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CHAPTER 3

Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability
0SYNOPSIS OF CHAPTER
The goal of this chapter is to explore the basis of competitive advantage at the level of the individual company. Put another way, the central question with which the chapter deals is why, within a given industry, some companies do better than others. This is a very important chapter because it introduces a framework for understanding competitive advantage that will be used throughout the rest of the book. The chapter opens with a presentation of a basic model of competitive success. The text asserts that, to gain a competitive advantage, the firm must adopt an effective strategy, which will lead to the formation of distinctive competencies, or firm-specific strengths. The distinctive competencies arise from the firm’s resources and capabilities. Successful firms adopt strategies that build upon existing competencies or develop new competencies. Next, the text explains that companies use their competencies to offer superior value to customers. The relationship between pricing, demand, costs, and differentiation is explored, as they relate to the creation of superior value. The discussion of the value chain aims to show students how the different value-creation activities of a company fit together. A point strongly emphasized here is that each of the value chain activities is a potential source of value creation. The chapter then examines the role of distinctive competencies in helping to achieve the four generic building blocks of competitive advantage: superior efficiency, quality, innovation, and customer responsiveness. Companies that have superior performance in one or more of these areas are able to differentiate their products and/or reduce costs, which leads to value creation and higher profitability. The financial calculation of superior value (profitability) is explored in detail. The durability of competitive advantage is the focus of the next section, which argues that the durability of a company’s competitive advantage is a function of three factors: the height of barriers to imitation, the capability of competitors, and the general dynamism of the industry environment. Finally, the chapter addresses the reasons why formerly successful companies fail, focusing on organizational inertia, past strategic commitments, and the Icarus paradox. The concluding section of the text mentions ways that companies can avoid competitive failure and sustain a competitive advantage.

0TEACHING OBJECTIVES0
10. 20. 30. 40. 50. Examine the internal causes of competitive success and failure. Show how effective strategies create distinctive 0competencies, including resources and capabilities, which then aid a firm in achieving competitive advantage. Describe the process of value creation, using the concepts of pricing, demand, costs, and differentiation. Familiarize students with the concept of the value chain, and show how the different value-creation activities of a company fit together. Explain how distinctive competencies lead to superior efficiency, quality, innovation, and responsiveness to customers, which in turn allow a company to differentiate its products and lower its costs. Describe how competitive advantage leads to higher profitability, using financial measures.

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physical. Distinctive competencies enable firms to create superior value for customers. a. including location selection (infrastructure). and make decisions within the context of an organization. All rights reserved. B0. and intangible resources. they experience higher profitability. and industry dynamism. technological. Resources that create a strong demand for the firm’s products are valuable. a focus on markets with lower entry costs such as suburbs and small towns. These skills reside in the way a company makes decisions and manages its internal processes. including0 the height of barriers to imitation. including its resources and capabilities. human. to maintain their competitive advantage. 0OPENING CASE: BJ’S WHOLESALE—COMPETITIVE ADVANTAGE The Opening Case describes the competitive advantages enjoyed by BJ’s Wholesale. D0. E0. a membership-based discount retailer that uses a business model similar to that of Costco or Sam’s Club. The choice of industry affects firm performance but. by helping them to achieve the four main building blocks of competitive advantage: efficiency. high volume ordering (materials management). The firms in this industry provide a limited selection of products in a no-frills environment. and allowing them to sell a high volume of low-priced products. 0Why do some companies do better than their competitors? What is the basis of competitive advantage? B0. and to take steps to avoid competitive failure. profitability and other performance measures. by definition. and especially its distinctive competencies. and organizational resources of the company. such as land. Capabilities are. plant. 80.30 70. 20. and the role of strategic choice in developing distinctive competencies. the capability of competitors. such as brand names. buildings. innovation. and it has a sustained competitive advantage when it is able to maintain this high profit rate over a number of years. a retail customer orientation that allows them to charge slightly higher prices. BJ’s is the smallest of the big three competitors. Competitive Advantage. They reside not so much in individuals as in the way individuals interact. BJ’s competitive advantages include a location clustering strategy for efficiency. Internal analysis leads to the identification of a firm’s strengths and weakness. and Profitability Identify the factors that influence the durability of a company’s competitive advantage. II0. intangible. but the most rapidly growing and the most profitable. Explain the role played by organizational inertia. some companies are more profitable than others. cooperate. including resources and capabilities. patents. A company has a competitive advantage when its profit rate is higher than the average for its industry. within any given industry. 90. Chapter 3: Internal Analysis: Distinctive Competencies. Overview0 A0. It’s also important for firms to sustain their competitive advantages over time. Resources refer to the financial. Unique and valuable resources lead to a distinctive competency. . They can be divided into tangible resources. Distinctive Competencies and Competitive Advantage A0. Copyright © Houghton Mifflin Company. and acceptance of credit cards (customer service). Teaching Note: This case provides an overview of many of the important concepts of this chapter. keeping costs low. b. and technological or marketing knowledge. Superior value creation is driven by a firm’s ability to differentiate its products or reduce its expenses. which are of two types: resources and capabilities. and equipment. distinctive competencies. Resources that are firm-specific and difficult to imitate are unique. quality. Competitive advantage derives from a firm’s distinctive competencies. When firms are able to create superior value. past strategic commitments. LECTURE OUTLINE0 I0. and responsiveness to customers. and the Icarus paradox in the failure of many formerly successful companies. competitive advantage. Capabilities refer to a company’s skills at coordinating its resources and putting them to productive use. Discuss the steps that companies can take to avoid failure and sustain a competitive advantage. and an information system that lowers costs and further increases efficiency. 10. reputation. C0. The Opening Case also provides several examples of value chain functional area. b. a.

Show Transparency 15 Figure 3. and Competencies C0. Another factor that causes the price to be lower than the value is the impossibility of segmenting the market so that the company can charge each customer a price that reflects that individual’s reservation price (their assessment of the value of a product). 50. it may not be able to create or sustain a distinctive competency. b0. The Value Chain A0. Competitive advantage (and higher profits) goes to those companies that can create superior value—and the way to create superior value is to drive down the cost structure of the business and/or differentiate the product in some way so that consumers value it more and are prepared to pay a premium price. Under Option 1. A company’s value chain is a sequence of interrelated activities for transforming inputs into outputs that customers value. a company can create more value for its customers in two ways. but capabilities are essential. The company makes a profit so long as the price is greater than the cost. a company can lower its price (P).4. The price a company charges is typically less than the value assigned by the consumer. the greater the difference that can exist between price and value. each of which can add value to the product. but unless it has the capability to use those resources effectively.Chapter 3: Internal Analysis: Distinctive Competencies. . creating a higher value (V). Its profit rate will be greater the lower costs are.6: The Roots of Competitive Advantage III0.2: Strategy. Show Transparency 16 Figure 3. The customer captures that difference in value as a consumer surplus. Value is assigned by customers based on product attributes such as performance. The distinction between resources and capabilities is of the utmost importance in understanding the source of a distinctive competency.3. and quality.4: Value Creation and Pricing Options D0. relative to the price.3: Value Creation per Unit 40. and increased volume of sales. Copyright © Houghton Mifflin Company. Customers are then willing to pay a higher price (P increases). a company can make the product more attractive. All rights reserved. The process consists of a number of primary activities and support activities. the company’s profit margin is equal to the difference between price and costs (P–C). Competitive Advantage. design. Looking at Figure 3. unique and valuable resources are helpful in creating distinctive competencies. Capabilities. raising costs (C) but also raising value (V). which occurs because the company is competing with other companies and so must charge a lower price than it could as a monopoly supplier. Looking at Figure 3. the more flexibility it has in assigning a price. and the company’s costs of production. and Profitability 31 30. whereas the consumer surplus is equal to the difference between value and price (V–P). The more value a company creates. 10. more demand. Economies of scale realized because of the increased volume allow the company to reduce its costs (C). Show Transparency 17 Figure 3. L0ow cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry. Under Option 2. Thus. 30. Resources. A company’s profit rate and hence competitive advantage is determined by the value customers place on the company’s goods or services. A company may have unique and valuable resources. a0. The lower the competitive intensity. Show Transparency 18 Figure 3. 20. the price the company charges for the products or service.

Competitive Advantage. Pfizer salespeople also logged more “face time” with physicians than Lilly’s.7: The Value Chain 10. which increase the perceived product value. which is very similar to Prozac and has been gaining share from Lilly. 0By superior product design. It is also the job of the human resource function to ensure that people are adequately trained. from procurement through production and into distribution. R&D may develop more efficient production processes. Zoloft. b0. Pfizer has enjoyed rapidly increasing revenues and market share and. Production is concerned with the creation of a good or service. making them more attractive to consumers. dealing with customer service inquiries. Production can also create value by performing its activities in a way that is consistent with high product quality. production takes place when the service is actually delivered to the customer. production. The efficiency with which this is carried out can significantly lower cost. and Profitability Show Transparency 19 Figure 3. Marketing and sales functions create value through brand positioning and advertising. was the market leader in antidepressant drugs. and compensated to perform their value creation tasks. For physical products. Alternatively. creation and delivery of the product. marketing and sales. c0. The actions included publishing the results of safety comparisons describing Zoloft as safer than Prozac. Students can then predict whether these actions would be likely to lead to a sustained competitive advantage for Pfizer. rival Pfizer introduced its own antidepressant. which increase the functionality of products. Information systems refer to the (largely) electronic systems for managing inventory. Information systems. introduced by Eli Lilly. .0 The production function creates value by performing its activities efficiently so that lower costs result. production means manufacturing. and Pfizer focused on visits to primary care physicians. spending more time on physician’s visits. which can then design products that better match those needs. a greater return on the company’s investment in developing Zoloft. a0. tracking sales. who increasingly prescribe antidepressants but are less familiar with them than are psychiatrists. its marketing. STRATEGY IN ACTION 3. The human resource function helps to create value by ensuring that the company has the right mix of skilled people to perform its value creation activities effectively. and focusing on the more malleable primary care physicians. are holding out the promise of being able to alter the efficiency and effectiveness with which a company manages its other value chain activities. The role of the customer service function is to provide after-sales service and support. d. motivated. The case notes several specific actions taken by the firm to differentiate their products from those of their competitors. The materials management function controls the transmission of physical materials through the value chain. pricing products. R&D can develop superior product designs. Teaching Note: This case describes Pfizer’s ability to create value for customers through the value chain function of marketing and sales. and service. Research and development (R&D) is concerned with the design of products and production processes. R&D occurs in manufacturing enterprises as well as service companies. c. rather than psychiatrists. The support activities of the value chain provide inputs that allow the primary activities to take place. Zoloft’s success is due to an aggressive marketing and sales campaign designed to convince physicians that Zoloft is a safer drug. This function can create a perception of superior value in the minds of consumers by solving customer problems and supporting customers after they have purchased the product. Copyright © Houghton Mifflin Company. when coupled with the communications features of the Internet. a. lowering costs.1: VALUE CREATION AT PFIZER Prozac. One good discussion point would be to ask students whether these actions might be expensive or difficult for other firms to imitate. But in 1992. 20. and with its support and after-sales service. and so on. 0They also create value by discovering consumer needs and communicating them to the R&D function of the company.32 Chapter 3: Internal Analysis: Distinctive Competencies. selling products. thereby creating more value. Primary activities have to do with the design. All rights reserved. b. There are four primary activities: research and development. which leads to differentiation and lower costs. For services. therefore.

3: CONTINENTAL AIRLINES GOES FROM WORST TO FIRST In 1994. and it still does. Quality products are goods and services that have attributes that customers perceive as desirable. air carrier. with less employee time wasted fixing defective products or services. In turn. the lower the cost of inputs required to produce a given output. innovation. Classroom discussion of the case could center on the question of whether any firm could hope to imitate Southwest’s low-cost competitive advantage—the answer would probably be negative. enabling it to grow market share by offering lower prices. What resources and capabilities would be required for such an attack. and decided to spend more in order to improve quality. 0The factors are all highly interrelated. quality. Companies with high employee productivity and capital productivity will have low costs of production.2: SOUTHWEST AIRLINES’ LOW COST STRUCTURE Southwest Airlines has consistently achieved the lowest costs in the industry. The Generic Building Blocks of Competitive Advantage A0. STRATEGY IN ACTION 3. 20. d0. The firm is known for hiring only those with positive attitudes and good teamwork skills. 10. Another contributor is its no-frills operations. irrespective of industry. Gordon Bethune became CEO of Continental Airlines. Operations costs are further reduced because the firm only flies point-to-point. Bethune felt that the firm had cut costs too low. Competitive Advantage. control systems. and how might it lead to changes in the airline industry? C0. no assigned seats. In addition.0 They are generic because they represent actions that any company can adopt. Teaching Note: This case illustrates a number of ways in which Southwest Airlines has fostered high employee productivity and high capital productivity. and Profitability 33 The final support activity is the company infrastructure. A major contributor to the low costs is the company’s high employee productivity. Providing high-quality products creates a brand-name reputation for a company’s products. STRATEGY IN ACTION 3. The more efficient a company. for opportunities to drive down costs. at least in the short term. Higher product quality can also result in greater efficiency. enabling them to serve more passengers with fewer personnel. meaning that the product does the job it was designed for and does it well. which means lower unit costs. Show Transparency 20 Figure 3.Chapter 3: Internal Analysis: Distinctive Competencies. He set a goal for reliability improvement and gave bonuses when this goal was met. and doesn’t use a hub system. as most of the other major carriers do. reducing the need for a large number of gates and personnel. Within a year. On important attribute is reliability. including care in hiring. they should also be viewed as part of the infrastructure of a company. 20. High productivity is due to a number of factors.S. and no paper tickets. and helping the firm to weather industry downturns. Thus efficiency helps a company attain a low-cost competitive advantage. or the company-wide context within which all the other value-creation activities take place. Because0 top management can exert considerable influence in shaping these aspects of a company. IV0. Southwest’s efficiency creates a challenge for competitors. the firm ranked in the top three in reliability.8: Generic Building Blocks of Competitive Advantage B0. . The infrastructure includes the organizational structure. Quality applies equally to goods and to services. from ticketing to baggage handling to food service to aircraft maintenance to route scheduling. which had the lowest customer satisfaction and on-time ratings of any U. One of the keys to achieving high efficiency is utilizing inputs in the most productive way possible. 10. Four generic factors build competitive advantage by allowing companies to better differentiate their products or become more efficient in reducing costs: efficiency. with only one type of aircraft. Southwest has scrutinized each area of airline operations. and responsiveness to customers. Copyright © Houghton Mifflin Company. Efficiency is measured by the cost of inputs required to produce a given output. Incentives such as profit sharing also encourage hard work and cooperation. and organizational culture. All rights reserved. no meals. this enhanced reputation allows the company to charge a higher price for its products. A followup question could address the possibility of a successful competitive attack by an airline pursuing a different strategy. This translates into higher employee productivity.

10. This uniqueness allows a company to differentiate and charge a premium price. They can also increase profitability by getting more sales revenue from their capital investment. V0. and that higher level of effort by employees led to improved on-time performance and higher customer satisfaction. One way to increase customer responsiveness is to improve the efficiency production processes and the quality of products. Analyzing Competitive Advantage and Profitability0 A0. Teaching Note: This case provides an excellent example of the ways in which higher quality can contribute to higher efficiency. about Southwest Airlines. Continental experienced a dramatic increase in employee productivity. Through the changes described in this case. E0. In summary. Another way to increase responsiveness is to reduce customer response time. or the amount of time it takes for a good to be delivered or a service to be performed.10: Drivers of Profitability (ROIC) 20. F0. organizational structures. until imitation occurs). Competitive Advantage. 40. Which of the two firms has the greatest competitive advantage? Why? How long will that competitive advantage endure? What will it take for other firms to successfully imitate or bypass that advantage? D0. or by increasing sales revenues faster than expenses. They can compare their processes and outcomes to competitors. ROIC can be decomposed into two parts. 30. Managers can increase profitability by increasing return on sales. Capital turnover is calculated as revenues divided by invested capital. Achieving customer responsiveness requires that a company give its customers exactly what they want when they want it. superior innovation can lead to higher prices or lower unit costs. Successful innovation may also allow a company to reduce its unit costs.2. Ask students to consider the information in this case in conjunction with that presented in Strategy in Action 3. Another way to increase responsiveness is to develop new products that have features currently not incorporated in existing products. and superior customer responsiveness enables a company to charge a higher price. The most widely used measure of financial performance is profitability. Managers must understand the financial impact of their strategies. 20. Product innovation occurs if there is anything new or novel about the company’s products. B0. Another way to increase responsiveness is to customize goods and services to the unique demands of individual customers. and strategies developed by a company. Continental was able to both reduce costs and increase differentiation. Profitability can be measured in different ways. and represents how effectively the company uses its invested capital to generate revenues. production processes. 10. C0. 30. and Profitability Bethune empowered front-line employees to handle contingency situations as they saw fit. Thus innovation includes advances in the kinds of products. superior quality enables a company both to charge a higher price and to lower its costs. and represents how effectively the company converts sales revenues into profits. management systems. superior efficiency enables a company to lower its costs. Process innovation occurs if there is anything new or novel about the way a company operates. The increased flexibility and decentralization has had a tremendous impact on customers’ perception of the quality of service they receive at Continental. ROIC is calculated as net profits divided by invested capital. either by reducing expenses for a given level of sales. 0RUNNING CASE: DRIVERS OF PROFITABILITY FOR DELL COMPUTER AND COMPAQ Copyright © Houghton Mifflin Company. Successful innovation gives a company something unique that its competitors lack (that is. 10. . All rights reserved. 20. using benchmarking.34 Chapter 3: Internal Analysis: Distinctive Competencies. ROIC represents the effectiveness with which a company is using the funds it has available for investment. Return on Sales is calculated as net profit divided by revenues. It involves doing everything possible to identify customer needs and to satisfy those needs. but return on invested capital (ROIC) is one of the most widely used. Show Transparency 21 Figure 3.

] Teaching Note: Dell’s low-cost.” a. (2)0 0Technological know-how should be protected by patents. a company’s capabilities are not dependent upon one individual. distribution. B0. Marketing and technological know-how are intangible resources that are relatively easy to imitate. The easiest distinctive competencies to imitate are those based on firm-specific tangible resources such as buildings. A high dynamism (rapid rate of innovation) means that product life cycles are shortening and that competitive advantage can be very transitory. You can ask students to consider whether Compaq will ever be able to successfully imitate Dell’s low-cost strategy. Therefore. The Durability of Competitive Advantage0 A0. and equipment. They are likely to decide that Compaq cannot. there are always other strategies that could also lead to success. [Compaq was acquired by Hewlett Packard in 2001. which are visible to competitors and can be readily purchased. has an important but veiled message about the impact of strategy on performance. Barriers to imitation are factors that make it difficult for a competitor to copy a company’s distinctive competency. as a result of Dell’s low inventory. Dell’s COGS is higher than Compaq’s. In addition. ask students whether that implies that Compaq will ultimately fail. as evidenced by the figures quoted in the case. like several in this chapter.0 The longer it takes to imitate a company’s distinctive competency. d. Next. while Compaq’s expenses are greater because it is trying to differentiate its products with proprietary technology. however. Also. b. c. sustained advantage. which send a signal to competitors. Brand names symbolize a company’s reputation. direct sales business model has been remarkably successful. leading to an ROIC of 38 percent. but in practice. no one person can duplicate capabilities. b. Dell’s focus on low cost PCs helps to keep its expenses low. the company will find it difficult to respond to new competition if doing so requires a break with this commitment. Durability refers to the length of time that a competitive advantage lasts. it is often possible to “invent around” patents. or whether they could succeed by adopting a different strategy. Capabilities are often invisible to outsiders. and are protected by law. 0A related concept is absorptive capacity—that is. and the movement of marketing personnel between companies facilitates the diffusion of know-how.Chapter 3: Internal Analysis: Distinctive Competencies. . (1)0 Marketing strategies are visible to competitors. This case. Intangible resources are more difficult to imitate. Classroom discussion could include ideas for alternative strategies that might be useful to Compaq in competing against Dell. plant. and web-based information system. with much lower sales. value often migrates away from established competitors and toward new enterprises that are operating with new business models. a. This influence on the durability of competitive advantage is called “capability of competitors. and are based on the way in which decisions are made and processes managed deep within a company. and therefore personnel movement will not be as useful in imitating capabilities. efficient manufacturing processes. Thus. but its SG&A expenses are lower. the greater is the opportunity for the company to improve on that competency or build other competencies. VI0. Imitation of capabilities is more difficult than imitation of resources. and Profitability 35 Dell enjoys a low-cost competitive advantage. assimilate. Managers must seek out alternate strategies if they want their firms to succeed against powerful rivals. as compared to Compaq’s ROIC of 13 percent. Industry dynamism refers to the rate of product innovation. Three factors lead to durability: high barriers to imitation. Firms with a low absorptive capacity may experience an internal inertia that slows their ability to innovate and imitate. 30. 0Also. 20. once it has been created. giving the firm an ROIC that is three times greater than its nearest competitor’s. and retailing expenses. Competitive Advantage. Copyright © Houghton Mifflin Company. You should make sure that students understand this point: Strategies can give firms a powerful. Successful companies earn above-average returns. When a company is committed to a particular way of doing business based on a set of resources and capabilities. when innovations reshape the rules of competition in an industry. but are the product of how numerous individuals interact within a unique organizational setting. Dell has reduced expenses in many areas of its operations. poor capability of competitors. Dell’s PPE expenses are just one-third of Compaq’s. and utilize new knowledge. 10. due to Dell’s use of a direct sales model. All rights reserved. Durability of competitive advantage is difficult for any company to sustain in a highly dynamic industry. and low dynamism in the industry. the ability of an enterprise to identify.

DEC’s superiority in producing high quality VAX minicomputers made it one of the largest corporations in the world. Many successful companies become so dazzled by their own early success that they believe that pursuing the same course of action is the way to future success. a0. and overcome inertia. may also contribute to competitive failure. in the form of specialized engineering know-how. 10. returning to profitability only with the ouster of CEO Ken Olsen and a drastic change in strategy. Only by doing so will a company be able to build and maintain the Copyright © Houghton Mifflin Company. however. 10. you can ask students to describe the causes of DEC’s failure. An organization’s capabilities contribute to inertia. gave rise to his demise.36 Chapter 3: Internal Analysis: Distinctive Competencies. This attitude. Sooner or later failure ensues. To avoid failure.] Teaching Note: This case provides a striking example of how successful firms can lose their competitive advantage. The most successful firms are those that continually learn. DEC went through a terrible change of fortune in the early 1990s. DEC suffered from the Icarus paradox. STRATEGY IN ACTION 3. because the resources are not well suited for other. who made himself a pair of wings from wax and feathers. because they are difficult to change. the only way that a company can maintain a competitive advantage over time is to continually improve its efficiency. capabilities can provide competitive advantage and also competitive disadvantage. making it more difficult for DEC to adapt. and customer responsiveness. Maintaining a competitive advantage requires a company to continue focusing on the four generic building blocks of competitive advantage—efficiency. Thus. and CEO Olsen was one of the worst offenders in terms of protecting his “turf” from changes proposed by others. and the Icarus paradox. However. using the terms identified in section VII above. quality. . Three related reasons for failure are explored here: inertia. B0. track best industrial practice and use benchmarking.” “builders. Turf battles may result. The firm’s large size led to inertia. such as investments in specialized resources. melting the wings and plunging to his death.” and “salesmen. One of the best ways to develop distinctive competencies is to identify best industrial practice and to adopt it. [Compaq was acquired by Hewlett Packard in 2001. and customer responsiveness—and to do whatever is necessary to develop distinctive competencies that contribute toward superior performance in these areas. evolving uses. Avoiding Failure and Sustaining Competitive Advantage0 A0. his ability to fly. through strategic mis-steps. leading to strategic failure. leads a company to become so specialized and inner-directed that it loses sight of market realities and the fundamental requirements for achieving a competitive advantage. a. In today’s dynamic and fast-paced environments. innovation.” b0. it became so specialized and inner-directed that it lost sight of customers and competitors. All rights reserved. and therefore will be resisted. they earn very low or negative profits. Competitive Advantage. The inertia argument is that companies find it difficult to change their strategies and structures in order to adapt to changing competitive conditions. quality. To facilitate classroom discussion. institute continuous improvement and learning. the company’s success carried the seeds of its destruction. 30. 20. b. The Icarus paradox is based on the Greek myth of Icarus. Prior strategic commitments. Changing resources is difficult and expensive. companies can focus on the building blocks of competitive advantage. Failing companies are not just below average. DEC was acquired by Compaq in 1998. Dazzled by its early success. They may pursue strategies such as “craftsmen. and the firm became dangerously out of touch with changing customer needs and industry conditions. prior strategic commitments. Changing capabilities would require a redistribution of power and influence among the key decision makers. Students will see that DEC suffered from all three of the major causes of failure. which made change less likely. seeking out ways of improving their operations and constantly upgrading the value of their distinctive competencies or creating new competencies. 30. Managers can also learn to exploit luck. An increasingly narrow focus on engineering capability led to a neglect of other functions. innovation. Finally. The paradox is that his greatest asset. then flew so well that he went too close to the sun. and Profitability VII0. DEC also had prior strategic commitments.” “pioneers.4: THE ROAD TO RUIN AT DEC By 1990. 20.

and they need to constantly adapt to new situations. innovation. ask students to consider how long those benefits endured. but also with business. Barriers to imitation will be lowest. The ability to overcome the inertial barriers to change within an organization is one of the key requirements for continuing to maintain a competitive advantage. it indicates the critical role played by efficiency. One should also note that barriers to imitation will be higher when a company’s distinctive competencies. Ultimately. all competitive advantages can be imitated or become obsolete due to changing environmental conditions. was able to loan Gates the $50. which was then licensed to IBM for a tremendous profit. are based on capabilities as opposed to resources. founder of Microsoft. and hence competitive advantage. 20. However. To spark a classroom discussion. It is difficult to imagine how sustained excellence could be the product of anything other than conscious effort. and the dynamism of the environment. Teaching Note: Many students will enter the classroom with the idea that success is largely a matter of luck: knowing the right people. In addition. and corporate strategies. being in the right place at the right time. Copyright © Houghton Mifflin Company. innovation. he knew that IBM was looking to acquire such a system. When is a company’s competitive advantage most likely to endure over time? The durability of competitive advantage is a function of three main factors—the height of barriers to imitation. it’s important to stress to students that a sustained success over determined rivals is unlikely to be result of mere luck.Chapter 3: Internal Analysis: Distinctive Competencies. the key role assigned to capabilities in maintaining a competitive advantage suggests that barriers to imitation are higher and competitive advantage is more durable when that advantage is based on organizational capabilities. Students will see that luck is useful.5: BILL GATES’ LUCKY BREAK Bill Gates. but Microsoft’s continued high performance has been mainly due to Gates’ astute use of that initial profit to acquire resources and capabilities that would lead to enduring success. Consequently. and customer responsiveness. the capability of competitors. To be continually successful. Competitive Advantage. you can ask students to describe other examples of organizations that benefited from luck. when distinctive competencies are based on tangible resources. or experiencing a sudden and undeserved windfall. the company lacks capable competitors. A company should direct its strategies toward achieving excellence in each of these areas. There were several elements of luck in this beginning. Luck can play a critical role in determining competitive success and failure.000 to acquire the system from Seattle Computer. a prominent Seattle attorney. and competitive advantage most fleeting. of strategy. and customer responsiveness. but transitory. such as a helpful change in tax policy or the development of a new product just as demand grew. STRATEGY IN ACTION 3. This case acknowledges the relatively limited role that luck can play in organizational success. while focusing attention on the ways in which planning has contributed to Microsoft’s more recent successes. First. companies need to continually improve their efficiency. He knew that Seattle Computer had developed a PC operating system. and the environment in which it is based is not very dynamic. 40. rather. What are the main implications of the material discussed in this chapter for strategy formulation? The material discussed in this chapter has several key implications for strategy formulation. companies can be flexible and prepared to exploit lucky breaks as they occur. and it should do so not just with functional-level strategies. It follows that a competitive advantage is more durable when barriers to imitation are high. However. and Profitability 37 resources and capabilities that underpin excellence in productivity. but it is an unconvincing explanation for the persistent success of a company. that is. 50. innovation. quality. and customer responsiveness in building a competitive advantage. quality. A further implication concerns the durability of competitive advantage. They have heard this idea many times in our popular culture and media. Then. His father. Through his mother’s business contacts. benefited from luck in the company’s first product. 0ANSWERS TO DISCUSSION QUESTIONS00 10. global. Thus companies should pay close attention to strategies that help build a high-performance culture. All rights reserved. the MS-DOS operating system. quality. a premium should be placed on strategies and structures that encourage organizational flexibility and adaptiveness. it is the logical result of a series of thoughtful and deliberate plans and actions. Describe the benefits that came to the organization as a result of luck. .

are also preferred by customers. When returns are inadequate for an extended period of time. Also. on what is this advantage based and is that advantage sustainable. answering the following questions: (1) does your business school have a competitive advantage. that is. innovation. All other measures of success. quality. Therefore. as shown in the Strategy in Action 3. although luck may explain a company’s success in particular cases. Swatch watches are made of inexpensive plastic components. Competitive Advantage. traditional materials.38 Chapter 3: Internal Analysis: Distinctive Competencies. and the firm will be forced out of business. 50.S. as measured by the return on invested capital? Ultimately. such as motivated employees. and Profitability However. Yes. (4) how might the Internet change the way in which business education is delivered. News and World Report or Business Week that publish annual rankings of business schools. Wal-Mart is a good example. and it can happen as the result of features of the product itself. and so on. quality. although one may imagine a company getting lucky and coming into possession of resources that allow it to achieve excellence in one or more of these dimensions. because of the variety of items they sell in one location. but only the firms that are prepared to adapt are able to fully exploit those opportunities. and (5) does the Internet pose a threat to the competitive position of your school in the market for business education. (3) if your business school does not enjoy a competitive advantage. For example. to maintain its advantage over the long run. innovation. it is an unconvincing explanation for a company’s persistent success. and yet. Another example is a maker of above-ground pools. innovative products or satisfied customers. Recall our argument that the generic building blocks of competitive advantage are superior productivity. whose products are cheaper to produce than are in-ground pools. fashion. Why is it important to understand the drivers of profitability. are secondary because they are not absolutely vital to the firm’s survival. when a company achieves profits and is able to make adequate returns to shareholders in the form of dividends or enhanced share value. identify the inhibiting factors that are holding it back. including styling. 0SMALL-GROUP EXERCISE: ANALYZING COMPETITIVE ADVANTAGE The students are asked to break up into groups of three to five people and to analyze the competitive position of their business school. They have a very low-cost operation. as profits are. and customer responsiveness. 40. enabling it to continue its operations. quality. Is it possible for a company to be the lowest cost producer in its industry and simultaneously have an output that is most valued by customers? Discuss this statement.5 about the lucky beginnings of Microsoft Corporation. but to argue that success is entirely a matter of luck is to strain credibility. Other companies are able to have low costs and still be valued by customers due to having a low cost production process. All rights reserved. Teaching Note: This question should solicit an interesting debate and in particular allow the students to apply the concepts learned in this chapter. Consumers are paying for features of the product other than quality. nothing lasts forever. Other products that are valued by customers but are relatively low cost to produce include the new Volkswagen Beetle and designer clothing such as Ralph Lauren’s expensive cotton shirts. which can also be accessed via the Internet on the respective magazine’s web site. You can guide students to publications such as U. funds will become unavailable. Keep in mind also that competition is a process in which companies are continually trying to outdo one another in their ability to achieve high productivity. it is difficult to conceive how sustained excellence in any of these four dimensions could be the product of anything other than conscious effort. Which is more important in explaining the success and failure of companies: strategizing or luck? Both strategy and luck are undoubtedly important in explaining success and failure. . Gravy Training: Inside Copyright © Houghton Mifflin Company. This is so because. or is it an opportunity for your school to enhance its competitive position. or as a result of the low cost of the production process. the success or failure of a profit-making corporation will hinge upon its ability to provide adequate returns to shareholders (adequate as compared to other investments of similar risk). it is clear that lucky opportunities do come along. 30. of strategy. in order to stay one step ahead of its competitors. but command premium prices as compared to watches made of more durable. For an in-depth study of this question. and customer responsiveness. and customer responsiveness and constantly seeking innovations. the firm will continue to attract financing. a company must embrace the concept of continuous improvement. constantly upgrading its efficiency. yet are preferred by many customers due to the ease and speed of installation. this is certainly possible. Given this. (2) if so. However. Luck may play a role in success.

students may need to reference library materials or a web site that provides information about competition and industry factors.jnj. In the General Task. Then the students should link J&J’s distinctive competence to its competitive advantage. (This short list was current as of the time of publication of this manual. Competitive Advantage.com). which can be beneficial or harmful to the firm.hoovers. or is lucky to some extent. either alone or with small groups. competitive advantage. the capability of competitors. The questions can be used as a written assignment. One site that provides a general industry overview in Hoover’s Online. All rights reserved. and whether and why their firm is experiencing difficulty in adapting to changing industry conditions. but it is more helpful to think of the extent of the difficulty or the extent of the luck in relative terms. based on information about a company of their choosing. You should monitor students’ answers. as well as finding similar data for their firm’s major competitors. You can remind them that. Questions 4 and 5 presents a chance for you to discuss the dual nature of many environmental changes— virtually every development and trend can pose a threat to an organization. as well as whether their firm is developing new competencies. they are asked to decide whether their firm’s strategies are building upon existing competencies. as well as providing opportunities. every firm has some difficulty in adaptation. but if they fail to understand this point. and describe the company’s distinctive competencies. and future strategies. preparedness and competency enable the firm to fully exploit its lucky opportunity. Finally. but be aware that a company’s position in its industry can change very rapidly!) Students should identify reasons such as barriers to imitation. evaluate the company’s performance on the four generic building blocks of competitive advantage. and encourage them to start early. 0STRATEGIC MANAGEMENT PROJECT: MODULE 3 This module asks students to identify their company’s competitive advantages and disadvantages. Citibank. They should then apply the concepts learned in this chapter through answering whether J&J has a distinctive competence and what the nature of this competence is. but if they experience difficulties. Teaching Note: Students should be able to identify successful firms with ease. In addition. the students should answer those same questions. Students’ answers will vary. 0ARTICLE FILE 3 Students should find an example of a company that has sustained its competitive advantage for more than ten years. or Sprint. or can be the basis of classroom discussion. Encourage students to make comparisons to competitors as they answer items related to the difficulty in adaptation and the extent of luck in influencing success. They should identify the source of its competitive advantage and describe why it has persisted over time. internal operations. distinctive competencies. be sure to clarify. and so on. and Profitability 39 the Business of Business Schools by Stuart Crainer and Des Dearlove (Jossey-Bass Publishers. depending on your school and the students’ perception of its competitive position. especially to questions 1–3. you might suggest such companies as Wal-Mart. They will need to find data about the firm’s history. 1999) is recommended. Allow plenty of time for completion of this portion.com. industry conditions. They will then need to evaluate and interpret all of that data. and industry dynamism as reasons for sustained competitive advantage. Teaching Note: This portion of the strategic management project will likely require a great deal of both research and thought for the students. Emphasize to students that each development or trend must be carefully considered to see both its good and bad aspects. a detailed analysis of the distinctive competence in terms of resources and capabilities is required. Copyright © Houghton Mifflin Company. Further. to ensure that they have understood the concepts of this chapter and are applying them correctly to this problem. Finally. Disney.Chapter 3: Internal Analysis: Distinctive Competencies. at www. . even if luck has played some part in their firm’s success. the students should evaluate the imitability of J&J’s competitive advantage. 0EXPLORING THE WEB: VISITING JOHNSON & JOHNSON The students are asked to visit the web site of Johnson & Johnson (www. strategy. Students then are asked to describe the varying roles of strategy and luck in developing the firm’s competencies. In order to describe these factors. Most students will readily find that strategy has had a far greater impact on their firm than has luck. Next. the students evaluate the barriers to imitation that benefit their firm. This portion of the project will emphasize the related nature of building blocks. In other words. it will illustrate how strategic choices lead to consequences.

that the sources and types of competencies varies considerably across firms. including technological know-how. do you think that Cisco did worse or better than its rivals? How successful do you think Cisco will be once demand revives? Why? Although many high-tech industries have suffered reverses in recent years. Cisco’s adaptive nature makes it more likely that the company is poised to take advantage of growing demand.5 billion and profitability shrank to under 6 percent. and inventory management. 0CLOSING CASE: CISCO SYSTEMS Cisco’s founders invented the router. responsiveness to customers. which allow it to differentiate its products and charge premium prices. including the ability to develop a set of complementary products to provide customers with easier access to the technology and a skill in developing helpful and efficient on-line sites. rework due to ordering mistakes.7 percent. they will find that a different firm presents a much different picture—that is. and so on. brand name reputation. giving the firm a high absorptive capacity and lessening the chance of a successful imitation of its competitive advantages. J&J has experienced sustained high profits. The advantages are based mostly on intangible resources and capabilities. All rights reserved. Cisco is very innovative. . hubs. due to their intangible and secretive nature. Copyright © Houghton Mifflin Company. but it also has an aggressive approach to moving sales and customer support on-line. creating a low-cost competitive advantage. 40. The resources and capabilities are the result of strategic choices about the company’s innovativeness. a computer that allows many computers to communicate with each other. by offering easy. It is also interesting to compare J&J with an unsuccessful firm. Cisco is clearly a product innovator.40 Chapter 3: Internal Analysis: Distinctive Competencies. revenues fell to under $18. How does the implementation of an e-business infrastructure at Cisco help the company to create value? Cisco uses the Internet to differentiate its products and services. Its advantage allows the company to both reduce expenses and increase differentiation. The competencies are based upon resources and capabilities such as technological know-how. leading to above average returns. The company also has strategic capabilities. 30. Cisco was the leading supplier of routers. And in fact. In 2002. the firm operates in a highly dynamic environment. looking for similarities and differences. By 1999. However. The firm is flexible and adaptive. which are harder to imitate than are tangible resources. Competitive Advantage. Cisco’s web site helps the company to reduce expenses on sales personnel. When students complete the General Task. and that makes it more vulnerable to imitation. again looking for similarities and differences. including a depiction of the resources and capabilities of the firm. indicating their durable competitive advantage over competitors. when the industry rebounds. thus enabling the explosive growth of the Internet. yielding huge dividends in terms of efficiency gains and customer satisfaction. its return on invested capital fell to just 6. and patents. and then they allow the order to be processed more quickly. hitting $22 billion in 2001. brand name reputation. Also. In 2000–2002. 0Answers to Case Discussion Questions0 10. willing to make changes to keep pace with changing conditions. On the basis of the case. J&J’s distinctive competencies are likely to be durable. and Profitability Teaching Note: Students will discover that Johnson & Johnson has distinctive competencies. the telecommunications equipment industry suffered a sharp contraction in demand. it is likely that Cisco performed better than most companies in those industries. and other network equipment for the Internet. It is interesting to ask students to compare J&J with successful firms in other industries. The company’s web sites help customers simplify and customize the ordering process. These activities would fall into the marketing and sales and materials management functions. continuous support to customers before and after the sale. which is a difficult strategy to imitate. with constant product and process innovation. 20. and how those enable the firm to achieve both low-cost and differentiation competitive advantages over their rivals. because they are hard to imitate. Teaching Note: The Closing Case describes the ways in which Cisco achieves its competitive advantage. What are the sources of competitive advantage at Cisco? Cisco has a number of resources that provide the company with a competitive advantage. In addition. and close relationships with buyers. Although Cisco’s sales continued to expand. How secure do you think Cisco’s competitive advantage is? Cisco’s position is relatively secure. and that should contribute to relatively good performance in tough times.