CHAPTER 3

Assessing the Internal

Environment of the
Firm

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 Learning Objectives

After reading this chapter, you should have a good understanding of:
3-1 The primary and support activities of a firm’s value chain.
3-2 How value-chain analysis can help managers create value by
investigating relationships among activities within the firm and
between the firm and its customers and suppliers.
3-3 The resource-based view of the firm and the different types of
tangible and intangible resources, as well as organizational
capabilities.
3-4 The four criteria that a firm’s resources must possess to maintain a
sustainable advantage and how value created can be appropriated
by employees and managers.
3-5 The usefulness of financial ratio analysis, its inherent limitations,
and how to make meaningful comparisons of performance across
firms.
3-6 The value of the “balanced scorecard” in recognizing how the
interests of a variety of stakeholders can be interrelated.

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 The Importance of the Internal
Environment

Consider. . .

Which activities must a firm effectively manage

and integrate in order to attain competitive
advantages in the marketplace?

Which resources and capabilities must a firm

create and nurture in order to sustain a
competitive advantage?

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 Value-Chain Analysis

Value-chain analysis looks at the sequential process

of value-creating activities.
• Value is the amount buyers are willing to pay
for what a firm provides.
• How is value created within the organization?
• How is value created for other organizations in
the overall supply chain or distribution
channel?
• The value received must exceed the costs of
production.

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 Value-Chain Analysis Primary Activities

Primary activities contribute to the physical

creation of the product or service; the sale &
transfer to the buyer; and service after the sale.
• Inbound logistics
• Operations
• Outbound logistics
• Marketing & sales
• Service

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 Question
(1 of 2)

In assessing its primary activities, an airline

would examine
A. employee training programs.
B. baggage handling.
C. criteria for lease versus purchase decisions.
D. the effectiveness of its lobbying activities.

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 Value-Chain Analysis Support Activities

Support activities either add value by

themselves or add value through important
relationships with both primary activities & other
support activities.
• Procurement
• Technology development
• Human resource management
• General administration

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 The Value Chain

Exhibit 3.1 The Value Chain: Primary and Support Activities

Adapted from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by The
Free Press.

Jump to Appendix 1 for long description.

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 Primary Activity: Inbound Logistics

Inbound logistics are primarily associated with

receiving, storing & distributing inputs to the
product.
• Material handling
• Warehousing
• Inventory control
• Vehicle scheduling
• Returns to suppliers
Factors to consider include:
• Location of distribution facilities
• Warehouse layout

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 Primary Activity: Operations

Operations include all activities associated with

transforming inputs into the final product form.
• Machining
• Packaging & Assembly
• Testing or quality control
• Printing
• Facility operations
Factors to consider include:
• Efficient plant operations & layout
• Incorporation of appropriate process technology

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 Primary Activity: Outbound Logistics

Outbound logistics includes collecting, storing, &

distributing the product or service to buyers.
• Finished goods & warehousing
• Material handling
• Delivery vehicle operation
• Order processing, scheduling & distribution
Factors to consider include:
• Effective shipping processes
• Minimizing shipping costs by grouping goods into
large lot sizes

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 Primary Activity:
Marketing & Sales

Marketing & sales activities involve purchases

of products & services by end users and includes
how to induce buyers to make those purchases.
• Advertising & promotion
• Sales force management
• Pricing & price quoting
• Channel selection & channel relations
Factors to consider include:
• Innovative approaches to promotion & advertising
• Proper identification of customer segments &
needs

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 Primary Activity: Service

Service includes all actions associated with

providing service to enhance or maintain the value
of the product.
• Installation & repair
• Training
• Parts supply
• Product adjustment
Factors to consider include:
• Quick response to customer needs
• Quality of service personnel, ongoing training

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 Support Activity: Procurement

Procurement involves how the firm purchases

inputs used in its value chain.
• Procurement of raw material inputs
• Optimizing quality & speed
• Minimizing associated costs
• Development of collaborative win-win relationships
with suppliers
• Analysis & selection of alternative sources of inputs
to minimize dependence on one supplier

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 Support Activity: Technology
Development

Technology development is related to a wide

range of activities.
• Effective R&D activities for process & product
initiatives
• Collaborative relationships between R&D and other
departments
• State-of-the-art facilities & equipment
• Excellent professional qualifications of personnel
• Use of data analytics

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 Support Activity: Human Resource
Management

Human resource management consists of

activities involved in recruitment, hiring, training
& development, & compensation of all types of
personnel.
• Effective employee recruiting, development, &
retention mechanisms
• Quality relations with trade unions
• Reward & incentive programs to motivate all
employees

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 Support Activity:
General Administration

General administration involves:

• Effective planning systems to attain overall goals &
objectives
• Excellent relations with diverse stakeholder groups
• Effective information technology to coordinate &
integrate value-creating activities across the value
chain
• Ability of top management to anticipate & act on
key environmental trends & events, create strong
values, culture & reputation

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 Interrelationships Among Value-Chain
Activities

Managers must not ignore the importance of

relationships among value-chain activities.
• What are the interrelationships among activities
within the firm?
• What are the relationships among activities within
the firm and with other stakeholders such as
customers & suppliers?
Consider integrating customers into the value
chain.
• Creating individualized products
• Soliciting ideas for products & services

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 Example: The Value Chain in Service
Organizations

Exhibit 3.4 Some Examples of Value Chains in Service Industries

Jump to Appendix 2 for long description.

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 Resource-Based View of the Firm

The resource-based view of the firm (RBV)

integrates two activities.
1. An internal analysis of phenomena within a
company
2. An external analysis of the industry & its
competitive environment
Resources can lead to a competitive advantage.
• If they are valuable, rare, hard to duplicate
• If tangible resources, intangible resources, &
organizational capabilities are combined

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 Types of Tangible Firm Resources

Tangible resources are assets that are relatively

easy to identify.
• Physical assets: plant & facilities, location,
machinery & equipment
• Financial assets: cash & cash equivalents,
borrowing capacity, capacity to raise equity
• Technological resources: trade secrets,
patents, copyrights, trademarks, innovative
production processes
• Organizational resources: effective planning
processes, evaluation & control systems

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 Types of Intangible Firm Resources

Intangible resources are difficult for

competitors to account for or imitate. They are
embedded in unique routines & practices.
• Human resources: trust, experience &
capabilities of employees; managerial skills &
effectiveness of work teams, firm specific
practices & procedures
• Innovation resources: technical & scientific
expertise & ideas; innovation capabilities
• Reputation resources: brand names,
reputation for fairness with suppliers, non-zero
sum relationships; reputation for reliability &
product quality with customers

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 Types of Firm Resources:
Organizational Capabilities

Organizational capabilities are competencies

or skills that a firm employs to transform inputs
into outputs. It is the capacity to combine
tangible & intangible resources to attain desired
ends.
• Outstanding customer service
• Excellent product development capabilities
• Superb innovation processes & flexibility in
manufacturing processes
• Ability to hire, motivate, & retain human capital

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 Question
(2 of 2)

Gillette combines several technologies to attain

unparalleled success in the wet-shaving industry.
This is an example of their
A. tangible resources.
B. intangible resources.
C. organizational capabilities.
D. strong primary activities.

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 Firm Resources and Sustainable
Competitive Advantages

Strategic resources have four attributes.

1. Valuable in formulating & implementing
strategies to improve efficiency or
effectiveness
2. Rare or uncommon; difficult to exploit
3. Difficult to imitate or copy due to physical
uniqueness, path dependency, causal
ambiguity, or social complexity
4. Difficult to substitute with strategically
equivalent resources or capabilities

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 Sources of Inimitability

Physical uniqueness are resources that are

physically unique, therefore impossible to
duplicate.
Path dependency: hard to duplicate because of
all that has happened along the path followed in
the development and/or accumulation of
resources.
Causal ambiguity: impossible to explain what
caused a resource to exist or how to re-create it.
Social complexity: resources that result from
social engineering such as interpersonal relations,
culture.

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 Criteria for Sustainable Competitive
Advantage

Is a resource or capability . . .
Valuable? Rare? Difficult to Without Implications for
Imitate? Substitutes? Competitiveness?

No No No No Competitive disadvantage

Yes No No No Competitive parity

Yes Yes No No Temporary competitive

advantage

Yes Yes Yes Yes Sustainable competitive

advantage

Exhibit 3.7 Criteria for Sustainable Competitive Advantage and Strategic Implications
Source: Adapted from Barney, J.B. 1991. Firm Resources and Sustained Competitive Advantage. Journal of Management, 17:99 – 120.

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 The Generation and Distribution of the
Firm’s Profits

Four factors help explain the extent to which

employees and managers will be able to obtain a
proportionately high level of the profits that they
generate
1. Employee bargaining power
2. Employee replacement cost
3. Employee exit costs
4. Manager bargaining power

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 Evaluating Firm Performance

Balanced Scorecard Financial Ratio

Analysis Analysis
• Employees • Balance sheet

• Owners • Income statement

• Customer satisfaction • Market valuation

• Internal processes • Historical comparison

• Comparison with
• Innovation, learning &
industry norms
improvement activities
• Comparison with key
• Financial perspectives
competitors

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 Financial Ratio Analysis

Five types of financial ratios:

1. Short-term solvency or liquidity
2. Long-term solvency measures
3. Asset management or turnover
4. Profitability
5. Market value
Meaningful ratio analysis must include:
• Analysis of how ratios change over time
• Comparison with industry norms
• Comparison with key competitors

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 The Balanced Scorecard

A meaningful integration of many issues that

come into evaluating performance
Four key perspectives:
1. How do customers see us? (customer
perspective)
2. What must we excel at? (internal perspective)
3. Can we continue to improve and create value?
(innovation & learning perspective)
4. How do we look to shareholders? (financial
perspective)

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 Customer Perspective vs. Internal
Business Perspective

Managers articulate goals for customer concerns.

• Time versus Quality
• Performance and service versus Cost
Then focus on those critical internal operations
that enable them to satisfy customer needs.
• Business processes
• Cycle time, quality, employee skills, productivity
• Decisions
• Coordinated actions
• Key resources and capabilities

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 Innovation and Learning Perspective

Managers must make frequent changes to

existing products & services as well as introduce
entirely new products with extended capabilities.
This requires:
• Human capital (skills, talent, knowledge)
• Information capital (information systems,
networks)
• Organization capital (culture, leadership)

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 Financial Perspective

Managers must measure how the firm’s strategy,

implementation, and execution are indeed
contributing to bottom line improvement. Financial
goals include:
• Profitability, growth, shareholder value
This should lead to:
• Improved sales
• Increased market share
• Reduced operating expenses
• Higher asset turnover

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 Limitations of the Balanced Scorecard

• Not a “quick fix” – needs proper execution

• Needs a commitment to learning
• Needs employee involvement in continuous
process improvement
• Needs cultural change
• Needs a focus on nonfinancial rather than
financial measures
• Needs data on actual performance

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