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This document provides an outline for a chapter about analyzing resources and capabilities for strategy formulation. It discusses how analyzing a firm's internal resources and capabilities, rather than just focusing on external factors, can provide a more stable basis for long-term strategy. Firms can develop competitive advantage by exploiting their unique portfolio of tangible and intangible resources. The chapter will cover identifying, appraising, and developing a firm's resources and capabilities in order to formulate strategies that create sustainable competitive advantage.
![CSAC05 1/13/07 9:21 Page 129
CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 129
contrast, emphasizes the uniqueness of each company and suggests that the key
to profitability is not through doing the same as other firms, but rather through
exploiting differences. Establishing competitive advantage involves formulating and
implementing a strategy that exploits the uniqueness of a firm’s portfolio of resources
and capabilities.
The remainder of this chapter outlines a resource-based approach to strategy
formulation. Fundamental to this approach is recognizing that a firm must seek a
thorough and profound understanding of its resources and capabilities. Such under-
standing provides a basis for:
1 Selecting a strategy that exploits an organization’s key strengths. Mariah
Carey’s disastrous 2001–2 was the result of her straying from her core
competences (see Strategy Capsule 5.1). Walt Disney’s turnaround under
Michael Eisner’s leadership was the result of exploiting its underlying
resources more effectively (see Strategy Capsule 5.2).
2 Developing the firm’s resources and capabilities. Resource analysis is not just
about deploying existing resources, it is also concerned with filling resource
gaps and building capability for the future. Toyota, Microsoft, Johnson &
Johnson, and British Petroleum are all companies whose long-term success
STRATEGY CAPSULE 5.1
Focusing Strategy around Core Capabilities:
Lyor Cohen on Mariah Carey
2001 was a disastrous year for Mariah Carey. “I said to her, what’s your competitive
Her first movie, Glitter, was a flop, the sound- advantage? A great voice, of course. And
track was Carey’s most poorly received album what else? You write every one of your
in a decade, her $80 million recording contract songs – you’re a great writer. So why did
was dropped by EMI, and she suffered a you stray from your competitive advantage?
nervous breakdown. If you have this magnificent voice and you
Lyor Cohen, the aggressive, workaholic chief write such compelling songs, why are you
executive of Island Def Jam records was quick dressing like that, why are you using all
to spot an opportunity: these collaborations [with other artists and
other songwriters]? Why? It’s like driving a
“I cold-called her on the day of her release
Ferrari in first – you won’t see what that
from EMI and I said, I think you are an
Ferrari will do until you get into sixth gear.”
unbelievable artist and you should hold
your head up high,” says Cohen. “What I Cohen signed Carey in May 2002. Under
said stuck on her and she ended up Universal Music’s Island Def Jam Records, Carey
signing with us.” returned to her core strengths: her versatile
voice, song-writing talents, and ballad style.
His strategic analysis of Carey’s situation was
Her new album, The Emancipation of Mimi,
concise:
was the biggest-selling album of 2005, and in
2006 she won a Grammy award.](https://image.slidesharecdn.com/csac051-p-110520053600-phpapp01/85/Csac05-1-p-7-320.jpg)
![CSAC05 1/13/07 9:21 Page 159
CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 159
Appendix: Knowledge Management and
the Knowledge-based View of the Firm
During the past ten years our thinking about resources and capabilities and their
management has been extended and reshaped by a surge of interest in knowledge
management. Knowledge management refers to processes and practices through
which organizations generate value from knowledge. Initially, knowledge manage-
ment was primarily concerned with information technology – especially the use of
intranets, groupware, and databases for storing, analyzing, and disseminating infor-
mation. Subsequent developments in knowledge management have been concerned
less with data and more with organizational learning – especially the transfer of best
practices – and the management of intellectual property. The level of interest in know-
ledge management is indicated by the number of large corporations that have created
the position of chief knowledge officer, the spawning of knowledge management prac-
tices by consulting firms, and a flood of books on the subject.
Academic interest in the role of knowledge within organizations represents the
confluence of several research streams including resource-based theory, the economics
of information, epistemology, evolutionary economics, and the management of tech-
nology. The outcome has been a knowledge-based view of the firm that considers the
firm as a set of knowledge assets with the purpose of deploying these assets to create
value.50
Is knowledge management a major breakthrough in management practice or mere
fad? A growing body of evidence points to the ability of knowledge management to
generate substantial gains in performance. At the same time many of its manifesta-
tions are highly dubious. The Wall Street Journal reports that Saatchi & Saatchi’s
director of knowledge management is “absorbing everything under the sun,” includ-
ing the implications of breakthrough products such as Japanese pantyhose “embedded
with millions of microcapsules of vitamin C and seaweed extract that burst when
worn to provide extra nourishment for the limbs.”51 Lucy Kellaway of the Financial
Times notes that beyond the simple truth that “The subject [of knowledge manage-
ment] has attracted more needless obfuscation and wooly thinking by academics and
consultants than any other.”52
My approach is to regard knowledge management and the knowledge-based view
of the firm as important extensions of our analysis of resources and capabilities. In
terms of resources, knowledge is acknowledged to be the overwhelmingly important
productive resource; indeed, the value of people and machines lies primarily in the
fact that they embody knowledge. From the strategic viewpoint, knowledge is a
particularly interesting resource: many types of knowledge are scarce, much of it is
difficult to transfer, and complex forms of knowledge may be very difficult to repli-
cate. Capabilities may be viewed as the manifestation of the knowledge of the organ-
ization. Knowledge management offers valuable tools for creating, developing,
maintaining, and replicating organizational capabilities.
Types of Knowledge
The single most useful contribution of knowledge management is the recognition that
different types of knowledge have very different characteristics. A key distinction is](https://image.slidesharecdn.com/csac051-p-110520053600-phpapp01/85/Csac05-1-p-37-320.jpg)
Csac05[1].p
- 1. CSAC05 1/13/07 9:21 Page 123 5 Analyzing Resources and Capabilities Analysts have tended to define assets too narrowly, identifying only those that can be measured, such as plant and equipment. Yet the intangible assets, such as a particular technology, accumulated consumer information, brand name, reputation, and corporate culture, are invaluable to the firm’s competitive power. In fact, these invisible assets are often the only real source of competitive edge that can be sustained over time. —HIROYUKI ITAMI, MOBILIZING INVISIBLE ASSETS You’ve gotta do what you do well. —LUCINO NOTO, FORMER VICE CHAIRMAN, EXXON MOBIL OUTLINE l Introduction and Objectives l Organizational Capabilities Classifying Capabilities l The Role of Resources and The Architecture of Capability Capabilities in Strategy Formulation l Appraising Resources and Capabilities Basing Strategy on Resources and Establishing Competitive Advantage Capabilities Sustaining Competitive Advantage Resources and Capabilities as Sources of Appropriating the Returns to Profit Competitive Advantage l The Resources of the Firm l Putting Resource and Capability Tangible Resources Analysis to Work: A Practical Guide Intangible Resources Step 1 Identify the Key Resources and Human Resources Capabilities 123
- 2. CSAC05 1/13/07 9:21 Page 124 124 PART II THE TOOLS OF STRATEGY ANALYSIS Step 2 Appraising Resources and l Summary Capabilities Step 3 Developing Strategy Implications l Self-Study Questions l Developing Resources and Capabilities l Appendix: Knowledge Management and the Knowledge-based View of the The Relationship between Resources Firm and Capabilities Replicating Capabilities l Notes Developing New Capabilities Approaches to Capability Development Introduction and Objectives In Chapter 1, I noted that the focus of strategy thinking has been shifted from the exter- nal environment towards its internal environment. In this chapter, we will make the same transition. In looking within the firm, we will concentrate our attention on the resources and capabilities that firms possess. In doing so, we shall build the foundations for our analysis of competitive advantage (which began in Chapter 3 with the discussion of key success factors). By the time you have completed this chapter you will be able to: l Appreciate the role of a firm’s resources and capabilities as a basis for formulating strategy. l Identify and appraise the resources and capabilities of a firm. l Evaluate the potential for a firm’s resources and capabilities to confer sustainable competitive advantage. l Use the results of resource and capability analysis to formulate strategies that exploit internal strengths while defending against internal weaknesses. l Identify the means through which a firm can develop its resources and capabilities. We begin by explaining why a company’s resources and capabilities are so important to its strategy.
- 3. CSAC05 1/13/07 9:21 Page 125 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 125 The Role of Resources and Capabilities in Strategy Formulation Strategy is concerned with matching a firm’s resources and capabilities to the oppor- tunities that arise in the external environment. So far, the emphasis of the book has been the identification of profit opportunities in the external environment of the firm. With this chapter, our emphasis shifts from the interface between strategy and the external environment towards the interface between strategy and the internal envir- onment of the firm – more specifically, with the resources and capabilities of the firm (see Figure 5.1). Increasing emphasis on the role of resources and capabilities as the basis for strat- egy is the result of two factors. First, as firms’ industry environments have become more unstable, so internal resources and capabilities rather than external market focus has been viewed as a securer base for formulating strategy. Second, it has become in- creasingly apparent that competitive advantage rather than industry attractiveness is the primary source of superior profitability. Let us consider each of these factors. Basing Strategy on Resources and Capabilities During the 1990s, ideas concerning the role of resources and capabilities as the prin- cipal basis for firm strategy and the primary source of profitability coalesced into what has become known as the resource-based view of the firm.1 To understand why the resource-based view has had a major impact on strategy thinking, let us go back to the starting point for strategy formulation: typically some statement of the firm’s identity and purpose (often expressed in a mission statement). Conventionally, firms have answered the question “what is our business?” in terms of the market they serve: “who are our customers?” and “which of their needs are we seeking to serve?” However, in a world where customer preferences are volatile and the identity of customers and the technologies for serving them are changing, a market-focused strategy may not provide the stability and constancy of direction needed to guide strategy over the long term.2 When the external environment is in a FIGURE 5.1 Analyzing resources and capabilities: the interface between strategy and the firm THE FIRM THE INDUSTRY l ENVIRONMENT Goals and Values l Resources and l Competitors STRATEGY Capabilities l Customers l Structure and Systems l Suppliers The The Firm–Strategy Environment–Strategy Interface Interface
- 4. CSAC05 1/13/07 9:21 Page 126 126 PART II THE TOOLS OF STRATEGY ANALYSIS FIGURE 5.2 Honda Motor Company: product development milestones Honda First gasoline- Technical Competes in 4-cylinder powered car Civic Hybrid Research Isle of Man TT 750cc to meet US (dual gasoline/ Institute motorcycle motorcycle Low Emission electric) founded races Vehicle Standard Portable Civic GS generator Power products: (natural Honda wins ground tillers, marine gas Indy First engines, generators, powered) Championship motorcycle: 405cc pumps, chainsaws, 98cc, 2-cycle motor- snowblowers Dream D cycle 1946 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2006 The 50cc N360 mini Acura Car Home co- Begins Supercub car division generation production of system diesel engines 4-cycle Honda Enters Indy engine Civic car racing First product: Enters Formula 1 1000cc Model A Grand Prix racing Gold Wing clip-on engine touring for bicycles motorcycle state of flux, the firm itself, in terms of its bundle of resources and capabilities, may be a much more stable basis on which to define its identity.3 In their 1990 landmark paper, “The Core Competence of the Corporation,” C. K. Prahalad and Gary Hamel painted to the potential for capabilities to be the “roots of competitiveness,” source of new products, and foundation for strategy.4 For example: l Honda Motor Company is the world’s biggest motorcycle producer and a lead supplier of automobiles. But it has never defined itself either as a motorcycle company or a motor vehicle company. Since its founding in 1948, its strategy has been built around its expertise in the development and manufacture of engines; this capability has successfully carried it from motorcycles to a wide range of gasoline-engined products (see Figure 5.2). l Canon Inc. had its first success producing 35 mm cameras. Since then it has gone on to develop fax machines, calculators, copy machines, printers, video cameras, camcorders, semiconductor manufacturing equipment, and many other products. Almost all Canon’s products involve the application of three areas of technological capability: precision mechanics, microelectronics, and fine optics.
- 5. CSAC05 1/13/07 9:21 Page 127 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 127 FIGURE 5.3 The evolution of capabilities and products: 3M Sandpaper Road signs and Videotape Carborundum markings mining Floppy disks and Scotchtape Audio tape data storage products Acetate Post-it notes film Housewares/kitchen PRODUCTS products Surgical tapes and dressings Pharmaceuticals Materials sciences Flexible Health sciences circuitry CAPABILITIES Microreplication New product Thin-film Abrasives Adhesives development technologies and introduction l 3M Corporation has expanded from sandpaper, into adhesive tapes, audiotapes and videotapes, road signs, medical products, and floppy disks. Its product list comprises over 30,000 separate products. Is it a conglomerate? Certainly not, claims 3M. Its vast product range rests on a foundation of key technologies relating to adhesives and thin-film coatings, and its remarkable ability to manage the development and marketing of new products (see Figure 5.3). In general, the greater the rate of change in a firm’s external environment, the more likely it is that internal resources and capabilities will provide a secure foundation for long-term strategy. In fast-moving, technology-based industries, new companies are built around specific technological capabilities. The markets where these capabilities are applied are a secondary consideration. Motorola, the Texas-based supplier of wire- less telecommunications equipment, semiconductors, and direct satellite communica- tions, has undergone many transformations, from being a leading provider of TVs and car radios to its current focus on telecom equipment. Yet, underlying these trans- formations has been a consistent focus on wireless electronics. When a company faces the imminent obsolescence of its core product, should its strategy focus on continuing to serve fundamental customer needs or on deploying its resources and capabilities in other markets? l When Olivetti, the Italian typewriter manufacturer, faced the displacement of typewriters by microcomputers during the 1980s, it sought to maintain its
- 6. CSAC05 1/13/07 9:21 Page 128 128 PART II THE TOOLS OF STRATEGY ANALYSIS focus on serving the word processing needs of businesses by expanding into PCs. The venture was a costly failure.5 By contrast, Remington, another leading typewriter manufacturer, moved into products that required similar technical and manufacturing skills: electric shavers and other personal care appliances.6 l Eastman Kodak’s dominance of the world market for photographic products based on chemical imaging has been threatened by digital imaging. Over the past 25 years, Kodak has invested billions of dollars developing digital technologies and digital imaging products. Yet profits and market leadership in digital imaging remain elusive for Kodak. Might Kodak have been better off sticking with its chemical know-how and developing its interests in specialty chemicals, pharmaceuticals, and healthcare?7 The difficulties experienced by established firms in adjusting to technological change within their own markets are well documented – in typesetting and in disk- drive manufacturing, successive technological waves have caused market leaders to falter and allowed new entrants to prosper.8 Resources and Capabilities as Sources of Profit In Chapter 1, we identified two major sources of superior profitability: industry attractiveness and competitive advantage. Of these, competitive advantage is the more important. Internationalization and deregulation have increased competitive pressure within most sectors; as a result, few industries (or segments) offer cozy refuges from vigorous competition. As we observed in the previous chapter (see Table 4.1), indus- try factors account for only a small proportion of interfirm profit differentials. Hence, establishing competitive advantage through the development and deployment of re- sources and capabilities, rather than seeking shelter from the storm of competition, has become the primary goal for strategy. The distinction between industry attractiveness and competitive advantage (based on superior resources) as sources of a firm’s profitability corresponds to economists’ distinction between different types of profit (or rent). The profits arising from mar- ket power are referred to as monopoly rents; those arising from superior resources are Ricardian rents, after the 19th-century British economist David Ricardo. Ricardo showed that, even when the market for wheat was competitive, fertile land would yield high returns. Ricardian rent is the return earned by a scare resource over and above the cost of bringing it into production.9 In practice, distinguishing between profit arising from market power and profit arising from resource superiority is less clear in practice than in principle. A closer look at Porter’s five forces framework suggests that industry attractiveness derives ulti- mately from the ownership of resources. Barriers to entry, for example, are the result of patents, brands, distribution channels, learning, or some other resource possessed by incumbent firms. Similarly, the lack of rivalry resulting from the dominance of a single firm (monopoly) or a few firms (oligopoly) is usually based on the concentrated ownership of key resources such as technology, manufacturing facilities, or distribu- tion facilities. The resource-based approach has profound implications for companies’ strategy formulation. When the primary concern of strategy was industry selection and posi- tioning, companies tended to adopt similar strategies. The resource-based view, by
- 7. CSAC05 1/13/07 9:21 Page 129 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 129 contrast, emphasizes the uniqueness of each company and suggests that the key to profitability is not through doing the same as other firms, but rather through exploiting differences. Establishing competitive advantage involves formulating and implementing a strategy that exploits the uniqueness of a firm’s portfolio of resources and capabilities. The remainder of this chapter outlines a resource-based approach to strategy formulation. Fundamental to this approach is recognizing that a firm must seek a thorough and profound understanding of its resources and capabilities. Such under- standing provides a basis for: 1 Selecting a strategy that exploits an organization’s key strengths. Mariah Carey’s disastrous 2001–2 was the result of her straying from her core competences (see Strategy Capsule 5.1). Walt Disney’s turnaround under Michael Eisner’s leadership was the result of exploiting its underlying resources more effectively (see Strategy Capsule 5.2). 2 Developing the firm’s resources and capabilities. Resource analysis is not just about deploying existing resources, it is also concerned with filling resource gaps and building capability for the future. Toyota, Microsoft, Johnson & Johnson, and British Petroleum are all companies whose long-term success STRATEGY CAPSULE 5.1 Focusing Strategy around Core Capabilities: Lyor Cohen on Mariah Carey 2001 was a disastrous year for Mariah Carey. “I said to her, what’s your competitive Her first movie, Glitter, was a flop, the sound- advantage? A great voice, of course. And track was Carey’s most poorly received album what else? You write every one of your in a decade, her $80 million recording contract songs – you’re a great writer. So why did was dropped by EMI, and she suffered a you stray from your competitive advantage? nervous breakdown. If you have this magnificent voice and you Lyor Cohen, the aggressive, workaholic chief write such compelling songs, why are you executive of Island Def Jam records was quick dressing like that, why are you using all to spot an opportunity: these collaborations [with other artists and other songwriters]? Why? It’s like driving a “I cold-called her on the day of her release Ferrari in first – you won’t see what that from EMI and I said, I think you are an Ferrari will do until you get into sixth gear.” unbelievable artist and you should hold your head up high,” says Cohen. “What I Cohen signed Carey in May 2002. Under said stuck on her and she ended up Universal Music’s Island Def Jam Records, Carey signing with us.” returned to her core strengths: her versatile voice, song-writing talents, and ballad style. His strategic analysis of Carey’s situation was Her new album, The Emancipation of Mimi, concise: was the biggest-selling album of 2005, and in 2006 she won a Grammy award.
- 8. CSAC05 1/13/07 9:21 Page 130 130 PART II THE TOOLS OF STRATEGY ANALYSIS STRATEGY CAPSULE 5.2 Resource Utilization: Revival at Walt Disney In 1984, Michael Eisner became CEO of the admission charges. Encouraged by the success Walt Disney Company. Between 1984 and of Tokyo Disneyland, Disney embarked on 1988, Disney’s sales revenue increased from further international duplication of its US $1.66 billion to $3.75 billion, net income from theme parks with Euro Disneyland just out- $98 million to $570 million, and the stock side Paris, France. A chain of Disney Stores market’s valuation of the company from $1.8 was established to push sales of Disney billion to $10.3 billion. merchandise. The key to the Disney turnaround was the The most ambitious feature of the mobilization of Disney’s considerable resource turnaround was Disney’s regeneration as a base. Prominent among Disney’s underutilized movie studio. Eisner began a massive expan- resources were 28,000 acres of land in Florida. sion of its Touchstone label, which had been With the help of the Arvida Corporation, a land established in 1983 with the objectives of development company acquired in 1984, Dis- putting Disney’s film studios to fuller use and ney began hotel, resort, and residential devel- establishing the company in the teenage and opment of these landholdings. New attractions adult markets. Disney Studios doubled the were added to the Epcot Center, and a new number of movies in production. In 1988, it theme park, the Disney-MGM Studio Tour, was became America’s leading studio in terms built. Disney World expanded beyond theme of box office receipts. Studio production parks into resort vacations, the convention was further boosted by Disney’s increasing TV business, and residential housing. presence, both through the Disney Channel To exploit its huge film library, Disney intro- and programs for network TV. duced videocassette sales of Disney movies Above all, the new management team was and licensed packages of movies to TV net- exploiting Disney’s most powerful and endur- works. The huge investments in the Disney ing asset: the affection of millions of people of theme parks were more effectively exploited different nations and different generations for through heavier marketing effort and increased the Disney name and the Disney characters. owes much to their commitment to nurturing talent, developing technologies, and building capabilities that allow adaptability to their changing business environments. Our starting point is to identify and assess the resources and capabilities available to the firm. The Resources of the Firm It is important to distinguish between the resources and the capabilities of the firm: resources are the productive assets owned by the firm; capabilities are what the firm
- 9. CSAC05 1/13/07 9:21 Page 131 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 131 FIGURE 5.4 The links among resources, capabilities, and competitive advantage INDUSTRY KEY COMPETITIVE SUCCESS FACTORS STRATEGY ADVANTAGE ORGANIZATIONAL CAPABILITIES RESOURCES TANGIBLE INTANGIBLE HUMAN l Financial (cash, l Technology l Skills/know-how securities, borrowing (patents, copyrights, l Capacity for capacity) trade secrets) communication l Physical (plant, l Reputation (brands, and collaboration equipment, land, relationships) l Motivation mineral reserves) l Culture can do. Individual resources do not confer competitive advantage, they must work together to create organizational capability. It is capability that is the essence of superior performance. Figure 5.4 shows the relationship among resources, capabili- ties, and competitive advantage. Drawing up an inventory of a firm’s resources can be surprisingly difficult. No such document exists within the accounting or management information systems of most corporations. The corporate balance sheet provides a limited view of a firm’s resources – it comprises mainly financial and physical resources. To take a wider view of a firm’s resources it is helpful to identify three principal types of resource: tangible, intan- gible, and human resources. Tangible Resources Tangible resources are the easiest to identify and evaluate: financial resources and physical assets are identified and valued in the firm’s financial statements. Yet, balance sheets are renowned for their propensity to obscure strategically relevant informa- tion, and to under- or overvalue assets. Historic cost valuation can provide little indication of an asset’s market value. Disney’s movie library had a balance sheet value of $4.6 billion in 2005, based on production cost less amortization. Its land assets (including its 28,000 acres in Florida) were valued at a paltry $1.1 billion. However, the primary goal of resource analysis is not to value a company’s assets, but to understand their potential for creating competitive advantage. Information that British Airways possesses tangible fixed assets with a book value of £8.2 billion is of little use in assessing their strategic value. To assess British Airways’ ability to compete effectively in the world airline industry we need to know about the composition of these assets, the location of land and buildings, the types of plane and their age, and so on.
- 10. CSAC05 1/13/07 9:21 Page 132 132 PART II THE TOOLS OF STRATEGY ANALYSIS Once we have fuller information on a company’s tangible resources we explore how we can create additional value from them. This requires that we address two key questions: 1 What opportunities exist for economizing on their use? It may be possible to use fewer resources to support the same level of business, or to use the existing resources to support a larger volume of business. In the case of British Airways, there may be opportunities for consolidating administrative offices and engineering and service facilities. Improved inventory control may allow economies in inventories of parts and fuel. Better control of cash and receivables permits a business to operate with lower levels of cash and liquid financial resources. 2 What are the possibilities for employing existing assets more profitably? Could British Airways generate better returns on some of its planes by redeploying them into cargo carrying? Should BA seek to redeploy its assets from Europe and the North Atlantic to Asia-Pacific? Might it reduce costs in its European network by reassigning routes to small franchised airlines (such as 93 Airways and Loganair)? Intangible Resources For most companies, intangible resources are more valuable than tangible resources. Yet, in company financial statements, intangible resources remain largely invisible – particularly in the US where R&D is expensed. The exclusion or undervaluation of intangible resources is a major reason for the large and growing divergence between companies’ balance sheet valuations (“book values”) and their stock market valu- ations (see Table 5.1). Among the most important of these undervalued or unvalued intangible resources are brand names. Table 5.2 shows companies owning brands valued at $15 billion or more. Brand names and other trademarks are a form of reputational asset: their value is in the confidence they instill in customers. This value is reflected in the price premium that customers are willing to pay for the branded product over that for an unbranded or unknown brand. Brand value (or “brand equity”) can be estimated by taking the price premium attributable to a brand, multiplying it by the brand’s annual sales vol- ume, then calculating the present value of this revenue stream. The brand valuations in Table 5.2 involve estimating the operating profits for each brand (after taxation and a capital charge), estimating the proportion of net operating income attributable to the brand, then capitalizing these returns. The value of a company’s brands can be increased by extending the product/market scope over which the company markets those brands. Philip Morris is an expert at internationalizing its brand franchises. Harley-Davidson’s brand strength has not only permitted the company to obtain a price premium of about 40% above that of comparable motorcycles, but also to license its name to the manufacturers of clothing, coffee mugs, cigarettes, and restaurants. Reputation may be attached to a company as well as to its brands. Companies depend on the support from employees, customers, investors, and governments.10 Harris Interactive shows Johnson & Johnson followed by Coca-Cola, Google, UPS, and 3M to have the highest “reputation quotients.”11 Like reputation, technology is an intangible asset whose value is not evident from most companies’ balance sheets. Intellectual property – patents, copyrights, trade
- 11. CSAC05 1/13/07 9:21 Page 133 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 133 TABLE 5.1 Major companies with the Highest Market-to-Book Ratios, December 2005 Valuation Valuation Company ratio Country Company ratio Country Yahoo! Japan 72.0 Japan Coca-Cola 7.8 US Colgate-Palmolive 20.8 US Diageo 7.4 UK GlaxoSmithKline 13.4 UK 3M 7.3 US Anheuser-Busch 12.6 US Nokia 6.7 Finland eBay 11.2 US Sanofi-Aventis 6.3 France SAP 10.8 Germany AstraZeneca 5.9 UK Yahoo! 10.7 US Johnson & Johnson 5.7 US Dell Computer 10.0 US Boeing 5.7 US Sumitomo Mitsui Financial 8.8 Japan Eli Lily 5.6 US Procter & Gamble 8.4 US Cisco Systems 5.5 US Qualcomm 8.3 US Roche Holding 5.5 Switz. Schlumberger 8.2 US L’Oreal 5.3 France Unilever 8.1 Neth./UK Altria 5.2 US PepsiCo 8.0 US Novartis 5.1 Switz. Note: The table includes companies with the highest market capitalization as a proportion of balnce sheet net asset value among the top 200 companies of the world with the largest market capitalization at the end of 2005. secrets, and trademarks – comprise technological and artistic resources where own- ership is defined in law. Over the past 20 years, companies have become more atten- tive to the value of their intellectual property. Texas Instruments was one of the first companies to begin managing its patent portfolio in order to maximize its licensing revenues. For some companies, their ownership of intellectual property is a key source of their market value. For example, Qualcomm’s patents relating to CDMA digital wireless telephony make it one of the most valuable companies in the telecom sector, while IBM’s position as the world’s biggest patent holder results in a royalty stream of over $1.2 billion a year. Human Resources The human resources of the firm are the expertise and effort offered by its employees. Human resources do not appear on corporate balance sheets for the simple reason that people are not owned: they offer their services under employment contracts. Identify- ing and appraising the stock of human resources within a firm is complex and difficult. Human resources are appraised at the time of recruitment and throughout the period of employment, e.g. through annual performance reviews. Companies are continually seeking more effective methods to assess the perform- ance and potential of their employees. Over the past decade, human resource appraisal has become far more systematic and sophisticated. Organizations are relying less on formal qualifications and years of experience and more on attitude, motivation, learning capacity, and potential for collaboration. Competency modeling
- 12. CSAC05 1/13/07 9:21 Page 134 134 PART II THE TOOLS OF STRATEGY ANALYSIS TABLE 5.2 The World’s Most Valuable Brands, 2006 Brand value Change Country Rank Brand in 2006, $ billion from 2004 of origin 1 Coca-Cola 67.5 0% USA 2 Microsoft 59.9 −2% USA 3 IBM 53.4 −1% USA 4 GE 47.0 +7% USA 5 Intel 35.6 +6% USA 6 Nokia 26.5 +10% Finland 7 Disney 26.4 −2% USA 8 McDonald’s 26.0 +4% USA 9 Toyota 24.8 +10% Japan 10 Marlboro 21.2 −4% USA 11 Mercedes Benz 20.0 −6% Germany 12 Citi 20.0 0% USA 13 Hewlett-Packard 18.9 −10% USA 14 American Express 18.6 +5% USA 15 Gillette 17.5 +5% USA 16 BMW 17.1 +8% Germany 17 Cisco 16.6 +4% USA 18 Louis Vuitton 16.1 n.a. France 19 Honda 15.8 +6% Japan SOURCE: INTERBRAND. 20 Samsung 15.0 19% S. Korea Note: Brand values are calculated as the net present value of future earnings generated by the brand. involves identifying the set of skills, content knowledge, attitudes, and values associated with superior performers within a particular job category, then assessing each employee against that profile.12 The results of such competency assessments can then be used to identify training needs, make selections for hiring or promotion, and determine compensation. A key outcome of systematic assessment has been recog- nition of the importance of psychological and social aptitudes in linking technical and professional abilities to overall job performance. Recent interest in emotional intelli- gence reflects growing recognition of the importance of social and emotional skills and values.13 The ability of employees to harmonize their efforts and integrate their separate skills depends not only on their interpersonal skills but also the organizational con- text. This organizational context as it affects internal collaboration is determined by a key intangible resource: the culture of the organization. The term organizational culture is notoriously ill defined. It relates to an organization’s values, traditions, and social norms. Building on the observations of Peters and Waterman that “firms with sustained superior financial performance typically are characterized by a strong set of core managerial values that define the ways they conduct business,” Jay Barney identifies organizational culture as a firm resource of great strategic importance that is potentially very valuable.14
- 13. CSAC05 1/13/07 9:21 Page 135 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 135 Organizational Capabilities Resources are not productive on their own. A brain surgeon is close to useless with- out a radiologist, anesthetist, nurses, surgical instruments, imaging equipment, and a host of other resources. To perform a task, a team of resources must work together. An organizational capability is a “firm’s capacity to deploy resources for a desired end result.”15 Just as an individual may be capable of playing the violin, ice skating, and speaking Mandarin, so an organization may possess the capabilities needed to manufacture widgets, distribute them throughout Latin America, and hedge the resulting foreign exchange exposure. We use the terms capability and competence interchangeably.16 Our primary interest is in those capabilities that can provide a basis for competi- tive advantage. Selznick used distinctive competence to describe those things that an organization does particularly well relative to its competitors.17 Prahalad and Hamel coined the term core competences to distinguish those capabilities fundamental to a firm’s strategy and performance.18 Core competences, according to Hamel and Prahalad, are those that: l Make a disproportionate contribution to ultimate customer value, or to the efficiency with which that value is delivered, and l Provide a basis for entering new markets.19 Prahalad and Hamel criticize US companies for emphasizing product management over competence management. They compare the strategic development of Sony and RCA in consumer electronics. Both companies were failures in the home video mar- ket. RCA introduced its videodisk system, Sony its Betamax videotape system. For RCA, the failure of its first product marked the end of its venture into home video systems and heralded a progressive retreat from the consumer electronics industry. RCA was acquired by GE, which then sold off the combined consumer electronics division to Thomson of France. Sony, on the other hand, acknowledged the failure of Betamax, but continued to develop its capabilities in video technology. This continuous development and upgrading of its video capabilities resulted in a string of successful video products from camcorders and digital cameras to the PlayStation game console. Classifying Capabilities To identify a firm’s capabilities, we need to have some basis for classifying and dis- aggregating its activities. Two approaches are commonly used: 1 A functional analysis identifies organizational capabilities in relation to each of the principal functional areas of the firm. Table 5.3 classifies the principal functions of the firm and identifies organizational capabilities pertaining to each function. 2 A value chain analysis separates the activities of the firm into a sequential chain. Michael Porter’s representation of the value chain distinguishes between primary activities (those involved with the transformation of inputs and interface with the customer) and support activities (see Figure 5.5). Porter’s generic value chain identifies a few broadly defined activities that can be disaggregated to provide a more detailed identification of the firm’s
- 14. CSAC05 1/13/07 9:21 Page 136 136 PART II THE TOOLS OF STRATEGY ANALYSIS TABLE 5.3 A Functional Classification of Organizational Capabilities Functional area Capability Exemplars CORPORATE l Financial control Exxon Mobil, PepsiCo FUNCTIONS l Strategic management of multiple businesses General Electric, Procter & Gamble l Strategic innovation BP, Google l Multidivisional coordination Unilever, Shell l Acquisition management Cisco, Bank of America l International management Shell, Citigroup MANAGEMENT l Comprehensive, integrated MIS network Wal-Mart, Capital One, Dell Computer INFORMATION linked to managerial decision making RESEARCH & l Research IBM, Merck DEVELOPMENT l Innovative new product development 3M, Apple l Fast-cycle new product development Canon, Inditex (Zara) OPERATIONS l Efficiency in volume manufacturing Briggs & Stratton, YKK l Continuous improvements in operations Toyota, Harley-Davidson l Flexibility and speed of response Four Seasons Hotels PRODUCT DESIGN l Design capability Nokia, Apple Computer MARKETING l Brand management P&G, Altria l Promoting reputation for quality Johnson & Johnson l Responsiveness to market trends MTV, L’Oreal SALES AND l Effective sales promotion and execution PepsiCo, Pfizer DISTRIBUTION l Efficiency and speed of order processing L. L. Bean, Dell Computer l Speed of distribution Amazon.com l Quality and effectiveness of customer service Singapore Airlines, Caterpillar FIGURE 5.5 Porter’s value chain FIRM INFRASTRUCTURE SUPPORT ACTIVITIES HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT PROCUREMENT INBOUND OPERATIONS OUTBOUND MARKETING SERVICE LOGISTICS LOGISTICS AND SALES PRIMARY ACTIVITIES
- 15. CSAC05 1/13/07 9:21 Page 137 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 137 activities (and the capabilities that correspond to each activity). Thus, marketing might include market research, test marketing, advertising, promotion, pricing, and dealer relations.20 The Architecture of Capability Why is 3M so good at developing new products for a variety of home, office, and medical needs? How is Wal-Mart able to combine relentless cost focus and high levels of flexibility and adaptability? Why is Toyota so superior to either Ford or GM in developing new models of car and launching them globally? We can guess, but the fact remains: we don’t really know how organizational capabilities are created or why one company performs a capability more effectively than another. To begin to understand organizational capabilities, let us look at their structure. Capability as Routine Organizational capability requires the expertise of various individuals to be integrated with capital equipment, technology, and other resources. But how does this integration occur? Virtually all productive activities involve teams of people undertaking closely coordinated actions – typically without detailed direc- tion. Richard Nelson and Sidney Winter have used the term organizational routines to refer to these regular and predictable patterns of activity made up of a sequence of coordinated actions by individuals.21 Such routines form the basis of most organiza- tional capabilities. At the manufacturing level, a series of routines governs the passage of raw materials and components through the production process to the factory gate. Sales, ordering, distribution, and customer service activities are similarly organized through a number of standardized, complementary routines. Even top management functions comprise routines for monitoring business unit performance, capital bud- geting, and strategic planning. Like individual skills, organizational routines develop through learning-by-doing. Just as individual skills become rusty when not exercised, so it is difficult for organiza- tions to retain coordinated responses to contingencies that arise only rarely. Hence, there may be a tradeoff between efficiency and flexibility. A limited repertoire of routines can be performed highly efficiently with near-perfect coordination. The same organization may find it extremely difficult to respond to novel situations.22 Routinization is an essential step in translating directions and operating practices into capabilities. In every McDonald’s hamburger restaurant, operating manuals pro- vide precise directions for the conduct of every activity undertaken, from the placing of the pickle on the burger to the maintenance of the milk-shake machine. In practice, the operating manuals are seldom referred to in the course of day-to-day operations – through continuous repetition, tasks become routinized. The Hierarchy of Capabilities Whether we examine capabilities from a func- tional or value chain approach, it is evident that broad functions or value chain activities can be disaggregated into more specialist capabilities performed by smaller teams of resources. What we observe is a hierarchy of capabilities where more gen- eral, broadly defined capabilities are formed from the integration of more specialized capabilities. For example: l A hospital’s capability in treating heart disease depends on its integration of capabilities pertaining to a patient’s diagnosis, physical medicine,
- 16. CSAC05 1/13/07 9:21 Page 138 138 PART II THE TOOLS OF STRATEGY ANALYSIS cardiovascular surgery, pre- and post-operative care, as well as capabilities relating to various administrative and support functions. l Toyota’s manufacturing capability – its system of “lean production” – integrates capabilities relating to the manufacture of components and subassemblies, supply-chain management, production scheduling, assembly, quality control procedures, systems for managing innovation and continuous improvement, and inventory control. Figure 5.6 offers a partial view of the hierarchy of capabilities of a telecom equip- ment maker. At the highest level of integration are those capabilities which integrate across multiple functions. New product development draws upon a broad range of functional capabilities – which is why it is so difficult to manage. One solution to the problems of integrating functional know-how into new product development is the creation of cross-functional product development teams. The use of such product development teams (led by a “heavyweight” team leader) by Toyota, Nissan, and FIGURE 5.6 The hierarchical nature of capabilities: a manufacturer of PBXs CROSS- New product Customer Quality FUNCTIONAL development support management CAPABILITIES capability capability capability Human BROAD R&D and Marketing Operations MIS resource FUNCTIONAL design and sales capability capability management CAPABILITIES capability capability capability ACTIVITY- Materials Process Product Test Manufacturing RELATED management engineering engineering engineering capability CAPABILITIES capability capability capability capability (Operations related only) SPECIALIZED Printed Telset System CAPABILITIES circuit-board assembly assembly (Manufacturing assembly related only) SINGLE-TASK Automated Manual Surface CAPABILITIES through-hole Wave insertion of mounting of (Only those component soldering components components related to PCB insertion assembly) INDIVIDUALS’ SPECIALIZED KNOWLEDGE
- 17. CSAC05 1/13/07 9:21 Page 139 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 139 Honda has been a key reason for these firms’ fast-cycle new product development compared with US and European car companies.23 Appraising Resources and Capabilities So far, we have established what resources and capabilities are, how they can provide a long-term focus for a company’s strategy, and how we can go about identifying them. However, if the focus of this book is the pursuit of profit, we also need to appraise the potential for resources and capabilities to earn profits for the company. The profits that a firm obtains from its resources and capabilities depend on three factors: their abilities to establish a competitive advantage, to sustain that competitive advantage, and to appropriate the returns to that competitive advantage. Each of these depends on a number of resource characteristics. Figure 5.7 shows the key relationships. Establishing Competitive Advantage For a resource or capability to establish a competitive advantage, two conditions must be present: 1 Scarcity. If a resource or capability is widely available within the industry, then it may be essential to compete, but it will not be a sufficient basis for competitive advantage. In oil and gas exploration, new technologies such as directional drilling and 3-D seismic analysis are critical to reducing the costs FIGURE 5.7 Appraising the strategic importance of resources and capabilities THE EXTENT OF Scarcity THE COMPETITIVE ADVANTAGE ESTABLISHED Relevance Durability THE PROFIT-EARNING SUSTAINABILITY OF POTENTIAL THE COMPETITIVE Transferability OF A RESOURCE OR ADVANTAGE CAPABILITY Replicability Property rights Relative APPROPRIABILITY bargaining power Embeddedness
- 18. CSAC05 1/13/07 9:21 Page 140 140 PART II THE TOOLS OF STRATEGY ANALYSIS of finding new reserves. However, these technologies are widely available from oilfield service and IT companies. As a result, such technologies are “needed to play,” but they are not sufficient to win. 2 Relevance. A resource or capability must be relevant to the key success factors in the market. British coal mines produced some wonderful brass bands. Unfortunately, musical capabilities did little to assist the mines in meeting competition from cheap imported coal and North Sea gas. As retail banking shifts toward automated teller machines and online transactions, so the retail branch networks of the banks have become less relevant for customer service. Sustaining Competitive Advantage The profits earned from resources and capabilities depend not just on their ability to establish competitive advantage, but also on how long that advantage can be sustained. This depends on whether resources and capabilities are durable and whether rivals can imitate the competitive advantage they offer. Resources and capabilities are imitable if they are transferable or replicable. Durability Some resources are more durable than others and, hence, are a more secure basis for competitive advantage. The increasing pace of technological change is shortening the useful life span of most resources including capital equipment and proprietary technologies. Brands, on the other hand, can show remarkable resilience to time. Heinz sauces, Kellogg’s’ cereals, Campbell’s soup, Hoover vacuum cleaners, and Coca-Cola have been market leaders for over a century. Transferability The simplest means of acquiring the resources and capabilities necessary for imitating another firm’s strategy is to buy them. The ability to buy a resource or capability depends on its transferability – the extent to which it is mobile between companies. Some resources, such as finance, raw materials, components, machines produced by equipment suppliers, and employees with standardized skills (such as short-order cooks and auditors), are transferable and can be bought and sold with little difficulty. Some resources are not easily transferred – either they are entirely firm specific, or their value depreciates on transfer.24 Sources of immobility include: l Geographical immobility of natural resources, large items of capital equipment, and some types of employees may make it difficult for firms to acquire these resources without relocating themselves. l Imperfect information regarding the quality and productivity of resources creates risks for buyers. Such imperfections are especially important in relation to human resources – hiring decisions are typically based on very little knowledge of how the new employee will perform. Sellers of resources have better information about the characteristics of the resources on offer than potential buyers – this creates a “lemons problem” for firms seeking to acquire resources.25 Jay Barney has shown that different valuations of resources by firms can result in their being either underpriced or overpriced, giving rise to differences in profitability between firms.26 l Complementarity between resources means that the detachment of a resource from its “home team” causes it to lose productivity and value. Thus, if brand
- 19. CSAC05 1/13/07 9:21 Page 141 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 141 reputation is associated with the company that created it, a change in ownership of the brand erodes its value. The transfer of the Thinkpad brand of notebook computers from IBM to Lenovo almost certainly eroded its value.27 l Organizational capabilities, because they are based on teams of resources, are less mobile than individual resources. Even if the whole team can be transferred (in investment banking it has been commonplace for whole teams of analysts or M&A specialists to defect from one bank to another), the dependence of the team on a wider network of relationships and corporate culture may pose difficulties for recreating the capability in the new company. Replicability If a firm cannot buy a resource or capability, it must build it. In finan- cial services, most innovations in new derivative products can be imitated easily by competitors. In retailing too, competitive advantages that derive from store layout, point-of-sale technology, charge cards, and extended opening hours can also be copied easily by competitors. Less easily replicable are capabilities based on complex organizational routines. Federal Express’s national, next-day delivery service and Nucor’s system for steel manufacturing that combines efficiency with flexibility are complex capabilities based on unique corporate cultures. Some capabilities appear simple but prove difficult to replicate. Just-in-time scheduling and quality circles are relatively simple techniques used effectively by Japanese companies. Although neither require advanced manu- facturing technologies or sophisticated information systems, their dependence on high levels of collaboration through communication and trust meant that many American and European firms had difficulty implementing them. Even where replication is possible, incumbent firms may benefit from the fact that resources and capabilities that have been accumulated over a long period can only be replicated at disproportionate cost by would-be imitators. Dierickx and Cool identify two major sources of incumbency advantage: l Asset mass efficiencies occur where a strong initial position in technology, distribution channels, or reputation facilitates the subsequent accumulation of these resources. l Time compression diseconomies are the additional costs incurred by imitators when attempting to accumulate rapidly a resource or capability. Thus, “crash programs” of R&D and “blitz” advertising campaigns tend to be less productive than similar expenditures made over a longer period.28 Appropriating the Returns to Competitive Advantage Who gains the returns generated by superior capabilities? We should normally expect that such returns accrue to the owner of that capability. However, ownership is not always clear-cut: capabilities depend heavily on the skills and efforts of employees – who are not owned by the firm. For companies dependent on human ingenuity and know-how, the mobility of key employees represents a constant threat to their com- petitive advantage (see Strategy Capsule 5.3). In investment banks and other human capital-intensive firms, the struggle between employees and shareholders to appro- priate rents is reminiscent of the war for surplus value between labor and capital that
- 20. CSAC05 1/13/07 9:21 Page 142 142 PART II THE TOOLS OF STRATEGY ANALYSIS STRATEGY CAPSULE 5.3 When Your Competitive Advantage Walks Out the Door: Gucci On September 10, 2001, French retailer Pinault How great a blow was De Sole and Ford’s Printemps Redoute (PPR) agreed to acquire departure to the parent PPR? In principle, a Gucci Group – the Italian-based fashion house new CEO and new head of design could be and luxury goods maker. On November 4, 2003 hired. In practice, talent of the ilk of De Sole the managers and shareholders of the two and Ford was a rare commodity. Especially rare companies were stunned to learn that Chair- was the combination of a designer and a CEO man Domenico De Sole and Vice Chairman Tom who could work together with the harmony Ford would be leaving Gucci in April 2004. and shared vision of De Sole and Ford. The duo had masterminded Gucci’s trans- The stock market’s reaction was ominous. formation from a chaotic, near-bankrupt fam- On November 3, 2003 Gucci’s share price was ily firm with an over-licensed brand into a close $86.10; on November 6 it had fallen to $84.60, rival to LVMH – the luxury goods powerhouse. however, in the absence of PPR’s guarantee to As creative director, Tom Ford had established acquire their shares at $85.52, analysts esti- Gucci as the hottest label around, through mated that Gucci would be trading at around fashion shows that were practically rock shows, $74. The implication is that Gucci was worth associations with famous faces, and hiring $1.2 billion less without De Sole and Ford than young designers such as Stella McCartney and with them. Alexander McQueen. De Sole’s astute leader- ship had instituted careful planning and finan- cial discipline, and built Gucci’s global presence Source: Adapted from articles in the Financial Times during (especially in Asia). November 5–8, 2003. Marx analyzed. It is notable that in 2005, average employee pay among Goldman Sachs’ 24,000 staff (including secretaries and janitors) was $520,000.29 The preva- lence of partnerships (rather than joint-stock companies) in professional service industries (lawyers, accountants, and management consultants) reflects the desire to avoid conflict between owners and its human resources. The less clearly defined are property rights in resources and capabilities, the greater the importance of relative bargaining power in determining the division of returns between the firm and its individual members. In the case of team-based organizational capabilities, this balance of power between the firm and an individual employee depends crucially on the relationship between individuals’ skills and organizational routines. The more deeply embedded are individual skills and knowledge within organ- izational routines, and the more they depend on corporate systems and reputation, the weaker the employee is relative to the firm. Conversely, the closer an organizational capability is identified with the expertise of individual employees, and the more effective those employees are at deploying their bargaining power, the better able employees are to appropriate rents. If the
- 21. CSAC05 1/13/07 9:21 Page 143 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 143 individual employee’s contribution to productivity is clearly identifiable, if the em- ployee is mobile, and if the employee’s skills offer similar productivity to other firms, the employee is in a strong position to appropriate most of his or her contribution to the firm’s value added. Does the $27.7 million paid to Shaquille O’Neal fully exploit his value to the Miami Heat? In most professional sports, it appears that strategies based exclusively on signing superstar players result in the players appropriating most of the rents, with little surplus available for the clubs – this was certainly the fate of Real Madrid during 2002–6.30 In recent years investment banks and consulting com- panies have emphasized the team-based nature of their capabilities. In downplaying the role of individual expertise, they can improve their firm’s potential for appropri- ating the returns to their capabilities. Putting Resource and Capability Analysis to Work: A Practical Guide We have covered the principal concepts and frameworks for analyzing resources and capabilities. How do we put this analysis into practice? Let me offer a simple, step-by-step approach to how a company can appraise its resources and capabilities and then use the appraisal to guide strategy formulation. Step 1 Identify the Key Resources and Capabilities To draw up a list of the firm’s resources and capabilities, we can begin from outside or inside the firm. From an external focus, we begin with key success factors (see Chapter 3). What factors determine why some firms in an industry are more success- ful than others and on what resources and capabilities are these success factors based? Suppose we are evaluating the resources and capabilities of Volkswagen AG, the German-based automobile manufacturer. We can start with key success factors in the world automobile industry: low-cost production, attractively designed new models embodying the latest technologies, and the financial strength to weather the cyclical- ity and heavy investment requirements of the industry. What capabilities and resources do these key success factors imply? They would include manufacturing capabilities, new product development capability, effective supply chain management, global dis- tribution, brand strength, scale-efficient plants with up-to-date capital equipment, a strong balance sheet, and so on. To organize and categorize these various resources and capabilities, it is helpful to switch to the inside of VW and look at the company’s value chain, identifying the sequence of activities from new product development to purchasing, to supply chain management, to component manufacture, assembly, and right the way through to dealership support and after-sales service. We can then look at the resources that underpin the capabilities at each stage of the value chain. Table 5.4 lists VW’s principal resources and capabilities. Step 2 Appraising Resources and Capabilities Resources and capabilities need to be appraised against two key criteria. First is their importance: which resources and capabilities are most important in conferring sus- tainable competitive advantage? Second, where are our strengths and weaknesses as compared with competitors?
- 22. CSAC05 1/13/07 9:21 Page 144 144 PART II THE TOOLS OF STRATEGY ANALYSIS Assessing Importance The temptation in assessing which resources and cap- abilities are most important is to concentrate on customer choice criteria. What we must bear in mind, however, is that our ultimate objective is not to attract customers, but to make superior profit through establishing a sustainable competitive advantage. For this purpose we need to look beyond customer choice to the underlying strategic characteristics of resources and capabilities. To do this we need to look at the set of appraisal criteria outlined in the previous section on “Appraising Resources and Capabilities.” In the case of VW many resources and capabilities are essential to com- , pete in the business, but several of them are not scarce (for example, total quality management capability and technologically advanced assembly plants have become widely diffused within the industry), while others (such as IT capability and design capability) are outsourced to external providers – either way, they are “needed to play” but not “needed to win.” On the other hand, resources such as brand strength and a global distribution network, and capabilities such as fast-cycle new product development and global logistics capability, cannot be easily acquired or internally developed – they are critical to establishing and sustaining advantage. Assessing Relative Strengths Objectively appraising the comparative strengths and weaknesses of a company’s resources and capabilities relative to competitors is difficult. In assessing their own competencies, organizations frequently fall victim to past glories, hopes for the future, and their own wishful thinking. The tendency toward hubris among companies – and their senior managers – means that business success often sows the seeds of its own destruction.31 Among the failed industrial com- panies in America and Europe are many whose former success blinded them to their stagnating capabilities and declining competitiveness: examples include the cutlery producers of Sheffield, England and the integrated steel giants of the United States. To identify and appraise a company’s capabilities, managers must look both inside and outside. Internal discussion can be valuable in sharing insights and evidence and building consensus regarding the organization’s resource and capability profile. The evidence of history can be particularly revealing in reviewing instances where the com- pany has performed well and those where it has performed poorly: do any patterns appear? Finally, to move the analysis from the subjective to the objective level, bench- marking is a powerful tool for quantitative assessment of performance relative to that of competitors. Benchmarking is “the process of identifying, understanding, and adapting outstanding practices from organizations anywhere in the world to help your organization improve its performance.”32 Benchmarking offers a systematic frame- work and methodology for identifying particular functions and processes and then for comparing their performance with other companies. Strategy Capsule 5.4 offers some examples. As McKinsey & Co. has shown, performance difference between top- performing and average-performing companies in most activities tends to be wide.33 Ultimately, appraising resources and capabilities is not about data, it’s about insight and understanding. Every organization has some activity where it excels or has the potential to excel. For Federal Express, it is a system that guarantees next-day delivery anywhere within the United States. For BMW it is the ability to integrate world-class engineering with design excellence and highly effective marketing. For McDonald’s, it is the ability to supply millions of hamburgers from thousands of outlets throughout the world, with remarkable uniformity of quality, customer service, and hygiene. For General Electric, it is a system of corporate management that
- 23. CSAC05 1/13/07 9:21 Page 145 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 145 STRATEGY CAPSULE 5.4 Using Benchmarking to Assess Capabilities Benchmarking allows companies, first, to make l At Bank of America, Vice Chairman, Martin objective assessments of their capabilities rela- Sheen, commented, “We have worked a lot tive to competitors and, second, to put into with the Royal Bank of Canada on place programs to imitate other companies’ benchmarking because our sizes and superior capabilities. For example: philosophies are comparable and we’re not direct competitors. We have had some l Xerox Corporation is the pioneer of particularly good exchanges with them on benchmarking. Losing market share during processes. We can also benchmark through the 1980s, logistics engineer Robert Camp the Research Board against an array of performed detailed comparisons that competitors reported in a disguised showed the massive superiority of fashion. What these do is to highlight Japanese competitors in cost efficiency, anomalies. You can’t get down to a unit quality, and new product development cost or systems task level. But if a over American companies. Looking beyond comparable company has 22 people and direct competitors, every department was we have 60, we can sit down and try to encouraged to look globally to identify figure out what’s going on.” best-in-class companies against which to benchmark. For inventory control and The key stages in the benchmarking process customer responsiveness, Xerox are: first, deciding what to benchmark; second, benchmarked L. L. Bean, the direct-mail identifying partners; third, establishing bench- clothing company. marking metrics; fourth, gathering data; and l During the early 1980s, a benchmarking fifth, analysis. study by General Motors discovered that Toyota could make a changeover from one Sources: Robert C. Camp, Benchmarking: The Search for model to another on an automobile Industry Best Practices that Lead to Superior Performance (Milwaukee: Quality Press, 1989); American Productivity & assembly line in eight minutes. The Quality Center, The Benchmarking Management Guide comparable time at GM plants was eight (Cambridge, MA: Productivity Press, 1993); R. S. Kaplan, hours. The result was profound inquiry “Limits to Benchmarking,” Balanced Scorecard Report, November–December, 2005. within GM as to the appropriateness of its manufacturing strategy and the state of its operational capabilities. reconciles coordination, innovation, flexibility, and financial discipline in one of the world’s largest and most diversified corporations. All these companies are examples of highly successful enterprises. One reason why they are successful is that they have recognized what they can do well and have based their strategies on their strengths. For poor-performing companies, the problem is not necessarily an absence of dis- tinctive capabilities, but a failure to recognize what they are and to deploy them effectively.
- 24. CSAC05 1/13/07 9:21 Page 146 146 PART II THE TOOLS OF STRATEGY ANALYSIS TABLE 5.4 Appraising VW’s Resources and Capabilities VW’s relative Importance1 strength2 Comments RESOURCES R1. Finance 6 6 A− credit rating is above average for the industry, but free cash flow remains negative R2. Technology 7 5 Despite technical strengths, VW is not a leader in automotive technology R3. Plant and 8 8 Has invested heavily in upgrading plants equipment R4. Location 4 4 Plants in key low-cost, growth markets (China, Mexico, Brazil), but German manufacturing base is very high cost R5. Distribution 8 5 Geographically extensive distribution with special strength in (dealership emerging markets. Historically weak position within the US network) R6. Brands 6 5 VW, Audi, Bentley, and Bugatti brands are strong – but added to Skoda and Seat too, VW’s brands lack clear marker focus CAPABILITIES C1. Product 9 4 Traditionally weak at VW, with few big hits: Beetle development (introduced 1938), Golf (1974), Passat (1974), Vanagon (1979). Despite major upgrading, product development still weak compared to industry leaders C2. Purchasing 7 5 Traditionally weak – strengthened by senior hires from Opel and elsewhere C3. Engineering 7 9 The core technical strength of VW C4. Manufacturing 8 4 VW is a high-cost producer with below average quality C5. Financial 6 4 Has traditionally lacked a strong financial orientation management C6. R&D 5 4 Despite several technical strengths, VW is not a leader in automotive innovation C7. Marketing 9 4 Despite traditional weakness in recognizing and meeting and sales customer needs in different national markets, VW has increased its sensitivity to the market, improved brand management, and managed its advertising and promotion with increasing dexterity C8. Government 4 8 Important in emerging markets relations C9. Strategic 7 4 Effective restructuring and cost cutting, but lack of management consistency and consensus at top management level 1 Both scales range from 1 to 10 (1 = very low, 10 = very high). 2 VW’s resources and capabilities are compared against those of GM, Ford, Toyota, DaimlerChrysler, Nissan, honda, Fiat, and PSA, where 5 represents parity. The ratings are based on the author’s subjective judgment.
- 25. CSAC05 1/13/07 9:21 Page 147 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 147 FIGURE 5.8 Appraising VW’s resources and capabilities (hypothetical) 10 Superfluous Strengths Key Strengths Relative Strength 5 1 Zone of Irrelevance Key Weaknesses 1 5 10 Strategic Importance Note: The table is based on the ratings of resources and capabilities in Table 5.4. Bringing Together Importance and Relative Strength Putting together the two criteria – importance and relative strength – allows us to highlight a com- pany’s key strengths and key weaknesses. Consider, for example, Volkswagen AG. Table 5.4 provides a partial (and hypothetical) identification and appraisal of VW’s resources and capabilities during the late 1990s in relation to the two criteria of importance and relative strength outlined above. Figure 5.8 then brings the two criteria together into a single display. Dividing this display into four quadrants allows us to identify those resources and capabilities that we may regard as key strengths and those that we may identify as key weaknesses. For example, our assessment suggests that plant and equipment, engineering capability, and supply chain management are key strengths of VW, while distribution (a relatively weak presence in the US and Japan), new product development (no consistent record of fast-cycle development of market-winning new models), and financial management are key weaknesses. Step 3 Developing Strategy Implications Our key focus is on the two right-hand quadrants of Figure 5.8. How do we exploit our key strengths most effectively? What do we do about our key weaknesses in terms of both upgrading them and reducing our vulnerability to them? Finally, what about our “inconsequential” strengths? Are these really superfluous, or are there ways in which we can deploy them to greater effect? Exploiting Key Strengths Having identified resources and capabilities that are important and where our company is strong relative to competitors, the key task is to formulate our strategy to ensure that these resources are deployed to the greatest effect. If engineering is a key strength of VW then it may wish to seek differentiation , advantage through technical sophistication and safety features. If VW is effective in managing government relations and is well positioned in the potential growth
- 26. CSAC05 1/13/07 9:21 Page 148 148 PART II THE TOOLS OF STRATEGY ANALYSIS markets of China, Eastern Europe, and Latin America, exploiting this strength may require developing models that will appeal to these markets. To the extent that different companies within an industry have different capability profiles, this implies differentiation of strategies within the industry. Thus, Toyota’s outstanding manufacturing capabilities and fast-cycle new product development, Hyundai’s low-cost manufacturing capability that derives from its South Korean location, and Peugeot’s design flair suggest that each company should be pursuing a distinctively different strategy. Managing Key Weaknesses What does a company do about its key weaknesses? It is tempting to think of how companies can upgrade existing resources and capabil- ities to correct such weaknesses. However, converting weakness into strength is likely to be a long-term task for most companies. In the short to medium term, a company is likely to be stuck with the resources and capabilities that it inherits from the previ- ous period. The most decisive – and often most successful – solution to weaknesses in key func- tions is to outsource. Thus, in the automobile industry, companies have become in- creasingly selective in the activities they perform internally. During the 1930s, Ford was almost completely vertically integrated. At its massive River Rouge plant, coal and iron ore entered at one end, completed cars exited at the other. By 2003, Ford had outsourced most component manufacture, much of its design work was being undertaken by independent design studios, and services ranging from IT to security were being provided by third parties. In athletic shoes and clothing, Nike undertakes product design, marketing, and overall “systems integration,” but manufacturing, logistics, and many other functions are contracted out. We shall consider the vertical scope of the firm at greater depth in Chapter 13. Through clever strategy formulation a firm may be able to negate the impact of its key weaknesses. Consider Harley-Davidson: in competition with Honda, Yamaha, and BMW and with sales of 300,000 bikes a year (compared with 4 million at Honda), , Harley is unable to compete on technology. How has it dealt with this problem? It has made a virtue out of its outmoded technology and traditional designs. Harley- Davidson’s obsolete push-rod engines and recycled designs have become central to the retro-look appeal of the “hog.” What about Superfluous Strengths? What about those resources and capabil- ities where a company has particular strengths, but these don’t appear to be import- ant sources of sustainable competitive advantage? One response may be to lower the level of investment from these resources and capabilities. If a retail bank has a strong, but increasingly underutilized, branch network, this may be an opportunity to prune its real estate assets and invest in IT approaches to customer services. However, in the same way that companies can turn apparent weaknesses into competitive strengths, so it is possible to develop innovative strategies that turn apparently inconsequential strengths into valuable resources and capabilities. Edward Jones’ network of brokerage offices and 8,000-strong sales force looked increasingly irrelevant in an era when brokerage transactions were increasingly going on-line. However, by emphasizing personal service, the trustworthiness of its brokers, and its traditional, conservative investment virtues, Edward Jones has continued to build market share.34
- 27. CSAC05 1/13/07 9:21 Page 149 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 149 Consider too my own institution, Georgetown University’s McDonough School of Business. A unique characteristic of the school is its Jesuit heritage, at first glance an unlikely source of competitive advantage in the fiercely competitive MBA market. Yet, to the extent that a fundamental principle of Jesuit education is developing the whole person and that success as a manager is not just about what you know but also about who you are, Georgetown’s Jesuit tradition can provide a key differentiating factor through the MBA program’s emphasis on developing the values, integrity, and emo- tional intelligence necessary to be a successful business leader. Developing Resources and Capabilities Conventional approaches to developing resources and capabilities have emphasized gap analysis – identifying discrepancies between the current position and the desired future position, then adopting policies to fill those gaps. Such approaches are of limited value. In the case of resources, investing in areas of weakness – whether it is proprietary technology or manufacturing facilities – can be very expensive and, because of the complex complementarities between different resources, such invest- ments may deliver limited returns. In the case of capabilities, because we know little about their structure or operation, developing them is a hazardous endeavor. The Relationship between Resources and Capabilities Possibly the most difficult problem in developing capabilities is that we know little about the linkage between resources and capabilities. In most sports, the relationship between the skills of the individual players and team performance is weak. In Euro- pean football (soccer), teams built with modest expenditures (Bayern Munich, PSV Eindhoven, and Valencia) often outplay star-studded, big-budget teams (Real Madrid, Chelsea, and Inter Milan). In international competitions – the soccer world cup, Olympic games, and ice hockey world cup – smell, resource-poor countries often humiliate the preeminent national teams. Among business firms, we observe the same phenomenon. The firms that demon- strate the most outstanding capabilities are not necessarily those with the greatest resource endowments: l In automobiles, GM has four times the output of Honda and four times the R&D expenditure, yet it is Honda, not GM, that is world leader in power train technology. l In animated movies, the most successful productions in recent years were by newcomers Pixar (Toy Story, The Incredibles) and Aardman Animations (Wallace and Gromit) rather than by industry giant, Walt Disney. l In telecom equipment it was the upstart Cisco rather than industry leaders Lucent, Nortel Networks, and Alcatel that established leadership in the new world of package switching. According to Hamel and Prahalad, it is not the size of a firm’s resource base that is the primary determinant of capability, but the firm’s ability to leverage its resources. Resources can be leveraged in the following ways:
- 28. CSAC05 1/13/07 9:21 Page 150 150 PART II THE TOOLS OF STRATEGY ANALYSIS l Concentrating resources through the processes of converging resources on a few clearly defined and consistent goals; focusing the efforts of each group, department, and business unit on individual priorities in a sequential fashion; and targeting those activities that have the biggest impact on customers’ perceived value. l Accumulating resources through mining experience in order to achieve faster learning, and borrowing from other firms – accessing their resources and capabilities through alliances, outsourcing arrangements, and the like. l Complementing resources involves increasing their effectiveness through linking them with complementary resources and capabilities. This may involve blending product design capabilities with the marketing capabilities needed to communicate these to the market, and balancing to ensure that limited resources and capabilities in one area do not hold back the effectiveness of resources and capabilities in another. l Conserving resources involves utilizing resources and capabilities to the fullest by recycling them through different products, markets, and product generations; and co-opting resources through collaborative arrangements with other companies.35 Replicating Capabilities Growing capabilities requires that the firm replicates them internally.36 Some of the world’s most successful corporations are those that have been able to replicate their capabilities in different product and geographical markets. Ray Kroc’s genius was to take the original McDonald’s formula and replicate it thousands of times over in building a global chain of hamburger restaurants. Other leading service companies – Starbucks, Mandarin Oriental Hotels, IKEA, eBay – have built global presence on the principle that once a capability has been developed, its replication in another location can be achieved at a low cost. If routines develop learning-by-doing, and the knowledge that underpins them is tacit, replication is far from easy. Replication requires systematization of the know- ledge that underlies the capability – typically through the formulation of standard operating procedures. Thus, McDonald’s has distilled its business system into oper- ating procedures and training manuals that govern the operation and maintenance of every aspect of its restaurants. This systematization presumes that the firm can more fully articulate the processes that underlie its capabilities. In the case of semiconduc- tor fabrication, these processes are so complex and the know-how involved so deeply embedded that the only way that Intel can replicate its production capabilities is by replicating its lead plant in every detail – a process called “Copy Exactly.”37 Developing New Capabilities Creating certain resources – a brand or an overseas distribution network – may be difficult, costly, and time consuming, but at least the challenge can be comprehended and planned. Creating organizational capability poses a much higher level of difficulty. If capabilities are based on routines that develop through practice and learning, what can the firm do to establish such routines within a limited time period? We know that capabilities involve teams of resources working together, but, even with the tools of
- 29. CSAC05 1/13/07 9:21 Page 151 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 151 business process mapping, we typically have sketchy understanding of how people, machines, technology, and organizational culture fit together to achieve a particular level of performance. In the same way that we can only speculate about what makes Tiger Woods the greatest golfer of our time, we are unable fully to diagnose how Dell achieves its brilliance at logistics management or how Electronic Arts has been able to develop video games that continue to set new standards in complexity, sophistication, and player involvement. Capability as a Result of Early Experiences Organizational capability is path dependent – a company’s capabilities today are the result of its history. More import- antly, this history will constrain what capabilities the company can perform in the future. To understand the origin of a company’s capabilities, a useful starting point is to study the circumstances that existed and events that occurred at the time of the company’s founding and early development. How did Wal-Mart develop its super- efficient system of warehousing and distribution? This system was not the result of careful planning and design, but of initial conditions: because of its rural locations, the company was unable to get reliable distribution from its suppliers, and so it estab- lished its own distribution system. How does one explain Wal-Mart’s amazing com- mitment to cost efficiency? Its management systems are undoubtedly important, but ultimately it is Wal-Mart’s origins in small-town Arkansas and the values and personality of its founder, Sam Walton, that sustains its obsession with efficiency and cost cutting. Consider too the world’s largest oil and gas majors (see Table 5.5). Despite long his- tories of competing together in the same markets, with near-identical products, and TABLE 5.5 Distinctive Capabilities as a Consequence of Childhood Experiences: The Oil Majors Company Distinctive capability Early history Exxon Financial management Exxon’s predecessor, Standard Oil (NJ), was the holding company for Rockefeller’s Standard Oil Trust Royal Dutch Shell Coordinating a decentralized Shell Transport & Trading headquartered global network of 200+ in London and founded to sell Russian operating companies oil in China and the Far East Royal Dutch Petroleum headquartered in The Hague; founded to exploit Indonesian reserves BP “Elephant hunting” Discovered huge Persian reserves, went on to find Forties field (North Sea) and Prudhoe Bay (Alaska) ENI Deal making in politicized The Enrico Mattei legacy; the environments challenge of managing government relations in post-war Italy Mobil Lubricants Vacuum Oil Co. founded in 1866 to supply patented petroleum lubricants
- 30. CSAC05 1/13/07 9:21 Page 152 152 PART II THE TOOLS OF STRATEGY ANALYSIS similar strategies, the majors display very different capability profiles. Exxon and the Royal Dutch Shell Group have shared parallel development for over a century yet have very different capability profiles. Exxon is known for its financial management capabilities exercised through rigorous investment controls and emphasis on cost efficiency. Shell is known for its decentralized, international management capabilities, in particular its adaptability to a wide variety of national environments. These differ- ences can be traced back to the companies’ 19th-century origins. Exxon (then Stand- ard Oil New Jersey) was part of Rockefeller’s Standard Oil Trust, where it played a key holding company role with responsibilities for the financial management of other parts of the Standard Oil empire. Shell was established to sell Russian oil in China and the Far East, while Royal Dutch was established to exploit Indonesian oil reserves. With head offices thousands of miles away in Europe, it was imperative that the group developed a decentralized, adaptable management style. Organizational Capability: Rigid or Dynamic? These long periods over which capabilities develop have important implications for firms’ capacity for change. The more highly developed a firm’s organizational capabilities are, the narrower its repertoire and the more difficult it is for the firm to adapt them to new circumstances. Dorothy Leonard argues that core capabilities are simultaneously core rigidities – they inhibit firms’ ability to access and develop new capabilities.38 Nevertheless, some com- panies appear to have the capacity to continually upgrade, extend, and reconfigure their organizational capabilities. David Teece and his colleagues have referred to dynamic capabilities as the “firm’s ability to integrate, build, and reconfigure internal and external competences to address rapidly changing environments.”39 There is little consensus in the literature as to what dynamic capabilities are Eisenhardt and Martin identify dynamic capabilities as routines that enable a firm to reconfigure its resources – these include R&D, new product development and acquisition capabili- ties. Zollo and Winter define dynamic capabilities as higher level processes through which the firm modifies its operating routines.40 What is agreed is that dynamic capabilities are far from common. For most companies highly developed capabilities in existing products and technologies create barriers to developing capabilities in new products and new technologies. When adapting to radical change within an industry, or in exploiting entirely new business opportunities, are new firms at an advantage or disadvantage to established firms? It depends on whether the change or the innovation is competence enhancing or com- petence destroying. In TV manufacturing, the most successful new entrants were ex- isting producers of radios – the new technology was compatible with their capabilities. However, in most new industries, the most successful firms tend to be startups rather than established firms. In personal computers, it was newcomers such as Dell, Acer, Compaq, and Gateway that emerged as most successful during the 1990s. Among established firms, relatively few (IBM, Hewlett-Packard, and Toshiba) went on to significant success. Many others (e.g., Xerox, GE, Texas Instruments, AT&T, and Olivetti) exited. In wireless telephony, too, it was startups – Vodafone, McCaw Cellular, Orange – that were more successful than established telephone companies.41 Approaches to Capability Development So, how do companies go about developing new capabilities? Let us review five approaches commonly utilized.
- 31. CSAC05 1/13/07 9:21 Page 153 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 153 Acquiring Capabilities: Mergers and Acquisitions If new capabilities can only be developed over long periods, then acquiring a company that has already developed the desired capability can short-circuit the tortuous process of capability development. In technologically fast-moving environments, established firms typically use acquisitions as a means of acquiring specific technical capabilities – Cisco Systems and Microsoft have each benefited substantially from such acquisitions. Microsoft’s adaptation to the internet and its entry into video games was achieved through mul- tiple acquisitions. Each year, Microsoft hosts its VC Summit, where venture capitalists from all over the world are invited to marker their companies. However, using acquisitions as a means of extending a company’s capability base involves major risks. On its own, acquisition does not achieve the intended goal. Once the acquisition has been made, the acquiring company must find a way to integrate the acquiree’s capabilities with its own. All too often, culture clashes, personality of man- agement systems can result in the degradation or destruction of the very capabilities that the acquiring company was seeking. Accessing Capabilities: Strategic Alliances Given the high cost of acquir- ing companies, alliances offer a more targeted and cost effective means to access another company’s capabilities. A strategic alliance is a cooperative relationship between firms involving the sharing of resources in pursuit of common goals. Long-running technical collaboration between HP and Canon has allowed both firms to enhance their printer technology. Prior to acquisition in 2005, Pixar’s alliance with Disney allowed it to access Disney’s marketing and distribution capabilities. Strategic alliances comprise a wide variety of collaborative relationships, which include joint research, technology-sharing arrangements, shared manufacturing, joint marketing and/or dis- tribution arrangements, and vertical partnerships, to mention but a few. Alliances may involve formal agreements or they may be entirely informal; they may or may not involve ownership links. Alliances may also be for the purpose of acquiring the partner’s capabilities through organizational learning.42 When General Motors formed its NUMMI joint venture with Toyota, its motive was to learn Toyota’s “lean” approach to manufacturing.43 Where both alliance partners are trying to acquire one another’s capabilities, the result may well be a “competition for competence” that ultimately destabilizes the relationship.44 Creating Capabilities Creating organizational capability requires, first, acquiring the necessary resources and, second, integrating these resources. With regard to resource acquisition, particular attention must be given to organizational culture – values and behavioral norms are critically important influences on motivation and collaboration. In general, however, it is integration that presents the greatest chal- lenge. We know that capabilities are based on routines – coordinated patterns of activity – but we know little about how routines are established. The assumption has been that they “emerge” as a result of learning-by-doing. Recent research, however, has emphasized on the role of management in developing organizational capability through motivation and deliberate learning.45 Organizational structure and manage- ment systems are of particular importance: l Capabilities need to be housed within dedicated organizational units if organizational members are to achieve high levels of coordination. Thus, product development is facilitated when undertaken within product development units rather that through a sequence of “over-the-wall” transfers
- 32. CSAC05 1/13/07 9:21 Page 154 154 PART II THE TOOLS OF STRATEGY ANALYSIS from one functional department to another. Similarly, capabilities in quality management, change management, corporate social responsibility customer are all best developed when organizational units are dedicated to such activities. Inevitably, aligning organizational structure with the multiple capabilities creates organizational complexity. However, as we shall see in the next chapter, many capabilities are suited to informal structural arrangements. l Organizations need to take systematic approaches to capability development – the need to create, develop, and maintain organizational capabilities must be built into the design of management systems. The literature emphasizes the roles of search, experimentation, and problem solving in capability development.46 Systematic approaches to capability development – including the creation of organizational routines for defensive and offensive maneuvers – are central to the management and coaching of sports teams, but in most business organizations the heavy emphasis on maintaining current operations means that limited attention is devoted to explicit capability development. The management of motivation and incentives in one area that is relatively well developed. The literature places heavy emphasis on the role of strategic intent and performance aspirations in driving capability development. This has implications for both leadership and the design of incentives. Organizations often discover that the organizational structure, management systems, and culture that support existing capabilities may be unsuitable for new capabilities. To resolve this problem, companies may find it easier to develop new capabilities in new organizational units that are geographically separated from the main company – Strategy Capsule 5.5 offers examples. Given the complexity and uncertainty of programs to develop new organizational capabilities, an indirect approach may be preferable. If we cannot design new cap- abilities from scratch, but if we know what types of capabilities are required for dif- ferent products, then by pushing the development of particular products we can pull the development of the capabilities that those products require. For such an approach to be successful it must be systematic and incremental. Developing complex capabil- ities over a significant period of time requires a sequencing of products, where each stage of the sequence has specific capability development goals.47 Strategy Capsule 5.6 provides an example. This parallel development of a firm’s product portfolio and its base of resources and capabilities is referred to by Hiroyuki Itami as dynamic re- source fit.48 Matsushita utilized this in its international expansion strategy, moving from simple to more complex products: In every country batteries are a necessity, so they sell well. As long as we bring a few advanced automated pieces of equipment for the processes vital to final product quality, even unskilled labor can produce good products. As they work on this rather simple product, the workers get trained, and this increased skill level then permits us to gradually expand production to items with increasingly higher technology levels, first radios, then televisions.49 Ultimately, developing organizational capabilities is about building the know-how of the company, which requires integrating the knowledge of multiple organizational members. One of the most powerful tools for managing such process is knowledge management. We shall consider the role and potential of knowledge management in the appendix to this chapter.
- 33. CSAC05 1/13/07 9:21 Page 155 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 155 STRATEGY CAPSULE 5.5 Incubating Capabilities in Separate Organizational Units The model for organizationally separate devel- drawing on the resources and capabilities of opment units was Lockheed’s “skunk works” – the parent. However, the critical challenge is in a product development team established in reintegrating the new capabilities back into the Burbank, California during WWII to develop parent company. Xerox’s Palo Alto Research innovative new military aircraft. Since then, a Center (PARC) pioneered many of the tech- number of companies have used satellite units nologies that formed the basis of the micro- to develop new organizational capabilities: computer revolution of the 1980s. However, it was much easier for these technologies to l IBM developed its PC at a new unit led by flow to nearby competitors – Hewlett-Packard, veteran executive Bill Lowe and located in Apple, Microsoft, and Sun Microsystems – than Florida – a thousand miles from IBM’s it was for them to be absorbed by Xerox’s east corporate headquarters in New York. Lowe coast establishment.2 GM’s Saturn has had a claimed that isolation from IBM’s main similar experience. The Tennessee-based sub- organization was critical to the team’s sidiary achieved its objective of developing new creation of a product design and business manufacturing and marketing capabilities, but, system that were radically different from as yet, these seem to have had little impact on those of IBM’s mainframe business.1 the parent organization.3 l The pioneering online financial services company Egg was established by its London-based parent, Prudential Insurance, in the Midlands towns of Notes: 1 T. Elder, “Lessons from Xerox and IBM,” Harvard Dudley and Derby – well away from the Business Review (July–August 1989): 66–71. London headquarters. 2 Xerox PARC: Innovation without Profit? ICMR Case Study, 2004. These separate incubator units combine the 3 J. O’Toole, Forming the Future: Lessons from the Saturn flexibility and autonomy of a startup, while Corporation (New York: Harper, 1996). STRATEGY CAPSULE 5.6 Hyundai Motor: Developing Capabilities through Product Sequencing Hyundai’s emergence as a world class auto- opment process was characterized by a clear mobile producer is a remarkable example of objective in terms of product outcome, a tight capability development over a sequence of time deadline, responsibility allocated to a compressed phases. Each phase of the devel- development team, a clear recognition of the
- 34. CSAC05 1/13/07 9:21 Page 156 156 PART II THE TOOLS OF STRATEGY ANALYSIS l Hydrodynamics l Thermodynamics l Fuel engineering l Emission control l Auto styling l Lubrication and design l Kinetics and vibration l Casting and l FWD l Ceramics CAPABILITIES forging engineering l Electronic control l Chassis l CAD/CAM systems design l Assembly l Assembly l Tooling control l Production l Body systems l Large-scale design engineering production l Advanced integration l Local l Export component l Global logistics marketing marketing handling l Lifecycle engineering SKD / CKD ”Alpha” Accent Pony Excel Ford Cortina engine Avante Sonanta PRODUCTS 1968 1970 1974 1985 1994–95 capabilities that needed to be developed in each imported in parts. The figure shows the prin- phase, and an atmosphere of impending crisis cipal phases of Hyundai Motor’s development. should the project not succeed. The first phase was the construction of an assembly plant in Source: L. Kim, “Crisis construction and organizational the unprecedented time of 18 months in order learning: Capability building and catching up at Hyundai to build Hyundai’s first car – a Ford Cortina Motor,” Organizational Science 9 (1998): 506–21. Summary We have shifted the focus of our attention from organizational capabilities. Our interest is the the external to the internal environment of the potential for resources and capabilities to establish firm. This internal environment comprises many sustainable competitive advantage. Systematic features of the firm, but for the purposes of strat- appraisal of a company’s resources and capabilities egy analysis, the key issue is what the firm can do. provides the basis for formulating (or reformu- This means looking at the resources of the lating) strategy. How can the firm deploy its firm and the way resources combine to create strengths to maximum advantage? How can it
- 35. CSAC05 1/13/07 9:21 Page 157 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 157 FIGURE 5.9 Summary: a framework for analyzing resources and capabilities 4. Develop strategy implications: (a) In relation to strengths – How can these be exploited more effectively and fully? (b) In relation to weaknesses – Identify opportunities to outsource STRATEGY activities that can be better performed by other organizations – How can weaknesses be corrected through acquiring and developing resources and capabilities? 3. Appraise the firm’s resources and capabilities POTENTIAL FOR in terms of: SUSTAINABLE (a) strategic importance COMPETITIVE (b) relative strength ADVANTAGE 2. Explore the linkages between resources CAPABILITIES and capabilities 1. Identify the firm’s resources and capabilities RESOURCES minimize its vulnerability to its weaknesses? How Although much of the discussion has been can it develop and extend its capabilities to meet heavy on concepts and theory, the issues are the challenges of the future? Figure 5.9 provides practical. The management systems of most firms a simplified view of the approach to resource devote meticulous attention to the physical and analysis developed in this chapter. financial assets that are valued on their balance Despite the progress that has been made in the sheets; much less attention has been paid to the last ten years in our understanding of resources critical intangible and human resources of the and capabilities, there is much that remains unre- firm, and even less to the identification and ap- solved. We know little about the microstructures praisal of organizational capability. Most senior of organizational capabilities and how they are managers are now aware of the importance of established and develop. Can firms develop en- their resources and capabilities, but the tech- tirely new capabilities, or must top management niques of identifying, assessing, and developing accept that distinctive capabilities are the result of them are woefully underdeveloped. experience-based learning over long periods of Because the resources and capabilities of the time through processes that are poorly under- firm form the foundation for building competitive stood? If that is the case, strategy must be advantage, we shall return again and again to concerned with exploiting, preserving, and devel- the concepts of this chapter. Our next port of call oping the firm’s existing pool of resources and is the structures and systems through which the capabilities, rather than trying to change them. firm deploys its resources, builds and exercises its We have much to learn in this area. capabilities, and implements its strategy.
- 36. CSAC05 1/13/07 9:21 Page 158 158 PART II THE TOOLS OF STRATEGY ANALYSIS Self-Study Questions 1 In recent years Google has expanded from internet search across a broad range of internet services, including email, photo management, satellite maps, digital book libraries, blogger services, and telephony. To what extent has Google’s strategy focused on its resources and capabilities rather specific customer needs? What are Google’s principal resources and capabilities? 2 Microsoft’s main capabilities relate to the development and marketing of complex computer software and its greatest resource is its huge installed base of its Windows operating system. Does Microsoft’s entry into video game consoles indicate that its strategy is becoming divorced from its principal resources and capabilities? 3 During 1984–8, Michael Eisner, the newly installed CEO of Walt Disney Company, successfully exploited Disney’s existing resources to boost profitability. During the last eight years of Eisner’s tenure (1998–2005), however, profitability stagnated and share price declined. To what extent do you think that Eisner focused too heavily on exploiting inherited resources and not enough on developing Disney’s capabilities to meet the entertainment needs of a changing world? 4 Many companies announce in their corporate communications: “Our people are our most important resource.” In terms of the criteria listed in Figure 5.7, can employees be considered to be of the utmost strategic importance? 5 Given the profile of VW’s resources and capabilities outlined in Table 5.4 and Figure 5.8, what strategy recommendations would your offer VW? 6 Apply the approach outlined in the section “Putting Resource and Capability Analysis to Work” to your own business school. Begin by identifying the resources and capabilities relevant to success in the market for business education, appraise the resources and capabilities of your school, then make strategy recommendations regarding such matters as the programs to be offered and the overall positioning and differentiation of the school and its offerings. 7 Identify two sports teams: one that is rich in resources (e.g. talented players) but whose capabilities (as indicated by performance) have been poor; one that is resource-poor but has displayed strong team capabilities. What clues can you offer as to the determinants of capabilities among sports teams? 8 In 2006, Disney completed its acquisition of the film animation company Pixar for $7.4 billion. The high purchase price reflected Disney’s eagerness to gain Pixar’s animation capabilities, its talent (animators, technologists, and storytellers), and its culture of creativity. What risks does Disney face in achieving the goals of this acquisition?
- 37. CSAC05 1/13/07 9:21 Page 159 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 159 Appendix: Knowledge Management and the Knowledge-based View of the Firm During the past ten years our thinking about resources and capabilities and their management has been extended and reshaped by a surge of interest in knowledge management. Knowledge management refers to processes and practices through which organizations generate value from knowledge. Initially, knowledge manage- ment was primarily concerned with information technology – especially the use of intranets, groupware, and databases for storing, analyzing, and disseminating infor- mation. Subsequent developments in knowledge management have been concerned less with data and more with organizational learning – especially the transfer of best practices – and the management of intellectual property. The level of interest in know- ledge management is indicated by the number of large corporations that have created the position of chief knowledge officer, the spawning of knowledge management prac- tices by consulting firms, and a flood of books on the subject. Academic interest in the role of knowledge within organizations represents the confluence of several research streams including resource-based theory, the economics of information, epistemology, evolutionary economics, and the management of tech- nology. The outcome has been a knowledge-based view of the firm that considers the firm as a set of knowledge assets with the purpose of deploying these assets to create value.50 Is knowledge management a major breakthrough in management practice or mere fad? A growing body of evidence points to the ability of knowledge management to generate substantial gains in performance. At the same time many of its manifesta- tions are highly dubious. The Wall Street Journal reports that Saatchi & Saatchi’s director of knowledge management is “absorbing everything under the sun,” includ- ing the implications of breakthrough products such as Japanese pantyhose “embedded with millions of microcapsules of vitamin C and seaweed extract that burst when worn to provide extra nourishment for the limbs.”51 Lucy Kellaway of the Financial Times notes that beyond the simple truth that “The subject [of knowledge manage- ment] has attracted more needless obfuscation and wooly thinking by academics and consultants than any other.”52 My approach is to regard knowledge management and the knowledge-based view of the firm as important extensions of our analysis of resources and capabilities. In terms of resources, knowledge is acknowledged to be the overwhelmingly important productive resource; indeed, the value of people and machines lies primarily in the fact that they embody knowledge. From the strategic viewpoint, knowledge is a particularly interesting resource: many types of knowledge are scarce, much of it is difficult to transfer, and complex forms of knowledge may be very difficult to repli- cate. Capabilities may be viewed as the manifestation of the knowledge of the organ- ization. Knowledge management offers valuable tools for creating, developing, maintaining, and replicating organizational capabilities. Types of Knowledge The single most useful contribution of knowledge management is the recognition that different types of knowledge have very different characteristics. A key distinction is
- 38. CSAC05 1/13/07 9:21 Page 160 160 PART II THE TOOLS OF STRATEGY ANALYSIS between knowing how and knowing about. Know-how is primarily tacit in nature – it involves skills that are expressed through their performance (riding a bicycle, playing the piano). Knowing about is primarily explicit – it comprises facts, theories, and sets of instructions. The primary difference between tacit and explicit knowledge lies in their transferability. Explicit knowledge is revealed by its communication: it can be transferred across individuals, across space, and across time. This ease of commun- ication means that explicit knowledge – information especially – has the character- istics of a public good: once created, it can be replicated among innumerable users at very low marginal cost (IT has driven these costs to near zero for most types of information). Tacit knowledge, on the other hand, cannot be codified; it can only be observed through its application and acquired through practice, hence its transfer between people is slow, costly, and uncertain. This distinction has major implications for strategy. If explicit knowledge can be transferred so easily, it is seldom the foundation of sustainable competitive advantage. Because explicit knowledge leaks so quickly to competitors, it is only secure when it is protected, either by intellectual property rights (patents, copyrights, trade secrets) or by secrecy (“The formula for Coca-Cola will be kept in a safe in the vault of our Atlanta headquarters guarded by armed Coca-Cola executives”). The challenge of tacit knowledge is the opposite: if Ms. Jenkins is an incredibly successful salesperson, how can the skills embedded in her brain be transferred to the rest of the salesforce of Acme Delights? For consulting companies, the distinction between tacit (“person- alized”) and explicit (“systematized”) knowledge defines their business model and is a central determinant of their strategy.53 The tacit/explicit distinction has important implications for the distribution of decision-making authority within the company. If the knowledge relevant to decisions is explicit, it can be easily transferred and assembled in one place, hence permitting centralized decision making (treasury activities within companies are typically cen- tralized). If knowledge is primarily tacit, it cannot be transferred and decision making needs to be located among the people where the knowledge lies. If each salesperson’s knowledge of how to make sales is based on their intuition and their understanding of their customers’ idiosyncrasies, such knowledge cannot be easily transferred to their sales managers. It follows that decisions about their working hours and selling tactics should be made by them, not by the sales manager. Types of Knowledge Process A second component of knowledge management is understanding the processes through which knowledge is developed and applied. Two categories of knowledge processes can be identified: those that are concerned with increasing the stock of knowledge available to the organization, and those that are concerned with the application of the organization’s knowledge. J.-C. Spender refers to the former as knowledge generation and the latter as knowledge application. James March’s dis- tinction between exploration and exploitation recognizes a similar dichotomy.54 Within these two broad areas we can identify a number of different knowledge processes, each of which has been associated with particular techniques and approaches to knowledge management (see Figure 5.10). The best-developed and most widely applied techniques of knowledge manage- ment have focused on some of the most basic aspects of knowledge application and exploitation. For example:
- 39. CSAC05 1/13/07 9:21 Page 161 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 161 FIGURE 5.10 Knowledge processes within the organization Knowledge l Research Creation Knowledge Generation (“Exploration”) l Training Knowledge l Recruitment Acquisition l Intellectual property licensing l Benchmarking Knowledge l New product development Integration l Operations Knowledge l Strategic planning Sharing l Communities of practice Knowledge l Best practices transfer Knowledge Replication l On-the-job training Application (“Exploitation”) Knowledge Storage l Databases and Organization l Standard operating practices Knowledge l Intellectual capital accounting Measurement l Competency modeling Knowledge l Project reviews Identification l Competency modeling l In the area of knowledge identification, companies are increasingly assembling and systematizing information on their knowledge assets. These include assessments and reviews of patent portfolios and providing personnel data that allows each employee to identify the skills and experience of other employees in the organization. A key aspect of such knowledge identification is the recognition of knowledge that is being generated within the organization so that it can subsequently be stored for future use. Such knowledge identification is especially important in project-based organizations to ensure that knowledge developed in one project is not lost to the organization. Systematic post-project reviews are a central theme in the US Army’s “lessons learned” procedure, which distils the results of practice maneuvers and simulated battles into tactical guidelines and recommended procedures. A process is applied to learning from actual operations. During the military intervention in Bosnia in 1995, the results of every operation were forwarded to the Center for Lessons Learned to be collected and
- 40. CSAC05 1/13/07 9:21 Page 162 162 PART II THE TOOLS OF STRATEGY ANALYSIS codified. Resulting lessons learned were distributed to active units every 72 hours.55 By the late 1990s, every major management consulting firm had introduced a system whereby learning from each consulting project was identified, written up, and submitted to a common database. l Knowledge measurement involves measuring and valuing the organization’s stock of knowledge and its utilization. Skandia, the Swedish insurance company, has pioneered knowledge metrics with its system of intellectual capital accounting.56 Dow Chemical also uses intellectual capital management to link its intellectual property portfolio to shareholder value. l For knowledge to be efficiently utilized within the organization, knowledge storage and organization are critical. The key contribution of information technology to knowledge management has been in creating databases for storing information, for organizing information, and for accessing and communicating information, to facilitate the transfer of and access to knowledge. The backbone of the Booz-Allen & Hamilton’s “Knowledge-On- Line” system,57 Accenture’s “Knowledge Xchange,” and AMS’s “Knowledge Express”58 is an IT system that comprises a database, groupware, dedicated search engine, and an intranet that permits employees to input and access information. l Knowledge sharing and replication involves the transfer of knowledge from one part of the organization (or from one person) to be replicated in another part (or by another individual). A central function of IT-based knowledge management systems is to facilitate such transfer. However, tacit knowledge is not amenable to codification within an IT system. The traditional answer to the problem of replicating tacit knowledge is to use apprenticeships and other forms of on-the-job training. Recently, organizations have discovered the important role played by informal networks in transferring experiential knowledge. These self-organizing communities of practice are increasingly being deliberately established and managed as a means of facilitating knowledge sharing and group learning.59 Replicating capabilities poses an even greater challenge. Transferring best practices within companies is not simply about creating appropriate incentives; complexity and credibility of the knowledge involved are key impediments.60 l Knowledge integration represents one of the greatest challenges to any company. Producing most goods and services requires bringing together the knowledge of multiple individuals. The essential task of almost all organizational processes is integrating individual knowledge in an effective and efficient manner. For example, a strategic planning system may be seen as a vehicle for integrating the different knowledge bases of managers at different levels of the organization and from different functions in order to create the best strategy for the company. Similarly with new product development: the key is to integrate the knowledge of many technical experts and across a range of functions. A wide body of evidence points to the effectiveness of project teams in integrating knowledge.61 Within knowledge generation, it is possible to distinguish between the internal creation of knowledge (knowledge creation) and the search to identify and absorb existing knowledge from outside the organization (knowledge acquisition). The
- 41. CSAC05 1/13/07 9:21 Page 163 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 163 mechanisms through which knowledge is acquired from outside the organization are typically well known: hiring skilled employees, acquiring companies or their know- ledge resources, benchmarking companies that are recognized as “best-in-class” for certain practices, and learning through alliances and joint ventures. Creativity remains a key challenge for most companies. While most studies of creativity emphasize the role of the individual and the types of environment conducive to individual creativ- ity, Dorothy Leonard has explored the role of groups and group processes in stimu- lating innovation.62 We shall return to creativity and innovation in Chapter 11. Knowledge Conversion In practice, knowledge generation and application are not distinct. For example, the application of existing knowledge creates opportunities for learning that increase the stock of knowledge.63 Nonaka’s theory of knowledge creation identifies the processes of knowledge conversion – between tacit and explicit and between individual and organizational knowledge – as central to the organization’s building of its knowledge base.64 The conversion of knowledge between the different knowledge types (the “epistemological dimension”) and knowledge levels (the “ontological dimension”) forms a knowledge spiral in which the stock of knowledge broadens and deepens (see Figure 5.11). Thus, explicit knowledge is internalized into tacit knowledge in the form of intuition, know-how, and routines, while tacit knowledge is externalized into explicit knowledge through articulation and codification. Converting tacit into explicit knowledge is critical to companies that wish to repli- cate their capabilities: l Henry Ford’s Model T was initially produced on a small scale by skilled metal workers one car at a time. Ford’s assembly-line mass-production technology systematized that tacit knowledge, built it into machines and a business process, and replicated it in Ford plants throughout the world. With the FIGURE 5.11 Nonaka’s spiral of knowledge creation Epistemological Dimension SOURCE: I. NONAKA, “ON A KNOWLEDGE CREATING ORGANIZATION,” PAPER PRESENTED AT AIF Explicit Externalization Knowledge Combination NATIONAL CONGRESS (POSMA, OCTOBER 1993). Tacit Knowledge Ontological Socialization Internalization Dimension Individual Group Organization Inter-Organization Knowledge Level
- 42. CSAC05 1/13/07 9:21 Page 164 164 PART II THE TOOLS OF STRATEGY ANALYSIS FIGURE 5.12 Knowledge types and the transformation from craft to industrial enterprises Levels of knowledge Individual Organization Information Databases Facts Systems and procedures Scientific Intellectual property Explicit knowledge INDUSTRIAL ENTERPRISES Types of knowledge CRAFT ENTERPRISES Organizational Tacit routines Skills Know-how knowledge built into the system, car workers no longer needed to be skilled craftsmen. l When Ray Kroc discovered the McDonald brothers’ hamburger stand in Riversdale, California, he quickly recognized the potential for systematizing and replicating their process through operating manuals, videos, and training programs. It allows thousands of McDonald’s outlets worldwide to produce fast food to exacting standards by a labor force that, for the most part, possesses few culinary skills. This shift in the knowledge base of the firm, from tacit knowledge located in individuals to explicit knowledge held by the organization is fundamental to the transformation of craft enterprises into industrial enterprises. In addition to Ford and McDonald’s, Marriott in hotels, Andersen Consulting (now Accenture) in IT consulting, and Starbucks in coffee shops have pioneered transformation through systematization (see Figure 5.12). Conclusion Analysis of the characteristics of knowledge and the process through which it is created and deployed offers striking insights into the principles and practices of man- agement – including the development of organizational capability. Given the scope of knowledge management and the vast range of tools, techniques, and frameworks that have been developed, where does a company begin to incorpor- ate knowledge management within its management systems? A useful starting point,
- 43. CSAC05 1/13/07 9:21 Page 165 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 165 is to identify the linkage between knowledge and the basis on which the firm creates value. This can then highlight the key processes through which knowledge is gener- ated and applied. Consider the following examples: l For Dow Chemical, the core of its value creation is generating intellectual property in new chemical products and processes, and exploiting them through worldwide manufacturing, marketing, and sales. Dow’s “Intellectual Capital Management” places its central emphasis on the company’s patent portfolio and links its intellectual property to a broad range of intellectual capital variables and processes and ultimately to the company’s total value.65 l For McKinsey & Co., creating value for clients requires continually building on the knowledge it generates from client assignments, and conceptualizing and sharing that knowledge base. This is achieved through a system that ensures the knowledge generated from each project is captured and made available for subsequent client projects; a matrix structure of industry and functional practices that permits specialized knowledge to be created and stored; and an R&D function in the form of the McKinsey Global Institute.66 l For McDonald’s Corporation, knowledge management is primarily concerned with implementing the McDonald’s system. This is a detailed set of operating practices that extend from the company’s values down to the placing of a pickle on the bun of a Big Mac and the procedure for servicing a McDonald’s milkshake machine. The essence of the McDonald’s system is the systematization of knowledge into a detailed set of rules that are followed in every McDonald’s outlet. These explicit operating practices are internalized within employees’ cognition and behavior through rigorous attention to training, both in formal training programs at Hamburger University, and in training at individual restaurants.67 The design of every knowledge process must take account of the characteristics of the knowledge being deployed. The fundamental distinction here is between explicit and tacit knowledge. Take a simple example of the transfer of best practice between the different fabrication plants of a multinational semiconductor plant. If the know- ledge is explicit, then such knowledge can be disseminated in the form of reports, or directives requiring every plant to adopt a new standard operating procedure. If the knowledge is tacit – it is the result of the experience or intuition of a single plant manager – the task is more difficult. Transferring the best practice is likely to require either visits by other plant managers to the innovating plant, or for the innovating plant manager to adopt a consulting role and visit other plants in the group for the purpose of teaching employees there. It is in the area of managing tacit knowledge (which includes, typically, the major part of the knowledge relevant to organizational capability) where the major chal- lenges and opportunities in knowledge management lie. Information technology has made huge strides in the storage, analysis, and systematization of explicit know- ledge. However, the greater part of organizational learning is experience based and intuitive. Identifying this knowledge, and transferring it to other parts of the organ- ization in order to utilize it more effectively, remains a fundamental management challenge.
- 44. CSAC05 1/13/07 9:21 Page 166 166 PART II THE TOOLS OF STRATEGY ANALYSIS Notes 1 The “resource-based view” is described in J. B. Barney, 13 D. Goleman, Emotional Intelligence (New York: “Firm Resources and Sustained Competitive Advantage,” Bantam, 1995). Journal of Management 17 (1991): 99–120; J. Mahoney 14 J. Barney, “Organizational Culture: Can It Be a Source and J. R. Pandian, “The Resource-Based View within the of Sustained Competitive Advantage?,” Academy of Conversation of Strategic Management,” Strategic Management Review 11 (1986): 656–65. Management Journal 13 (1992): 363–80; M. A. Peterlaf, 15 C. E. Helfat and M. Lieberman, “The Birth of “The Cornerstones of Competitive Advantage: A Capabilities: Market Entry and the Importance of Resource-Based View,” Strategic Management Journal 14 Prehistory,” Industrial and Corporate Change 12 (2002): (1993): 179–92; D. Collis and C. Montgomery, 725–60. “Competing on Resources: Strategy in the 1990s,” 16 G. Hamel and C. K. Prahalad argue (Harvard Business Harvard Business Review ( July–August 1995): 119–28. Review, May–June 1992: 164–5) that “the distinction 2 Ted Levitt (“Marketing Myopia,” Harvard Business between competencies and capabilities is purely Review, July–August 1960: 24– 47) proposed that the semantic.” answer to such volatily was for firms to define their 17 P Selznick, Leadership in Administration: A Sociological . markets broadly rather than narrowly. Railroad Interpretation (New York: Harper & Row, 1957). companies should view themselves as in the 18 C. K. Prahalad and G. Hamel, “The Core Competence transportation business; oil companies should think of of the Corporation,” op. cit. themselves as energy companies. The fact is that 19 G. Hamel and C. K. Prahalad, letter, Harvard Business railroad companies that entered airlines and road Review (May–June 1992): 164–5. transportation generally performed poorly, as did the oil 20 Porter’s value chain is the main framework of his companies that went into coal, nuclear energy, and solar Competitive Advantage (New York: Free Press, 1984). power. McKinsey & Company refers to the firm’s value chain as 3 J. Kay, “Resource Based Strategy,” Financial Times its “business system.” See: C. F. Bates, P Chatterjee, . (September 27, 1999). F. W Gluck, D. Gogel, and A. Puri, “The Business . 4 C. K. Prahalad and G. Hamel, “The Core Competence System: A New Tool for Strategy Formulation and Cost of the Corporation,” Harvard Business Review Analysis,” in McKinsey on Strategy (Boston: McKinsey (May–June 1990): 79–91. & Company, 2000). 5 “Olivetti: On the Ropes,” Economist (May 20, 1995): 21 R. R. Nelson and S. G. Winter, An Evolutionary Theory 60–1; “Olivetti Reinvents Itself Once More,” Wall Street of Economic Change (Cambridge, MA: Belknap, 1982). Journal (February 22, 1999): A.1. 22 As a result, specialists perform well in stable 6 www.remington-products.com. environments while generalists do well in variable 7 “Eastman Kodak: Meeting the Digital Challenge,” in conditions. ( J. Freeman and M. Hannan, “Niche Width R. M. Grant, Cases in Contemporary Strategy Analysis and the Dynamics of Organizational Populations,” 6th edn (Oxford, Blackwell, 2008). American Journal of Sociology 88, 1984: 1116– 45). 8 M. Tripsas, “Unraveling the Process of Creative 23 K. B. Clark and T. Fujimoto, Product Development Destruction: Complementary Assets and Incumbent Performance (New York: Free Press, 1991). Survival in the Typesetter Industry,” Strategic 24 See Richard Caves’ discussion of “specific assets” in Management Journal 18, Summer Special Issue (1997): “International Corporations: The Industrial Economics 119– 42; J. Bower and C. M. Christensen, “Disruptive of Foreign Investment,” Economica 38 (1971): 1–27. Technologies: Catching the Wave,” Harvard Business 25 G. Akerlof, “The Market for Lemons: Qualitative Review ( January–February 1995): 43–53. Uncertainty and the Market Mechanism,” Quarterly 9 J. W Trailer, “On the Theory of Rent and the Mechanics . Journal of Economics 84 (1970): 488–500. of Profitability,” CSU Chico, 2002 26 J. B. Barney, “Strategic Factor Markets: Expectations, (www.csuchico.edu/~jtrailer/Trailer.doc). Luck and Business Strategy,” Management Science 32 10 C. Fombrun, “The Value to be Found in Corporate (October 1986): 1231– 41. Reputation,” Financial Times Mastering Management 27 “Lenovo Makes Break With IBM Brand,” New York Series (December 4, 2000): 8–10. Times (April 11, 2006). 11 www.harrisinteractive.com. 28 I. Dierickx and K. Cool, “Asset Stock Accumulation and 12 E. Lawler, “From Job-Based to Competency-Based Sustainability of Competitive Advantage,” Management Organizations,” Journal of Organizational Behavior 15 Science 35 (1989): 1504–13. (1994): 3–15; L. Spencer, D. McClelland, and S. 29 “Goldman Sachs,” Economist (April 29, 2006): 77–80. Spencer, Competency Assessment Methods: History and 30 “Real Madrid: A Contingency Theory Explanation of State of the Art (Hay/McBer Research Group, 1994); How to Fail,” www.davidbruceallen.com/strategyoped. L. Spencer and S. Spencer, Competence At Work: 31 D. Miller, The Icarus Paradox: How Exceptional Models for Superior Performance (New York, Wiley: Companies Bring About Their Own Downfall (New 1993). York: Harper-Business, 1990).
- 45. CSAC05 1/13/07 9:21 Page 167 CHAPTER 5 ANALYZING RESOURCES AND CAPABILITIES 167 32 Benchnet: The Benchmarking Exchange 1978–1995,” Strategic Management Journal 21 (2000): (www.benchnet.com). 1016–81. 33 S. Walleck, D. O’Halloran, and C. Leader, 42 See, for example, M. Lyles, “Learning Among Joint- “Benchmarking World-Class Performance,” McKinsey venture Sophisticated Firms,” Management International Quarterly 1 (1991); “The Link Between Management Review 28, Special Issue (1988): 85–98; A. Mody, and Productivity,” McKinsey Quarterly (February 2006). “Learning Through Alliances,” Journal of Economic 34 C. Markldes, All the Right Moves (Boston: Harvard Behavior and Organization 20 (1993): 151–70; D. C. Business School Press, 1999). Mowery, J. E. Oxley, and B. S. Silverman, “Strategic 35 G. Hamel and C. K. Prahalad, Competing for the Future Alliances and Interfirm Knowledge Transfer,” Strategic (Boston: Harvard Business School Press, 1994). Management Journal 17, Winter Special Issue (1996): 36 S. Winter, “The Four Rs of Profitability: Rents, 77–93; A. C. Inkpen and M. M. Crossan, “Believing Is Resources, Routines, and Replication,” in C. Seeing: Joint Ventures and Organizational Learning,” Montgomery (ed.), Resource-Based and Evolutionary Journal of Management Studies 32 (1995): 595–618. Theories of the Firm (Boston: Kluwer, 1995): 147–78. 43 J. A. Badaracco, The Knowledge Link: How Firms 37 “Copy Exactly Factory Strategy” Compete Through Strategic Alliances (Boston: Harvard (www.intel.com/pressroom/kits/manufacturing/ Business School Press, 1991). copy-exactly.htm). See also: G. Szulanski and S. Winter, 44 G. Hamel, “Competition for Competence and Inter- “Getting it Right the Second Time,” Harvard Business partner Learning within International Strategic Review ( January 2002): 62–9; and C. Baden-Fuller and Alliances,” Strategic Management Journal 12, Summer S. G. 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Administrative Science Quarterly 48 (March 2003). 50 “The knowledge-based view” offers a rationale for the 41 Established firms typically fail to survive radical firm that is based on its effectiveness as an institution for innovation. See, for example, R. M. Henderson and creating, assembling, and transforming knowledge into K. B. Clark, “Architectural Innovation: The goods and services. See: B. Kogut and U. Zander, Reconfiguration of Existing Product Technologies and “Knowledge of the Firm, Combinative Capabilities and Failure of Established Firms,” Administrative Science the Replication of Technology, Organization Science Quarterly 35 (1990): 9–30; C. Christensen, “The Rigid 3 (1992): 387–99; R. M. Grant, “Toward a Knowledge- Disk Drive Industry: A History of Commercial and based Theory of the Firm,” Strategic Management Technological Turbulence,” Business History Review 67 Journal 17, Winter Special Issue (1996): 109–22. (1993): 531–88; M. 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