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Strategy: Core Concepts and Analytical ApproachesArthur A. Thompson, The University of Alabama 7th Edition, 2022-2023

An e-book marketed by McGraw Hill Education

Chapter 4Evaluating a Company’s Resources and Ability to Compete SuccessfullyBefore executives can chart a new strategy, they must reach common understanding of the company’s current position.—W. Chan Kim and Rene Mauborgne

Organizations succeed in a competitive marketplace over the long run because they can do certain things their customers value better than can their competitors.—Robert Hayes, Gary Pisano, and David Upton

A new strategy nearly always involves acquiring new resources and capabilities.—Laurence Capron and Will Mitchell

Chapter 3 described how to use the tools of industry and competitive analysis to assess a company’s external environment and lay the groundwork for matching a company’s strategy to its external situation. This chapter discusses techniques for evaluating a company’s internal situation, with emphasis on its collection of resources and capabilities, the competitiveness of its prices and internal operating costs, and its competitive strength versus rivals. The analytical spotlight is trained on six questions:

1. How well is the company’s present strategy working?

2. What are the company’s important resources and capabilities, and do they have enough competitivepower to produce a competitive advantage over rival companies?

4. Are the company’s prices and costs competitive with those of key rivals, and does it have anappealing customer value proposition?

5. Is the company competitively stronger or weaker than key rivals?

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

6. What strategic issues and problems does top management need to address in crafting a strategy tofit the company's situation?

In probing for answers to these questions, five analytical tools—resource and capability analysis, SWOT analysis, value chain analysis, benchmarking, and competitive strength assessment—are used. All five are valuable techniques for revealing a company’s ability to compete successfully and for helping company managers match their strategy to the company’s particular circumstances.

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY WORKING?In evaluating how well a company’s present strategy is working, one must start with a clear view of what the strategy is. Figure 4.1 shows the key components of a single-business company’s strategy. The first thing to examine is the company’s competitive approach. What moves has the company made recently to attract customers and improve its market position—for instance, has it cut prices, improved the design of its product, added new features, stepped up advertising, entered a new foreign or domestic geographic market, or merged with a competitor? Is it striving for a competitive advantage based on low costs or an appealingly different or better product offering? Is it concentrating on serving a broad spectrum of customers or a narrow market niche? The company’s functional strategies in R&D, production, marketing, finance, human resources, information technology, and so on further characterize company strategy, as do any efforts to establish competitively valuable alliances or partnerships with other enterprises.

FIGURE 4.1 Identifying the Components of a Single-Business Company’s Strategy

Actions to respond to important changes in the macro-environment or in industry and competitive conditions

Planned, proactive moves to attract customers and out-compete rivals via more appealing product attributes, better product quality, wider selection, lower prices, superior service, and so on

Initiatives to build competitive advantage based on: • Lower costs and prices

relative to rivals?• A different or better

product offering?• Superior ability to serve

a market niche or specificgroup of buyers?

Efforts to expand or narrow geographic coverage

Efforts to build competitively valuable partnerships and strategic alliances with other enterprises

R&D, technology, product design strategy

Supply chain management strategy

Production strategy

Sales, marketing, and distribution strategies

Information technology strategy

Human resources strategy

Finance strategy

BUSINESS STRATEGY

The actions and approaches crafted

to compete successfully in a particular

business

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

The three best indicators of how well a company’s strategy is working are (1) whether the company is achieving its stated financial and strategic objectives, (2) whether the company is an above-average industry performer, and (3) whether the company is gaining customers and gaining market share. Persistent shortfalls in meeting company performance targets and mediocre performance in the marketplace relative to rivals are reliable warning signs that the company has a weak strategy, suffers from poor strategy execution, or both. Specific indicators of how well a company’s strategy is working include:

• Whether the firm’s sales are growing faster, slower, or at about the same pace as the market as awhole, thus resulting in a rising, eroding, or stable market share.

• How well the company stacks up against rivals on product innovation, product quality, price, customer service, and other relevant factors on which buyers base their choice of brands.

• Whether the firm’s brand image and reputation are growing stronger or weaker.

• Whether the firm’s profit margins are increasing or decreasing.

• Trends in the firm’s net profits, return on investment, and stock price and how these compare to thesame trends for other companies in the industry.

• Whether the company’s overall financial strength, credit rating, key financial and operating ratios,and cash flows from operations are improving, remaining steady, or deteriorating.

• Evidence of internal operating improvements (fewer product defects, faster delivery times, increasesin employee productivity, a growing stream of successful product innovations, and ongoing costsavings).

The bigger the improvements in a company’s market standing and competitive strength and the stronger its financial and operating performance, the more likely it has a well-conceived, well-executed strategy. Run-of-the-mill market results, mediocre financial performance, and sparse operating improvements are red flags that raise questions about a company’s strategy and whether radical changes in strategy or internal operations are needed.

Sluggish financial performance and second-rate market accomplishments almost always signal weak strategy, weak execution, or both.

Table 4.1 provides a compilation of the financial ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

TABLE 4.1 Key Financial Ratios: How to Calculate Them and What They Mean

Ratio How Calculated What It Shows

Profitability Ratios1. Gross profit margin Sales revenues—Cost of goods sold

Sales revenuesShows the percentage of revenues available to cover operating expenses and yield a profit. Higher is better and the trend should be upward.

2. Operating profit margin(or return on sales)

Sales revenues—Operating expensesSales revenues

orOperating income

Sales revenues

Shows the profitability of current operations without regard to interest charges and income taxes. Earnings before interest and taxes is commonly referred to as EBIT. Higher is better and the trend should be upward.

3. Net profit margin (ornet return on sales)

Profits after taxesSales revenues

Shows after-tax profits per dollar of sales. Higher is better and the trend should be upward.

4. Total return on assets Profits after taxes + InterestTotal assets

A measure of the return on total monetary investment in the enterprise. Interest is added to after-tax profits to form the numerator since total assets are financed by creditors as well as by stockholders. Higher is better and the trend should be upward.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

5. Net return on totalassets (ROA)

Profits after taxesTotal assets

A measure of the return earned by stockholders on the firm’s total assets. Higher is better and the trend should be upward.

6. Return on stockholders’equity (ROE)

Profits after taxes Total stockholders’ equity

Shows the return stockholders are earning on their capital investment in the enterprise. A return in the 12–15% range is “average,” and the trend should be upward.

7. Return on investedcapital (ROIC)—sometimes referredto as return on capitalemployed (ROCE)

Profits after taxes Long-term debt +

Total stockholders’ equity

A measure of the return shareholders are earning on the long-term monetary capital invested in the enterprise. A higher return reflects greater bottom-line effectiveness in the use of long-term capital, and the trend should be upward.

8. Earnings per share(EPS)

Profits after taxes Number of shares of

common stock outstanding

Shows the earnings for each share of common stock outstanding. The trend should be upward, and the bigger the annual percentage gains, the better.

Liquidity Ratios1. Current ratio Current assets

Current liabilitiesShows a firm’s ability to pay current liabilities using assets that can be converted to cash in the near term. Ratio should definitely be higher than 1.0; ratios of 2 or higher are better still.

2. Working capital Current assets – Current liabilities Bigger amounts are better because the company has more internal funds available to (1) pay its current liabilities on a timely basis and (2) finance inventory expansion, additional accounts receivable, and a larger base of operations without resorting to borrowing or raising more equity capital.

Leverage Ratios1. Total debt-to-assets

ratioTotal liabilities Total assets

Measures the extent to which borrowed funds (both short-term loans and long-term debt) have been used to finance the firm’s operations. A low fraction or ratio is better—a high fraction indicates overuse of debt and greater risk of bankruptcy.

2. Long-term debt-to-capital ratio

Long-term debtLong-term debt +

Total stockholders’ equity

An important measure of creditworthiness and balance sheet strength. It indicates the percentage of capital investment in the enterprise that has been financed by both long-term lenders and stockholders. A ratio below 0.25 is usually preferable since monies invested by stockholders account for 75% or more of the company’s total capital. The lower the ratio, the greater the capacity to borrow additional funds. Debt-to-capital ratios above 0.50 and certainly above 0.75 indicate a heavy and perhaps excessive reliance on long-term borrowing, lower creditworthiness, and weak balance sheet strength.

3. Debt-to-equity ratio Total liabilitiesTotal stockholders’ equity

Shows the balance between debt (funds borrowed both short term and long term) and the amount that stockholders have invested in the enterprise. The further the ratio is below 1.0, the greater the firm’s ability to borrow additional funds. Ratios above 1.0 and definitely above 2.0 put creditors at greater risk, signal weaker balance sheet strength, and often result in lower credit ratings.

4. Long-term debt-to-equity ratio

Long-term debt Total stockholders’ equity

Shows the balance between long-term debt and stockholders’ equity in the firm’s long-term capital structure. Low ratios indicate greater capacity to borrow additional funds if needed.

5. Times-interest-earned(or coverage) ratio

Operating incomeInterest expenses

Measures the ability to pay annual interest charges. Lenders usually insist on a minimum ratio of 2.0, but ratios progressively above 3.0 signal progressively better creditworthiness.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

Activity Ratios

Days of inventory InventoryCost of goods sold ÷ 365

Measures inventory management efficiency. Fewer days of inventory are usually better.

Inventory turnover Cost of goods soldInventory

Measures the number of inventory turns per year. Higher is better.

Average collection period

Accounts receivableTotal sales ÷ 365

orAccounts receivableAverage daily sales

Indicates the average length of time the firm must wait after making a sale to receive cash payment. A shorter collection time is better.

Other Important Measures of Financial Performance

Dividend yield on common stock

Annual dividends per share Current market price per share

A measure of the return that shareholders receive in the form of dividends. A “typical” dividend yield is 2–3%. The dividend yield for fast-growth companies is often below 1% (maybe even 0); the dividend yield for slow-growth companies can run 4–5%.

Price-earnings ratio Current market price per shareEarnings per share

P-E ratios above 20 indicate strong investorconfidence in a firm’s outlook and earnings growth;firms whose future earnings are at risk or likely to growslowly typically have ratios below 12.

Dividend payout ratio Annual dividends per shareEarnings per share

Indicates the percentage of after-tax profits paid out as dividends.

Internal cash flow After-tax profits + Depreciation A quick and rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, and taxes. Such amounts can be used for dividend payments or funding capital expenditures.

Free cash flow After-tax profits + Depreciation – Capital expenditures – Dividends

A quick and rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, taxes, dividends, and desirable reinvestments in the business. The larger a company’s free cash flow, the greater its ability to internally fund new strategic initiatives, repay debt, make new acquisitions, repurchase shares of stock, or increase dividend payments.

QUESTION 2: WHAT ARE THE COMPANY’S IMPORTANT RESOURCES AND CAPABILITIES AND DO THEY HAVE ENOUGH COMPETITIVE POWER TO PRODUCE A COMPETITIVE ADVANTAGE OVER RIVALS?An essential element of deciding whether a company’s internal situation is fundamentally healthy or unhealthy entails examining the attractiveness of its resources and capabilities. A company’s resources and capabilities are competitive assets and determine whether its competitive power in the marketplace will be impressively strong or disappointingly weak. Companies with second-rate competitive assets are nearly always relegated to a trailing position in the industry.

Resource and capability analysis provides managers with a powerful tool for sizing up the company’s competitive assets and determining whether they can provide the foundation necessary for competitive success in the marketplace. This is a two-step process. The first step is to identify the company’s competitively important resources and capabilities. The second step is to examine them more closely to ascertain which

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

are the most competitively important and whether they can support a sustainable competitive advantage over rival firms. This second step involves applying four tests of the competitive power of a resource or capability.

Identifying a Company’s Competitively Important Resources and CapabilitiesA company’s competitively important resources and capabilities are fundamental building blocks in crafting a competitive strategy.1 Broadly speaking, any asset or productive input that a firm owns or controls qualifies as a resource. Most firms have many kinds and types of resources, and these tend to vary widely in quality and competitive value. For example, a company’s brand name is a resource, whose value varies widely. Some brands like Coca-Cola, Nike, and Google are quite valuable because they are well-known globally while others are virtually unknown and have little competitive value (Turtle Beach, Kumho, Asus). Our interest here is not in cataloging every resource a company has but rather in identifying those resources that have competitive value and can enhance its competitiveness.

Identifying Valuable Company Resources. Valuable or competitively relevant resources can relate to any of the following:

• Physical resources: valuable land and real estate, state-of-the-art manufacturing plants, equipment, distribution facilities, and/or well-equipped R&D facilities, the locations of retail stores, plants, and distribution centers (including the overall pattern of their physical locations), and ownership of or access rights to valuable natural-resource deposits.

• Human assets and intellectual capital: an educated, well-trained, talented and experienced workforce, the cumulative learning and know-how of key personnel and work groups regarding important business functions and/or technologies; proven managerial and leadership skills, proven skills in operating key parts of the business efficiently and effectively.2

• Organizational and technological resources: proprietary technology and production capabilities, patents, proven R&D capabilities, strong e-commerce capabilities, proven quality control systems, state-of-the-art information and data management systems (systems for monitoring various operating activities in real-time, just-in-time inventory management systems, and business analytics capabilities), and proven software development capabilities.

• Financial resources: cash and marketable securities, a strong balance sheet and credit rating (thus giving the company added borrowing capacity and access to additional financial capital).

• Intangible assets: brand names, trademarks, copyrights, company image, reputational assets (for technological leadership or excellent product quality or customer service or honesty and fair dealing), buyer loyalty and goodwill, a strong work ethic and motivational drive that is embedded in the company’s workforce, a tradition of close teamwork and coordination across the company’s organizational units, the creativity and innovativeness of certain personnel and work groups, the trust and effective working relationships established with various external partners, and cultural norms and behaviors that promote responding quickly to changing circumstances, fast organizational learning, and continuously striving to achieve operating excellence in the performance of internal activities.

• Relationships: alliances, joint ventures or partnerships that provide access to valuable technologies, specialized know-how, or attractive geographic markets; fruitful partnerships with suppliers that reduce costs and/or enhance product quality and performance; a strong network of distributors and/or retail dealers.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

Identifying Valuable Company Capabilities. A capability concerns the proficiency with which a company can perform an activity. A company’s skill or proficiency in performing different facets of its operations can range from one of minimal capability (perhaps having just struggled to perform an activity for the first time) to the other extreme of being able to perform the activity with a level of competence that exceeds any other company in the industry. In general, the competitive value of a capability depends on two factors: the competence a company has achieved in performing the activity and the role of the activity in the company’s strategy, as explained below:

1. A company’s proficiency rises from that of mere ability to perform an activity to the level of a competence when it learns to perform the activity consistently well and at acceptable cost. Usually, competence in performing an activity originates with deliberate efforts to simply develop the ability to do it, however imperfectly or inefficiently. Then, as experience builds and the company gains proficiency to perform the activity consistently well and at an acceptable cost, its ability evolves into a true competence and capability. Whether a competence has competitive value depends on whether it relates directly to a company’s strategy or competitive success or whether it concerns an activity that has minimal competitive bearing (like administering employee benefit programs or accuracy in preparing financial statements).

CORE CONCEPTA company has a competence in performing an activity when, over time, it gains the experience and know-how to perform an activity consistently well and at acceptable cost.

Some competitively valuable competencies relate to fairly specific skills and expertise (like just-in-time inventory control, low-cost manufacturing efficiency, picking locations for new stores, or designing an unusually appealing and user-friendly website for online sales). They spring from proficiency in a single discipline or function and may be performed in a single department or organizational unit. Other competencies, however, are inherently multidisciplinary and cross-functional. They are the result of effective collaboration among people with different expertise working in different organizational units. A competence in continuous product innovation, for example, comes from teaming the efforts of people and groups with expertise in market research, new product R&D, design and engineering, cost-effective manufacturing, and market testing. Virtually all organizational competences are knowledge based, residing in the intellectual capital of company employees and not in assets on its balance sheet.

2. A core competence is a proficiently performed internal activity that is central to a company’s strategy and competitiveness.3 A core competence is a more competitively valuable capability than a competence because of the well-performed activity’s key role in the company’s strategy and the contribution it makes to the company’s market success, competitiveness, and profitability. A core competence can relate to any of several aspects of a company’s business: expertise in integrating multiple technologies to create families of new products, skills in manufacturing a high-quality product at a low cost, or the capability to fill customer orders accurately and swiftly. Most core competencies are grounded in cross-department combinations of knowledge and expertise rather than being the product of a single department or work group. Amazon.com has a core competence in online retailing and website operations. Kellogg’s has a core competence in developing, producing, and marketing breakfast cereals. Microsoft has a core competence in developing operating systems for computers and user software like Microsoft Office®. L’Oréal, the world’s largest beauty products company with 18 dermatologic and cosmetic research centers, a large accumulation of scientific knowledge concerning skin and hair care, patents and secret formulas for hair and skin care products, and robotic techniques for testing the safety of hair and skin care products, has developed a strong and competitively successful core competence in developing hair care products, skin care products, cosmetics, and fragrances.

CORE CONCEPTA core competence is an activity that a company performs quite well and that is also central to its strategy and competitiveness. A core competence is a more important capability than a competence because it adds power to a company’s strategy and has a bigger positive impact on its competitive success.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

3. A distinctive competence is a competitively valuable activity that a company performs better than its rivals.4 A distinctive competence thus signifies greater proficiency than a core competence. Because a distinctive competence represents a level of proficiency that rivals do not have, it qualifies as a competitively superior capability with competitive advantage potential. It is always easier for a company to build competitive advantage when it has a distinctive competence in performing an activity important to market success, when rival companies do not have offsetting competencies, and when it is costly and time-consuming for rivals to imitate the competence. Companies that have a distinctive competence include Google, which has a distinctive competence in search engine technology, and Walt Disney Co., which has a distinctive competence in creating and operating theme parks.

CORE CONCEPTA distinctive competence is a competitively important activity that a company performs better than its rivals—it thus represents a competitively superior capability.

In determining whether a company has a competitively attractive collection of resources and capabilities, it is important to identify which of its skills and proficiencies qualify as a competence, which represent a core competence, and whether it may enjoy a distinctive competence in one or more activities it performs.5 Both core competencies and distinctive competencies are valuable because they enhance a company’s competitiveness. But mere ability to perform an activity well does not necessarily give a company competitive clout. Some competencies merely enable market survival because most rivals also have them—indeed, not having a competence or competitive capability that rivals have can result in competitive disadvantage. An apparel manufacturer cannot survive without the capability to produce its apparel items cost efficiently, given the intensely price-competitive nature of the apparel industry. A cell-phone maker cannot survive without the capability to introduce next-generation cell phones with appealing new features and functions that attract a profitable number of buyers. A provider of subscription-based streamed entertainment cannot prosper without the capabilities to create appealing original content.

Astute Bundling of a Company’s Resources and Capabilities Can Result in Added Competitive Power. In identifying company resources and capabilities with competitive value, it is important to understand that a particular resource or capability which may not seem to have much competitive value by itself can be much more valuable when bundled with certain other company resources and/or capabilities (that also, taken singly, appear to lack important competitive value). There are numerous instances when resource/capability bundles have important competitive power even when individual components of the bundle do not. For example, Nike’s resource bundle of styling expertise, professional endorsements, well-regarded brand name and image, marketing and brand-building skills, network of distributors/retailers, and managerial know-how has provided sufficient competitive power for Nike to remain the dominant global leader in athletic footwear and sports apparel for over 20 years.

CORE CONCEPTA resource/capability bundle is a group of resources and/or capabilities that, when linked and integrated into a functioning whole, has greater competitive value than the summed value of the individual components—in other words, combining individual resources and capabilities into an integrated bundle produces a 1 + 1 = 3 gain in competitive power versus just a 1 + 1 = 2 gain when the same resources and capabilities are unbundled.

It is equally important to understand that the value of a company resource/capability is often also a function of the company’s proficiency in using the resource/capability to perform an activity.6 For instance, the degree to which a company’s manufacturing plants are a competitively valuable resource hinges, in part, upon whether the products being manufactured are of poor quality, lower-than-average quality, better-than-average quality, or superior quality. A company’s manufacturing capabilities thus matter. Moreover, in most cases, a company’s manufacturing capabilities are enhanced or weakened by its product R&D capabilities and its product design capabilities.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

Four Ways to Test the Competitive Power of a Resource or CapabilityWhat is most telling about the importance and value of a company’s resources and capabilities, individually and collectively, is how powerful they are in the marketplace. The competitive power of a resource or capability is measured by how many of the following four tests it can pass:7

1. Does the resource or capability have competitive value? The competitive value of a resource or capability is determined by how much it helps a company improve its customer value proposition (and thereby better attract and please customers), the degree to which it enables a company to compete effectively against rivals, and its role in the company’s profit proposition. Unless a resource or capability contributes to the power of a company’s strategy and helps maintain or enhance the company’s competitiveness vis-à-vis rivals, it cannot pass the test of being competitively valuable. Companies must guard against contending that most any kind of expertise or know-how or well-performed activity qualifies as a core or a distinctive competence or gives them substantial competitive clout. Apple’s iOS operating system for its PCs is by most accounts a world beater (compared to Windows 10), but Apple has failed to convert its know-how and capability in operating system design into competitive success in the global PC market—its global market share in PCs has lagged well behind HP, Dell, and Lenovo for over two decades. Moreover, it is important to recognize that a resource or capability can quickly lose its competitive value because of rapid changes in technology or customer preferences or the importance of certain distribution channels or other market-related factors. For example, a company’s ability to benefit from strong capabilities in product innovation is governed by how quickly rivals can introduce their own new products with many of the same features. The branch offices of commercial banks are becoming a less valuable competitive asset because of growing use of direct deposits, automated teller machines, debit cards, and telephone and online banking options that reduce the need to “go to the bank.”

2. Do many or most rivals have much the same resource or capability? A resource or capability that most of a company’s rivals also possess cannot be a basis for outcompeting rivals or achieving competitive advantage. Indeed, when most companies in an industry can legitimately lay claim to having a particular resource or capability, then that resource or capability is valuable only from the standpoint of helping industry members maintain competitive parity in the marketplace and perhaps indicating the resource or capability is an industry key success factor. A resource or capability achieves its greatest competitive value only if (1) it is rare (in the sense of being possessed by one, or at most two, companies competing in the same market arena) and (2) has sufficient competitive power (like a distinctive competence) to enable a firm to outcompete rivals and gain a sustainable competitive advantage.

3. Is the resource or capability hard to copy? The more difficult and more expensive it is for rivals to imitate a competitively valuable resource or capability, the greater its potential for enabling a company to outcompete rivals and win a competitive advantage. Resources tend to be difficult to copy when they are unique (a fantastic real estate location, patent-protected technology or product features, an unusually talented and motivated labor force), when they must be built over time in ways that are difficult to imitate (a well-known brand name, mastery of a complex production process, a global network of dealers and distributors), and when they entail financial outlays or large-scale operations that few industry members can undertake. Capabilities can be hard to copy and take considerable time for rivals to develop when they have high skill or knowledge-based requirements, involve complicated technology, and/or entail extensive cross-functional collaboration. Valuable resources and capabilities that are also hard-to-copy can often significantly boost a company’s competitive strength and sustain good-to-excellent profitability.

4. Can the value of a resource or capability be trumped by substitute resources and capabilities of rivals? Resources that are valuable, not widely possessed by rivals, and hard to copy, lose much of their competitive power if rivals have substitute resources or capabilities of equal or

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

greater competitive power.8 For instance, manufacturers relying on robotics and automated production processes to gain a cost advantage in production activities may find their technology-based cost advantage completely nullified by rivals who also can implement robot-assisted production techniques but who also move their production operations to countries having both low wages and an adequately skilled labor force, and thereby can achieve even lower production costs.

The vast majority of companies are not well endowed with standout resources or capabilities capable of passing all four tests with high marks. Most firms have a mixed bag of resources and capabilities—one or two quite valuable, some good, many satisfactory (on a par with rivals), and others mediocre. Resources and capabilities that are competitively valuable pass the first of the four tests, but not necessarily the other three. As contributors to the competitiveness of a company’s strategy, competitively valuable resources/capabilities are mainly important in gaining parity with many (maybe most) rivals; but such resources/capabilities may or may not have the competitive power to produce significant competitive advantage without the presence of important bundling effects or other qualities that greatly boost buyer appeal for a company’s product offering.

CORE CONCEPTThe degree of success a company enjoys in the marketplace is governed by the combined competitive power of its resources and capabilities.

For a company to have resources/capabilities that can pass the first two tests entails a much higher hurdle—having a resource or capability that is valuable, likely not possessed by rivals (rare), and potentially has significant competitive power because it is competitively superior in some important respect. Companies in the top tier of their industry may have as many as two or three core competencies but only a very few companies, usually the strongest industry leaders or up-and-coming challengers, have a capability that truly qualifies as a distinctive competence. A standout resource that delivers competitive superiority is as rare as a distinctive competence. This is why, absent important resource/capability bundling effects, it is so hard for a company to achieve a sustainable competitive advantage over rivals. Achieving sustainable competitive advantage usually requires a company to have at least one resource/capability that can pass the first three tests (except in those instances where important resource/capability bundling effects are present).

However, as discussed earlier, a company that lacks a standout resource or distinctive competence and only has resources/capabilities that can pass the first test can still integrate a group of good-to-adequate resources and capabilities into a competitively effective bundle that yields adequate to good profitability. Fast-food chains like Wendy’s, Shake Shack, and Burger King, despite having only satisfactory resources and capabilities, have nonetheless achieved respectable market positions and profitability competing against McDonald’s. Discount retailers Target and Kohl’s have bundled good enough resources and capabilities to profitably compete against Walmart and its richer, deeper resources/capabilities. Underdog Lululemon, a performance sport apparel retailer whose chief competitors include Nike, Adidas, and Under Armour—all of which have broader and deeper collections of competitively valuable resources and capabilities, has nonetheless put together a sufficiently strong collection of resources and capabilities to grow its sales and profitability competing head-to-head against these three better-known global rivals.

A Company’s Important Resources and Capabilities Must Be Dynamic and Freshly-Honed to Sustain Its CompetitivenessFor a company’s important resources and capabilities to remain competitively valuable over time, they must be continually polished, updated, and sometimes augmented with altogether new kinds of resources and expertise.9 It takes freshly honed and sometimes totally refurbished or completely new resources/capabilities for a company to effectively respond to ongoing changes in customer needs and expectations. Diligent managerial attention to sharpening and recalibrating company competencies

CORE CONCEPTA company requires a dynamically evolving portfolio of competitively valuable resources and capabilities to sustain its competitiveness and help drive improvements in its performance. Otherwise, the power of its competitive assets grow stale.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

and capabilities protects a company’s long-term competitiveness against the improving capabilities of rivals and their strategic maneuvering to win bigger sales and market shares. Absent such attention, a company’s competencies and capabilities risk becoming stale over time and eroding company performance.10

The Role of Dynamic Capabilities. Management’s challenge in creating and maintaining a dynamic and competitively effective portfolio of resources and capabilities has two elements: (1) attending to ongoing recalibration and refurbishment of the company’s competitive assets and (2) casting a watchful eye for opportunities to develop totally new resources and capabilities for delivering better customer value and/or outcompeting rivals. Companies that succeed in meeting both challenges are likely to be in the enviable position of having an ever stronger and competitively potent arsenal of resources and capabilities.

Executive attention to making sure a company always has competitively valuable resources and capabilities that dynamically evolve and help sustain the company’s competitiveness is a strategically important top management task.

Company executives that grasp the strategic importance of incrementally improving the company’s existing competitive assets and from time-to-time adding new resources/capabilities make a point of ensuring that these actions are an ongoing, high-priority activity. By making proactive oversight of these activities a routine managerial function, they gain the experience and know-how to do a consistently good job of dynamically managing the company’s important competitive assets. At that point, their ability to freshen and augment the company’s resource/capability portfolio becomes what is known as a dynamic capability.11 This dynamic capability also includes an ongoing top management search for opportunities to create new resources and capabilities to increase the company’s competitiveness. When a company’s executive management team achieves proficient dynamic capability to modify, deepen, and augment the company’s competitively important resources and capabilities, the company is better able to maintain, if not enhance, its competitiveness in the marketplace and significantly improve its chances for long-term competitive success.

QUESTION 3: WHAT ARE THE COMPANY’S COMPETITIVELY IMPORTANT STRENGTHS AND WEAKNESSES AND ARE THEY WELL-SUITED TO CAPTURING ITS BEST MARKET OPPORTUNITIES AND DEFENDING AGAINST EXTERNAL THREATS?One of the simplest and most powerful tools for assessing a company’s overall situation is widely known as SWOT analysis, so named because it zeros in on a company’s competitively important Strengths and Weaknesses, its market Opportunities, and those external Threats that can adversely impact the company’s well-being. Doing a first-rate SWOT analysis has considerable managerial value because it helps company managers single out and focus on all the factors needed to craft a winning strategy that fits the company’s overall internal and external situation. To achieve good fit with the company’s situation, managers must devise a strategy that capitalizes on the company’s most potent competitive strengths, corrects important competitive weaknesses, aims squarely at capturing the company’s best market opportunities, and helps defend against the external threats to its future well-being and business prospects.

SWOT analysis is a simple but powerful tool for sizing up a company’s competitively relevant strengths and weaknesses, its market opportunities, and the external threats to its future well-being.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

Identifying a Company’s Competitively Important StrengthsA strength can relate to something a company is good at doing (a competitively important capability or a core competence), a competitively valuable resource (like a well-known brand name or a reputation for award-winning customer service or large numbers of high-traffic store locations), and certain kinds of competitively relevant achievements or attributes that contribute to a company’s competitiveness in the marketplace (like having low overall costs relative to competitors, being a market share leader, having a wider product line than rivals, and having wider geographic market coverage than rivals).

CORE CONCEPTA company’s competitively important strengths are competitive assets that positively impact its competitiveness and ability to succeed in the marketplace.

Most usually, a company’s strengths stem from the caliber and competitive power of its resources and capabilities; managers can draw on resource and capability analysis to make objective assessments of the potency of the company’s resources and capabilities. While individual resources and capabilities that can pass one or more of the four tests of competitive power typically represent the company’s greatest strengths, managers should be careful not to overlook the competitive strength that results from bundling less potent resources and capabilities. Further, a resource or capability that lacks much competitive power may still be useful for successfully gaining entry into a new market or market segment. A resource bundle that fails to match those of top-tier companies may, nonetheless, allow a company to compete quite successfully against second-tier rivals.

Identifying a Company’s Competitively Important WeaknessesA weakness, or competitive deficiency, is something a company lacks or does poorly (in comparison to others) or a condition that puts it at a disadvantage in the marketplace. A company’s weaknesses can relate to (1) inferior or unproven skills, expertise, capabilities, or intellectual capital in competitively important areas of the business; (2) deficiencies in competitively important physical, organizational, or intangible resources; or (3) weak or missing capabilities in key areas. Company weaknesses are thus internal shortcomings or deficiencies that constitute competitive liabilities. Nearly all companies have competitive liabilities of one kind or another. Whether a company’s weaknesses make it competitively vulnerable depends on how much they matter in the marketplace and whether they are mostly offset or minimized by the company’s strengths.

CORE CONCEPTA company’s weaknesses are internal short-comings that constitute competitive liabilities.

Table 4.2 contains a representative sample of things to consider in identifying a company’s competitively relevant strengths and weaknesses. Sizing up a company’s complement of strengths and weaknesses is akin to constructing a strategic balance sheet, where strengths represent competitive assets and weaknesses represent competitive liabilities. Obviously, the ideal outcome is for a company’s competitive assets to outweigh its competitive liabilities by a healthy margin—a 50-50 balance (or worse) is ominous.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

TABLE 4.2 What to Look for in Identifying a Company’s Strengths, Weaknesses, Opportunities, and Threats

Potential Strengths and Competitive Assets• Core competencies in _______• A distinctive competence in _______• A product strongly differentiated from those of rivals• Resources and capabilities well matched to industry

key success factors• A strong financial condition; ample financial resources

to grow the business• Strong brand name/company reputation• Strong customer loyalty• Proven technological capabilities, proprietary

technology/important patents• Strong bargaining power over suppliers or buyers• Cost advantages over rivals• Proven skills in advertising and promotion• Proven product innovation capabilities• Proven capabilities in improving production processes• Good supply chain management capabilities• Strong customer service capabilities• Better product quality relative to rivals• Wide geographic coverage and/or strong global

distribution capability• Alliances/joint ventures with firms that provide access

to valuable technology, expertise and/or attractive geographic markets

Potential Market Opportunities• Openings to win market share from rivals• Sharply rising buyer demand for the industry’s product• Serving additional customer groups or market

segments• Expanding into new geographic markets• Expanding the company’s product line to meet a

broader range of customer needs• Utilizing existing company skills or technological

know-how to enter new product lines or new businesses

• Online sales via the Internet• Integrating forward or backward• Falling trade barriers in attractive foreign markets• Acquiring rival firms or companies with attractive

capabilities• Entering into alliances or joint ventures to expand the

firm’s market coverage or boost its competitiveness• Openings to exploit emerging new technologies

Potential Weaknesses and Competitive Deficiencies• No well-developed or proven core competencies• Resources and capabilities that are not well matched to

an industry’s key success factors• Too much debt; a weak credit rating• Short on financial resources to grow the business and

pursue promising initiatives • Higher overall unit costs relative to key rivals• Weaker product innovation capabilities than key rivals• A product/service with attributes or features inferior to

those of rivals• Too narrow a product line relative to rivals • Weaker brand name/reputation than rivals• Weaker dealer network than key rivals • Weak global distribution capability• Weaker product quality, R&D, and/or technological

know-how than key rivals• In an overcrowded strategic group• Losing market share because _________• Competitive disadvantages in ________• Inferior intellectual capital relative to rivals• Subpar profitability because _________• Plagued with internal operating problems or obsolete

facilities• Too much underutilized plant capacity

Potential External Threats to a Company’s Future Profitability• More intense competitive pressures from industry rivals

and/or sellers of substitute products—may squeeze profit margins

• The entry (or likely entry) of new competitors into the company’s market stronghold (especially lower-cost foreign competitors)

• Growing bargaining power of buyers and/or suppliers• Slowing or declining market demand for the industry’s

product• A shift in buyer needs and tastes away from the

industry’s product• Adverse demographic changes that threaten to curtail

demand for the industry’s product• Vulnerability to unfavorable industry driving forces • Unfavorable trade policies and tariffs; disruptive trade

wars • Costly new regulatory requirements• Tighter credit conditions• Rising prices for energy or other key inputs

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

Identifying a Company’s Best Market OpportunitiesMarket opportunity is a big factor in shaping a company’s strategy. Indeed, managers can’t properly tailor strategy to the company’s external situation without first identifying its market opportunities and appraising the growth and profit potential each one holds. Depending on the prevailing circumstances, a company’s opportunities can be plentiful or scarce, fleeting or lasting, and can range from wildly attractive (an absolute “must” to pursue) to marginally interesting (because of the high risks, large capital requirements, or unappealing revenue growth and profit potentials) to unsuitable (because the company’s resource strengths and capabilities are ill-suited to successfully capitalize on some opportunities). Typical market opportunities are shown in Table 4.2.

Newly emerging and fast-changing markets sometimes present stunningly big or “golden” opportunities, but it is typically hard for managers at one company to peer into “the fog of the future” and spot them much ahead of managers at other companies.12 But as the fog begins to clear, golden opportunities are nearly always pursued rapidly. And the companies that seize them are usually those that have been actively waiting, staying alert with diligent market reconnaissance, and preparing themselves to capitalize on shifting market conditions by patiently assembling an arsenal of competitively valuable resources and a war chest of cash to finance aggressive action when the time comes.13 In mature markets, unusually attractive market opportunities emerge sporadically, often after long periods of relative calm—but future market conditions may be less foggy, thus facilitating good market reconnaissance and making emerging opportunities easier for industry members to detect.

In evaluating a company’s market opportunities and ranking their attractiveness, managers have to guard against viewing every industry opportunity as a company opportunity. Rarely does a company have sufficient resources and capabilities to pursue all available market opportunities simultaneously without spreading itself too thin. More importantly, a company’s resource strengths and competitively valuable capabilities are almost always better-suited for pursuing and capturing some opportunities than others; indeed, few companies have the resources and capabilities needed to be competitively successful in pursuing every one of an industry’s opportunities. A company is always well advised to pass on a particular market opportunity unless it has or can readily acquire potent enough resources and capabilities to compete successfully and profitably in pursuing the opportunity. Competitive weak companies—because they lack the requisite resource strengths and capabilities—can find themselves hopelessly outclassed if they unwisely try to pursue an industry’s biggest and best market opportunities in head-to-head competition with rivals having much stronger resources and competitive capabilities. Consequently, in choosing which market opportunities to pursue, company strategists should concentrate their attention on those opportunities where the requirements for competitive success match up well with the company’s resource strengths and most potent capabilities—it is precisely these opportunities where the company is most likely to enjoy competitive success, attractive profitability, and good potential for achieving a sustainable competitive advantage over rivals.

CORE CONCEPTThe most appealing market opportunities for a company to pursue are those where its resource strengths and valuable capabilities will be competitively powerful in the marketplace and generate the greatest competitive success. The pursuit of opportunities with good resource/capability fit offer a company its best prospects for both attractive profitability and the achievement of a sustainable competitive advantage over rivals.

Identifying the External Threats to a Company’s Future ProfitabilityOften, certain factors in a company’s external environment pose threats to its competitive well-being and future profitability. External threats can stem from such factors as the growing intensity of one more competitive pressure, the emergence of cheaper or better technologies, the entry of lower-cost foreign competitors into a company’s market stronghold, new regulations that are more burdensome to a company than to its competitors, unfavorable demographic shifts, and political upheaval in a foreign country where the company has facilities. Table 4.2 lists representative potential threats.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

External threats may pose no more than a moderate degree of adversity (all companies confront some threatening elements in the course of doing business), or they may be so ominous they put a company’s future survival at risk. On rare occasions, market shocks can give birth to a sudden-death threat that throws a company into an immediate crisis and battle to survive. In 2017–2019, many companies engaged in international trade faced threats stemming from trade disputes between the United States and numerous other countries and the imposition of higher tariffs on the goods the companies were exporting or importing. In 2020, the sudden emergence of the Covid-19 pandemic posed a significant threat to the worldwide airline industry, cruise lines, the tourist industry, restaurants (due to restrictions on indoor dining), many retailers (due to stay-at-home orders and the reluctance of people to go shopping), and the owners of metropolitan downtown commercial office buildings (due to tenants either allowing or mandating that their employees work from home.) The pandemic-related threat to many of these businesses extended into 2021. Going forward, it was unclear how long the many different pandemic-related downturns would last, creating much uncertainty and speculation among the adversely affected businesses and industries about if and when buyer demand and sales revenues would revert to “normal.” In 2021, motor vehicle manufacturers were experiencing weak sales of gasoline-powered vehicles partly because of rising sales of electric vehicles and greater willingness of consumer to seriously consider the purchase of electric vehicles due to the introduction of new models of electric vehicles with longer driving ranges on a single battery charge and enhanced self-driving capabilities. Increasing demand for electric vehicles over the long-term also threatened the businesses of oil producers across the world due to the resulting weaker demand for gasoline. Concerns about climate change were prompting governments in many countries to impose new rules and regulation restricting oil and natural gas drilling and production and greater subsidies for the installation of solar roofs and the construction of solar farms and wind turbines. Plainly, it is management’s job to identify the threats to the company’s future prospects and to evaluate what strategic actions can be taken to neutralize or lessen their impact.

What Do the SWOT Listings Reveal?SWOT analysis involves more than making four lists. The two most important parts of SWOT analysis are drawing conclusions from the SWOT listings about the company’s overall situation, and translating these conclusions into strategic actions to create an overall strategy well-matched to the company’s overall situation—as indicated by its strengths and weaknesses, its market opportunities, and its external threats. Figure 4.2 shows the steps involved in gleaning insights from SWOT analysis.

Simply making lists of a company’s strengths, weaknesses, opportunities, and threats is not enough. The payoff from SWOT analysis comes from the conclusions that can be drawn about the company’s overall situation and the implications for strategy improvement that flow from the four lists.

The answers to the following questions often reveal just what story the SWOT listings tell about the company’s overall situation:

• What are the attractive aspects of the company’s situation?• What aspects are of the most concern?• Do the company’s strengths give it sufficient competitive power to compete successfully?• Are the company’s weaknesses/deficiencies of major or minor consequence? Must remedial action

be taken immediately? Or, are the weaknesses/deficiencies sufficiently negated by the company’s strengths that corrective action is probably not the best use of company resources?

• Does the company have resources and capabilities that are especially well-suited to successfully pursuing and capturing its most attractive market opportunities? Is the company lacking certain resources or capabilities that make it inadvisable to pursue any particular market opportunities?

• Are the external threats alarming, or are they something the company appears able to deal with and defend against?

• All things considered, where on a scale of 1 to 10 (where 1 is alarmingly weak and 10 is exceptionally strong), does the company’s overall situation and future prospects rank?

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

FIGURE 4.2 The Three Steps of SWOT Analysis: Identify, Draw Conclusions, Translate into Strategic Action

Identify the company’s competitively important strengths and competitive assets

Identify the company’s competitively important weaknesses and deficiencies

Identify the company’s market opportunities

Identify external threats to the company’s future well-being

Conclusions concerning the company’s overall business situation:• Where on the scale from “alarmingly weak” to

“exceptionally strong” does the attractiveness of the company’s situation rank?

• What are the attractive and unattractive aspects of the company’s situation?

Implications for improving company strategy:• Use company strengths and capabilities as

corner stones for strategy.• Pursue those market opportunities best suited to

company strengths and capabilities.• Correct weaknesses and deficiencies that impair

pursuit of important market opportunities or heighten vulnerability to external threats.

• Use company strengths to lessen the impact of important external threats.

What Can Be Gleaned from the SWOT Listings?

The final piece of SWOT analysis is to translate the diagnosis of the company’s internal and external circumstances into actions for improving the company’s strategy and business prospects.

Translating the SWOT Analysis Results into Effective Strategic Action. The SWOT analysis results provide excellent guidance to managers in crafting a strategy (or improving an existing strategy) in ways that may enable the strategy to pass the three tests of a winning strategy. As you should recall, a winning strategy must fit the company’s internal and external situation, help build competitive advantage, and boost company performance. Four conditions are necessary for a company’s strategy to be a good to excellent fit with its overall situation:

1. The foundation and centerpiece of a company’s strategy to profitably compete against rivals must be its most competitively powerful resourcesand capabilities. Using a company’s most potent resources and capabilities to power its strategy gives the company its best chance for market success, competitive advantage, and better performance.14 Should the power of the company’s resources and capabilities prove competitively stronger than those of some or many rivals, its future business performance should be good. And, in the best-case outcome, if certain of the company’s most potent resources and capabilities are hard for rivals to copy or trump, then achieving a sustainable competitive advantage can be within reach. Strategies that place heavy demands on areas and activities where the company is comparatively weak or has unproven competitive capability should be avoided.

CORE CONCEPTRelying on a company’s strongest resources and capabilities to power its strategy produces the best fit with the company’s internal and external situation, thereby making such an approach to crafting strategy the surest route to market success and good business results.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

2. The strategy must include actions to correct those competitive weaknesses that make the company vulnerable to attack from rivals, depress profitability, or disqualify it from pursuing a particularly attractive opportunity. However, there is scant reason to devote much attention to correcting those weaknesses or deficiencies that are well defended by other company resources and capabilities.

3. The company’s strategy must include strategic initiatives aimed squarely at capturing those market opportunities best suited to the company’s strengths and competitive assets. Management should almost always deploy some of the company’s most potent resources and capabilities to spearhead such initiatives. Indeed, what makes a market opportunity attractive to pursue is that the company has competitively powerful resources and capabilities that can be used to seize opportunities to grow the business, boost performance, and potentially achieve competitive advantage. However, there are instances where some market opportunities can be pursued with resource/capability bundles having sufficient competitive power to get the job done.

4. The strategy should include efforts to defend against those external threats that can adversely impact the company’s long-term business prospects or put its survival at risk. How much attention to devote to defending against external threats hinges on how vulnerable the company is, whether attractive defensive moves can be taken to lessen their impact, and whether the costs of undertaking such moves represent the best use of company resources. Some external threats are often beyond a firm’s ability to influence or defend against; in such cases, the best course of action can be to wait until the threat materializes and try to offset its impact with actions in other parts of the business.

QUESTION 4: ARE THE COMPANY’S PRICES AND COSTS COMPETITIVE WITH THOSE OF KEY RIVALS, AND DOES IT HAVE AN APPEALING CUSTOMER VALUE PROPOSITION?Company managers are often stunned when a competitor cuts its price to “unbelievably low” levels or when a new market entrant comes on strong with a very low price. Such rivals may not, however, be “dumping” (an economic term for selling at prices below cost) or buying market share with a super-low price or waging a desperate move to gain sales—they may simply have substantially lower costs. Then there are occasions when a competitor storms the market with a new product that ratchets the quality level up so high some customers will abandon competing sellers even if they have to pay more for the new product—this is what has happened with some of Apple’s new iPhone models.

Regardless of where on the price-quality-performance spectrum a company competes, it must remain competitive in terms of its customer value proposition to stay in the game. Two telling signs of whether a company’s business position is strong or precarious are (1) whether its prices are justified by the value it delivers to customers and (2) whether its costs are competitive with industry rivals delivering similar customer value at a similar price. The greater the amount of customer value a company can offer profitably compared to its rivals, the less vulnerable it is to competitive attack. And if it can deliver the same amount of value at lower costs (or more value at the same cost), it will enjoy a competitive edge.

Two analytical tools are particularly useful in determining whether a company’s customer value proposition, prices, and costs are competitive: value chain analysis and benchmarking.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

The Concept of a Company Value ChainEvery company’s business consists of a collection of activities undertaken in the course of designing, producing, marketing, delivering, and supporting its product or service. All of the various activities a company performs internally combine to form a value chain—so-called because creating value for customers is what chains a company’s various activities into a purposeful group of functions and tasks. A company’s value chain consists of two broad categories of activities: the primary activities foremost in the company’s scheme for creating and delivering value to customers and the requisite support activities that facilitate and enhance the performance of the primary activities.15 The kinds of primary and secondary activities that comprise a company’s value chain vary according to the specifics of its business—hence, the primary and secondary activities shown in Figure 4.3 are illustrative rather than definitive.

CORE CONCEPTA company’s value chain identifies the primary activities it performs that create customer value and the related support activities. The “outputs” of an organization’s value chain activities are the value delivered to customers and the resulting revenues it collects. The “inputs” are all of the resources required to conduct the various value chain activities; use of these resources creates costs.

For example, the primary activities at hotel operators like Marriott include site selection and construction, reservations, the operation of hotel properties (check-in and check-out, maintenance and housekeeping, dining and room service, and conventions and meetings), and management of its portfolio of hotel property locations. Its principal support activities include accounting, hiring and training, advertising, building a recognized and reputable brand name, and general administration. The primary activities for retailers like Best Buy or Home Depot involve merchandise selection and buying, supply chain management, store layout and product display, sales floor operations, website operations for online sales, and customer service, whereas its support activities include site selection, hiring and training, store maintenance, advertising, and general administration. Supply chain management is a crucial activity for Toyota, Costco, and Apple but is not a value chain component at Facebook or PayPal or Visa. Sales and marketing are dominant activities at Procter & Gamble and Nike but have far lesser roles at oil drilling companies and natural gas pipeline companies. Order delivery is a crucial activity at Domino’s Pizza but is currently not an internal value chain activity at McDonald’s, Walgreens, and TJMaxx.

With its focus on value-creating activities, the value chain is an ideal tool for examining the workings of a company’s business model—its customer value proposition and profit proposition. It permits a deep look at the company’s cost structure and ability to charge low or at least competitive prices. It can reveal the costs a company is spending on product differentiation efforts to deliver greater customer value and support higher prices, such as product quality and customer service. Company value chains necessarily include a profit margin component, since profits are necessary to compensate owners/shareholders who bear risks and provide capital. When the revenues generated from a company’s value-creating activities are sufficient to cover operating costs and yield an attractive profit, then the organization has an appealing value chain—its customer value proposition and its profit proposition are well aligned and signal a successful business model. Absent the ability to create a value chain capable of delivering sufficient customer value and producing adequate profitability, a company is competitively vulnerable and its survival open to question.

Comparing the Value Chains of Rival Companies Value chain analysis facilitates a comparison of how rivals, activity-by-activity, deliver value to customers. Typically, there are important differences in the value chains of rival companies. A company that makes a no-frills product and provides minimal customer services has a value chain with activities and costs that are different from a competitor that produces a full-featured, high-performance product and has a full range of customer service offerings. The “operations” component of the value chain for a manufacturer that makes all of its own parts and components and assembles them into a finished product differs from the “operations” of a rival

CORE CONCEPTThe greater the value a company can profitably deliver to its customers relative to the value close rivals deliver, the less competitively vulnerable it becomes. The higher a company’s costs relative to those of rivals delivering comparable customer value at a comparable price, the more competitively vulnerable it becomes.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

producer that buys the needed parts and components from outside suppliers and only performs assembly operations. Movie theaters that show the new releases of movie studios and derive a big portion of their revenues from concession sales employ different value-creating activities and have different costs from Netflix and other providers of movies streamed over the Internet directly to viewers’ TVs and mobile devices.

Differences in the value chains of close competitors raise two very important questions. One, whose value chain delivers the best customer value relative to the prices being charged? Two, which company has the lowest cost value chain? When one competitor employs a value chain approach that delivers greater value to customers relative to the price it charges, it gains competitive advantage even if its costs are equivalent to (or maybe slightly higher than) those of its close rivals. When close competitors deliver much the same value to customers, charge comparable prices, and employ similar value chains, then competitive advantage accrues to the company that operates its value chain most cost efficiently. Consequently, it is incumbent on company managers to vigilantly monitor how effectively and efficiently the company delivers value to customers relative to rival companies—gaining a competitive edge over rivals hinges on being able to deliver equivalent customer value at lower cost or greater customer value at the same cost.

FIGURE 4.3 A Representative Company Value Chain

PRIMARY ACTIVITIES• Supply Chain Management—Activities, costs, and assets associated with purchasing fuel, energy, raw

materials, parts and components, merchandise, and consumable items from vendors; receiving, storing and disseminating inputs from suppliers; inspection; and inventory management.

• Operations —Activities, costs, and assets associated with converting inputs into final product form (producing, assembly, packaging, equipment maintenance, facilities, operations, quality assurance, environmental protection).

• Distribution—Activities, costs, and assets dealing with physically distributing the product to buyers (finished goods warehousing, order processing, order picking and packing, shipping, delivery vehicle operations, establishing and maintaining a network of dealers and distributors).

• Sales and Marketing—Activities, costs, and assets related to sales force efforts, advertising and promotion, market research and planning, and dealer/distributor support.

• Service—Activities, costs, and assets associated with providing assistance to buyers, such as installations, spare parts delivery, maintenance and repair, technical assistance, buyer inquiries, and complaints.

SUPPORT ACTIVITIES• Product R&D, Technology, and Systems Development—Activities, costs, and assets relating to product R&D, process

R&D, process design improvement, equipment design, computer software development, telecommunications systems, computer-assisted design and engineering, database capabilities, and development of computerized support systems.

• Human Resource Management—Activities, costs, and assets associated with the recruitment, hiring, training, development, and compensation of all types of personnel; labor relations activities; and development of knowledge-based skills and core competencies.

• General Administration—Activities, costs, and assets relating to general management, accounting and finance, legal regulatory affairs, safety and security, management information systems, forming strategic alliances and collaborating with strategic partners, and other overhead functions.

Supply Chain

Manage- ment

Operations DistributionSales and Marketing

Service Profit Margin

Product R&D, Technology, and Systems Development

Human Resources Management

General Administration

Primary Activities

and Costs

Support Activities

and Costs

Source: Based on the discussion in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), pp. 37–43.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

A Company’s Primary and Support Activities Identify the Major Components of Its Internal Cost Structure The combined costs of all the various primary and support activities comprising a company’s value chain define its internal cost structure. Further, the cost of each activity contributes to whether the company’s overall cost position relative to rivals is favorable or unfavorable. The roles of value chain analysis and benchmarking are to develop the data for comparing a company’s costs activity-by-activity against the costs of key rivals and to learn which internal activities are a source of cost advantage or disadvantage.

Each activity in a company’s value chain gives rise to costs and ties up assets.

Evaluating a company’s cost-competitiveness involves using what accountants call activity-based costing to determine the costs of performing each value chain activity.16 The degree to which a company’s total costs should be broken down into costs for specific activities depends on how valuable it is to know the costs of specific activities versus broadly defined activities. At the very least, cost estimates are needed for each broad category of primary and support activities, but cost estimates for more specific activities within each broad category may be needed if a company discovers it has a cost disadvantage vis-à-vis rivals and wants to pin down the exact source or activity causing the cost disadvantage. However, a company’s own internal costs are insufficient to assess whether its product offering and customer value proposition are competitive with those of rivals. Cost and price differences among competing companies can have their origins in activities performed by suppliers or by distribution allies involved in getting the product to the final customers or end users of the product, in which case the company’s entire value chain system becomes relevant.

The Value Chain System for an Entire IndustryA company’s value chain is embedded in a larger system of activities that includes the value chains of its suppliers and the value chains of whatever wholesale distributors and retailers it utilizes in getting its product or service to end users.17 Suppliers’ value chains are relevant because suppliers perform activities and incur costs in creating and delivering the purchased inputs used in a company’s own value-creating activities. The costs, performance features, and quality of these inputs influence a company’s own costs and product differentiation capabilities. Anything a company can do to help its suppliers drive down the costs of their value chain activities or improve the quality and performance of the items being supplied can enhance its own competitiveness—a powerful reason for working collaboratively with suppliers in managing supply chain activities.18 Automakers, for example, have encouraged their automotive parts suppliers to build plants near the auto assembly plants to facilitate just-in-time deliveries, reduce warehousing and shipping costs, and better enable close collaboration on parts design and production scheduling.

Similarly, the value chains of a company’s distribution channel partners are relevant because (1) the costs and margins of a company’s distributors and retail dealers are part of the price the ultimate consumer pays, and (2) the activities that distribution allies perform affect sales volumes and customer satisfaction. For these reasons, companies normally work closely with their distribution allies (who are their direct customers) to perform value chain activities in mutually beneficial ways. For instance, motor vehicle manufacturers have a competitive interest in working closely with their automobile dealers to (1) promote better customer satisfaction with dealers’ repair and maintenance services and (2) develop sales and marketing programs to achieve higher sales volumes. Producers of bathroom and kitchen faucets are heavily dependent on whether the sales and promotional activities of their distributors and building supply retailers are effective in attracting the interest of homebuilders and do-it-yourselfers, and whether distributors/retailers operate their value chains cost effectively enough to be able to sell at prices that lead to attractive sales volumes.

A company’s cost-competitiveness depends not only on the costs of internally performed activities (its own value chain) but also on costs in the value chains of its suppliers and distribution channel allies.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

As a consequence, accurately assessing a company’s competitiveness entails scrutinizing the nature and costs of value chain activities across an industry’s entire value chain system for delivering a product or service to end-use customers. A typical industry value chain that incorporates the value chains of suppliers and forward channel allies (if any) is shown in Figure 4.4. As was the case with company value chains, the specific activities comprising industry value chains vary significantly from industry to industry. The primary value chain activities in the pulp and paper industry (timber farming, logging, pulp mills, paper making, and distribution) differ from the primary value chain activities in the home appliance industry (product design, parts and components manufacture, assembly, wholesale distribution, retail sales) and differ yet again for the soft drink industry (processing of basic ingredients and syrup manufacture, bottling and can filling, wholesale distribution, advertising, and retail merchandising).

FIGURE 4.4 A Representative Value Chain System for an Entire Industry

Supplier-Related Value Chains

A Company’s Own Value Chain

Forward Channel Value Chains

Activities, costs, and margins of suppliers

Internally performed activities,

costs, and

margins

Activities, costs, and margins

of forward channel

allies and strategic partners

Buyer or end-user

value chains

Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), p. 35.

Once a company has developed good cost estimates for each major activity in its own value chain, has a good grasp of the value chains its close rivals employ, and has sufficient cost data relating to the value chain activities of suppliers and distribution allies, it is ready to explore whether its costs compare favorably or unfavorably with those of key rivals. This is where benchmarking comes in.

Benchmarking: A Tool for Assessing Whether the Costs and Effectiveness of a Company’s Value Chain Activities Are in LineBenchmarking entails comparing how different companies (both inside and outside the industry) perform various value chain activities—how inventories are managed, how products are assembled, how fast the company can get new products to market, how customer orders are filled and shipped—and then making cross-company comparisons of the costs of these activities.19 The objectives of benchmarking are to identify the best means of performing an activity, to learn how other companies have actually achieved lower costs or better results in performing benchmarked activities, and to take action to emulate those best practices whenever benchmarking reveals that its costs and results of performing an activity are not on a par with what other companies have achieved. A best practice is a method or technique of performing an activity or business

CORE CONCEPTBenchmarking is a potent tool for learning which companies are best at performing particular activities and emulating their techniques (or “best practices”) to improve the cost and effectiveness of a company’s own internal activities.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

process that produces results superior to those achieved with other methods/techniques. To qualify as a legitimate best practice, the method must have been employed by at least one enterprise and shown to be consistently effective in lowering costs, improving quality or performance, shortening time requirements, enhancing safety, or achieving some other highly positive operating outcome(s).

Xerox pioneered the use of benchmarking to become more cost competitive, quickly deciding not to restrict its benchmarking efforts to its office equipment rivals but to extend them to any company regarded as “world class” in performing any activity relevant to Xerox’s business.20 Other companies quickly picked up on Xerox’s approach. Toyota managers got their idea for just-in-time inventory deliveries by studying how U.S. supermarkets replenished their shelves. Southwest Airlines reduced the turnaround time of its aircraft at each scheduled stop by studying pit crews on the auto racing circuit. More than 80 percent of Fortune 500 companies reportedly use benchmarking for comparing themselves against rivals in performing activities in ways that produce superior outcomes.

The tough part of benchmarking is not whether to do it but rather how to gain access to information about other companies’ practices and costs. Sometimes benchmarking can be accomplished by collecting information from published reports, trade groups, and industry research firms and by talking to knowledgeable industry analysts, customers, and suppliers. Sometimes field trips to the facilities of competing or noncompeting companies can be arranged to observe how things are done, ask questions, compare practices and processes, and perhaps exchange data on various cost components—but the problem here is that most companies, even if they agree to host facilities tours and answer questions, are unlikely to share competitively sensitive cost information. Furthermore, comparing one company’s costs to another’s costs may not involve comparing apples to apples if the two companies employ different cost accounting principles to calculate the costs of particular activities.

However, a third and fairly reliable source of benchmarking information has emerged. The explosive interest of companies in benchmarking costs and identifying best practices has prompted consulting organizations (Accenture, A.T. Kearney, Benchnet—The Benchmarking Exchange, and Best Practices, LLC) and several trade associations (the Qualserve Benchmarking Clearinghouse and the Strategic Planning Institute’s Council on Benchmarking) to gather benchmarking data, distribute information about best practices, and provide comparative cost data without identifying the names of particular companies. Having an independent group gather the information and report it in a manner that disguises the names of individual companies protects competitively sensitive data and lessens the potential for unethical behavior by company personnel in gathering their own data about competitors.

Strategic Options for Creating an Advantage or Remedying a Disadvantage as Concerns Cost or the Value Delivered to CustomersExamining the costs of a company’s own value chain activities and comparing them to rivals indicates who has how much of a cost advantage or disadvantage and which cost components are responsible. Value chain analysis and benchmarking can also disclose whether a company has an advantage or disadvantage vis-à-vis rivals in delivering value to customers. Such information is vital in strategic actions to create a cost or value advantage or eliminate a cost/value disadvantage. The three main areas in a company’s total value chain system where company managers can try to create a cost/value advantage or remedy a cost/value disadvantage are (1) a company’s own activity segments, (2) suppliers’ part of the overall value chain, and (3) the distribution channel portion of the chain.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

Improving the Performance of Internally Performed Activities Managers can pursue any of several strategic approaches to reduce the costs of internally performed value chain activities and improve a company’s cost competitiveness:21

• Implement best practices throughout the company, particularly for high-cost activities.

• Redesign the product and/or some of its components to eliminate high-cost components or facilitate speedier and more economical manufacture or assembly.

• Relocate high-cost activities to geographic areas where they can be performed more cheaply.

• Outsource certain internally performed activities to vendors or contractors that can perform them more cheaply than they can be performed in-house.

• Shift to lower-cost production technologies and/or invest in productivity-enhancing equipment (robotics, flexible manufacturing techniques, real-time process monitoring).

• Stop performing activities of minimal value to customers (like seldom-used customer services).

A second approach to eliminating a competitive disadvantage or creating a competitive advantage in how internal activities are performed is by improving the performance of those activities capable of delivering added value to customers. Efforts to deliver higher customer value at the same or lower cost can include:

• Adopting best practice approaches for activities affecting quality and customer service and activities known to affect buyer brand preferences.

• Implementing new design innovations and/or investing in production methods that improve quality, curtail maintenance requirements, extend product life, or reduce after-the-sale repair costs incurred by customers.

• Emphasizing better performance of activities most responsible for creating those product/service attributes known to impact buyer preferences for one brand versus another brand—the goal here should be to revamp those activities that result in attributes that cause buyers to dislike the company’s brand and to do an even better job of performing activities that can further enhance the attributes that buyers like about the company’s brand).

• Outsourcing activities to vendors/contractors with the resources/capabilities to help deliver higher customer value at the same or lower cost.

In searching for cost-reducing opportunities or value-enhancing opportunities, it is important to recognize that the manner in which one activity is done spills over to impact the costs/value of how other activities are performed. For instance, how a television or washing machine is designed impacts the number of parts and components, their respective manufacturing costs, the time and expense of assembling the various parts and components into a finished product, and, from a customer value perspective, how well the product performs, repair frequencies, maintenance costs, and product life.

Improving the Performance of Supplier-Related Value Chain Activities A company can gain cost savings in supplier-related value chain activities by pressuring suppliers for lower prices, switching to lower-priced substitute inputs, and collaborating closely with suppliers to identify mutual cost-saving opportunities.22 For example, collaborating with suppliers to achieve just-in-time deliveries from suppliers can lower a company’s inventory and internal logistics costs and may also allow suppliers to economize on their warehousing, shipping, and production scheduling costs—a win–win outcome for both. In a few instances, companies may find it is cheaper to integrate backward into the business of high-cost suppliers and make the item in-house instead of buying it from outsiders.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

A company can enhance the value it delivers to customers through its supplier relationships by selecting/retaining only those suppliers that meet higher-quality standards, bringing in suppliers to partner in the design process, and providing quality-based incentives to suppliers, particularly as concerns reducing parts defects. Fewer defects not only improve quality throughout the value chain system but also can curtail the annoyance customers have when a recently purchased product fails shortly after purchase (due to parts failures) and has to be repaired or replaced under warranty. In addition, fewer defects lower warranty costs and lower the costs of product testing and replacement of defective parts/components prior to shipment.

Improving the Performance of Distribution-Related Value Chain Activities Any of three means can be used to achieve better cost-competitiveness in the distribution portion of an industry value chain:23

1. Pressure distributors, dealers, and other forward channel allies to reduce their costs and markups to make the final price to buyers more competitive with the prices of rival brands.

2. Collaborate with forward channel allies to identify win–win opportunities to reduce costs. For example, a chocolate manufacturer learned that by shipping its bulk chocolate in liquid form in tank cars instead of in 10-pound molded bars, it could save its candy bar manufacturing customers the costs associated with unpacking and melting and also eliminate its own costs of molding and packing bars.

3. Change to a more economical distribution strategy, including switching to cheaper distribution channels (selling direct to consumers via the online sales at the company’s website) or possibly integrating forward into company-owned retail outlets.

The means of enhancing differentiation through the activities of distribution-related allies include (1) engaging in cooperative advertising and promotion campaigns, (2) creating exclusive distribution arrangements or using other incentives to boost the efforts of distribution allies to deliver enhanced value to end-use customers, (3) creating and enforcing higher standards for distribution allies to observe in performing their activities, and (4) providing training to forward channel partners in using best practices to perform their activities.

Translating Proficient Performance of Value Chain Activities into Competitive AdvantageA company that does a first-rate job of managing its value chain activities relative to competitors stands a good chance of achieving sustainable competitive advantage. As shown in Figure 4.5, competitive advantage can be achieved by out-managing rivals in either of two ways: (1) by performing value chain activities more efficiently and cost effectively, thereby gaining a low-cost advantage over rivals or (2) by performing certain value chain activities in ways that drive value-creating improvements in quality, features, performance, and other attributes, thereby gaining a differentiation-based competitive advantage keyed to what customers perceive as a superior product offering.

Performing value chain activities in ways that give a company either a lower-cost advantage or a value-creating differentiation advantage over rivals are two surefire ways to secure competitive advantage.

Achieving Proficient Performance of Value Chain Activities Depends on Having the Right Resources and Capabilities As laid out in Figure 4.5, either approach requires focused management attention on building and nurturing resources and capabilities that enable the value chain activities to be performed proficiently enough to produce the desired outcome—lower costs or greater value-creating differentiation. A company’s value chain is all about performing activities, and proficient performance of key activities requires having not just the right resources and capabilities but developing and constantly improving them so they become ever more competitively valuable.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

Achieving a cost-based competitive advantage requires determined efforts to be cost-efficient in performing value chain activities. Such efforts must be ongoing and persistent, and they have to involve each and every value chain activity. The goal must be continuous cost reduction, not on-again/off-again efforts. This requires a frugal culture where all company personnel not only exhibit cost-conscious behavior but also where they are diligent in discovering and implementing operating practices that lower costs. Cost-benchmarking and aggressive implementation of cost-lowering best practices must be the norm. Companies whose managers are truly committed to low-cost performance of value chain activities and succeed in engaging company personnel to discover innovative ways to drive costs out of the business have a real chance of gaining a durable low-cost edge over rivals. It is not as easy as it seems to imitate a company’s low-cost practices. Walmart, Nucor Steel, Dollar General, Irish airline Ryanair, Toyota, and French discount retailer Carrefour have been highly successful in preserving a low-cost advantage by out-managing their rivals in how cost efficiently company value chain activities are performed.

On the other hand, companies that succeed in achieving a differentiation-based competitive advantage do so because of a strong commitment to proficiently performing those value chain activities that add value for customers and more strongly differentiate their product offering from rivals. For example, uniquely good customer service capabilities are crucial at such high-end hotel properties as Ritz-Carlton, Four Seasons, and St. Regis. First-rate product innovation capabilities are paramount at Google, Microsoft, Johnson & Johnson, and Walt Disney. Product design capabilities underlie IKEA’s success in the furniture business. Standout engineering design and manufacturing/assembly capabilities are essential at Mercedes and BMW. To the extent that a company continues to invest resources in building greater and greater proficiency in performing the targeted value chain activities, and top management makes the associated resources and capabilities cornerstones of the company’s strategy to attract and please customers, then, over time, its proficiencies rise to the level of a core competence. Later, with further organizational learning and gains in proficiency, a core competence may evolve into a distinctive competence. Such superiority over rivals in performing one (or possibly several) differentiation-enhancing value chain activities can prove unusually difficult for rivals to match or offset. As a general rule, it is substantially harder for rivals to achieve “best in industry” proficiency in performing a key value chain activity than it is for them to clone the features and attributes of a hot-selling product or service.24 This is especially true when a company with a distinctive competence avoids becoming complacent and works diligently to maintain its industry-leading expertise and capability.

Becoming more cost efficient than rivals in performing value chain activities entails building and nurturing resources and capabilities that differ substantially from those needed to achieve a value-enhancing, differentiation-based competitive advantage.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

FIGURE 4.5 Translating Company Performance of Value Chain Activities into Competitive Advantage

Company managers decide to perform value chain activities in ways that drive

improvements in quality, features,

performance, and other

differentiation-enhancing

aspects

Competencies and

capabilities gradually emerge in performing

certain differentiation-

enhancing value chain

activities

Company proficiency in

performing some of these differentiation-

enhancing value chain

activities rises to the

level of a core competence

Company proficiency in

performing one or more

differentiation-enhancing value chain

activities continues to

build and evolves into a distinctive competence

Company gains a

competitive advantage based on superior

differentiation-enhancing capabilities that deliver

added value to customers

Option 2: Beat rivals by performing certain differentiation-enhancing value chain activities more proficiently, thus creating a differentiation-based competitive advantage keyed to delivering what customers perceive as a superior product offering.

Option 1: Beat rivals by performing value chain activities more cheaply, thus achieving a cost-based competitive advantage

Company managers decide to perform value chain activities

in the most cost-efficient

manner—every value chain activity is

examined for possible cost

savings

Competencies and

capabilities gradually emerge in performing

many value chain

activities very cost efficiently

Company proficiency in cost-efficient performance

of value chain activities

rises to the level of a core

competence

Company proficiency in cost-efficient performance

of value chain activities

continues to build and

evolves into a distinctive competence

Company gains a

competitive advantage based on superior

cost-lowering capabilities

Source: Based in part on the single-industry value chain displayed in Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), p. 35.

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER THAN KEY RIVALS?Using value chain analysis and benchmarking to determine a company’s competitiveness on price, cost, and delivering value to customers is necessary but not sufficient. A more comprehensive assessment of the company’s overall competitive strength is needed. The answers to two questions are of particular interest: First, how does the company rank relative to competitors on each important factor that determines market success? Second, all things considered, does the company have a net competitive advantage or disadvantage versus its closest rivals?

An easy-to-use method for answering these two questions involves developing quantitative strength ratings for the company and its key competitors on each industry key success factor and each competitive trait or capability that impacts a company’s competitiveness and determines whether it is competitively strong or weak. Much of the information needed for doing a competitive strength assessment comes from previous

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

analyses. Industry and competitive analysis reveal the key success factors and competitive capabilities that separate industry winners from losers. Benchmarking data and scouting key competitors provide a basis for judging the competitive strength of rivals on such factors as cost, key product attributes (quality, styling, performance features), customer service, image and reputation, financial strength, technological capability, distribution capability, and other competitively important traits. SWOT analysis reveals how the company in question stacks up on these same strength measures.

Step 1 in doing a competitive strength assessment is to make a list of the industry’s key success factors and the most telling measures of competitive strength or weakness (six to ten measures usually suffice). Step 2 is to assign weights to each of the measures of competitive strength based on their perceived importance—it is highly unlikely that all the different measures are equally important. For instance, in an industry where the products/services of rivals are virtually identical, having low unit costs relative to rivals is nearly always the most important determinant of competitive strength. Importance weights can be as high as 0.50 in situations where one particular competitive strength measure is overwhelmingly decisive, or the high weights might be only 0.20 or 0.25 when two or three strength measures are more important than the rest. Lesser competitive strength indicators can carry weights of 0.05 or 0.10. The sum of the weights for each measure must add up to 1.0.

Step 3 is to rate the firm and its rivals on each competitive strength measure, using a rating scale of 1 to 10 (where 1 is competitively very weak and 10 is competitively very strong). Step 4 is to multiply each strength rating by its importance weight to obtain weighted strength scores (a strength rating of 4 multiplied by an importance weight of 0.20 gives a weighted strength score of 0.80). Step 5 is to sum each company’s weighted strength ratings to obtain an overall weighted competitive strength rating. Step 6 is to use the overall weighted competitive strength ratings to draw conclusions about the size and extent of the company’s net competitive advantage or disadvantage vis-à-vis its rivals and to take specific note of areas of strength and weakness.

Table 4.3 provides an example of competitive strength assessment in which a hypothetical company (ABC Company) competes against two rivals. In the example, relative cost is the most telling measure of competitive strength and the other strength measures are of lesser importance. The company with the highest rating on a given measure has an implied competitive edge on that measure, with the size of its edge reflected in the difference between its weighted rating and rivals’ weighted ratings. For instance, Rival 1’s 3.00 weighted strength rating on relative cost signals a considerable cost advantage versus ABC Company (with a 1.50 weighted score on relative cost) and an even bigger cost advantage against Rival 2 (with a weighted score of 0.30). The measure-by-measure ratings reveal the competitive areas where a company is strongest and weakest, and against whom.

The weighted overall competitive strength scores indicate how all the different strength measures add up—whether the company has a net overall competitive advantage or disadvantage versus each rival. The more a company’s weighted overall competitive strength rating exceeds the scores of lower-rated rivals, the stronger is its overall competitiveness versus those rivals; the further a company’s score is below those of higher-rated rivals, the weaker is its ability to compete successfully. The bigger the difference between a company’s overall weighted rating and the scores of lower-rated rivals, the bigger is its implied net competitive advantage over these rivals. Thus, Rival 1’s overall weighted score of 7.70 indicates a greater net competitive advantage over Rival 2 (with a score of 2.10) than over ABC Company (with a score of 5.95). Conversely, the bigger the difference between a company’s overall rating and the scores of higher-rated rivals, the greater its implied net competitive disadvantage. Rival 2’s score of 2.10 gives it a smaller net competitive disadvantage against ABC Company (with an overall score of 5.95) than against Rival 1 (with an overall score of 7.70).

The sizes of the differences between a company’s overall weighted score and that of a lower rated rival signals both their differing degrees of competitiveness and the size of the higher rated company’s net competitive advantage and the lower-rated company’s net disadvantage.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

TABLE 4.3 A Representative Weighted Competitive Strength Assessment

Competitive Strength Assessments [Rating scale: 1 = Very weak; 10 = Very strong]

ABC Co. Rival 1 Rival 2 Key Success Factors and Strength Measures

Importance Weight

Strength Rating

WeightedScore

Strength Rating

WeightedScore

Strength Rating

WeightedScore

Quality/product performance 0.10 8 0.80 5 0.50 1 0.10

Reputation/image 0.10 8 0.80 7 0.70 1 0.10

Manufacturing capability 0.10 8 0.20 10 1.00 5 0.50

Technological skills 0.05 10 0.50 1 0.05 3 0.15

Dealer network/distribution capability 0.05 9 0.45 4 0.20 5 0.25

New product innovation capability 0.05 9 0.45 4 0.20 5 0.25

Financial resources 0.10 5 0.50 10 1.00 3 0.30

Relative cost position 0.30 5 1.50 10 3.00 1 0.30

Customer service capabilities 0.15 5 0.75 7 1.05 1 0.15

Sum of importance weights 1.00

Weighted overall competitive strength rating 5.95 7.70 2.10

Strategic Implications of the Competitive Strength AssessmentsIn addition to showing how competitively strong or weak a company is relative to its rivals, the strength ratings provide guidelines for designing wise offensive and defensive strategies. For example, if ABC Co. wants to go on the offensive to win additional sales and market share, such an offensive probably needs to be aimed directly at winning customers away from Rival 2 (which has a lower overall strength score) rather than Rival 1 (which has a higher overall strength score). Moreover, while ABC has high ratings for technological skills (a 10 rating), dealer network/distribution capability (a 9 rating), new product innovation capability (a 9 rating), quality/product performance (an 8 rating), and reputation/image (an 8 rating), these strength measures have low importance weights—meaning that ABC has strengths in areas that don’t translate into much competitive clout in the marketplace. Even so, it outclasses Rival 2 in all five areas, plus it enjoys substantially lower costs than Rival 2 (ABC has a 5 rating on relative cost position versus a 1 rating for Rival 2)—and relative cost position carries the highest importance weight of all the strength measures. ABC also has greater competitive strength than Rival 2 regarding customer service capabilities (which carries the second-highest importance weight). Hence, because ABC’s strengths are in the very areas where Rival 2 is weak, ABC is in good position to attack Rival 2. Indeed, ABC may well be able to persuade a number of Rival 2’s customers to switch their purchases over to its product.

But ABC should be cautious about cutting prices aggressively to win customers away from Rival 2, because Rival 1 could interpret that as an attack by ABC to win away Rival 1’s customers as well. And Rival 1 is in far and away the best position to compete on the basis of low price, given its high rating on relative cost in an industry where low costs are competitively important (relative cost carries an importance weight of 0.30). Rival 1’s very strong relative cost position vis-à-vis both ABC and Rival 2 arms it with the ability to use its lower-cost advantage to thwart any price-cutting on ABC’s part. Clearly ABC is vulnerable to any retaliatory price cuts by Rival 1—Rival

A company’s competitive strength scores pinpoint its strengths and weaknesses against rivals and point directly to the kinds of offensive/defensive actions it can use to exploit its competitive strengths and reduce its competitive vulnerabilities.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

1 can easily defeat both ABC and Rival 2 in a price-based battle for sales and market share. If ABC wants to defend against its vulnerability to potential price-cutting by Rival 1, it needs to aim a portion of its strategy at lowering its costs.

The point here is that a competitively astute company should take both the individual and overall strength scores into account in deciding what strategic moves to make. When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense to consider offensive moves based on these strengths to exploit rivals’ competitive weaknesses. When a company has important competitive weaknesses in areas where one or more rivals are strong, it makes sense to consider defensive moves to curtail its vulnerability.

QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS DOES TOP MANAGEMENT NEED TO ADDRESS IN CRAFTING A STRATEGY TO FIT THE SITUATION?The final and most important analytical step is to zero in on exactly which strategic issues company managers need to worry about and consider in crafting a strategy well-suited to the company’s specific circumstances. Compiling a “worry list” involves drawing heavily on the results of the analysis of both the company’s external and internal environments. The task here is to get a clear fix on exactly what competitive challenges the company confronts on the road ahead, which of the company’s competitive shortcomings need to be remedied, what obstacles stand in the way of improving the company’s competitive position in the marketplace and boosting its financial performance, what combination of strategic actions offers the best path to competitive advantage, and what specific problems/issues merit front-burner attention by company managers in crafting future strategic actions.

The “worry list” of significant strategic issues and problems that need to be dealt with in forthcoming strategic initiatives can include things such as how to stave off market challenges from new foreign competitors, how to combat the price discounting of rivals, how to reduce the company’s high costs and pave the way for price reductions, how to sustain the company’s present rate of growth in light of slowing buyer demand, whether to expand the company’s product line, whether to correct the company’s competitive deficiencies by acquiring a rival company with the missing strengths, whether to expand into foreign markets rapidly or cautiously, whether to reposition the company and move to a different strategic group, what to do about growing buyer interest in substitute products, and what to do to combat the aging demographics of the company’s customer base. The worry list thus relies on such language as “how to…,” “what to do about…,” and “whether to…” to precisely identify the specific issues/problems that management needs to address and try to resolve in deciding what upcoming strategic actions to take. The worry list thus serves as an agenda of strategically relevant issues/problems that managers need to focus on in crafting a refurbished strategy that fits the particulars of the company’s external and internal situation.

Compiling a “worry list” that sets forth the strategic issues and problems a company faces should embrace such language as “how to…,” “whether to …” and what to do about….” The purpose of compiling a worry list is to create an agenda of items that need to be addressed in crafting a set of strategic actions that fit the company’s overall situation.

Only after managers have first done serious strategic thinking about how to deal with the items on the worry list are they truly prepared to pick and choose among the alternative strategic actions and initiatives in fashioning an overall strategy that suits the company’s situation—the items on the worry list are most definitely a relevant and important part of the company’s situation.25 If the items on the worry list are relatively minor—which suggests the company’s present strategy is mostly on track and reasonably well matched to the company’s overall situation—company managers seldom need to go much beyond fine-tuning the present strategy to arrive at

CORE CONCEPTA strategy is neither complete nor well matched to the company’s situation unless it contains actions and initiatives to address each issue or problem on the “worry list.”

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

a strategy suitable for the road ahead. If, however, the issues and problems confronting the company signal that the present strategy requires significant overhaul, the task of crafting a revamped strategy better suited to the company’s internal and external situation needs to be right at the top of management’s action agenda.

KEY POINTSThere are six key questions to consider in evaluating a company’s resources and ability to compete successfully:

1. How well is the company’s present strategy working? This involves evaluating the strategy from a qualitative standpoint (completeness, internal consistency, rationale, and suitability to the situation) and also from a quantitative standpoint (the strategic and financial results the strategy is producing). The stronger a company’s current overall performance, the less likely the need for radical strategy changes. The weaker a company’s performance and/or the faster the changes in its external situation, the more its current strategy must be questioned.

2. What are the company’s important resources and capabilities, and do they have the competitive power to enable the company to produce a competitive advantage over rival companies? The task here is to identify the company’s most valuable resources and capabilities and to assess their competitive power using four tests. The degree of success a company enjoys in the marketplace is governed by the combined competitive power of its resources and capabilities. Executive attention to making sure a company always has competitively valuable resources and capabilities that dynamically evolve and help sustain the company’s competitiveness is a strategically important top management task.

3. What are the company’s competitively important strengths and weaknesses and how well-suited are they to capturing its best market opportunities and defending against the external threats to its future well-being? A SWOT analysis provides an overview of a firm’s situation and is an essential component of crafting a strategy that is well-suited to the company’s internal and external circumstances. The two most important parts of a SWOT analysis are (1) drawing conclusions about what story the compilation of strengths, weaknesses, opportunities, and threats tell about the company’s overall situation, and (2) acting on those conclusions to better develop a strategy that satisfies the three requirements of a winning strategy: (1) fit the company’s internal and external situation, (2) help build competitive advantage, and (3) improve performance. A company’s most competitively potent resources and capabilities should be the foundation of its strategy. Using a company’s most potent resources and capabilities to power its strategy gives the company its best chance for market success, competitive advantage, and better performance. A well-conceived strategy must include actions to correct those competitive weaknesses that make the company vulnerable to attack from rivals, depress profitability, or disqualify it from pursuing a particularly attractive opportunity. Market opportunities and external threats come into play because fitting a company’s strategy to a company’s situation requires aiming an important portion of the company’s strategy at pursuing attractive market opportunities and defending against threats to its future profitability and well-being.

4. Are the company’s prices and costs competitive with those of key rivals, and does it have an appealing customer value proposition? The greater the value a company can profitably deliver to its customers relative to the value delivered by close rivals, the less competitively vulnerable it becomes. The higher a company’s costs relative to those of rivals delivering comparable customer value at a comparable price, the more competitively vulnerable it becomes. Value chain analysis and benchmarking are essential tools in determining how well a company is performing particular functions and activities, learning whether its costs are in line with competitors, and deciding which internal activities and business processes need to be scrutinized for improvement. Performing value chain activities in ways that give a company either a lower-cost advantage or a value-creating differentiation advantage over rivals are two surefire ways to create competitive advantage.

Chapter 4 • Evaluating a Company’s Resources and Ability to Compete Successfully

5. Is the company competitively stronger or weaker than key rivals? The key appraisals here involve how the company matches up against key rivals on industry key success factors and other chief determinants of competitive success and whether and why the company has a competitive advantage or disadvantage. Quantitative competitive strength assessments, using the method presented in Table 4.3, indicate where a company is competitively strong and weak, and provide insight into the company’s ability to defend or enhance its market position. As a rule, a company’s competitive strategy should be built around its competitive strengths and should aim at shoring up areas where it is competitively vulnerable. When a company has important competitive strengths in areas where one or more rivals are weak, it makes sense to consider offensive moves to exploit rivals’ competitive weaknesses. When a company has important competitive weaknesses in areas where one or more rivals are strong, it makes sense to consider defensive moves to curtail its vulnerability.

6. What strategic issues and problems does top management need to address in crafting a strategy to fit the situation? This analytical step zeros in on the strategic issues and problems that stand in the way of the company’s success. It involves drawing on the results of both the analysis of the company’s external environment and the evaluations of the company’s overall internal situation to compile a “worry list” of issues and problems that managers need to address and try to resolve in refurbishing the company’s strategy to better fit its overall situation. The worry list uses such language as “how to…,” “whether to…” and ‘what to do about…” to single out the specific strategy-related concerns that merit front-burner management attention. A company’s strategy is neither complete nor well matched to the particulars of its situation unless it contains actions and initiatives to address every issue or problem on the worry list.

Accurate appraisal of a company’s internal situation, like penetrating analysis of its external environment, is a valuable precondition for good strategy making. Absent such analysis, company managers are unlikely to craft a strategy that is well suited to the company’s resources, competitive capabilities, and best market opportunities.

100

Chapter 4: Evaluating a Company’s Resources and Ability to Compete Successfully

Question 1: How Well Is The Company’s Present Strategy Working?
Question 2: What Are The Company’s Important Resources and Capabilities and Do They Have Enough Competitive Power To Produce A Competitive Advantage Over Rivals?
Question 3: What Are The Company’s Competitively Important Strengths and Weaknesses and Are They Well-Suited To Capturing Its Best Market Opportunities and Defending Against External Threats?
Question 4: Are The Company’s Prices And Costs Competitive With Those of Key Rivals, and Does It Have An Appealing Customer Value Proposition?
Question 5: Is The Company Competitively Stronger or Weaker Than Key Rivals?
Question 6: What Strategic Issues and Problems Does Top Management Need to Address in Crafting a Strategy to Fit the Situation?
Key Points

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