Internal analysis

1 Introduction

Assessing the strategic position of an organisation is a two-sided exercise. The previous chapters looked outwards – at the ecosystem, PESTEL factors, industry forces and competitors. This chapter looks inwards, at the organisation’s own resources and competences. Strategies succeed when what the organisation is good at matches what the environment demands; where there is a mismatch, either the strategy or the capabilities must change.

This chapter covers:

• Resources and competences, and how they combine into strategic capability

• Testing resources and competences: the VRIO criteria

• Position-based versus resource-based approaches to strategy

• Typical resources (the ‘M words’)

• The resource audit, and matching resources to strategy

• Tangible and intangible value drivers, and the data used to measure them

• The product life cycle

Porter’s value chain also gives important insights into the internal workings of an organisation; it is covered in Chapter 7 together with value networks and supply chains.

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2 Resources and competences

2.1 Strategic capability

When analysing an organisation’s position we have to analyse its strategic capability – its ability to compete and survive. Capability depends on two ingredients:

• Resources – the things the organisation has: machines, buildings, cash, patents, people, brands, data.

• Competences – the ways the organisation uses what it has: the skills, routines and know-how that turn resources into products, services and profits.

There is no point in having one without the other. A robotic production line (a resource) is worthless without the engineering skill to run it (a competence); equally, skilled engineers achieve little without equipment to work with.

Capabilities come at two levels:

Threshold capabilities rise over time: yesterday’s advantage (a website, next-day delivery) becomes today’s entry ticket. Strategic capability therefore has to be maintained and renewed, not just achieved once.

2.2 Unique resources and core competences

The ‘extra’ capabilities that create competitive advantage come from two sources:

• Unique resources – resources one organisation has that others cannot readily obtain. Examples include a patented drug (protecting, say, a pharmaceutical company’s monopoly for the life of the patent), a mine containing a rare metal, a prime retail location, an exclusive licence, or a proprietary customer data set.

• Core competences – ways in which an organisation uses its resources better than competitors do, in ways that others cannot easily imitate or obtain.

Genuinely unique resources are rare. Most resources – production equipment, vehicles, standard software – can simply be bought, and once rivals can buy the same resources they can copy what is being achieved. Core competences are usually the safer foundation for advantage: because they are embedded in people, culture and routines they are harder for outsiders even to identify, let alone copy. Apple’s repeated ability to design hardware, software and services that work seamlessly together is a core competence that competitors have struggled to replicate for decades.

2.3 Testing resources and competences: VRIO

How do we know whether a resource or competence can support sustainable competitive advantage? The standard test (developed by Barney) asks four questions – the VRIO criteria:

Only a resource or competence that passes all four tests supports sustained competitive advantage. A patent may be valuable, rare and legally inimitable, but if the company lacks the manufacturing and marketing organisation to exploit it, it earns nothing.

3 Position-based and resource-based strategies

Traditional strategic planning was largely position-based (associated with Porter). The strategist studies the environment – PESTEL, Porter’s five forces – works out where the attractive positions are, and then changes what the organisation does to occupy them. If the economy weakens, launch a budget range; if film cameras die, make digital ones. The environment leads; the organisation follows.

A more recent approach (Prahalad and Hamel) is resource-based strategy. It starts from a warning: successful combinations of resources and competences – especially unique resources and core competences – take years to build and are hard for others to copy. They are the organisation’s ‘crown jewels’ and the real explanation of its success. A purely position-based approach can lure an organisation into markets where it has no relevant capabilities, while it abandons the very capabilities that made it successful. Instead, the resource-based school says: identify your core competences and ask what other markets they could win in – create your own future around your strengths rather than merely reacting to the environment.

As so often in strategy, a balance is needed. There is no point clinging to existing resources and competences once technology or public taste has moved on and the products they support have become unpopular. But it is equally dangerous to throw strengths away casually: an organisation that has succeeded in one market through specific capabilities has no automatic right to succeed in another market that demands entirely different ones.

4 Typical resources

Many of an organisation’s resources can be remembered by the ‘M words’:

5 The resource audit: matching resources to strategy

Internal analysis is not just a stocktake for its own sake. When a strategy is being chosen and implemented, the organisation must audit the key resources and capabilities the strategy requires and compare them with what it actually has. The syllabus expects you to be able to advise on resource availability and on aligning resource allocation to strategic choices.

A resource audit asks, for each element of the proposed strategy:

1. What resources and competences does this strategy require (people, skills, technology, capacity, finance, data, partners)?

2. What do we currently have, and of what quality? (The M words above are a useful checklist.)

3. Where are the gaps – and can they realistically be closed in the time available?

4. Which existing resources are no longer needed and can be released?

Where gaps exist, there are broadly three ways to close them – sometimes summarised as build, buy or borrow:

• Build – develop the capability internally: recruit, train, invest in systems and R&D. Slow, but the capability is then owned and hard for rivals to copy.

• Buy – acquire the capability: purchase assets, license technology, or acquire a company that already has it. Fast, but expensive and integration often disappoints.

• Borrow – partner: joint ventures, alliances, outsourcing, or joining a platform or network (see Chapters 7 and 10). Fast and flexible, but the capability is shared and the partner has its own interests.

5.1 Re-aligning resource allocation

The harder half of the job is usually not finding new resources but re-allocating existing ones. Resources tend to stay where they have always been: established units defend their budgets, and last year’s allocation quietly becomes this year’s. A new strategy that is announced but not funded is not a strategy – it is a press release. Re-alignment means:

• Moving money, people and management attention from legacy activities to the activities the strategic choices depend on

• Being explicit about what the organisation will stop doing, and releasing the resources tied up in it

• Challenging allocations from a zero base rather than incrementally rolling budgets forward

• Accepting internal resistance as a predictable cost of change – links to change management (Chapter 14)

Monitoring whether resources have genuinely moved – through action plans, targets and KPIs – is part of strategic control, covered in Chapter 8 and Chapter 12.

6 Tangible and intangible value drivers

A value driver is anything that materially increases the value an organisation creates – the levers that, if improved, make the business worth more. When generating and evaluating options, strategists should know which drivers matter for their business and what data can measure each one. Value drivers divide into tangible and intangible:

For most modern organisations the intangible drivers dominate: the market value of technology, pharmaceutical and consumer-brand companies is overwhelmingly explained by assets that barely appear on the statement of financial position. That is why internal analysis must look well beyond the balance sheet – and why frameworks such as integrated reporting (Chapter 8) deliberately report on all the ‘capitals’ an organisation uses, not just financial capital.

7 The product life cycle

You will have met the product life cycle in Paper E2; it is revised here because internal analysis must include the age profile of the organisation’s products. It can be vital to recognise which stage each product has reached, to be sure that future revenue is secure. Many pharmaceutical companies face a sharp fall in revenue when a valuable drug loses its patent protection – and some have faced several income streams ending almost simultaneously, a so-called patent cliff.

The classic diagram shows how sales revenue and net cash flows change as a product moves from introduction through growth to maturity and decline:

The model’s great weakness is that it predicts nothing: no product is guaranteed to follow the pattern, and the phases vary enormously in length – maturity can last six months or sixty years. What strategists most want to know is when irrevocable decline will set in, and the diagram cannot tell them. What it does provide is a set of labels, each carrying strategic implications:

7.1 Managing a portfolio of life cycles

Ideally a company arranges for a succession of products, each generation reaching its peak as the previous one fades, so that total revenue stays reasonably stable:

This ‘succession planning’ for products is fine in theory and notoriously difficult in practice, because:

• New products are often delayed – development snags, production problems or regulatory hold-ups postpone launch

• Existing products can decline sooner and faster than expected, because of shifts in technology, taste or the economy

The product life cycle links forward to portfolio models such as the BCG matrix (Chapter 11), which look at the balance of an organisation’s products and businesses as a whole.

8 Test your knowledge

Two short exercises close the chapter in the online notes: ten flashcards on the terms and frameworks above, and ten practice questions with worked feedback on every option. Work through the cards first, then the questions.