03

Chapter
Three
Internal
Analysis:
Distinctive
Competencies,
Competitive
Advantage,
and
Profitability
Copyright Houghton Mifflin Company. All rights reserved.
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Internal Analysis includes an assessment of:
Quantity and quality of a companys
resources and capabilities
Ways of building unique skills
and company-specific or
distinctive competencies

Internal Analysis
The purpose of internal analysis is to pinpoint the
strengths and weaknesses of the organization.
Strengths lead to superior performance.
Weaknesses lead to inferior performance.
Building and sustaining a competitive advantage
requires a company to achieve superior:

Efficiency
Quality
Innovations
Responsiveness to customers
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Internal Analysis:
Strengths and Weaknesses
Internal analysis - along with the external analysis of
the companys environment - gives managers the
information to choose the strategies and business
model to attain a sustained competitive advantage.
Strengths
Of the enterprise
are assets that
boost
profitability
Weaknesses
Of the enterprise
are liabilities that
lead to lower
profitability
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Internal Analysis:
A Three-Step Process
1. Understand the process by which companies
create value for customers and profit for
themselves.
Resources
Capabilities
Distinctive competencies
2. Understand the importance of superiority in
creating value and generating high profitability.
Efficiency
Quality
3. Analyze the sources of the companys
competitive advantage.
Strengths that are driving profitability
Weaknesses opportunities for improvement
Innovation
Responsiveness to Customers
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Competitive Advantage
A firms profitability is greater than the average
profitability for all firms in its industry.
Sustained Competitive Advantage
A firm maintains above average and superior
profitability and profit growth for a number of years.
The Primary Objective of Strategy
is to achieve a
Sustained Competitive Advantage
which in turn results in
Superior Profit and Profit Growth.
Distinctive competencies
D.c are firm specific strengths that allow a company to
differentiated its products from those offered by its rivals
and or achieve substantially lower cost.
Resources- refers to assets of a comapany- tangible and
intangible.Resources are valuable when they are enable a
company to create strong demand for its products.
Capabilities-refers to a companys skills at coordinating its
resources and putting them to productive use
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Strategy, Resources,
Capabilities, and Competencies
Figure 3.1
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Competitive Advantage,
Value Creation, and Profitability

1. VALUE or UTILITY the customer gets from
owning the product
2. PRICE that a company charges for its
products
3. COSTS of creating those products
Consumer surplus is the excess utility a
consumer captures beyond the price paid.
Basic Principle: the more utility that consumers
get from a companys products or services, the
more pricing options the company has.
How profitable a company becomes
depends on three basic factors:
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Value Creation per Unit
Figure 3.2
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Value Creation
and Pricing Options
There is a dynamic
relationship among utility,
pricing, demand, and costs.
Figure 3.3
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Comparing Toyota
and General Motors
Superior value creation requires that the gap between
perceived utility (U) and costs of production (C)
be greater than that obtained by competitors.
Figure 3.4
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The Value Chain
A company is a chain of activities for transforming
inputs into outputs that customers value
including the primary and support activities.
Figure 3.5
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Building Blocks
of Competitive Advantage

The Generic
Distinctive Competencies
Allow a company to:
Differentiate product offering
Offer more utility to customer
Lower the cost structure
regardless of the industry,
its products, or its services

Figure 3.6
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Efficiency
Measured by the quantity of inputs it
takes to produce a given output:
Efficiency = Outputs / Inputs
Productivity leads to greater efficiency
and lower costs:
Employee productivity
Capital productivity
Superior efficiency helps a company
attain a competitive advantage
through a lower cost structure.
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Quality
Reliable and
Differentiated by attributes that customers
perceive to have higher value
The impact of quality on competitive
advantage:
High-quality products differentiate and increase
the value of the products in customers eyes.
Greater efficiency and lower unit costs are
associated with reliable products.
Superior quality = customer perception
of greater value in a products attributes
Form, features, performance, durability, reliability, style, design
Quality products are goods and services that are:
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A Quality Map for Automobiles
When customers
evaluate the quality of a
product, they commonly
measure it against two
kinds of attributes:
1. Quality as Excellence
2. Quality as Reliability
Figure 3.7
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Innovation
Innovation is the act of creating
new products or new processes
Product innovation
Creates products that customers
perceive as more valuable and
Increases the companys pricing options
Process innovation
Creates value by lowering production costs

Successful innovation can be a major
source of competitive advantage
by giving a company something unique,
something its competitors lack.
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Responsiveness to Customers

Superior quality and innovation are integral to
superior responsiveness to customers.
Customizing goods and services to the unique
demands of individual customers or customer
groups.
Enhanced customer responsiveness
Customer response time, design,
service, after-sales service and support

Superior responsiveness to customers
differentiates a companys products and services
and leads to brand loyalty and premium pricing.
Identifying and satisfying customers
needs better than the competitors
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Competitive Advantage:
The Value Creation Cycle
Figure 3.8
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Analyzing Competitive
Advantage and Profitability
When a companies profitability is greater than the average of all
other companies in the same industry that compete for the same
customers
Benchmarking
Comparing company performance against that of competitors and
the companys historic performance

Measures of Profitability

Return On Invested Capital (ROIC)
Net profit Net income after tax
Capital invested Equity + Debt to creditors

Net Profit
Net Profit = Total revenues Total costs

=
ROIC
=
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Definitions of
Basic Accounting Terms
Table 3.1
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Drivers of Profitability (ROIC)
Figure 3.9
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Comparing Wal-Mart to Target
Figure 3.10
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The Durability of Competitive
Advantage
1.Barriers to Imitation
Making it difficult to copy a companys distinctive competencies
Imitating Resources
Imitating Capabilities
2.Capability of Competitors
Strategic commitment
Commitment to a particular way of doing business
Absorptive capacity
Ability to identify, value, assimilate, and use knowledge
3.Industry Dynamism
Ability of an industry to change rapidly
The DURABILITY of a companys competitive advantage over
its competitors depends on:
Competitors are also seeking to develop distinctive
competencies that will give them a competitive edge.
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Why Companies Fail
Inertia
Companies find it difficult to change their
strategies and structures
Prior Strategic Commitments
Limit a companys ability to imitate and
cause competitive disadvantage
The Icarus Paradox
A company can become so specialized and inner directed
based on past success that it loses sight of market realities
Categories of rising and falling companies:
Craftsmen Builders Pioneers Salespeople
When a company loses its competitive advantage,
its profitability falls below that of the industry.
It loses the ability to attract and generate resources.
Profit margins and invested capital shrink rapidly.
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Avoiding Failure:
Sustaining Competitive Advantage
1. Focus on the Building Blocks of Competitive
Advantage
Develop distinctive competencies and superior performance in:
Efficiency Quality
Innovation Responsiveness to Customers
2. Institute Continuous Improvement and Learning
Recognize the importance of continuous learning within the organization
3. Track Best Practices and Use Benchmarking
Measure against the products and practices of the most efficient global
competitors
4. Overcome Inertia
Overcome the internal forces that are barriers to change
Luck may play a role in success, so
always exploit a lucky break - but remember:
The harder I work, the luckier I seem to get.
J P Morgan

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