CHAPTER 3 Assessing the Internal Environment of the Firm Copyright Anatoli Styf/Shutterstock 1 Learning Objectives After reading this chapter, you should have a good understanding of: 3-1 The primary and support activities of a firm’s value chain. 3-2 How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and suppliers. 3-3 The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities. 3-4 The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees and managers. 3-5 The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms. 3-6 The value of the “balanced scorecard” in recognizing how the interests of a variety of stakeholders can be interrelated. ©McGraw-Hill Education. 2 The Importance of the Internal Environment Consider. . . Which activities must a firm effectively manage and integrate in order to attain competitive advantages in the marketplace? Which resources and capabilities must a firm create and nurture in order to sustain a competitive advantage? ©McGraw-Hill Education. What if two firms compete in the same industry and both have many strengths in a variety of functional areas: marketing, operations, logistics, etc.? However, one of these firms outperforms the other by a wide margin over a long period of time. How can this be? The value-creating activities that the firm manages well, and the bundles of resources and capabilities that the firm has created and nurtured over time are crucial to answering these questions. 3 Value-Chain Analysis Value-chain analysis looks at the sequential process of value-creating activities. Value is the amount buyers are willing to pay for what a firm provides. How is value created within the organization? How is value created for other organizations in the overall supply chain or distribution channel? The value received must exceed the costs of production. ©McGraw-Hill Education. SWOT is a good starting point, but it doesn’t give enough guidance regarding the specific action steps needed to enact strategic change. For instance, a firm may have a capability that is a strength, but that, by itself, cannot create or sustain competitive advantage. It’s too easy to become preoccupied with a single dimension or element of what is, essentially, a moving target…MORE analysis may be necessary, which is where the value chain comes in. Value-chain analysis = a strategic analysis of an organization that uses value-creating activities. Value is the amount that buyers are willing to pay for what a firm provides them and is measured by total revenue, a reflection of the price a firm’s product commands, and the quantity it can sell. A firm is profitabl ...

1. CHAPTER 3
Assessing the Internal Environment of the Firm
Copyright Anatoli Styf/Shutterstock
1
Learning Objectives
After reading this chapter, you should have a good
understanding of:
3-1 The primary and support activities of a firm’s value chain.
3-2 How value-chain analysis can help managers create value
by investigating relationships among activities within the firm
and between the firm and its customers and suppliers.
3-3 The resource-based view of the firm and the different types
of tangible and intangible resources, as well as organizational
capabilities.
3-4 The four criteria that a firm’s resources must possess to
maintain a sustainable advantage and how value created can be
appropriated by employees and managers.
3-5 The usefulness of financial ratio analysis, its inherent
limitations, and how to make meaningful comparisons of
performance across firms.
3-6 The value of the “balanced scorecard” in recognizing how
the interests of a variety of stakeholders can be interrelated.
©McGraw-Hill Education.

2. 2
The Importance of the Internal Environment
Consider. . .
Which activities must a firm effectively manage and integrate in
order to attain competitive advantages in the marketplace?
Which resources and capabilities must a firm create and nurture
in order to sustain a competitive advantage?
©McGraw-Hill Education.
What if two firms compete in the same industry and both have
many strengths in a variety of functional areas: marketing,
operations, logistics, etc.? However, one of these firms
outperforms the other by a wide margin over a long period of
time. How can this be? The value-creating activities that the
firm manages well, and the bundles of resources and
capabilities that the firm has created and nurtured over time are
crucial to answering these questions.
3
Value-Chain Analysis
Value-chain analysis looks at the sequential process of value-
creating activities.
Value is the amount buyers are willing to pay for what a firm
provides.
How is value created within the organizatio n?
How is value created for other organizations in the overall
supply chain or distribution channel?
The value received must exceed the costs of production.
©McGraw-Hill Education.

3. SWOT is a good starting point, but it doesn’t give enough
guidance regarding the specific action steps needed to enact
strategic change. For instance, a firm may have a capability that
is a strength, but that, by itself, cannot create or sustain
competitive advantage. It’s too easy to become preoccupied
with a single dimension or element of what is, essentially, a
moving target…MORE analysis may be necessary, which is
where the value chain comes in. Value-chain analysis = a
strategic analysis of an organization that uses value-creating
activities. Value is the amount that buyers are willing to pay for
what a firm provides them and is measured by total revenue, a
reflection of the price a firm’s product commands, and the
quantity it can sell. A firm is profitable when the value it
receives exceeds the total costs involved in creating its product
or service. Creating value for buyers that exceeds the costs of
production (i.e. margin) is a key concept used in analyzing a
firm’s competitive position.
4
Value-Chain Analysis Primary Activities
Primary activities contribute to the physical creation of the
product or service; the sale & transfer to the buyer; and service
after the sale.
Inbound logistics
Operations
Outbound logistics
Marketing & sales
Service
©McGraw-Hill Education.
Primary activities = sequential activities of the value chain that
refer to the physical creation of the product or service, its sale
and transfer to the buyer, and its service after sale, including
inbound logistics, operations, outbound logistics, marketing and
sales, and service.

4. 5
Question
(1 of 2)
In assessing its primary activities, an airline would examine
employee training programs.
baggage handling.
criteria for lease versus purchase decisions.
the effectiveness of its lobbying activities.
©McGraw-Hill Education.
Answer: B – baggage handling involves transfer of service to
buyer and is part of airline operations
6
Value-Chain Analysis Support Activities
Support activities either add value by themselves or add value
through important relationships with both primary activities &
other support activities.
Procurement
Technology development
Human resource management
General administration
©McGraw-Hill Education.
Support activities = activities of the value chain that either add
value by themselves or add value through important
relationships with both primary activities and other support
activities; including procurement, technology development,
human resource management, and general administration.
7
The Value Chain

5. Exhibit 3.1 The Value Chain: Primary and Support Activities
Adapted from Competitive Advantage: Creating and Sustaining
Superior Performance by Michael E. Porter. Copyright © 1985,
1998 by The Free Press.
Jump to Appendix 1 for long description.
©McGraw-Hill Education.
To get the most out of value-chain analysis, view the concept in
its broadest context, without regard to the boundaries of your
own organization – place your organization within a more
encompassing value chain that includes your firm’s suppliers,
customers, and alliance partners. This helps identify how value
is created for other organizations in the overall supply chain or
distribution channel. For an interesting example, look at Case
General Motors. (Remember the strategic groups discussion
from Chapter 2? What does GM have to do to compete with
other groups in its industry? How important might the value
chain be in this industry?)
8
Primary Activity: Inbound Logistics
Inbound logistics are primarily associated with receiving,
storing & distributing inputs to the product.
Material handling
Warehousing
Inventory control
Vehicle scheduling
Returns to suppliers
Factors to consider include:
Location of distribution facilities
Warehouse layout
©McGraw-Hill Education.
Inbound logistics = receiving, storing, and distributing inputs of

6. a product. Example = Toyota’s just-in-time (JIT) inventory
systems where parts deliveries arrive at the assembly plants
only hours before they are needed. This allows Toyota to fill a
buyer’s new car order in just 5 days. Inbound logistics includes
location of distribution facilities, design of material and
inventory control systems, warehouse layout and design, and
efficient systems to return products to suppliers.
9
Primary Activity: Operations
Operations include all activities associated with transforming
inputs into the final product form.
Machining
Packaging & Assembly
Testing or quality control
Printing
Facility operations
Factors to consider include:
Efficient plant operations & layout
Incorporation of appropriate process technology
©McGraw-Hill Education.
Operations = all activities associated with transforming inputs
into the final product form. Example = Shaw Industries’ ability
to reduce expenses associated with the disposal of dangerous
chemicals used in the manufacture of floor coverings.
Operations includes assessment of efficiency of plant
operations, incorporation of appropriate process technology,
efficient plant layout and workflow design, degree of
automation, extent of appropriate quality control systems.
10
Primary Activity: Outbound Logistics
Outbound logistics includes collecting, storing, & distributing
the product or service to buyers.

7. Finished goods & warehousing
Material handling
Delivery vehicle operation
Order processing, scheduling & distribution
Factors to consider include:
Effective shipping processes
Minimizing shipping costs by grouping goods into large lot
sizes
©McGraw-Hill Education.
Outbound logistics = collecting, storing, and distributing the
product or service to buyers. Example = Campbell Soup uses an
electronic network so retailers can inform Campbell of product
needs and inventory levels. This allows Campbell to forecast
future demand and determine which products to replenish,
delivering inventory the same day. The retailer gains efficiency,
and therefore has an incentive to carry a broader line of
Campbell products. Outbound logistics includes effective
shipping processes to provide quick delivery and minimize
damages, efficient finished goods warehousing processes, the
ability to ship goods in large lot sizes to minimize
transportation costs, and the use of quality material handling
equipment. (See also Case Campbell Soup.)
11
Primary Activity:
Marketing & Sales
Marketing & sales activities involve purchases of products &
services by end users and includes how to induce buyers to
make those purchases.
Advertising & promotion
Sales force management
Pricing & price quoting
Channel selection & channel relations
Factors to consider include:

8. Innovative approaches to promotion & advertising
Proper identification of customer segments & needs
©McGraw-Hill Education.
Marketing and sales = activities associated with purchases of
products and services by end users and the inducements used to
get them to make purchases. Example = the Mercedes-Benz
AMG got premiere “product placement” as a fleet of these
showed up to pick up James Bond in the 2016 Spectre movie.
Marketing and sales includes the development of a highly
motivated and competent sales force, innovative approaches to
promotion and advertising, selection of the most appropriate
distribution channels, proper identification of customer
segments and needs, and effective pricing strategies.
12
Primary Activity: Service
Service includes all actions associated with providing service to
enhance or maintain the value of the product.
Installation & repair
Training
Parts supply
Product adjustment
Factors to consider include:
Quick response to customer needs
Quality of service personnel, ongoing training
©McGraw-Hill Education.
Service = actions associated with providing service to enhance
or maintain the value of the product. Example = Nordstrom
service reps can take control of the customer’s web browser and
lead her to the specific product she wants. Service includes
effective use of procedures to solicit customer feedback and to
act on information, quick response to customer needs and

9. emergencies, ability to furnish replacement parts, effective
management of parts and equipment inventory, quality of
service personnel and ongoing training, and warranty and
guarantee policies.
13
Support Activity: Procurement
Procurement involves how the firm purchases inputs used in its
value chain.
Procurement of raw material inputs
Optimizing quality & speed
Minimizing associated costs
Development of collaborative win-win relationships with
suppliers
Analysis & selection of alternative sources of inputs to
minimize dependence on one supplier
©McGraw-Hill Education.
SUPPORT ACTIVITIES are those functions that support the
value chain. Each industry might have distinct value activities
that are unique to that industry, but here are some common
ones. Procurement = the function of purchasing inputs used in
the firm’s value chain, including raw materials, supplies, and
other consumable items as well as assets such as machinery,
laboratory equipment, office equipment, and buildings. Example
= Microsoft does formal reviews of its outside suppliers,
including a feedback system that helps clarify expectations. In
addition to the above activities, procurement includes effective
procedures to purchase advertising and media services, and the
ability to make proper lease versus buy decisions.
14
Support Activity: Technology Development
Technology development is related to a wide range of activities.
Effective R&D activities for process & product initiatives

10. Collaborative relationships between R&D and other departments
State-of-the-art facilities & equipment
Excellent professional qualifications of personnel
Use of data analytics
©McGraw-Hill Education.
Technology development = activities associated with the
development of new knowledge that is applied to the firm’s
operations. The array of technologies employed in most firms is
very broad, ranging from technologies used to prepare
documents and transport goods, to those embodied in processes
and equipment or the product itself. Technology development
related to the product and its features supports the entire value
chain, while other technology development is associated with
particular primary or support activities. Example = the French
firm Techniq is a global leader in the energy industry, focusing
on pipelines. In collaboration with Schlumberger, Techniq has
developed “intelligent” pipes that add significant value for
customers, while increasing Techniq’s margins. Technology
development includes activities related to the process as well as
the product, such as enhancing the ability to meet critical
deadlines. Strategy Spotlight 3.2 discusses how Coca-Cola has
used data analytics to meet the taste demands of its global
customers.
15
Support Activity: Human Resource Management
Human resource management consists of activities involved in
recruitment, hiring, training & development, & compensation of
all types of personnel.
Effective employee recruiting, development, & retention
mechanisms
Quality relations with trade unions
Reward & incentive programs to motivate all employees

11. ©McGraw-Hill Education.
Human resource management = activities involved in the
recruiting, hiring, training, development and compensation of
all types of personnel. It supports both individual primary and
support activities such as the hiring of engineers and scientists,
as well as supporting the entire value chain through activities
such as negotiations with labor unions. Example = JetBlue
recruited flight attendants with a one-year contract so they
could travel, meet lots of people, then decide what else they
might like to do. Human resource management includes creating
a quality work environment to maximize overall employee
performance and minimize absenteeism.
16
Support Activity:
General Administration
General administration involves:
Effective planning systems to attain overall goals & objectives
Excellent relations with diverse stakeholder groups
Effective information technology to coordinate & integrate
value-creating activities across the value chain
Ability of top management to anticipate & act on key
environmental trends & events, create strong values, culture &
reputation
©McGraw-Hill Education.
General administration = general management, planning,
finance, accounting, legal and government affairs, quality
management, and information systems; activities that support
the entire value chain and not individual activities. These
activities can be among the most important activities for
competitive advantage. Example = how a telephone operating
company effectively negotiates and maintains ongoing relations
with regulatory bodies. General administration also includes,

12. for instance, the ability to obtain low-cost funds for capital
expenditures and working capital. Leadership plays a critical
role here as well: Mark Zuckerberg and Jack Ma have been
critical to the success of their respective companies, Facebook
and Alibaba.
17
Interrelationships Among Value-Chain Activities
Managers must not ignore the importance of relationships
among value-chain activities.
What are the interrelationships among activities within the
firm?
What are the relationships among activities within the firm and
with other stakeholders such as customers & suppliers?
Consider integrating customers into the value chain.
Creating individualized products
Soliciting ideas for products & services
©McGraw-Hill Education.
Interrelationships = collaborative and strategic exchange
relationships between value-chain activities either (a) within
firms or (b) between firms. Strategic exchange relationships
involve exchange of resources such as information, people,
technology, or money that contribute to the success of the firm.
Example = within the firm, how effective human resource
practices can support the entire value chain. Example = between
the firm and stakeholders, how teaming up with customers
through a “prosumer” or crowdsourcing relationship can help
the firm gain insight into customer needs and leverage the
wisdom of the customer to create value for all. However, be
careful, because customers can use this forum to criticize the
company and its products. Research has shown that
crowdsourcing can backfire half the time.
18

13. Example: The Value Chain in Service Organizations
Exhibit 3.4 Some Examples of Value Chains in Service
Industries
Jump to Appendix 2 for long description.
©McGraw-Hill Education.
The value chain might be configured differently depending on
the type of business a firm is engaged in. For instance a travel
agent adds value by creating an itinerary that includes
transportation, accommodations, and activities customized to
the client’s budget and travel dates, while a law firm provides
services specific to the client’s circumstances. Both involve
work “operations” dependent on the application of specialized
knowledge based on the specifics, the “inputs” of the situation,
and the outcome, the “output” the client desires. In retail, a firm
adds value by developing expertise in the procurement of
finished goods and by displaying these goods in stores in a way
that enhances sales. Therefore procurement is a primary activity
rather than a support activity. In an engineering services firm,
research and development are primary activities, providing
inputs to the engineering process, while innovative designs are
the outputs. How the primary and support activities of a given
firm are configured and deployed will often depend on industry
conditions and whether the company is service and/or
manufacturing oriented. (For more discussion in a service
context, see Case United Way.)
19
Resource-Based View of the Firm
The resource-based view of the firm (RBV) integrates two
activities.
An internal analysis of phenomena within a company
An external analysis of the industry & its competitive
environment

14. Resources can lead to a competitive advantage.
If they are valuable, rare, hard to duplicate
If tangible resources, intangible resources, & organizational
capabilities are combined
©McGraw-Hill Education.
A firm’s strengths and capabilities – no matter how unique or
impressive – do NOT necessarily lead to a competitive
advantage. Resource-based view of the firm (RBV) =
perspective that firms’ competitive advantages are due to their
endowment of strategic resources that are valuable, rare, costly
to imitate, and costly to substitute. Without these unique
resources, the firm can only attain competitive parity. RBV goes
beyond a SWOT analysis to integrate internal and external
perspectives in a broader competitive context. RBV can reveal
how core competencies embedded in a firm can help it exploit
new product and market opportunities.
20
Types of Tangible Firm Resources
Tangible resources are assets that are relatively easy to identify.
Physical assets: plant & facilities, location, machinery &
equipment
Financial assets: cash & cash equivalents, borrowing capacity,
capacity to raise equity
Technological resources: trade secrets, patents, copyrights,
trademarks, innovative production processes
Organizational resources: effective planning processes,
evaluation & control systems
©McGraw-Hill Education.
Firm resources are all assets, capabilities, organizational
processes, information, knowledge, etc. controlled by a firm –
resources that enable it to develop and implement value-

15. creating strategies. Tangible resources = organizational assets
that are relatively easy to identify, including physical assets,
financial resources, organizational resources, and technological
resources. These include assets that the firm uses to create value
for its customers: physical resources such as the plant’s
proximity to customers and suppliers; financial resources such
as accounts receivables; organizational resources such as
employee development, evaluation and reward systems;
technological resources such as trade secrets and patents.
21
Types of Intangible Firm Resources
Intangible resources are difficult for competitors to account for
or imitate. They are embedded in unique routines & practices.
Human resources: trust, experience & capabilities of employees;
managerial skills & effectiveness of work teams, firm specific
practices & procedures
Innovation resources: technical & scientific expertise & ideas;
innovation capabilities
Reputation resources: brand names, reputation for fairness with
suppliers, non-zero sum relationships; reputation for reliability
& product quality with customers
©McGraw-Hill Education.
Intangible resources = organizational assets that are difficult to
identify and account for, and are typically embedded in unique
routines and practices, including human resources, innovation
resources, and reputation resources. Example = Harley-
Davidson’s strong brand image. A firm’s specific practices and
procedures, and the firm’s culture, may also be resources that
provide competitive advantage.
22
Types of Firm Resources:
Organizational Capabilities

16. Organizational capabilities are competencies or skills that a
firm employs to transform inputs into outputs. It is the capacity
to combine tangible & intangible resources to attain desired
ends.
Outstanding customer service
Excellent product development capabilities
Superb innovation processes & flexibility in manufacturing
processes
Ability to hire, motivate, & retain human capital
©McGraw-Hill Education.
Organizational capabilities = the competencies and skills that a
firm employs to transform inputs into outputs. Capabilities
involve an organization’s capacity to deploy tangible and
intangible resources over time and generally in combination,
and to leverage those capabilities to bring about a desired end.
Example = Apple’s ability to combine and package
technological components in new and innovative ways while
also seeking to integrate the value chain. See Case Apple.
23
Question
(2 of 2)
Gillette combines several technologies to attain unparalleled
success in the wet-shaving industry. This is an example of their
tangible resources.
intangible resources.
organizational capabilities.
strong primary activities.
©McGraw-Hill Education.
Answer: C, organizational capabilities in combining
technologies in innovative ways
24

17. Firm Resources and Sustainable Competitive Advantages
Strategic resources have four attributes.
Valuable in formulating & implementing strategies to improve
efficiency or effectiveness
Rare or uncommon; difficult to exploit
Difficult to imitate or copy due to physical uniqueness, path
dependency, causal ambiguity, or social complexity
Difficult to substitute with strategically equivalent resources or
capabilities
©McGraw-Hill Education.
Strategic resources (also firm resources or organizational
resources) = firms’ capabilities that are valuable, rar e, costly to
imitate, and costly to substitute. Firm attributes must be
valuable in order to be considered resources and potential
sources of competitive advantage. These valuable resources
enable a firm to formulate and implement strategies that
improve its efficiency or effectiveness. If competitors or
potential competitors also possessed the same valuable
resource, it is not a source of competitive advantage unless it is
uncommon or rare. Inimitability or being difficult to imitate is
the key to value creation because it constrains competition.
Having a resource that competitors can easily copy generates
only temporary value. Non-substitutability means there is no
strategically equivalent valuable resources that are themselves
not rare or inimitable. However, even though a company cannot
exactly imitate someone else’s resource, it may be able to
develop an equivalent resource from another source, such as
Amazon internet capabilities allows it to compete against prime
brick-and-mortar Barnes & Noble locations.
25
Sources of Inimitability
Physical uniqueness are resources that are physically unique,

18. therefore impossible to duplicate.
Path dependency: hard to duplicate because of all that has
happened along the path followed in the development and/or
accumulation of resources.
Causal ambiguity: impossible to explain what caused a resource
to exist or how to re-create it.
Social complexity: resources that result from social engineering
such as interpersonal relations, culture.
©McGraw-Hill Education.
Physical uniqueness = a beautiful resort location, mineral
rights, or patents. Path dependency = a characteristic of
resources that is developed and or accumulated through a
unique series of events. See Strategy Spotlight 3.4 for an
example. Causal ambiguity = a characteristic of the firm’s
resources that is costly to imitate because a competitor cannot
determine what the resource is and/or how it can be re-created.
Google is given as an example. Social complexity = a
characteristic of a firm’s resources that is costly to imitate
because the social engineering required is beyond the capability
of competitors, including interpersonal relations among
managers, organizational culture, and reputation with suppliers
and customers.
26
Criteria for Sustainable Competitive Advantage
Is a resource or capability . . .Valuable?Rare?Difficult to
Imitate?Without Substitutes?Implications for
Competitiveness?NoNoNoNoCompetitive
disadvantageYesNoNoNoCompetitive
parityYesYesNoNoTemporary competitive
advantageYesYesYesYesSustainable competitive advantage
Exhibit 3.7 Criteria for Sustainable Competitive Advantage and
Strategic Implications
Source: Adapted from Barney, J.B. 1991. Firm Resources and

19. Sustained Competitive Advantage. Journal of Management,
17:99 – 120.
©McGraw-Hill Education.
Resources and capabilities must be rare and valuable as well as
difficult to imitate or substitute in order for a firm to attain
competitive advantages that are sustainable over time. If
resources and capabilities do not meet any of the four criteria it
would be difficult to develop any type of competitive advantage
in the short or long run. If resources and capabilities are not
difficult for competitors to imitate or substitute firms could
attain some level of competitive parity. Only when all four
criteria are satisfied will competitive advantages be sustained
over time.
27
The Generation and Distribution of the Firm’s Profits
Four factors help explain the extent to which employees and
managers will be able to obtain a proportionately high level of
the profits that they generate
Employee bargaining power
Employee replacement cost
Employee exit costs
Manager bargaining power
©McGraw-Hill Education.
The resource based view of the firm is useful in determining
when firms will create competitive advantages and enjoy high
levels of profitability. These profits can be retained or
appropriated by employees or managers (and not owners or
shareholders) by various methods: employee bargaining power
allows employees to earn disproportionately high wages; if
employee skills are rare it will be costly to replace them; if an

20. employee’s expertise is firm-specific or of limited value it
would be difficult for the employee to explain his or her
specific contribution to the firm, therefore, would be costly for
that employee to exit; if managers have sources of information
that may not be readily available to others they will have
bargaining power. See Chapter 9 for a discussion of how
corporate governance can be a critical control mechanism here.
28
Evaluating Firm Performance
Balanced Scorecard Analysis
Employees
Owners
Customer satisfaction
Internal processes
Innovation, learning & improvement activities
Financial perspectives
Financial Ratio Analysis
Balance sheet
Income statement
Market valuation
Historical comparison
Comparison with industry norms
Comparison with key competitors
©McGraw-Hill Education.
Financial ratio analysis = a technique for measuring the
performance of a firm according to its balance sheet, income
statement, and market valuation. When performing a financial
ratio analysis, you must take into account the firm’s
performance from a historical perspective (not just at one point
in time) as well as how it compares with both industry norms
and key competitors. Balanced scorecard = a method of

21. evaluating a firm’s performance using performance measures
from the customers’ perspectives, as well as internal, innovation
and learning, and financial perspectives.
29
Financial Ratio Analysis
Five types of financial ratios:
Short-term solvency or liquidity
Long-term solvency measures
Asset management or turnover
Profitability
Market value
Meaningful ratio analysis must include:
Analysis of how ratios change over time
Comparison with industry norms
Comparison with key competitors
©McGraw-Hill Education.
Financial ratio analysis = a technique for measuring the
performance of the firm according to its balance sheet, income
statement, and market valuation. A meaningful ratio analysis
must go beyond the calculation and interpretation of financial
ratios. It must include how ratios change over time as well as
how they are interrelated. A firm’s financial position should not
be analyzed in isolation: historical comparisons, comparisons
with industry norms, and comparisons with key competitors
make financial analysis more meaningful. Appendix 1 to
Chapter 13 (the case analysis chapter) provides detailed
definitions for and discussions of each of these types of ratios
as well as examples of how each is calculated.
30
The Balanced Scorecard
A meaningful integration of many issues that come into
evaluating performance

22. Four key perspectives:
How do customers see us? (customer perspective)
What must we excel at? (internal perspective)
Can we continue to improve and create value? (innovation &
learning perspective)
How do we look to shareholders? (financial perspective)
©McGraw-Hill Education.
Balanced scorecard = a method of evaluating a firm’s
performance using performance measures from the customers’
perspectives, as well as internal, innovation and learning, and
financial perspectives. It includes financial measures that
reflect the results of actions already taken, but it complements
these indicators with measures of customer satisfaction, internal
processes, and the organization’s innovation and improvement
activities – operational measures that drive future financial
performance. The balanced scorecard approach recognizes how
the interests of a variety of stakeholders can be interrelated.
31
Customer Perspective vs. Internal Business Perspective
Managers articulate goals for customer concerns.
Time versus Quality
Performance and service versus Cost
Then focus on those critical internal operations that enable them
to satisfy customer needs.
Business processes
Cycle time, quality, employee skills, productivity
Decisions
Coordinated actions
Key resources and capabilities
©McGraw-Hill Education.
Customer perspective = measures of firm performance that

23. indicate how well firms are satisfying customers’ expectations.
Managers must translate their general mission statements on
customer service into specific measures that reflect the factors
that really matter to customers. Internal business perspective =
measures of firm performance that indicate how well a firm’s
internal processes, decisions, and actions are contri buting to
customer satisfaction. Customer-based measures are important,
however they must be translated into indicators of what the firm
must do internally to meet customer’s expectations. The internal
measures should reflect business processes that have the
greatest impact on customer satisfaction.
32
Innovation and Learning Perspective
Managers must make frequent changes to existing products &
services as well as introduce entirely new products with
extended capabilities. This requires:
Human capital (skills, talent, knowledge)
Information capital (information systems, networks)
Organization capital (culture, leadership)
©McGraw-Hill Education.
Innovation and learning perspective = measures of firm
performance that indicate how well firms are changing their
product and service offerings to adapt to changes in the internal
and external environments. A firm’s ability to improve,
innovate, and learn is tied directly to its value. Simply put, only
by developing new products and services, creating greater val ue
for customers, and increasing operational efficiencies can a
company penetrate new markets, increase revenues and margins,
and enhance shareholder value. A firm’s ability to do well from
an innovation and learning perspective is more dependent on its
intangible than tangible assets.
33

24. Financial Perspective
Managers must measure how the firm’s strategy,
implementation, and execution are indeed contributing to
bottom line improvement. Financial goals include:
Profitability, growth, shareholder value
This should lead to:
Improved sales
Increased market share
Reduced operating expenses
Higher asset turnover
©McGraw-Hill Education.
Financial perspective = measures of firms financial performance
that indicate how well strategy, implementation and execution
are contributing to bottom-line improvement. Periodic financial
statements remind managers that improved quality, response
time, productivity, and innovative products benefit the firm
only when they result in improved sales, increased market
share, reduced operating expenses, or higher asset turnover.
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Limitations of the Balanced Scorecard
Not a “quick fix” – needs proper execution
Needs a commitment to learning
Needs employee involvement in continuous process
improvement
Needs cultural change
Needs a focus on nonfinancial rather than financial measures
Needs data on actual performance
©McGraw-Hill Education.
There is general agreement that there is nothing inherently
wrong with the concept of the balanced scorecard. The key
limitation is that some executives may view it as a “quick fix”

25. that can be easily installed. Implementing a balanced metrics
system is an evolutionary process. It is not a one-time task that
can be quickly checked off as completed. If managers do not
recognize this from the beginning and fail to commit to it long-
term, the organization will be disappointed. Poor execution
becomes the cause of such performance outcomes. And
organizational scorecards must be aligned with individuals’
scorecards to turn the balanced scorecards into a powerful tool
for sustained performance. (For a variation on the balanced
scorecard concept, see the Malcolm Baldrige National Quality
Award at https://www.nist.gov/baldrige/baldrige-criteria-
commentary. This award encourages organizations to focus on
critical aspects of managing and performing as an organization,
using an integrated performance management framework that
addresses innovation management, intelligent risk, and strategic
priorities; social media; operational effectiveness; and work
systems and core competencies. Through a self-study process,
organizations can submit their findings for the award in
business/non profit, education, and healthcare categories.)
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ADA APPENDICES
Description of Images
©McGraw-Hill Education.
Appendix 1 The Value Chain
Return to slide.
Porter's two different categories of activities are represented.
The top arrows, one leading into another, are Primary
Activities: Inbound logistics, operations, outbound logistics,
marketing and sales, and service. Below this are the Support
Activities: general administration, human resource management,
technology development, and procurement.
©McGraw-Hill Education.

26. ©McGraw-Hill Education.
37
Appendix 2 Example: The Value Chain in Service Organizations
Return to slide.
The graphic depicts primary value-chain activities for retail and
engineering services.
Primary value-chain activities for retail are
partnering with vendors,
purchasing goods,
managing distributing inventory,
operating stores,
marketing and selling.
Primary value-chain activities for engineering services are
research and development,
engineering,
designs and solutions,
marketing and sales,
service.
©McGraw-Hill Education.
©McGraw-Hill Education.
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