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CHAPTER 3
Assessing the Internal
Environment of the Firm

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No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
 Learning Objectives
After reading this chapter, you should be able to:
1. Identify the primary and support activities of a firm’s value chain.
2. Understand 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. Describe the resource-based view of the firm and the different types
of tangible and intangible resources, as well as organizational
capabilities.
4. Explain 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.
5. Explain the usefulness of financial ratio analysis, its inherent
limitations, and how to make meaningful comparisons of
performance across firms.
6. Identify the value of the “balanced scorecard” in recognizing how
the interests of a variety of stakeholders can be interrelated.

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 Looking Ahead

Value-Chain Analysis.

Resource-Based View of the Firm.

Evaluating Firm Performance: Two

Approaches.

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 The Important 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 direct

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

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 Question 1

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 and
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.

Access the text alternative for slide images.

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 Primary Activity: Inbound Logistics

Inbound logistics are primarily associated with

receiving, storing and 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 and Assembly.
• Testing or quality control.
• Printing.
• Facility operations.
Factors to consider include:
• Efficient plant operations and layout.
• Incorporation of appropriate process technology.

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 Primary Activity: Outbound Logistics

Outbound logistics includes collecting, storing,

and distributing the product or service to buyers.
• Finished goods and warehousing.
• Material handling.
• Delivery vehicle operation.
• Order processing, scheduling and 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 and Sales
Marketing and sales activities involve
purchases of products and services by end users,
and how to get buyers to make those purchases.
• Advertising and promotion.
• Sales force management.
• Pricing and price quoting.

• Channel selection and channel relations.

Factors to consider include:
• Innovative approaches to promotion and
advertising.
• Identification of customer segments and 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 and 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 and speed.
• Minimizing associated costs.
• Development of collaborative win-win
relationships with suppliers.
• Analysis and 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 research and development activities for
process and product initiatives.
• Collaborative relationships between research and
development and other departments.
• State-of-the-art facilities and 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 and development, and compensation of
all types of personnel.
• Effective employee recruiting, development, and
retention mechanisms.
• Quality relations with trade unions.
• Reward and incentive programs to motivate all
employees.

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 Support Activity: General Administration

General administration involves:

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

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 Example: The Value Chain in Service
Organizations

Exhibit 3.4 Some Examples of Value Chains in Service

Industries
Access the text alternative for slide images

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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 and its
competitive environment.
Resources can lead to a competitive advantage.
• If they are valuable, rare, hard to duplicate
• If tangible resources, intangible resources, and
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 and facilities, location,
machinery and equipment.
• Financial assets: cash and cash equivalents,
borrowing capacity, capacity to raise equity.
• Technological resources: data analytic
algorithms, patents, copyrights, trademarks.
• Organizational resources: effective planning
processes, evaluation and 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 and practices.
• Human resources: trust, experience and
capabilities of employees; managerial skills, firm
specific practices and procedures.
• Innovation resources: technical and scientific
expertise and ideas; innovation capabilities.
• Reputation resources: brand names, reputation
for fairness with suppliers, non-zero sum
relationships; reputation for reliability and 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.
Capacity to combine tangible and intangible
resources, using organizational processes to
attain desired ends.
• Outstanding customer service.
• Excellent product development capabilities.
• Innovativeness of products and services, and
flexibility in manufacturing processes
• Ability to hire, motivate, and retain human capital.
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 Question 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
Resources that can provide a firm with the
potential for a sustainable competitive advantage
have four attributes.
1. Valuable in formulating and 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: these 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 Is a Is a resource Is a resource or What are the
capability resource or or capability capability WITHOUT IMPLICATIONS FOR
VALUABLE? capability DIFFICULT TO SUBSTITUTES? COMPETITIVENESS?
RARE? IMITATE?

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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 Example: Building Sustainable
Competitive Advantages Through Data
Firms can use the power of artificial intelligence
to build an in-imitable sustainable advantage.
• Through path dependency based on accumulated
data that yields an in-depth understanding of
markets and operations over time.
• Through social complexity as the firm leverages
the data it collects to increase value chain
efficiencies in specialized ways.
• Through a strong culture and managerial
communication that focuses on a continual
improvement of products and services.

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 The Generation and Distribution of the
Firm’s Profits

Four factors help explain the extent to which employees

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

Other stakeholder groups can also appropriate a portion

of rents.
• Monopoly suppliers or a single buyer.
• Excessive taxation by the government.

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 Evaluating Firm Performance
Balanced Scorecard Financial Ratio
Analysis Analysis
• Employees. • Balance sheet.
• Owners. • Income statement.
• Customer • Market valuation.
satisfaction.
• Historical comparison.
• Internal processes.
• Innovation, learning • Comparison with
and improvement industry norms.
activities. • Comparison with key
• Financial competitors.
perspectives.
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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 and learning perspective)
4. How do we look to shareholders? (financial
perspective)

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 Customer Perspective vs. Internal
Business Perspective
Using the balanced scorecard, 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

The balanced scorecard requires managers to

make frequent changes to existing products and
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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 Limitation of the Balanced Scorecard

A focus on improving balance across a set of

criteria can yield consistent performance, but:
• It’s 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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