Chapter 3

The Internal Organization:

Resources, Capabilities, Core
Competencies, and Competitive
Advantages
Hitt,
Hitt, Ireland,
Ireland, Hoskisson,
Hoskisson, Harrison,
Harrison, Strategic
Strategic Management:
Management: Concepts
Concepts and
and Cases:
Cases: Competitiveness
Competitiveness andand Globalization,
Globalization, 14
14 th Edition.
th
Edition. ©© 2024
2024
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 Learning Objectives
By the end of this chapter, you should be able to:
3.1 Explain why a firm needs to study and understand its internal organization.
3.2 Define value, and discuss its importance.
3.3 Describe the differences between tangible and intangible resources.
3.4 Define capabilities, and discuss their development.
3.5 Describe four criteria used to determine if resources and capabilities are core
competencies.
3.6 Explain how firms analyze value chains to determine where they are able to create
value when using their resources, capabilities, and core competencies.
3.7 Define outsourcing, and discuss reasons for its use.
3.8 Discuss the importance of identifying internal strengths and weaknesses.

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 3-1
Understanding the Firm’s Internal Environment

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 Understanding the Firm’s Internal
Environment (1 of 3)
• Firms and organizations achieve strategic competitiveness and ea
rn above-average returns by acquiring, bundling, and leveraging t
heir resources for the purpose of taking advantage of opportunitie
s in the external environment in ways that create value for custom
ers.
• Competitors will eventually learn how to duplicate the benefits of a
ny firm’s value-creating strategy.
− Thus, all competitive advantages have a limited life.

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 Understanding the Firm’s Internal
Environment (2 of 3)
• In general, a competitive advantage’s • For all firms, the challenge is to
sustainability is a function of three effectively manage current core
factors: competencies while simultaneously
− The rate of core competence developing new ones.
obsolescence because of • Only when firms are able to do this
environmental changes
can they expect to:
− The availability of substitutes for the
− achieve strategic competitiveness.
core competence
− earn above-average returns.
− The imitability of the core
competence − remain ahead of competitors in both
the short and long term.
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 Understanding the Firm’s Internal
Environment (3 of 3)
• By analyzing its internal organization, a firm determines what it can do.
• Matching what a firm can do with what it might do yields insights for the
firm to select its strategies.
− Can do—a function of its resources, capabilities, and core competencies
in the internal organization
− Might do—a function of opportunities and threats in the external
environment

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 Why Understand the Internal Organization
(1 of 2)
• In today’s global economy, some of the resources that were
traditionally critical to firms’ efforts to produce, sell, and distribute
their goods or services are now less likely to be the source of
competitive advantages.
• This is because an increasing number of firms are using their
resources to form core competencies through which they
successfully implement an international strategy as a means of
overcoming the advantages created by more traditional resources.

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 Why Understand the Internal Organization
(2 of 2)
• Firms analyzing their internal organization should use a global
mind-set to do so.
− A global mind-set is the ability to analyze, understand, and manage
an internal organization in ways that are not dependent on the
assumptions of a single country, culture, or context.
• Analyzing the firm’s internal organization requires that evaluators
understand how to leverage the firm’s unique bundle of resources
and capabilities.

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 Figure 3.1
Components of an Internal Analysis

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 Knowledge Check 3-1

The source of capabilities is:

a. competition.
b. core competencies.
c. resources.
d. advantages.

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 3-2
Creating Value and Its Importance

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 Creating Value and Its Importance (1 of 3)

• Value is measured by a product’s • The strategic decisions managers

performance characteristics and by its make about the internal
attributes for which customers are organization:
willing to pay.
− are nonroutine.
• Firms create value by innovatively
building and leveraging their resources − have ethical implications.
to form capabilities and core − significantly influence the firm’s
competencies. ability to earn above-average
• Ultimately, creating value for customers returns.
is the source of above-average returns
for a firm.
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 Creating Value and Its Importance (2 of 3)

• Making decisions regarding the firm’s assets:

− involves identifying, developing, deploying, and protecting resources,
capabilities, and core competencies.
− is challenging and difficult.
− is increasingly internationalized.
• A firm can improve by studying its mistakes.
− The learning generated by making and correcting mistakes can be
important in the creation of new capabilities and core competencies.
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 Figure 3.2 Conditions Affecting Managerial
Decisions About Resources, Capabilities, and
Core Competencies
Condition Uncertainty Uncertainty exists about the characteristics of the
firm’s general and industry environments and
customers’ needs.
Condition Complexity Complexity results from the interrelationships
among conditions shaping a firm.

Condition Intraorganizational Intraorganizational conflicts may exist among

Conflicts managers making decisions as well as among
those affected by the decisions.

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 Creating Value and Its Importance (3 of 3)
• In making decisions affected by these three conditions, judgment is
required.
− Judgment is the capability of making successful decisions when no obviously
correct model or rule is available or when relevant data are unreliable or
incomplete.
− When exercising judgment, decision makers:
 must be aware of possible cognitive biases, such as overconfidence.
 often take intelligent risks.

• In a competitive landscape, executive judgment can become a valuable

capability.
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 Polling Activity 3-2

Strategic leaders are individuals who need to make effective choices about the
use and development of the firm’s …
a. resources.
b. capabilities.
c. core competencies.

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 3-3
Resources, Tangible and Intangible

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 Resources, Tangible and Intangible (1 of 4)

• The foundations of competitive advantage are:

− Resources
− Capabilities
− Core competencies
• Resources are bundled to create organizational capabilities.
• Capabilities are the source of a firm’s core competencies, which are
the basis of establishing competitive advantages.

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 Resources, Tangible and Intangible (2 of 4)
• Broad in scope, resources cover a • Tangible resources are assets
spectrum of individual, social, and that can be observed and
organizational phenomena. quantified.
• By themselves, resources do not • Four primary categories of tangible
allow firms to create value for resources are:
customers as the foundation for
• Financial
earning above-average returns.
• Organizational
• Some of a firm’s resources are
tangible, while others are • Physical
intangible. • Technological
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 Table 3.1 Tangible Resources
Financial • The firm’s capacity to borrow
Resources • The firm’s ability to generate funds through internal operations
Organizational • Formal reporting structures
Resources
Physical • The sophistication of a firm’s plant and equipment and the
Resources attractiveness of its location
• Distribution facilities
• Product inventory
Technological • Availability of technology-related resources such as copyrights,
Resources patents, trademarks, and trade secrets

Sources: Adapted from J. B. Barney, 1991, Firm resources and sustained competitive advantage, Journal of Management,
17: 101; R. M. Grant, 1991, Contemporary Strategy Analysis, Cambridge: U.K.: Blackwell Business, 100–102.
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 Resources, Tangible and Intangible (3 of 4)

• Intangible resources are assets that are rooted deeply in the firm’s
history, accumulate over time, and are relatively difficult for
competitors to analyze and imitate.
• Three primary categories of intangible resources are:
• Human
• Innovation
• Reputational

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 Table 3.2 Intangible Resources
Human • Knowledge
Resources • Trust
• Skills
• Abilities to collaborate with others
Innovation • Ideas
Resources • Scientific capabilities
• Capacity to innovate
Reputational • Brand name
Resources • Perceptions of product quality, durability, and reliability
• Positive reputation with stakeholders such as suppliers and
customers
Sources: Adapted from R. Hall, 19 92, The strategic analysis of intangible resources, Strategic Management Journal, 13:
136–139; R. M. Grant, 19 91, Contemporary Strategy Analysis, Cambridge U.K.: Blackwell Business, 101–104.
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 Resources, Tangible and Intangible (4 of 4)

• Tangible Resources: • Intangible Resources:

• are hard to leverage. • are less visible and more
difficult for competitors to
• are difficult to derive additional
understand, purchase, imitate,
business or value from.
or substitute for.
• are more relied on to be the
foundation for a firm’s
capabilities.
• can be leveraged.
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 Knowledge Check 3-3

Which of the following are an intangible resource?

a. Manufacturing facilities
b. Distribution centers
c. Formal reporting structures
d. Managerial capabilities

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 3-4
Capabilities and Core Competencies

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 Capabilities and Core Competencies
• Capabilities are:
− created by combining individual tangible and intangible resources.
− used to complete the organizational tasks required to produce, distribute,
and service the goods or services the firm provides to customers.
− the foundation for building core competencies and competitive advantages.
− often based on developing, carrying, and exchanging information and
knowledge through the firm’s human capital.
− Strategic human capital allows a firm to develop capabilities through
matching the knowledge, skills, and abilities of their employees to particular
strategic objectives.
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 Table 3.3 Example of Firms’ Capabilities
(1 of 2)
Functional Areas Capabilities Examples of Firms
Distribution • Effective use of logistics management • Walmart
techniques

Human Resources • Motivating, empowering, and retaining • Microsoft

employees

Management Information • Effective and efficient control of inventories • Walmart

Systems through point-of-purchase data collection
methods

Marketing • Effective promotion of brand-name products • Procter & Gamble

• Effective customer service • Ralph Lauren Corp.
• Innovative merchandising • McKinsey & Co.
• Nordstrom Inc.
• Crate & Barrel

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 Table 3.3 Example of Firms’ Capabilities
(2 of 2)
Functional Areas Capabilities Examples of Firms
Management • Ability to envision the future of clothing • Hugo Boss
• Zara

Manufacturing • Design and production skills yielding reliable • Komatsu

products • Witt Gas Technology
• Product and design quality • Sony
• Miniaturization of components and products
Research & • Innovative technology • Caterpillar
Development • Development of sophisticated elevator control • Otis Elevator Co.
solutions • Chaparral Steel
• Rapid transformation of technology into new • Thomson Consumer
products and processes Electronics
• Digital technology

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 Core Competencies

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

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 Building Core Competencies

• Two tools help firms identify their core competencies:

− The four criteria of sustainable competitive advantage (VRIO
Framework)
− Value chain analysis

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 Knowledge Check 3-4
Effective customer service is a capability within which of the following
functional areas?
a. Distribution
b. Human resources
c. Marketing
d. Management

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 3-5
The Four Criteria of Sustainable
Competitive Advantage

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 The Four Criteria of Sustainable
Competitive Advantage (1 of 2)
• Capabilities that are valuable, rare, costly to imitate, and nonsubstitutable are
core competencies.
• Capabilities failing to satisfy the four criteria are not core competencies,
meaning that although every core competence is a capability, not every
capability is a core competence.
• In slightly different wording:
− For a capability to be a core competence, it must be valuable and unique from a
customer’s point of view.
− For a core competence to be a potential source of competitive advantage, it must
be inimitable and nonsubstitutable by competitors.
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 Table 3.4 The Four Criteria of Sustainable
Competitive Advantage
Valuable Capabilities • Help a firm neutralize threats or exploit opportunities
Rare Capabilities • Are not possessed by many others
Costly-to-Imitate • Historical: A unique and a valuable organizational culture
Capabilities 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
Non substitutable • No strategic equivalent
Capabilities

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 The Four Criteria of Sustainable
Competitive Advantage (2 of 2)
• Core competencies are: − Costly to imitate
− Valuable  Costly-to-imitate
capabilities are capabilities
 Valuable capabilities allow the that other firms cannot easily
firm to exploit opportunities or develop.
neutralize threats in its external
environment. − Nonsubstitutable
− Rare  Nonsubstitutable
capabilities are capabilities
 Rare capabilities are that do not have strategic
capabilities that few, if any, equivalents.
competitors possess.
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 Table 3.5 Outcomes from Combinations of the
Criteria for Sustainable Competitive Advantage
Is the Is the Is the Capability Is the Capability Competitive Performance
Capability Capability Costly to Nonsubstitutable? Consequences Implications
Valuable? Rare? Imitate?

No No No No Competitive Below-average
disadvantage returns

Yes No No Yes/No Competitive parity Average returns

Yes Yes No Yes/No Temporary Average returns

competitive to above-average
advantage returns
Yes Yes Yes Yes/No Sustainable Above-average
competitive returns
advantage

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 Polling Activity 3-5

Which type of capability contributes the most to a sustainable competitive

advantage?
a. Valuable capability
b. Rare capability
c. Costly to imitate capability
d. Nonsubstitutable capability

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 3-6
Value Chain Analysis

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 Value Chain Analysis (1 of 4)

• Value chain analysis allows the firm to understand the parts of its
operations that create value and those that do not.
• Understanding these issues is important because the firm earns
above-average returns only when the value it creates is greater than
the costs incurred to create that value.
• The value chain is a template that firms use to analyze their cost
positions and to identify the multiple means that can be used to
facilitate implementation of their chosen strategies.
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Figure 3.3 A Model of the Value Chain

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 Value Chain Analysis (2 of 4)
• Value chains are segmented into:
− Value chain activities are activities or tasks the firm completes in
order to produce products and then sell, distribute, and service those
products in ways that create value for customers.
− Support functions include the activities or tasks the firm completes in
order to support the work being done to produce, sell, distribute, and
service the products the firm is producing.
• A firm can develop a capability and/or a core competence in any of
the value chain activities and support functions.

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 Figure 3.4
Creating Value

through
Value Chain
Activities

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Figure 3.5
Creating
Value
through
Support
Functions

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 Value Chain Analysis (3 of 4)
• All items in both figures should be evaluated relative to competitors’
capabilities and core competencies.
• To become a core competence and a source of competitive advantage, a
capability must allow the firm to either:
− perform an activity in a manner that provides value superior to that provided
by competitors, or
− perform a value-creating activity that competitors cannot perform.

• Value chain analysis can help managers determine which activities hold
the most potential for the firm to develop a competence.

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 Value Chain Analysis (4 of 4)
• Value chain analysis can also be used to look for deficiencies in the
organization that could be holding back the creation of value.
• This part of the analysis rests on the assumption that a firm is a value
creation system.
• In a value creation system, each part of a system depends on other
parts of the system to create value.
• Creating value for customers by completing activities that are part of the
value chain requires building strong and productive relationships with
stakeholders (social capital).

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 Discussion Activity 3-6

Trust is identified as a potential source of competitive advantage.

Have you ever been involved in a situation in which trust was
instrumental in accomplishing an organization’s goals? If so, what
outcomes were made possible because of trust?

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 Discussion Activity 3-6 Debrief

Have you ever been involved in a situation in which trust was instrumental in
accomplishing an organization’s goals? If so, what outcomes were made possible
because of trust?
• The organizations we trust are the ones we are likely to frequent and
recommend to others—which builds social capital for the company.
• Organizations with social capital have the potential to grow, expand, and reach
new markets.

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 3-7
Reasons for Outsourcing

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 Reasons for Outsourcing (1 of 3)

• When the firm cannot create value in • Firms engaging in effective

either a value chain activity or a outsourcing:
support function, outsourcing is − increase their flexibility.
considered.
− mitigate risks.
• Outsourcing is the purchase of a − reduce their capital investments.
value-creating activity or a support
function activity from an external • Firms should use outsourcing only for
supplier. activities where they:
− cannot create value.
− are at a substantial disadvantage
compared to competitors.
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 Reasons for Outsourcing (2 of 3)

• Outsourcing can be effective • By nurturing a smaller number of

because few, if any, organizations capabilities, a firm:
possess the resources and − increases the probability of
capabilities required to achieve developing core competencies
competitive superiority in each and achieving a competitive
value chain activity and support advantage because it does not
function. become overextended.
− can fully concentrate on those
areas in which it has the potential
to create value.
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 Reasons for Outsourcing (3 of 3)

• There are concerns associated with outsourcing; two significant

concerns are:
− The potential loss in a firm’s ability to innovate
− The loss of jobs within the focal firm
• Firms are sometimes able to enhance their own innovation
capabilities by studying how the companies to which they’ve
outsourced complete those activities.

Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024
Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Knowledge Check 3-7

Outsourcing is concerned with how components, finished goods, or

services will be:
a. distributed.
b. obtained.
c. produced.
d. managed.

Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024
Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 3-8
Competencies, Strengths, Weaknesses,
and Strategic Decisions

Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024
Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Competencies, Strengths, Weaknesses,
and Strategic Decisions (1 of 2)
• By analyzing the internal organization, firms identify their strengths
and weaknesses as reflected by their resources, capabilities, and
core competencies.
• If a firm has weak capabilities or does not have core competencies
in areas required to achieve a competitive advantage, it must
acquire those resources and build the needed capabilities and
competencies.

Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024
Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Competencies, Strengths, Weaknesses,
and Strategic Decisions (2 of 2)
• Having a significant quantity of resources is not the same as having
the “right” resources.
− The “right” resources are those with the potential to be formed into
core competencies as the foundation for creating value for customers
and developing competitive advantages because of doing so.
• The ability of a core competence to be a permanent competitive
advantage can’t be assumed.
− All core competencies have the potential to become core rigidities that
generate inertia and stifle innovation.
Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024
Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Knowledge Check 3-8

When a company assumes that a core competence will be a

permanent competitive advantage, that competency runs the risk of
becoming a core:
a. rigidity.
b. incompetence.
c. disadvantage.
d. resource.
e. . Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024
Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Summary
Click the link to review the objectives for this presentation.

Link to Objectives

Hitt, Ireland, Hoskisson, Harrison, Strategic Management: Concepts and Cases: Competitiveness and Globalization, 14 th Edition. © 2024
Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.