Strategic Management - Concepts and Cases (Frank T. Rothaermel, 3e, 2016)

1. Chapter 4
Internal Analysis: Resources, Capabilities, and
Core Competencies

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The AFI Strategy Framework
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description
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Chapter 4 Outline
4.1 Core Competencies
4.2 The Resource-Based View
– Two Critical Assumptions
– The VRIO Framework
– Isolating Mechanisms: How to Sustain a Competitive
Advantage
4.3 The Dynamic Capabilities Perspective
4.4 The Value Chain Analysis
4.5 Implications for the Strategist
– Using SWOT Analysis to Generate Insights from External
and Internal Analysis

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Learning Objectives (1 of 2)
LO 4-1 Differentiate among a firm’s core competencies,
resources, capabilities, and activities.
LO 4-2 Compare and contrast tangible and intangible
resources.
LO 4-3 Evaluate the two critical assumptions behind the
resource-based view.
LO 4-4 Apply the VRIO framework to assess the
competitive implications of a firm’s resources.

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Learning Objectives (2 of 2)
LO 4-5 Evaluate different conditions that allow a firm to
sustain a competitive advantage.
LO 4-6 Outline how dynamic capabilities can enable a
firm to sustain a competitive advantage.
LO 4-7 Apply a value chain analysis to understand which
of the firm’s activities in the process of
transforming inputs into outputs generate
differentiation and which drive costs.
LO 4-8 Conduct a SWOT analysis to generate insights
from external and internal analysis and derive
strategic implications.

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Core Competencies

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What Are Core Competencies?
• Unique strengths
• Embedded deep within a firm
• Allow a firm to differentiate its products and services
from those of its rivals
• Results in:
– Creating higher value for the customer or
– Offering products and services at lower cost

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Exhibit 4.1 Competitive Advantage based on Core
Competencies, Resources, Capabilities
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Examples of Core Competencies
• IKEA
– Superior in designing modern functional home furnishings at low cost
• Beats Electronics
– Superior marketing: perception of coolness
• Facebook
– Superior algorithms to offer targeted online ads
• General Electric
– Superior expertise in industrial engineering, designing and
implementing efficient management processes, and developing and
training leaders

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Resources, Capabilities and Activities Help Deliver
Core Competencies
• Resources:
– Any assets that a firm can draw on
• Capabilities:
– Organizational and managerial skills
• Activities:
– Distinct and fine-grained business processes

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Exhibit 4.3 Links to Competitive Advantage and
Superior Firm Performance
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description

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The Resource-Based View

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What is the Resource Based View (RBV)?
• A model that sees certain types of resources (VRIO)
as key to superior firm performance
– Valuable
– Rare
– Costly to Imitate
– Organized to Capture Value
• Resources fall into two categories:
– Tangible
– Intangible

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Exhibit 4.4 Tangible and Intangible Resources
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Example Google Headquarters
• Tangible Resource
– Googleplex: land + futuristic building
• Intangible Resource
– Location: heart of Silicon Valley
• Large & computer savvy workforce
• Largest concentration of venture capitalists in the U.S.

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Two Critical Assumptions of the RBV
• Resource Heterogeneity
– A firm is bundle of resources and capabilities that differ
across firms
• Resource Immobility
– A firm has resources that tend to be “sticky” and that do
not move easily from firm to firm

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Exhibit 4.5 The VRIO Decision Tree
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A Resource is Valuable If…
• It enables the firm to exploit an opportunity.
• It enables the firm to offset a threat.
• It enables a firm to increase its economic value
creation (V – C).
• Example: Beats Electronics:
– Design and marketing of premium headphones
• Production = ~$15
• Retail = $150 - $450

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A Resource is Rare If…
• Only one or a few firms possess it
• Example: Beats Electronics:
– Product placement
– Vast celebrity endorsement

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A Resource Is Costly to Imitate If…
• Firms that do not possess the resource are unable to
develop or buy the resource at a reasonable price.
• Example: Beats Electronics:
– Dr. Dre relies on gut instinct in making decisions rather
than market research.
– The social capital of Dr. Dre and Jimmy Lovine might be
impossible to replicate.

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A Resource Is Organized to Capture Value If…
• It has an effective organizational structure.
• It has coordinating systems.
• Example: Xerox Palo Alto Research Center:
– Developed the first word-processing application Graphical
User Interface (GUI), Ethernet, Mouse, Personal Computer
– These innovations did not fit within the Xerox focus.
– Management was busy pursuing innovations in the
photocopier business.

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Strategy Highlight 4.1
The Rise and Fall of Groupon
• A daily-deal website, offering group coupons
• Grew quickly
– 260 million subscribers, 500,000 merchants
– $6 billion buyout offer (Google 2011), was declined
• It was valuable, and rare, but not costly to imitate.
– More specialized local startups began

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Isolating Mechanisms
• Barriers to imitation
• Protect resources, capabilities, or competencies that
underlie a firm’s competitive advantage.
• How:
1. Better expectations of future resource value
2. Path dependence
3. Causal ambiguity
4. Social complexity
5. Intellectual property (IP) protection

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The Dynamic Capabilities Perspective

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Dynamic Capabilities
• A firm’s ability to:
– Create, deploy, modify, reconfigure, upgrade, and leverage
its resources over time
• Helps prevent a core rigidity
– A former core competency that turned into a liability as
the environment changed

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Strategy Highlight 4.2 (1 of 2)
Dynamic Capabilities at IBM
• IBM is a solutions company
– Solves data-based problems for clients
– The data / the problems change over time
• Has successfully transformed itself several times over
its 100-year history

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Strategy Highlight 4.2 (2 of 2)
Dynamic Capabilities at IBM
• Current disruptions:
– Cloud computing
– Systems of engagement
– Big data and analytics

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The Dynamic Capabilities Perspective
• A model that emphasizes a firm’s ability to:
– Modify and leverage its resource base
– Gain and sustain competitive advantage in a constantly
changing environment

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Resource Stocks and Flows
• Resource stocks
– The firm’s current level of intangible resources
• Resource flows
– The firm’s level of investments to maintain or build a
resource

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Exhibit 4.7 The Bathtub Metaphor
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SOURCE: Figure based on metaphor
used in I. Dierickx and K. Cool (1989),
“Asset stock accumulation and
sustainability of competitive
advantage,” Management Science
35: 1504–1513.

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The Value Chain Analysis

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What Is the Value Chain?
• Internal activities a firm engages in when
transforming inputs into outputs
• Each activity adds incremental value
– Primary activities directly add value
– Support activities add value indirectly
• Example: Beats Electronics:
– Headphones designed by Dr. Dre
– Packaging: premium unboxing experience
– Superb displays in Apple stores

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Exhibit 4.8 The Value Chain
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Primary Activities
• Firm activities that add value directly
• Transform inputs into outputs as the firm moves a
product or service horizontally along the internal
value chain.
• Examples:
– Supply chain management
– Operations
– Distribution
– Marketing and sales
– After-sales service

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Support Activities
• Firm activities that add value indirectly
• Necessary to sustain primary activities
– Research and development (R&D)
– Information systems
– Human resources
– Accounting and finance
– Firm infrastructure including processes, policies, and
procedures

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Implications for the Strategist

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How to Generate Additional Insights
• SWOT analysis combines external and internal
analysis:
– External analysis: Covered in Chapter 3
– Internal analysis: Covered in Chapter 4
• Purpose:
– Leverage internal strengths to exploit external
opportunities
– Mitigate internal weaknesses and external threats

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SWOT Analysis
• A framework that allows managers to synthesize
insights obtained from an internal and external
analysis to derive strategic implications
• Internal Analysis
– Strengths
– Weaknesses
• External Analysis
– Opportunities
– Threats

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Strategic SWOT Questions
• How can the firm use strengths to take advantage of
opportunities?
• How can the firm use strengths to reduce the
likelihood and impact of threats?
• How can the firm overcome weaknesses that prevent
the firm from taking advantage of opportunities?
• How can the firm overcome weaknesses that will
make threats a reality?

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The Final Step…
• Evaluate the pros and cons of each strategic
alternative.
• Select one or more alternatives to implement.
• Carefully explain decision rationale.
– Including why other strategic alternatives were rejected

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A Word of Caution
• A strength can also be a weakness.
• An opportunity can also be a threat.
• Example:
– Google is located in Silicon Valley.
• Strength: near Universities
• Weakness: high cost of living

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Chapter 4 Summary

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Take Away Concepts (1 of 8)
LO 4-1 Differentiate among a firm’s core competencies, resources,
capabilities, and activities.
• Core competencies are unique, deeply embedded, firm-specific strengths
that allow companies to differentiate their products and services and thus
create more value for customers than their rivals, or offer products and
services of acceptable value at lower cost.
• Resources are any assets that a company can draw on when crafting and
executing strategy.
• Capabilities are the organizational and managerial skills necessary to
orchestrate a diverse set of resources to deploy them strategically.
• Activities are distinct and fine-grained business processes that enable firms
to add incremental value by transforming input into goods and services.

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Take Away Concepts (2 of 8)
LO 4-2 Compare and contrast tangible and intangible resources.
• Tangible resources have physical attributes and are visible.
• Intangible resources have no physical attributes and are invisible.
• Competitive advantage is more likely to be based on intangible
resources.

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Take Away Concepts (3 of 8)
LO 4-3 Evaluate the two critical assumptions behind the resource-based
view.
• The first critical assumption—resource heterogeneity—is that
bundles of resources, capabilities, and competencies differ across
firms. The resource bundles of firms competing in the same industry
(or even the same strategic group) are unique to some extent and
thus differ from one another.
• The second critical assumption—resource immobility—is that
resources tend to be “sticky” and don’t move easily from firm to firm.
Because of that stickiness, the resource differences that exist
between firms are difficult to replicate and, therefore, can last for a
long time.

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Take Away Concepts (4 of 8)
LO 4-4 Apply the VRIO framework to assess the competitive implications of
a firm’s resources.
• For a firm’s resource to be the basis of a competitive advantage, it must have VRIO
attributes: valuable (V), rare (R), and costly to imitate (I). The firm must also be able
to organize (O) in order to capture the value of the resource.
• A resource is valuable (V) if it allows the firm to take advantage of an external
opportunity and/or neutralize an external threat. A valuable resource enables a firm to
increase its economic value creation (V – C).
• A resource is rare (R) if the number of firms that possess it is less than the number of
firms it would require to reach a state of perfect competition.
• A resource is costly to imitate (I) if firms that do not possess the resource are unable
to develop or buy the resource at a comparable cost.
• The firm is organized (O) to capture the value of the resource if it has an effective
organizational structure, processes, and systems in place to fully exploit the
competitive potential.

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Take Away Concepts (5 of 8)
LO 4-5 Evaluate different conditions that allow a firm to sustain a
competitive advantage.
• Several conditions make it costly for competitors to imitate the
resources, capabilities, or competencies that underlie a firm’s
competitive advantage: (1) better expectations of future resource
value (or simply luck), (2) path dependence, (3) causal ambiguity,
and (4) social complexity.
• These barriers to imitation are isolating mechanisms because they
prevent rivals from competing away the advantage a firm may enjoy.

48. ©McGraw-Hill Education.
Take Away Concepts (6 of 8)
LO 4-6 Outline how dynamic capabilities can enable a firm to sustain a
competitive advantage.
• To sustain a competitive advantage, any fit between a firm’s internal
strengths and the external environment must be dynamic.
• Dynamic capabilities allow a firm to create, deploy, modify, reconfigure, or
upgrade its resource base to gain and sustain competitive advantage in a
constantly changing environment.

49. ©McGraw-Hill Education.
Take Away Concepts (7 of 8)
LO 4-7 Apply a value chain analysis to understand which of the firm’s
activities in the process of transforming inputs into outputs generate
differentiation and which drive costs.
• The value chain describes the internal activities a firm engages in when transforming
inputs into outputs.
• Each activity the firm performs along the horizontal chain adds incremental value and
incremental costs.
• A careful analysis of the value chain allows managers to obtain a more detailed and
fine-grained understanding of how the firm’s economic value created breaks down
into a distinct set of activities that helps determine perceived value and the costs to
create it.
• When a firm’s set of distinct activities is able to generate value greater than the costs
to create it, the firm obtains a profit margin (assuming the market price the firm is able
to command exceeds the costs of value creation).

50. ©McGraw-Hill Education.
Take Away Concepts (8 of 8)
LO 4-8 Conduct a SWOT analysis to generate insights from external and
internal analysis and derive strategic implications.
• Formulating a strategy that increases the chances of gaining and
sustaining a competitive advantage is based on synthesizing
insights obtained from an internal analysis of the company’s
strengths (S) and weaknesses (W) with those from an analysis of
external opportunities (O) and threats (T).
• The strategic implications of a SWOT analysis should help the firm
to leverage its internal strengths to exploit external opportunities,
while mitigating internal weaknesses and external threats.

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Key Terms
• Activities
• Capabilities
• Causal ambiguity
• Core competencies
• Core rigidity
• Costly-to-imitate resource
• Dynamic capabilities
• Dynamic capabilities perspective
• Intangible resources
• Intellectual property (IP) protection
• Isolating mechanisms
• Organized to capture value
• Path dependence
• Primary activities
• Rare resource
• Resource-based view
• Resource flows
• Resource heterogeneity
• Resource immobility
• Resource stocks
• Resources
• Social complexity
• Support activities
• SWOT analysis
• Tangible resources
• Valuable resource
• Value chain
• VRIO framework

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Chapter 4 Cases & Exercises

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Chapter Case 4: Consider This… (1 of 2)
• Did Apple purchase Beats for its talent?
– Talents of Beats co-founders (Iovine & Dr. Dre)
• They have creative talent.
• They have a successful track record.
• They have deep & far reaching networks.
– Apple has lacked visionary leadership since Jobs’
death.
• Both Iovine and Dr. Dre are taking on leadership roles at
Apple.
– Bringing in flashy celebrities might have been
unthinkable for Jobs.

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Chapter Case 4: Consider This… (2 of 2)
• Do you agree that Beats Electronics’ core
competencies are its marketing savvy and Dr. Dre’s
coolness factor?
• What are the potential downsides of this multi-
billion- dollar “acqui-hire?”
• Do you think these competencies will remain as
valuable under Apple?
• Why do you think Apple purchased Beats?

55. ©McGraw-Hill Education.
My Strategy Exercise
What Is My Competitive Advantage?
• What are your strengths and weaknesses?
• What are you doing to ensure your capabilities
are dynamic?
– Skill upgrades, behavior modifications, etc.
• Are some of your strengths valuable, rare, and
costly to imitate?
• How could you persuade your boss that you
could be a vital source of sustainable
competitive advantage?

56. ©McGraw-Hill Education.
Small Group Exercise #1
• Brand valuation: can be a key intangible resource
• Develop two or three examples:
– Products being called the brand name vs. the product type
• Does such brand valuation give the leading brand a
competitive advantage?
– Or does it produce confusion in the market for all products
or services in that category?
• Provide advice to the leading brand.

57. ©McGraw-Hill Education.
Small Group Exercise #2 (1 of 2)
• Groupon:
– Vision: to be a global leader in local commerce
– Core Competency: local market making
• Low barriers to entry
• Easily imitated

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Small Group Exercise #2 (2 of 2)
• How might Groupon reinvest or upgrade its
technology and sales skills so it builds a global
customer base?
• Brainstorm ways that Groupon might add value for
its customers.

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End of Chapter 4

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Strategy Smart Videos

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Strategy Smart Videos (1 of 6)
• Jay Barney
• Resource Based View of the Firm
• Link:
– https://www.youtube.com/watch?v=-KN81_oYl1s
• 4:23 Minutes

62. ©McGraw-Hill Education.
Strategy Smart Videos (2 of 6)
• Honda: The Power of Dreams
• Competencies are honed over long periods of
time through learning from failure
• Link:
– http://www.youtube.com/watch?v=1bPzCZCmMfQ
• 8:22 Minutes

63. ©McGraw-Hill Education.
Strategy Smart Videos (3 of 6)
• Steve Jobs and Bill Gates
• 2007 Interview, Core Competencies discussed
• Link:
– https://www.youtube.com/watch?v=85PMSYAguZ8
• 15:05 Minutes

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Strategy Smart Videos (4 of 6)
• Steve Jobs
• Rare footage from 1980, discussing Competitive
Advantage and Capabilities
• Link:
– https://www.youtube.com/watch?v=0lvMgMrNDlg
• 22:54 Minutes

65. ©McGraw-Hill Education.
Strategy Smart Videos (5 of 6)
• Beats Electronics by Dr. Dre
• Commercial: Hear What You Want
• Link:
– https://www.youtube.com/watch?v=4Ttsx5squWg
• 2:47 minutes

66. ©McGraw-Hill Education.
Strategy Smart Videos (6 of 6)
• Caroline Cummings, VP of Business Development at
Palo Alto Software
• What is a SWOT Analysis?
• Link:
– https://www.youtube.com/watch?v=4aFB9xrkdiU
• 3:43 minutes

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Chapter Case 4

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Chapter Case 4: Beats by Dr. Dre (1 of 2)
• Dr. Dre (Andrew Young)
– First hip-hop billionaire
– Successful music producer, rapper, and entrepreneur
– Strong work ethic, expects perfection
– One of the best-connected businesspeople in music
– Founded Beats Electronics: premium headphones
• Apple acquired Beats Electronics for $3 billion
– Largest acquisition in Apple’s history
– Hoping that some of Beats’ coolness will spill over to
its brand

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Chapter Case 4: Beats by Dr. Dre (2 of 2)
• Beats Coolness Factor
– Celebrity endorsements
• Music celebrities wore them in their music videos.
• Famous athletes wear them in public.
– Custom Beats created for stars
• Disruption in Content Delivery
– Changing from downloads to streaming
– Apple is lagging behind Pandora
• iTunes radio was created in 2013, has been falling flat

70. ©McGraw-Hill Education.
Appendix 1 The AFI Strategy Framework
The important inside circle is titled "Gaining and Sustaining a Competitive Advantage" that is at the very center of the image, with
five different circles on on the outside of it. Arrows go back and forth from the center circle to each of the five outer circles. The
five outer circles are labeled: (1) Getting Started, (2) External and Internal Analysis, (3) Formulation: Business Strategy, (4)
Formulation, Corporate Strategy, and (5) Implementation.
Each of these outer five circles have a brief description beside them to explain what the circle means:
Under the first outer circle titled "Getting Started", it says: Part 1, Strategy Analysis, "What is Strategy (Chapter 1)" and "Strategic
Leadership: Managing the Strategy Process (Chapter 2)".
Under the second outer circle titled "External and Internal Analysis", it says: Part 1, Strategy Analysis, "External Analysis: Industry
Structure, Competitive Forces and Strategic Groups (Chapter 3)", "Internal Analysis: Resources, Capabilities and Core
Competencies (Chapter 4)", and "Competitive Advantage, Firm Performance, and Business Models (Chapter 5)".
Under the third outer circle titled "Formulation: Business Strategy", it says: Part 2, Strategy Formulation, "Business Strategy:
Differentiation, Cost Leadership and Integration (Chapter 6)" and "Business Strategy, Innovation and Entrepreneurship (Chapter
7)".
Under the fourth outer circle titled "Formulation: Corporate Strategy", it says: Part 2, Strategy Formulation, "Corporate Strategy:
Vertical Integration and Diversification (Chapter 8)", "Corporate Strategy: Strategic Alliances, Mergers and Acquisitions (Chapter
9)", and "Global Strategy: Competing Around the World (Chapter 10)".
Under the fifth outer circle titled "Implementation", it says: Part 3, Strategy Implementation, "Organizational Design: Structure,
Culture and Control (Chapter 11)", and "Corporate Governance and Business Ethics (Chapter 12)".
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71. ©McGraw-Hill Education.
Appendix 2 Exhibit 4.1 Competitive Advantage based on Core
Competencies, Resources, Capabilities
This image shows circles within several circles. The center-most circle is titled
"Firm". That circle is contained within another circle titled, "Strategic Group."
That circle is contained within another circle titled, "Industry." That circle is
contained within another circle titled, "External Environment." The External
Environment circle contains six arrows pointing inward, and they are titled:
Economic, Sociocultural, Technological, Ecological, Legal and Political.
The focus in this picture is on the center circle, titled "Inside the Firm, Core
Competencies, Resources, and Capabilities"
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72. ©McGraw-Hill Education.
Appendix 3 Exhibit 4.3 Links to Competitive
Advantage and Superior Firm Performance
The first box is titled "Resources" and has an arrow pointing towards the
second box titled "Core Competencies". The third box is titled "Capabilities"
and has an arrow pointing towards the second box titled "Core
Competencies". The second box titled "Core Competencies" has an arrow
pointing towards a fourth box titled "Activities". The fourth "Activities" box
has an arrow pointing towards a fifth box titled "Competitive Advantage". The
fifth box titled "Competitive Advantage" has an arrow pointing towards a
sixth box titled "Superior Firm Performance." The sixth box titled "Superior
Firm Performance has two arrows coming out of it, one pointing towards the
first box titled "Resources", and one pointing towards the third box titled
"Capabilities." Labels along these arrow lines are titled "Reinvest, Hone, and
Upgrade."
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73. ©McGraw-Hill Education.
Appendix 4 Exhibit 4.4 Tangible and Intangible Resources
This image shows a box, titled "Resources" that points to two
boxes, one titled "Tangible" and the other titled "Intangible."
Tangible resources include visible, physical attributes such as
labor, capital, land, buildings, plant, equipment, and supplies.
Intangible resources include invisible, non-physical attributes
such as culture, knowledge, brand equity, reputation, and
intellectual property such as patents, designs, copyrights,
trademarks and trade secrets.
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74. ©McGraw-Hill Education.
Appendix 5 Exhibit 4.5 The VRIO Decision Tree
It is a decision tree to decide if the resource, capability, or competency under
consideration fulfills the VRIO requirements. Each of the attributes
accumulate. Only if a firm’s managers are able to answer “yes” four times to
the attributes listed in the decision tree is the resource in question a core
competency that underpins a firm’s sustainable competitive advantage.
Is the Resource Capability or Competency Valuable? If no, then there is a
Competitive Disadvantage. If yes...
Is the Resource Capability or Competency Rare? If no, then there is a
Competitive Parity. If yes...
Is the Resource Capability or Costly to Imitate? If no, then there is a
Temporary Competitive Advantage. If yes...
Is the Resource Capability or Competency Organized to Capture Value? If no,
then there is a Temporary Competitive Advantage. If yes, then there is a
Sustainable Competitive Advantage.
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75. ©McGraw-Hill Education.
Appendix 6 Exhibit 4.7 The Bathtub Metaphor
This image shows a bathtub that is being filled with water. The amount of water in the
bathtub indicates a company’s level of a specific intangible resource stock—such as its
dynamic capabilities, new product development, engineering expertise, innovation
capability, reputation for quality, and so on.
Intangible resource stocks are built through investments over time. These resource
flows are represented in the drawing by the different faucets, from which water flows
into the tub. These faucets indicate investments the firm can make in different
intangible resources. Investments in building an innovation capability, for example,
differ from investments made in marketing expertise. Each investment flow would be
represented by a different faucet.
How fast the bathtub fills, however, also depends on how much water leaks out of the
tub. The outflows represent a reduction in the firm’s intangible resource stocks.
Resource leak-age might occur through employee turnover, especially if key
employees leave. Significant re-source leakage can erode a firm’s competitive
advantage. A reduction in resource stocks can occur if a firm does not engage in a
specific activity for some time and forgets how to do this activity well.
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76. ©McGraw-Hill Education.
Appendix 7 Exhibit 4.8 The Value Chain
The primary activities add value directly as the firm transforms inputs into outputs—
from raw materials through production phases to sales and marketing and finally
customer service, specifically:
•Supply chain management.
•Operations.
•Distribution.
•Marketing and sales.
•After-sales service
Other activities, called support activities, add value indirectly. These activities include:
•Research and development (R&D).
•Information systems.
•Human resources.
•Accounting and finance.
•Firm infrastructure including processes, policies, and procedures
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