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Chapter 3
Evaluating a
Firm’s
Internal
Capabilities
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
What Does Internal Analysis Tell Us?
Internal analysis provides a comparative look at
a firm’s capabilities
• Internal analysis is a way of looking inside a firm
to determine what the firm’s strengths and weaknesses
might be compare to competitors
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Why Does Internal Analysis Matter?
Internal analysis helps a firm:
• determine if its resources and capabilities are
likely sources of competitive advantage
• establish strategies that will exploit any sources
of competitive advantage
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Theory Behind Internal Analysis
The Resource-Based View
• developed to answer the question: Why do some
firms achieve better economic performance
than others?
• used to help firms achieve competitive advantage
and superior economic performance
• assumes that a firm’s resources and capabilities
are the primary drivers of competitive advantage
and economic performance
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Resource-Based View
Resources and Capabilities
Resources:
• tangible and intangible assets of a firm
» tangible: factories, products intangible: reputation
• used to conceive of and implement strategies
Capabilities:
• a subset of resources that enable a firm to
take full advantage of other resources
» marketing skill, cooperative relationships
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Resource-Based View
Resources and Capabilities
Firm Assets:
Are these resources
or capabilities?
Machinery
?
Collective Product Design Skill
?
Recruiting Skill
?
Engineering Skill of Individuals
?
Mineral Deposits
?
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Resource-Based View
• Four Categories of Resources
• financial—the money available to the firm from
whatever source (debt, equity, retained earnings,
etc.)
• physical—machinery, factories, offices, raw
materials, geographic location, technology
• human—training, experience, individual intelligence,
judgment, work ethic
• organizational—reporting structures, reward
systems, coordinating systems, relationships, etc.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Resource-Based View
Two Critical Assumptions of the RBV
• Resource Heterogeneity
» different firms may have different resources
• Resource Immobility
» it may be costly for firms without certain
resources to acquire or develop them
» some resources may not spread from firm to
firm easily
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Resource-Based View
What do these assumptions really mean?
• if one firm has resources that are valuable
and other firms don’t, and…
• if other firms can’t imitate these resources
without incurring high costs, then…
• the firm possessing the valuable resources
will likely gain a sustained competitive advantage
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Resource-Based View
Resource Heterogeneity
• A firm may possess resources that are similar to the resources
of other firms (homogeneous). However, the managers of that
firm may employ firm capabilities in such way as to create
heterogeneous bundles of resources. In other words, managers
can take common resources and create uncommon bundles of
resources so that firm differences exist— even if the original
basic building blocks (resources) are the same.
• competitive advantage typically stems from several
resources and capabilities ‘bundled’ together
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Internal Analysis Tool
• The VRIO framework is the analysis ‘tool’ of the RBV.
This framework is a way of examining resources to
determine if a resource is likely to be a source of
competitive advantage. Four criteria must be met if a
resource is to lead to competitive advantage.
• Four Important Questions :
• Value – Does the resource enable the firm to exploit an opportunity
or neutralize a threat? The evidence of a positive response to this
question is usually that the resource somehow increases revenue or
decreases cost.
• Rarity – Is the resource rare? Is the resource rare enough that there
is still scarcity in the marketplace for this resource?
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The Internal Analysis Tool
• Imitability – Is the resource costly to imitate?
Specifically, is the resource so costly to imitate that no
one would try to imitate it?
• Organization – Is the firm organized in such a way that
the resource can be exploited?
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The VRIO Framework
If a firm has resources that are:
• valuable,
• rare, and
• costly to imitate, and…
• the firm is organized to exploit these resources,
then the firm can expect to enjoy a sustained
competitive advantage.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
The VRIO Framework
Applying the Tool
• a resource or bundle of resources is subjected to
each question to determine the competitive
implication of the resource
• each question is considered in a comparative
sense (competitive environment)
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
• The Question of Value
– in theory: Does the resource enable the firm to exploit an
external opportunity or neutralize an external threat?
• This is a straightforward question intended to ascertain whether or
not the resource is strategically relevant. There is a cost to the firm
of carrying any resource and if the firm does not receive some
benefit that outweighs the cost, then the firm is at a competitive
disadvantage. If the firm receives a benefit that outweighs the
carrying cost of the resource, then we would conclude that the
resource is valuable, and could, therefore, be a potential source of
competitive advantage.
• (Levi’s reputation allows it to charge a premium for its Docker’s
pants)
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
•
•
The Question of Rarity
Having established that a resource is valuable, we next turn our attention to
the question of rarity. We are interested in whether a resource is rare
enough that it creates a difference between the focal firm and its
competitors such that the focal firm realizes some advantage from the
difference. This question is tied to the assumption of resource
heterogeneity. If there is to be any advantage in having a resource, it must
create differences between firms.
•
Some firm resources that are valuable but not rare are still very important to
the firm (e.g., telephone systems).
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
Valuable and Rare
If a firm’s resources are:
The firm can expect:
Not Valuable
Competitive Disadvantage
Valuable, but Not Rare
Competitive Parity
Valuable and Rare
Competitive Advantage
(at least temporarily)
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
The Question of Imitability
• the temporary competitive advantage of valuable
and rare resources can be sustained only if
competitors face a cost disadvantage in imitating
the resource
» intangible resources are usually more
costly to imitate than tangible resources
(Harley-Davidson’s styles may be easily
imitated, but its reputation cannot)
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
The Question of Imitability
• if there are high costs of imitation, then the firm
may enjoy a period of sustained competitive
advantage
» a sustained competitive advantage will last
only until a duplicate or substitute emerges
 if a firm has a competitive advantage, others
will attempt to imitate it (Razor scooters
were a big hit and others quickly imitated them)
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
• The Question of Imitability
• Costs of Imitation
• There are several categories of cost that firms may face
as they attempt to imitate valuable and rare resources.
These sources of cost are examined with the aim of
helping students understand and exploit these costs. If a
firm is protected by the high costs of imitation that
competitors face, then the firm can expect the
competitive advantage to be sustained.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
The Question of Imitability
Costs of Imitation
Causal Ambiguity (Southwest Airlines – HR)
• A firm may face a cost disadvantage in acquiring
valuable and rare resources because it is unclear exactly
which resources need to be imitated in order to get the
desired effect.
•
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
The Question of Imitability
Costs of Imitation
Social complexity may create a cost disadvantage
for a firm attempting to imitate a valuable and rare
resource because the desired resource may be the
result of a set of complex social relationships.
Duplicating these relationships may be extremely
costly or even impossible.
• the social relationships entailed in resources may be so
complex that managers cannot really manage them
or replicate them
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
• The Question of Imitability
• Costs of Imitation
• Patents help to create cost disadvantages for imitators, but
they are not an ironclad protection for patent holders. One
problem for those seeking a patent is that potentially sensitive
information has to be disclosed to get the patent in the first
place. This information could prove useful to others
attempting to develop a similar product or solution. Another
problem for patent holders is that the patent must be enforced
if others choose to infringe on the patent. For these reasons,
some firms opt for a trade secret instead of a patent. Trade
secrets offer a different level of protection, but there is little, if
any, a priori disclosure requirement.
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
Value, Rarity, & Imitability
If a firm’s resources are:
The firm can expect:
Valuable, Rare, but
not Costly to Imitate
Temporary
Competitive Advantage
Valuable, Rare, and
Costly to Imitate
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
Sustained
Competitive Advantage
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Evaluating a Firm’s Internal Capabilities
Applying the VRIO Framework
• The Question of Organization
• The logic behind the question of organization is simply
that a firm must be appropriately organized to be able to
exploit the potential competitive advantage stemming
from valuable, rare, and costly-to-imitate resources and
capabilities. Conceivably a firm could have a valuable,
rare, and costly-to-imitate resource and never realize a
competitive advantage because of inadequate
organization.
• examples: formal and informal reporting structures,
management controls, compensation policies,
relationships, etc.
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Evaluating a Firm’s Internal Capabilities
The VRIO Framework
Valuable?
Rare?
Costly to
Imitate?
Exploited by
Organization?
No
No
Competitive
Implications
Disadvantage
No
Parity
Yes
Yes
No
Temporary
Advantage
Yes
Yes
Yes
Yes
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
Yes
Sustained
Advantage
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Evaluating a Firm’s Internal Capabilities
The VRIO Framework
Costly to Exploited by Competitive
Valuable? Rare? Imitate? Organization? Implications
Economic
Implications
Disadvantage
Below
Normal
No
Parity
Normal
Yes
Yes
No
Temporary
Advantage
Above
Normal
Yes
Yes
Yes
Sustained
Advantage
Above
Normal
No
No
Yes
Yes
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
Internal Analysis
Tells us:
• what the firm should do, given the relative
strengths and weaknesses of resources and
capabilities
Managers’ Job:
• bundle resources and capabilities to
achieve competitive advantage
VRIO Framework Helps Managers Recognize
Sources of Competitive Advantage
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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Evaluating a Firm’s Internal Capabilities
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stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or otherwise,
without the prior written permission of the publisher. Printed in the
United States of America.
Copyright ©2012 Pearson Education, Inc.
publishing as Prentice Hall
Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall.
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