CHAPTER 3EVALUATING A COMPANY’S EXTERNAL ENVIRONMENT(c) 2016

CHAPTER 3
EVALUATING A COMPANY’S EXTERNAL ENVIRONMENT
(c) 2016 by McGraw-Hill Education. This is proprietary
material solely for authorized instructor use. Not authorized for
sale or distribution in any manner. This document may not be
copied, scanned, duplicated, forwarded, distributed, or posted
on a website, in whole or part.
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THIS CHAPTER WILL HELP YOU UNDERSTAND:
LO 1How to recognize the factors in a company’s broad macro-
environment that may have strategic significance.
LO 2How to use analytic tools to diagnose the competitive
conditions in a company’s industry.
LO 3How to map the market positions of key groups of industry
rivals.
LO 4How to use multiple frameworks to determine whether an
industry’s outlook presents a company with sufficiently
attractive opportunities for growth and profitability.
FIGURE 3.1

From Thinking Strategically about the Company’s Situation to
Choosing a Strategy
Chapter 3
Chapter 4
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The macro-environment encompasses the broad environmental
context in which a company’s industry is situated that includes
strategically relevant components over which the firm has no
direct control.
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CORE CONCEPT
4

PESTEL analysis focuses on the six principal components of
strategic significance in the macro-environment:
Political
Economic
Social
Technological
Environmental
Legal
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CORE CONCEPT
5
THE STRATEGICALLY RELEVANT FACTORS IN THE
COMPANY'S MACRO-ENVIRONMENT
PESTEL Analysis
Focuses on principal components of strategic significance in the
macro-environment:
Political factors
Economic conditions (local to worldwide)
Sociocultural forces
Technological factors
Environmental factors (the natural environment)
Legal/regulatory conditions

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FIGURE 3.2
The Components of a Company’s Macro-Environment
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ASSESSING A COMPANY’S INDUSTRY AND
COMPETITIVE ENVIRONMENT
How strong are the industry’s competitive forces?
What are the driving forces in the industry, and what impact
will they have on competitive intensity and industry
profitability?
What market positions do industry rivals occupy—who is
strongly positioned and who is not?
What strategic moves are rivals likely to make next?
What are the industry’s key success factors?
Is the industry outlook conducive to good profitability?
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THE FIVE FORCES FRAMEWORK
The Five Competitive Forces:
Competition from rival sellers
Competition from potential new entrants
Competition from producers of substitute products
Supplier bargaining power
Customer bargaining power

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FIGURE 3.3
The Five-Forces Model of Competition: A Key Analytical Tool
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USING THE FIVE-FORCES MODEL
OF COMPETITION
Step 1
For each of the five forces, identify the different parties
involved, along with the specific factors that bring about
competitive pressures.
Step 2
Evaluate how strong the pressures stemming from each of the
five forces are (strong, moderate, or weak).
Step 3
Determine whether the five forces, overall, are supportive of

high industry profitability.
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COMPETITIVE PRESSURES THAT INCREASE RIVALRY
AMONG COMPETING SELLERS
Buyer demand is growing slowly or declining.
It is becoming less costly for buyers to switch brands.
Industry products are becoming less differentiated.
There is unused production capacity, andor products have high
fixed costs or high storage costs.
The number of competitors is increasing andor they are
becoming more equal in size and competitive strength.
The diversity of competitors is increasing.
High exit barriers keep firms from exiting the industry.
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FIGURE 3.4
Factors Affecting the Strength of Rivalry

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COMPETITIVE PRESSURES ASSOCIATED WITH THE
THREAT OF NEW ENTRANTS
Entry Threat Considerations:
Expected defensive reactions of incumbent firms
Strength of barriers to entry
Attractiveness of a particular market’s growth
in demand and profit potential
Capabilities and resources of potential entrants
Entry of existing competitors into market segments
in which they have no current presence

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MARKET ENTRY BARRIERS
FACING NEW ENTRANTS
Incumbent cost advantages related to learning and experience,
proprietary patents and technology, favorable locations, and
lower fixed costs
Strong brand preferences and customer loyalty
Strong “network effects” in customer demand
High capital requirements
Building a network of distributors or dealers and securing
adequate space on retailers’ shelves
Restrictive regulatory and trade policies
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Whether an industry’s entry barriers ought to be considered
high or low depends on the resources and capabilities possessed
by the pool of potential entrants.
High entry barriers and weak entry threats today do not always
translate into high entry barriers and weak entry threats
tomorrow.

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STRATEGIC MANAGEMENT PRINCIPLE
FIGURE 3.5
Factors Affecting the Threat of Entry
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COMPETITIVE PRESSURES FROM THE SELLERS OF
SUBSTITUTE PRODUCTS
Substitute Products Considerations:
Readily available and attractively priced?
Comparable or better in terms of quality, performance, and
other relevant attributes?
Offer lower switching costs to buyers?
Indicators of Substitutes’ Competitive Strength:
Increasing rate of growth in sales of substitutes
Substitute producers adding new output capacity
Increasing profitability of substitute producers

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FIGURE 3.6
Factors Affecting Competition from Substitute Products
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COMPETITIVE PRESSURES STEMMING FROM SUPPLIER
BARGAINING POWER
Supplier Bargaining Power Depends On:
Strength of demand for and availability of suppliers’ products.
Whether suppliers provide a differentiated input that enhances
the performance of the industry’s product.
Industry members’ costs for switching among suppliers
Size and number of suppliers relative to industry members
Possibility of backward integration into suppliers’ industry
Fraction of the cost of the supplier’s product relative to the
total cost of the industry’s product
Availability of good substitutes for suppliers’ products
Whether industry members are major customers of suppliers.

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FIGURE 3.7
Factors Affecting the Bargaining Power of Suppliers
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COMPETITIVE PRESSURES STEMMING
FROM BUYER BARGAINING POWER AND
PRICE SENSITIVITY
Buyer Bargaining Power Considerations:
Strength of buyers’ demand for sellers’ products
Degree to which industry goods are differentiated
Buyers’ costs for switching to competing sellers or substitutes
Number and size of buyers relative to number of sellers
Threat of buyers’ integration into sellers’ industry
Buyers’ knowledge of products, costs and pricing
Buyers’ discretion in delaying purchases
Buyers’ price sensitivity due to low profits, size of purchase,

and consequences of purchase
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FIGURE 3.8
Factors Affecting the Bargaining Power of Buyers
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IS THE COLLECTIVE STRENGTH OF THE FIVE
COMPETITIVE FORCES CONDUCIVE TO GOOD
PROFITABILITY?
Is the state of competition in the industry stronger than
“normal”?
Can industry firms expect to earn decent profits given
prevailing competitive forces?
Are some of the competitive forces sufficiently powerful to
undermine industry profitability?
Even one powerful force may be enough to make the industry
unattractive in terms of its profit potential

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The strongest of the five forces determines the extent of the
downward pressure on an industry’s profitability.
Having more than one strong force means that an industry has
multiple competitive challenges with which to cope.
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CORE CONCEPT
COMPLEMENTORS AND THE VALUE NET
How the Value Net differs from the Five Forces
Focuses on the interactions of industry participants with a
particular (focal) company.
Defines the category of “competitors” to include the focal
firm’s direct competitors, industry rivals, the sellers of
substitute products, and potential entrants.
Introduces a new category of industry participant—
“complementors”—producers of products that enhance the value
of the focal firm’s products when they are used together.

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Complementors are the producers of complementary products,
which are products that enhance the value of the focal firm’s
products when they are used together.
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CORE CONCEPT
FIGURE 3.9
The Value Net
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MATCHING COMPANY STRATEGY

TO COMPETITIVE CONDITIONS
Effectively matching a firm’s business strategy to prevailing
competitive conditions has two aspects:
Pursuing avenues that shield the firm from as many competitive
pressures as possible.
Initiating actions calculated to shift competitive forces in the
firm’s favor by altering underlying factors driving the five
forces.
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A company’s strategy is increasingly effective the more it
provides some insulation from competitive pressures, shifts the
competitive battle in the company’s favor, and positions firms
to take advantage of attractive growth opportunities.
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INDUSTRY DYNAMICS AND
THE FORCES DRIVING CHANGE
Driving forces analysis has three steps:

Identifying what the driving forces are.
Assessing whether the drivers of change are,
on the whole, acting to make the industry more or less
attractive.
Determining what strategy changes are needed to prepare for the
impact of the driving forces.
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Driving forces are the major underlying causes of change in
industry and competitive conditions.
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CORE CONCEPT
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The most important part of driving forces analysis is to
determine whether the collective impact of the driving forces
will be to increase or decrease market demand, make
competition more or less intense, and lead to higher or lower
industry profitability.
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ASSESSING THE IMPACT OF THE FACTORS DRIVING
INDUSTRY CHANGE
Are the driving forces as a whole causing demand for the
industry’s product to increase or decrease?
Is the collective impact of the driving forces making
competition more or less intense?
Will the combined impacts of the driving forces lead to higher
or lower industry profitability?
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The real payoff of driving-forces analysis is to help managers
understand what strategy changes are needed to prepare for the
impacts of the driving forces.
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ADJUSTING STRATEGY TO PREPARE
FOR THE IMPACTS OF DRIVING FORCES
What strategy adjustments will be needed
to deal with the impacts of the driving forces on industry
conditions?
What adjustments must be made immediately?
What actions currently being taken should be halted or
abandoned?
What can we do now to prepare for adjustments we anticipate
making in the future?
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STRATEGIC GROUP ANALYSIS
Strategic Group
Consists of those industry members with similar competitive
approaches and positions in the market:
Having comparable product-line breadth
Emphasizing the same distribution channels
Depending on identical technological approaches
Offering the same product attributes to buyers
Offering similar services and technical assistance
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A strategic group is a cluster of industry rivals that have similar
competitive approaches and market positions.
Strategic group mapping is a technique for displaying the
different market or competitive positions that rival firms occupy
in the industry.
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CORE CONCEPTS
USING STRATEGIC GROUP MAPS TO ASSESS THE

MARKET POSITIONS OF KEY COMPETITORS
Constructing a strategic group map:
Identify the competitive characteristics that delineate strategic
approaches used in the industry.
Plot the firms on a two-variable map using pairs of the
competitive characteristics.
Assign firms occupying about the same map location to the
same strategic group.
Draw circles around each strategic group, making the circles
proportional to the size of the group’s share of total industry
sales revenues.
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TYPICAL VARIABLES USED
IN CREATING GROUP MAPS
Price/quality range (high, medium, low)
Geographic coverage (local, regional, national, global)
Product-line breadth (wide, narrow)
Degree of service offered (no frills, limited, full)
Distribution channels (retail, wholesale, Internet, multiple)
Degree of vertical integration (none, partial, full)
Degree of diversification into other industries (none, some,
considerable)

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GUIDELINES FOR CREATING GROUP MAPS
Variables selected as map axes should not be highly correlated.
Variables should reflect important (sizable) differences among
rival approaches.
Variables may be quantitative, continuous, discrete andor
defined in terms of distinct classes and combinations.
Drawing group circles proportional to the combined sales of
firms in each group will reflect the relative sizes of each
strategic group.
Drawing maps using different pairs of variables will show the
different competitive positioning relationships present in the
industry’s structure.
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Strategic group maps reveal which companies are close
competitors and which are distant competitors.
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Footnote: Circles are drawn roughly proportional to the sizes of
the chains, based on revenues.
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Comparative Market Positions of Producers in the U.S. Beer
Industry: A Strategic Group Map Example
ILLUSTRATION CAPSULE 3.1
material solely for authorized instructor use. Not authori zed for
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Which strategic group is located in the least favorable market
position? Which group is in the most favorable position?
Which strategic group is likely to experience increased
intragroup competition?
Which groups are most threatened by the likely strategic moves
of members of nearby strategic groups?
Comparative Market Positions of Producers in the U.S. Beer
Industry: A Strategic Group Map Example

ILLUSTRATION CAPSULE 3.1
Some strategic groups are more favorably positioned than others
because they confront weaker competitive forces and/ or
because they are more favorably impacted by industry driving
forces.
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THE VALUE OF STRATEGIC GROUP MAPS
Maps are useful in identifying which industry members are
close rivals and which are distant rivals.
Not all map positions are equally attractive:
Prevailing competitive pressures from the industry’s five forces
may cause the profit potential of different strategic groups to
vary.
Industry driving forces may favor some strategic groups and
hurt others.

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COMPETITOR ANALYSIS
Competitive Intelligence
Information about rivals that is useful in anticipating their next
strategic moves.
Signals of the Likelihood of Strategic Moves:
Rivals under pressure to improve financial performance
Rivals seeking to increase market standing
Public statements of rivals’ intentions
Profiles developed by competitive intelligence units
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Studying competitors’ past behavior and preferences provides a
valuable assist in anticipating what moves rivals are likely to
make next and outmaneuvering them in the marketplace.
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FIGURE 3.10
A Framework for Competitor Analysis
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A FRAMEWORK FOR COMPETITOR ANALYSIS
Indicators of a rival firm’s likely strategic moves and
countermoves:
The rival firm’s current strategy
The rival firm’s objectives
The rival firm’s capabilities
The rival firm’s assumptions
about itself and its industry
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USEFUL QUESTIONS TO HELP PREDICT THE LIKELY
ACTIONS OF IMPORTANT RIVALS
Which competitors’ strategies are achieving good results?

Which competitors are losing in the marketplace or badly need
to increase unit sales and market share?
Which rivals are likely make major moves to enter new
geographic markets or to increase sales and market share in a
particular geographic region?
Which rivals can expand product offerings to enter new product
segments where they do not have a presence?
Which rivals can be acquired? Which rivals are financially able
and looking to make an acquisition?
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CREATING A STRATEGIC PROFILE
OF A RIVAL COMPETITOR FIRM
Current Strategy
How is the competitor positioned in the market?
What is the basis for its competitive advantage?
What kinds of investments is it making (as an indicator of its
expected growth trajectory)?
Objectives
What are its financial performance objectives?
What are its strategic objectives?
How well is it performing in meeting its objectives?
Is it under pressure to improve its performance?

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CREATING A STRATEGIC PROFILE
OF A RIVAL COMPETITOR FIRM (cont’d)
Capabilities
What are the competitor’s current capabilities?
What weaknesses does it have?
Which capabilities is it making efforts to obtain?
Assumptions
What do the competitor’s top managers believe about their
strategic situation?
How will their beliefs affect the competitor’s behavior in the
market?
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KEY SUCCESS FACTORS
Key Success Factors (KSFs)
Are the strategy elements, product and service attributes,
operational approaches, resources, and competitive capabilities
that are necessary for competitive success by any and all firms
in an industry.
Vary from industry to industry, and over time within the same
industry, and in importance as drivers of change and
competitive conditions change.

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Key success factors are the strategy elements, product and
service attributes, operational approaches, resources, and
competitive capabilities that are essential to surviving and
thriving in the industry.
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CORE CONCEPT
IDENTIFICATION OF KEY SUCCESS FACTORS
On what basis do buyers of the industry’s product choose
between the competing brands of sellers? That is, w hat product
attributes and service characteristics are crucial to competitive
success?
Given the nature of competitive rivalry prevailing in the
marketplace, what resources and competitive capabilities must a
firm have to be competitively successful?
What shortcomings are almost certain to put a firm
at a significant competitive disadvantage?
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THE INDUSTRY OUTLOOK FOR PROFITABILITY
An industry environment is fundamentally attractive if it
presents a company with good opportuni ty for above-average
profitability.
An industry environment is fundamentally unattractive if a
firm’s profit prospects in the industry are unappealingly low.
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FACTORS TO CONSIDER IN ASSESSING INDUSTRY
ATTRACTIVENESS
How the firm is being impacted by the state of the macro-
environment.
Whether strong competitive forces are squeezing industry
profitability to subpar levels.
Whether the presence of complementors and the possibility of
cooperative actions improve the company’s prospects.
Whether industry profitability will be favorably or unfavorably
affected by the prevailing driving forces.
Whether the firm occupies a stronger market position than
rivals.
Whether this is likely to change in the course of competitive
interactions.
How well the firm’s strategy delivers on industry key success
factors.

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The degree to which an industry is attractive or unattractive is
not the same for all industry participants and all potential
entrants.
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INDUSTRY ATTRACTIVENESS IS NOT THE SAME FOR
ALL PARTICIPANTS
Industry outsiders may conclude that they have the resources to
easily hurdle the barriers to entering an attractive industry
while other outsiders may find the same industry unattractive
because they do not want to challenge market leaders and have
better opportunities elsewhere.
A particular industry’s attractiveness depends in large part
on whether a company has the resources and capabilities to be
competitively successful and profitable in that environment.

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WHAT SHOULD A CURRENT COMPETITOR DECIDE
ABOUT ITS INDUSTRY?
When a competitor decides an industry is attractive, it should
invest aggressively to capture the opportunities it sees and to
improve its long-term competitive position in the business.
When a strong competitor concludes its industry is relatively
unattractive and lacking in opportunity, it may elect to protect
its present position, investing cautiously if at all and looking
for opportunities in other industries.
A competitively weak company in an unattractive industry may
see its best option as finding a buyer, perhaps a rival, to acquire
its business.
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LO 1How to recognize the factors in a company’s broad macro-
environment that may have strategic significance.
LO 2How to use analytic tools to diagnose the competitive
conditions in a company’s industry.
LO 3How to map the market positions of key groups of industry
rivals.
LO 4How to use multiple frameworks to determine whether an
industry’s outlook presents a company with sufficiently
attractive opportunities for growth and profitability.
CHAPTER 4 Evaluating a Company’s Resources, Capabilities,
and Competitiveness
Copyright © McGraw-Hill Education. Permission required for
reproduction or display.
LEARNING OBJECTIVES
How to take stock of how well a company’s strategy is working
Why a company’s resources and capabilities are centrally
important in giving the company a competitive edge over rivals
How to assess the company’s strengths and weaknesses in light
of market opportunities and external threats
How a company’s value chain activities can affect the
company’s cost structure and customer value proposition

How a comprehensive evaluation of a company’s competitive
situation can assist managers in making critical decisions about
their next strategic moves
© McGraw-Hill Education.
2
EVALUATING A FIRM’S INTERNAL SITUATION
How well is the firm’s present strategy working?
What are the firm’s competitively important resources and
capabilities?
Is the firm able to take advantage of market opportunities and
overcome external threats to its well-being?
Are the firm’s prices and costs competitive with those of key
rivals, and does it have an appealing customer value
proposition?
Is the firm competitively stronger or weaker than key rivals?
What strategic issues and problems merit front-burner
managerial attention?
QUESTION 1: HOW WELL IS THE FIRM’S PRESENT
STRATEGY WORKING?
The three best indicators of how well a company’s strategy is
working are:
Whether the company is achieving its stated financial and
strategic objectives
Whether its financial performance is above the industry average
Whether it is gaining customers and increasing its market share

FIGURE 4.1 Identifying the Components of a Single-Business
Company’s Strategy
Jump to Appendix 1 long image description
SPECIFIC INDICATORS OF
STRATEGIC SUCCESS
Trends in the firm’s sales and earnings growth
Trends in the firm’s stock price
The firm’s overall financial strength
The firm’s customer retention rate
The rate at which new customers are acquired
Evidence of improvement in internal processes such as defect
rate, order fulfillment, delivery times, days of inventory, and
employee productivity
STRATEGIC MANAGEMENT PRINCIPLE (1 of 14)
Sluggish financial performance and second-rate market
accomplishments almost always signal weak strategy, weak
execution, or both.

TABLE 4.1 Key Financial Ratios: How to Calculate Them and
What They Mean (1 of 8)Profitability RatiosHow
CalculatedWhat It ShowsGross profit marginSales revenues −
Cost of goods sold
Sales revenuesShows the percentage of revenues available to
cover operating expenses and yield a profit.Operating profit
margin (or return on sales)Sales revenues − Operating expenses
Sales revenues
or
Operating income
Sales revenuesShows the profitability of current operations
without regard to interest charges and income taxes. Earnings
before interest and taxes is known as EBIT in financial and
business accounting.Net profit margin (or net return on
sales)Profits after taxes
Sales revenuesShows after-tax profits per dollar of sales.Total
return on assetsProfits after taxes + Interest
Total assetsA measure of the return on total investment in the
enterprise. Interest is added to after-tax profits to form the
numerator, since total assets are financed by creditors as well as
by stockholders.
What They Mean (2 of 8)Profitability RatiosHow
CalculatedWhat It ShowsNet return on total assets (ROA)Profits
after taxes
Total assets
A measure of the return earned by stockholders on the firm’s
total assets.Return on stockholders’ equity (ROE) Profits after
taxes
Total stockholders’ equityThe return stockholders are earning
on their capital investment in the enterprise. A return in the

12%–15% range is average.Return on invested capital (ROIC)—
sometimes referred to as return on capital employed (ROCE)
Profits after taxes
Long-term debt +
Total stockholders’ equityA measure of the return that
shareholders are earning on the monetary capital invested in the
enterprise. A higher return reflects greater bottom-line
effectiveness in the use of long-term capital.
What They Mean (3 of 8)Liquidity RatiosHow CalculatedWhat
It ShowsCurrent ratio Current assets
Current liabilitiesShows a firm’s ability to pay current
liabilities using assets that can be converted to cash in the near
term. Ratio should be higher than 1.0.Working capitalCurrent
assets − Current liabilitiesThe cash available for a fir m’s day-
to-day operations. Larger amounts mean the company has more
internal funds to (1) pay its current liabilities on a timely basis
and (2) finance inventory expansion, additional accounts
receivable, and a larger base of operations without resorting to
borrowing or raising more equity capital.
What They Mean (4 of 8)Leverage RatiosHow CalculatedWhat
It ShowsTotal debt-to-assets ratio Total debt
Total assets
Measures the extent to which borrowed funds (both short-term
loans and long-term debt) have been used to finance the firm’s

operations. A low ratio is better—a high fraction indicates
overuse of debt and greater risk of bankruptcy.Long-term debt-
to-capital ratio Long-term debt
Long-term debt +
Total stockholders’ equityA measure of creditworthiness and
balance-sheet strength. It indicates the percentage of capital
investment that has been financed by both long-term lenders and
stockholders. A ratio below 0.25 is preferable since the lower
the ratio, the greater the capacity to borrow additional funds.
Debt-to-capital ratios above 0.50 indicate an excessive reliance
on long-term borrowing, lower creditworthiness, and weak
balance- sheet strength.
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What They Mean (5 of 8)Leverage RatiosHow CalculatedWhat
It ShowsDebt-to-equity ratio Total debt
Total stockholders’ equityShows the balance between debt
(funds borrowed, both short term and long term) and the amount
that stockholders have invested in the enterprise. The further
the ratio is below 1.0, the greater the firm’s ability to borrow
additional funds. Ratios above 1.0 put creditors at greater risk,
signal weaker balance sheet strength, and often result in lower
credit ratings.Long-term debt-to-equity ratio Long-term debt
Total stockholders’ equityShows the balance between long-term
debt and stockholders’ equity in the firm’s long-term capital
structure. Low ratios indicate a greater capacity to borrow
additional funds if needed.Times-interest-earned (or coverage)
ratio Operating income
Interest expensesMeasures the ability to pay annual interest

charges. Lenders usually insist on a minimum ratio of 2.0, but
ratios above 3.0 signal progressively better creditworthiness.
What They Mean (6 of 8)Activity RatiosHow CalculatedWhat It
ShowsDays of inventory Inventory
Cost of goods sold ÷ 365Measures inventory management
efficiency. Fewer days of inventory are better.Inventory
turnoverCost of goods sold InventoryMeasures the number of
inventory turns per year. Higher is better.Average collection
periodAccounts receivable
Total sales ÷ 365
or
Accounts receivable
Average daily salesIndicates the average length of time the firm
must wait after making a sale to receive cash payment. A
shorter collection time is better.
What They Mean (7 of 8)Other RatiosHow CalculatedWhat It
ShowsDividend yield on common stockAnnual dividends
per share
Current market price
per shareA measure of the return that shareholders receive in
the form of dividends. A “typical” dividend yield is 2% –3%.
The dividend yield for fast-growth companies is often below
1%; the dividend yield for slow-growth companies can run 4%–
5%.Price-to-earnings (P/E) ratioCurrent market price
per share
Earnings per shareP/E ratios above 20 indicate strong investor

confidence in a firm’s outlook and earnings growth; firms
whose future earnings are at risk or likely to grow slowly
typically have ratios below 12.Dividend payout ratioAnnual
dividends
per share
Earnings per shareIndicates the percentage of after-tax profits
paid out as dividends.
What They Mean (8 of 8)Other RatiosHow CalculatedWhat It
ShowsInternal cash flowAfter-tax profits + DepreciationA rough
estimate of the cash a company’s business is generating after
payment of operating expenses, interest, and taxes. Such
amounts can be used for dividend payments or funding capital
expenditures.Free cash flowAfter-tax profits + Depreciation –
Capital expenditures – Dividends
A rough estimate of the cash a company’s business is generating
after payment of operating expenses, interest, taxes, dividends,
and desirable reinvestments in the business. The larger a
company’s free cash flow, the greater its ability to internally
fund new strategic initiatives, repay debt, make new
acquisitions, repurchase shares of stock, or increase dividend
payments.
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QUESTION 2: WHAT ARE THE FIRM’S MOST IMPORTANT
RESOURCES AND CAPABILITIES, AND WILL THEY GIVE
THE FIRM A LASTING COMPETITIVE ADVANTAGE OVER

RIVAL COMPANIES?
Competitive assets
Are the firm’s resources and capabilities
Are the determinants of its competitiveness and ability to
succeed in the marketplace
Are what a firm’s strategy depends on to develop sustainable
competitive advantage over its rivals
CORE CONCEPTS (1 of 9)
A resource is a competitive asset that is owned or controlled by
a firm.
A capability or competence is the capacity of a firm to perform
an internal activity competently through deployment of a firm’s
resources.
A firm’s resources and capabilities represent its competitive
assets and are determinants of its competitiveness and ability to
succeed in the marketplace.
IDENTIFYING THE FIRM'S RESOURCES AND
CAPABILITIES
A resource:
A productive input or competitive asset that is owned or
controlled by a firm (e.g., a fleet of oil tankers)
A capability:
The capacity of a firm to perform some activity proficiently
(e.g., superior skills in marketing)

Resource and capability analysis is a powerful tool for sizing up
a firm’s competitive assets and determining if they can support
a sustainable competitive advantage over market rivals.
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TABLE 4.2 Types of Company Resources (1 of 2)Tangible
resourcesPhysical resources: land and real estate; manufacturing
plants, equipment, or distribution facilities; the locations of
stores, plants, or distribution centers, including the overall
pattern of their physical locations; ownership of or access rights
to natural resources (such as mineral deposits)Financial
resources: cash and cash equivalents; marketable securities;
other financial assets such as a company’s credit rating and
borrowing capacityTechnological assets: patents, copyrights,
production technology, innovation technologies, technological
processesOrganizational resources: IT and communication
systems (satellites, servers, workstations, etc.); other planning,
coordination, and control systems; the company’s organizational
design and reporting structure
TABLE 4.2 Types of Resources (2 of 2)Intangible
resourcesHuman assets and intellectual capital: the education,
experience, knowledge, and talent of the workforce, cumulative
learning, and tacit knowledge of employees; collective learning

embedded in the organization, the intellectual capital and know -
how of specialized teams and work groups; the knowledge of
key personnel concerning important business functions;
managerial talent and leadership skill; the creativity and
innovativeness of certain personnelBrands, company image, and
reputational assets: brand names, trademarks, product or
company image, buyer loyalty and goodwill; company
reputation for quality, service, and reliability; reputation with
suppliers and partners for fair dealingRelationships: alliances,
joint ventures, or partnerships that provide access to
technologies, specialized know-how, or geographic markets;
networks of dealers or distributors; the trust established with
various partnersCompany culture and incentive system: the
norms of behavior, business principles, and ingrained beliefs
within the company; the attachment of personnel to the
company’s ideals; the compensation system and the motivation
level of company personnel
IDENTIFYING CAPABILITIES
An organizational capability
Is the intangible but observable capacity of a firm to perform a
critical activity proficiently using a related combination (cross -
functional bundle) of its resources
Is knowledge-based, residing in people and in a firm’s
intellectual capital or in its organizational processes and
systems, emboding tacit knowledge

A resource bundle is a linked and closely integrated set of
competitive assets centered around one or more cross-functional
capabilities.
The VRIN Test for sustainable competitive advantage asks if a
resource is Valuable, Rare, Inimitable, and Non-substitutable.
VRIN TESTING: RESOURCES AND CAPABILITIES
Identifying the firm’s resources and capabilities by testing the
competitive power of its resources and capabilities:
Is the resource (or capability) competitively valuable?
Is the resource rare—is it something rivals lack?
Is the resource hard to copy (inimitable)?
Is the resource invulnerable to the threat of substitution of
different types of resources and capabilities (non-substitutable)?
VRIN: FOUR TESTS OF A RESOURCE’S COMPETITIVE
POWER
Valuable
Rare
Inimitable
Nonsubstitutable
Support for competitive
advantage?
Support for sustained competitive advantage?
Resource

Social complexity (company culture, interpersonal relationships
among managers or R&D teams, trust-based relations with
customers or suppliers) and causal ambiguity are two factors
that inhibit the ability of rivals to imitate a firm’s most valuable
resources and capabilities.
Causal ambiguity makes it very hard to figure out how a
complex resource contributes to competitive advantage and
therefore exactly what to imitate.
A firm requires a dynamically evolving portfolio of resources
and capabilities to sustain its competitiveness and help drive
improvements in its performance.
CORE CONCEPT (4 of 9)
A dynamic capability is the ongoing capacity of a firm to
modify its existing resources and capabilities or create new ones
by:
Improving existing resources and capabilities incrementally
Adding new resources and capabilities
to the firm’s competitive asset portfolio
MANAGING RESOURCES AND CAPABILITIES
DYNAMICALLY
Threats to resources and capabilities
Rivals providing better substitutes over time
Capabilities decaying from benign neglect
Disruptive competitive environment change
Manage capabilities dynamically by:

Attending to the ongoing modification of existing competitive
assets
Taking advantage of any opportunities to develop totally new
kinds of capabilities
QUESTION 3: WHAT ARE THE FIRM’S STRENGTHS AND
WEAKNESSES IN RELATION TO MARKET
OPPORTUNITIES AND EXTERNAL THREATS?
SWOT Analysis
Is a powerful tool for sizing up a firm’s:
Internal strengths (the basis for strategy)
Internal weaknesses (deficient capabilities)
Market opportunities (strategic objectives)
External threats (strategic defenses)
CORE CONCEPT (5 of 9)
SWOT analysis is a simple but powerful tool for sizing up a
company’s strengths and weaknesses, its market opportunities,
and the external threats to its future well-being.
Basing a company’s strategy on its most competitively valuable
strengths gives the company its best chance for market success.

IDENTIFYING A COMPANY’S INTERNAL STRENGTHS
A competence:
Is an activity that a firm has learned to perform with
proficiency—a true capability
A core competence:
Is a proficiently performed internal activity that is central to a
firm’s strategy and competitiveness
A distinctive competence:
Is a competitively valuable activity that a firm performs better
than its rivals
Core Concepts (6 of 9)
A competence is an activity that a firm has learned to perform
with proficiency—a capability, in other words.
A core competence is an activity that a firm performs
proficiently and that is also central to its strategy and
competitive success.
A distinctive competence is a competitively important activity
that a firm performs better than its rivals—it thus represents a
competitively superior internal strength.
IDENTIFYING A FIRM’S WEAKNESSES AND
COMPETITIVE DEFICIENCIES
A weakness (competitive deficiency):
Is something a firm lacks or does poorly (in comparison to
others) or a condition that puts it at a competitive disadvantage
in the marketplace
Types of weaknesses
Inferior skills, expertise, or intellectual capital

Deficiencies in physical, organizational, or intangible assets
Missing or competitively inferior capabilities
in key areas
Core CONCEPTS (7 of 9)
A firm’s strengths represent its competitive assets.
A firm’s weaknesses are shortcomings that constitute
competitive liabilities.
IDENTIFYING A COMPANY’S MARKET OPPORTUNITIES
Characteristics of market opportunities
An absolute “must pursue” market:
Represents much potential but is hidden in “fog of the future”
A marginally interesting market:
Presents high risk and questionable profit potential
An unsuitable or mismatched market:
Is best avoided as the firm’s strengths are not matched to
market factors
A company is well advised to pass on a particular market
opportunity unless it has or can acquire the competencies
needed to capture it.

IDENTIFYING THREATS TO A FIRM’S FUTURE
PROFITABILITY
Types of threats:
Normal course-of-business threats
Sudden-death (survival) threats
Considering threats
Identify the threats to the firm’s future prospects
Evaluate what strategic actions can be taken to neutralize or
lessen their impact
TABLE 4.3 What to Look for in Identifying a Company’s
Strengths, Weaknesses, Opportunities , and Threats (1 of
4)Potential Strengths and Competitive AssetsPotential
Weaknesses and Competitive DeficienciesCompetencies that are
well matched to industry key success factorsNo clear strategic
visionAmple financial resources to grow the businessNo wel l-
developed or proven core competenciesStrong brand-name
image or company reputationNo distinctive competencies or
competitively superior resourcesEconomies of scale or learning-
and experience-curve advantages over rivalsLack of attention to
customer needsOther cost advantages over rivalsA product or
service with features and attributes that are inferior to those of
rivalsAttractive customer baseWeak balance sheet, few financial
resources to grow the firm, too much debtProprietary
technology, superior technological skills, important
patentsHigher overall unit costs relative to those of key
competitors
Strengths, Weaknesses, Opportunities, and Threats (2 of

4)Potential Strengths and Competitive Assets
(continued)Potential Weaknesses and Competitive Deficiencies
(continued)Strong bargaining power over suppliers or
buyersToo narrow a product line relative to rivalsResources and
capabilities that are valuable and rareWeak brand image or
reputationResources and capabilities that are hard to copy and
for which there are no good substitutesWeaker dealer network
than key rivals or lack of adequate distribution
capabilitySuperior product qualityLack of management
depthWide geographic coverage or strong global distribution
capabilityA plague of internal operating problems or obsolete
facilitiesAlliances or joint ventures that provide access to
valuable technology competencies, or attractive geographic
marketsToo much underutilized plant capacityResources that are
readily copied or for which there are good substitutes
4)Potential Market OpportunitiesPotential External Threats to a
Company’s Future ProfitabilityMeeting sharply rising buy
demand for the industry’s productIncreasing intensity of
competition among industry rivals—may squeeze profit
marginsServing additional customer groups or market
segmentsSlowdowns in market growthExpanding into new
geographic marketsLikely entry of potent new
competitionsExpanding the company’s product line to meet a
broader range of customer needsGrowing bargaining power of
customers or suppliersUtilizing existing company skills or
technological know-how to enter new product lines or new
businessesA shift in buyer needs and tastes away from the
industry’s productAdverse demographic changes that threaten to
curtail demand for the industry’s product

4)Potential Market Opportunities (continued)Potential External
Threats to a Company’s Future Profitability (continued)Taking
advantage of failing trade barriers in attractive foreign
marketsAdverse economic conditions that threaten critical
suppliers or distributorsAcquiring rival firms or companies with
attractive technological expertise or capabilitiesChanges in
technology—particularly disruptive technology that can
undermine the company’s distinctive competenciesTaking
advantage of emerging technological developments to innovate
Entering into alliances or joint ventures to expand the firm’s
market coverage or boost its competitive capabilityRestricti ve
foreign trade policies
Costly new regulatory requirements
Tight credit conditions
Rising prices on energy or other key inputs
Strategic Management Principle (6 of 14)
Simply making lists of a company’s strengths, weaknesses,
opportunities, and threats is not enough.
The payoff from SWOT analysis comes from the conclusions
about a company’s situation and the implications for strategy
improvement that flow from the four lists.
WHAT DO SWOT LISTINGS REVEAL?
SWOT analysis involves:
Drawing conclusions from the SWOT listings
about the firm’s overall situation
Translating these conclusions into strategic actions by the firm
that:

Match its strategy to its internal strengths and to market
opportunities
Correct important weaknesses and defend it against external
threats
FIGURE 4.2 The Steps Involved in SWOT Analysis: Identify
the Four Components of SWOT, Draw Conclusions, Translate
Implications into Strategic Actions
USING SWOT ANALYSIS
What are the attractive aspects of the firm’s situation?
What aspects are of the most concern?
Are the firm’s internal strengths and competitive assets
sufficiently strong to enable it to compete successfully?
Are the firm’s weaknesses and competitive deficiencies
correctable, or could they be fatal if not remedied soon?
Do the firm’s strengths outweigh its weaknesses by an attractive
margin?
Does the firm have attractive market opportunities
that are well suited to its internal strengths?
Does the firm lack the competitive assets (internal strengths) to
pursue the most attractive opportunities?
Where on a scale of 1 to 10 (1 = weak and 10 = strong)
do the firm’s overall situation and future prospects rank?

QUESTION 4: HOW DO A FIRM’S VALUE CHAIN
ACTIVITIES IMPACT ITS COST STRUCTURE AND
CUSTOMER VALUE PROPOSITION?
Signs of a firm’s competitive strength:
Its prices and costs are in line with rivals
Its customer-value proposition is competitive and cost effective
Its bundled capabilities are yielding a sustainable competitive
advantage
The higher a firm’s costs are above those of close rivals, the
more competitively vulnerable it becomes.
Conversely, the greater the amount of customer value that a
firm can offer profitably relative to close rivals, the less
competitively vulnerable the firm becomes.
THE CONCEPT OF A COMPANY VALUE CHAIN
The value chain:
Identifies the inner workings of the firm's customer value
proposition and business model
Permits a deep look at the firm’s cost structure and its ability to
profitably offer low prices
Reveals the emphasis that a firm places on activities that
enhance differentiation and support higher prices

Core Concept (8 of 9)
A company’s value chain identifies the primary activities and
related support activities that create customer value.
FIGURE 4.3 A Representative Company
Value Chain
COMPARING THE VALUE CHAINS OF RIVAL FIRMS
Value chain analysis
Facilitates a comparison, activity-by-activity, of how
effectively and efficiently a firm delivers value to its customers,
relative to its competitors
The value chain analysis process:
Segregates the firm’s operations into different types of primary
and secondary activities to identify the major components of its
internal cost structure
Uses activity-based costing to evaluate the activities
Does the same for significant competitors
VALUE CHAIN SYSTEM FOR AN ENTIRE INDUSTRY
Industry value chain
The firm’s internal value chain

The value chains of industry suppliers
The value chains of channel intermediaries
Effects of the industry value chain
Costs and margins of suppliers and channel partners can affect
prices to end consumers
Activities of channel partners can affect industry sales volumes
and customer satisfaction
FIGURE 4.4 A Representative
Value Chain System
Illustration Capsule 4.1 The Value Chain for Boll & BranchA
king-size set of sheets from Boll & Branch is made from 6
meters of fabric, requiring 11 kilograms of raw cotton. Raw
Cotton $ 28.16Spinning/Weaving/Dyeing
12.00Cutting/Sewing/Finishing 9.50Material Transportation
3.00Factory Fee 15.80Cost of Goods$68.46Inspection Fees
5.48Ocean Freight/Insurance 4.55Import Duties
8.22Warehouse/Packing 8.50Packaging 15.15Customer Shipping
14.00Promotions/Donations 30.00Total Cost$154.38Boll &
Brand MarkupAbout 60%Boll & Brand Retail
Price$250.00Gross Margin$ 95.62

The Value Chain for Boll & Branch
Which activities in the value chain are primary activities?
Which are secondary activities?
Which activities are linked to the value chain for the entire
industry?
Where in the industry activity chain could Boll & Branch
possibly reduce cost(s) without reducing its competitive
strength?
A firm’s cost competitiveness depends not only on the costs of
internally performed activities (its own value chain) but also on
costs in the value chains of its suppliers and distribution
channel allies.
Core Concept (9 of 9)
Benchmarking is a potent tool for improving a company’s own
internal activities that is based on learning how other companies
perform them and borrowing their “best practices.”
USING BENCHMARKING TO ASSESS A FIRM’S VALUE
CHAIN ACTIVITIES
Benchmarking:
Involves improving a firm’s internal activities based on learning
from other firms’ “best practices”

Assesses whether the cost competitiveness and effectiveness of
a firm’s value chain activities are in line with its competitors’
activities
Sources of benchmarking information
Reports, trade groups, analysts, and customers
Visits to benchmark companies
Data from consulting firms
Strategic Management Principle (9 of 14 )
Benchmarking the costs of a firm's activities against those of
rivals provides hard evidence of whether the firm is cost-
competitive.
DELIVERED-COST BENCHMARKING IN THE CEMENT
INDUSTRY
Which of the five benchmarked manufacturing and logistics
costs are likely to be most affected by fluctuating market
conditions?
Why is the collection of competitive intelligence to accurately
benchmark delivered costs of such importance in the cement
industry?
How could key data about competitors published by the PCA
create an temptation for unethical price fixing, market or
customer allocation schemes, dealing arrangements, bid rigging,
or bribery in the industry?
STRATEGIC OPTIONS FOR REMEDYING A COST OR
VALUE DISADVANTAGE

Areas in the total value chain system for a firm to look for ways
to improve its efficiency and effectiveness:
The firm’s own internal activity segments
The suppliers’ part of the value chain system
The forward channel portion of the value chain system
IMPROVING INTERNALLY PERFORMED VALUE CHAIN
ACTIVITIES
Implement best practices throughout the firm, particularly for
high-cost activities.
Eliminate cost-producing activities altogether by redesigning
products and revamping the internal value chain.
Relocate high-cost activities to areas where they can be
performed more cheaply.
Outsource activities that can be performed by vendors or
contractors more cheaply than if done in-house.
Invest in productivity-enhancing, cost-saving technological
improvements.
Find ways to detour around activities or items where costs are
high.
Redesign products or components to facilitate speedier and
more economical manufacture or assembly.
IMPROVING THE EFFECTIVENESS OF THE CUSTOMER
VALUE PROPOSITION AND ENHANCING
DIFFERENTIATION
Implement best practices for quality of high-value activities.
Adopt best practices and technologies that spur innovation,

improve design, and enhance creativity.
Implement the best practices in providing customer service.
Reallocate resources to activities having the most impact on
value for the customer and their most important purchase
criteria.
For intermediate buyers, gain an understanding of how the
activities the firm performs impact the buyer’s value chain.
Adopt best practices for marketing, brand management, and
enhancing customer perceptions.
IMPROVING SUPPLIER-RELATED VALUE CHAIN
ACTIVITIES
Pressure suppliers for lower prices.
Switch to lower-priced substitute inputs.
Collaborate closely with suppliers to identify mutual cost-
saving opportunities.
Work with suppliers to enhance the firm’s differentiation.
Select and retain suppliers who meet higher-quality standards.
Coordinate with suppliers to enhance design or other features
desired by customers.
Provide incentives to suppliers to meet higher-quality standards,
and assist suppliers in their efforts to improve.
IMPROVING VALUE CHAIN ACTIVITIES OF
DISTRIBUTION PARTNERS
Achieving cost-based competitiveness
Pressure forward channel allies to reduce their costs and
markups.

Collaborate with forward channel allies to identify win-win
opportunities to reduce costs.
Change to a more economical distribution strategy, including
switching to cheaper distribution channels.
ENHANCING DIFFERENTIATION THROUGH ACTIVITIES
AT THE FORWARD END OF THE VALUE CHAIN SYSTEM
Engage in cooperative advertising and promotions with forward
channel allies.
Use exclusive arrangements with downstream sellers or other
mechanisms that increase their incentives to enhance delivered
customer value.
Create and enforce standards for downstream activities and
assist in training channel partners in business practices.
Performing value chain activities with capabilities that permit
the firm to either outmatch rivals on differentiation or beat them
on costs will give the firm a competitive advantage.
OPTION 1 FOR TRANSLATING PROFICIENT
PERFORMANCE OF VALUE CHAIN ACTIVITIES INTO
COMPETITIVE ADVANTAGE

OPTION 2 FOR TRANSLATING PROFICIENT
PERFORMANCE OF VALUE CHAIN ACTIVITIES INTO
COMPETITIVE ADVANTAGE
QUESTION 5: IS THE FIRM COMPETITIVELY STRONGER
OR WEAKER THAN KEY RIVALS?
Assessing the firm’s overall competitive strength
How does the firm rank relative to competitors on each of the
important factors that determine market success?
Does the firm have a net competitive advantage or disadvantage
versus major competitors?
Strategic management principle (11 of 14)
High-weighted competitive strength ratings signal a strong
competitive position and possession of competitive advantage;
low ratings signal a weak position and competitive
disadvantage.
STEPS IN THE COMPETITIVE STRENGTH ASSESSMENT

PROCESS
Make a list of the industry’s key success factors and measures
of competitive strength or weakness.
Assign weights to each competitive strength measure based on
its perceived importance.
Score competitors on each competitive strength measure and
multiply by each measure by its corresponding weight.
Sum the weighted strength ratings on each factor to get an
overall measure of competitive strength for each company.
Use overall strength ratings to draw conclusions about the
company’s net competitive advantage or disadvantage and to
take specific note of areas of strength and weakness.
TABLE 4.4 A Representative Weighted Competitive
Strength AssessmentCompetitive Strength Assessment(rating
scale: 1 = very weak, 10 = very strong)ABC Co.Rival 1 Rival 2
Key Success Factor/
Strength MeasureImportance WeightStrength RatingWeighted
ScoreStrength RatingWeighted ScoreStrength RatingWeighted
ScoreQuality/product
performance0.1080.8050.5010.10Reputation/image0.1080.807
0.7010.10Manufacturing
capability0.1020.20101.0050.50Technological
skills0.05100.501 0.053 0.15Dealer network/distribution
capability0.0590.454 0.205 0.25New product innovation
capability0.0590.454 0.205 0.25 Financial resources0.1050.50
101.003 0.30 Relative cost position0.3051.50 103.001 0.30
Customer service capabilities0.1550.75 7 1.051 0.15Sum of
importance weights1.00Overall weighted competitive strength
rating5.957.702.10

A company’s competitive strength scores pinpoint its strengths
and weaknesses against rivals and point directly to the kinds of
offensive and defensive actions it can use to exploit its
competitive strengths and reduce its competitive vulnerabilities.
STRATEGIC IMPLICATIONS OF COMPETITIVE STRENGTH
ASSESSMENT
The higher a firm’s overall weighted strength rating, the
stronger its overall competitiveness versus rivals.
The rating score indicates the total net competitive advantage
for a firm relative to other firms.
Firms with high competitive strength scores are targets for
benchmarking.
The ratings show how a firm compares against rivals, factor by
factor (or capability by capability).
Strength scores can be useful in deciding what strategic moves
to make.
QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS
MERIT FRONT-BURNER MANAGERIAL ATTENTION?
Strategic priority “how to” issues
How to meet challenges of new foreign competitors
How to combat the price discounting of rivals
How to both reduce high costs and prepare for price reductions
How to sustain growth as buyer demand slows
How to adapt to the changing demographics of the firm’s

customer base
Compiling a list of problems and roadblocks creates a strategic
agenda of problems that merit prompt managerial attention.
QUESTION 6: WHAT STRATEGIC ISSUES AND PROBLEMS
MERIT FRONT-BURNER MANAGERIAL ATTENTION?
Strategic priority “should we” issues
Expand rapidly or cautiously into foreign markets?
Reposition the firm to move to a different strategic group?
Counter increasing buyer interest in substitute products?
Expand the firm’s product line?
Correct the firm’s competitive deficiencies by acquiring a rival
firm with the missing strengths?
A good strategy must contain ways to deal with all the strategic
issues and obstacles that stand in the way of the company’s
financial and competitive success in the years ahead.
Appendix 1 Figure 4.1 Identifying the Components of a Single-
Business Company’s Strategy

Components include:
improved design, better features, higher quality, and lower
prices to attract customers;
responding to changes in the macro-environment, industry, or
competitive conditions;
competitive advantage based on lower costs, better products,
superior service ability serving a market niche or specific group
of buyers; varying geographic coverage;
partnering and building strategic alliances with other enterpr ises
in the industry
Also listed are the key functional strategies of the business
strategy (the action plan for managing a single business). They
are: R&D, technology, product design strategy; supply chain
management strategy; production strategy; sales, marketing, and
distribution strategies; information technology strategy; human
resources strategy; and finance strategy
Return to slide
Appendix 2 Table 4.1 Key Financial Ratios: How to Calculate
Them and What They Mean
Gross profit margin. Sales revenues minus cost of goods sold
divided by sales revenues. This shows the percentage of
revenues available to cover operating expenses and yield a
profit.
Operating profit margin (return on sales). Sales revenues minus
operating expenses divided by sales revenues. Or operating
income divided by sales revenues. This shows the profitability
of current operations without regard to interest charges and
income taxes. Earnings before interest and taxes is known as
EBIT in financial and business accounting.
Net profit margin (net return on sales). Profits after taxes
divided by sales revenues. This shows after-tax profits per
dollar of sales.
Total return on assets. Profits after taxes plus interest divided

by total assets. This shows a measure of the return on total
investment in the enterprise. Interest is added to after-tax
profits to form the numerator, since total assets are financed by
creditors as well as by stockholders.
Net return on total assets (ROA). Profits after taxes divided by
total assets. This shows a measure of the return earned by
stockholders on the firm’s total assets.
Return on stockholders' equity (ROE). Profits after taxes
divided by total stockholders' equity. This shows the return
stockholders are earning on their capital investment in the
enterprise. A return in the 12 percent to 15 percent range is
average.
Return on invested capital (ROIC), sometimes known as return
on capital employed (ROCE). Profits after taxes divided by the
sum of long-term debt plus total stockholders' equity. This
shows a measure of the return that shareholders are earning on
the monetary capital invest in the enterprise. A higher return
reflects greater bottom-line effectiveness in the use of long-
term capital.
Return to slide
Liquidity ratios:
Current ratio. Current assets divided by current liabilities. This
shows a firm’s ability to pay current liabilities using assets that
can be converted to cash in the near term. Ratio should be
higher than 1.0.
Working capital. Current assets minus current liabilities. This
shows the cash available for a firm’s day-to-day operations.
Larger amounts mean the company has more internal funds to
(1) pay its current liabilities on a timely basis and (2) finance
inventory expansion, additional accounts receivable, and a
larger base of operations without resorting to borrowing or

raising more equity capital.
Leverage ratios:
Total debt-to-assets ratio. Total debt divided by total assets.
This measures the extent to which borrowed funds (both short-
term loans and long-term debt) have been used to finance the
firm’s operations. A low ratio is better; a high fraction indicates
overuse of debt and a greater risk of bankruptcy.
Long-term debt-to-capital ratio. Long-term debt divided by the
sum of long-term debt plus total stockholder equity. This shows
a measure of creditworthiness and balance sheet strength. It
indicates the percentage of capital investment that has been
financed by both long-term lenders and stockholders. A ratio
below 0.25 is preferable since the lower the ratio, the greater
the capacity to borrow additional funds. Debt-to-capital ratios
above 0.50 indicate an excessive reliance on long-term
borrowing, lower creditworthiness, and weak balance sheet
strength.
Debt-to-equity ratio. Total debt divided by total stockholders'
equity. This shows the balance between debt (funds borrowed
both short term and long term) and the amount that stockholders
have invested in the enterprise. The further the ratio is below
1.0, the greater the firm’s ability to borrow additional funds.
Ratios above 1.0 put creditors at greater risk, signal weaker
balance sheet strength, and often result in lower credit ratings.
Long-term debt-to-equity ratio. Long-term debt divided by total
stockholders' equity. This shows the balance between long-term
debt and stockholders’ equity in the firm’s long-term capital
structure. Low ratios indicate a greater capacity to borrow
additional funds if needed.
Times-interested-earned (or coverage) ratio. Operating income
divided by interest expenses. This measures the ability to pay
annual interest charges. Lenders usually insist on a minimum
ratio of 2.0, but ratios above 3.0 signal progressively better
creditworthiness.
Return to slide

Days of inventory. Inventory divided by the quotient of cost of
goods sold divided by 365. This measures inventory
management efficiency. Fewer days of inventory are better.
Inventory turnover. Cost of goods sold divided by inventory.
This measures the number of inventory turns per year. Higher is
better.
Average collection period. Accounts receivable divided by the
quotient of total sales divided by 365. Or accounts receivable
divided by average daily sales. This indicates the average length
of time the firm waits after making a sale to receive cash
payment. A shorter collection time is better.
Return to slide
Dividend yield on common stock. Annual dividends per share
divided by current market price per share. This shows a measure
of the return that shareholders receive in the form of dividends.
A “typical” dividend yield is 2 percent to 3 percent. The
dividend yield for fast-growth companies is often below 1
percent; the dividend yield for slow-growth companies can run
4 percent to 5 percent.
Price-to-earnings (P/E) ratio. Current market price per share
divided by earnings per share. This shows that P/E ratios above
20 indicate strong investor confidence in a firm’s outlook and
earnings growth; firms whose future earnings are at risk or
likely to grow slowly typically have ratios below 12.
Dividend payout ratio. Annual dividends per share divided by
earnings per share. This indicates the percentage of after -tax
profits paid out as dividends.

Internal cash flow. After-tax profits plus depreciation. This
shows a rough estimate of the cash a company’s business is
generating after payment of operating expenses, interest, and
taxes. Such amounts can be used for dividend payments or
funding capital expenditures.
Free cash flow. After-tax profits plus depreciation minus capital
expenditures minus dividends. This shows a rough estimate of
the cash a company’s business is generating after payment of
operating expenses, interest, taxes, dividends, and desirable
reinvestments in the business. The larger a company’s free cash
flow, the greater its ability to internally fund new strategic
initiatives, repay debt, make new acquisitions, repurchase
shares of stock, or increase dividend payments.
Return to slide
Appendix 6 Table 4.2 Types of Company Resources
Tangible resources:
Physical resources: land and real estate; manufacturing plants,
equipment, or distribution facilities; the locations of stores,
plants, or distribution centers, including the overall pattern of
their physical locations; ownership of or access rights to natural
resources (such as mineral deposits)
Financial resources: cash and cash equivalents; marketable
securities; other financial assets such as a company’s credit
rating and borrowing capacity
Technological assets: patents, copyrights, production
technology, innovation technologies, technological processes
Organizational resources: IT and communication systems
(satellites, servers, workstations, etc.); other planning,
coordination, and control systems; the company’s organizational
design and reporting structure.
Intangible resources:
Human assets and intellectual capital: the education,
experience, knowledge, and talent of the workforce, cumulative

learning, and tacit knowledge of employees; collective learning
embedded in the organization, the intellectual capital, and
know-how of specialized teams and work groups; the knowledge
of key personnel concerning important business functions;
managerial talent and leadership skill; the creativity and
innovativeness of certain personnel
Brands, company image, and reputational assets: brand names,
trademarks, product or company image, buyer loyalty and
goodwill; company reputation for quality, service, and
reliability; reputation with suppliers and partners for fair
dealing
Relationships: alliances, joint ventures, or partnerships that
provide access to technologies, specialized know -how, or
geographic markets; networks of dealers or distributors; the
trust established with various partners
Company culture and incentive system: the norms of behavior,
business principles, and ingrained beliefs within the company;
the attachment of personnel to the company’s ideals; the
compensation system and the motivation level of company
personnel
Return to slide
Appendix 7 VRIN: Four Tests of a Resource’s Competitive
Power
A resource has support for a competitive advantage if it is
valuable and rare.
A resource has support for sustained competitive advantage if it
is inimitable and non-substitutable.
Return to slide
Appendix 8 Figure 4.2 The Steps Involved in SWOT Analysis:
Identify the Four Components of SWOT, Draw Conclusions,

Translate Implications into Strategic Actions
What can be gleaned from the SWOT listings?
The first two steps of SWOT analysis are:
Identify company strengths and competitive assets
Identify company weaknesses and competitive deficiencies
These two steps lead to conclusions concerning the company’s
overall business situation. This includes determining where on
the scale from “alarmingly weak” to “exceptionally strong” the
attractiveness of the company’s situation ranks. It also includes
what the attractive and unattractive aspects of the company’s
situation are.
The last two steps of SWOT analysis are:
Identify the company's market opportunities
Identify external threats to the company's future well-being
These two steps reveal implications for improving company
strategy. This includes using company strengths as the
foundation for the company’s strategy; pursuing those market
opportunities best suited to company strengths; correcting
weaknesses and deficiencies that impair pursuit of important
market opportunities or heighten vulnerability to external
threats; and using company strengths to lessen the impact of
important external threats.
Return to slide
Appendix 9 Figure 4.3 A Representative Company Value Chain
Primary activities and costs of a company's value chain are:
Supply chain management
Operations
Distribution
Sales and marketing service
Profit margin
These primary activities and costs are supported by the
following
Product R&D

Technology
Systems development
Human resource management
General administration
Return to slide
Appendix 10 Figure 4.4 A Representative Value Chain System
A representative value chain system shows the following
Supplier-related value chains: activities, costs, and margins of
suppliers
A company's own value chain: internally performed activities,
costs, and margins
Forward-channel value chains: (1) activities, costs, and margins
of forward-channel allies and strategic partners and (2) buyer or
end-user value chains
Return to slide
Appendix 11 Illustration Capsule 4.1 The Value Chain for Boll
& Branch
The cost of goods, including the raw cotton; the spinning,
weaving, and dyeing; cutting, sewing, and finishing; the
transportation of the material, and the factory fee is $68.46.
The inspection fees, ocean freight/insurance, import duties,
warehouse/packing, packaging, customer shipping, and
promotions/donations total $154.38.
Boll & Branch’s markup is about 60%.
Boll & Branch’s retail price is $250.00, resulting in a gross
margin of $95.62.
Return to slide

Appendix 12 Option 1 for Translating Proficient Performance of
Value Chain Activities into Competitive Advantage
The steps a company would take to beat rivals by creating more
customer value from value chain activities, for a differentiation-
based competitive advantage
Managers decide to perform value chain activities to drive
improvements in quality, features, performance and other
differentiation-enhancing aspects.
Competencies gradually emerge in performing activities that
drive improvements in quality, features, and performance.
Company proficiency in performance some of the
differentiation-enhancing activities rises to the level of a core
competence.
Company proficiency in the core competence continues to build
and evolves into a distinctive competence.
Company gains a competitive advantaged based on superior
differentiation capabilities.
Return to slide
Appendix 13 Option 2 for Translating Proficient Performance of
Value Chain Activities into Competitive Advantage
The steps a company would take to beat rivals by conducting
value chain activities more efficiently, for a cost-based
competitive advantage
Managers decide to perform value chain activities in the most
cost-efficient manner.
Competencies gradually emerge in driving down the cost of
value chain activities (such as production, inventory,
management, etc.).
Company capabilities in performing certain value chain
activities more efficiently rises to the level of a core
competence.
Company proficiency in the core competence continues to build

and evolves into a distinctive competence.
Company gains a competitive advantaged based on superior
cost-lowering capabilities.
Return to slide
Appendix 14 Table 4.4 A Representative Weighted Competitive
Strength AssessmentRating scale: 1 equals very weak, 10 equals
very strongKey success factor/strength measureImportance
weightABC Co. Strength RatingABC Co. Weighted ScoreRival
1 Strength RatingRival 1 Weighted scoreRival 2 Strength
RatingRival 2 Weighted ScoreQuality/product
performance0.1080.8050.5010.10Reputation/image0.1080.8070.
7010.10Manufacturing
capability0.1020.20101.0050.50Technological
skills0.05100.5010.0530.15Dealer network/ distribution
capability0.0590.4540.2050.25New product innovation
capability0.0590.4540.2050.25Financial
resources0.1050.50101.0030.30Relative cost
position0.3051.50103.0010.30Customer servicer
capabilities0.1550.7571.0510.15Sum of importance
weights1.00Overall weightedABC Co.=5.95Rival 1 = 7.70Rival
2 = 2.10
Return to slide
Requirement
Ch 3 and Ch 4 Company’s Environment and Resources
· Read Chapters 3 Evaluating a Company’s Environment & Ch
4 Evaluating a company’s resources, capabilities, and
competitiveness

· Use 2 L.O.s from Ch 3 and 2 L.Os from Ch 4 to analyze the
company’s management (each L.O. should have 3 examples at
100 words per example).
Ch3 and Ch4 are attached
Rating sheet
Thompson et al. Crafting & Executing Strategy
Chapter Rating Form
Content and Organization of the Presentation.
Organization of material (5 points)
1. Cover Page with Date, your name, and Topic
2. Introduce the topic with 1 paragraph
3. Body
a. Answer should include a minimum of 3 answers in addressing
the question
b. clearly states which principles apply to your company
(includes spelling, grammar, and full sentences)
4. Select 2 Learning Objectives (L.O.) for a Chapter
a. How are the L.O.’s relevant to your final paper
b. Minimum 100 words each L.O.
Chapter NAME
L.O. 1
L.O. 2
example [email protected] 100 words
example 1 @ 100 words
Example 2 @ 100 words

Chapter NAME
L.O. 1
L.O. 2
5. Conclusion … 3 key concepts you want the audience to
remember
6. Works cited
7. Spell check, grammar check, etc.
TOTAL POINTS ____________________
Example

This paper will discuss chapters 7 and 8. Chapter 7, “Strategies
for competing in international markets”, presents reasons why a
company choose to compete in international markets. It also
presents strategic options for entering foreign markets, and the
advantages and disadvantages of each. Chapter 8, “Corporate
Strategy”, discusses diversification. Diversification is the act of
broadening one’s capabilities and hedging risk to ensure more
shareholder value. Chapter 8 discusses how, why, and when to
diversify.
Chapter 7 Strategies for Competing in International Markets
LO 1: The primary reason companies choose to compete in
international markets.
Learning objective 1 explains why a company may opt to
expand outside its domestic market. There are five major
reasons a company might do so. These reasons are new
customers, lower costs, access to low-cost production, exploit
core competencies, and to gain access to resources and
capabilities located in foreign markets.
1. To gain access to new customers. Expanding into foreign
markets offers potential for revenues, profits, and growth. It is
especially attractive to companies that are stagnating in their

domestic market. Companies might also expand to new markets
to extend the life of their products. Toyota expanded into Hong
Kong, and one of their older models have been in use as Hong
Kong’s taxi cabs. The Toyota comfort started as a taxicab in
Japan in 1995, and Toyota was able to expand the use of these
cars to Hong Kong. Toyota Comfort has been the main taxicab
in Hong Kong, as well. A large target market may also offer
companies opportunity to earn a return on large investments
more rapidly, than staying in a domestic market. This is
important to R&D industries, where innovation is fast-paced
and imitated rapidly.
2. To achieve lower costs through economics of scale,
experience, and increased purchasing power. Companies are
driven to sell in international level because domestic sales
volume is, sometimes, not large enough to capture fully
economies of scale in product development, marketing, or
manufacturing. Firms expand internationally to increase the rate
of accumulating experience and move down the learning curve.
Expansion can also lower a company’s input costs by having a
greater pooled purchasing power. Popular businesses of today
are all international. Brands such as McDonald’s, KFC, Nestle,
Toyota, Honda, and Sony, moved into markets in different
continents to achieve more capabilities.
3. To gain access to low-cost inputs of production. Companies
in industries based on natural resources often find it necessary
to operate in international level because of raw material
supplies. Raw materials are located in different parts of the
world. Companies that enter foreign markets that have access to
these have lower costs than companies who stay domestic and
need to find outside partners for raw materials. Aside from this,
companies also enter foreign markets to access low -cost labor
costs. Apple designs their products in California and makes
their products in China because of lower labor cost. This drives
down the cost to make their products and getting a larger
margin from cost of goods sold to revenues.
4. To further exploit its core competencies. A company can

extend its domestic market-leading position into a regional or
global market-leading position by furthering its core
competencies. Companies can often leverage their resources
internationally by replicating a successful business model, using
it as a basic blueprint for international operations. Examples of
these blueprints are Starbucks, McDonald’s, KFC, and other
restaurant chains. While, these chains are successful, there are
still countries that they have not yet expanded into. The core
competencies of Starbucks is serving coffee, and other tasty
drinks that are to the liking of many people, they have expanded
in many different countries doing the same thing, and adding
the culture of the country in the menu.
5. To gain access to resources and capabilities located in
foreign markets. An important motive for entering foreign
markets is to acquire resources and capabilities that may be
unavailable in a company’s domestic market. Companies often
make acquisitions in other markets to gain access to capabilities
that complement their own. Companies may also choose to
establish operations in other countries to utilize local
distribution networks, gain local marketing expertise, or gain
technical knowledge. One company that is famous for
acquisitions is Nestle. Nestle is a Swiss multinational food and
drink company that has bought and merged with many different
international companies. They are one of the biggest
conglomerates of food making and are now making pet food as
well.
LO 3: The five major strategic options for entering foreign
markets.
There five major different ways for a company to expand
and enter foreign markets. These are exporting, licensing,
franchising, establishing a subsidiary, and joint ventures. Each
have their own advantages and disadvantages.
1. Exporting has low foreign investment. A company will not
need to invest plenty of capital into exporting unlike the other
choices. Exporting involves using domestic plants as a
production base for exporting their products to foreign markets.

CHAPTER 3EVALUATING A COMPANY’S EXTERNAL ENVIRONMENT(c) 2016

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