The Internal Environment

Chapter 3
The Internal Environment:

Resources, Capabilities and
Core Competencies
Michael
Michael A.
A. Hitt
Hitt
R.
R. Duane
Duane Ireland
Ireland
Robert
Robert E.
E. Hoskisson
Hoskisson
©2000 South-Western College Publishing
Ch3
Learning Objectives
1. Explain the need for firms to study and

understand their internal environment.
2. Define value and discuss its importance.
3. Describe the differences between tangible
and intangible resources.
4. Define capabilities and discuss how they are
developed.
Ch3
Learning Objectives Continued
5. Describe four criteria used to determine

whether resources and capabilities are core
competencies.
6. Explain how value chain analysis is used to
identify and evaluate resources and capabilities.
7. Define outsourcing and discuss the reasons for
its use.
8. Discuss the importance of identifying internal
strengths and weaknesses.
Ch3
Chapter 2
Strategic External
Environment
The Strategic
Management
Inputs
Strategic Intent
Strategic Mission
Chapter 3
Internal
Environment
Process
Strategy Formulation Strategy Implementation
Chapter 4 Chapter 5 Chapter 6 Chapter 10 Chapter 11

Business-Level Competitive Corporate-Level Corporate Structure
Strategic
Actions
Strategy Dynamics Strategy Governance & Control
Chapter 7 Chapter 8 Chapter 9 Chapter 12 Chapter 13

Acquisitions & International Cooperative Strategic Entrepreneurship
Restructuring Strategy Strategies Leadership & Innovation
Outcomes
Strategic
Strategic
Competitiveness
Feedback Above Average
Returns
Ch3
Value and It’s Importance
• Is measured by a product’s performance

characteristics and by its attributes for
which customers are willing to pay
• Firms create value by innovatively
building and leveraging their resources
and capabilities
• Firms unable to create value for
customers suffer performance declines
Ch3
Chapter 2
External Environment
What the Firm Might Do
Sustainable
Competitive
Advantage
Chapter 3
Internal Environment
What the Firm Can Do
Ch3
Competitive
Discovering Core Advantage
Gained through
Competencies Core Competencies
Strategic
Competitiveness
Discovering Above-Average
Core Returns
Core
Competencies
Competencies
Sources of
Competitive
Advantage
Capabilities Criteria of Value

Teams of Sustainable Chain
Resources Advantages Analysis
Resources
* Tangible
* Valuable * Outsource
* Intangible * Rare
* Costly to Imitate
* Nonsubstitutable Ch3
Key Questions for Managers
in Internal Analysis
How do we assemble bundles of Resources,
Capabilities and Core Competencies to create
VALUE for customers?
And...
Will environmental changes make our core
competencies obsolete?
Are substitutes available for our core

competencies?
Are our core competencies easily imitated?
Ch3
Conditions Affecting Managerial Decisions About
Resources, Capabilities and Core Competencies
Uncertainty
regarding characteristics of the general and the
industry environments, competitor’s actions, and
customer’s preferences.
Complexity
regarding the interrelated causes shaping a firm’s
environments and perceptions of the environments
Intraorganizational Conflicts
among people making managerial decisions and
those affected by them Ch3
Discovering Core
Competencies
Resources
* Tangible
* Intangible
Ch3-
Resources What a firm Has...
What a firm has to work with:

its assets, including its people and
the value of its brand name
Ch3-
its assets, including its people
and the value of its brand name
Resources represent inputs into a

firm’s production process...
such as capital equipment, skills of
employees, brand names, finances
and talented managers
Ch3-
Resources represent inputs into a

firm’s production process...
such as capital equipment, skills
of employees, brand names,
finances and talented managers
“Some genius invented the Oreo. We’re just

living off the inheritance.” F. Ross Johnson,
Former President & CEO,
RJR Nabisco
Ch3-
Tangible Resources
* Financial
* Physical Resources represent inputs into a
* Human Resources firm’s production process...
* Organizational
such as capital equipment, skills
of employees, brand names,
finances and talented managers
Intangible Resources
* Technological
“Some genius invented the Oreo.
* Innovation We’re just living off the inheritance.”
* Reputation F. Ross Johnson,
Former President & CEO, RJR Nabisco
Ch3-
Discovering Core
Competencies
Capabilities
Teams of
Resources
Resources
* Tangible
* Intangible
Ch3-
Capabilities What a firm Does...
Capabilities represent:
the firm’s capacity or ability to integrate
individual firm resources to achieve a desired
objective.
Ch3-
the firm’s capacity or ability to integrate individual
firm resources to achieve a desired objective.
Capabilities develop over time as a result of complex

interactions that take advantage of the interrelationships
between a firm’s tangible and intangible resources that
are based on the development, transmission and
exchange or sharing of information and knowledge as
carried out by the firm's employees.
Ch3-
the firm’s capacity or ability to integrate individual
firm resources to achieve a desired objective.
Capabilities develop over time as a result of complex
interactions that take advantage of the interrelationships
between a firm’s tangible and intangible resources that are
based on the development, transmission and exchange or
sharing of information and knowledge as carried out by the
firm's employees.
Capabilities become important when they are combined
in unique combinations which create core competencies
which have strategic value and can lead to competitive
advantage.
Ch3-
Discovering Core
Competencies
Discovering
Core
Core
Competencies
Competencies
Sources of
Competitive
Advantage
Capabilities
Teams of
Resources
Resources
* Tangible
* Intangible
Ch3-
Core Competencies What a firm Does...
that is Strategically
Valuable
“…are the essence of what makes an organization

unique in its ability to provide value to
customers.”
Leonard-Barton, Bowen, Clark, Holloway & Wheelwright
McKinsey & Co. recommends identifying three to four

competencies to use in framing strategic actions.
Ch3-
Discovering Core
Competencies
Discovering
Core
Core
Competencies
Competencies
Sources of
Competitive
Advantage
Capabilities Criteria of
Teams of Sustainable
Resources Advantages
Resources
* Valuable
* Tangible
* Intangible * Rare
* Costly to Imitate
* Nonsubstitutable * Outsource
Ch3-
For a strategic capability to be a
Valuable
Core Competency, it must be:
Valuable
Rare
Costly to Imitate
Nonsubstitutable
Ch3-
Valuable
Valuable
Capabilities that help a firm neutralize threats or exploit
opportunities
Rare
Capabilities that are not possessed by many others
Costly to Imitate
Capabilities that other firms cannot develop easily,
usually due to unique historical conditions, causal
ambiguity or social complexity Ch3-
What Criteria Make Core
Competencies Costly to Imitate?
Unique Historical Conditions
An unusual evolutionary pattern of growth may contribute to the
development of competencies in a manner that is unique to those
particular circumstances
Example: Disney created Mickey Mouse at a time when
animated motion pictures were new
Causal Ambiguity
This occurs when competitors are unable to detect how a firm uses
its competencies as a foundation for competitive advantage
Social Complexity
Occurs when the firm’s capabilities are the result of complex social
phenomena, such as interpersonal relationships, trust and friendships
among managers or a firm’s reputation with suppliers and customers
Ch3-
Core Competencies must be: that is Strategically
Valuable
Valuable
Capabilities that either help a firm to exploit opportunities to
create value for customers or to neutralize threats in the
environment
Rare
Capabilities that are possessed by few, if any, current or potential
competitors
Costly to Imitate
Capabilities that other firms cannot develop easily, usually due to
unique historical conditions, causal ambiguity or social complexity
Nonsubstitutable
Capabilities that do not have strategic equivalents, such as firm-
specific knowledge or trust-based relationships Ch3-
Core Competencies
Resources Core Competence

• Inputs to a firm’s
• A strategic capability
production process
Does the capability satisfy

the criteria of sustainable YES
The source of Capability competitive advantage?
• Integration of a
team of resources NO
Capability
• A nonstrategic team
of resources
Ch3-
Outcomes from Combinations of the Criteria for
Sustainable Competitive Advantage
Costly to Nonsub- Competitive Performance
Valuable Rare
Imitate stitutable Consequences Implications
Below
Competitive
NO NO NO NO Average
Disadvantage
Returns
Competitive Average
YES NO NO YES/NO
Parity Returns
Temporary Aver./Above
YES YES NO YES/NO Competitive Average
Advantage Returns
Sustainable Above
YES YES YES YES Competitive Average
Advantage Returns
Ch3-
Discovering Core
Competencies
Discovering
Core
Core
Competencies
Competencies
Sources of
Competitive
Advantage

Resources
* Valuable
* Tangible
* Intangible * Rare
* Costly to Imitate
* Nonsubstitutable * Outsource Ch3-
Value Chain Analysis
Identifying Resources and Capabilities That Can Add Value
Support
Activities
Primary Activities Ch3-

Support
Activities
Logistics
Inbound

Support
Activities
Operations
Logistics
Inbound

Support
Activities
Operations
Outbound
Logistics
Logistics
Inbound

Support
Activities
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics

Support
Activities
Service
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics

Support
Activities
Procurement
Service
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics

Support
Activities
Technological Development
Procurement
Service
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics

Support
Human Resource Management
Activities
Procurement
Service
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics

Firm Infrastructure
Support
Activities
Procurement
Service
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics

Firm Infrastructure
Human Resource Management M
Support A
R
Activities G
Technological Development IN
Procurement
Service
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics
IN
RG
A
M
Outsourcing
Strategic Choice to Purchase Some Activities From Outside Suppliers
Firm Infrastructure
Support A
R
Activities G
Technological Development IN
Procurement
Service
Operations
Outbound
Marketing
Logistics
Inbound
& Sales
Logistics
IN
RG
A
M
Outsourcing
Strategic Choice to Purchase Some Activities From Outside Suppliers
Firm Infrastructure

Support A
Firms often purchase a portion
Technological Development R activities
Activities G
of their value-creating
Technological Development IN suppliers
from specialty external
Procurement
who can perform these functions
Procurement more efficiently
Service
Operations
Outbound
Marketing
Service
Logistics
Inbound
& Sales
Logistics
IN
RG
Outbound
Inbound Operations Logistics Marketing
A
& Sales
M
Logistics

Strategic Rationales for Outsourcing
Improve Business Focus
Lets company focus on broader business issues by having outside
experts handle various operational details
Provide Access to World-Class Capabilities
The specialized resources of outsourcing providers makes world-
class capabilities available to firms in a wide range of applications
Accelerate Business Re-Engineering Benefits
Achieves re-engineering benefits more quickly by having outsiders--
who have already achieved world-class standards--take over process
Share Risks
Reduces investment requirements and makes firm more flexible,
dynamic and better able to adapt to changing opportunities
Free Resources for Other Purposes

Permits firm to redirect efforts from non-core activities toward those
that serve customers more effectively Ch3-
To capitalize on the usefulness of the
Value Chain concept...
it is important to recognize that...
Ch3-
Value Chains are part of a Total Value System
Supplier Value Chain Firm Value Chain Channel Value Chain Buyer Value Chain
Ch3-
Firm Value Chain Channel Value Chain Buyer Value Chain
Supplier Value Chain
Upstream Value
Perform valuable activities that

complement the firm’s activities
Ch3-
Supplier Value Chain Firm Value Chain Buyer Value Chain
Upstream Value Channel Value Chain

Each firm must eventually find a way to

become a part of some buyer’s value chain
Ch3-
Supplier Value Chain Firm Value Chain Channel Value Chain
Upstream Value Each firm must eventually Buyer Value Chain

find a way to become a part of
Perform valuable activities that some buyer’s value chain
Ultimate basis for differentiation is the ability

to play a role in a buyer’s value chain
This creates VALUE!!
Ch3-
Supplier Value Chain Firm Value Chain Channel Value Chain Buyer Value Chain
Upstream Value Each firm must eventually find a way to

become a part of some buyer’s value chain
complement the firm’s activities Ultimate basis for differentiation is the
ability to play a role in a buyer’s value chain
This creates VALUE!!
Value chains vary for firms in an industry,

reflecting each firm’s unique qualities:
• History
• Strategy
• Success at Implementation
Ch3-
Core Competencies--Cautions and Reminders
Never take for granted that core competencies will
continue to provide a source of competitive advantage
All core competencies have the potential to become

Core Rigidities
Core Rigidities are former core competencies that sow
the seeds of organizational inertia and prevent the firm
from responding appropriately to changes in the
external environment
Strategic myopia and inflexibility can strangle the firm’s
ability to grow and adapt to environmental change or
competitive threats
Ch3-
Discovering Core
Competencies
Strategic
Competitiveness
Core Returns
Core
Competencies
Competencies
Sources of
Competitive
Advantage

Resources
* Valuable
* Tangible
* Intangible * Rare
* Costly to Imitate * Outsource
* Nonsubstitutable Ch3-
Chapter 2
External The Strategic
Environment
Strategic
Strategic Intent
Intent Management
Chapter 3
Strategic Mission
Process
Internal
Environment
Ch3-
Chapter 2
External
Environment
The Strategic
Strategic Intent
Chapter 3
Strategic Mission
Management
Process
Internal
Environment
Strategic Intent
Ch3-
Chapter 2
External
Environment Strategic Intent
The Strategic
Chapter 3 Strategic Mission Management
Process
Internal
Environment
Leveraging of a firm’s resources,

capabilities and core competencies
Strategic Intent to accomplish what may appear to
be unattainable goals in the compe-
titive environment
A statement of the firm’s unique

purpose and the scope of its
Strategic Mission operations in product market
terms
Ch3-
Competitive
Discovering Core Advantage
Gained through
Competencies Core Competencies
Strategic
Competitiveness
Core Returns
Core
Competencies
Competencies
Sources of
Competitive
Advantage

Resources
* Valuable
* Tangible
* Intangible * Rare
* Costly to Imitate * Outsource
* Nonsubstitutable Ch3-
Ch3-

The Internal Environment

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The Internal Environment

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Chapter 3

The Internal Environment:

1. Explain the need for firms to study and

5. Describe four criteria used to determine

Strategy Formulation Strategy Implementation

Chapter 4 Chapter 5 Chapter 6 Chapter 10 Chapter 11

Strategy Dynamics Strategy Governance & Control

Chapter 7 Chapter 8 Chapter 9 Chapter 12 Chapter 13

• Is measured by a product’s performance

Capabilities Criteria of Value

Are substitutes available for our core

What a firm has to work with:

Resources represent inputs into a

Resources represent inputs into a

“Some genius invented the Oreo. We’re just

Capabilities develop over time as a result of complex

“…are the essence of what makes an organization

McKinsey & Co. recommends identifying three to four

Resources Core Competence

Does the capability satisfy

Capabilities Criteria of Value

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Primary Activities Ch3-

Human Resource Management M

Primary Activities Ch3-

Free Resources for Other Purposes

it is important to recognize that...

Firm Value Chain Channel Value Chain Buyer Value Chain

Supplier Value Chain

Perform valuable activities that

Supplier Value Chain Firm Value Chain Buyer Value Chain

Upstream Value Channel Value Chain

Perform valuable activities that

Each firm must eventually find a way to

Supplier Value Chain Firm Value Chain Channel Value Chain

Upstream Value Each firm must eventually Buyer Value Chain

Ultimate basis for differentiation is the ability

This creates VALUE!!

Upstream Value Each firm must eventually find a way to

This creates VALUE!!

Value chains vary for firms in an industry,

All core competencies have the potential to become

Capabilities Criteria of Value

Leveraging of a firm’s resources,

A statement of the firm’s unique

Capabilities Criteria of Value

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