Strategic Management and Business Policy

Unit 6

Unit 6
Structure

Internal Competences and Resources

6.1 Introduction 6.2 Caselet Objectives 6.3 Competence Analysis 6.4 Resource Analysis 6.5 Value Chain Analysis 6.6 Cost Analysis 6.7 Financial Competence Analysis 6.8 External Sources of Competence 6.9 Case Study 6.10 Summary 6.11 Glossary 6.12 Terminal Questions 6.13 Answers 6.14 References

6.1 Introduction
For effectiveness, all management strategies should be based on or be commensurate with the internal competences of a company or its organizational capabilities. A number of theories or models have been put forward about internal capabilities or core competences which companies must acquire or use to survive in todays competitive market. Another way to put this is: the strategy a company adopts should depend on its competence level in terms of resources. Time and again, companies have discovered and/or experienced this, and they have achieved results. From 1980 to 1988, Canon grew by 264 per cent and Honda by 200 per cent. Canons personal copiers, Hondas entry into four-wheeler market, Casios small-screen colour LCD television, Yamahas digital pianoall were developed by respective core competencies. In India, Greaves introduced Garuda (the three-wheeler diesel auto) making use of its competence in diesel engines; IFB-Bosch entered the washing machine segment making use of its fine blanking technology. Dabur, with its expertise in traditional Indian medicine, has entered into food products (juice, honey, mint, etc.).
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6.2 Caselet
Core competence is the combination of processes and technologies that a company possesses. It includes the knowledge and experience of operations, the activities that bring the company high returns and the qualities that are considered central to the success of the organization. Core competence gives a company its competitive advantage by enabling it to deliver value to its customers. Changing core competence requires key skills and abilities in a new job or field of operations. Xerox is an example of a company that diversified and adopted new core competence to enable it to compete in a different market. In the early 20th century the company came into being with the invention of xerography, which was the precursor of photocopying technology. Through innovation, the company invented Ethernet technology, which helped prepare the foundation for the Internet of today. The shift from hard copy to digital technology required new core competence. Any core competence developed by a company stays with it for a long time.
Source: http://smallbusiness.chron.com/examples-changing-core-competencies18422.html

Objectives
After studying this unit, you should be able to: Define competence of an organization and the various types of competences Describe resource analysis Explain the concept and practice of value chain analysis Analyse the financial competence of an organization through cost analysis Discuss external sources of competence, including strategic outsourcing

6.3 Competence Analysis

Competence is the ability to perform a task or achieve some objectives. Competence levels vary across organizations, and, also, within an organization from time to time. Difference in performance among companies in the same market and product category is, due to the difference in their competence levels. This happens because only some companies are able to demonstrate the
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competences demanded by particular competitive situations. This applies to a particular company also. Just for survival, a company needs to possess a particular level of competence; but, for clear competitive advantage or sustained growth, a company would require a different level or type of competence. Four major types or levels of competence may be distinguished: 1. Core competence 2. Distinctive competence 3. Strategic competence 4. Threshold competence

6.3.1 Core Competence

Core competence of a company is one of its special or unique internal competence. Core competence is not just a single strength or skill or capability of a company; it is interwoven resources, technology and skill or synergy culminating into a special or core competence. Core competence gives a company a clear competitive advantage over its competitors. Sony has a core competence in miniaturization; Xeroxs core competence is in photocopying; Canons core competence lies in optics, imaging and laser control; Hondas core competence is in engines (for cars and motorcycles); 3Ms core competence is in sticky tape technology; JVCs in video tape technology; ITCs in tobacco and cigarettes and Godrejs in locks and storewels. Hamel and Prahalad, two of the greatest exponents of core competence, argue in The Core Competence of the Corporation (HBR, 1990) that the central building block of the corporate strategy is core competence. Hamel and Prahalad defined core competence as the combination of individual technologies and production skills that underlie a companys product lines. According to them, Sonys core competence in manufacturing allows the company to make everything from the Sony walkman to video cameras to notebook computer. Canons core competence in optics, imaging and microprocessor controls have enabled it to enter markets as seemingly diverse as copiers, laser printers, cameras and image scanners. To achieve core competence, a particular competence level of a company should satisfy three criteria: (a) It should relate to an activity or process that inherently underlies the value in the product or service as perceived by the customer. This is important because managers often take an internal view of value and either miss or deliberately overlook the customer perspective.
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(b) It should lead to a level of performance in a product or process which is significantly better than those of competitors. Benchmarking is a good way and is generally recommended for undertaking performance standard and also for differentiating between good and bad performance. (We will be discussing benchmarking in Unit 11). (c) It should be robust, i.e., difficult for competitors to imitate. In a fast changing world, many advantages gained in different ways (like a superior product feature, a new marketing campaign or an innovative price policy/strategy) are not robust and are likely to be short lived. Core competence is not about such incremental changes or improvements, but, about the whole process through which continuous change and improvement take place which lead to or sustain clearly differentiated advantage.1

6.3.2 Distinctive Competence

Core competence may not be enough, because it focuses predominantly on the product or process and technology, or, as Hamel and Prahalad put it; The combination of individual technologies and production skills. There are two problems with this. First, strong and aggressive competitors may develop, either through parallel innovations or imitations, similar products or processes which are highly competitive. This is what Japanese companies have done in the fields of electronics and automobiles, and now South Korea is doing to Japanese electronics; IBMs core computer technology is also facing the same problem. Second, to secure competitive advantage, only product, process or technology or technological innovation may not be enough; this has to be amply supported by special capabilities in the related vital areas like resource or financial management, cost management, marketing, logistics, etc. Hamel and Prahalad themselves have said later (1994):
We have to look at the organization as a portfolio of competencies, of underlying strengths, and, not just a portfolio and business unit .... We must also identify those core competencies that would allow us to create new products; and we must ask ourselves what we can leverage as we move into the future, and what we can do that other companies might find difficult.2

Distinctive competences may provide an answer to some of these points. Distinctive competence is based on the assumption that there are different alternative ways to secure competitive advantage and not only special technical and production expertise as emphasized by core competence.

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Distinctive competence includes core competence as one of the alternatives. But, there are other alternatives that are also based on organizational capabilities. So, distinctive competence is more broad based. Thompson and Strickland (1992) have defined distinctive competence as:
Distinctive competence is the unique capability that helps an organization in capitalizing upon a particular opportunity; the competitive edge it may give a firm in the marketplace.3

So, the focus in distinctive competence is on exploiting a market opportunity. And, depending on the market or competitive situation, one or some of the alternative competences may work ; for example, product or process superiority (core competence), product differentiation (situational or adaptability), cost effectiveness or cost efficiency to support a price strategy, special capability in marketing or distribution, etc. Under given circumstances, one of these, or a combination of some of these, will produce a distinctive competence which would be appropriate or best suited to exploit the opportunity and produce desired results. Since resources are limited, identification of distinctive competence may also help efficient allocation of resources. Reliance Industries, for example, has developed its distinctive competence in conceiving, implementing and managing large scale projects and mobilizing requisite resources for that. They do not think in terms of core competence. Mukesh Ambani, Chairman and MD, has described it like this:
We do not believe in core competence; we believe in building competence around people and processes to create value.4

6.3.3 Strategic Competence Strategic competence coexists with, or supports, core competence and distinctive competence. Strategic competence is the competence level required to formulate, implement and produce results with a particular strategy, for example, to outwit competitors. Hindustan Unilever did this. In the mid- and the late 80s, they used their strategic competence to out manoeuvre Nirma (which was launched very aggressively) and re-establish their leadership in the detergent market. Strategic competence may also involve combination or convergence of different capabilities as in the case of Hindustan Unilever.

6.3.4 Threshold Competence

Threshold competence is the competence level required just for survival in the market or business. The competence level of a company may be weaker than
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many of its competitors. Threshold competence may be adopted by No. 5 or No. 6 player in the market or those struggling to survive. Companies with threshold competence can, over time, graduate to a higher level of competence. But, continued threshold competence can also lead to closure of business. Multi-product or multi-SBU companies may often possess a portfolio of competences. In some product or business, they may have core competence, but, not in all. ITCs core competence is in tobacco and cigarettes, but, they have distinctive competence in hospitality business and agri-business. Hindustan Unilever has distinctive competence and strategic competence in many businesses. But, they had been surviving with threshold competence in vanaspati business (Dalda) for some time, and finally, they exited from that business. A conceptual portfolio of organizational competence consisting of core competence, distinctive competence, strategic competence and threshold competence is shown in Figure 6.1.

Figure 6.1 Portfolio of Organizational Competence

Activity 1 Now that you know what is core competence, choose any three companies and compare their core competence. Write a comparative analyis on the same.

Self-Assessment Questions
1. The ability to perform a task or achieve some objectives is called ______. 2. Sonys competence in miniaturization; Xeroxs competence in photo copying; Canons competence in optics, imaging and laser control are examples of _______competence.
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3. The unique capability that helps an organization in capitalizing upon a particular opportunity; the competitive edge it may give a firm in the marketplace is called: (a) Strategic competence (b) Core competence (c) Distinctive competence (d) None of these 4. The competence level required to formulate, implement and produce results with a particular strategy, say, to outwit competitors, is known as strategic competence . (True/False)

6.4 Resource Analysis

Resources create competences. Resources also limit competences because for developing certain types or levels of competences or capabilities, commensurate resources may not always be forthcoming. This shows that competence analysis and resource analysis are intrinsically related. Resources do not mean only financial resources. In strategic management analysis, organizational resources can be classified into four major categories: Physical resources Financial resources Human resources Intangible resources Physical resources are buildings (factory or office), machines or production capacity. The nature and quality of physical resources depend on the age, condition, location and capability of these resources. Financial resources include cash, capital, debtors, creditors and suppliers of funds (shareholders, banks, financial institutions, etc.). Financial resources are the source of all investments of a company. Human resources are people. Human resources include skills, knowledge applications and adaptability of people or employees in an organization. In knowledge-based economies and todays complicated business management systems, human resource has become the most valuable asset. Intangible resources are also called intellectual capital, and, of late, are being recognized as of strategic importance to companies. Intangible resource includes knowledge or intellectual capital in the form of patents, brands, business systems, customer databases and relationships with strategic partners. Intangible resource
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or intellectual capital also includes goodwill or corporate image of an organization which helps immensely during business transactions. Intellectual capital forms an important asset of many organizations, and, there are thoughts to find ways of assessing and accounting for value of intangibles.5 Like competences, resources can also be of different levels of adequacy or effectiveness. For example, threshold resources, like threshold competences, are resources required to stay in business or in a market or segment. Threshold resources may sometimes be the minimum level required for market entry. But to stay in business, the threshold level has to increase over time because of the actions of the competitors and/or new entrants. So, the threshold resource level is always relative to the market position of a particular product. In contrast, unique resources like core competence or distinctive competence enable an organization to establish or sustain its product or business better than competitors resources. Uniqueness of the resources also makes these difficult to imitate. Resources may have to be continuously developed and/or adjusted to competence levels to secure or sustain competitive advantage. Due to the development of technology and changes in competition levels, some resources may become redundant at some point of time. Unless organizations are able to dispose of or abandon redundant resources and develop new resources, they may not be able to stay in competition. Banking sector is a good example. In the US and Europe, many traditional banks are still operating with a large number of branches. However, in the new technology world, many new competitors do not have any branches and have invested heavily in call centres and Internet banking. In 2000, average transaction cost with branch operation was 1 compared with 54 p through telephones and only 15 p through the Internet. Also branch transaction costs are rising as volumes are falling and more customers are switching to e-banking.6 So, the message is clear. Organizations may have to change their resource base as competitive situation demands.

Self-Assessment Questions
5. In strategic management analysis, organizational resources can be classified into categories: (a) Physical and non-physical resources (b) Financial and human resources

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(c) Physical, financial and human resources (d) Physical, financial, human and intangible resources 6. Knowledge or intellectual capital in the form of patents, brands, business systems, customer databases and relationships with strategic partners is classified as ________resource. 7. In order to secure or sustain competitive advantage, _________ may have to be continuously developed and/or adjusted to competence levels. 8. Absence of _____may lead to underutilization or wastage of resources.

6.5 Value Chain Analysis

Various competences and resources of an organization can be integrated into a chain of activities which an organization performs to meet customer demand. Since each of these activities is expected to create value when it is performed, the chain can appropriately be called a value chain. Michael Porter (1985) introduced the concept of value chain analysis. Now, it has become common for professional companies to do this analysis. Value chain analysis helps in understanding how value is created in organizations through various activities. These activities can be divided into two broad categories: primary activities and support activities. Primary activities are directly concerned with the creation or delivery of a product or service or customer value. Support activities, as the name indicates, support the primary activities, or, more, correctly, help to improve the effectiveness or efficiency of primary activities. Primary activities can be divided into five major areas: inbound logistics, operations, outbound logistics, marketing and sales and service. Inbound logistics: These are activities concerned with receiving, storing and distributing raw materials and inputs to the production or service division. Inbound logistics also include materials handling, stock control, transportation of inputs, etc. Operations: These are activities involved in transforming various inputs into final product or service. Operations also include machinery, packaging, assembly, testing, etc. Outbound logistics: These include collecting, storing and distributing or delivering final products to customers. For tangible products (industrial or

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consumer goods), this would include warehousing, materials handling, transportation, etc. In the case of service, these may be more concerned with arrangements for bringing customers close to the service location. (e.g., sports events, entertainment events, etc.). Marketing and sales: These comprise activities such as advertising, sales promotion, selling, sales force management, pricing, channel selection, channel management, etc. Marketing and sales provide the most important link between the company and the customer. Service: These include activities which maintain or enhance value of a product or service such as installation, repair, training, supply of spares and prompt after-sales service, etc. Support activities can be divided into four categories: procurement, technology development, human resource management and organizational infrastructure. Procurement: This relates to the processes for acquiring or purchasing various resource inputs like raw materials, intermediate inputs, equipment, machinery, etc. Procurement primarily supports inbound logistics and operations. Technology development: Technology is involved in all value creations. Key technologies are concerned directly with the product, (e.g., R&D, product design, quality control, etc.,) or with processes, (e.g.,process development). Technology development is fundamental to the innovative capacity of an organization. Technology mainly supports operations. Human resource management: This provides support to all primary activities in the value chain. More specifically, HRM is concerned with recruiting, managing, training and developing people within the organization. Infrastructure: This is the organizational system including finance, MIS, general management, strategic planning, etc. Infrastructure also comprises organizational structures, values and culture. Infrastructure, directly or indirectly, supports all primary activities. Figure 6.2 shows the value chain in an organization in terms of primary activities and support activities and the value or margin these activities are expected to create. Primary activities and support activities may appear to be two separate blocks, but, in reality, they are all interconnected activities in a cohesive value chain.

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Figure 6.2 Value Chain in an Organization Source: M E Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: The Free Press, 1985).

Competences or activities in the value chain can contribute to customer value in two ways. First is competences in individual activities (for example, operations or production or marketing). Second is the competence in linking activities together. This includes the ability to integrate all the separate activities (both primary and support activities) to deliver some customer value, and, thereby ensure that they do not contribute to conflicting goals. An organization may have core competence in manufacturing processes that produce engineering products of unique specifications very difficult for competitors to match or imitate. But, the company may not be able to gain competitive advantage from this unless it is able to take care of its inbound logistics, outbound logistics and marketing and sales. It is the combined effect of all these activities which creates or destroys value. Organizations can effectively use value chain analysis to identify the weak links (and also the strong links) in the chain for further analysis, review and necessary action. In using the value chain, an organization should concentrate on two aspects. First, it should ascertain how different activities, both primary and support, are being performed so that contribution of each activity to organizational objectives or goals can be measured. If a particular activity is not contributing satisfactorily, required changes can be made in that. This is the job of strategic management. The second aspect is the coordination or integration of various activities into a cohesive value chain. Many companies perform individual activities efficiently, but, in the absence of a proper coordination mechanism, their overall effectiveness is low. The solution to this is integrated value chain. Many companies are re-engineering their organizational processes for performing various activities in their value chain in an integrated way.7 Value chain analysis of Hero Cycles is given as an example in Box. 6.1.
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Box 6.1: Value Chain Analysis of Hero Cycles

Hero Cycles is a single product company and concentrates exclusively on manufacturing bicycles. Hero Cycles has positioned its product as lowpriced, functionally useful and suitable for mass marketing. Its strategy is based on overall cost leadership and has adopted commensurate strategies for all activities in the value chain to become the most competitive in the industry. Value chain analysis of Hero Cycles is given here in terms of primary activities and support activities. Primary Activities The first primary activity in the value chain is inbound logistics. This involves inward movement of different types of materials. These materials are divided into three categories: raw materials (mostly steel); components requiring further machining at the companys plant; and, components and parts (like tyres, tubes and other accessories) which can be assembled without any further processing. The company saves cost in inbound logistics in several ways. First, except for some critical components, it procures components from small-scale manufacturers in the neighbourhood which enjoy cost advantage in terms of lower overhead and also transportation. Second, the company pays its vendors in cash and enjoys cash discount. Third, the company has trained many component manufacturers and because component manufacturing does not involve high technology, they produce quality components at reasonable cost. In operations, the company saves cost through higher productivity which is achieved through motivated and loyal workers. In few cases like rim manufacturing, automation helps higher productivity. In outbound logistics, Hero Cycles has adopted just-in-time approach for finished products in which bicycles are transported within one week of their manufacturing. The company has appointed stockists in almost all cities of the country to make outbound logistics more effective. In marketing and sales, the company has reduced the number of intermediaries in its distribution channel and goes directly to the stockists and, through the stocktists, to customers. The company believes that in the present competitive environment, satisfied customers are the best source of publicity and promotion. This way, marketing and selling cost of the company is very low, if not negligible.

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In service, the company does not have to do much in terms of managing the activity because bicycle requires very little after-sales service. Support Activities Hero Cycles conducts various support activities in such a way that it either saves cost on these activities directly or they provide strong support to primary activities. Firm infrastructure which includes general management, finance, accounts, etc., performs efficiently. The company is able to achieve significant cost saving in finance area. Since it is a cash rich and debt-free company, it does not have to bear any interest burden in contrast to some others in the industry. In human resource management, the company is far superior to its industry competitors, and its HR policies and practices can even be the envy of many organizations outside the bicycle industry. The companys HRM practices are based on one basic value: employees even at the lowest level are treated at par with owners and shareholders and top-level managers. Even the chairman remembers the names of workers and calls each of them by his/her name. This infuses a feeling of belongingness among the employees. In technology development, the company has adopted a policy of informalization rather than structuring too many processes and systems. Its R&D activities are always aimed at making bicycles more functionally useful rather than adding styles and colours which are reserved for cycles for the export market. In procurement, there are two centralized systems; one for human resource, and the other for physical resource. Procurement system for physical resources gives ample support to inbound logistics. In conclusion, it can be said that Hero Cycles value chain provides high value to its customers and also to the organization. This differentiates the company from its competitors. Activity 2 Having read the value chain analysis of Hero Cycles, choose another company and compare its value chain with that of Hero Cycles.

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Self-Assessment Questions
9. The chain of activities that an organization performs to meet customer demand is called _________. 10. The various activities in a value chain can be divided into two broad categories: (a) primary and secondary activities (b) primary and support activities (c) high-level and low-level activities (d) priority and non-priority activities 11. Inbound logistics, operations, outbound logistics, marketing and sales and service are classified under (a) primary activities (b) secondary activities (c) tertiary activities (d) support activities 12. Activities that help to improve the effectiveness or efficiency of primary activities are known as _______.

6.6 Cost Analysis

Price or market competitiveness of a product or business depends on its cost competitiveness. Cost competitiveness itself is a competence or capability. Therefore, cost management becomes a very important strategic function of an organization. Cost competitiveness implies two thingscost efficiency and cost effectiveness. Both may appear same or similar as concepts, but analytically the difference between the two is quite significant. Efficiency is an input-output relationshiphow much has been produced or achieved per unit of input or cost. Given an input or cost level, higher the output, more efficient is the production process. Conversely, cost efficiency may be defined as the level of resources or cost required to produce a particular output or create a given value. So, lesser the resources or cost, more efficient is the value creation process. Effectiveness is more plan-output relationshiphow much of the plan has been fulfilled or realized given a resource level or cost. Effectiveness,
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therefore, is the ability to contribute to the defined level of objectives or goals or to produce results. Both cost efficiency and cost effectiveness are important dimensions of cost management. Cost efficiency and cost effectiveness are not exclusive to each other. So, companies can simultaneously aim at cost efficiency and cost competitiveness which can lead to cost competence. Cost competence, achieved through proper cost management, can also contribute to cost efficiency and cost effectiveness (Figure 6.3).

Figure 6.3 Cost Management, Cost Competences, Cost Efficiency and Cost Effectiveness

6.6.1 Cost Efficiency

Various factors contribute to cost efficiency in an organization. These may even include factors which are not directly related to cost or cost management like general work environment or culture in the organization, motivation levels of managers, approach of the top management, etc. However, here we shall consider the factors that are directly related to cost competence or cost efficiency. Four major factors may be identified: economies of scale, supply cost or cost of raw materials and inputs, product or process design, and experience or experience effect (Figure 6.4).

Figure 6.4 Sources of Cost Efficiency Source: G Johnson, and K Scholes, (2005), 166. Sikkim Manipal University Page No. 147

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Economies of scale: We know from economics that economies of scale are the most conventional and, also a very important source of cost efficiency. In manufacturing organizations, fixed cost (per unit of output), which initially remains very high, starts going down progressively as output increases. Because of this, average cost of output decreases as output increases, or the scale of operations increases. This also means increase in capacity utilization of plant and machinery. In non-manufacturing organizations or non-manufacturing activities, economies of scale can be effected through mass advertising, mass marketing, extensive distribution, etc. Economies of scale can also be achieved through global partnering and global networks. Many MNEs sustain their competitiveness in the market through scale advantage. Supply cost: Costs of raw materials and various inputs constitute supply cost. Inputs generally include raw material inputs or intermediate inputs and energy inputs. In an extended sense, these inputs can include factor inputs like labour also. In highly raw material-intensive industries like steel, cement and non-ferrous metals, supply costs constitute a very high proportion of total cost of the product and, therefore, become a very important determinant of the level of cost efficiency. In these industries, location influences supply cost because transportation becomes a significant component of total raw material cost. This is the reason why, in these industries, many plants are located near the raw material source or mines. This gives cost advantage to companies. In such industries, ownership of raw material can also give definite cost advantage. This is why steel manufacturers like Tata Steel and nonferrous metal manufacturers, like NALCO, BALCO, and HINDALCO, have their own captive sources of raw materials (ores). In fact, NALCO, primarily because of its captive sourcing of high quality bauxite, is one of the lowest cost producers of aluminum in the world. Even in those industries which are not highly raw material-intensive, supply cost management becomes an important determinant of cost advantage or cost disadvantage. Inventory (of raw materials, components and spares) planning and management are also part of this. Companies are becoming increasingly aware of this. The automobile sector is a good example. All Japanese automobile manufacturers have established close linkages with their vendors suppliers of automobile ancillariesthrough different kinds of partnerships and alliances and implementation of JIT principles. Maruti in India is also a very good example. Companies are also reducing the number of vendors to make the raw material supply chain more cohesive and cost efficient. Product/process design: Product design starts at the R&D stage even if it is an imitation. Many feel that product design is the first step in efficient cost management, because the nature of the product determines, to a large extent,
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the raw material and other input requirements and supply cost. Cost efficiency in production processes can be achieved through better process engineering, increase in productivity (depends partly on the technology level) and better working capital management. Many companies have achieved cost efficiency through these methods. Cost competitiveness through product design need not, however, be confined to manufacturing or production process alone. Innovative product design can lead to cost saving through its influence on other parts of the value chain also like distribution or after-sales service. Canon proved this in its battle with Xerox. Xeroxs competitive advantage was built on its service and support network. Canon designed a copier which needed far less servicing8 and, through this, made one of the strong competence areas of Xerox largely redundant. In the process, Canon also achieved cost efficiency by spending much less on its service network. Experience: Experience in any activity in an organization can be an important source of cost advantage or cost efficiencybe it manufacturing or any other functional area. Many studies have been conducted to establish the relationship between cumulative experience gained in an organization and its unit cost. The relationship is generally expressed as an inverse relationship between cumulative output and unit costunit cost decreases as cumulative output increases. This is shown in the experience curve (Figure 6.5).

Figure 6.5 The Experience Curve

The experience curve is the result of two major factors, namely, the learning effects and economies of scale. Learning effects refer to cost saving which comes from learning by doing. Labour, for example, learns through repetitive processes, how to perform a task more efficiently on the shop floor or in assembly
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lines. Due to this, labour productivity increases and this leads to cost reduction or cost efficiency. Similarly, in a new production process, management learns over time, how to manage the new operations more efficiently; and, management efficiency eventually leads to cost efficiency. Same applies to operations like logistics. Economies of scale as mentioned above contribute to cost reduction by distributing fixed cost over larger output. Learning effects, however, may die out after some time. Some feel that learning effects are really important during the start-up period of a new process. Even if it is a complex assembly process, workers may almost reach perfection after a few years, and all effects on the experience curve may cease after two or three years. Any further downward slope of the curve (that is, cost reduction) may occur only because of economies of scale which can continue over larger output. In a cost-conscious organization, all the four major factors, i.e., economies of scale, supply cost, product/process design and experience may play active roles for achieving cost efficiency. However, economies of scale and experience effect can occur only after an organization has been in operation for sometime. Newly launched companies or products must concentrate on product/ process design and supply cost and try to reduce the experience cycle through a more efficient management system.

Self-Assessment Questions
13. Cost competitiveness implies two things_______and __________. 14. Factors like economies of scale, supply cost or cost of raw materials and inputs, product or process design, and experience or experience effect contribute to __________in an organization. 15. The more the resources or cost, more efficient is the value creation process. (True/False) 16. Companies that achieve cost efficiency and cost competitiveness also achieve _________.

6.7 Financial Competence Analysis

Financial competence or financial health of an organization can be analysed with the help of various financial ratios. Financial ratios are computed from a companys income statement and balance sheet. Comparison of ratios over time, and with industry averages, give meaningful statistics which can be used
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to identify and analyse or evaluate financial strengths and weaknesses. Various financial ratios of an organization can be classified into five major categories: (a) Liquidity ratios (b) Leverage ratios (c) Activity ratios (d) Profitability ratios (e) Growth ratios Liquidity ratios relate to current assets and liabilities and indicate an organizations short-term obligations. Leverage ratios pertain to debts and show the extent to which an organization has been financed by debt. Activity ratios relate turnover to resources and measure how effectively an organization is using its resources. Profitability ratios pertain to returns and margins and show different measures of returns/margins on sales and investment. Growth ratios relate to organizational growth indicators and measure an organizations growth in sales, income, etc. Ten key financial ratios for a company are given below: 1. Current ratio 3. Inventory turnover ratio 5. Gross profit margin 7. Return on total assets (ROA) 9. Earnings per share 2. Debt-to-equity ratio 4. Total assets turnover ratio 6. Net profit margin 8. Return on equity (ROE) 10. Price-earnings ratio

Generally speaking, higher the values (or percentages) of the above ratios (except debt-equity ratio), better are they as indicators of financial competence or health of a company. The most desirable ratios for a company would depend on factors like nature of the companys business, market or competitive situation and the industry average. Financial ratio analysis should be carried out by financial analysts in the company or the strategic planning group or outside consultants. Such analysis should not be done in isolation; this should be done in relation to other resources and competences to optimize overall internal competence of an organization. Financial ratio analysis, however, is not without limitations. Financial ratios are based on accounting data, and, companies differ in their treatment of items like depreciation, inventory valuation, reserves, tax provisions, R&D expenditures, etc. These factors can affect comparative ratios. Therefore, conformity to industry ratios does not automatically mean that a company is performing well. Similarly,
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deviations from industry averages also do not indicate that a company is doing badly. For example, a high inventory turnover ratio can indicate efficient inventory management and, a strong working capital position, but, it can also mean a serious inventory shortage and a weak working capital position.9

Self-Assessment Questions
17. Financial ratios are computed from a companys ________statement and balance sheet. 18. Financial ratio analysis should be done in relation to other resources and competences to optimize overall internal competence of an organization. (True/False)

6.8 External Sources of Competence

Not many companies can hope to possess all the competences required to survive in todays highly complex and rapidly changing market. Many organizations are, therefore, entering into alliances, joint ventures or network relationships with others within their business system to overcome identified internal weaknesses. Studies conducted by the Nordic Business Schools on the performance of Swedish firms in international markets revealed that many companies faced a competence inadequacy situation, e.g., not owning appropriate technology or not having the marketing skills to enter a new market segment. And many of these companies sought solutions to this problem by entering into network relationships with other companies (Hakansson, 1989). Studies also showed that one of the commonest forms of business networking was forming alliances to achieve faster rates of product and/or process innovation. Conway (1987) has constructed a framework in an attempt to define various potential participants (or actors) whom a company might like to bring together for formation of a network to overcome an identified innovation competency problem. These include : (a) Upstream innovators found among the companys suppliers. (b) Downstream actors found within the companys customer base. (c) Horizontal actors found from companies within the same market system.

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(d) Knowledge participants such as universities and research institutes. (e) Regulatory actors, e.g., governments or statutory bodies. (f) Environmental actors, e.g., environmental pressure groups. The implications of the Conway framework are that the company which feels that internal innovation competences are not sufficient to adequately support future business plan, is now able to consider the formation of external alliances to overcome this problem.

6.8.1 Strategic Outsourcing

Capability sourcing is becoming the new trend. It is no longer a companys ownership of capabilities which matters, but, what matters is its ability to make the most of available critical capabilities whether they reside inside or outside the company. Outsourcing is becoming so sophisticated that even core functions like engineering, R&D, manufacturing and marketing canand often should be moved outside. And, this trend is changing the way companies think about their organizations, their value chains and, their competitive position.10 Experience of companies like Chrysler, American Express and 7-Eleven (the US retailer) have shown that strategic outsourcing can significantly improve a companys competitive position. Gottfredson, Puryear and Phillips (2005) have suggested a framework for capability sourcing or strategic outsourcing. To complete the outsourcing process, a company has to move progressively in three steps. The first step is to identify the competences or capabilities of business, which constitute the core of the core of a company. These are activities which the company does better and cheaper than its rivals. For 7-Eleven, the core of the core is in store merchandising and product ordering; for Pfizer, it is developing and marketing pharmaceutical compounds; for American Express, it is identifying customer segments and card offering tailored to them. Everything exists in the company to support the core of the core. In deciding what to outsource, and what not to, a company should consider two factors; first, whether a capability is proprietary, that is, possessed only by the company and, also unique to itself and second, whether it is common enough and possessed by many in the industry. Based primarily on these two factors, a company should decide which capabilities have high outsourcing potential and which should remain under the companys control. This can be seen more clearly in a sourcing probability map. This is given in Figure 6.6. The vertical axis of the

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map depicts how proprietary a process or function or capability is; the horizontal axis shows how common a process or function is. The less proprietary and more common a process or capability is, the stronger a candidate it is for outsourcing.

Figure 6.6 Outsourcing Probability Map Source: M Gottfredson, R Puryear, and S Phillips, Strategic Sourcing: From Periphery to the Core, Harvard Business Review (February, 2005), 138.

Activities or capabilities which appear in the lower left segment of the map are strong prospects for captive sourcing. Such capabilities may even be candidates for insourcing, that is, if a company feels that it is really the best at/ in a given process or capability, it should have an opportunity to perform the activity for other companies also. A good example of successful insourcing is FedEx. FedEx plans and manages inbound transportation for more than 1500 product suppliers into 26 General Motors power train facilities. This capability puts FedEx at the leading edge of the $225 billion logistics outsourcing industry.11 Capabilities, which fall in the upper right segment of the map, are strong candidates for outsourcing. Capabilities, which fall in the middle of the sourcing
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map, generally require more detailed analysis of the company and the industry. An organization needs to consider such factors as substitute products, standards and regulations to make out how these capabilities will shape in the future. A decision for outsourcing should be based on these considerations. The second step in the capability sourcing process is for a company to decide how it should outsource the identified capabilities. There is a cost for capability sourcing: there is a quality angle also. How does a company decide on these factors? A capability assessment map (Figure 6.7) can be a good guide.

Figure 6.7 A Capability Sourcing Map Source: M Gottfredson, R Puryear, and S Phillips, Strategic Sourcing: From Periphery to the Core, Harvard Business Review (February, 2005), 138.

The map depicts each capability according to its cost and quality relative to the top-performing competitors or suppliers (industry median). This map helps a company decide which key capability gaps it should fill. For example, activities or capabilities which fall in the upper-left segment (relatively high cost capabilities whose quality levels exceed requirements) should be outsourced to low-cost providerseven if it means a reduction in quality.

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The third and final step in capability sourcing is a reality check or more a feasibility check in terms of location or physical proximity of the capability to be outsourced. For example, if it is a tangible product or technology, physical proximity becomes an important factor because of cost and time implications. But, for intangibles like R&D, design, engineering, etc., physical proximity may be much less important. A company, however, has to look into this reality or feasibility aspect. According to Gottfredson, Puryear and Phillips, if a company goes through the proposed three-step process, it will have the right framework for a comprehensive capability sourcing strategy.

Self-Assessment Questions
19. One of the commonest forms of business networking is forming ______to achieve faster rates of product and/or process innovation. 20. In order to improve their competitive position, companies are adopting ______, that is, moving one or more of the functions in the value chain outside.

6.9 Case Study

Southwest Airlines: Excellence through Integrated Cost Management According to many, Southwest Airlines is the best airline in the US and one of the best in the world. Analysts and even competitors attribute this to Southwests low-cost strategy. But, closer analysis reveals that it is integrated cost management or leadership which gives the company its competitive position in the global airlines industry and is also the source of its profitable operations. Six strategic factors contribute to Southwests integrated cost management leadership. These are: very low ticket prices; limited passenger service (for example, no meals, no baggage transfers); lean and highly productive ground and gate crews; frequent, reliable departures; high aircraft utilization; and short-haul, point-to-point routes between mid-sized cities and secondary airports.* These factors or activities are linked in a kind of value chain that leads to highly effective cost management. This also results in high profitability.

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It is often asked, how does Southwest make high profits? The answer is to be found, in addition to other factors, in price risk management or hedging of aviation fuel price. Southwest has concluded hedging agreements till 2009 with hedge price not exceeding $35 per barrel for at least 25 per cent of its annual fuel requirements. It can also exercise option for about 25 per cent of its fuel needs for $26 per barrel. In a highly volatile crude oil/ fuel oil market, price hedging gives very significant cost advantage to a company. Due to its successful integrated cost management, Southwest has become highly competitive in the airline industry. Many full service airlines have tried to adopt Southwests cost strategy, but they have remained unsuccessful, primarily because they have not been able to properly emulate or integrate various cost management actions/ functions. Kelly, Southwests CEO, said: I feel very good about our competitive position as long as we continue to improve. In Southwest Airlines, cost management, competitive action and growth are closely interlinked. Integration of, and fit among, critical activities is key to sustainable competitive advantage of all Companies, including Southwest Airlines. Porter describes it like this:
Strategic fit among many activities is fundamental not only to competitive advantage, but also the sustainability of that advantage. It is harder for a rival to match an array of interlocked activities than merely to imitate a particular ... approach.** * Hitt et al, Management of Strategy (Cengage Learning, India Edition, 2007), 107. ** M E Porter, What is Strategy? Harvard Business Review, 74, no. 6 (1996).

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6.10 Summary
Let us recapitulate the important concepts discussed in this unit: For effectiveness, all management strategies should be commensurate with internal competencies or capabilities of a company. Four major types or levels of competence are: core competence, distinctive competence, strategic competence and threshold competence. Resources create competences. Resource also limits competences because of resource crunch. In strategic management analysis, organizational resources can be classified into four major categories: physical resources, financial resources, human resources and intangible resources. Various competences and resources of an organization can be integrated into a chain of activities which performs to meet customer demand. This chain of activities is a value-creating process and is more appropriately described as a value chain. Activities in the value chain are divided into primary activitiesactivities directly concerned with the creation of a product or customer valueand support activities. Price or market competitiveness of a product on business depends on cost competitiveness, Cost competitiveness itself is a competence or capability. Cost competitiveness implies two thingscost efficiency and cost effectiveness. Financial competence or financial health of an organization can be analysed with the help of five categories of financial ratios: liquidity ratios (relate to current assets and liabilities), leverage ratios (pertain to debts), activity ratios (relate turnover to resource), profitability ratios (returns/ margins on investment/sales) and growth ratios (growth indicators). Capability sourcing is becoming the new trend and it can significantly improve competitive position.

6.11 Glossary
Competence: The ability to perform a task or achieve some objectives. Core competence: The special or unique internal competence of a company.
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Distinctive competence: The combination of individual technologies and production skills of a company. Economies of scale: Reduction in cost per unit resulting from increased production, realized through operational efficiencies. Liquidity ratios: Ratios that measure a firm's ability to meet its shortterm financial obligations on time, such as the ratio of current assets to current liabilities. Outsourcing: When a company or corporation will either buy products it intends to resell or hire another company to perform certain functions that would cost them too much to do themselves Strategic competence: The competence level required to formulate, implement and produce results with a particular strategy, say, to outwit competitors. Threshold competence: The competence level required just for survival in the market or business. Value chain: Various competences and resources of an organization that can be integrated into a chain of activities which an organization performs to meet customer demand.

6.12 Terminal Questions

1. Distinguish between core competence, distinctive competence, strategic competence and threshold competence. Use examples. 2. Distinguish between different kinds of resources. Which are intangible resources? 3. What is a value chain? Analyse the roles of primary activities and support activities in a value chain. 4. Explain the concept of cost efficiency of an organization. Analyse the major determinants of cost efficiency. 5. State five major categories of financial ratios of a company. Explain each of them. 6. Explain an outsourcing probability map. Use a diagram. 7. What is a capability sourcing map? Illustrate with a diagram.

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6.13 Answers Answers to Self-Assessment Questions

1. Competence 2. Core 3. (c) Distinctive competence 4. True 5. Intangible 6. (d) Physical, financial, human and intangible resources 7. Resources 8. resource analysis or audit 9. value chain 10. (b) primary and support activities 11. (a) primary activities 12. support activities 13. cost efficiency, cost effectiveness 14. cost efficiency 15. False 16. cost competence 17. income 18. True 19. Alliances 20. strategic outsourcing

Answers to Terminal Questions

1. Four major types or levels of competence are: core competence, distinctive competence, strategic competence and threshold competence. Refer to Section 6.3 for further details. 2. Organizational resources can be classified into four major categories physical, financial, human and intangible resources. Refer to Section 6.4 for further details.
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3. Various activities which an organization performs to meet customer demand can appropriately be called a value chain. Refer to Section 6.5 for further details. 4. Various factors contribute to cost efficiency in an organization. Refer to Section 6.6.1 for further details. 5. The various financial ratios of an organization can be classified into five major categories: liquidity ratios, leverage ratios, activity ratios, profitability ratios and growth ratios. Refer to Section 6.7 for further details. 6. To complete the outsourcing process, a company has to move progressively in three steps. Refer to Section 6.8.1 for further details. 7. A capability assessment map (Figure 6.10) can be a good guide for a company to decide how should it.outsource the identified capabilities. Refer to Section 6.8.1 for further details.

6.14 References
1. Aaker, D A. 1995. Strategic Market Management. 4th edn. New York: John Wiley & Sons. 2. Gottfredson, M, R Puryear, and S Phillips. Strategic Sourcing: From Periphery to the Core. Harvard Business Review, February, 2005. 3. Hamel, G, and C K Prahalad. The Core Competence of the Corporation. Harvard Business Review, MayJune, 1990. 4. Hamel, G, and C K Prahalad. 1994. Competing for the Future. Boston: Harvard Business School Press. 5. Porter, M E. 1985. Competitive Advantage: Creating and Sustaining Superior Performance. New York: The Free Press. 6. Thompson, A A, and A J Strickland. 1994. Strategic Management: Concepts and Cases. Texas: Business Publications. Endnotes
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G Johnson, and K Scholes, Exploring Corporate Strategy, 6 th ed. (Pearson Education, 2005), 157. G Hamel, and C K Prahalad, Competing for the Future, (Boston: Harvard Business School Press, 1994). A A Thompson, and A J Strickland, Strategic Management: Concepts and Cases, (1994), 77.

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A V Desai, A Rival of Your Size, BusinessWorld (October 9, 2000), 16. V Baruch, HR Accounting : The Issue Can No Longer be Ignored, The International Journal of Applied Human Resource Management 1, no. 1 (2000). G Johnson, and K Scholes, Exploring Corporate Strategy, 6 th ed. (Pearson Education, 2005), 154. M Hammer, and J Champy, Re-engineering the Corporation (New York: Harper Business, 1993). G Johnson, and K Scholes, Exploring Corporate Strategy (2005), 167. F R David, Strategic Management: Concepts and Cases (2003), 140. M Gottfredson, R Puryear, and S Phillips, Strategic Sourcing: From Periphery to the Core, Harvard Business Review (February, 2005), 132. M Gottfredson, R Puryear, and S Phillips, Harvard Business Review (2005), 139.

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