Solution Manual for Strategic Management 2nd

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INSTRUCTOR MANUAL NEWER

FACULTY

CHAPTER 4
INTERNAL ANALYSIS: RESOURCES, CAPABILITIES,
AND CORE COMPETENCIES

CHAPTER OUTLINE Per sp e ctiv e

4 . 4 T h e V a l u e C h a in
Ch a p te r Case A n a l y si s
Nike’s Core Competency:
The Risky Business of 4 . 5 I m p li c a ti o n s f o r t h e Str ate g i st
Fairy Tales
S t r a t e g y T er m
4 . 1 Lo o k i n g Pr o je c t
In sid e t h e Fir m f o r
Core my STRATEGY
C o m p ete n ci e s

4 . 2 Th e
R e so u r c e - Ba se d
View

4 . 3 T h e D y n a m ic
C a p a b i lit i e s
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Overview of the firm’s activities in the process of transforming inputs into outputs
generate differentiation and which drive costs.
In this chapter, we turn our
attention to inside the firm. LO 4-8 Conduct a SWOT analysis to combine external and internal analysis
One of the key messages of and derive strategic implications.
this chapter is that a firm’s
ability to gain and sustain
competitive advantage is partly
driven by core competencies—
unique strengths that are
embedded deep within a firm.
Core competencies allow a
firm to differentiate its
products and services from
those of its rivals, creating
higher value for the customer
or offering products and
services of comparable value
at lower cost. We will analyze
why differences in firm
performance exist within the
same industry. We ground the
discussion in theory with the
resource-based view and
dynamic capabilities
perspective. We introduce
frameworks to analyze internal
resources and activities
and close with integrating the
internal and the external (from
Chapter 3) in a SWOT
analysis.

Learning
Objectives
LO 4-1 Differentiate among a
firm’s resources, capabilities,
core competencies, and
activities.

LO 4-2 Compare and contrast

tangible and intangible resources.

LO 4-3 Evaluate the two critical

assumptions behind the resource-
based view.

LO 4-4 Apply the VRIO

framework to assess the
competitive implications of
a firm’s resources.

LO 4-5 Evaluate different

conditions that allow firms to
sustain their competitive
advantage.

LO 4-6 Outline how

dynamic capabilities can
help a firm to sustain
competitive advantage.

LO 4-7 Apply a value chain

analysis to understand which

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Consider This Discussion Questions

CHAPTER CASE The case indicates that Nike’s core competency is to create heroes.
What does this mean? How did Nike build its core competency? Does it
This brief case is obey the VRIO attributes?
designed to provide Nike chose as celebrity endorsers athletes that succeeded against the odds,
overcame hardships, or came from disadvantaged backgrounds. They
material for an internal identified future superstars and placed huge bets on a single athlete in a
analysis of Nike’s core sport. They began with basketball and gradually moved to add athletes in
other sports. Celebrity endorsements are valuable because they attract brand
competencies that led it
loyalty. Moreover, Nike celebrities appeal to a broad range of athletes and
to a commanding market non-athletes as a result of the emotional draw of the back stories. Few of
share in both basketball Nike’s competitors have taken this approach, so it is still a rare capability.
The existing contracts provide some protection against imitation with
and running shoes. specific heroes, but there are a lot of athletes out there with interesting life
stories, so rivals could imitate this competence. Others may argue that the
expertise Nike has built over the years creates path- dependent barriers to
In the “Consider This” imitation. Students might also point out that among potential celebrity
endorsers, there is probably more of a cachet associated with signing with
section at the end of the Nike than other brands because everyone wants to be a hero. Clearly, Nike
chapter, contemplate the has organized its firm resources and processes around this competence and
embedded it deep within the firm. Others might argue that the high level of
risks and dynamics of risk in this strategy, as seen from the multiple failures outlined in the case,
Nike’s core competency illustrate how challenging it can be for the firm to control the value of this
competence. The balance of benefit gained between the athlete and the firm
and use that as a basis can easily tip against Nike if the athlete gets into trouble.
for considering
What would it take for Nike’s approach to turn from a strength
competitive strategies for into a weakness? Did this tipping point already occur? Why or why
Nike’s rivals. not?
Students are likely to point out that Nike’s competence in creating heroes by
focusing on athletes from disadvantaged backgrounds can lead, and has led,
to public relations nightmares. It is risky. The key to this discussion is to
draw in the students’ knowledge from their marketing courses on how
closely brand image is tied to a celebrity endorser’s public image. If an
athlete is highly successful on the field wearing your shoes, do your
customers associate marital
infidelity with a negative impression of the shoes? Clearly, the unfortunate “bullet” tag line in the Pistorius ads made a
negative association highly likely, but in other cases it may be much less closely tied in the minds of the customer.
AACSB 2013 Standard 9 Integrating knowledge across fields
What recommendations would you have for Phil Knight and Nike? Can you identify a way to
“reframe” the competency of creating heroes? Or a new way to think of heroes that would continue to
build the brand?
An obvious way of diversifying risk is to spread endorsement funds across multiple athletes. This reduces the
positive impact of each association on the brand, but it also reduces the negative impacts of a “failed hero.”
Students may come up with many new ideas on how to build heroes. One such concept that would lower the
firm’s risk is to reduce the emphasis on heroes that have risen from disadvantaged circumstances to heroes who
serve the community through charitable activities. Since these heroes would be multidimensional with both
athletic and philanthropic successes, they may fall from grace less spectacularly.
If you are a competitor of Nike (such as adidas, Under Armour, New Balance, or Li Ning), how could you exploit
Nike’s apparent vulnerability? Provide a set of concrete recommendations.
Students should find this a rich topic for creative thinking. Encourage them to identify both offensive and
defensive tactics. Ideas might include keeping disgraced endorsers in the limelight; developing endorsement
deals with other athletes; creating campaigns based on the idea that everyone is a hero to someone; or creating
endorsement deals with child athletes. AACSB 2013 Standard 9 Thinking creatively

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4.1 LOOKING INSIDE FOR FIRM COMPETENCIES [LO 4-1]

You might want to begin your lecture by returning to the illustration of peeling back layers of an onion to show students
the strategic analysis process of beginning in the broad macroenvironment, closing in to the industry environment, and
then finally reaching the firm environment. Refer to Exhibit 4.2 to help students put external and internal analysis in
context.
Core competencies allow a firm to differentiate its products and services from those of its rivals, creating higher
value for the customer or offering products and services of comparable value at lower cost. The important point here
is that competitive advantage can be driven by core competencies.

Exercises
Encourage students to work in small groups to develop a list of resources for a simple case, then a list of capabilities.
When they have spent a few moments on this, call on various groups to allow you to create a list of resources and
capabilities on the board. Then, explain how resources work in concert with capabilities. As an example using the
Starbucks mini-case,
you might discuss how Starbucks’ resource of exclusive supply contracts with superior coffee growers, combined with
Starbucks’ capabilities to roast coffee and to train highly skilled baristas, enables them to create a core competence of
superior tasting coffee. In a capstone course, you might use this exercise to illustrate the interaction of business-
level strategy and marketing functional strategy. AACSB 2013 Standard 9 Integrating knowledge across fields

End of Chapter Small-Group Exercise 1

Brand valuations were mentioned in the chapter as a potential key intangible resource for firms. Some
product brands are so well established that the entire category of products (including those made by
competitors) may be called by the brand name rather than the product type. In your small group, develop
two or three examples of this happening in the marketplace. In any of the cases noted, does such brand
valuation give the leading brand a competitive advantage? Or does it produce confusion in the market for all
products or services in that category?
Students will have a variety of answers for this activity. Many classic retail products such as Band-Aids, Kleenex,
ChapStick, and Coke will come up in the small groups. In addition, Google is commonly mentioned for all things
search- related on the Internet. In the case of the classic retail products, you can bring out the discussion to ask “if the
brand Band- Aid got you to the drug store, but when you got there you bought the cheaper store-brand adhesive
strips… Did Johnson & Johnson, which owns Band-Aid, waste its marketing funds building up their brand?” The
answer is dependent on how much traffic that awareness of the product brings to get consumers to the shelf, and what
percent of those consumers, once in the store, go ahead and buy the brand that got them to the store shelf in the first
place. Google has a somewhat different
problem. Many people assume they are using the Google search engine when they may not be. The default search
engine at the Yahoo portal has been Bing since a 2010 agreement between Yahoo and Microsoft, for example.
AACSB 2013
Standard 9 Integrating knowledge across fields

End of Chapter Discussion Question 1

Why is it important to study the internal resources, capabilities, and activities of firms? What insights
can be gained?
Because it gives managers the ability to formulate a tailored strategy for their company according to the resources,
capabilities, and activities available to address external issues for the firm. By using internal analysis tools such as
VRIO and activity systems, managers can gain the insight of evaluating a firm’s current situation and seek to update
the firm’s strategic fit with the environment.

Examples
In a similar way, Sony’s strategy in the consumer electronics industry was to first build the resources and capabilities
to successfully commercialize a pocket radio. This success laid the foundation for Sony’s core competency in the
miniaturization of electronic technology and was subsequently applied to the Sony Walkman, followed by its MP3
Player. In the same industry (mobile devices), Apple has demonstrated core competency in user-friendly product
design, which challenges Apple engineers to empathize with customers and deploy engineering knowledge in
innovative and category- defining products like the iPod, iPhone, and iPad. Apple products have long been seen as
engineered for users’ enjoyment, resulting in a “cult-like following” among Apple users.

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4.2 THE RESOURCE-BASED VIEW

Intangible and Intangible Resources [LO 4-
2]

Exercise
Assign each of the examples in Exhibit 4.3 to a different team and ask them to develop a list of the tangible
resources, intangible resources, and capabilities that are needed to deliver the core competency of the firm.

Discussion Topics
To augment the textbook’s description of the reasons that intangible resources are more likely to lead to competitive
advantage than external resources, it may be interesting to discuss the challenges of managing key resources that are
largely intangible. Two things to emphasize are ownership and control. Contrast manufacturing equipment, such as a
superior performing heat exchanger, with brand value or knowledge stocks, such as a deep understanding of the
relationship of a range of chemical drugs to the disease conditions that they are designed to treat. When you go home
in the evening and
then come back to the plant, your heat exchanger is still there, bolted to the ground. Your knowledge stocks, although
you may own them (through employee contracts and they may be documented in patents and other firm codified
knowledge), the bulk of their value is in the minds of employees, who could retire or change employers at any time.
Your equipment is going to operate the same way today as it did yesterday and basically do what it is told to do. Your
employees may have new ideas that they are not motivated to share at work. Although your brand value is recognized
as good will on your balance sheet, it lies fundamentally in the minds and perceptions of your customers. This
perception is entirely out of your control. You may be able to influence how customers perceive your brand, but you
cannot control it or otherwise exercise your “ownership” to improve it.
IKEA has disclosed that its brand value is $11 billion What are the ramifications of this fact for strategic
management? Would you conclude from the resource-based view that there are only advantages to maximizing your
brand value or are there some disadvantages of having large intangible corporate assets? See “IKEA discloses $11B
secret,” The Wall Street
Journal, 8/13/12. AACSB 2013 Standard 9 Integrating knowledge across fields

4.2 THE RESOURCE-BASED VIEW

RBV Assumptions [LO 4-
3]

Discussion Topics
Invite students to identify examples of resource heterogeneity within an industry. For example, compare the search
algorithm capability of Microsoft (Bing) versus Google or the economies of scale of Wal-Mart versus Target, or
the app store content for Android, Apple, Microsoft, and BlackBerry.
Invite students to identify examples of resource immobility within an industry—for example, long patent lives for
proprietary drugs, long-term licenses for access to petroleum reserves (usually 20 years or more), trademark
protection for valuable Disney characters, or copyright protection for the Harry Potter books and licensing.

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4.2 THE RESOURCE-BASED VIEW

The VRIO Framework [LO 4-
4]

We recommend describing each of the four characteristics of the VRIO analysis separately in your lecture. Of
particular note is that the fourth characteristic is actually about the organization or firm itself rather than its
resources. This point is often difficult for students to grasp, as they are often not used to ordering their thoughts into
levels of analysis, so it is worth emphasizing.

Examples
In some instances, firms are able to create a competitive advantage but fail to capture it because of actions of their
stakeholders.13 This sounds like a contradiction, doesn’t it? It is not. Consider this: Once a firm has created a
competitive advantage, a battle can ensue over how the spoils of that competitive advantage are split among the firm’s
different stakeholders.14 In the U.S. car industry, the United Auto Workers (UAW) had such a stronghold on GM,
Chrysler, and Ford that some argue they were a major factor in creating a competitive disadvantage (although
management signed the labor contracts with the unions).15 In the investment banking industry, employees are powerful
stakeholders. Skilled human capital is one of the most important resources in investment banking (as in other
professional services such as management consulting and law firms). As a consequence of their strong position, the
combined annual bonuses of investment banks’ employees frequently exceed the bank’s net income. In 2007, the year
before the financial meltdown, the net income of the big-five U.S. investment banks combined (Bear Sterns, Goldman
Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley) was a little over $10 billion, and the total of the bonuses
paid to the employees was close to $40 billion. 16 During
2008, the worst year in terms of stock performance since the Great Depression, the big-five investment banks lost
$25 billion, but still paid bonuses that exceeded $25 billion.17 These data show that although investment banks
clearly have valuable resources (namely, employees) that can create competitive advantage, those same resources
are powerful stakeholders that can capture the value they create. By capturing that value, the employee stakeholders
left less value for other stakeholders, such as stockholders or customers. AACSB 2013 Standard 9 Economic,
political, regulatory, legal, technological, and social contexts of organizations in a global society
The commercialization of the CAT scanner provides a classic example for a VRIO analysis, in which direct imitation
through a work-around allowed a second mover not only to mitigate the innovator’s advantage but also to gain and
even sustain a competitive advantage. Based on internal research, the British conglomerate EMI developed and
launched the computed axial tomography (CAT) scanner. This technology, for which EMI received several patents,
can take three- dimensional pictures of the human body and is considered to be the most important breakthrough in
radiology since the discovery of X-rays. The invention of the CAT scanner also paved the way for follow-up
innovations like nuclear magnetic resonance imaging (MRI). Despite its initial success, EMI lost out quickly to GE
Medical Systems (GEMS). How can the innovator with a patent-protected technology lose out to a follower? GEMS
was able to reverse-engineer EMI’s CAT scanner to produce a model that worked around EMI’s patents. Moreover,
GEMS was able to leverage important complementary resources such as financing, large-scale manufacturing, and a
wide distribution and marketing network. While EMI clearly possessed a valuable and rare resource, it was not able to
protect itself from GE’s substitution attempt.
The leading video game consoles are Sony’s PlayStation 3, Microsoft’s Xbox One, and Nintendo’s Wii. Sony and
Microsoft tend to compete on stronger technological prowess, a larger library of games, and deeper pockets of cash. On
the other hand, Nintendo has over the years created and nurtured a valuable, rare, and hard-to-imitate resource: a deep
understanding of the casual gamer that has enabled Nintendo to develop products that respond to the casual gamer’s
preferences. With the introduction of its Wii game console, Nintendo’s knowledge of the “casual gamer” became a
valuable resource. The Wii console has the unique feature of a wireless handheld pointing device that can detect
movements in three dimensions. This unique feature allows Nintendo to court a broader demographic, thereby
continuing to expand Nintendo’s knowledge of its customer base and strengthening its basis for competitive advantage.
Nintendo’s deep knowledge about the casual gamer is also rare, as Sony and Microsoft have largely ignored this market
segment. It is difficult to imitate as well, since that knowledge has been built over such a long period of time. Similar to
Apple, Nintendo tightly integrates hardware and software to enhance the user experience, and thus it is organized to
exploit its deep knowledge of the casual gamer. That knowledge of its customer is therefore a VRIO resource, allowing
it to gain a competitive advantage in the hotly contested video-game market. Yet, the competition is not standing still.
Microsoft and Sony have introduced motion features in their latest video game consoles as well. This example gives
you an opportunity to discuss the durability of competitive
advantage and open up a dialogue on why Nintendo’s advantage lasted so many years.

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Exercise
An excellent exercise to illustrate a VRIO analysis is the Egg Drop exercise described in Warner, A. G. (2005), “An
egg- centric approach to teaching strategic types: Adapting a classic exercise,” J of Mgt Educ (29) 583. It is also fun
for students. AACSB 2013 Standard 9 Thinking creatively

End of Chapter Discussion Question 3

The resource-based view of the firm identifies four criteria that managers can use to evaluate whether
particular resources and capabilities are core competencies and can, therefore, provide a basis for
sustainable competitive advantage. Are these measures independent or interdependent? Explain. If (some
of) the measures are interdependent, what implications does that fact have for managers wanting to create
and sustain a competitive advantage?

These measures are largely interdependent. A resource that is rare but not valuable is not going to help drive any
competitive advantage for the firm. This implies the management team needs to be focused on steps to support each
of the four stages of VRIO to get to a sustained competitive advantage.

End of Chapter Small-Group Exercise 2

Strategy Highlight 4.1
“Applying VRIO: The Rise
and Fall of Groupon”
After the students have generated ideas in their group, you may want
to update them on the strategic actions that Groupon has taken and ask
them to compare Groupon’s revised strategies to their proposals.
AACSB 2013
Standard 9 Information technology and thinking creatively
In 2013, the stock market responded positively to a new strategy to
develop a network of warehouses to support the sale of goods, growth in
business through their mobile app, rapid growth in North American
revenue, a shift away from pushing deals through e-mail to a
marketplace for deals that users can pull when they want them, and the
firing of CEO Andrew Mason.
To “Groupon and its ‘weird’ CEO,” The Wall Street Journal, 1/31/12,
and an accompanying video, offer the opportunity for enhancement of
this discussion. If you need to assess critical reasoning skills, you
might show
the video and ask students whether they agree or disagree with the
statement from the strategy highlight: Groupon’s ability to facilitate
local commerce is neither valuable nor rare.” They should be asked to
justify
their view by (1) identifying relevant facts from the textbook and the
video to support their position, (2) evaluating the credibility of those
facts, (3) disputing the contrary evidence, and (4) providing strong
logical arguments. AACSB 2013 Standard 9 Analytical thinking
Next, you may want to broaden the discussion to talk about why a firm
that is moving from a start-up mode to a maturing market environment
might need a different CEO. How do the capabilities that a firm needs
from its leader change and the company and industry mature?

4.2 THE RESOURCE-BASED VIEW

How to Sustain a Competitive Advantage [LO 4-
5]

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There are four conditions above and beyond core competencies that can help a firm protect and sustainNEWER
a competitive
MANUAL FACULTY
advantage. If one of any of these four is present, the firm can strengthen its basis for competitive advantage,
increasing its chance to be sustainable over a longer period of time.

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Example
We find students generally “get” the ideas behind the first two ways to protect competitive advantage (better
expectations and path dependence); however, some students may need some additional explanation of the differences
between causal ambiguity and social complexity. In some sense, this is natural because there is a relationship between
these two items. Social complexity can be one reason for causal ambiguity. But if we think of a firm’s activity
system, such as that of Vanguard or Southwest Airlines, as a visual of some of the key processes occurring inside the
firm, we can see this differentiation more clearly. The complexity is represented by the overall diagram showing
multiple systems working together. Causal ambiguity, on the other hand, is pointing to the fact that we can’t identify
within the firm specifically how the firm has been able to be successful. Vanguard’s mission is “to help clients reach
their financial goals by being the world’s highest-value provider of investment products and services.” Vanguard
pursues its mission through its unique set
of interconnected activities: strict cost control, direct distribution, low expenses with savings passed on to clients,
offering a broad array of mutual funds, efficient investment management approach, straightforward client
communication and education, and customer segmentation. Vanguard is now one of the largest investment-
management companies. This allows Vanguard to benefit from economies of scale (e.g., cost savings accomplished
through a larger number of customers served and a greater amount of assets managed), further driving down cost. In
turn, by lowering its cost structure, Vanguard can offer more customized services without raising its overall cost.
Despite increased customization, Vanguard still has one of the lowest expense ratios in the industry. Even in a
changing environment, the firm continues to pursue its strategy of low- cost investing combined with quality service.
If firms add activities that don’t fit their strategic positioning (e.g., if
Vanguard added local retail offices in shopping malls, thereby increasing operating costs), they create “strategic misfits”
that are likely to erode a firm’s competitive advantage.
SWA uses activities such as frequent and reliable departures, limited in-flight passenger service, low ticket prices,
short- haul point-to-point flights using secondary airports, flying only one type of aircraft (which reduces pilot training
time and maintenance cost), high aircraft utilization, and a lean, highly productive, and highly motivated ground and
gate crew. Each core activity, in turn, is supported by a number of other activities. For example, the core activity of a
lean, highly productive, and highly motivated ground and gate crew is supported by stock compensation plans and
flexible contracts
and work hours. Ideally, the activities pursued are consistent with one another, and complement and reinforce one
another.
Strategy Highlight This example offers the opportunity to build on the discussion of
4.2 serendipity begun in Chapter 2. Invite the students to work in small
“Bill ‘Lucky’ Gates” groups to decide which resources and capabilities were critical to
Microsoft’s success in operating systems. Which of these did the firm
obtain purely through ‘luck’ and which did the firm/Bill Gates
consciously develop?

Example of path dependence: the U.S. customary system of measurements using miles, pounds, gallons, and so on
was established in the 1820s. Today, the United States is the only industrial nation in the world not using the metric
system as the official method of measurement, putting it at a disadvantage in some cross-border transactions and
negotiations.

End of Chapter Ethical/Social Issues 1

It is legal to take apart publicly available products and services and try to replicate them and even develop
work- arounds for relevant patents. But is it ethical? If a key capability protected by patents or trademarks in
your firm is being reverse-engineered by the competition, what are your options for a response? Also, how do
you evaluate Google’s decision to move its servers to Hong Kong? For Google’s values, see
http://www.google.com/about/company/philosophy/.

It is legal to take apart publicly available products and services to replicate or produce similar products. However,
many students will find it isn’t ethical. It is a common business practice across many developed and emerging
countries around the globe. If this situation occurs, it is considered a patent violation, also known as an
infringement. If this occurs, the
patentee can sue for relief in the designated federal court. However, in many markets, by the time a case comes to
court, the business opportunity is already lost. Many firms take more of a “continuous improvement” approach and
press forward

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with new innovations and features in hopes of staying “one step ahead” of the competition. AACSB
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2013 Standard 9
Ethical understanding and reasoning

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4.3 THE DYNAMIC CAPABILITIES PERSPECTIVE [LO 4-6]

For a firm to sustain advantage over time, any fit between its internal strengths and the external environment must
be dynamic. The firm must be able to change its resource base and activity system as the external environment
changes. Dynamic capabilities are essential in order to gain and sustain competitive advantage.

End of Chapter Ethical/Social Issues 2

The chapter mentions that one type of resource flow is the loss of key personnel who move to another firm.
Assume that the human resources department of your firm has started running ads and billboards for open
positions near the office of your top competitor. Your firm is also running Google ads on a keyword search for
this same competitor. Is there anything unethical about this activity? Would your view change if this key
competitor had just announced a major layoff?

Students will have a variety of viewpoints on this matter. As a matter of practice, the other firm can also run ads
outside “my firm” as well. Effective managers recognize many of their best employees will have headhunters call
them with jobs at competitors, for example. The best counter to this situation is keeping an open dialogue with the
associates at the firm so you know why they come to work every morning. If they are fairly satisfied with their current
assignments and job
situation, they will not answer the competitor ads, nor the headhunter phone calls. We find this does often change the
student’s perspective on the situation. Some of the most ardent in favor of an ethical violation in the first question
now see it has a bridge to a fresh employment option for employees who did, or may be about to, lose their jobs.
AACSB 2013
Standard 9 Ethical understanding and reasoning (able to identify ethical issues and address the issues in a
socially responsible manner)

Examples
In Exhibit 4.7, the investments can be several different types. It could be money, but it could also be people or time
invested in building intangible resource stocks. The outflow can be key employees that leave the organization or the
lack of organizational memory, causing the same lesson to be learned several times.
A useful example of dynamic capabilities in action is IBM’s success at transforming itself from a hardware company
to a services company. IBM—nicknamed Big Blue—helped kick-start the PC revolution in 1981 by setting an open
standard in the computer industry with the introduction of the IBM PC running on an Intel 8088 chip and a Microsoft
operating system (MS-DOS). Ironically, in the years following, IBM nearly vanished after experiencing the full force
of that revolution, because its executives believed that the future of computing lay in mainframe and mini-computers
that would be produced
by fully integrated companies. However, with an open standard in personal computing, the entire industry value
chain disintegrated, and many new firms entered into its different stages. This in turn led to a strategic misfit for
IBM, which resulted in a competitive disadvantage. Rather than breaking up IBM into independent businesses,
Gerstner refocused the
company on satisfying market needs, which demanded sophisticated IT services. Keeping IBM together as one entity
allowed Gerstner to integrate hardware, software, and services to provide sophisticated solutions to customers’ IT
challenges. IBM was also quick to capitalize on the emergence of the Internet to add further value to its business
solutions.
They also moved quickly to sell their PC business when substitution from tablet computers were just beginning to impact
demand. The IBM of today is an agile and nimble global IT-services company. You might want to show the NY Times
video How Does Watson Work? to accompany this discussion.
Another firm that has been successful in implementing this was AT&T, which started off as a landline phone
company. This declining part of their business has been replaced with additional businesses such as mobile
telephone infrastructure, television, and Internet packages.

Discussion Topics
A firm that has been less successful in developing dynamic capabilities that would enable it to transform itself in
response to industry conditions is Dell. They have decided to take the firm private to try to make the necessary
changes without the pressure for positive earnings of a public company, but the fact remains that they are highly
dependent on earnings from their PC business. The profitability of the PC business is under pressure from substitutes
(tablets and smartphones), low- cost Asian manufacturers, and rivals who are better resourced to compete by
bundling servers with high-margin services.
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How has Dell attempted to respond to the current industry environment? What are some of the challenges they will
face? How likely are they to succeed? See “Dell’s profits fall 72%; Sales flat,” The Wall Street Journal, 8/16/13.
You may want to offer the students some contrasting examples of firms within the same industry that have either
responded successfully or failed to respond successfully to changes in their competitive environment. We expect most
students have shopped in a Circuit City store and they also have probably been in a Best Buy and have purchased
products online through firms such as Amazon. We can also draw parallels here to Borders and Barnes & Noble,
though Borders never reached the “great” status of a Circuit City. Blockbuster can be compared with Netflix also.
One key point we like to bring out in the class discussion is that though Best Buy (and Barnes & Noble) survived thus
far, their future success is far from certain. We use these points to have a class discussion about shopping online
versus in brick-and-mortar stores. What do brick-and-mortar stores need to do to be successful in this retail
environment? What skills and resources do they need for success going forward? Students often find this an engaging
discussion and many will have extensive ideas on how brick stores can survive and even thrive.
Background on Circuit City: It was at one time the largest and most successful consumer-electronics retailer in the
United
States. Indeed, Circuit City was so successful that it was included as one of only 11 companies featured in Jim Collins’
2001 best-seller Good to Great. The company was able to build and refine a set of core competencies (a unique set of
activities that the firm excels at) that enabled it to create a higher economic value than its competitors. In particular,
Circuit
City created world-class competencies in efficient and effective logistics expertise. It deployed sophisticated point-of-
sale
and inventory-tracking technology, supported by IT investments that enabled the firm to connect the flow of information
among geographically dispersed stores. This expertise in turn allowed detailed tracking of customer preferences and
thus enabled Circuit City to respond quickly to changing trends. The company also relied on highly motivated,
well-trained
sales personnel to provide superior service and thus build and maintain customer loyalty. These core competencies
enabled Circuit City to implement a “4S business model”—service, selection, savings, and satisfaction—that it
applied to big-ticket consumer electronics with an unmatched degree of consistency. Perhaps even more important
during the company’s high- performance run, many capable competitors were unable to replicate Circuit City’s core
competencies. In the fall of 2008,
however, Circuit City filed for bankruptcy. What happened?
Circuit City’s core competencies lost value because the firm neglected to upgrade and protect them and was
thus outflanked by Best Buy and online retailers like Amazon. Moreover, Circuit City’s top-management team
was also distracted by pursuing noncore activities such as the creation of CarMax, a retail chain for used cars, a foray
into providing an alternative to video rentals through its proprietary DivX DVD player, and an attempted merger with
Blockbuster (which filed for bankruptcy in 2010).
Perhaps the biggest blunder that Circuit City’s top-management team committed was to lay off 3,000 of the firm’s highest-
paid sales personnel. The layoff was done to become more cost-competitive with Best Buy and, in particular,
the burgeoning online retailers. The problem was that the highest-paid salespeople were also the most experienced
and loyal ones, better able to provide superior customer service. It appears that laying off key human capital—given
their valuable, rare, and difficult-to-imitate nature—was a supreme strategic mistake! Not only did Circuit City
destroy part of its core competency, it also allowed its main competitor—Best Buy—to recruit Circuit City’s top
salespeople. With that transfer of personnel to Best Buy went the transfer of important tacit knowledge underlying some
of Circuit City’s core competencies, which in turn not only mitigated Circuit City’s advantage but also allowed Best
Buy to upgrade its core competencies. In particular, Best Buy went on to develop its innovative “customer-centricity”
model, based on a set of skills that allowed its store employees to identify and more effectively serve specific customer
segments.
Why did Circuit City lose its competitive advantage? Circuit City failed to upgrade and protect their competencies,
which resulted in their losing customers to firms such as Best Buy and Amazon. It may be that the senior leaders of
Circuit City were distracted with other (newer) businesses like CarMax.
What could Circuit City’s management have done differently? Circuit City’s management should have kept a
majority of their experienced sales personnel. The layoff of the firm’s highest-paid personnel led to an irreversible
strategic mistake that ended up working against the company. Even though keeping the personnel would have been
more costly, they were the most experienced and loyal in their field for providing superior customer service, which
gave them their competitive advantage.
What is the future of Best Buy as the leader in big-box electronic retailing? What resources and capabilities
will positively impact its future? The future of Best Buy is uncertain since it faces competition with online
retailers like Amazon, even with the development of the innovative “customer-centricity” model. Through the
recruitment of previous
Circuit City employees with extensive strategic knowledge, Best Buy has a great base of resources and capabilities that
may provide a basis for competitive advantage, but they will need to continue evolving to compete with online
commerce.

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4.4 THE VALUE CHAIN ANALYSIS [LO 4-7]

The value chain describes the internal activities a firm engages in when transforming inputs into outputs. The concept
is general enough to be applied to basically any firm, from those in old-line manufacturing industries to those in
high-tech ones or even service firms.
We find that fewer students today have actually seen something “made.” This can create some confusion
regarding the differences between primary and support activities. You may ask if any of the students have worked
in any sort of manufacturing or process-related business. Using an example of a product or service will help the
students frame the differences between primary and support functions.

Discussion Topics
Activity systems can be an effective way to show the level of “fit” of the firm’s activities. Strategic activity
systems are socially complex. While one can observe several elements of a strategic activity system, the
capabilities necessary to orchestrate and manage the network of activities cannot be so easily observed and
therefore are difficult to imitate.

Hong Kong’s subway system has global expansion aspirations and is succeeding against the local firms. What makes
resources and capabilities enable MTR to capture bids for subways outside their home country? Which links in the
value chain of MTR are superior to those of other subway operators? In the politically sensitive area of public
transportation and subways, how is it advantageous or disadvantageous for a firm like MTR to be based in Hong
Kong? See “Hong Kong’s
subway system wants to run the world,” The Wall Street Journal, 9/19/13. AACSB 2013 Standard 9
Systems and processes in organizations, including planning and design, production/operations, supply
chains, marketing, and distribution

End of Chapter Discussion Question 2

Conduct a value chain analysis for McDonald’s. What are its primary activities? What are its support
activities? Identify the activities that add the most value for the customer. Why? Which activities help
McDonald’s to contain costs? Why? AACSB 2013 Standard 9 Systems and processes in organizations, including
planning and design, production/operations, supply chains, marketing, and distribution and Financial theories,
analysis, reporting, and markets
Draw the students’ attention to Exhibit 4.8. Ask them to identify at least one activity in each category. Taking the
consumers’ perspective should be easy for them and they are likely to identify research and development of new
menu items and the sourcing high-quality ingredients at good prices as generating the most value for them. They are
likely to identify supply chain management as critical to cost control. Some of them may have experience working for
McDonald’s or another fast food restaurant. If so, they should be able to identify the major cost structure drivers as
store labor, food wastage, and foot traffic per store. They may also note the importance of getting the maximum
impact and reach from advertising and sales promotion programs. If your course is a capstone that focuses on
integrating theory across functional areas, you might also ask the students to download the spreadsheet of
McDonald’s financial highlights. By analyzing these statements, they should be able to see the high level of SG&A
(mainly marketing) and the high operating costs for company-owned stores. They also should identify the importance
of franchise operations to market share, cash flow, and margins, showing that service to franchisees is critically
important.
In the last few years, McDonald’s has made a lot of changes to its menu, adding more healthy choices and more
higher-priced items, such as those offered in McCafé (e.g., premium roast coffee, frappé, and fruit smoothies),
and has also enhanced its in-restaurant services (e.g., free, unlimited Wi-Fi, newer interiors). Did McDonald’s
new priorities—in terms of a broader, healthier menu and an improved in-restaurant experience—require
changes to its traditional value chain activities? If so, how? Try to be as specific as possible in comparing the
McDonald’s of the recent past (focusing on low-cost burgers) to the McDonald’s of today.
Invite students to check out McDonald’s corporate blog to get a real-time update and an international perspective.
The students should be able to identify differences in R&D, marketing, and design and engineering, but most
importantly they should identify the impact on the supply chain processes of incorporating more fresh, less frozen
food ingredients.

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4.5 IMPLICATIONS FOR THE STRATEGIST

How to Sustain a Competitive Advantage [LO 4-
8]

We bring together the concepts of this chapter’s internal analysis with those of Chapter 3 about external analysis in the
SWOT analysis. In addition to simply using the SWOT analysis appropriately, an additional step is required to make it
a truly useful tool in the strategic management process: making decisions about how to create competitive advantage
from the elements listed in the SWOT categories. It is for this reason we bring in the SWOT matrix tool here. The
matrix adds alternatives, which are developed from the SWOT elements. This is a critically important step that helps to
drive strategy
out of the analysis phase and toward the implementation stage, because as we have already learned (from Mintzberg
in Chapter 2), a strategy that has no action behind it is not really a strategy at all! Alternatives build plans that match
the organization’s strengths to its opportunities, minimize or address its weaknesses, and help it compete in the face
of threats.

Discussion Topics
Exhibit 4.9 provides key questions for managers to consider as they construct a SWOT analysis. You may want to
use one of the mini-cases in the text as a basis for inviting students to brainstorm alternatives for each box in the
diagram.

Example
An enhancement of the basic SWOT analysis is to consider both current as well as potential conditions. That is,
conduct the SWOT in two stages: First, list the elements that are current strengths, weaknesses, opportunities, and
threats. Then, repeat the process with the focus on potential strengths, weaknesses, opportunities, and threats. This
two-stage process, illustrated in Exhibit 4.10 provides a perspective of the possible dynamic changes facing the
organization. The following is an
example put together in 2011 about the major U.S. retailing firm Target Inc. The current SWOT addresses some
of the major aspects of the firm at that time. The potential conditions are created with the perspective that
environmentally friendly products continue to take a more dominant role in the core retail marketplace going
forward. AACSB 2013
Standard 9 Application of knowledge (able to translate knowledge of business and management into practice)

CURRENT CONDITIONS
Strengths Weaknesses
1. Opened stores in every state except Vermont 1. Low international expansion vs. competitors
2. Ranked 30 on Fortune 500 of 2010 2. Few distribution channels
3. Partnerships with well-established brands 3. Higher prices than competitors in the industry
4. Owns many other subsidiaries 4. Material weakness exists

Opportunities Threats
1. Expand globally 1. Differentiation
2. Focus more on private products 2. Interruptions with vendors/supply chains
3. Strategically acquire expansion in Canada 3. Unsuccessfully managing workforce
4. Reduce operation cost/increase revenue 4. Failure to address safety concerns

POTENTIAL CONDITIONS
Strengths Weaknesses
1. Method products 1. Not enough research
2. Biodegradable products 2. Lacking promotion/advertising
3. Reusable eco-friendly store bags 3. Face for new “green” approach not present
4. Highly recognizable bull’s-eye logo 4. More products needed to reach larger clientele

Opportunities Threats
1. Can help promote a “green” environment 1. New competition
2. Possibly change the marketing mix for sustainable retail products 2. Release of new green programs
3. Explore other companies seeking to join eco-friendly theme 3. Customers’ change of preference
4. Target could invest in research of biodegradable products 4. Change of government regulations

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STRATEGY TERM Term Project Module 4

PROJECT In this section, students will study the business strategy of the firm they have
previously selected for this project. Be sure to instruct the students to focus
only on ONE business unit if they have selected a larger firm with several
operations. The following are some general thoughts on the type of
information students would have in response to the questions for this module
of the project. AACSB
2013 Standard 9 Application of knowledge (able to translate knowledge of
business and management into practice)

A good place to start with an internal firm analysis is to catalog the assets
a firm has. Make a list of the firm’s tangible assets. Then, make a
separate list of the intangible assets you can identify. Refer to Exhibit
4.4.
K Tangible Assets: Property, Plant, Equipment, etc.
K Intangible: Brand, Knowledge Stocks, etc.

Now extend beyond the asset base and use the VRIO framework to identify
the competitive position held by your firm. Which, if any, of these
resources are helpful in sustaining the firm’s competitive advantage?
The competitive position held by your firm could be a temporary competitive
advantage with some level of valuable and rare resources. The costly to imitate
strengths may be considered more of a continuum and it would matter as to
the industry context what “costly” meant. Many firms find that they are not
actually
organized to capture the value as efficiently as their competitors, and this can
be an area of productive focus for quite a number of organizations.

Identify the core competencies that are at the heart of the firm’s
competitive advantage. (Remember, a firm will have only one, or at most
a few, core competencies, by definition.)
Following Exhibit 4.5, take the list of resources from question 1 earlier and
review
them in the context of capabilities either discovered in the VRIO
analysis in question 2 or from your own research of the firm. Where the
resources and
capabilities are in alignment is a rich location for core competencies.

Perform a SWOT analysis for your firm. Remember that strengths and
weaknesses (S, W) are internal to the firm, and opportunities and threats
(O, T) are external.
See Exhibit 4.10 for a hypothetical example of a SWOT matrix for the case of
McDonald’s.

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Looking Inside Yourself: What Is My

m y STRATEGY Competitive Advantage?
Here, we encourage the student to take what he/she has learned about
competitive advantage and apply it to his personal career. Encourage students
How to position to spend a few minutes looking at themselves to discover their own
yourself for competitive advantages. AACSB 2013 Standard 9 Reflective thinking (able to
understand oneself in the context of society)
career advantage
1. Write down your own personal strengths and weaknesses. What sort
of organization will permit you to really leverage your strengths and
keep you highly engaged in your work (person–organization fit)? Do
some of your weaknesses need to be mitigated through additional
training or mentoring from a more seasoned professional?
Some of our students who are looking for the “what to do after graduation” have
found this exercise to be a useful way to think about what they are good at and
what they would probably want to stay away from as far as a future career.

2. Personal capabilities also need to be evaluated over time. Are your

strengths and weaknesses different today from what they were five
years ago? What are you doing to make sure your capabilities are
dynamic? Are you upgrading skills, modifying behaviors, or otherwise
seeking to change your future strengths and weaknesses?
Many students find college to be a time of growth and upgrading skills both in
and
out of the classroom. Be sure to encourage your students to think about the
“softer” side of growth, such as presentation skills, self-confidence, etc.

3. Are some of your strengths valuable, rare, and costly to imitate? How
can you organize your work to help capture the value of your key
strengths (or mitigate your weaknesses)?
This exercise can involve a bit of “thinking outside the box” for some students,
but a number of them who have taken it seriously have reported some new
findings about how to build and promote their strengths.

4. In this chapter, we discussed that the strategic activity system

happening inside the firm can be a vital source of sustainable competitive
advantage. If you are currently or previously employed, consider how
your professional activities can help reinforce the key value added
activities in your department or organization.
Encouraging students to do an activity systems map (such as the Vanguard
example) can be a quite useful experience for both the student and the firm
(if they are currently employed there). Some organizations have used these
maps to
recognize some non-value added activities which they could modify or even
eliminate. Knowing how your job fits in the scheme of things for the firm can
be very enlightening.

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