Lecture 5:

Internal environmental audit – Strategic

capabilities

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 Topic Outline
I. Introduction

II. Foundations of strategic capabilities

III. ‘VRIO’ strategic capabilities as a basis of competitive advantage

IV. Diagnosing strategic capabilities

V. Managing strategic capabilities

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 I. Introduction
Strategic capabilities: the key issues

Figure 3.1 Strategic capabilities: the key issues (course book)

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 Resource-based strategy
The resource-based view (RBV) of strategy asserts
that the competitive advantage and superior
performance of an organisation is explained by the
distinctiveness of its capabilities.
 Managers need to understand how their
organizations are different from their rivals in ways
that may be the basis of achieving competitive
advantage and superior performance.

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II. Foundations of strategic capabilities
1. Resources and competences
2. Dynamic capabilities
3. Threshold and distinctive capabilities
4. Core competences

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 1. Resources and competences
• Strategic capabilities are capabilities of an
organization that contribute to its long-term
survival or competitive advantage.
• There are two components of strategic capabilities:
– Resources are the assets that organisations have or can
call upon (e.g. from partners or suppliers),that is, ‘what
we have’ .
– Competences are the ways those assets are used or
deployed effectively, that is, what we do well’.

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Components of strategic capabilities

Table 3.1 Components of strategic capabilities

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 2. Dynamic capabilities
Dynamic capability is the ability of an organisation
to renew and recreate its strategic capabilities to
meet the needs of changing environments.

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 3. Threshold and distinctive
capabilities (1)
• Threshold capabilities are those needed for an
organisation to meet the necessary requirements
to compete in a given market and achieve parity
with competitors in that market – ‘qualifiers’.
• Distinctive capabilities are those that critically
underpin competitive advantage and that others
cannot imitate or obtain – ‘winners’.

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 Threshold and distinctive capabilities (2)

Competitive advantage is explained by the distinctiveness of capabilities:

 Distinctive resources (e.g. a long-established brand)
 Distinctive competences: ways of doing things that are unique
to that organization and effectively utilized so as to be valuable
to customers and difficult for competitors to obtain or imitate.
(AKA as core competence)

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 4. Core competences
Core competences1 are the linked set of skills,
activities and resources that, together:
• deliver customer value
• differentiate a business from its competitors
• potentially, can be extended and developed as
markets change or new opportunities arise.
1
G. Hamel and C.K. Prahalad, ‘The core competence of the corporation’,
Harvard Business Review, vol. 68, no. 3 (1990),
pp. 79–91.

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 III. VRIO strategic capabilities as a basis of
competitive advantage
The four key criteria by which capabilities can
be assessed in terms of providing a basis for
achieving sustainable competitive advantage are:
•value,
•rarity,
•inimitability and
•non-substitutability

1 Jay Barney: ‘Firm resources and sustained competitive advantage’, Journal

of Management, vol. 17 (1991), no. 1, pp. 99–120.
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Criteria for the inimitability of strategic
capabilities

Figure 3.3 VRIN (course book 10th ed.)

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 1. V – Value of strategic capabilities
Strategic capabilities are of value when they:
• take advantage of opportunities and neutralise
threats,
• provide value to customers
• provide potential competitive advantage
• at a cost that allows an organisation to realise
acceptable levels of return

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 2. R - Rarity
• Rare capabilities are those possessed uniquely by
one organisation or by a few others only. (E.g. a
company may have patented products, have
supremely talented people or a powerful brand.)
• Rarity could be temporary.
(Eg: Patents expire, key individuals can leave or
brands can be de-valued by adverse publicity.)

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 3. Inimitability
Inimitable capabilities are those that competitors find
difficult to imitate or obtain.
• Competitive advantage can be built on unique
resources (a key individual or IT system) but these
may not be sustainable (key people leave or others
acquire the same systems).
• Sustainable advantage is more often found in
competences (the way resources are managed,
developed and deployed) and the way competences
are linked together and integrated.

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Criteria for the inimitability of strategic
capabilities

Figure 3.3 Criteria for the inimitability of strategic capabilities (course book)

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 4. N – Non-substitutability
Competitive advantage may not be sustainable if
there is a threat of substitution.
• Product or service substitution from a different
industry/market. For example, postal services
partly substituted by e-mail.
• Competence substitution. For example, a skill
substituted by expert systems or IT solutions

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 5. Organisational knowledge
Organisational knowledge is the collective
intelligence, specific to an organisation,
accumulated through both formal systems and the
shared experience of people in that organisation.
– Explicit/objective knowledge is transmitted in formal
systematic ways (e.g. System manuals, files of market
research and intelligence).
– Tacit knowledge: that is, more personal, context-specific
and hard to formalise and communicate – so it is
difficult to imitate, for example, the knowledge and
relationships in a top R&D team.
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 Example of VRIN/VRIO assessment
• Illustration 3.3 (course book, p.81): Groupon
and the sincerest form of flattery
• Group discussion to answer 3 questions at the
end of the case.

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 IV. Diagnosing strategic capabilities
1. Benchmarking
2. The value chain and the value system
3. Activity systems
4. SWOT

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 1. Benchmarking
Benchmarking is a means of understanding how an
organisation compares with others – typically
competitors.
Two approaches to benchmarking:
• Industry/sector benchmarking - comparing
performance against other organisations in the same
industry/sector against a set of performance indicators.
• Best-in-class benchmarking - comparing an
organisation’s performance or capabilities against ‘best-
in-class’ performance – wherever that is found even in
a very different industry. (E.g. BA benchmarked its
refuelling operations against Formula 1).

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 2. The value chain and the value system
a. The value chain
• The value chain describes the categories of
activities within an organisation which, together,
create a product or service.
• The value chain invites the strategist to think of an
organisation in terms of sets of activities – sources
of competitive advantage can be analysed in any or
all of these activities.

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 The value chain (cont)

Figure 3.4 The value chain within an organization (course book)

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 Uses of the value chain
• A generic description of activities – understanding
the discrete activities and how they both contribute
to consumer benefit and how they add to cost.
• Identifying activities where the organisation has
particular strengths or weaknesses
• Analysing the competitive position of the
organisation using the VRIN criteria – thus
identifying sources of sustainable advantage.
• Looking for ways to enhance value or decrease cost
in value activities (e.g. outsourcing)

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 b. The value system
• The value system comprises the set of inter-
organisational links and relationships that are
necessary to create a product or service.
• Competitive advantage can be derived from
linkages within the value system.

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The value system (cont)

Figure 3.5 The value system (course book)

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 Uses of the value system
• Understanding cost/price structures across the
value network – analysing the best area of focus
and the best business model .
• Identifying ‘profit pools’ within the value network
and seek to exploit these.
• The ‘make or buy’ decision: deciding which
activities to do ‘in-house’ and which to outsource.
• Partnering and relationships – deciding who to
work with and the nature of these relationships.

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 3. Activity system
Mapping activity systems:
• Identify ‘higher order strategic themes’ that is, how
the organisation meets the critical success factors
in the market.
• Identify the clusters of activities that underpin
these themes and how they fit together.
• Map this in terms of how activity systems are
interrelated.

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 Mapping activity systems (1)
• Identify ‘higher order strategic themes’ that is, how
the organisation meets the critical success factors
in the market.
• Identify the clusters of activities that underpin
these themes and how they fit together.
• Map this in terms of how activity systems are
interrelated.

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E.g. Mapping activity systems at GK

Illustration 3.5 Activity systems at Geelmuyden.Kiese (course book) 31

 Using activity system maps
• A means of identifying strategic capabilities in
terms of linkages of activities
• Internal and external links are identified (e.g. in
terms of the needs of customers).
• Therefore helps identify bases of competitive
advantage.
• And sustainable advantage for example, in terms
of bases of inimitability.

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 4. SWOT analysis
SWOT summarises the strengths, weaknesses,
opportunities and threats likely to impact on
strategy development.

INTERNAL STRENGTHSWEAKNESSES
ANAYSIS

EXTERNAL OPPORTUNITIES THREATS

ANALYSIS
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 Uses of SWOT analysis
• Key environmental impacts are identified using the
analytical tools explained in Chapter 2.
• Major strengths and weaknesses are identified using
the analytic tools explained in Chapter 3.
• Scoring (e.g. + 5 to - 5) can be used to assess the
interrelationship between environmental impacts and
the strengths and weaknesses.
• SWOT can be used to examine strengths, weaknesses,
opportunities and threats in relation to competitors.
• SWOT can be used to generate strategic options– using
a TOWS matrix.
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The TOWS matrix

Figure 3.6 : The TOWS matrix (course book)

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 Dangers in a SWOT analysis
• Long lists with no attempt at prioritisation.
• Over generalisation – sweeping statements often
based on biased and unsupported opinions.
• SWOT is used as a substitute for analysis – it
should result from detailed analysis using the
frameworks in Chapters 2 and 3.
• SWOT is not used to guide strategy – it is seen as
an end in itself.

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 V. Managing strategic capability
Internal capability development:
• Leveraging capabilities – identifying capabilities in
one part of the organisation and transferring them
to other parts (sharing best practice).
• Stretching capabilities - building new products or
services out of existing capabilities.

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 Managing strategic capabilities (cont)
• External capability development – adding capabilities
through mergers, acquisitions or alliances.
• Ceasing activities – non-core activities can be
stopped, outsourced or reduced in cost.
• Monitor outputs and benefits – to understand
sources of consumer benefit and enhance anything
that contributes to this.
• Managing the capabilities of people – training,
development and organisation learning.

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Essential readings:
• Chapter 3: Strategic capabilities
Course book: Johnson, G. et al (2014). Exploring
strategy: text and cases. Harlow: Pearson.
• Case study for group discussion in tutorials for
assignment 2:
“Rocket Internet – will the copycat be imitated?
(course book, p.102)

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