Sustaining Competitive Advantage

IES462
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SMN-679-E
November 2010
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Sustaining Competitive Advantage
Competitive Strategy
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DILBERT © (2009) Scott Adams. Used By permission of UNIVERSAL UCLICK. All rights reserved
1. Introduction
In “Value Creation and Capture,” we discussed how firms gain competitive advantage and
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create value by making choices and trade-offs. Strategy is choosing among competing
priorities and alternatives to gain a competitive advantage. The note also illustrated how
gaining a competitive advantage allows firms to create and capture more value than rivals,
and hence generate greater profit. “Value Creation and Capture” focused on the business-
level strategies that a firm could employ, that is, how a firm chooses to compete in individual
product markets. This note focuses on the internal analysis of a firm, concentrating on how a
firm can combat imitation by utilizing its unique resources, capabilities and core
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competencies.
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This technical note was prepared by Bryan S. Ly, MBA 2011, and Professor Govert Vroom. November 2010.
Copyright © 2010 IESE. To order copies contact IESE Publishing via www.iesep.com. Alternatively, write to iesep@iesep.com,
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Last edited: 3/14/13

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SMN-679-E Sustaining Competitive Advantage
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In an increasingly competitive global environment, firms must continue focusing on creating
sustainable, long-term advantages. Figure 1 shows the evolution of the return on investment
(ROI) of nearly 700 business units. The top line represents the average ROI of the top 50%
performing business units, while the bottom line represents the ROI of the bottom 50% units.
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As can be seen from this figure, the difference between the originally well performing and
poorly performing business units almost fully dissipated over the 10-year timeframe of the
study. Research suggests that above-average performance declines towards the average much
more rapidly than many managers believe.
Figure 1
Limits of sustainability
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40
30
ROI %
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20
10
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0
1 2 3 4 5 6 7 8 9 10
Year
Source: Ghemawat, P., Commitment: The Dynamic of Strategy, New York, Free Press, 1991.
However, firms can increase the probability of developing a sustainable competitive advantage
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by using their own unique resources, capabilities and core competencies to implement their
strategies. Firms can create greater value by innovatively combining and leveraging their
resources and capabilities. This resource-based approach emphasizes that the key to profitability
lies in exploiting a firm’s unique strengths and doing things differently than competitors.
2. Definitions
Understanding the concepts of resources and capabilities is fundamental to the resource-
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based approach used in this note. In “Value Creation and Capture,” we defined competitive
advantage as the ability to create and capture more value than rivals. As resources,
capabilities and core competencies allow firms to create and capture value, they are the
characteristics that make up the foundation for creating a competitive advantage. Figure 2
illustrates how a firm’s resources, capabilities and competitive advantage link together.
2 IESE Business School-University of Navarra
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Sustaining Competitive Advantage SMN-679-E
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Figure 2
Linkages between resources, capabilities and competitive advantage
INDUSTRY KEY COMPETITIVE

STRATEGY
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SUCCESS FACTORS ADVANTAGE
ORGANIZATIONAL
CAPABILITIES
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RESOURCES
TANGIBLE INTANGIBLE ORGANIZATIONAL

• Financial • Technology • Skills/Know-How
• Physical • Reputation • Integration
• Motivation
Source: Grant, R. M., Contemporary Strategy Analysis, 7th edition, West Sussex, UK, John Wiley & Sons, 2010.
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2.1 Resources
It is important to distinguish between the resources and capabilities of the firm: resources are
the productive assets owned by the firm; capabilities are what the firm can do with those
resources. In general, resources alone are insufficient in creating a competitive advantage as
they are rarely unique to the firm and other firms may have access to the same resources.
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Only by innovatively combining several resources can a firm create a competitive advantage.
For example, consider the case of Amazon.com. From its early beginnings as an online book
retailer, Amazon’s competitive advantage was its unique combination of service and
distribution resources. Amazon’s unique distribution network allowed it to ship millions of
products to millions of customers. As Amazon’s more traditional brick-and-mortar rivals
attempted to enter the online space, Amazon’s combination of resources gave it a clear
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competitive advantage over its competitors. Eventually, many of these competitors were
forced to make arrangements with Amazon to handle their online presence.
A firm’s resources can be divided into three main categories: tangible, intangible and
organizational. In the following sections, consider some of the most important resources of a
football club, using the example of FC Barcelona.
Tangible Resources
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Tangible resources are assets that can be seen and more easily evaluated: financial resources
and physical assets are identified and valued in the firm’s financial statements. It is
important to keep in mind that the purpose of resource analysis is not to value a firm’s assets
but to identify their potential for creating a competitive advantage. The two types of tangible
resources are financial and physical.
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Example: FC Barcelona
Figure 3
Tangible resources of FC Barcelona
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Tangible Resources
Financial • World’s 3rd richest football club
• Revenues approx. ¼300M
• Ability to borrow capital from banks
Physical • Camp Nou – Capacity of 98,787, the largest
stadium in Europe and the 11 th largest in the world
Source: own elaboration based on Wikipedia.
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Intangible Resources
Often, intangible resources are a more effective source of competitive advantage than
tangible resources. However, because they are not visible on a firm’s balance sheet,
intangible resources are often hidden and their value difficult to measure.
Intangible resources include assets that are typically ingrained in the firm’s history and have
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been built up over time. Embedded in a firm’s unique routines and operation, intangible
resources are relatively difficult for competitors to analyze, understand or imitate. As a result,
firms prefer to rely on them rather than on tangible resources as the foundation for their
capabilities and core competencies. Research has shown that “the more unobservable a
resource is, the more sustainable will be the competitive advantage that is based on it” (Hitt,
Ireland and Hoskisson, 2005). Intangible resources, such as brand reputation, are the result of
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years of superior quality, making it very difficult to imitate or purchase.
Intangible resources may be divided in innovation and technological resources, and

reputational resources (Figure 4).
Figure 4
Intangible resources of FC Barcelona
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Intangible Resources
Innovation and • La Masia – A successful feeder system for
technological
homegrown talent development: Messi,
Iniesta, Puyol, Xavi, Busquets, etc.
• Trademarks
• Copyrights
Reputational • History of success – 1st Treble, 20 La Liga,
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25 Copa del Rey, 3 Champions League

• Brand name
• Reputation
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Organizational Resources
A firm’s organizational, or human, resources consist of the knowledge and effort of

employees. Similar to intangible resources, organizational resources are less visible and more
difficult to measure. Organizational resources affect how employees collaborate and integrate
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their separate skills. This also has to do with the culture of an organization, which can be
defined as an organization’s values, traditions and social norms. Research has shown that
firms with strong managerial values defining the way they conduct business often have
sustained superior financial performance.
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Figure 5
Organizational resources of FC Barcelona
Organizational Resources
Human Resources • Managerial capabilities – Pep Guardiola
• Reigning “World Player of the Year” – Lionel Messi
Structure • Unlike many other football clubs, the fans of FC
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Barcelona own and operate the club
2.2 Capabilities
As stated earlier, resources alone are insufficient in delivering competitive advantage, as they are
unproductive on their own. Instead, resources must work together to create an organizational
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capability, and it is this capability that delivers superior performance. Capabilities are defined as a
“firm’s capacity to deploy resources for a desired end result” (Grant, 2010). In addition, capabilities
emerge over time through complex interactions between tangible, intangible and human resources.
As illustrated in the tables below, two common approaches to help identify a firm’s
capabilities are:
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x Functional analysis – A functional analysis classifies the organizational capabilities in

relation to each of the primary functional areas. Figure 6 lists the main functions of a
firm and identifies capabilities located within a particular function.
x Value-chain analysis – A value-chain analysis classifies the activities of a firm into a

value chain. The value chain is divided into primary activities and support activities
(Figure 7). Primary activities are the activities involved in the conversion of inputs
and the interfaces with customers. Support activities are the activities required for the
primary activities to take place1.
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1 In this note, we are making a distinction between capabilities and activities. We are looking at activities from an internal firm
perspective, where activities are coordinated actions performed by teams of people in a series of productive tasks. With regard to
the Value Creation model discussed in the previous note, activities can be considered in terms of cost. Capabilities on the other
hand, are considered from the external customer perspective. In the Value Creation model, this would be considered the
deployment of resources to add value by increasing customer willingness to pay.
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Figure 6
Functional classification of organizational capabilities
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Figure 7
Value chain
Finance
Support R&D
Ma
Activities
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Infrastructure
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Human Resource Management
Marketing
Inbound Outbound
Operations & Service
Logistics Logistics
Sales
Primary Activities
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Source: Michael Porter, Competitive advantage, New York, US, The Free Press, 1985, pp. 11-15.
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It is important to recognize that a hierarchy of capabilities exists, where the capabilities we
can identify tend to be defined in broad strokes: operational capability, marketing capability,
etc. However, broadly defined capabilities can be broken down into more specific capabilities.
For example, operational capability can be broken up into manufacturing capability, process
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engineering capability and more. In fact, it can also work in reverse where broad capabilities
can be combined to form even wider cross-functional capabilities such as new product
development or quality management. The result is a hierarchy of capabilities where more
general capabilities are composed of specialized capabilities (Figure 8). For example, consider
Toyota’s manufacturing capability, which combines capabilities relating to component
manufacturing, supply-chain management and quality control, among many others.
Figure 8
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The hierarchical nature of capabilities
Cross- Functional Capabilities
CFC New Product Development, Customer Support, Quality Management
Broad Operations, R&D Design, MIS Capability, Marketing and Sales,

Functional Human Resource Management
Capabilities
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Activity Related Manufacturing, Material Management, Process Engineering,
Product Engineering, Test Engineering
Capabilities
For example, Manufacturing related only (Assembly,

Specialized Capabilities Production, …)
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For example, Assembly related only

Single -Task Capabilities
Resources
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2.3 Core Competencies

Core competencies are capabilities fundamental to a firm’s competitive advantage and
performance. According to Prahalad and Hamel (1990), core competencies are those that:
x Provide a significant contribution to the perceived customer value.

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x Provide potential access to a wide variety of markets.
x Are difficult to imitate.
A firm’s core competencies emerge and accumulate over time as a firm learns how to
effectively deploy different resources and capabilities. Core competencies are the activities a
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firm performs especially well compared to competitors and through which the firm adds
unique value to its goods or services over a long period of time. It is important to note that
not all of a firm’s resources and capabilities are strategic assets, which are those assets that
add competitive value and are possible sources of competitive advantage.
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In other words, “for a capability to be a core competence, it must be valuable and non-
substitutable, from a customer’s point of view, and unique and inimitable, from a
competitor’s point of view” (Hitt, Ireland and Hoskisson, 2005).
3. Building Core Competencies
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With resources and capabilities defined, the next step is to analyze the potential for resources
and capabilities to generate profit for a company. The profits that a firm obtains from its
resources and capabilities depends on its ability to:
x Establish a competitive advantage.
x Sustain a competitive advantage.

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3.1 Establishing Competitive Advantage
For a resource or capability to establish a competitive advantage, two conditions must exist:
x Valuable – A resource or capability must allow a firm to exploit opportunities or

counteract threats in its competitive environment. A firm can create value for
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customers by effectively using capabilities to exploit opportunities.
x Rare – A resource or capability must not be widely available in an industry.

Capabilities possessed by many rivals will not be a competitive advantage for any of
them as competitive advantages only result if firms are able to exploit the capabilities
that are different from those of competitors.
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3.2 Sustaining Competitive Advantage

The long-term profitability of a firm depends not only on its ability to establish a competitive
advantage, but also on the ability to sustain that advantage. In the short-term, a firm can
earn a competitive advantage by using capabilities that are valuable and rare. However, if the
capabilities are imitable, firms can only expect to retain this competitive advantage for as
long as it takes rivals to successfully imitate the capabilities. In order to be sustainable, a
capability must satisfy the criteria of being:
x
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Imperfectly imitable – It must be costly for rivals to imitate the resource or capability.
x Non-substitutable – A resource or capability must not have strategic equivalents.
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Imperfectly Imitable
It is clear that valuable and rare resources are potential sources of competitive advantage.
However, these same resources can only be sources of sustained competitive advantage if
other firms cannot obtain them by direct duplication or substitution, or can obtain them only
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at a high cost. In other words, these resources are imperfectly imitable.
In general, there are two ways that firms can attempt to imitate resources, either through
duplication or purchase of the resources. Consider the case of a firm with an R &D-driven
competitive advantage. If competitors are able to replicate the R&D skill but at a much higher
cost, then the advantage may be sustainable.
From the perspective of a firm that owns a valuable resource, it might be worthwhile to think
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about how it could increase the difficulty of imitating the particular resource. Obviously, one
approach could be to protect the resource through secrecy or through patenting. There are two
other aspects that are worth considering, as they may help the firm building resources that are
difficult to imitate: (1) importance of history and (2) complexity and interconnectedness.
Importance of history - It may be possible for a firm to develop a competitive advantage

due to unique historical conditions. “As firms evolve, they pick up skills, abilities and
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resources that are unique to them, reflecting their particular path through history” (Hitt,
Ireland and Hoskisson, 2005).
Dierickx and Cool (1989) argue that “success breeds success.” In other words, that a strong
initial position facilitates future resource accumulation. A strong initial position can be the
result of historical circumstances: a firm can gain an advantage through a first-mover
advantage. That is, a firm is the first to recognize and exploit a new opportunity, providing
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the firm with a unique, defendable position in an industry (technological leadership,

preemption of valuable assets, creation of switching costs).
Moreover, imitators attempting to rapidly accumulate a resource or capability will incur

additional costs. For example, “crash” R&D programs are typically less productive than
similar R&D investments over longer periods. Another example would be that the amount of
knowledge an MBA student accumulates in a one-year program may be less than if the
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student were in a two-year program. In other words, knowledge and capabilities are
accumulated over time.
A metaphor often used for this idea is that of a bathtub. Consider, for example, R&D. The total
amount of R&D know-how is represented by the amount of water in the tub at a particular point
in time. The stock of know-how is affected by R&D spending (water inflow through the faucet)
and knowledge depreciation (water outflow). The crucial point to note is that management can
directly affect flows (through R&D spending, advertising, etc.), but stocks (know-how, reputation,
etc.) only adjust over time. The consequence is both negative and positive: it is hard to build
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stocks of valuable assets, but luckily it is also very hard to imitate them.
Complexity and interconnectedness – Another reason why a firm’s resources and

capabilities may be costly to imitate is their complexity and interconnectedness. The success
of a firm may not depend on its ability to do only one thing well but rather on its ability to
do thousands of things well. While each individual resource and capability could be
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duplicated with ease, it would be costly to imitate the entire network. Furthermore, the sheer
number of resources and capabilities is difficult even for the firm owning the resources to
describe fully. Competitors trying to imitate the firm’s success will have difficulty
understanding, let alone imitating it. Imitation can be costly if the capabilities that generate
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competitive advantage are the result of complex and ambiguous interactions between
individuals, groups and technology.
While the barriers to imitation mentioned above are conceptually distinct, they often go hand
in hand. Especially capabilities that have been built up over time tend to be complex and
interconnected, making them especially hard to imitate.
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Non-substitutable
Imitating firms can also attempt to substitute resources if it is costly to imitate a resource. A
capability is substitutable if it can be replaced by an equivalent alternative that can be used
to achieve the same strategy. For example, if a firm possesses a competitive advantage due to
the strong interpersonal skills of its sales force, a competitor can substitute a customer
relationship management (CRM) system for interpersonal communication skills. If the effects
are the same, then interpersonal skills and the CRM system can be considered substitutes. If
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the cost of obtaining the substitute is greater than the cost of obtaining the original
resources, the capability may still be considered sustainable.
3.3 The VRIS Framework

The concepts of value, rarity, imitability and substitutability (VRIS) can be brought together
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in a single framework to understand the potential for exploiting a firm’s resource or

capability (Figure 9).
Figure 9
Criteria of sustainable competitive advantage
The Four Criteria of Sustainable Competitive Advantage (VRIS framework)

Value • Help a firm neutralize threats or exploit opportunities
No
Rarity • Are not possessed by many others

• Historical: A unique and a valuable organizational culture
Imitability
or brand name
• Ambiguous cause: The causes and uses of a
competence are unclear
• Social complexity: Interpersonal relationships, trust, and
friendship among managers, suppliers and customers
Substitutability • No strategic equivalent
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Source: Hitt, M. A., R. D. Ireland, and R. E. Hoskisson, Strategic Management, 9th edition, USA, Thomson, 2010.
Figure 10 illustrates that all four criteria described above are necessary conditions to achieve a
sustainable competitive advantage. If one or more conditions are not met, the firm will end up
with a temporary competitive advantage, competitive parity, or even a competitive
disadvantage.
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Figure 10
Competitive and performance implications (Hitt, Ireland and Hoskisson, 2005)
Is the Resource or Is the Resource or

Is the Resource or Is the Resource or Competitive Performance
Capability Costly to Capability
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Capability Valuable? Capability Rare? Consequences Implications
Imitate? Non-substitutable?
Competitive Below-Average
No No No No
Disadvantage Returns
Yes No No Yes/No Competitive Parity Average Returns
Average Returns to
Temporary Competitive
Yes Yes No Yes/No Above Average
Advantage
Return
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Sustainable Above Average
Yes Yes Yes Yes
Competitive Advantage Return
Source: Hitt, M. A., R. D. Ireland, and R. E. Hoskisson, Strategic Management, 9th edition, USA, Thomson, 2010.
4. Summary
This note has focused on the potential of resources and capabilities to establish sustainable
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competitive advantage. Resources and capabilities are the foundation for creating
competitive advantage. However, the sustainability of the competitive advantage depends on
how easily the resources can be imitated.
History has demonstrated that no competitive advantage lasts forever. Competitors are
constantly using their own unique resources, capabilities and core competencies to create
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new value creating propositions that duplicate or compete against the firm’s competitive
advantage. As a result, since a firm’s competitive advantage is not sustainable forever, firms
must continue exploiting their current competitive advantage while also using their resources
and capabilities to build future competitive advantages.
Core competencies based on capabilities less visible to rivals are more likely sources of
competitive advantage, as they are more difficult to understand and imitate. Core
competencies accumulated over time and intricately linked also provide a greater defense
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against imitation.
It is important to remember that firms that have the most outstanding resources and
capabilities are not always the most successful. It is the creation of strong linkages between
resources and capabilities that generate a stronger competitive advantage. Consider the
example of how a team with limited financial resources such as the Oakland Athletics was
able to successfully compete against a financial juggernaut such as the New York Yankees. In
the story popularized by the New York Times bestseller “Moneyball,” the Oakland Athletics’
general manager, Billy Beane, developed an innovative approach to baseball utilizing non-
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traditional statistics to assess the player’s value. This approach gave the team a competitive
advantage that allowed them to spend their limited budget more efficiently and compete with
teams with much deeper pockets.
Firms must be able to recognize their core competencies and develop their strategy accordingly
to create a sustainable competitive advantage that cannot easily be replaced by its rivals.
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Glossary
Capabilities – the deployment of resources to create customer value.
Core competencies – capabilities fundamental to a firm’s competitive advantage and
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performance.
Hierarchy of capabilities – the hierarchy recognizes that more general capabilities are
composed of specialized capabilities.
Imperfectly imitable – resources and capabilities that are (too) costly to imitate.
Intangible resources – assets that are difficult to see and their value difficult to measure;
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formed over time and more difficult to imitate.
Non-substitutable – resources and capabilities that cannot be substituted by alternative,

equivalent resources and capabilities.
Organizational resources – this resource consists of the knowledge and effort of employees;
difficult to measure and less visible.
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Primary activities – activities involved in the conversion of inputs and the interfaces with
customers; i.e., inbound and outbound logistics, marketing and sales, operations, service.
Rare – resource and capabilities that are not widely available in the industry.
Resources – the productive assets owned by the firm.

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Strategic assets – those assets that add competitive value and are possible sources of
competitive advantage.
Support activities – activities required for the primary activities to take place; i.e., finance,
R&D, human resources.
Tangible resources – assets that can be seen and more easily evaluated; financial and
physical assets, which are identified and valued in a firm’s financial statements.
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Valuable – resources and capabilities that allow a firm to create value for its customers by
exploiting opportunities or counteracting threats in the competitive environment.
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References
Barney, J. B., “Organizational Culture: Can it be a Source of Competitive Advantage,” The
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Academy of Management Review, 11 (3), 1986, pp. 656-665.
Barney, J. B., “Looking Inside for Competitive Advantage,” The Academy of Management
Executive, 8 (4), 1995, pp. 49-61.
Barney, J. B., Gaining and Sustaining Competitive Advantage, 4th edition, Upper Saddle
River, NJ: Prentice Hall, 2010.
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Barney, J. B. and D. N. Clark, Resource-Based Theory – Creating and Sustaining Competitive
Advantage, Oxford, UK: Oxford University Press, 2007.
Dierickx, I. and K. Cool, “Asset Stock Accumulation and Sustainability of Competitive

Advantage,” Management Science, 35 (12), 1989, pp. 1504-1511.
Ghemawat, P., Commitment: The Dynamic of Strategy, New York: Free Press, 1991.
Ghemawat, P., Strategy and the Business Landscape, 3rd edition, Upper Sadle River, NJ:
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Prentice Hall, 2009.
Grant, R. M., Contemporary Strategy Analysis, 7th edition, West Sussex, UK: John Wiley &
Sons, 2010.
Hitt, M. A., R. D. Ireland, and R. E. Hoskisson, Strategic Management, 9th edition, USA,
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Thomson, 2010.
Ly, B. S. and G. Vroom, “Value Creation and Capture,” SMN-678-E, IESE, 2010.
Porter, M., Competitive advantage, New York, US, The Free Press, 1985, pp. 11-15.
Prahalad, C. K. and G. Hamel (May 1990), “The Core Competence of a Corporation,” Harvard
Business Review, pp. 79-91.
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2 IESE Business School-University of Navarra

INDUSTRY KEY COMPETITIVE

TANGIBLE INTANGIBLE ORGANIZATIONAL

IESE Business School-University of Navarra 3

Source: own elaboration based on Wikipedia.

years of superior quality, making it very difficult to imitate or purchase.

Intangible resources may be divided in innovation and technological resources, and

25 Copa del Rey, 3 Champions League

Source: own elaboration based on Wikipedia.

4 IESE Business School-University of Navarra

A firm’s organizational, or human, resources consist of the knowledge and effort of

Source: own elaboration based on Wikipedia.

x Functional analysis – A functional analysis classifies the organizational capabilities in

x Value-chain analysis – A value-chain analysis classifies the activities of a firm into a

IESE Business School-University of Navarra 5

Human Resource Management

6 IESE Business School-University of Navarra

Cross- Functional Capabilities

CFC New Product Development, Customer Support, Quality Management

Broad Operations, R&D Design, MIS Capability, Marketing and Sales,

For example, Manufacturing related only (Assembly,

For example, Assembly related only

2.3 Core Competencies

x Provide a significant contribution to the perceived customer value.

x Provide potential access to a wide variety of markets.

x Are difficult to imitate.

IESE Business School-University of Navarra 7

3. Building Core Competencies

x Establish a competitive advantage.

x Sustain a competitive advantage.

x Valuable – A resource or capability must allow a firm to exploit opportunities or

customers by effectively using capabilities to exploit opportunities.

x Rare – A resource or capability must not be widely available in an industry.

3.2 Sustaining Competitive Advantage

x Non-substitutable – A resource or capability must not have strategic equivalents.

8 IESE Business School-University of Navarra

Importance of history - It may be possible for a firm to develop a competitive advantage

the firm with a unique, defendable position in an industry (technological leadership,

Moreover, imitators attempting to rapidly accumulate a resource or capability will incur

Complexity and interconnectedness – Another reason why a firm’s resources and

IESE Business School-University of Navarra 9

3.3 The VRIS Framework

in a single framework to understand the potential for exploiting a firm’s resource or

The Four Criteria of Sustainable Competitive Advantage (VRIS framework)

Rarity • Are not possessed by many others

10 IESE Business School-University of Navarra

Is the Resource or Is the Resource or

Yes No No Yes/No Competitive Parity Average Returns

IESE Business School-University of Navarra 11

Core competencies – capabilities fundamental to a firm’s competitive advantage and

Non-substitutable – resources and capabilities that cannot be substituted by alternative,

Resources – the productive assets owned by the firm.

12 IESE Business School-University of Navarra

Dierickx, I. and K. Cool, “Asset Stock Accumulation and Sustainability of Competitive

IESE Business School-University of Navarra 13

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