Chapter 3: Assessing Internal Environment

Value Chain Analysis

• Value chain analysis is a sequential process of value-creating activities based on the
principle that organizations exist to create value for their customers.

• Value chain analysis provides greater insight into analyzing a firm's competitive position
as it helps a company understands how it adds value to something and subsequently
how it can sell its product or service for more than the cost of adding the value,
thereby generating a profit margin.

The organization’s activities are divided into two separate sets of activities that add value-
Primary activities and Supportive activities.

Primary activities: Primary activities refers to the activities associated with physical
creation of the product or service, its sale and transfer to the buyer, and its service after
sale, including inbound logistics, operations, outbound logistics, marketing and sales, and
service.
Inbound Logistics:
• Inbound Logistics is preliminary associated with receiving, storing and distributing
inputs to the product.
• It includes- material handling, warehousing, inventory control, vehicle scheduling and
returns to suppliers.
Operation:
• Operation includes all activities associated with transforming inputs into the final
product form, such as machining, packaging, assembly, testing, printing and facility
operation.
Outbound logistics:
• Outbound logistics is associated with collecting, storing, and distributing the product
or service to buyers.
• These activities include finished goods, warehousing, material handling, delivery
vehicles operation, order processing and scheduling.
Marketing and Sales:
• Marketing and sales activities are associated with purchases of products and
services by end users and the inducements used to get them to make purchases.
• They include advertising, promotion, sales force, quoting, channel selection, channel
relations, and pricing.
Service:
• The primary activity of service include all action associated with providing service to
enhance or maintain the value of the product, such as installation, repair, training,
parts supply, and product adjustment.

Support activities: Activities of the value chain that either add value by themselves or
add value through important relationships with both primary activities and other support
activities including procurement, technology development, human resource management, and
general administration.
 Procurement:
• Procurement refers to the function of purchasing inputs used in the firm's value
chain.
• Purchased inputs include raw materials, supplies, and other consumable items as
well as assets such as machinery, laboratory equipment, office equipment, and
buildings.
Technology development
• Every value activity embodies technology, ranging from technologies used to prepare
documents and transport goods to those embodied in process and equipment or
product itself.
• Technology development related to the product and its features supports the entire
value chain, while other technology development is associated with particular primary
or support activities.
Human resource management
• Human resource management consists of activities involved in the recruiting, hiring,
training, development, and compensation of all types of personnel.
• It supports both individual primary and support activities (e.g. hiring of engineers
and scientists) and the entire value chain (e.g. negotiation with labor unions).
Infrastructure
• Consists of a number of activities, including general management, planning, finance,
accounting, legal and government affairs, quality management, and Information
systems.
• It typically supports the entire value chain and not individual activities.

Factors to consider in assessing a firm’s primary activities

Inbound Logistics: Operation Outbound Marketing and Sales Service
Logistics
Location of Efficient plant Effective Highly motivated Effective use of procedures
distribution operations shipping and competent sales to solicit customer feedback
facilities processes force and to act on information.
Appropriate
Material and level of Efficient Innovative Quick response to customer
inventory control automation in finished goods approaches to needs and emergencies.
systems manufacturing warehousing promotion and
processes advertising Ability to furnish replacement
Systems to Quality parts.
reduce time to production Shipping of Selection of most
send “returns” to control systems goods in large appropriate Effective management of
suppliers lot sizes distribution channels parts and equipment
Efficient plant inventory.
Warehouse layout layout and Quality Proper identification
and designs workflow design material of customer Quality of service personnel
handling segments and needs and ongoing training.
equipment Warranty and guarantee
Effective pricing policies
strategies
 Factors to consider in assessing a firm’s supportive activities
Procurement Technological Human resource General Administration
Development management
Procurement of raw Effective R&D Effective Effective planning systems
material inputs activities for process recruiting,
and product initiatives. development, and Ability of top management to
Development of retention anticipate and act on key
collaborative “win-win” Positive collaborative mechanisms for environmental trends and events.
relationships with relationships between employees.
suppliers R&D and other Ability to obtain low-cost funds
departments. Quality relations for capital expenditures and
Effective procedures to with trade unions.
working capital.
purchase advertising State-of-the art
and media services facilities and Quality work
Excellent relationships with diverse
equipment. environment to
maximize overall stakeholder groups.
Analysis and selection
of alternate sources of Culture to enhance employee
inputs to minimize creativity and performance and Ability to coordinate and integrate
dependence on one innovation. minimize activities across the value chain.
supplier absenteeism.
Excellent professional Highly visible to inculcate
Ability to make proper qualifications of Reward and organizational culture, reputation,
lease versus buy personnel. incentive programs and values
decisions Ability to meet critical to motivate all
deadlines. employees

Interrelationships among Value Chain Activities

There are two levels of interrelationships and collaborative exchange relationship between
value chain activities:
Interrelationships among activities within the firm
• Primary activities add value directly to the production process, but they are not
necessarily more important than support activities.
• Nowadays, competitive advantage mainly derives from technological improvements or
innovations in business models or processes. Therefore, such support activities as
'information systems', 'R&D' or 'general management' are usually the most important
source of differentiation advantage.
• On the other hand, primary activities are usually the source of cost advantage,
where costs can be easily identified for each activity and properly managed.

Relationships among activities within the firm and with other stakeholders (e.g., customers
and suppliers) that are part of the firm’s expanded value chain.
Strategic exchange of resources such as information, people, technology, or money that
contribute to the firm success.
What are the use of value chain analysis in internal assessment of a firm?
1. The value chain is a very flexible strategy tool for looking at business, competitors and
the respective places in the industry’s value system.
2. Value chain analysis visually analyze a company's business activities to see how the
company can create a value for its customers and create competitive advantage for
itself.
3. A firm gains a competitive advantage by performing primary and supportive activities
better or at lower cost than competitors.
• Primary activities add value directly to the production process. These activities are
usually the source of cost advantage, where costs can be easily identified for each
activity and properly managed.
• Nowadays, competitive advantage mainly derives from technological improvements or
innovations in business models or processes. Therefore, such support activities as
'information systems', 'R&D' or 'general management' are usually the most important
source of differentiation advantage.
Value chain analysis systematically examine how primary and supportive activities interact
with one another and affect each other’s cost and performance.
4. Comparing business model with competitors’ using the value chain can give a much
deeper understanding of company’s strengths and weaknesses.
5. It helps to understand the organization’s issues involved with the promise of
making customer value commitments and focuses attention on the activities needed to
deliver the value proposition.
6. It can be adapted for any type of business – manufacturing, retail or service, big or
small.
7. Helps to stay out of the “No Profit Zone”
8. Aligns spending with value processes.

Resource-based view of the firm:

• The Resource Based View (RBV) takes an ‘inside-out’ view on why organizations
succeed or fail in the market place.
• According to RBV, firm’s abilities depends on the resources and capabilities that reside
within the organization which develop sustainable competitive advantages.
• However, not all the resources of firm will be sources of competitive advantage.
• The ability and potentiality of firms' strategic resources to confer competitive advantage
depends on how valuable, rare, costly they are for competitor to imitate, and
substitute.

Three types of firm’s resources:

Tangible resources:
 These are assets that are relatively easy to identify.
 Tangible resources include the physical assets, financial resources, organizational
resources, and technological resources, used to create value for customers.
 The value of tangible resources is constrained as they are difficult to leverage–it is
difficult to derive additional business or value from a tangible resource
Financial resources Physical resources Technological Organizational resources
resources
• Cash • Modern plant and facilities • Trade • Effective strategic planning
secrets processes
• Accounts • State-of-the-art machinery
receivables and equipment • Innovative • Excellent evaluation and
production control systems
• Capacity to raise • Proximity to customers and processes
equity suppliers • Employee development
• Patents, system
• Ability to borrow • Favorable manufacturing copyrights,
fund locations trademarks • Reward system

Intangible resources
Intangible resources are assets that are
- Difficult to identify and account for
- Typically attached in unique routines and practices, and
- That have develop and accumulated over time.
These include human resources, innovation resources, and reputation resources.
As Intangible resources are less visible, they more difficult for competitors to understand,
purchase, imitate or substitute for.
Firms prefer to rely on intangible resources as the foundation for their capabilities and core
competencies.
Human Resources Innovation Reputation resources
resources
• Experience and capabilities of • Technical and • Brand name
employees scientific skills • Reputation with suppliers for
• Trust • Ideas fairness, non-zero sum
• Effectiveness of work teams • Innovation relationships
• Managerial skills capacities • Reputation with customers
• Firm-specific practices and procedures for reliability and product
quality.

Organizational capabilities
 Organizational capabilities are competencies or skills that a firm employs to transform
inputs to outputs, and capacity to combine tangible and intangible resources to attain
desired end.
 Organizational capabilities enable the firm to convert same inputs as rivals have into
goods and services with greater efficiency and better quality.
 Example of organizational capabilities are:

• Outstanding customer service

• Excellent product development capabilities
• Innovativeness of products and services
• Ability to hire, motivate, and retain human capital.
Firms resources and sustainable competitive advantages:
The four attributes that a firm’s resources must possess to maintain a sustainable
advantages are-
1. Strategic resources must be valuable
2. It must be rare among the firm’s current and potential competitors.
3. The resources must be difficult for competitors to imitate.
4. No substitutes readily available.
Is the resources valuable?
• Organizational resources can be a source of competitive advantage only when they
are valuable in the sense that it exploits opportunities and neutralize threats in the
firm’s environment.
• Resources are valuable when they enable a firm to formulate and implement
strategies that improve its efficiency or effectiveness.
Is the Resource Rare?
• If current competitors or potential competitors also possesses the same valuable
resources, it is not a source of competitive advantage because all of these firms
have the capability to exploit the resources in the same way.
• Common strategies based on similar resources would give no one firm an advantage
• Competitive advantages are gained only from uncommon resources i.e. resources that
are rare to other competitors.
Can the Resource be imitated?
Difficulty in imitating resources is key to value creation because it constrains competition.
Profits generated from inimitable resources are more likely to be sustainable.
To become inimitable, resources must have at least one of the following characteristics:
• Physical uniqueness:
A characteristic of a firm's resources that is inherently difficult to copy.
E.g. a beautiful resort location, mineral rights, Pfizer’s pharmaceutical patent simply cannot
be limited.
• Path dependency:
A characteristic of resources that is developed and/or accumulated through a unique series
of events. Thus these resources are unique and therefore scarce.
Competitors cannot go out and buy these resources quickly and easily.
These must be built up over a time in ways that are difficult to accelerate.
• Causal ambiguity:
A characteristic of a firm's resources that is costly to imitate because a competitor cannot
determine what the resource is and/or how it can be recreated.
• Social complexity:
A characteristic of a firm's resources that is costly to imitate because the social
engineering required is beyond the capability of competitors. For example, a variety of firm
resources include interpersonal relations among managers in the firm, its culture, and its
reputation with its suppliers and customers.
Are Substitutes Readily Available?
 There must be no strategically equivalent valuable resources that are themselves not
rare or inimitable.
 Substitutability may take at least two forms
a) Though it may be impossible for a firm to imitate exactly another’s firm
resources, it may be able to substitute a similar resource that enables it to
develop and implement the same strategy. For example, a competitor firm may
be unable to copy firm’s high quality top management team, but it might be able
to develop its own unique management team.
b) Very different firm resources can become strategic substitutes (such as e-
business as a substitute for physical retail facility.
Evaluating Firm’s Performance: Two Approaches
Financial ratio analysis
Financial ratio analysis identifies how a firm is performing
according to its balance sheet, income statement, and market
valuation.
 The beginning point in analyzing the financial position of
a firm is to compute and analyze five different types of
financial ratios.
1. Short-term solvency or liquidity
2. Long-term solvency measures
3. Asset management
4. Profitability
5. Market value
 Meaningful ratio analysis must include –
 Analysis of how ratios change over time
 How ratios are interrelated.
 When performing a financial ratio analysis, firm must consider its performance from a
historical perspective (not just at one point in time) as well as how it compares with
both industry norms and key competitors.
- Historical comparison: When evaluating a firm’s financial performance, it is very
useful to compare its financial position over time. The comparison must be drawn
between the past performance of the organization and present status of the same
organization.
- Comparison with industry norms: When evaluating a firm’s financial performance, it
must compare with its industry norms. A firm’s current ratio or profitability may appear
impressive at first glance. However it may pale when compared with industry standard
or norms.
- Comparison with key competitors
One can gain valuable insight into firm’s financial and competitive position, when
comparison is made between firm and its most direct rivals.

Stakeholder perspective:
Firms must satisfy a broad range of stakeholders including employees, customers, and
owners to ensure their long term viability.
Integrating financial analysis and stakeholder perspective:
The Balance Scorecard
• A method of evaluating firm’s performance using performance measures from the
customers’, internal, innovation and learning, and financial perspectives.
 How do customers see us? (Customer perspective)
 What must we excel at? (Internal perspective)
 Can we continue to improve and create value? (Innovation and learning
perspective).
 How do we look to shareholders? (Financial perspective)
• A Balanced Scorecard analysis attempts to translate a company's vision and mission
statement into the practicalities of managing the business better at every level.
Four key perspectives:
1. Customer perspective:
• Customer perspectives means “How do customers see us?”
• Customer perspective measures of firms’ performance that indicate how well firms are
satisfying customers’ expectation in terms of quality, price, and availability of products
or services on time.
• Customers provide feedback regarding if their needs are being met with current
products.
• Low performance in customer perspective might cause a decay of business even if
current financial and other perspectives are well performed.
2. Internal business perspective
Internal business perspective views organizational performance through the lenses of the
quality and efficiency related to product or services or other key business processes such
as cycle time, employee skills, productivity, decisions and actions, coordination, resources
and capabilities, that contributing to customer satisfaction.
3. Innovation and learning perspective
• Innovation and learning perspective measures of firms’ performance that indicate how
well firms are changing their product and service offerings to adapt to changes in the
internal and external environment.
• A firm’s ability to do well from an innovation and learning perspective is more
dependent on its intangible assets that are key to breakthrough performance. Such as:
 Human capital (skills, talent, and knowledge)
 Information capital (information systems and network)
 Organizational Capital ( culture and leadership)
4. Financial Perspective:
• Financial Perspective views organizational financial performance and the use of financial
resources and measures whether a company’s strategy and operations add value for
shareholders.
• Typical financial goals are profitability, growth, shareholder value, increased market
share, reduced operating expenses, higher asset turnover etc.
 Main advantages of the balanced scorecard
 The Balanced Scorecard provides a powerful framework for building and communicating
strategy. It clarifies strategy and make strategy operational and links budget with
strategy.
 The balanced scorecard measures performance in a variety of ways, rather than relying
on one figure.
 Senior management can evaluate whether lower level managers have improved one
area at the expense of another.
 Managers are unlikely to be able to distort the performance measure as bad
performance is difficult to hide if multiple performance measures are used.
 It takes a long-term, strategic approach to business performance.
 It is flexible, as what is measured can be changed over time to reflect changing
priorities.
 'What gets measured gets done'. If managers know they are being appraised on
various aspects of performance, they will pay attention to these areas, rather than
simply paying 'lip service' to them.
 The balanced scorecard integrates financial and non-financial goals and performance
measures into a single system – a thing which traditional controlling techniques never
consider.
Potential Limitations of the Balanced Scorecard
i. Balanced Scorecard is a vague concept and approach to controlling an organization’s
success, as there are neither any set of standard goals nor any set of standard
performance measures, for each of the four perspectives.
ii. Moreover setting standards for each of the key performance indicators can prove
difficult where the organization has no previous experience of performance
measurement.
iii. Balanced Scorecard just considers organizational performance from four perspectives.
It suggests nothing about what should be done to better performance in each of
these perspectives.
iv. Limited or ineffective executive sponsorship
v. Inappropriate links to scorecard measures to compensation
vi. Too much emphasis on financial measures rather than nonfinancial measures
vii. Poor data on actual performance
viii. Inconsistent or inappropriate Terminology
ix. Balanced Scorecard ignores many more important perspectives e.g. managerial
development perspectives, social responsibility perspective and so on.
x. If a company relies on balanced scorecard method for complete evaluation of
company's performance without integrating with an accounting system, it will not
be completely efficient.
xi. High Implementation Costs
xii. Balanced scorecards may give a broader internal focus, but they do not give a full
external picture. They consider customers but they do not consider other key
performance indicators, such as competitors or changes business environment, for
example.
xiii. All employees should buy into a balanced scorecard system for it to work
effectively. But resistance towards balanced scorecard can be from either a top
management officer or even from other officers.