Resources and Capabilities of Organization

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 can do. Individual resources do not confer a competitive advantage, they must work together to create organizational capability. It is the capability that is the essence of superior performance. The relationship among resources, capabilities, 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 resources: tangible, intangible, 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 information, 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 its potential for creating a competitive advantage. Information that British Airways possesses tangible fixed assets with a book value of £8.2 billion is of little use in assessing its 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.

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:

• 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.
  
  
• What are the possibilities for employing existing assets more profitably?

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 valuations.

Company	Ratio	Country
Yahoo! Japan	72.0	japan
Colgate-Palmolive	20.8	US
GlaxoSmithKline	13.4	UK
Anheuser-Busch	12.6	US
eBay	11.2	US
SAP	10.8	Germany
Yahoo!	10.7	US
Dell Computer	10.0	US
Sumitomo Mitsui Financial	8.8	Japan
Procter & Gamble	8.4	US
Qualcomm	8.3	US
Schlumberger	8.2	US
Unilever	8.1	Neth./UK
PepsiCo	8.0	US
Coca-Cola	7.8	US
Diageo	7.4	UK
3M	7.3	US
Nokia	6.7	Finland
Sanofi-Aventis	6.3	France
AstraZeneca	5.9	UK
Johnson & Johnson	5.7	US
Boeing	5.7	US
Eli Lily	5.6	US
Cisco Systems	5.5	US
Roche Holding	5.5	Switz.
L’Oreal	5.3	France
Altria	5.2	US
Novartis	5.1	Switz.

Among the most important of these undervalued or unvalued intangible resources are brand names. 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 volume, then calculating the present value of this revenue stream.

The brand valuations 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, and 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.

Rank	Brand	Brand value in 2006, $ billion	Change from 2004	Country of origin
1	Coca-Cola	67.5	0%	USA
2	Microsoft	59.5	−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
20	Samsung	15.0	+19%	S. Korea

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.

Harris Interactive shows Johnson & Johnson followed by Coca-Cola, Google, UPS, and 3M to have the highest “reputation quotients.”

Like reputation, technology is an intangible asset whose value is not evident from most companies’ balance sheets. Intellectual property – patents, copyrights, trade secrets, and trademarks – comprise technological and artistic resources where ownership is defined in law. Over the past 20 years, companies have become more attentive to the value of their intellectual property.

Texas Instruments was one of the first companies to begin managing its patent portfolio to maximize its licensing revenues. For some companies, their ownership of intellectual property is a key source of their market value.

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. Identifying 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 employment, e.g. through annual performance reviews.

Companies are continually seeking more effective methods to assess the performance 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 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.

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 the recognition of the importance of psychological and social aptitudes in linking technical and professional abilities to overall job performance. Recent interest in emotional intelligence reflects growing recognition of the importance of social and emotional skills and values.

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.

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Organizational Capabilities

Resources are not productive on their own. A brain surgeon is close to useless without 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 result.”

Just as an individual may be capable of playing the violin, ice skating, and speaking Mandarin, 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.

Our primary interest is in those capabilities that can provide a basis for competitive advantage. Selznick used distinctive competence to describe those things that an organization does particularly well relative to its competitors. Prahalad and Hamel coined the term core competencies to distinguish those capabilities fundamental to a firm’s strategy and performance.

Core competencies, according to Hamel and Prahalad, are those that:

• Make a disproportionate contribution to ultimate customer value, or to the efficiency with which that value is delivered, and
  
  
• Provide a basis for entering new markets.

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 market. RCA introduced its videodisk system, and 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 disaggregating its activities. Two approaches are commonly used:

• A functional analysis identifies the organizational capabilities of each of the principal functional areas of the firm. Table 9.3 classifies the principal functions of the firm and identifies the organizational capabilities of each function.
  
  
• 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.
  
  
  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 activities (and the capabilities that correspond to each activity). Thus, marketing might include market research, test marketing, advertising, promotion, pricing, and dealer relations.

Functional Area	Capability	Exemplars
Corporate Functions	Financial control Strategic management of multiple businesses Strategic innovation Multi-divisional coordination Acquisition management International management	Exxon Mobil, PepsiCo General Electric, Procter & Gamble BP, Google Unilever, Shell Cisco, Bank of America Shell, Citigroup
Management Information	Comprehensive, integrated MIS network linked to managerial decision making	Wal-Mart, Capital One, Dell Computer
Research & Development	Research Innovative new product development Fast-cycle new product development	IBM, Merck 3M, Apple Canon, Inditex (Zara)
Operations	Efficiency in volume manufacturing Continuous improvements in operations Flexibility and speed or response	Briggs & Stratton, YKK Toyota, Harley-Davidson Four Season Hotels
Product Design Marketing	Design capability Brand management Promoting reputation for quality Responsiveness to market trends	Nokia, Apple Computer P&G, Altria Johnson & Johnson MTV, L’Oreal
Sales and Distribution	Effective sales promotion and execution Efficiency and speed of order processing Speed of Distribution Quality and effectiveness of customer service	PepsiCo, Pfizer L.L. Bean, Dell Computer Amazon.com Singapore Airlines, Caterpillar

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 cars and launching them globally? We can guess, but the fact remains: we don’t 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 direction. 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.

Such routines form the basis of most organizational 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 several standardized, complementary routines. Even top management functions comprise routines for monitoring business unit performance, capital budgeting, and strategic planning.

Like individual skills, organizational routines develop through learning by doing. Just as individual skills become rusty when not exercised, it is difficult for organizations to retain coordinated responses to contingencies that arise only rarely. Hence, there may be a trade-off 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.

Routinisation is an essential step in translating directions and operating practices into capabilities. In every McDonald’s hamburger restaurant, operating manuals provide 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.

Hierarchy of Capabilities

Whether we examine capabilities from a functional 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 general, broadly defined capabilities are formed from the integration of more specialized capabilities. For example:

• A hospital’s capability in treating heart disease depends on its integration of capabilities about a patient’s diagnosis, physical medicine, cardiovascular surgery, pre-and post-operative care, as well as capabilities relating to various administrative and support functions.
  
  
• 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.

Offers a partial view of the hierarchy of capabilities of a telecom equipment 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 problem 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 Honda has been a key reason for these firms’ fast-cycle new product development compared with the US and European car companies.

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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: its 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 several resource characteristics.

Establishing Competitive Advantage

For a resource or capability to establish a competitive advantage, two conditions must be present:

• 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 of finding new reserves. However, these technologies are widely available from oilfield services and IT companies. As a result, such technologies are “needed to play,” but they are not sufficient to win.
  
  
• 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, 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 a 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 over 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.

Sources of immobility include:

• 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.
  
  
• Imperfect information regarding the quality and productivity of resources creates risks for buyers. Such imperfections are especially important in 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. Jay Barney has shown that different valuations of resources by firms can result in their either being underpriced or overpriced, giving rise to differences in profitability between firms.
  
  
• Complementarity between resources means that the detachment of a resource from its “home team” causes it to lose productivity and value. Thus, if brand 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.
  
  
• 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

Replicability: If a firm cannot buy a resource or capability, it must build it. In financial 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. 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 requires advanced manufacturing technologies nor 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 a disproportionate cost by would-be imitators. Dierickx and Cool identify two major sources of incumbency advantage:

• Asset mass efficiencies occur where a strong initial position in technology, distribution channels, or reputation facilitates the subsequent accumulation of these resources.
  
  
• 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.

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 competitive advantage.

In investment banks and other human capital-intensive firms, the struggle between employees and shareholders to appropriate rents is reminiscent of the war for surplus value between labor and capital that Marx analyzed. The prevalence 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 their human resources.

The less clearly defined 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 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 individual skills and knowledge within organizational 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 individual employee’s contribution to productivity is identifiable, if the employee 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.

In recent years investment banks and consulting companies have emphasized the team-based nature of their capabilities. In downplaying the role of individual expertise, they can improve their firm’s potential for appropriating the returns to their capabilities.

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Placing Resource and Capability Analysis to Work

We have covered the principal concepts and frameworks for analyzing resources and capabilities. How do we put this analysis into practice? Let us discuss the 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. What factors determine why some firms in an industry are more successful 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 cyclicality 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 capabilities, effective supply chain management, global distribution, 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.

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 sustainable competitive advantage? Second, where are our strengths and weaknesses as compared with competitors?

Assessing Importance

The temptation in assessing which resources and capabilities 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 “Appraising Resources and Capabilities.”

In the case of VW, many resources and capabilities are essential to compete 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 competencies, organizations frequently fall victim to past glories, hopes for the future, and wishful thinking. The tendency toward hubris among companies – and their senior managers – means that business success often sows the seeds of its destruction. Among the failed industrial companies 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 company 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, benchmarking 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.” Benchmarking offers a systematic framework and methodology for identifying particular functions and processes and then for comparing their performance with other companies.

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. Federal Express, 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 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 distinctive capabilities, but a failure to recognize what they are and to deploy them effectively.

Bringing Together Importance and Relative Strength

Putting together the two criteria – importance and relative strength – allows us to highlight a company’s key strengths and key weaknesses. Consider, for example, Volkswagen AG. 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

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 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 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 capabilities 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 previous period.

The most decisive – and often most successful – solution to weaknesses in key functions is to outsource. Thus, in the automobile industry, companies have become increasingly selective in the activities they perform internally. Through clever strategy formulation, a firm may be able to negate the impact of its key weaknesses.

What about Superfluous Strengths?

What about those resources and capabilities where a company has particular strengths, but these don’t appear to be important 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, it is possible to develop innovative strategies that turn inconsequential strengths into valuable resources and capabilities.

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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 investments may deliver limited returns. In the case of capabilities, because we know little about their structure or operation, developing them is a hazardous endeavor.

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 European football (soccer), teams built with modest expenditures often outplay star-studded, big-budget teams. 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 demonstrate the most outstanding capabilities are not necessarily those with the greatest resource endowments:

• In automobiles, General Motors has four times the output of Honda and four times the R&D expenditure, yet it is Honda, not General Motors, that is the world leader in power train technology.
  
  
• 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.
  
  
• In telecom equipment, it was the upstart Aircel rather than industry leaders Vodafone, Airtel, Idea Cellular, and Reliance 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:

• 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.
  
  
• Accumulating resources through mining experience to achieve faster learning, and borrowing from other firms – accessing their resources and capabilities through alliances, outsourcing arrangements, and the like.
  
  
• Complementing resources involves increasing their effectiveness by 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.
  
  
• 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.

Replicating Capabilities

Growing capabilities requires that the firm replicates them internally. 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 – Nike, Reebok, and Levis – have built a 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 knowledge that underlies the capability – typically through the formulation of standard operating procedures. Thus, McDonald’s has distilled its business system into operating 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 semiconductor 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.”

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 period?

We know that capabilities involve teams of resources working together, but, even with the tools of business process mapping, we typically have a 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 importantly, 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 established its distribution system. How does one explain Wal-Mart’s amazing commitment to cost efficiency? Its management systems are undoubtedly important, but ultimately it is Walmart’s origins in small-town Arkansas and the values and personality of its founder, Sam Walton, that sustain its obsession with efficiency and cost-cutting.

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 to new circumstances. Dorothy Leonard argues that core capabilities are simultaneously core rigidities – they inhibit firms’ ability to access and develop new capabilities.

Nevertheless, some companies 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 competencies to address rapidly changing environments.”

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 capabilities. Zollo and Winter define dynamic capabilities as higher-level processes through which the firm modifies its operating routines.

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 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 competence destroying. In TV manufacturing, the most successful new entrants were existing producers of radios – the new technology was compatible with their capabilities. However, in most new industries, the most successful firms tend to be start-ups rather than established firms.

In personal computers, it was newcomers such as Dell, Acer, and Compaq 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 start-ups – Vodafone, Idea Cellular, Reliance – that were more successful than established telephone companies.

Approaches to Capability Development

So, how do companies go about developing new capabilities? Let us review a few approaches commonly utilized.

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 multiple acquisitions. Each year, Microsoft hosts its VC Summit, where venture capitalists from all over the world are invited to market their companies. However, using acquisitions as a means of extending a company’s capability base involves major risks.

On its own, the 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 and the personality of management 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 acquiring 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. The long-running technical collaboration between HP and Canon has allowed both firms to enhance their printer technology.

Strategic alliances comprise a wide variety of collaborative relationships, which include joint research, technology-sharing arrangements, shared manufacturing, joint marketing and/or distribution 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 to acquire the partner’s capabilities through organizational learning.

Creating Capabilities

Creating organizational capability requires, first, acquiring the necessary resources and, second, integrating these resources. Concerning 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 challenge. 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 the role of management in developing organizational capability through motivation and deliberate learning. Organizational structure and management systems are of particular importance:

• 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 than through a sequence of “over-the-wall” transfers from one functional department to another.
  
  
  Similarly, capabilities in quality management, change management, and corporate social responsibility customer are all best developed when organizational units are dedicated to such activities. Inevitably, aligning organizational structure with multiple capabilities creates organizational complexity.
  
  
• 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.
  
  
  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 is one relatively well-developed area.
  
  
  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.

Given the complexity and uncertainty of programs to develop new organizational capabilities, an indirect approach may be preferable. If we cannot design new capabilities from scratch, but if we know what types of capabilities are required for different 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.

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 a process is knowledge management.