CHAPTER

3
The Internal Organization: Resources,
Capabilities, Core Competencies, and
Competitive Advantages
LEARNING OBJECTIVES
Studying this chapter should provide you with the strategic management
knowledge needed to:
1 Explain why firms need to study and understand their internal organization.
2 Define value and discuss its importance.
3 Describe the differences between tangible and intangible resources.
4 Define capabilities and discuss their development.
5 Define four criteria used to determine if resources and capabilities are core
competencies.
6 Explain how firms analyze their value chain to determine where they are able
to create value when using their resources, capabilities, and core
competencies.
7 Define outsourcing and discuss reasons for its use.
8 Discuss the importance of identifying internal strengths and weaknesses.
9 Describe the importance of avoiding core rigidities.
 Chapter Introduction (slide 1 of 2)
• Firms and organizations achieve strategic competitiveness
and earn above-average returns by acquiring, bundling, and
leveraging their resources for the purpose of taking
advantage of opportunities in the external environment in
ways that create value for customers.
• Competitors will eventually learn how to duplicate the
benefits of any firm’s value-creating strategy.
• Thus, all competitive advantages have a limited life.
 Chapter Introduction (slide 2 of 2)
• In general, a competitive advantage’s sustainability is a
function of three factors:
1. The rate of core competence obsolescence because of
environmental changes
2. The availability of substitutes for the core competence
3. The imitability of the core competence
• For all firms, the challenge is to effectively manage
current core competencies while simultaneously
developing new ones.
• Only when firms are able to do this can they expect to:
• Achieve strategic competitiveness
• Earn above-average returns
• Remain ahead of competitors in both the short and long term
 3-1 Analyzing the
Internal Organization
• By analyzing its internal organization, a firm
determines what it can do.
• Matching what a firm can do (a function of its resources,
capabilities, and core competencies in the internal
organization) with what it might do (a function of
opportunities and threats in the external environment)
yields insights for the firm to select its strategies.
 3-1a The Context of
Internal Analysis (slide 1 of 2)
• In today’s global economy, some of the resources
that were traditionally critical to firms’ efforts to
produce, sell, and distribute their goods or services
are now less likely to be the source of competitive
advantages.
• This is because an increasing number of firms are using
their resources to form core competencies through
which they successfully implement an international
strategy as a means of overcoming the advantages
created by more traditional resources.
 3-1a The Context of
Internal Analysis (slide 2 of 2)
• Firms analyzing their internal organization
should use a global mind-set to do so.
• A global mind-set is the ability to analyze, understand,
and manage an internal organization in ways that are not
dependent on the assumptions of a single country, culture,
or context.
• Analyzing the firm’s internal organization requires
that evaluators understand how to leverage the
firm’s unique bundle of resources and capabilities.
 Figure 3.1
Components of an Internal Analysis
 3-1b Creating Value (slide 1 of 2)

• Value 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 to form capabilities and core competencies.
• Ultimately, creating value for customers is the source of
above-average returns for a firm.
• What the firm intends regarding value creation affects its
choice of business-level strategy and its organizational
structure.
 3-1b Creating Value (slide 2 of 2)

• Core competencies, in combination with

product-market positions, are the firm’s most
important sources of competitive advantage.
• A firm’s core competencies, integrated with an
understanding of the results of studying the conditions in
the external environment, should drive the selection of
strategies.
 3-1c The Challenge of Analyzing
the Internal Organization (slide 1 of 3)
• The strategic decisions managers make about the internal
organization:
• Are nonroutine
• Have ethical implications
• Significantly influence the firm’s ability to earn above-average
returns
• Making decisions regarding the firm’s assets:
• Involves identifying, developing, deploying, and protecting
resources,
capabilities, and core competencies
• Is challenging and difficult
• Is increasingly internationalized
• A firm can improve by studying its mistakes.
• The learning generated by making and correcting mistakes can be
important in the creation of new capabilities and core competencies.
 3-1c The Challenge of Analyzing
the Internal Organization (slide 2 of 3)
• Three conditions affect managers as they
analyze the internal organization and make
decisions about resources:
1. Uncertainty
2. Complexity
3. Intraorganizational conflict
 Figure 3.2
Conditions Affecting Managerial Decisions about
Resources, Capabilities, and Core Competencies
 3-1c The Challenge of Analyzing
the Internal Organization (slide 3 of 3)
• In making decisions affected by these three conditions,
judgment is required.
• Judgment is the capability of making successful decisions when no
obviously correct model or rule is available or when relevant data are
unreliable or incomplete.
• When exercising judgment, decision makers:
• Must be aware of possible cognitive biases, such as overconfidence
• Often take intelligent risks
• Strategic leaders are individuals with an ability to
examine the firm’s resources, capabilities, and core
competencies and make effective choices about their use.
 3-2 Resources,
Capabilities, and Core
• Competencies
The foundation of competitive advantage are:
• Resources
• Capabilities
• Core competencies
• Resources are bundled to create organizational
capabilities.
• In turn, capabilities are the source of a firm’s
core competencies, which are the basis of
establishing competitive advantages.
 3-2a Resources (slide 1 of
4)

• Broad in scope, resources cover a spectrum of

individual, social, and organizational phenomena.
• By themselves, resources do not allow firms to
create value for customers as the foundation for
earning above-average returns.
 3-2a Resources (slide 2 of
4)

• Some of a firm’s resources are tangible, while

others are intangible.
• Tangible resources are assets that can be observed and
quantified.
• Examples: Production equipment, manufacturing facilities,
distribution centers, and formal reporting structures
• Four primary categories of tangible resources are:
1. Financial
2. Organizational
3. Physical
4. Technological
 Table 3.1
Tangible Resources
Financial Resources • The firm’s capacity to borrow
• The firm’s ability to generate funds through
internal operations
Organizational Resources • Formal reporting structures
Physical Resources • The sophistication of a firm’s plant and equipment
and the attractiveness of its location
• Distribution facilities
• Product inventory
Technological Resources • Availability of technology-related resources such as
copyrights, patents, trademarks, and trade secrets

Sources: Adapted from J. B. Barney, 1991, Firm resources and sustained

competitive advantage, Journal of Management, 17: 101; R. M. Grant, 1991,
Contemporary Strategy Analysis, Cambridge: U.K.: Blackwell Business, 100–
102.
 3-2a Resources (slide 3 of
4)

• Intangible resources are assets that are rooted deeply

in the firm’s history, accumulate over time, and are
relatively difficult for competitors to analyze and imitate.
• Examples: Knowledge, managerial capabilities,
organizational routines, brand name, and organizational
culture
• Three primary categories of intangible resources are:
1. Human
2. Innovation
3. Reputational
 Table 3.2
Intangible Resources
Human Resources • Knowledge
• Trust
• Skills
• Abilities to collaborate with others
Innovation Resources • Ideas
• Scientific capabilities
• Capacity to innovate
Reputational Resources • Brand name
• Perceptions of product quality, durability, and
reliability
• Positive reputation with stakeholders such as
suppliers and customers

Sources: Adapted from R. Hall, 1992, The strategic analysis of intangible resources,
Strategic Management Journal, 13: 136–139; R. M. Grant, 1991, Contemporary
Strategy Analysis, Cambridge U.K.: Blackwell Business, 101–104.
 3-2a Resources (slide 4 of
4)

Tangible Resources
• Tangible resources are hard to leverage.
• That is, it is difficult to derive additional business or value from a
tangible resource.

Intangible Resources
• Compared to tangible resources, intangible resources:
• Are less visible and more difficult for competitors to understand,
purchase, imitate, or substitute for
• Are more relied on to be the foundation for a firm’s capabilities
• Can be leveraged
 3-2b Capabilities
• Capabilities are:
• Created by combining individual tangible and intangible
resources
• Used to complete the organizational tasks required to produce,
distribute, and service the goods or services the firm provides to
customers for the purpose of creating value for them
• The foundation for building core competencies and hopefully
competitive advantages
• Often based on developing, carrying, and exchanging
information and knowledge through the firm’s human capital
• Often developed in specific functional areas or in a part of a
functional area
 Table 3.3
Example of Firms’ Capabilities (slide 1 of 2)
Functional Areas Capabilities Examples of Firms
Distribution • Effective use of logistics • Walmart
management techniques
Human • Motivating, empowering, and • Microsoft
Resources retaining employees
Management • Effective and efficient control of • Walmart
Information inventories through point-of-
Systems purchase data collection methods
Marketing • Effective promotion of brand- • Procter & Gamble
name products • Ralph Lauren
• Effective customer service Corp.
• Innovative merchandising • McKinsey &
Co.
• Nordstrom
Inc.
• Crate & Barrel
 Table 3.3
Example of Firms’ Capabilities (slide 2 of 2)
Functional Areas Capabilities Examples of Firms
Management • Ability to envision the future of • Hugo Boss
clothing • Zara
Manufacturing • Design and production skills • Komatsu
yielding reliable products • Witt Gas
• Product and design quality Technology
• Miniaturization of components • Sony
and products
Research & • Innovative technology • Caterpillar
Development • Development of sophisticated • Otis Elevator Co.
elevator control solutions • Chaparral Steel
• Rapid transformation of technology • Thomson
into new products and processes Consumer
• Digital technology Electronics
 3-2c Core Competencies

• Core competencies:
• Are capabilities that serve as a source of competitive
advantage for a firm over its rivals
• Emerge over time through an organizational process of
accumulating and learning how to deploy different
resources and capabilities
• The activities the company performs especially well
compared to competitors
• The activities through which the firm adds unique
value to the goods or services it sells to customers
 3-3 Building Core Competencies

• Two tools help firms identify their core

competencies:
1. The four criteria of sustainable competitive
advantage
2. Value chain analysis
 3-3a The Four Criteria of
Sustainable Competitive
Advantage (slide 1 of 2)
• Core competencies are capabilities that are:
• Valuable
• Valuable capabilities allow the firm to exploit opportunities or
neutralize threats in its external environment.
• Rare
• Rare capabilities are capabilities that few, if any, competitors
possess.
• Costly to imitate
• Costly-to-imitate capabilities are capabilities that other firms
cannot easily develop.
• Nonsubstitutable
• Nonsubstitutable capabilities are capabilities that do not have
strategic equivalents.
 Table 3.4
The Four Criteria of Sustainable Competitive Advantage

Valuable Capabilities • Help a firm neutralize threats or exploit

opportunities
Rare Capabilities • Are not possessed by many others
Costly-to-Imitate Capabilities • Historical: A unique and a valuable
organizational culture or brand name
• Ambiguous cause: The causes and uses
of
a competence are unclear
• Social complexity: Interpersonal
relationships, trust, and friendship among
managers, suppliers, and customers

Nonsubstitutable Capabilities • No strategic equivalent

 3-3a The Four Criteria of
Sustainable Competitive
Advantage (slide 2 of 2)
• Capabilities failing to satisfy the four criteria are not
core competencies, meaning that although every
core competence is a capability, not every capability
is a core competence.
• In slightly different wording:
• For a capability to be a core competence, it must be valuable
and unique from a customer’s point of view.
• For a core competence to be a potential source of
competitive advantage, it must be inimitable and
nonsubstitutable by competitors.
 Table 3.5
Outcomes from Combinations of the Criteria
for Sustainable Competitive Advantage
 3-3b Value Chain Analysis (slide 1 of 2)

• Value chain analysis allows the firm to understand

the parts of its operations that create value and those
that do not.
• Understanding these issues is important because the firm
earns above-average returns only when the value it creates
is greater than the costs incurred to create that value.
 3-3b Value Chain Analysis (slide 2 of 2)
• The value chain is:
• A template that firms use to analyze their cost position and to
identify the multiple means that can be used to facilitate
implementation of a chosen strategy
• Segmented into value chain activities and support functions
• Value chain activities are activities or tasks the firm completes in
order to produce products and then sell, distribute, and service those
products in ways that create value for customers.
• Support functions include the activities or tasks the firm completes in
order to support the work being done to produce, sell, distribute, and
service the products the firm is producing.
• A firm can develop a capability and/or a core competence
in any of the value chain activities and support functions.
• When it does so, it has the ability to create value for customers.
 Figure 3.3
A Model of the Value Chain
 Figure 3.4
Creating Value through Value Chain Activities
 Figure 3.5
Creating Value through Support Functions
 3-4 Outsourcing (slide 1 of 2)
• When the firm cannot create value in either a value chain
activity or a support function, outsourcing is considered.
• Outsourcing is the purchase of a value-creating activity or a
support function activity from an external supplier.
• Firms engaging in effective outsourcing:
• Increase their flexibility
• Mitigate risks
• Reduce their capital investments
• Firms should use outsourcing only for activities where
they:
• Cannot create value
• Are at a substantial disadvantage compared to competitors
 3-4 Outsourcing (slide 2 of 2)
• Outsourcing can be effective because few, if any, organizations possess the
resources and capabilities required to achieve competitive superiority in
each value chain activity and support function.
• By outsourcing activities in which it lacks competence, a firm:
• Increases the probability of developing core competencies and achieving a
competitive advantage because it does not become overextended
• Can fully concentrate on those areas in which it has the potential to create value
• There are two significant concerns associated with outsourcing:
1. The potential loss in a firm’s ability to innovate
2. The loss of jobs within the focal firm
• Outsourcing to a foreign supplier is commonly called offshoring.
 3-5 Competencies, Strengths,
Weaknesses, and Strategic Decisions
(slide 1 of 2)

• By analyzing the internal organization, firms

identify their strengths and weaknesses as
reflected by their resources, capabilities, and
core competencies.
• If a firm has weak capabilities or does not have core
competencies in areas required to achieve a competitive
advantage, it must acquire those resources and build the
needed capabilities and competencies.
 3-5 Competencies, Strengths,
Weaknesses, and Strategic Decisions
(slide 2 of 2)
• Having a significant quantity of resources is not the
same as having the “right” resources.
• The “right” resources are those with the potential to be formed into
core competencies as the foundation for creating value for
customers and developing competitive advantages because of doing
so.
• The ability of a core competence to be a permanent
competitive advantage can’t be assumed.
• All core competencies have the potential to become core
rigidities that generate inertia and stifle innovation.
Thank You