether the company is gaining customers and gaining market share. Persistent shortfalls
in meeting company performance targets and mediocre performance in the marketplace relative to rivals are
reliable warning signs that the company has a weak strategy, suffers from poor strategy execution, or both.
Specific indicators of how well a company’s strategy is working include:
• Whether the firm’s sales are growing faster, slower, or at about the same pace as the market as a
whole, thus resulting in a rising, eroding, or stable market share.
• How well the company stacks up against rivals on product innovation, product quality, price, customer
service, and other relevant factors on which buyers base their choice of brands.
• Whether the firm’s brand image and reputation are growing stronger or weaker.
• Whether the firm’s profit margins are increasing or decreasing.
• Trends in the firm’s net profits, return on investment, and stock price and how these compare to the
same trends for other companies in the industry.
• Whether the company’s overall financial strength, credit rating, key financial and operating ratios,
and cash flows from operations are improving, remaining steady, or deteriorating.
• Evidence of internal operating improvements (fewer product defects, faster delivery times, increases
in employee productivity, a growing stream of successful product innovations, and ongoing cost
savings).
The bigger the improvements in a company’s market

standing and competitive strength and the stronger its Sluggish financial performance and second-rate
financial and operating performance, the more likely it market accomplishments almost always signal
has a well-conceived, well-executed strategy. Run-of-the- weak strategy, weak execution, or both.
mill market results, mediocre financial performance, and
sparse operating improvements are red flags that raise questions about a company’s strategy and whether
radical changes in strategy or internal operations are needed.
Table 4.1 provides a compilation of the financial ratios most commonly used to evaluate a company’s financial
performance 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 Shows the percentage of revenues available to cover
Sales revenues operating expenses and yield a profit. Higher is better
and the trend should be upward.
2. Operating profit margin Sales revenues—Operating expenses Shows the profitability of current operations without
(or return on sales) Sales revenues regard to interest charges and income taxes. Earnings
or before interest and taxes is commonly referred to as
EBIT. Higher is better and the trend should be upward.
Operating income
Sales revenues
3. Net profit margin (or Profits after taxes Shows after-tax profits per dollar of sales. Higher is
net return on sales) Sales revenues better and the trend should be upward.
4. Total return on assets Profits after taxes + Interest A measure of the return on total monetary investment
Total assets 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. Higher is better
and the trend should be upward.

5. Net return on total Profits after taxes A measure of the return earned by stockholders on the
assets (ROA) Total assets firm’s total assets. Higher is better and the trend should
be upward.
6. Return on stockholders’ Profits after taxes Shows the return stockholders are earning on their
equity (ROE) Total stockholders’ equity capital investment in the enterprise. A return in the
12–15% range is “average,” and the trend should be
upward.
7. Return on invested Profits after taxes A measure of the return shareholders are earning
capital (ROIC)— Long-term debt + on the long-term monetary capital invested in the
sometimes referred Total stockholders’ equity enterprise. A higher return reflects greater bottom-line
to as return on capital effectiveness in the use of long-term capital, and the
employed (ROCE) trend should be upward.
8. Earnings per share Profits after taxes Shows the earnings for each share of common stock
(EPS) Number of shares of outstanding. The trend should be upward, and the
common stock outstanding bigger the annual percentage gains, the better.
Liquidity Ratios
1. Current ratio Current assets Shows a firm’s ability to pay current liabilities using
Current liabilities assets that can be converted to cash in the near term.
Ratio should definitely be higher than 1.0; ratios of 2 or
higher are better still.
2. Working capital Current assets – Current liabilities Bigger amounts are better because the company
has more internal funds available 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 Total liabilities Measures the extent to which borrowed funds (both
ratio Total assets short-term loans and long-term debt) have been used
to finance the firm’s operations. A low fraction or ratio
is better—a high fraction indicates overuse of debt and
greater risk of bankruptcy.
2. Long-term debt-to- Long-term debt An important measure of creditworthiness and balance
capital ratio Long-term debt + sheet strength. It indicates the percentage of capital
Total stockholders’ equity investment in the enterprise that has been financed
by both long-term lenders and stockholders. A ratio
below 0.25 is usually preferable since monies invested
by stockholders account for 75% or more of the
company’s total capital. The lower the ratio, the greater
the capacity to borrow additional funds. Debt-to-capital
ratios above 0.50 and certainly above 0.75 indicate a
heavy and perhaps excessive reliance on long-term
borrowing, lower creditworthiness, and weak balance
sheet strength.
3. Debt-to-equity ratio Total liabilities Shows the balance between debt (funds borrowed
Total stockholders’ equity 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 and
definitely above 2.0 put creditors at greater risk, signal
weaker balance sheet strength, and often result in
lower credit ratings.
4. Long-term debt-to- Long-term debt Shows the balance between long-term debt and
equity ratio Total stockholders’ equity stockholders’ equity in the firm’s long-term capital
structure. Low ratios indicate greater capacity to
borrow additional funds if needed.
5. Times-interest-earned Operating income Measures the ability to pay annual interest charges.
(or coverage) ratio Interest expenses Lenders usually insist on a minimum ratio of 2.0, but
ratios progressively above 3.0 signal progressively
better creditworthiness.

Activity Ratios
Days of inventory Inventory Measures inventory management efficiency. Fewer
Cost of goods sold ÷ 365 days of inventory are usually better.
Inventory turnover Cost of goods sold Measures the number of inventory turns per year.
Inventory Higher is better.
Average collection Accounts receivable Indicates the average length of time the firm must wait
period Total sales ÷ 365 after making a sale to receive cash payment. A shorter
or collection time is better.
Accounts receivable
Average daily sales
Other Important Measures of Financial Performance
Dividend yield on Annual dividends per share A measure of the return that shareholders receive
common stock Current market price per share in the form of dividends. A “typical” dividend yield is
2–3%. The dividend yield for fast-growth companies is
often below 1% (maybe even 0); the dividend yield for
slow-growth companies can run 4–5%.
Price-earnings ratio Current market price per share P-E ratios above 20 indicate strong investor
Earnings per share 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.
Dividend payout ratio Annual dividends per share Indicates the percentage of after-tax profits paid out
Earnings per share as dividends.
Internal cash flow After-tax profits + Depreciation A quick and 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.
Free cash flow After-tax profits + Depreciation – A quick and rough estimate of the cash a company’s
Capital expenditures – Dividends 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.
QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT

RESOURCES AND CAPABILITIES AND DO THEY HAVE
ENOUGH COMPETITIVE POWER TO PRODUCE A
COMPETITIVE ADVANTAGE OVER RIVALS?
An essential element of deciding whether a company’s internal situation is fundamentally healthy or unhealthy
entails examining the attractiveness of its resources and capabilities. A company’s resources and capabilities
are competitive assets and determine whether its competitive power in the marketplace will be impressively
strong or disappointingly weak. Companies with second-rate competitive assets are nearly always 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 competitively
important resources and 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. This second step involves applying four tests of the competitive power of a resource or
capability.
Identifying a Company’s Competitively Important Resources

and Capabilities
A company’s competitively important resources and capabilities are fundamental building blocks in crafting
a competitive strategy.1 Broadly speaking, any asset or productive input that a firm owns or controls qualifies
as a resource. Most firms have many kinds and types of resources, and these tend to vary widely in quality
and competitive value. For example, a company’s brand name is a resource, whose value varies widely.
Some brands like Coca-Cola, Nike, and Google are quite valuable because they are well-known globally
while others are virtually unknown and have little competitive value (Turtle Beach, Kumho, Asus). Our interest
here is not in cataloging every resource a company has but rather in identifying those resources that have
competitive value and can enhance its competitiveness.
Identifying Valuable Company Resources. Valuable or competitively relevant resources can relate to
any of the following:
• Physical resources: valuable land and real estate, state-of-the-art manufacturing plants, equipment,
distribution facilities, and/or well-equipped R&D facilities, the locations of retail stores, plants, and
distribution centers (including the overall pattern of their physical locations), and ownership of or
access rights to valuable natural-resource deposits.
• Human assets and intellectual capital: an educated, well-trained, talented and experienced
workforce, the cumulative learning and know-how of key personnel and work groups regarding
important business functions and/or technologies; proven managerial and leadership skills, proven
skills in operating key parts of the business efficiently and effectively.2
• Organizational and technological resources: proprietary technology and production capabilities,

patents, proven R&D capabilities, strong e-commerce capabilities, proven quality control systems,
state-of-the-art information and data management systems (systems for monitoring various
operating activities in real-time, just-in-time inventory management systems, and business analytics
capabilities), and proven software development capabilities.
• Financial resources: cash and marketable securities, a strong balance sheet and credit rating (thus
giving the company added borrowing capacity and access to additional financial capital).
• Intangible assets: brand names, trademarks, copyrights, company image, reputational assets
(for technological leadership or excellent product quality or customer service or honesty and fair
dealing), buyer loyalty and goodwill, a strong work ethic and motivational drive that is embedded
in the company’s workforce, a tradition of close teamwork and coordination across the company’s
organizational units, the creativity and innovativeness of certain personnel and work groups, the trust
and effective working relationships established with various external partners, and cultural norms
and behaviors that promote responding quickly to changing circumstances, fast organizational
learning, and continuously striving to achieve operating excellence in the performance of internal
activities.
• Relationships: alliances, joint ventures or partnerships that provide access to valuable technologies,
specialized know-how, or attractive geographic markets; fruitful partnerships with suppliers that
reduce costs and/or enhance product quality and performance; a strong network of distributors and/
or retail dealers.

Identifying Valuable Company Capabilities. A capability concerns the proficiency with which
a company can perform an activity. A company’s skill or proficiency in performing different facets of its
operations can range from one of minimal capability (perhaps having just struggled to perform an activity
for the first time) to the other extreme of being able to perform the activity with a level of competence that
exceeds any other company in the industry. In general, the competitive value of a capability depends on two
factors: the competence a company has achieved in performing the activity and the role of the activity in the
company’s strategy, as explained below:
1. A company’s proficiency rises from that of mere ability to perform an activity to the level of a competence
when it learns to perform the activity consistently
well and at acceptable cost. Usually, competence CORE CONCEPT
in performing an activity originates with deliberate A company has a competence in performing an
efforts to simply develop the ability to do it, however activity when, over time, it gains the experience
imperfectly or inefficiently. Then, as experience builds and know-how to perform an activity consistently
and the company gains proficiency to perform the
well and at acceptable cost.
activity consistently well and at an acceptable cost, its
ability evolves into a true competence and capability.
Whether a competence has competitive value depends on whether it relates directly to a company’s
strategy or competitive success or whether it concerns an activity that has minimal competitive bearing
(like administering employee benefit programs or accuracy in preparing financial statements).
Some competitively valuable competencies relate to fairly specific skills and expertise (like just-in-time
inventory control, low-cost manufacturing efficiency, picking locations for new stores, or designing
an unusually appealing and user-friendly website for online sales). They spring from proficiency in a
single discipline or function and may be performed in a single department or organizational unit. Other
competencies, however, are inherently multidisciplinary and cross-functional. They are the result of
effective collaboration among people with different expertise working in different organizational units.
A competence in continuous product innovation, for example, comes from teaming the efforts of people
and groups with expertise in market research, new product R&D, design and engineering, cost-effective
manufacturing, and market testing. Virtually all organizational competences are knowledge based,
residing in the intellectual capital of company employees and not in assets on its balance sheet.
2. A core competence is a proficiently performed internal activity that is central to a company’s strategy and
competitiveness.3 A core competence is a more competitively valuable capability than a competence
because of the well-performed activity’s key role in the company’s strategy and the contribution it makes
to the company’s market success, competitiveness,
and profitability. A core competence can relate to any CORE CONCEPT
of several aspects of a company’s business: expertise
A core competence is an activity that a company
in integrating multiple technologies to create families
performs quite well and that is also central to its
of new products, skills in manufacturing a high-
quality product at a low cost, or the capability to fill strategy and competitiveness. A core competence
customer orders accurately and swiftly. Most core is a more important capability than a competence
competencies are grounded in cross-department because it adds power to a company’s strategy
combinations of knowledge and expertise rather and has a bigger positive impact on its
than being the product of a single department or competitive success.
work group. Amazon.com has a core competence in
online retailing and website operations. Kellogg’s has a core competence in developing, producing,
and marketing breakfast cereals. Microsoft has a core competence in developing operating systems
for computers and user software like Microsoft Office®. L’Oréal, the world’s largest beauty products
company with 18 dermatologic and cosmetic research centers, a large accumulation of scientific
knowledge concerning skin and hair care, patents and secret formulas for hair and skin care products,
and robotic techniques for testing the safety of hair and skin care products, has developed a strong
and competitively successful core competence in developing hair care products, skin care products,
cosmetics, and fragrances.

3. A distinctive competence is a competitively valuable activity that a company performs better than its
rivals.4 A distinctive competence thus signifies greater proficiency than a core competence. Because
a distinctive competence represents a level of
proficiency that rivals do not have, it qualifies as a CORE CONCEPT
competitively superior capability with competitive
advantage potential. It is always easier for a company A distinctive competence is a competitively
to build competitive advantage when it has a important activity that a company performs better
distinctive competence in performing an activity than its rivals—it thus represents a competitively
important to market success, when rival companies superior capability.
do not have offsetting competencies, and when it is
costly and time-consuming for rivals to imitate the
competence. Companies that have a distinctive competence include Google, which has a distinctive
competence in search engine technology, and Walt Disney Co., which has a distinctive competence in
creating and operating theme parks.
In determining whether a company has a competitively attractive collection of resources and capabilities,
it is important to identify which of its skills and proficiencies qualify as a competence, which represent a
core competence, and whether it may enjoy a distinctive competence in one or more activities it performs.5
Both core competencies and distinctive competencies are valuable because they enhance a company’s
competitiveness. But mere ability to perform an activity well does not necessarily give a company competitive
clout. Some competencies merely enable market survival because most rivals also have them—indeed, not
having a competence or competitive capability that rivals have can result in competitive disadvantage. An
apparel manufacturer cannot survive without the capability to produce its apparel items cost efficiently, given
the intensely price-competitive nature of the apparel industry. A cell-phone maker cannot survive without the
capability to introduce next-generation cell phones with appealing new features and functions that attract
a profitable number of buyers. A provider of subscription-based streamed entertainment cannot prosper
without the capabilities to create appealing original content.
Astute Bundling of a Company’s Resources and

Capabilities Can Result in Added Competitive Power. CORE CONCEPT
In identifying company resources and capabilities with A resource/capability bundle is a group of
competitive value, it is important to understand that a resources and/or capabilities that, when linked and
particular resource or capability which may not seem integrated into a functioning whole, has greater
to have much competitive value by itself can be much competitive value than the summed value of the
more valuable when bundled with certain other company
individual components—in other words, combining
resources and/or capabilities (that also, taken singly,
individual resources and capabilities into an
appear to lack important competitive value). There are
numerous instances when resource/capability bundles integrated bundle produces a 1 + 1 = 3 gain in
have important competitive power even when individual competitive power versus just a 1 + 1 = 2 gain when
components of the bundle do not. For example, Nike’s the same resources and capabilities are unbundled.
resource bundle of styling expertise, professional
endorsements, well-regarded brand name and image,
marketing and brand-building skills, network of distributors/retailers, and managerial know-how has provided
sufficient competitive power for Nike to remain the dominant global leader in athletic footwear and sports
apparel for over 20 years.
It is equally important to understand that the value of a company resource/capability is often also a function
of the company’s proficiency in using the resource/capability to perform an activity.6 For instance, the
degree to which a company’s manufacturing plants are a competitively valuable resource hinges, in part,
upon whether the products being manufactured are of poor quality, lower-than-average quality, better-than-
average quality, or superior quality. A company’s manufacturing capabilities thus matter. Moreover, in most
cases, a company’s manufacturing capabilities are enhanced or weakened by its product R&D capabilities
and its product design capabilities.

Four Ways to Test the Competitive Power of a Resource

or Capability
What is most telling about the importance and value of a company’s resources and capabilities, individually
and collectively, is how powerful they are in the marketplace. The competitive power of a resource or
capability is measured by how many of the following four tests it can pass:7
1. Does the resource or capability have competitive value? The competitive value of a resource or
capability is determined by how much it helps a company improve its customer value proposition
(and thereby better attract and please customers), the degree to which it enables a company
to compete effectively against rivals, and its role in the company’s profit proposition. Unless
a resource or capability contributes to the power of a company’s strategy and helps maintain
or enhance the company’s competitiveness vis-à-vis rivals, it cannot pass the test of being
competitively valuable. Companies must guard against contending that most any kind of expertise
or know-how or well-performed activity qualifies as a core or a distinctive competence or gives
them substantial competitive clout. Apple’s iOS operating system for its PCs is by most accounts
a world beater (compared to Windows 10), but Apple has failed to convert its know-how and
capability in operating system design into competitive success in the global PC market—its global
market share in PCs has lagged well behind HP, Dell, and Lenovo for over two decades. Moreover,
it is important to recognize that a resource or capability can quickly lose its competitive value
because of rapid changes in technology or customer preferences or the importance of certain
distribution channels or other market-related factors. For example, a company’s ability to benefit
from strong capabilities in product innovation is governed by how quickly rivals can introduce their
own new products with many of the same features. The branch offices of commercial banks are
becoming a less valuable competitive asset because of growing use of direct deposits, automated
teller machines, debit cards, and telephone and online banking options that reduce the need to
“go to the bank.”
2. Do many or most rivals have much the same resource or capability? A resource or capability that
most of a company’s rivals also possess cannot be a basis for outcompeting rivals or achieving
competitive advantage. Indeed, when most companies in an industry can legitimately lay claim to
having a particular resource or capability, then that resource or capability is valuable only from the
standpoint of helping industry members maintain competitive parity in the marketplace and perhaps
indicating the resource or capability is an industry key success factor. A resource or capability
achieves its greatest competitive value only if (1) it is rare (in the sense of being possessed by one,
or at most two, companies competing in the same market arena) and (2) has sufficient competitive
power (like a distinctive competence) to enable a firm to outcompete rivals and gain a sustainable
competitive advantage.
3. Is the resource or capability hard to copy? The more difficult and more expensive it is for rivals
to imitate a competitively valuable resource or capability, the greater its potential for enabling a
company to outcompete rivals and win a competitive advantage. Resources tend to be difficult to
copy when they are unique (a fantastic real estate location, patent-protected technology or product
features, 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 production process, a
global network of dealers and distributors), and when they entail financial outlays or large-scale
operations that few industry members can undertake. Capabilities can be hard to copy and take
considerable time for rivals to develop when they have high skill or knowledge-based requirements,
involve complicated technology, and/or entail extensive cross-functional collaboration. Valuable
resources and capabilities that are also hard-to-copy can often significantly boost a company’s
competitive strength and sustain good-to-excellent profitability.
4. Can the value of a resource or capability be trumped by substitute resources and capabilities
of rivals? Resources that are valuable, not widely possessed by rivals, and hard to copy, lose
much of their competitive power if rivals have substitute resources or capabilities of equal or

greater competitive power.8 For instance, manufacturers relying on robotics and automated
production processes to gain a cost advantage in production activities may find their
technology-based cost advantage completely nullified by rivals who also can implement robot-
assisted production techniques but who also move their production operations to countries
having both low wages and an adequately skilled labor force, and thereby can achieve even
lower production costs.
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 and capabilities—one
or two quite valuable, some good, many satisfactory
(on a par with rivals), and others mediocre. Resources CORE CONCEPT
and capabilities that are competitively valuable pass the The degree of success a company enjoys in
first of the four tests, but not necessarily the other three.
the marketplace is governed by the combined
As contributors to the competitiveness of a company’s
competitive power of its resources and
strategy, competitively valuable resources/capabilities
are mainly important in gaining parity with many (maybe capabilities.
most) rivals; but such resources/capabilities may or may
not have the competitive power to produce significant competitive advantage without the presence of
important bundling effects or other qualities that greatly boost buyer appeal for a company’s product offering.
For a company to have resources/capabilities that can pass the first two tests entails a much higher hurdle—
having a resource or capability that is valuable, likely not possessed by rivals (rare), and potentially has
significant competitive power because it is competitively superior in some important respect. Companies
in the top tier of their industry may have as many as two or three core competencies but only a very few
companies, usually the strongest industry leaders or up-and-coming challengers, have a capability that truly
qualifies as a distinctive competence. A standout resource that delivers competitive superiority is as rare as
a distinctive competence. This is why, absent important resource/capability bundling effects, it is so hard for
a company to achieve a sustainable competitive advantage over rivals. Achieving sustainable competitive
advantage usually requires a company to have at least one resource/capability that can pass the first three
tests (except in those instances where important resource/capability bundling effects are present).
However, as discussed earlier, a company that lacks a standout resource or distinctive competence and
only has resources/capabilities that can pass the first test can still integrate a group of good-to-adequate
resources and capabilities into a competitively effective bundle that yields adequate to good profitability.
Fast-food chains like Wendy’s, Shake Shack, and Burger King, despite having only satisfactory resources and
capabilities, have nonetheless achieved respectable market positions and profitability competing against
McDonald’s. Discount retailers Target and Kohl’s have bundled good enough resources and capabilities to
profitably compete against Walmart and its richer, deeper resources/capabilities. Underdog Lululemon, a
performance sport apparel retailer whose chief competitors include Nike, Adidas, and Under Armour—all
of which have broader and deeper collections of competitively valuable resources and capabilities, has
nonetheless put together a sufficiently strong collection of resources and capabilities to grow its sales and
profitability competing head-to-head against these three better-known global rivals.
A Company’s Important Resources and Capabilities Must Be

Dynamic and Freshly-Honed to Sustain Its Competitiveness
For a company’s important resources and capabilities to
remain competitively valuable over time, they must be CORE CONCEPT
continually polished, updated, and sometimes augmented A company requires a dynamically evolving
with altogether new kinds of resources and expertise.9 It portfolio of competitively valuable resources and
takes freshly honed and sometimes totally refurbished
capabilities to sustain its competitiveness and help
or completely new resources/capabilities for a company
drive improvements in its performance. Otherwise,
to effectively respond to ongoing changes in customer
needs and expectations. Diligent managerial attention the power of its competitive assets grow stale.
to sharpening and recalibrating company competencies

and capabilities protects a company’s long-term competitiveness against the improving capabilities of rivals
and their strategic maneuvering to win bigger sales and market shares. Absent such attention, a company’s
competencies and capabilities risk becoming stale over time and eroding company performance.10
The Role of Dynamic Capabilities. Management’s challenge in creating and maintaining a dynamic
and competitively effective portfolio of resources and
capabilities has two elements: (1) attending to ongoing Executive attention to making sure a company
recalibration and refurbishment of the company’s always has competitively valuable resources
competitive assets and (2) casting a watchful eye for and capabilities that dynamically evolve and
opportunities to develop totally new resources and help sustain the company’s competitiveness is a
capabilities for delivering better customer value and/or strategically important top management task.
outcompeting rivals. Companies that succeed in meeting
both challenges are likely to be in the enviable position of having an ever stronger and competitively potent
arsenal of resources and capabilities.
Company executives that grasp the strategic importance of incrementally improving the company’s existing
competitive assets and from time-to-time adding new resources/capabilities make a point of ensuring that
these actions are an ongoing, high-priority activity. By making proactive oversight of these activities a routine
managerial function, they gain the experience and know-how to do a consistently good job of dynamically
managing the company’s important competitive assets. At that point, their ability to freshen and augment
the company’s resource/capability portfolio becomes what is known as a dynamic capability.11 This dynamic
capability also includes an ongoing top management search for opportunities to create new resources and
capabilities to increase the company’s competitiveness. When a company’s executive management team
achieves proficient dynamic capability to modify, deepen, and augment the company’s competitively important
resources and capabilities, the company is better able to maintain, if not enhance, its competitiveness in the
marketplace and significantly improve its chances for long-term competitive success.
QUESTION 3: WHAT ARE THE COMPANY’S

COMPETITIVELY IMPORTANT STRENGTHS AND
WEAKNESSES AND ARE THEY WELL-SUITED TO
CAPTURING ITS BEST MARKET OPPORTUNITIES AND
DEFENDING AGAINST EXTERNAL THREATS?
One of the simplest and most powerful tools for assessing a company’s overall situation is widely known
as SWOT analysis, so named because it zeros in on a company’s competitively important Strengths and
Weaknesses, its market Opportunities, and those external
Threats that can adversely impact the company’s well- SWOT analysis is a simple but powerful tool
being. Doing a first-rate SWOT analysis has considerable for sizing up a company’s competitively
managerial value because it helps company managers relevant strengths and weaknesses, its market
single out and focus on all the factors needed to craft a opportunities, and the external threats to its
winning strategy that fits the company’s overall internal and future well-being.
external situation. To achieve good fit with the company’s
situation, managers must devise a strategy that capitalizes on the company’s most potent competitive
strengths, corrects important competitive weaknesses, aims squarely at capturing the company’s best
market opportunities, and helps defend against the external threats to its future well-being and business
prospects.

Identifying a Company’s Competitively Important Strengths

A strength can relate to something a company is good
at doing (a competitively important capability or a core CORE CONCEPT
competence), a competitively valuable resource (like a A company’s competitively important strengths
well-known brand name or a reputation for award-winning are competitive assets that positively impact its
customer service or large numbers of high-traffic store
competitiveness and ability to succeed in the
locations), and certain kinds of competitively relevant
marketplace.
achievements or attributes that contribute to a company’s
competitiveness in the marketplace (like having low
overall costs relative to competitors, being a market share leader, having a wider product line than rivals, and
having wider geographic market coverage than rivals).
Most usually, a company’s strengths stem from the caliber and competitive power of its resources and
capabilities; managers can draw on resource and capability analysis to make objective assessments of the
potency of the company’s resources and capabilities. While individual resources and capabilities that can
pass one or more of the four tests of competitive power typically represent the company’s greatest strengths,
managers should be careful not to overlook the competitive strength that results from bundling less potent
resources and capabilities. Further, a resource or capability that lacks much competitive power may still be
useful for successfully gaining entry into a new market or market segment. A resource bundle that fails to
match those of top-tier companies may, nonetheless, allow a company to compete quite successfully against
second-tier rivals.
Identifying a Company’s Competitively Important Weaknesses

A 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 marketplace. A company’s weaknesses can relate
to (1) inferior or unproven skills, expertise, capabilities,
or intellectual capital in competitively important areas of CORE CONCEPT
the business; (2) deficiencies in competitively important A company’s weaknesses are internal short-
physical, organizational, or intangible resources; or (3)
comings that constitute competitive liabilities.
weak or missing capabilities in key areas. Company
weaknesses are thus internal shortcomings or
deficiencies that constitute competitive liabilities. Nearly all companies have competitive liabilities of one
kind or another. Whether a company’s weaknesses make it competitively vulnerable depends on how much
they matter in the marketplace and whether they are mostly offset or minimized by the company’s strengths.
Table 4.2 contains a representative sample of things to consider in identifying a company’s competitively
relevant strengths and weaknesses. Sizing up a company’s complement of strengths and weaknesses is akin
to constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses
represent competitive liabilities. Obviously, the ideal outcome is for a company’s competitive assets to
outweigh its competitive liabilities by a healthy margin—a 50-50 balance (or worse) is ominous.

TABLE 4.2 What to Look for in Identifying a Company’s Strengths,

Weaknesses, Opportunities, and Threats
Potential Strengths and Competitive Assets Potential Weaknesses and Competitive Deficiencies
• Core competencies in _______ • No well-developed or proven core competencies
• A distinctive competence in _______ • Resources and capabilities that are not well matched to
• A product strongly differentiated from those of rivals an industry’s key success factors
• Resources and capabilities well matched to industry • Too much debt; a weak credit rating
key success factors • Short on financial resources to grow the business and
• A strong financial condition; ample financial resources pursue promising initiatives
to grow the business • Higher overall unit costs relative to key rivals
• Strong brand name/company reputation • Weaker product innovation capabilities than key rivals
• Strong customer loyalty • A product/service with attributes or features inferior to
• Proven technological capabilities, proprietary those of rivals
technology/important patents • Too narrow a product line relative to rivals
• Strong bargaining power over suppliers or buyers • Weaker brand name/reputation than rivals
• Cost advantages over rivals • Weaker dealer network than key rivals
• Proven skills in advertising and promotion • Weak global distribution capability
• Proven product innovation capabilities • Weaker product quality, R&D, and/or technological
• Proven capabilities in improving production processes know-how than key rivals
• Good supply chain management capabilities • In an overcrowded strategic group
• Strong customer service capabilities • Losing market share because _________
• Better product quality relative to rivals • Competitive disadvantages in ________
• Wide geographic coverage and/or strong global • Inferior intellectual capital relative to rivals
distribution capability • Subpar profitability because _________
• Alliances/joint ventures with firms that provide access • Plagued with internal operating problems or obsolete
to valuable technology, expertise and/or attractive facilities
geographic markets • Too much underutilized plant capacity
Potential Market Opportunities Potential External Threats to a Company’s

• Openings to win market share from rivals Future Profitability
• Sharply rising buyer demand for the industry’s product • More intense competitive pressures from industry rivals
• Serving additional customer groups or market and/or sellers of substitute products—may squeeze
segments profit margins
• Expanding into new geographic markets • The entry (or likely entry) of new competitors into the
company’s market stronghold (especially lower-cost
• Expanding the company’s product line to meet a
foreign competitors)
broader range of customer needs
• Utilizing existing company skills or technological
• Growing bargaining power of buyers and/or suppliers
know-how to enter new product lines or new • Slowing or declining market demand for the industry’s
businesses product
• Online sales via the Internet • A shift in buyer needs and tastes away from the
industry’s product
• Integrating forward or backward
• Falling trade barriers in attractive foreign markets
• Adverse demographic changes that threaten to curtail
demand for the industry’s product
• Acquiring rival firms or companies with attractive
• Vulnerability to unfavorable industry driving forces
capabilities
• Entering into alliances or joint ventures to expand the
• Unfavorable trade policies and tariffs; disruptive trade
wars
firm’s market coverage or boost its competitiveness
• Openings to exploit emerging new technologies
• Costly new regulatory requirements
• Tighter credit conditions
• Rising prices for energy or other key inputs

Identifying a Company’s Best Market Opportunities

Market opportunity is a big factor in shaping a company’s strategy. Indeed, managers can’t properly tailor
strategy to the company’s external situation without first identifying 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 (an absolute
“must” to pursue) to marginally interesting (because of the high risks, large capital requirements, or
unappealing revenue growth and profit potentials) to unsuitable (because the company’s resource strengths
and capabilities are ill-suited to successfully capitalize on some opportunities). Typical market opportunities
are shown in Table 4.2.
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
much ahead of managers at other companies.12 But as the fog begins to clear, golden opportunities are
nearly always pursued 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 capitalize on shifting
market conditions by patiently assembling an arsenal of competitively valuable resources and a war chest
of cash to finance aggressive action when the time comes.13 In mature markets, unusually attractive market
opportunities emerge sporadically, often after long periods of relative calm—but future market conditions
may be less foggy, thus facilitating good market reconnaissance and making emerging opportunities 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 sufficient
resources and capabilities to pursue all available market
opportunities simultaneously without spreading itself too CORE CONCEPT
thin. More importantly, a company’s resource strengths The most appealing market opportunities for a
and competitively valuable capabilities are almost always company to pursue are those where its resource
better-suited for pursuing and capturing some opportunities
strengths and valuable capabilities will be
than others; indeed, few companies have the resources
competitively powerful in the marketplace and
and capabilities needed to be competitively successful
in pursuing every one of an industry’s opportunities. A generate the greatest competitive success. The
company is always well advised to pass on a particular pursuit of opportunities with good resource/
market opportunity unless it has or can readily acquire capability fit offer a company its best prospects for
potent enough resources and capabilities to compete both attractive profitability and the achievement of
successfully and profitably in pursuing the opportunity. a sustainable competitive advantage over rivals.
Competitive weak companies—because they lack the
requisite resource strengths and capabilities—can find themselves hopelessly outclassed if they unwisely try
to pursue an industry’s biggest and best market opportunities in head-to-head competition with rivals having
much stronger resources and competitive capabilities. Consequently, in choosing which market opportunities to
pursue, company strategists should concentrate their attention on those opportunities where the requirements
for competitive success match up well with the company’s resource strengths and most potent capabilities—it
is precisely these opportunities where the company is most likely to enjoy competitive success, attractive
profitability, and good potential for achieving a sustainable competitive advantage over rivals.
Identifying the External Threats to a Company’s Future

Profitability
Often, certain factors in a company’s external environment pose threats to its competitive well-being
and future profitability. External threats can stem from such factors as the growing intensity of one more
competitive pressure, the emergence 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 4.2 lists representative 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 so ominous they put a company’s future
survival at risk. On rare occasions, market shocks can give birth to a sudden-death threat that throws a company
into an immediate crisis and battle to survive. In 2017–2019, many companies engaged in international trade
faced threats stemming from trade disputes between the United States and numerous other countries and
the imposition of higher tariffs on the goods the companies were exporting or importing. In 2020, the sudden
emergence of the Covid-19 pandemic posed a significant threat to the worldwide airline industry, cruise lines,
the tourist industry, restaurants (due to restrictions on indoor dining), many retailers (due to stay-at-home orders
and the reluctance of people to go shopping), and the owners of metropolitan downtown commercial office
buildings (due to tenants either allowing or mandating that their employees work from home.) The pandemic-
related threat to many of these businesses extended into 2021. Going forward, it was unclear how long the
many different pandemic-related downturns would last, creating much uncertainty and speculation among
the adversely affected businesses and industries about if and when buyer demand and sales revenues would
revert to “normal.” In 2021, motor vehicle manufacturers were experiencing weak sales of gasoline-powered
vehicles partly because of rising sales of electric vehicles and greater willingness of consumer to seriously
consider the purchase of electric vehicles due to the introduction of new models of electric vehicles with
longer driving ranges on a single battery charge and enhanced self-driving capabilities. Increasing demand for
electric vehicles over the long-term also threatened the businesses of oil producers across the world due to
the resulting weaker demand for gasoline. Concerns about climate change were prompting governments in
many countries to impose new rules and regulation restricting oil and natural gas drilling and production and
greater subsidies for the installation of solar roofs and the construction of solar farms and wind turbines. Plainly,
it is management’s job to identify the threats to the company’s future prospects and to evaluate what strategic
actions can be taken to neutralize 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 Simply making lists of a company’s strengths,
conclusions from the SWOT listings about the company’s weaknesses, opportunities, and threats is not
overall situation, and translating these conclusions enough. The payoff from SWOT analysis comes
into strategic actions to create an overall strategy well- from the conclusions that can be drawn about the
matched to the company’s overall situation—as indicated company’s overall situation and the implications for
by its strengths and weaknesses, its market opportunities, strategy improvement that flow from the four lists.
and its external threats. Figure 4.2 shows the steps
involved in gleaning insights from SWOT analysis.
The answers to the following questions often reveal just what story the SWOT listings tell about the company’s
overall situation:
• What are the attractive aspects of the company’s situation?

• What aspects are of the most concern?
• Do the company’s strengths give it sufficient competitive power to compete successfully?
• Are the company’s weaknesses/deficiencies of major or minor consequence? Must remedial action
be taken immediately? Or, are the weaknesses/deficiencies sufficiently negated by the company’s
strengths that corrective action is probably not the best use of company resources?
• Does the company have resources and capabilities that are especially well-suited to successfully
pursuing and capturing its most attractive market opportunities? Is the company lacking certain
resources or capabilities that make it inadvisable to pursue any particular market opportunities?
• Are the external threats alarming, or are they something the company appears able to deal with and
defend against?
• All things considered, where on a scale of 1 to 10 (where 1 is alarmingly weak and 10 is exceptionally
strong), does the company’s overall situation and future prospects rank?

FIGURE 4.2 The Three Steps of SWOT Analysis: Identify, Draw Conclusions,
Translate into Strategic Action
Identify the company’s What Can Be Gleaned from the

competitively important SWOT Listings?
strengths and competitive
assets
Conclusions concerning the company’s overall business

situation:
Identify the company’s • Where on the scale from “alarmingly weak” to
competitively important “exceptionally strong” does the attractiveness of the
weaknesses and company’s situation rank?
deficiencies • What are the attractive and unattractive aspects of the
company’s situation?
Identify the Implications for improving company strategy:

company’s market • Use company strengths and capabilities as
opportunities cornerstones for strategy.
• Pursue those market opportunities best suited to
company strengths and capabilities.
• Correct weaknesses and deficiencies that impair
pursuit of important market opportunities or heighten
Identify external threats
vulnerability to external threats.
to the company’s
• Use company strengths to lessen the impact of
future well-being important external threats.
The final piece of SWOT analysis is to translate the diagnosis of the company’s internal and external
circumstances into actions for improving the company’s strategy and business prospects.
Translating the SWOT Analysis Results into Effective Strategic Action. The SWOT analysis results
provide excellent guidance to managers in crafting a strategy (or improving an existing strategy) in ways
that may enable the strategy to pass the three tests of a winning strategy. As you should recall, a winning
strategy must fit the company’s internal and external situation, help build competitive advantage, and boost
company performance. Four conditions are necessary for a company’s strategy to be a good to excellent fit
with its overall situation:
1. The foundation and centerpiece of a company’s strategy to profitably compete against rivals must
be its most competitively powerful resources
and capabilities. Using a company’s most potent CORE CONCEPT
resources and capabilities to power its strategy gives Relying on a company’s strongest resources and
the company its best chance for market success,
capabilities to power its strategy produces the
competitive advantage, and better performance.14
best fit with the company’s internal and external
Should the power of the company’s resources
and capabilities prove competitively stronger than situation, thereby making such an approach to
those of some or many rivals, its future business crafting strategy the surest route to market success
performance should be good. And, in the best-case and good business results.
outcome, if certain of the company’s most potent
resources and capabilities are hard for rivals to copy or trump, then achieving a sustainable competitive
advantage can be within reach. Strategies that place heavy demands on areas and activities where the
company is comparatively weak or has unproven competitive capability should be avoided.

2. The strategy must include actions to correct those competitive weaknesses that make the company
vulnerable to attack from rivals, depress profitability, or disqualify it from pursuing a particularly attractive
opportunity. However, there is scant reason to devote much attention to correcting those weaknesses or
deficiencies that are well defended by other company resources and capabilities.
3. The company’s strategy must include strategic initiatives aimed squarely at capturing those market
opportunities best suited to the company’s strengths and competitive assets. Management should
almost always deploy some of the company’s most potent resources and capabilities to spearhead
such initiatives. Indeed, what makes a market opportunity attractive to pursue is that the company
has competitively powerful resources and capabilities that can be used to seize opportunities to grow
the business, boost performance, and potentially achieve competitive advantage. However, there are
instances where some market opportunities can be pursued with resource/capability bundles having
sufficient competitive power to get the job done.
4. The strategy should include efforts to defend against those external threats that can adversely impact
the company’s long-term business prospects or put its survival at risk. How much attention to devote
to defending against external threats hinges on how vulnerable the company is, whether attractive
defensive moves can be taken to lessen their impact, and whether the costs of undertaking such moves
represent the best use of company resources. Some external threats are often beyond a firm’s ability
to influence or defend against; in such cases, the best course of action can be to wait until the threat
materializes and try to offset its impact with actions in other parts of the business.
QUESTION 4: ARE THE COMPANY’S PRICES AND

COSTS COMPETITIVE WITH THOSE OF KEY RIVALS,
AND DOES IT HAVE AN APPEALING CUSTOMER
VALUE PROPOSITION?
Company managers are often stunned when a competitor cuts its price to “unbelievably low” levels or when
a new market entrant comes on strong with a very low price. Such rivals may not, however, be “dumping”
(an economic term for selling at prices below cost) or buying market share with a super-low price or waging
a desperate move to gain sales—they may simply have substantially lower costs. Then there are occasions
when a competitor storms the market with a new product that ratchets the quality level up so high some
customers will abandon competing sellers even if they have to pay more for the new product—this is what
has happened with some of Apple’s new iPhone models.
Regardless of where on the price-quality-performance spectrum a company competes, it must remain

competitive in terms of its customer value proposition to stay in the game. Two telling signs of whether a
company’s business position is strong or precarious are (1) whether its prices are justified by the value it
delivers to customers and (2) whether its costs are competitive with industry rivals delivering similar customer
value at a similar price. The greater the amount of customer value a company can offer profitably compared
to its rivals, the less vulnerable it is to competitive attack. And if it can deliver the same amount of value at
lower costs (or more value at the same cost), it will enjoy a competitive edge.
Two analytical tools are particularly useful in determining whether a company’s customer value proposition,
prices, and costs are competitive: value chain analysis and benchmarking.

The Concept of a Company Value Chain

Every company’s business consists of a collection of activities undertaken in the course of designing,
producing, marketing, delivering, and supporting its
product or service. All of the various activities a company CORE CONCEPT
performs internally combine to form a value chain—so- A company’s value chain identifies the primary
called because creating value for customers is what chains activities it performs that create customer value and
a company’s various activities into a purposeful group of
the related support activities. The “outputs” of an
functions and tasks. A company’s value chain consists of
organization’s value chain activities are the value
two broad categories of activities: the primary activities
foremost in the company’s scheme for creating and delivered to customers and the resulting revenues
delivering value to customers and the requisite support it collects. The “inputs” are all of the resources
activities that facilitate and enhance the performance required to conduct the various value chain
of the primary activities.15 The kinds of primary and activities; use of these resources creates costs.
secondary activities that comprise a company’s value
chain vary according to the specifics of its business—hence, the primary and secondary activities shown in
Figure 4.3 are illustrative rather than definitive.
For example, the primary activities at hotel operators like Marriott include site selection and construction,
reservations, the operation of hotel properties (check-in and check-out, maintenance and housekeeping,
dining and room service, and conventions and meetings), and management of its portfolio of hotel property
locations. Its principal support activities include accounting, hiring and training, advertising, building a
recognized and reputable brand name, and general administration. The primary activities for retailers like
Best Buy or Home Depot involve merchandise selection and buying, supply chain management, store layout
and product display, sales floor operations, website operations for online sales, and customer service,
whereas its support activities include site selection, hiring and training, store maintenance, advertising, and
general administration. Supply chain management is a crucial activity for Toyota, Costco, and Apple but is
not a value chain component at Facebook or PayPal or Visa. Sales and marketing are dominant activities
at Procter & Gamble and Nike but have far lesser roles at oil drilling companies and natural gas pipeline
companies. Order delivery is a crucial activity at Domino’s Pizza but is currently not an internal value chain
activity at McDonald’s, Walgreens, and TJMaxx.
With its focus on value-creating activities, the value chain is an ideal tool for examining the workings of a
company’s business model—its customer value proposition and profit proposition. It permits a deep look at
the company’s cost structure and ability to charge low or at least competitive prices. It can reveal the costs a
company is spending on product differentiation efforts to deliver greater customer value and support higher
prices, such as product quality and customer service. Company value chains necessarily include a profit
margin component, since profits are necessary to compensate owners/shareholders who bear risks and
provide capital. When the revenues generated from a company’s value-creating activities are sufficient to
cover operating costs and yield an attractive profit, then the organization has an appealing value chain—its
customer value proposition and its profit proposition are well aligned and signal a successful business model.
Absent the ability to create a value chain capable of delivering sufficient customer value and producing
adequate profitability, a company is competitively vulnerable and its survival open to question.
Comparing the Value Chains of Rival Companies

Value chain analysis facilitates a comparison of how CORE CONCEPT
rivals, activity-by-activity, deliver value to customers. The greater the value a company can profitably
Typically, there are important differences in the value deliver to its customers relative to the value close
chains of rival companies. A company that makes a no- rivals deliver, the less competitively vulnerable it
frills product and provides minimal customer services has becomes. The higher a company’s costs relative
a value chain with activities and costs that are different
to those of rivals delivering comparable customer
from a competitor that produces a full-featured, high-
value at a comparable price, the more competitively
performance product and has a full range of customer
service offerings. The “operations” component of the vulnerable it becomes.
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 only performs assembly
operations. Movie theaters that show the new releases of movie studios and derive a big portion of their
revenues from concession sales employ different value-creating activities and have different costs from
Netflix and other providers of movies streamed over the Internet directly to viewers’ TVs and mobile devices.
Differences in the value chains of close competitors raise two very important questions. One, whose value
chain delivers the best customer value relative to the prices being charged? Two, which company has the
lowest cost value chain? When one competitor employs a value chain approach that delivers greater value
to customers relative to the price it charges, it gains competitive advantage even if its costs are equivalent
to (or maybe slightly higher than) those of its close rivals. When close competitors deliver much the same
value to customers, charge comparable prices, and employ similar value chains, then competitive advantage
accrues to the company that operates its value chain most cost efficiently. Consequently, it is incumbent
on company managers to vigilantly monitor how effectively and efficiently the company delivers value to
customers relative to rival companies—gaining a competitive edge over rivals hinges on being able to
deliver equivalent customer value at lower cost or greater customer value at the same cost.
FIGURE 4.3 A Representative Company Value Chain
Primary Supply
Activities Chain Sales and Service Profit
Operations Distribution
and Manage- Marketing Margin
Costs ment
Support Product R&D, Technology, and Systems Development

Activities
and Human Resources Management
Costs
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 (producing,
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 efforts, advertising and promotion,
market research and planning, and dealer/distributor support.
• Service—Activities, costs, and assets associated with providing assistance to buyers, such as installations,
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, telecommunications
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
regulatory affairs, 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.

A Company’s Primary and Support Activities Identify the Major Components of Its Internal Cost
Structure The combined costs of all the various primary and support activities comprising a company’s value
chain define its internal cost structure. Further, the cost of
each activity contributes to whether the company’s overall Each activity in a company’s value chain gives rise
cost position relative to rivals is favorable or unfavorable. to costs and ties up assets.
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.16 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 estimates are needed for each broad
category of primary and support activities, but cost estimates for more specific activities within each broad
category may be needed if a company discovers 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
are insufficient to assess whether its product offering and customer value proposition are competitive with
those of rivals. Cost and price differences 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 System for an Entire Industry

A 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 distributors and retailers it utilizes in getting its product
or service to end users.17 Suppliers’ value chains are relevant because suppliers perform activities and incur
costs in creating and delivering the purchased inputs used in a company’s own value-creating activities.
The costs, performance features, and quality of these inputs influence a company’s own costs and product
differentiation 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.18 Automakers, for example, have encouraged their automotive parts suppliers to build plants
near the auto assembly plants to facilitate just-in-time deliveries, reduce warehousing and shipping costs,
and better enable close collaboration on parts design and production scheduling.
Similarly, the value chains of a company’s distribution channel partners are relevant 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 distribution 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 A company’s cost-competitiveness depends
chain activities in mutually beneficial ways. For instance, not only on the costs of internally performed
motor vehicle manufacturers have a competitive interest activities (its own value chain) but also on
in working closely with their automobile dealers to (1) costs in the value chains of its suppliers and
promote better customer satisfaction with dealers’ repair distribution channel allies.
and maintenance services and (2) develop sales and
marketing programs to achieve higher sales volumes. Producers of bathroom and kitchen faucets are heavily
dependent on whether the sales and promotional activities of their distributors and building supply retailers
are effective in attracting the interest of homebuilders and do-it-yourselfers, and whether distributors/
retailers operate their value chains 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 scrutinizing the nature and
costs of value chain activities across an industry’s entire value chain system for delivering a product or
service to end-use customers. A typical industry value chain 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 comprising industry value chains vary significantly from industry to industry. The primary
value chain activities in the pulp and paper industry (timber farming, logging, pulp mills, paper making, and
distribution) differ from the primary value chain activities in the home appliance industry (product design,
parts and components manufacture, assembly, wholesale distribution, retail sales) and differ yet again for the
soft drink industry (processing of basic ingredients and syrup manufacture, bottling and can filling, wholesale
distribution, advertising, and retail merchandising).
FIGURE 4.4 A Representative Value Chain System for an Entire Industry

Supplier-Related A Company’s Forward Channel
Value Chains Own Value Chain Value Chains
Activities,
Internally costs, and
Activities, performed margins Buyer or
costs, and activities, of forward end-user
margins of costs, channel value
suppliers and allies and chains
margins strategic
partners
Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York:
Free Press, 1985), p. 35.
Once a company has developed good cost estimates for each major activity in its own value chain, has a
good grasp of the value chains its close rivals employ, and has sufficient cost data relating to the value chain
activities of suppliers and distribution allies, it is ready to explore whether its costs compare favorably or
unfavorably with those of key rivals. This is where benchmarking comes in.
Benchmarking: A Tool for Assessing Whether the Costs

and Effectiveness of a Company’s Value Chain Activities
Are in Line
Benchmarking entails comparing how different companies (both inside and outside the industry) perform
various value chain activities—how inventories are
managed, how products are assembled, how fast the CORE CONCEPT
company can get new products to market, how customer
orders are filled and shipped—and then making cross- Benchmarking is a potent tool for learning which
company comparisons of the costs of these activities.19 companies are best at performing particular
The objectives of benchmarking are to identify the best activities and emulating their techniques (or “best
means of performing an activity, to learn how other practices”) to improve the cost and effectiveness
companies have actually achieved lower costs or better of a company’s own internal activities.
results in performing benchmarked activities, and to
take action to emulate those best practices whenever
benchmarking reveals that its costs and results of performing an activity are not on a par with what other
companies have achieved. A best practice is a method or technique of performing an activity or business

process that produces results superior to those achieved with other methods/techniques. To qualify as a
legitimate best practice, the method must have been employed by at least one enterprise and shown to be
consistently effective in lowering costs, improving quality or performance, shortening time requirements,
enhancing safety, or achieving some other highly positive operating outcome(s).
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 performing any activity relevant to Xerox’s business.20 Other companies quickly picked up
on Xerox’s approach. Toyota managers got their idea for just-in-time inventory deliveries 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 use benchmarking for comparing themselves against rivals in performing activities in
ways that produce superior outcomes.
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 benchmarking can be accomplished by collecting information
from published reports, trade groups, and industry research firms and by talking to knowledgeable industry
analysts, customers, and suppliers. Sometimes field trips to the facilities of competing or noncompeting
companies can be arranged to observe how things are done, ask questions, compare practices and
processes, and perhaps exchange data on various cost components—but the problem here is that most
companies, even if they agree to host facilities tours and answer questions, are unlikely to share competitively
sensitive cost information. Furthermore, comparing one company’s costs to another’s 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 identifying best practices has prompted consulting organizations
(Accenture, A.T. Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC) and several
trade associations (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 by company personnel in
gathering their own data about competitors.
Strategic Options for Creating an Advantage or Remedying

a Disadvantage as Concerns Cost or the Value Delivered
to Customers
Examining the costs of a company’s own value chain activities and comparing them to rivals indicates who
has how much of a cost advantage or disadvantage and which cost components are responsible. Value
chain analysis and benchmarking can also disclose whether a company has an advantage or disadvantage
vis-à-vis rivals in delivering value to customers. Such information is vital in strategic actions to create a cost
or value advantage or eliminate a cost/value disadvantage. The three main areas in a company’s total value
chain system where company managers can try to create a cost/value advantage or remedy a cost/value
disadvantage are (1) a company’s own activity segments, (2) suppliers’ part of the overall value chain, and (3)
the distribution channel portion of the chain.

Improving the Performance of Internally Performed Activities Managers can pursue any of several
strategic approaches to reduce the costs of internally performed value chain activities and improve a
company’s cost competitiveness:21
• Implement best practices throughout the company, particularly for high-cost activities.
• Redesign the product and/or some of its components to eliminate high-cost components or facilitate
speedier and more economical manufacture or assembly.
• Relocate high-cost activities to geographic areas where they can be performed more cheaply.
• Outsource certain internally performed activities to vendors or contractors that can perform them
more cheaply than they can be performed in-house.
• Shift to lower-cost production technologies and/or invest in productivity-enhancing equipment

(robotics, flexible manufacturing techniques, real-time process monitoring).
• Stop performing activities of minimal value to customers (like seldom-used customer services).
A second approach to eliminating a competitive disadvantage or creating a competitive advantage in how

internal activities are performed is by improving the performance of those activities capable of delivering
added value to customers. Efforts to deliver higher customer value at the same or lower cost can include:
• Adopting best practice approaches for activities affecting quality and customer service and activities
known to affect buyer brand preferences.
• Implementing new design innovations and/or investing in production methods that improve quality,
curtail maintenance requirements, extend product life, or reduce after-the-sale repair costs incurred
by customers.
• Emphasizing better performance of activities most responsible for creating those product/service
attributes known to impact buyer preferences for one brand versus another brand—the goal
here should be to revamp those activities that result in attributes that cause buyers to dislike the
company’s brand and to do an even better job of performing activities that can further enhance the
attributes that buyers like about the company’s brand).
• Outsourcing activities to vendors/contractors with the resources/capabilities to help deliver higher

customer value at the same or lower cost.
In searching for cost-reducing opportunities or value-enhancing opportunities, it is important to recognize

that the manner in which one activity is done spills over to impact the costs/value of how other activities are
performed. For instance, how a television or washing machine is designed impacts the number of parts and
components, their respective manufacturing costs, the time and expense of assembling the various parts
and components into a finished product, and, from a customer value perspective, how well the product
performs, repair frequencies, maintenance costs, and product life.
Improving the Performance of Supplier-Related Value Chain Activities A company can gain
cost savings in supplier-related value chain activities by pressuring suppliers for lower prices, switching
to lower-priced substitute inputs, and collaborating closely with suppliers to identify mutual cost-saving
opportunities.22 For example, collaborating with suppliers to achieve 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 scheduling costs—a win–win outcome for both. In a few
instances, companies may find 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.

A company can enhance the value it delivers to customers through its supplier relationships by selecting/
retaining only those suppliers that meet higher-quality standards, bringing in suppliers to partner in the
design process, and providing quality-based incentives to suppliers, particularly as concerns reducing parts
defects. Fewer defects not only improve quality throughout the value chain system but also can curtail the
annoyance customers have when a recently purchased product fails shortly after purchase (due to parts
failures) and has to be repaired or replaced under warranty. In addition, fewer defects lower warranty costs
and lower the costs of product testing and replacement of defective parts/components prior to shipment.
Improving the Performance of Distribution-Related Value Chain Activities Any of three means
can be used to achieve better cost-competitiveness in the distribution portion of an industry value chain:23
1. Pressure distributors, dealers, and other forward channel allies to reduce their costs and markups to
make the final price to buyers more competitive with the prices of rival brands.
2. Collaborate with forward channel allies 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 in 10-pound molded bars, it could save its candy bar manufacturing customers the costs associated
with unpacking and melting and also eliminate its own costs of molding and packing bars.
3. Change to a more economical distribution strategy, including switching to cheaper distribution channels
(selling direct to consumers via the online sales at the company’s website) or possibly integrating
forward into company-owned retail outlets.
The means of enhancing differentiation through the activities of distribution-related allies include (1) engaging
in cooperative advertising and promotion campaigns, (2) creating exclusive distribution arrangements or using
other incentives to boost the efforts of distribution allies to deliver enhanced value to end-use customers, (3)
creating and enforcing higher standards for distribution allies to observe in performing their activities, and (4)
providing training to forward channel partners in using best practices to perform their activities.
Translating Proficient Performance of Value Chain Activities

into Competitive Advantage
A company that does a first-rate job of managing its value chain activities relative to competitors stands a
good chance of achieving sustainable competitive advantage. As shown in Figure 4.5, competitive advantage
can be achieved by out-managing rivals in either of
two ways: (1) by performing value chain activities more Performing value chain activities in ways that
efficiently and cost effectively, thereby gaining a low- give a company either a lower-cost advantage
cost advantage over rivals or (2) by performing certain or a value-creating differentiation advantage
value chain activities in ways that drive value-creating over rivals are two surefire ways to secure
improvements in quality, features, performance, and competitive advantage.
other attributes, thereby gaining a differentiation-based
competitive advantage keyed to what customers perceive as a superior product offering.
Achieving Proficient Performance of Value Chain Activities Depends on Having the Right
Resources and Capabilities As laid out in Figure 4.5, either approach requires focused management
attention on building and nurturing resources and capabilities that enable the value chain activities to be
performed proficiently enough to produce the desired outcome—lower costs or greater value-creating
differentiation. A company’s value chain is all about performing activities, and proficient performance of
key activities requires having not just the right resources and capabilities but developing and constantly
improving them so they become ever more competitively valuable.

Achieving a cost-based competitive advantage requires determined efforts to be cost-efficient in performing

value chain activities. Such efforts must be ongoing and persistent, and they have to involve each and every
value chain activity. The goal must be continuous cost reduction, not on-again/off-again efforts. This requires
a frugal culture where all company personnel not only exhibit cost-conscious behavior but also where they
are diligent in discovering and implementing operating practices that lower costs. Cost-benchmarking and
aggressive implementation of cost-lowering best practices must be the norm. Companies whose managers
are truly committed to low-cost performance of value chain activities and succeed in engaging company
personnel to discover innovative ways to drive costs out of the business have a real chance of gaining a
durable low-cost edge over rivals. It is not as easy as it seems to imitate a company’s low-cost practices.
Walmart, Nucor Steel, Dollar General, Irish airline Ryanair, Toyota, and French discount retailer Carrefour
have been highly successful in preserving a low-cost advantage by out-managing their rivals in how cost
efficiently company value chain activities are performed.
On the other hand, companies that succeed in achieving a differentiation-based competitive advantage do
so because of a strong commitment to proficiently performing those value chain activities that add value
for customers and more strongly differentiate their product offering from rivals. For example, uniquely good
customer service capabilities are crucial at such high-
end hotel properties as Ritz-Carlton, Four Seasons, and Becoming more cost efficient than rivals in
St. Regis. First-rate product innovation capabilities are performing value chain activities entails building
paramount at Google, Microsoft, Johnson & Johnson, and and nurturing resources and capabilities that
Walt Disney. Product design capabilities underlie IKEA’s differ substantially from those needed to
success in the furniture business. Standout engineering
achieve a value-enhancing, differentiation-
design and manufacturing/assembly capabilities are
based competitive advantage.
essential at Mercedes and BMW. To the extent that
a company continues to invest resources in building
greater and greater proficiency in performing the targeted value chain activities, and top management
makes the associated resources and capabilities cornerstones of the company’s strategy to attract and
please customers, then, over time, its proficiencies rise to the level of a core competence. Later, with further
organizational learning and gains in proficiency, a core competence may evolve into a distinctive competence.
Such superiority over rivals in performing one (or possibly several) differentiation-enhancing value chain
activities can prove unusually difficult for rivals to match or offset. As a general rule, it is substantially harder
for rivals to achieve “best in industry” proficiency in performing a key value chain activity than it is for them to
clone the features and attributes of a hot-selling product or service.24 This is especially true when a company
with a distinctive competence avoids becoming complacent and works diligently to maintain its industry-
leading expertise and capability.

FIGURE 4.5 Translating Company Performance of Value Chain Activities into

Competitive Advantage
Option 1: Beat rivals by performing value chain activities more cheaply, thus achieving a cost-based
competitive advantage
Company Competencies Company

managers decide Company
and proficiency in Company
to perform value proficiency in
capabilities cost-efficient gains a
chain activities cost-efficient
gradually performance competitive
in the most performance
emerge in of value chain advantage
cost-efficient of value chain
performing activities based on
manner—every activities
value chain many continues to superior
rises to the
activity is value chain build and cost-lowering
level of
examined for activities evolves into capabilities
a core
possible cost very cost a distinctive
competence
savings efficiently competence
Option 2: Beat rivals by performing certain differentiation-enhancing value chain activities more
proficiently, thus creating a differentiation-based competitive advantage keyed to delivering what
customers perceive as a superior product offering.
Company Company
Company Competencies Company proficiency in
and proficiency in gains a
managers decide performing
to perform value capabilities performing competitive
one or more advantage
chain activities in gradually some of these differentiation-
ways that drive emerge in differentiation- based on
enhancing superior
improvements in performing enhancing
quality, features, value chain differentiation-
certain value chain activities
performance, enhancing
differentiation- activities continues to
and other capabilities
enhancing rises to the build and
differentiation- that deliver
enhancing value chain level of a core evolves into
activities competence added value to
aspects a distinctive customers
competence
Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New
York: Free Press, 1985), p. 35.
QUESTION 5: IS THE COMPANY COMPETITIVELY

STRONGER OR WEAKER THAN KEY RIVALS?
Using value chain analysis and benchmarking to determine a company’s competitiveness on price, cost,
and delivering value to customers is necessary but not sufficient. A more comprehensive assessment of
the company’s overall competitive strength is needed. The answers to two questions are of particular
interest: First, how does the company rank relative to competitors on each important factor that determines
market success? Second, all things considered, does the company have a net competitive advantage or
disadvantage versus its closest rivals?
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 competitive trait or
capability that impacts a company’s competitiveness and determines whether it is competitively strong or
weak. Much of the information needed for doing a competitive strength assessment comes from previous

analyses. Industry and competitive analysis reveal the key success factors and competitive capabilities that
separate industry winners from losers. Benchmarking data and scouting key competitors provide a basis
for judging the competitive strength of rivals on such factors as cost, key product attributes (quality, styling,
performance features), customer service, image and reputation, financial strength, technological capability,
distribution capability, and other competitively important traits. SWOT analysis reveals how the company in
question stacks up on these same strength measures.
Step 1 in doing a competitive strength assessment is to make a list of the industry’s key success factors and
the most telling measures of competitive strength or weakness (six to ten measures usually suffice). Step 2 is
to assign weights to each of the measures of competitive strength based on their perceived importance—it
is highly unlikely that all the different measures are equally important. For instance, in an industry where the
products/services of rivals are virtually identical, having low unit costs relative to rivals is nearly always the
most important determinant of competitive strength. Importance weights can be as high as 0.50 in situations
where one particular competitive strength measure is overwhelmingly decisive, or the high weights might be
only 0.20 or 0.25 when two or three strength measures are more important than the rest. Lesser competitive
strength indicators can carry weights of 0.05 or 0.10. The sum of the weights for each measure must add up
to 1.0.
Step 3 is to rate the firm and its rivals on each competitive strength measure, using a rating scale of 1 to 10
(where 1 is competitively very weak and 10 is competitively very strong). Step 4 is to multiply each strength
rating by its importance weight to obtain weighted strength scores (a strength rating of 4 multiplied by
an importance weight of 0.20 gives a weighted strength score of 0.80). Step 5 is to sum each company’s
weighted strength ratings to obtain an overall weighted competitive strength rating. Step 6 is to use the
overall weighted competitive strength ratings to draw conclusions about the size and extent of the company’s
net competitive advantage or disadvantage vis-à-vis its rivals and to take specific note of areas of strength
and weakness.
Table 4.3 provides an example of competitive strength assessment in which a hypothetical company (ABC
Company) competes against two rivals. In the example, relative 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. For instance, Rival 1’s 3.00 weighted
strength rating on relative cost signals a considerable cost advantage versus ABC Company (with a 1.50
weighted score on relative cost) and an even bigger cost advantage against Rival 2 (with a weighted score
of 0.30). The measure-by-measure ratings reveal the competitive areas where a company is strongest and
weakest, and against whom.
The weighted overall competitive strength scores indicate how all the different strength measures add
up—whether the company has a net overall competitive advantage or disadvantage versus each rival.
The more a company’s weighted overall competitive strength rating exceeds the scores of lower-rated
rivals, the stronger is its overall competitiveness versus those rivals; the further a company’s score is below
those of higher-rated rivals, the weaker is its ability to compete successfully. The bigger the difference
between a company’s overall weighted rating and the scores of lower-rated rivals, the bigger is its implied
net competitive advantage over these rivals. Thus, Rival
1’s overall weighted score of 7.70 indicates a greater net The sizes of the differences between a
competitive advantage over Rival 2 (with a score of 2.10) company’s overall weighted score and that of
than over ABC Company (with a score of 5.95). Conversely, a lower rated rival signals both their differing
the bigger the difference between a company’s overall degrees of competitiveness and the size of
rating and the scores of higher-rated rivals, the greater the higher rated company’s net competitive
its implied net competitive disadvantage. Rival 2’s score
advantage and the lower-rated company’s net
of 2.10 gives it a smaller net competitive disadvantage
disadvantage.
against ABC Company (with an overall score of 5.95) than
against Rival 1 (with an overall score of 7.70).

TABLE 4.3 A Representative Weighted Competitive Strength Assessment
Competitive Strength Assessments

[Rating scale: 1 = Very weak; 10 = Very strong]
ABC Co. Rival 1 Rival 2
Key Success Factors Importance Strength Weighted Strength Weighted Strength Weighted
and Strength Measures Weight Rating Score Rating Score Rating 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 8 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
Weighted overall competitive
5.95 7.70 2.10
strength rating
Strategic Implications of the Competitive Strength

Assessments
In addition to showing how competitively strong or weak a company is relative to its rivals, the strength ratings
provide guidelines for designing wise offensive and defensive strategies. For example, if ABC Co. 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 overall 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 position 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 competitive
strength than Rival 2 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 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 prices aggressively to win customers 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 A company’s competitive strength scores
away the best position to compete on the basis of low pinpoint its strengths and weaknesses against
price, given its high rating on relative cost in an industry rivals and point directly to the kinds of offensive/
where low costs are competitively important (relative defensive actions it can use to exploit its
cost carries an importance weight of 0.30). Rival 1’s very competitive strengths and reduce its competitive
strong relative cost position vis-à-vis both ABC and Rival vulnerabilities.
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, it needs to aim a portion of its strategy at
lowering its costs.
The point here is that a competitively astute company should take both the individual and overall strength
scores into account 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 based
on these strengths 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.
QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS

DOES TOP MANAGEMENT NEED TO ADDRESS IN
CRAFTING A STRATEGY TO FIT THE SITUATION?
The final and most important analytical step is to zero in on exactly which strategic issues company
managers need to worry about and consider in crafting a strategy well-suited to the company’s specific
circumstances. Compiling a “worry list” involves drawing heavily on the results of the analysis of both the
company’s external and internal environments. The task here is to get a clear fix on exactly what competitive
challenges the company confronts on the road ahead, which of the company’s competitive shortcomings
need to be remedied, what obstacles stand in the way of improving the company’s competitive position in
the marketplace and boosting its financial performance, what combination of strategic actions offers the best
path to competitive advantage, and what specific problems/issues merit front-burner attention by company
managers in crafting future strategic actions.
The “worry list” of significant strategic issues and problems that need to be dealt with in forthcoming strategic
initiatives can include things such as how to stave off market challenges from new foreign competitors, how
to combat the price discounting of rivals, how to reduce the company’s high costs and pave the way for
price reductions, how to sustain the company’s present
Compiling a “worry list” that sets forth the
rate of growth in light of slowing buyer demand, whether
to expand the company’s product line, whether to correct strategic issues and problems a company faces
the company’s competitive deficiencies by acquiring should embrace such language as “how to…,”
a rival company with the missing strengths, whether to “whether to …” and what to do about….” The
expand into foreign markets rapidly or cautiously, whether purpose of compiling a worry list is to create
to reposition the company and move to a different an agenda of items that need to be addressed
strategic group, what to do about growing buyer interest in crafting a set of strategic actions that fit the
in substitute products, and what to do to combat the company’s overall situation.
aging demographics of the company’s customer base.
The worry list thus relies on such language as “how to…,” “what to do about…,” and “whether to…” to precisely
identify the specific issues/problems that management needs to address and try to resolve in deciding what
upcoming strategic actions to take. The worry list thus serves as an agenda of strategically relevant issues/
problems that managers need to focus on in crafting a refurbished strategy that fits the particulars of the
company’s external and internal situation.
Only after managers have first done serious strategic

thinking about how to deal with the items on the worry CORE CONCEPT
list are they truly prepared to pick and choose among the A strategy is neither complete nor well matched to
alternative strategic actions and initiatives in fashioning the company’s situation unless it contains actions
an overall strategy that suits the company’s situation—the and initiatives to address each issue or problem
items on the worry list are most definitely a relevant and
on the “worry list.”
important part of the company’s situation.25 If the items
on the worry list are relatively minor—which suggests
the company’s present strategy is mostly on track and reasonably well matched to the company’s overall
situation—company managers seldom need to go much beyond fine-tuning the present strategy to arrive at

a strategy suitable for the road ahead. If, however, the issues and problems confronting the company signal
that the present strategy requires significant overhaul, the task of crafting a revamped strategy better suited
to the company’s internal and external situation needs to be right at the top of management’s action agenda.
KEY POINTS
There are six key questions to consider in evaluating a company’s resources and ability to compete
successfully:
1. How well is the company’s present strategy working? This involves evaluating the strategy from a
qualitative standpoint (completeness, internal consistency, rationale, and suitability to the situation)
and also from a quantitative standpoint (the strategic and financial results the strategy is producing).
The stronger a company’s current overall performance, the less likely the need for radical strategy
changes. The weaker a company’s performance and/or the faster the changes in its external situation,
the more its current strategy must be questioned.
2. What are the company’s important resources and capabilities, and do they have the competitive
power to enable the company to produce a competitive advantage over rival companies? The
task here is to identify the company’s most valuable resources and capabilities and to assess their
competitive power using four tests. The degree of success a company enjoys in the marketplace is
governed by the combined competitive power of its resources and capabilities. Executive attention to
making sure a company always has competitively valuable resources and capabilities that dynamically
evolve and help sustain the company’s competitiveness is a strategically important top management
task.
3. What are the company’s competitively important strengths and weaknesses and how well-suited are
they to capturing its best market opportunities and defending against the external threats to its future
well-being? A SWOT analysis provides an overview of a firm’s situation and is an essential component
of crafting a strategy that is well-suited to the company’s internal and external circumstances. The two
most important parts of a SWOT analysis are (1) drawing conclusions about what story the compilation
of strengths, weaknesses, opportunities, and threats tell about the company’s overall situation, and
(2) acting on those conclusions to better develop a strategy that satisfies the three requirements
of a winning strategy: (1) fit the company’s internal and external situation, (2) help build competitive
advantage, and (3) improve performance. A company’s most competitively potent resources and
capabilities should be the foundation of its strategy. Using a company’s most potent resources and
capabilities to power its strategy gives the company its best chance for market success, competitive
advantage, and better performance. A well-conceived strategy must include actions to correct those
competitive weaknesses that make the company vulnerable to attack from rivals, depress profitability,
or disqualify it from pursuing a particularly attractive opportunity. Market opportunities and external
threats come into play because fitting a company’s strategy to a company’s situation requires aiming an
important portion of the company’s strategy at pursuing attractive market opportunities and defending
against threats to its future profitability and well-being.
4. Are the company’s prices and costs competitive with those of key rivals, and does it have an appealing
customer value proposition? The greater the value a company can profitably deliver to its customers
relative to the value delivered by close rivals, the less competitively vulnerable it becomes. The higher
a company’s costs relative to those of rivals delivering comparable customer value at a comparable
price, the more competitively vulnerable it becomes. Value chain analysis and benchmarking are
essential tools in determining how well a company is performing particular functions and activities,
learning whether its costs are in line with competitors, and deciding which internal activities and
business processes need to be scrutinized for improvement. Performing value chain activities in ways
that give a company either a lower-cost advantage or a value-creating differentiation advantage over
rivals are two surefire ways to create competitive advantage.

5. 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 competitive success and whether and why the company has a competitive advantage
or disadvantage. Quantitative competitive strength assessments, using the method presented in Table
4.3, indicate where a company is competitively strong and weak, and provide insight into the company’s
ability to defend or enhance its market 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 competitively
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 competitive 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 does top management need to address in crafting a strategy to
fit the situation? This analytical step zeros in on the strategic issues and problems that stand in the
way of the company’s success. It involves drawing on the results of both the analysis of the company’s
external environment and the evaluations of the company’s overall internal situation to compile a
“worry list” of issues and problems that managers need to address and try to resolve in refurbishing
the company’s strategy to better fit its overall situation. The worry list uses such language as “how
to…,” “whether to…” and ‘what to do about…” to single out the specific strategy-related concerns that
merit front-burner management attention. A company’s strategy is neither complete nor well matched
to the particulars of its situation unless it contains actions and initiatives to address every issue or
problem on the worry list.
Accurate appraisal of a company’s internal situation, like penetrating analysis of its external environment,
is a valuable precondition for good strategy making. Absent such analysis, company managers are unlikely
to craft a strategy that is well suited to the company’s resources, competitive capabilities, and best market
opportunities.


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Strategy: Core Concepts and Analytical Approaches

Arthur A. Thompson, The University of Alabama 7th Edition, 2022-2023

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

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

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT

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

Actions to respond to important Planned, proactive moves to attract

Initiatives to build competitive

Copyright © 2022 by Arthur A. Thompson. All rights reserved.

• Whether the firm’s profit margins are increasing or decreasing.

The bigger the improvements in a company’s market

Ratio How Calculated What It Shows

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QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT

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Identifying a Company’s Competitively Important Resources

• Organizational and technological resources: proprietary technology and production capabilities,

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Astute Bundling of a Company’s Resources and

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Four Ways to Test the Competitive Power of a Resource

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A Company’s Important Resources and Capabilities Must Be

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QUESTION 3: WHAT ARE THE COMPANY’S

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Identifying a Company’s Competitively Important Strengths

Identifying a Company’s Competitively Important Weaknesses

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TABLE 4.2 What to Look for in Identifying a Company’s Strengths,

Potential Market Opportunities Potential External Threats to a Company’s

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Identifying a Company’s Best Market Opportunities

Identifying the External Threats to a Company’s Future

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What Do the SWOT Listings Reveal?

• What are the attractive aspects of the company’s situation?

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Identify the company’s What Can Be Gleaned from the

Conclusions concerning the company’s overall business

Identify the Implications for improving company strategy:

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QUESTION 4: ARE THE COMPANY’S PRICES AND

Regardless of where on the price-quality-performance spectrum a company competes, it must remain

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The Concept of a Company Value Chain

Comparing the Value Chains of Rival Companies

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FIGURE 4.3 A Representative Company Value Chain

Support Product R&D, Technology, and Systems Development

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The Value Chain System for an Entire Industry

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FIGURE 4.4 A Representative Value Chain System for an Entire Industry

Benchmarking: A Tool for Assessing Whether the Costs

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Strategic Options for Creating an Advantage or Remedying

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• Shift to lower-cost production technologies and/or invest in productivity-enhancing equipment

A second approach to eliminating a competitive disadvantage or creating a competitive advantage in how

• Outsourcing activities to vendors/contractors with the resources/capabilities to help deliver higher

In searching for cost-reducing opportunities or value-enhancing opportunities, it is important to recognize