Firm Capabilities: Assessing Strengths and Weaknesses ppt

CHAPTER OUTLINE CASE 1: Pizza Hut CASE 2: General Motors Corporation Introduction The Value Chain Primary Activities Support Activities Pizza Industry Value Chain Primary Activities Supp

CHAPTER OUTLINE

CASE 1: Pizza Hut

CASE 2: General Motors Corporation

Introduction

The Value Chain

Primary Activities Support Activities

Pizza Industry Value Chain

Primary Activities Support Activities

Automobile Industry Value Chain

Primary Activities Support Activities

The Value Chain as Part

of a Business System

Pizza Hut General Motors

Capability Drivers

First-Mover Status Scale of Operation Experience Interrelationships

Assessing Competitive Advantage

First-Mover Advantages Scale and Experience Advantages

The Growth of the Internet and

Competitive Advantage Diagnosing Pizza Hut’s Capabilities

First-Mover Advantages Scale Advantages Experience Benefits Interrelationships

Achilles’ Heel of Established Firms

Assessing the Financial Position of

Engaging in Industrial Espionage

“Pirating” Employees

Conclusion Summary Exercises and Discussion Questions

WHAT YOU WILL LEARN

• The strategic tool known as the valuechain

• The use of the value chain inevaluating an organization’s internalstrengths and weaknesses

• The differences between primary andsupporting value-adding activities

• The concept of competitiveadvantage

• The concept of distinctivecompetence

• Some important economic sources

of competitive advantage

Pizza Hut, a division of Tricon Global Restaurants, is the

largest seller of pizza in the world As such, it enjoys unique

advantages not available to smaller rivals These advantages

have contributed significantly to its success in recent years,

enabling it to outperform the industry by a considerable

mar-gin in both revenue and growth Among the most important

advantages Pizza Hut enjoys as a result of its leadership

posi-tion are the following:

• Location: As the first competitor to establish a facility in

many high-traffic areas, it has been able to preempt some

of the most desirable restaurant locations.

• Reputation: It is better known by consumers than are

rivals This distinction provides it an important

marketing edge.

• Advertising clout: Because it can spread TV advertising

costs over so many units, it can afford to advertise on

nationwide TV; most rivals, having fewer units, are

effectively barred from this important advertising medium.

• Purchase discounts: Its large-scale purchase of advertising

time and food ingredients enables it to enjoy quantity

discounts not available to smaller competitors.

• Interrelationships: Its interrelationships with other units of

Tricon Global Restaurants, including Kentucky Fried

Chicken (KFC) and Taco Bell, enable Pizza Hut to gain significant negotiation leverage with advertising firms to conduct jointly sponsored marketing campaigns In addition, all three restaurant chains were once part of PepsiCo, the nation’s second largest provider of beverages and the leader in snack foods through Frito-Lay Even though all three restaurants are now formally separated from PepsiCo, they still closely work with Pepsi to secure lower cost beverages and other supplies from their former parent These advantages are not available to smaller rivals operating as single business firms.

Even with these many strengths, Pizza Hut has suffered its share of setbacks in the past Perhaps the most serious resulted from its refusal for many years to supply the growing demand for home delivery of cooked pizza This policy left the home delivery niche open to competitors Pizza Hut has since changed its stance and is now making a concerted effort to build market share in this area by opening up a series of pizza prepa- ration facilities that are solely dedicated to home delivery How- ever, it faces a series of formidable competitors—Domino’s Pizza, Pizza Inn, Little Caesar’s—all of whom have made seri- ous inroads into this market.

Despite its status as the world’s largest auto manufacturer,

General Motors has performed poorly in recent years,

suffer-ing a steady decline in market share (from 50 percent in 1979

to 35 percent in 1997), closing many factories, enduring

numerous strikes at its auto and parts plants, and laying off

thousands of workers Why has GM performed so poorly over

the past two decades? The most likely factors are several

weak-nesses that continue to plague General Motors, despite

numer-ous attempts to revitalize and improve its operations.

High Wage Costs

Even with steep appreciation in the value of the Japanese yen

during the 1990s, GM’s wage costs per hour still remained

higher than those of its Japanese competitors until very

recently This differential was particularly wide during the

1970s when Japanese companies first began their assault on the

U.S market The wage gap resulted in part from the historically lower wages paid to Japanese workers However, GM’s rela- tively high wage costs resulted mainly from its failure to improve productivity and to accurately assess the growing strengths of its foreign competitors When compared with Ford and Chrysler as recently as 1998, GM’s employee productivity per car was still anywhere from 40 percent to 60 percent lower The comparatively low productivity of GM resulted from the company’s inability to adjust to massive changes in the auto- mobile industry environment over the past two decades During the 1970s, GM, along with Ford and Chrysler, oper- ated in a relatively predictable environment that was insulated from significant foreign competition Within this safe cocoon, U.S firms were able to charge high prices and enjoy handsome profits Workers soon demanded a share in this prosperity in the form of higher wages and benefits Because foreign competition

appeared limited and current productivity levels appeared

satis-factory, GM management allowed personnel costs to rise to high

levels The net result was wage costs much higher than those of

Japanese auto makers, putting GM at a serious disadvantage just

at the time when it most needed competitive strength to ward off

growing amounts of foreign competition However, Chrysler and

Ford were pushed much closer to the brink of bankruptcy during

several downturns in the 1980s and 1990s than GM; some

ana-lysts have noted that this “taste of death” has forced important

changes in the way that both Chrysler and Ford design and build

their cars for a more demanding market GM, on the other hand,

was still large enough to avoid almost complete collapse.

Disgruntled Work Force

Despite high wages, GM workers have remained generally

unsatisfied in recent years Employees at GM felt alienated

from management, resulting in high absenteeism, shoddy work,

union rules limiting the tasks workers can perform, and general

hostility towards management These factors have led GM

workers to be less diligent and less enthusiastic about seeking

improvements in production methods than their counterparts in

other firms As a result, GM’s productivity dropped

signifi-cantly below that of competitors.

Lack of Focus in Manufacturing

GM makes more (and buys less) of the components it uses to

assemble cars than its rivals GM must therefore spend more on

factories, plants, and equipment than its competitors to build these components General Motors’ internal parts-making unit, known as Delphi Automotive Systems, produces a whole range

of different components and parts, ranging from automotive electronics to powertrains and engines However, Delphi faces many of the same labor-related and productivity problems that plague GM’s automotive assembly operations While a high degree of self-contained manufacturing can sometimes be an advantage, it turned out to be a weakness for GM High wages and worker alienation also plague GM’s component facilities,

so the components they supply are often more expensive, less well designed, and less conveniently delivered than similar items available from outside suppliers Oftentimes, outside sup- pliers can make components at far less cost and better quality than GM can.

Bureaucratic Delays

Because of its large size, GM experiences greater difficulty making and implementing decisions than its smaller competi- tors, often slowing its adaptation to changes in the industry environment For example, it lagged behind Japanese rivals in seizing new opportunities for engine computerization and fuel efficient automobiles Even routine changes such as new model introduction pose difficulties for GM Its introduction of the Cadillac Seville in the early 1990s, for example, was delayed for almost a year because of difficulties with the design, paint system, and quality control.

INTRODUCTION

To identify opportunities and to neutralize threats in the external environment, managers

must thoroughly evaluate their firm’s potential capabilities to compete A significant part

of successful strategy formulation depends on a careful assessment of the firm’s strengths

and weaknesses This requires each firm to conduct an internal analysis to determine those

activities it can perform better than its competitors Finding those activities or resources

that allow the firm to perform in ways that other competitors cannot do as well is one key

to developing effective strategies Even though numerous rivals may compete in the same

industry environment, some firms are likely to perform some activities better than others

Thus, each firm has its own particular set of strengths and weaknesses that influences how

it competes

This chapter examines the concept of firm capabilities and internal analysis of

strengths and weaknesses Developing effective strategies requires managers to

under-stand how each firm’s strengths and weaknesses may differ from those of competitors

These differences lay the foundation on which each firm bases its own strategy in the

competitive environment We begin by examining the concept of the value chain The

value chain is an analytical tool that helps firms understand how their primary and

sup-porting activities can be used to create value It is the starting point for helping firms

identify their strengths and weaknesses We will then apply the value chain analysis

tool to examine the types of activities that occur in two different industries: pizzas and

automobiles In a later section, we discuss other issues related to developing firm bilities outside of the value chain, such as financial analysis and internal organization.

capa-THE VALUE CHAIN

To understand how a firm builds its capabilities to compete, one must identify the specifictypes of activities that make up the firm’s competitive posture Every firm engages innumerous activities that, in sum, determine its competitiveness in serving customers in themarketplace These activities create economic value A useful analytical tool for portray-ing and analyzing these activities is the value chain shown in Exhibit 3-1.3The value chain

describes all of the activities that make up the economic performance and capabilities of

the firm It portrays activities required to create value for customers of a given product or

service As such, the value chain is an excellent means by which managers can determinethe strengths and weaknesses of each activity vis-a-vis the firm’s competitors

The value chain classifies each firm’s activities into two broad categories: primary

activities and support activities Primary activities relate directly to the actual creation,

development, manufacture, distribution, sale, and servicing of the product or serviceoffered to the firm’s customer These activities represent the key tasks a firm performs to

produce and deliver a product or service to a customer Support activities refer to those

tasks that contribute to or assist the firm’s primary activities In other words, support

activ-e x h i b i t (3-1) The Value Chain

value chain: an analytical

tool that describes all

activities that make up the

economic performance and

capabilities of the firm; used

to analyze and examine

activities that create value

for a given firm.

primary activities:

economic activities that

relate directly to the actual

creation, manufacture,

distribution, and sale of a

product or service to the

firm’s customer (see

support activities).

support activities:

economic activities that

assist the firm’s primary

activities (see primary

activities).

Reprinted/Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc from COMPETITIVE ADVANTAGE: Creating

and Sustaining Superior Performance, by Michael E Porter Copyright © 1985 by Michael E Porter.

ities work to enhance or to help the functioning of primary value-adding activities The

combination of both primary and support activities determines the firm’s basis for adding

value By breaking up the firm’s value chain into discrete, isolated centers of activity,

man-agers can assess whether they are performing each activity in ways that are better than that

of their competitors (for example, lower cost, better quality, faster delivery) In other

words, it is not enough to say that one firm is better than another in some overall way; the

value chain allows managers to compare their firm’s specific activities with the same

activ-ities performed by competitors Thus, comparing a firm’s chain with that of competitors

can provide valuable insight on each firm’s individual strengths and weaknesses

Activities in the value chain can be characterized as being upstream or downstream

Upstream activities occur far away from the consumer, closer to the firm’s suppliers In

other words, upstream activities are performed in the early stages of the value-adding

process Downstream activities occur closer to the firm’s buyers Downstream activities

add value to those inputs that were processed through earlier upstream value-adding

activities

Primary Activities

The sequence of activities through which raw materials are transformed into benefits

enjoyed by customers are called primary activities These activities are shown along the

bottom row of Exhibit 3-1 Five major activities make up this sequence: inbound logistics,

operations, outbound logistics, marketing/sales, and service Working together, these five

activities determine the key operational tasks surrounding the product or service

• Inbound logistics: In most industries, the transformation process begins with

conveyance or delivery of raw materials to a firm’s manufacturing (or service)

facilities

• Operations: Inputs are transformed into products

• Outbound logistics: Products are shipped to distributors or to final users

• Marketing/sales: Users are informed about products and encouraged to buy them

• Service: Once in the customers’ hands, products are installed, repaired, and

maintained

Let us now examine more closely the specific tasks and operational procedures that make

up these five primary activities

Inbound Logistics. As the words imply, inbound logistics deal with the handling of

materials and inventory received from the firm’s suppliers The typical operational

proce-dures and tasks surrounding inbound logistics include warehousing, storage, and control

of raw materials or managing component flows from different suppliers Inbound logistics

are considered a primary activity because they represent the beginning of the firm’s

value-adding conversion of inputs Inbound logistics represent a major source of direct costs to

the firm; thus, new techniques and improvements in inventory control, storage, and

mate-rials handling can dramatically improve a firm’s cost position in this activity Differences

in storage and inventory costs relative to one’s competitors can add up to a significant

com-petitive strength or weakness

In many firms, inbound logistics require significant capital investment The location

and management of warehouses, and the inventory held in them are important areas in

which to focus cost control and efficiency Many manufacturers around the world have

taken numerous steps in recent years to improve the efficiency and reduce costs involved

with inbound logistics activities At General Electric, for example, the huge dishwasher

and refrigerator plant at Louisville, Kentucky, uses highly automated bar-coding, sorting,

upstream activities:

economic activities that occur close to the firm’s suppliers but far away from the consumer Examples include inbound logistics, procurement, manufacturing, and operations (see also downstream activities).

downstream activities:

economic activities that occur close to the customer but far away from the firm’s suppliers Examples include outbound logistics, distribution, marketing, sales, and service (see also upstream activities).

and inventory checking systems that enable GE to move components and parts quicklyfrom the railhead to its factory Parts and components do not sit idle in warehouses forlong Fast movement of components and inventory greatly reduces the operating costs forthe entire Major Home Appliance Group business.

Improvements in inbound logistics activities are not confined to manufacturing firms.For example, both United Parcel Service (UPS) and Federal Express (now FedEx) havebuilt strong competitive positions by using techniques that promote super-efficient, time-responsive sorting of packages and overnight mail Both firms expect their business togrow with the rise of on-line through the Internet and e-commerce Banks and financialservice firms depend on extremely automated, real-time, and efficient inbound logistics tomanage, coordinate, and track the flow of payments and funds that enter their systems fordifferent purposes such as credit card payments, investments, and cash management

Operations. Operations are the activities and procedures that transform raw materials,components, and other inputs into finished end products In other words, operations con-cerns itself with the generation, manufacture, and/or production of products and services.Specific task activities in the operations realm include stamping, machining, testing, fab-

rication, and assembly In a broader sense, any type of processing activity that results in a

product or service is the heart of the firm’s operations Operations also represents the inant upstream activity in many firms Success in managing and improving upstream oper-ations over time represents a critical source of leverage in building or reinforcing a firm’sability to compete in a sustained manner Differences between firms conducting similartypes of operations may result from relative age of equipment, type of technology used,size of plant, economies of scale, productivity levels and gains, wage rates, and possibleimprovements resulting from longer experience

dom-In many ways, how a firm manages its production/transformation operations willstrongly influence the entire firm’s competitive posture For example, in the chemical, oilrefining, and paper industries, the dominant production mode is that of continuous flowprocesses Continuous flow processes are characterized by rigid and dedicated productionsystems geared to the standardized production of a single or limited range of products.These capital-intensive processes are costly to operate and hard to switch between prod-ucts; they represent very large fixed costs for the firm Any disruption of a continuous flowprocess generates enormous down-time costs for the firm As a result, firms in industrieswhose dominant production mode is that of continuous flow processes are likely todevelop strategies that recognize the nature of the production process’s high fixed costs,rigidity, and lack of flexibility in switching to alternative products

The considerable focus and effort that firms have placed on implementing total ity improvement (TQM) in manufacturing and service spawned new technologies andpractices that allow firms to improve the efficiency and quality of their operations-basedactivities Consider, for example, the illustration of Nucor in the steel industry Unlikeintegrated steel mills such as Bethlehem Steel, USX, and National, Nucor built up a sig-nificant competitive position in the steel industry by focusing on mini-mills These millsare super-efficient and can produce a ton of steel of significantly better quality for lesscost than older integrated mills Investment in highly responsive and efficient mini-millshas enabled Nucor to sustain its profitability for many years, even when the industrymoved into downturns and recessions The focus on improving operations has certainlynot been limited to the heavy manufacturing sector Motorola, a leading manufacturer ofsemiconductors, electronic components, and cellular telephones, has made enormousstrides by simultaneously improving the responsiveness, cost efficiency, and quality of itsmanufacturing process Motorola views sustained investment and improvement in

qual-advanced manufacturing technologies as central to its ability to compete This highly

admired U.S firm has built up substantial manufacturing capabilities that allow the firm

to produce winning new products every year against Japanese competitors in the

semi-conductor, communications equipment, and electronics business

Outbound Logistics. Outbound logistics refer to the transfer of finished end product to

the distribution channels The focus in outbound logistics is on managing the flow and

dis-tribution of products to the firm’s immediate buyers, such as wholesalers and retailers

Activities and procedures associated with outbound logistics include inventory control,

warehousing, storage, and transport of finished products As is the case with inbound

logis-tics and operations, improvements in efficiency and responsiveness of outbound logislogis-tics

can greatly aid the firm’s competitive posture Firms can build competitive strengths based

on their ability to lower the costs of outbound distribution and to enhance responsiveness

Procter and Gamble over the past several years has made major efforts to improve the

efficiency and turnaround of its outbound logistics activities By linking up more closely

with key wholesalers and retailers (Wal-Mart Stores, for example), P&G has accelerated

the timely delivery of goods that retailers have trouble stocking By making extensive use

of bar-coding technology, P&G and its key buyers balance the flow of inventory and goods

between P&G’s warehouses and the retailers’ store shelves This responsive distribution

system becomes an overwhelming competitive strength for P&G and helps the company

track which products are in particularly high demand Conversely, a close understanding

of how its products are distributed gives P&G a better understanding of how to work with

its buyers to improve everyone’s margin over time

Marketing and Sales. Marketing and sales activities include advertising, promotion,

product mix, pricing, specific distribution channels, working with wholesalers, and sales

force issues Marketing is vital in helping the firm determine the competitive scope of its

value-adding activities For example, some firms may decide to concentrate their efforts on

a specific market segment or niche, while other firms may want to pursue a more

broad-line product strategy Thus, marketing becomes a vehicle by which the firm can develop

specific competitive postures and strategies to serve a variety of segments or niches within

the industry Marketing activities deal extensively with pricing issues as well The price of

a firm’s product can be an important signal or indicator of the firm’s value-creating

capa-bilities; a product’s price becomes a surrogate measure of what value the firm is

deliver-ing to the market Marketdeliver-ing activities also represent a central part of the firm’s

down-stream value-adding activities; planning in these activities is oriented toward meeting the

needs of immediate buyers and the final consumer

Clearly, numerous companies have built extensive competitive positions and strengths

based on their superior approaches to managing marketing activities Companies such as

Coca-Cola, McDonald’s, Burger King, PepsiCo, American Home Products,

Bristol-Myers Squibb, Schering-Plough, and American Express come to mind as leading

corpo-rate examples of firms that have built effective competitive strengths based on excellence

in marketing activities

Service. Customer service is a central value-adding activity that a firm can seek to

improve over time During the 1990s, an increasing number of companies are redefining the

way they manage their customer service activities Value is more often defined in the eyes

of the customer rather than by what the firm thinks it has created Thus, customer service

has become a vital means to compete in any industry environment Customer service

includes such activities and procedures as warranty, repair, installation, customer support,

product adjustment and modification, and immediate response to customer needs Customerservice is so important as a competitive weapon because it enables a firm to create valueimmediately before the customer’s eyes How well the firm conducts these tasks willstrongly impact the customer’s preference for buying from the firm again in the future BothFedEx and UPS thrive in the overnight delivery business because of their superiorapproaches to customer service Conversely, the U.S Postal Service, which offers a similarovernight delivery service, has comparatively fewer customers in this segment than bothFedEx and UPS, despite the enormous size and reach of the postal system Lingering con-cerns (albeit declining) over the Postal Service’s reputation for service quality have limitedits ability to seize a big portion of this profitable market.

Companies in every industry ranging from telecommunications to hotels, industrialequipment to aerospace, are rethinking and reinventing the ways they perform customerservice activities For example, many current reengineering efforts are devoted to

improving how firms meet their customers’ needs Reengineering means redefining the

way firms organize their operations to improve responsiveness to customer needs Forexample, at GTE, customers can now call one number and get all of the information theyneed about their account from one customer service representative In the past, cus-tomers had to dial separate numbers for different requests, such as telephone installation,equipment repair, leasing, purchase, and account adjustments Now, one phone call toGTE enables a customer to have all of his/her questions and concerns addressed by acustomer service representative who can provide assistance and service on almost anyaspect of telecommunications that GTE provides Other telecommunications companies,such as SBC Communications, AT&T, Sprint, MCI Worldcom, and U.S West, are mov-ing in the same direction to improve the speed, accuracy, and delivery of their customerservice operations

Perhaps the most important source of technological change that has transformed thevery notion of fast and responsive customer service is the Internet Barnes & Noble,

L L Bean, Xerox, IBM, General Electric, Dell Computer, Fidelity Investments, CharlesSchwab, and Wells Fargo are among the firms that have begun to lead the way in usingthe Internet as a competitive weapon to dramatically improve their customer serviceoperations By creating sophisticated home pages on the World Wide Web, many com-panies are encouraging their current and potential customers to use the Internet as ameans to gather information, select their desired products, and order products throughon-line, instantaneous transactions In the financial services industry, for example, manysecurities brokerage operations (e.g., Fidelity, Schwab, Merrill Lynch, Morgan StanleyDean Witter) are building state-of-the-art, secure Internet sites that enable customers toset up accounts, transfer funds, and invest in stocks and other investment vehicles fromtheir computer screens In fact, entirely new companies with names such as Ameritradeand E*Trade have become thriving, vibrant competitors to existing financial servicefirms by offering customers low-cost commissions and transactions fees through theInternet to trade stocks

In the most advanced form of Internet-driven customer service, companies such asIBM, Intel, Dell, General Electric, and Amazon.com link up their customers’ ordersdirectly to their distribution facilities for immediate transaction processing These compa-nies are using the Internet to link up directly and transfer a customer’s order to their dis-tribution centers, factories, and even suppliers for immediate processing, billing, and deliv-ery Dell Computer, for example, can receive and process a customer’s order for a highlycustomized personal computer over the Internet and have it shipped and delivered in lessthan four days Amazon.com, a company that did not exist as recently as 1996, has become

a major retailer of books, compact discs (CDs), videos, toys, and other items through the

reengineering: the

complete rethinking,

reinventing, and redesign of

how a business or set of

activities operates.

Internet By allowing customers to order any book or music CD in print, Amazon.com

offers customers a fast, secure, and easy way to purchase these items (often at prices lower

than those of existing “brick-and-mortar” competitors) without leaving the comforts of

their home The Internet is becoming a powerful tool that companies and organizations in

every industry are using to make themselves more responsive to the needs of their

cus-tomers The Internet has become an important economic driver of distribution, marketing,

and service for all types of firms, even those in less technologically intensive industries

For example, grocery store chains are beginning to harness the power of the Internet to

enable customers to order food and other items for fast delivery Some analysts are

pre-dicting that by the middle of the next decade, on-line transactions on the Internet may

become anywhere from 25 to 33 percent of total revenues

Support Activities

The remaining activities of the value chain are undertaken to support primary activities

They are therefore referred to as support activities Support activities help the firm

improve coordination across and achieve efficiency within the firm’s primary value-adding

activities Support activities are located across the first four rows in Exhibit 3-1 and

include procurement, technology development, human resource management, and

firm-level infrastructure

• Procurement: Inputs are secured for primary activities

• Technology development: Methods of performing primary activities are improved

• Human resource management: Employees who will carry out primary activities are

recruited, trained, motivated, and supervised

• Infrastructure: Activities such as accounting, finance, legal affairs, and regulatory

compliance are carried out to provide ancillary support for primary activities

Since each primary activity generally requires assistance in each of these four areas, the

value chain includes four cells above each primary activity, one for each category of

sup-port activity Let us examine how each of these four supsup-port activities contributes to

build-ing the capabilities of the firm

Procurement. Procurement refers to purchasing the necessary inputs, resources, or

com-ponents for the firm’s primary value-adding activity The purchasing function involves

spe-cific procedures such as billing systems, methods for dealing with suppliers and vendors,

and information systems about different components and parts Even though it is a support

activity, the purchasing function can significantly enhance the firm’s cost position relative

to its competitors Improved procurement practices enable the firm to gain significant

economies of scale and higher bargaining power over suppliers if the firm coordinates its

procurement across different functions and even businesses

Technology Development. Technology is found in every value-adding activity within

the firm Given the rapid technological changes that are present in almost every

indus-try (e.g., new forms of communications, software, Internet), this support activity has

assumed enormous importance in every firm Technology in firms today transcends the

conventional wisdom that it is primarily focused on research and development (R&D)

Although most firms still have engineering and R&D staffs devoted to exploring and

using new sources of technology, in practice, technology is developed and used in

count-less ways throughout the firm It can be the software found in computers, the standard

operating procedures used to manage a factory, the human know-how employed in

support activities:

economic activities that assist the firm's primary activities (see primary activities).

developing, manufacturing, and selling products, the layout of the factory, the cated nature of the firm’s Internet capabilities, and the laboratory equipment involved inthe firm’s value-adding activities Technology is pervasive in both upstream and down-stream activities of the firm.

sophisti-Technology is concerned with both product development and process development.

Product development refers to the conception, design, and commercialization of new

products For example, the design of new aircraft, more sophisticated microchips, tasting potato chips, and faster-heating, microwave-oriented convenience foods all repre-sent different types of product development Even though the end products are completelydifferent, they all come from the firm’s ability to conceive and design new product ideas

better-Process development, on the other hand, refers to the development and use of new

pro-cedures, practices, or equipment to improve the value-adding activity itself For example,the development of new assembly and packaging techniques, the use of new factory lay-outs to reduce work-in-process (WIP), the creation of a new medium to deliver advertis-ing, and the improvement of inventory tracking systems represent different ways to con-duct process development The aim of process development is to adapt new techniques or

to improve existing methods of conducting value-adding activities

Many companies have refocused efforts on technology development to improve theirvalue-adding activities For example, Allen-Bradley (a unit of Rockwell International), aleading U.S producer of motor controls, has developed new techniques to use factoryautomation that have dramatically reduced the unit costs of new motor components Frito-Lay is currently investigating the potential of developing a new microwave-oriented potatochip These chips could be heated in the customer’s home microwave oven to provide afresher taste that is different from conventionally bagged potato chips General Electric hasinvested large sums to introduce new forms of flexible automation and materials handlingthat lower the production costs and improve the quality of its dishwashers and refrigera-tors These firms are investing steadily in technology—product and process—to find newsources of competitive strength

Human Resource Management. Human resource management refers to working withpeople throughout the firm These activities focus on recruiting, hiring, compensating, andtraining people to perform their jobs within the firm As with technology development,human resource development receives considerable attention from top management because

of its strategic role in helping the firm learn and build new types of competitive skills Humanresource management activities thus affect every aspect of the firm’s value-adding activities.When conducted properly, human resource management enables the firm to cultivatethe skills necessary for competitive success Although managers typically tend to think ofinvestments in terms of capital budgets and physical, durable assets, continuous investment

in the firm’s people represents a more enduring way to build the firm’s capabilities agers and employees are the most flexible and capable assets firms have By providing theright levels of training, firms can assign people to perform different tasks, thus enhancingjob satisfaction, efficiency, and quality However, assessing the direct costs of investing inhuman resource activities is often difficult, since factors such as employee turnover andmorale are hard to measure

Man-Successful human resource management is often a key factor in determining a firm’s petitive strengths As a result, hotels and restaurants need to ensure that their employees arewell trained and know the correct procedures for treating guests Direct customer serviceactivities, in particular, require extensive training Professional service firms, such as account-ing, architecture, management consulting, and legal firms, depend heavily upon the humanresource function to recruit, select, and hire the right people that make up the workforce

com-product development: the

conception, design, and

commercialization of new

products.

process development: the

design and use of new

procedures, technologies,

techniques, and other steps

to improve value-adding

activities.

Firm Infrastructure. Infrastructure include such activities as finance, accounting, legal

affairs, information systems, and payroll These activities assist all of a firm’s value-adding

functions, so it is difficult to put an accurate dollar figure on their worth to the firm Since

infrastructure costs are hard to isolate, they are often called overhead expenses Although

many firms seek to cut infrastructure expenses during business downturns, such activities

can be important sources of competitive strength For example, in highly regulated

envi-ronments, such as electric utilities, telecommunications, financial services, and

pharma-ceuticals, the firm’s legal department can be as critical to success as operations, outbound

logistics, marketing, or technology development activities Understanding legislation and

government regulations may be just as important as designing new types of drugs or

pric-ing long-distance telephone calls Thus, infrastructure activities cannot be ignored when

formulating competitive strategies

PIZZA INDUSTRY VALUE CHAIN

Let us now apply the value chain concept to a service setting, using the pizza restaurant

industry as our reference point (see Exhibit 3-2)

lease warehouse space

Transport dough, cheese, etc.,

to restaurants

Supervise kitchen personnel

Develop new menu items;

improve oven design Buy dough, cheese, ovens, and other supplies

Cook pizzas;

make salads;

prepare other menu items

Supervise advertising personnel

Discover new promotional materials

Buy TV time

Develop advertising copy

Supervise waiters

Improve restaurant layout

Buy tables, chairs, silverware to equip restaurant

Serve food to restaurant customers

Obtain funds, carry out accounting and payroll functions, and perform other administrative tasks for each activity.

Reprinted/Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc from COMPETITIVE ADVANTAGE: Creating

and Sustaining Superior Performance, by Michael E Porter Copyright © 1985 by Michael E Porter.

Primary Activities

The value chain in this industry begins with transport of foodstuffs, such as dough,cheese, and pasta, from suppliers to restaurants (inbound logistics) Materials are thenconverted in each restaurant’s kitchen into items such as pizza and salads (operations),which are then served to customers (service) In addition, customers must be persuaded

to seek restaurant service (marketing/sales) Note that outbound logistics is not a part ofthis industry’s value chain since customers come to a pizza restaurant to be served.Indeed, outbound logistics is, to a large degree, significantly absent from the value chain

in many service industries, including hospital services, tax preparation assistance, andhigher education

Support Activities

Let us now examine the support these activities require

Procurement. Trucks and warehouse space must be procured to perform inboundlogistics activity; ovens and foodstuffs to perform operations; TV advertising to performmarketing/sales; and tables, chairs, and silverware to provide restaurant service Sincerestaurant firms do not generally produce these inputs themselves, they must procurethem from outside vendors Identification of suppliers for these inputs, evaluation of sup-plier offerings, and negotiation of purchase terms are major procurement activities in thisindustry

Technology Development. Movement of materials to restaurant sites can be improved

by streamlining warehousing methods, kitchen operation by designing better ovens,marketing/sales by devising more effective advertising copy, and restaurant service byimproving restaurant design Opportunities for technology development thus exist ineach primary activity of the industry

Human Resource Management. Personnel responsible for inbound logistics, for ations and service, and for marketing must be hired, trained, and supervised

oper-Infrastructure. Finally, those involved in primary activities need financing and ing assistance, accounting activities, and legal affairs These are infrastructure activities

budget-AUTOMOBILE INDUSTRY VALUE CHAIN

To illustrate the value chain in a manufacturing context, consider the automobile industry(see Exhibit 3-3)

Primary Activities

The value chain in this industry begins with transport of components from suppliers to autoassembly facilities (inbound logistics) Components are then assembled into finished autos(operations), and the finished cars are shipped to dealers (outbound logistics) Finally,dealers sell cars to customers (marketing/sales) and maintain the products owned by cus-tomers (service)

Support Activities

These primary activities require assistance in each of the support areas noted previously

Procurement. Trucks and warehouse space must be procured to perform inbound and

out-bound logistics; machinery, raw materials, and components to operate factories; media

adver-tising space to conduct marketing/sales; and specialized tools, lubricants, parts, and

diagnos-tic machines to provide auto service Identification of suppliers for these inputs, evaluation of

supplier offerings, and negotiation of prices are procurement activities Note that procurement

does not deal with the physical movement of goods or “logistics.” Rather, it focuses on

iden-tification of suppliers, evaluation of supplier offerings, and negotiation of purchase terms

Technology Development. Inbound and outbound logistics activities in the auto industry

can be improved by redesigning the flow of component and finished product inventories in

warehouses and transportation facilities Auto firms can improve their operations by

simpli-fying product design, introducing automated manufacturing techniques, and redesigning

fac-tories to make work easier and more satisfying for employees Marketing and sales can be

improved through designing better advertising copy, while service activity can be improved

by instituting more efficient repair procedures, training service personnel to be more

respon-sive to customer needs, and installing more sophisticated diagnostic equipment Activities

undertaken to achieve such improvement are designated technology development

Human Resource Management. Personnel performing primary activities must be

recruited, trained, developed, and supervised Human resource management, through its

activities, helps improve product quality, innovation, and productivity

lease warehouse space

Transport components to assembly facility

Supervise assembly workers

Improve product design and assembly process

Buy components and assembly equipment

Make and assemble components into autos

(Same as inbound logistics)

(Same as inbound logistics)

(Same as inbound logistics)

Transport autos to dealers

Supervise advertising and sales personnel

Improve selling methods

Hire advertising agency; buy media time

Advertise, promote, and sell autos

Supervise maintenance personnel

Improve maintenance procedures

Buy tools for maintenance personnel

Maintain and repair autos

Reprinted/Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc from COMPETITIVE ADVANTAGE: Creating

and Sustaining Superior Performance, by Michael E Porter Copyright © 1985 by Michael E Porter.

Infrastructure. Primary activities require capital budgeting, financing, accounting, legalaffairs, governmental affairs, and other administrative assistance These infrastructure activ-ities help automakers finance expansion, communicate with shareholders, and work with thegovernment in implementing new types of environmental and fuel efficiency regulations.

THE VALUE CHAIN AS PART OF A BUSINESS SYSTEM

So far, we have seen how different activities make up the value chain A firm need notalways perform every single activity of the value chain Indeed, most firms do not The

subset of value chain activities that a firm actually performs is referred to as its business

system.4To illustrate, let us return to Pizza Hut and General Motors

Key: = Extensive activity

Reprinted/Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc from COMPETITIVE ADVANTAGE: Creating

and Sustaining Superior Performance, by Michael E Porter Copyright © 1985 by Michael E Porter.

performs no outbound logistics at all since customers come to its facilities to be served.

However, Pizza Hut is extensively involved in operations (food preparation),

marketing/sales (mainly advertising), and service (serving restaurant customers) These

three activities are therefore integral parts of its business system

Support Activities. Pizza Hut conducts procurement activity for each of its primary

activities For example, it procures dough, cheese, ingredients, and ovens for operations;

TV advertising time for marketing/sales; and tables, chairs, and silverware for service It

also conducts technology development activity for each primary activity For example,

Pizza Hut devotes considerable effort to improve pizza-making procedures, to enhance

advertising copy, and to streamline restaurant design It also conducts extensive human

resource management and infrastructure activities for each primary activity These support

activities are therefore integral parts of its business system

General Motors

General Motors’s business system is shown in Exhibit 3-5 As indicated, it includes many

but not all activities of the automobile industry value chain

Inbound Logistics

Reprinted/Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc from COMPETITIVE ADVANTAGE: Creating

and Sustaining Superior Performance, by Michael E Porter Copyright © 1985 by Michael E Porter.

Primary Activities. GM makes many of its own components, warehouses them, andtransports them to its assembly sites However, it also purchases an increasing number ofcomponents from outside suppliers These purchased components are generally delivered

to GM’s facilities by other firms, such as trucking and railroad companies Consequently,

GM performs some, but not all, inbound logistics activity associated with its business GMbuilds and assembles components into automobiles and delivers finished autos to dealers;thus it is extensively involved in both operations and outbound logistics GM advertises itsproducts, but leaves the actual selling up to its dealers; thus it performs only a portion ofthe marketing/sales activity associated with its industry Independently owned dealersmaintain and repair GM vehicles, so GM is not significantly involved in auto service

Support Activities. Procurement activities for GM include purchase of components forcars, factory equipment from machine tool companies, and lubricants and supplies fromoil companies General Motors devotes considerable effort to technology development forits key value-adding activities For example, it is attempting to improve internal ware-housing and factory inventory control through just-in-time (JIT) techniques GM hasinvested heavily in new forms of factory automation and software to improve both prod-uct quality and the responsiveness of its factories GM also commits substantial resourcesand effort to managing the human resource function For example, it must work closelywith the union leadership to create new labor contracts Within individual plants, GMattempts to cooperate with workers to find new ways and insights to build better cars.Finally, GM has an extensive group of people working in legal affairs and government rela-tions In recent years, the company has spent considerable time working with consumergroups and government safety boards

CAPABILITY DRIVERS

Once a firm’s various activities have been identified using the value chain, an analyst ested in strategy must then assess the firm’s capability in performing each activity Anyactivity that the firm can perform more efficiently than its rivals (because fewer resourcesare required) or more effectively than rivals (because greater customer benefits are producedwith the same resources) constitutes a strength Similarly, activities that the firm performsless efficiently and effectively than rivals constitute weakness The specific attributes andpractices that determine efficiency and effectiveness differ markedly across industries Forexample, the practices that enable the Walt Disney Company to excel in theme park opera-tions are very different from those underpinning Intel’s success in microprocessors As aresult of these differences, it is difficult to provide general guidance to a strategy analyst onwhat to look for when trying to assess a firm’s strengths and weaknesses However, guid-ance is possible at a more general level In most industries, enduring competitive strength—i.e., strength that cannot be easily duplicated or imitated by rivals—derives from a few fun-

inter-damental capability drivers Capability drivers represent broad routes to achieving

competitive strength regardless of the particular industry setting in which a firm operates

By assessing capability drivers underlying an activity, an analyst can often gain valuableinsight into whether a firm possesses strength in performing the activity In this section, weexamine four common capability drivers—first-mover status, scale, experience, and inter-relationships—and consider the kinds of competitive strength provided by each

First-Mover Status

Early entrants to an industry sometimes enjoy benefits that are not available to firms

arriv-ing later These benefits are referred to as first-mover advantages.5Common benefits in

capability drivers: the

basic economic and strategic

means by which a firm

builds an underlying source

of competitive advantage in

its market or industry.

Examples of basic capability

drivers include first-mover

the benefits that firms enjoy

from being the first or

earliest to compete in an

industry.

this category are patent protection, a government license, superior location, channel

access, supply access, and reputation (see Exhibit 3-6) Because established firms have

operated in the competitive environment for longer periods of time, they often possess

commanding, but not impenetrable, advantages over new entrants in these areas

Patent Protection. Established firms sometimes own patents on important technology

They enjoy a strong competitive advantage over new entrants that must either circumvent

the patented technology or develop a new one on their own Xerox Corporation, for

example, held early patent rights to the xerographic duplicating process These rights

gave it a strong advantage over other entrants during the long period over which the

patents applied In the pharmaceutical industry, patents are an important source of

advan-tage, since they legally protect the chemical composition of a drug from unauthorized

duplication by other firms For example, Smith Kline introduced a new type of ulcer

med-ication known as Tagamet during the 1970s Having received patent protection from the

government, Smith Kline enjoyed considerable profits from Tagamet until the patent

expired in the mid-1980s Other firms were prohibited from copying Smith Kline’s

patented formulas for making Tagamet The same patent protection capability gives Eli

Lilly and Pfizer significant competitive advantages in depression and blood pressure

med-ications respectively in the 1990s Patents thus represent a very strong source of

compet-itive advantage

Licenses. A government license is needed to operate some businesses Licenses are

nec-essary, for example, to operate an airline, a radio or TV station, an electric generation

facil-ity, and a gas distribution company Governments often limit the number of licenses they

make available Once all available licenses have been issued, new entrants may be blocked

from entering an industry or, if allowed to enter, may be forced to operate at a

disadvan-tage Thus, early holders of licenses have a significant competitive advantage over later

entrants

Location Sites In some industries, a suitable location is an important source of

compet-itive advantage A waterfront site, for example, may be useful to a boat dealer; a site near

a busy intersection is often useful for a fast-food operator By entering an industry early,

leaders can sometimes preempt the best locations Later entrants must often make do with

less attractive sites

Channel Access. Large, established firms sometimes lock up the most desirable channels

of distribution New entrants or smaller existing firms then have difficulty finding outlets

for their products, and must often engage in extensive promotions and negotiations with

wholesalers and retailers to obtain suitable shelf space For example, new entrants in thepackaged goods field—canned goods, breakfast cereal, diapers, personal care products—often face this challenge The chief distribution channels for such products are supermar-kets Because of limited capacity, supermarkets often restrict the amount of shelf space theydevote to each product category to just two or three brands, giving preference to well-knownbrands that can generate the most volume Because of this policy, smaller firms and newentrants often experience difficulty getting their products on the shelf.

Supply Access. Established firms can sometimes monopolize critical supplies Laterentrants then experience difficulty securing inputs for their own operations US Steel (nowUSX), for example, once controlled the world’s richest iron ore deposits Exclusive access

to this valuable resource gave it a formidable advantage over newcomers forced to rely onmore costly supplies that often required high transportation costs Established firms do notnecessarily have to own a resource to enjoy exclusive access A long-term supply contractcan sometimes produce the same benefit Large food processors, for example, sometimesdominate supply by entering into long-term contracts with groups or cooperatives of farm-ers in a region In the Midwest, companies such as Pillsbury, General Mills, Kellogg, Car-nation, Archers-Daniel-Midland (ADM), and Cargill are large purchasers of wheat andcorn They often buy huge amounts of wheat and corn through long-term contracts withfarmers for use in making processed foods This practice can make it difficult for a smallprocessor to secure low-cost supplies

Reputation. Many customers have already used products made by established firms Ifsatisfied, they will often seek out the same brand when making subsequent purchases.Even customers who have not yet tried an industry’s product will often be familiar with awell-known brand and therefore may give it higher preference when making their first pur-chase Established firms thus often enjoy a significant reputation advantage over laterentrants

Scale of Operation

Large, established firms produce, sell, and advertise in greater volume than smaller firmsand later entrants Their greater volume allows them to take advantage of economies ofscale within many primary and supporting value-adding activities Research has shownthat as the scale of many business activities increases, the cost of carrying them out perunit of output declines.6 This phenomenon is shown in Exhibit 3-7 Among the mostimportant contributors to economies of scale, shown in Exhibit 3-8, are specialization,fixed-cost spreading, purchase discounts, and vertical integration

Specialization. As the scale of an activity increases, more employees are needed to carry

it out The more employees who are involved in performing an activity, the greater are theopportunities for individuals to specialize Since specialization fosters expertise, increas-ing scale often enhances productivity

Fixed-Cost Spreading. Many fixed costs (for example, technology development andautomated production equipment) do not increase proportionally as an activity expands insize These costs can therefore be spread over a larger number of units as an activityincreases, resulting in declining per unit cost Because large firms can operate activities on

a big scale, they often have greater opportunity to spread and amortize fixed costs thansmaller rivals or later entrants