5.1 Introduction 

You now understand how the AFI framework provides a structured process for managing strategy. You also know that the analysis phase of strategic management answers the question “Where are we?” and includes analyzing a firm’s organizational performance, external environment and internal environment, synthesizing the external and internal analysis, and determining a firm’s strategic issue and strategic alternatives. The analysis phase of strategic management provides an important starting point for strategy formulation.

You have now analyzed a company’s organizational performance, which provides critical information about a firm’s external and internal environments. You have also analyzed a company’s external environment, which provides a critical outside-in perspective and helps companies to determine attractive markets in which to operate. A firm’s external environment includes those factors, forces, and competitive industry groups outside a firm’s direct control. Analyzing a firm’s external environment supports identifying a company’s opportunities and threats.

In this chapter, you consider a company’s internal environment, which provides a critical inside-out perspective of the firm. A company has direct control over its internal environment. Analyzing both the external and internal environments of an organization provides a balanced and 360-degree analysis for the firm. You also learn what resources, capabilities, and core competencies are and how these relate to creating and maintaining a competitive advantage. Next you learn the resource-based view (RBV) of firms. Then you learn what the VRIO framework is and how it is based on the resource-based view of a firm. You also learn the ways isolating mechanisms, including intellectual property, social complexity, and path dependence, serve as a value-added resource for organizations. The chapter explains a firm’s value chain before teaching you to analyze the internal environment of a firm using a VRIO analysis instrument and a value chain analysis instrument. Analyzing a firm’s internal environment supports identifying a company’s strengths and weaknesses.

5.2 Analyze the Internal Environment

Analyzing the internal environment of a firm provides critical information about key features internal to the organization over which the company has direct control.

A company has direct control over its internal resources, capabilities, and core competencies. An internal analysis of a firm identifies whether a company has the appropriate internal resources, capabilities, and core competencies to perform well and be competitive in attractive industries, markets, and market segments. The internal analysis helps to identify which internal resources, capabilities, and core competencies a firm needs to develop internally or acquire externally to be successful in the chosen markets.

At the end of the day, an organization needs to make sure that it has differentiating resources, capabilities, and core competencies that will drive a competitive advantage and will allow the organization to meet customer needs better than its competitors. While it is not possible for an organization to be superior to all its competitors in all relevant resources, capabilities, and competencies, it is important to identify and leverage a few success-critical factors that are unique to the organization, superior to its competitors, and relevant for the customers’ buying decisions. The starting point of the internal analysis is a thorough understanding of the relevant resources, key capabilities, and core competencies of the firm and how they are different from each other.

An internal analysis also identifies where value is added in a firm’s value chain.

While analyzing a firm’s external environment helps determine a company’s opportunities and threats, analyzing a company’s internal environment helps determine strengths and weaknesses of the company that it needs to consider in the strategy formulation process. Strengths can be leveraged to address opportunities in the market and to counteract threats. Weaknesses need to be addressed through the internal development or external acquisition of competencies if they are relevant and important for success in the market.

5.3 Resources, Capabilities, and Core Competencies

Resources, capabilities, and core competencies can all serve as the source of competitive differentiation in a winning strategy. Hence, they make up the basic building blocks of strategy, and it is important to start with a thorough understanding of these concepts and the differences between them.

Resources are the tangible or intangible assets that an organization owns. Tangible resources are resources that can be seen, touched, and quantified. These include physical assets, such as a firm’s property, plant, land, buildings, labor, supplies, equipment, capital, and cash. Intangible resources are difficult to see, touch, or quantify. Intangible resources include the knowledge and skills of employees, a firm’s reputation, brand equity, intellectual property, and a firm’s corporate culture.

For example, NVIDIA has strong strategic intangible resources, such as expert employee knowledge and skills and a positive and empowering corporate culture.

A strategic resource is a resource that has the potential to drive competitive differentiation and that can serve as a source of sustainable competitive advantage. Both tangible and intangible resources can be the source of a sustainable competitive advantage and are therefore strategic in nature.

For example, BASF is the world’s largest chemical company and has strategic tangible resources, such as huge fully integrated chemical plants that allow the company to manage the complete chemical value chain with synergies and economies of scale. On the other hand, Apple excels in its strategic intangible resources. Success-critical intangible resources are often the decisive strategic differentiator as it relates to corporate culture, innovation strength, and superior skills of the workforce as strategic resources.

Capabilities refer to what the organization can do with its tangible and intangible resources. Capabilities are the outcome and result of organizations using, bundling, managing, and leveraging their resources in a way that drives competitive differentiation and that adds value to its customers. Capabilities are born out of the resources that a firm has, and they are developed over time. A firm’s capabilities are its organizational and managerial abilities to orchestrate a diverse set of resources and deploy them strategically. Since different firms have different approaches for resources utilization, it is possible that different firms with similar resources have different capabilities.

NVIDIA uses its leadership excellence to effectively capitalize on its intangible resources of expert knowledge and skills and its positive and empowering corporate culture to create strategic capabilities such as designing highly parallel GPUs that can process many tasks simultaneously and developing frameworks like CUDA to enable programmers to take full advantage of its GPUs. These related capabilities drive NVIDIA’s competitive differentiation and adds value for its customers.

Core competencies are unique strengths embedded deep within a firm that allow the firm to differentiate its products and services from those of its rivals, creating higher value for the customer or offering products and services of comparable value at lower cost. Core competencies comprise a deep proficiency that enables a company to deliver unique value to customers. They embody the organization’s collective learning and help the firm to branch into a wide variety of related markets. If they are truly differentiating, they are hard for competitors to copy or procure. Core competencies play a key role in formulating strategy because they define the firm’s position and competitive advantage, and they create a sustainable competitive advantage for a company.

Returning to NVIDIA, the company has a core competency of leading the industry in AI computing. This is a deeply embedded and unique strength that allows NVIDIA to differentiate its products and services from those of its rivals and create higher value for its customers.

The term dynamic capability refers to an organization’s ability to continually use its existing resources to create new core competencies and enhance, upgrade, and improve existing capabilities to win with customers and beat competition.

NVIDIA has a dynamic capability of capitalizing on its intangible resources such as employee expert knowledge and skills and its positive and empowering corporate culture to rapidly innovate using the latest technology to create new solutions and bring those solutions to the market ahead of its competitors.

The process of developing core competencies is sophisticated and requires strong leadership, a robust strategy, and management expertise. The first step of identifying and leveraging core competencies is to isolate key abilities and hone them into organizationwide strengths. It is important to compare them with other firms with the same skills to ensure that the firm is developing unique competencies. After that, the firm needs to develop an understanding of what competencies customers value, investing accordingly to develop and sustain the valued competencies. Hence, core competencies need to be customer-perceivable and valued by the customers. Then the organization can create an organizational roadmap that sets goals for competence building, pursuing alliances, acquisitions, and licensing arrangements that will further build the organization’s core competencies. It is advisable to encourage communication and involvement in core competency development across the organization. Non-core competencies can be outsourced or divested to free up resources that can be used to deepen the firm’s core competencies.

Consumer giant Procter & Gamble identified the five core competencies below that meet the criteria and that make them the premier marketing company in the world (us.pg.com).

1. Consumer understanding. Uncovers the unarticulated needs of consumers.
2. Innovation. Translates consumer desires into new products.
3. Brand-building. Shapes purpose-inspired, benefit-driven brands.
4. Go-to-market capabilities. Reaches retailers and consumers at the right place and time.
5. Scale. Drives efficiency and consumer value.

Unilever is one of P&G’s main competitors and identifies the three differentiating strengths below as Unilever’s core competencies (unilever.com). Firms often refer to their core competencies by different terms. When you analyze a firm’s core competencies, it is most important that you understand what a core competency is and are able to recognize it, whether the company refers to its core competencies as core competencies, differentiating strengths, or some other term.

1. Powerful portfolio of leading category and brand positions
2. Strong presence in growth markets of the future
3. The global leader in sustainable business

These examples of P&G and Unilever illustrate how different companies that are direct rivals within the same industry determine different core competencies.

The Coca-Cola Company describes its core competencies as the ability to lead the world’s most sophisticated system of independent bottling partners while creating value for retail and restaurant customers (coca-cola.com).

These examples illustrate that core competencies need to go beyond topics that just sound good or that are just a wishlist of what a company wants to be. Core competencies need to be specific to the firm, relevant to customers, and capable of beating competition.

Lastly, let us consider how the concepts of resources, capabilities, and core competencies are connected and how they work together. The starting point is the firm’s resources, which are the tangible and intangible assets that a firm possesses to create value. However, just having physical assets is not sufficient to create a sustainable competitive advantage for a firm. The firm needs to use resources and translate them to customer-perceivable value that is relevant for customers’ buying decisions and that drives competitive differentiation.

This is where capabilities and core competencies come into play. Capabilities include the firm’s ability and aptitude to perform a certain task. A capability is a combination of personal and technical skills, knowledge, processes, tools, and behaviors that are critical to an organization’s success and future needs.

Core competencies focus on the application of organizational capabilities. The core competencies ultimately drive strategic success in the competitive arena.

Hence, a firm needs to define, refine, and continuously enhance its resources and capabilities to command core competencies that will drive a sustainable competitive advantage. If the firm does this successfully, it will win in its chosen markets and will be rewarded with a competitive advantage and superior financial performance. The positive financial results will then be reinvested in further honing the firm’s resources and capabilities that will lead to sustainably differentiating core competencies.

5.4 Resource-Based View and the VRIO Framework

By now, you know that strategy can be described as a firm’s answer to three critical strategic questions that every organization needs to answer:

1. Where to play?
2. How to win?
3. Right to win?

Regarding the first two questions, “Where to play?” is addressed at the corporate level and “How to win?” is addressed at the strategic business unit level. The third question, “Right to win?”, is considered by the specific strategies that are embedded into business-level strategies at the strategic business unit level, which include innovation strategy, sustainability and ethics strategy, technology strategy, and multinational strategy. Corporate-level strategy, business-level strategy, and these embedded strategies are all dealt with in detail in subsequent dedicated chapters. All three questions drive the firm’s formulation of a roadmap and action plan toward sustained superior performance.

Addressed at the strategic business unit level, how to win in a firm’s chosen market is largely driven by the firm’s ability to develop a winning strategy around its resources, capabilities, and core competencies that are superior to those of its competitors and that will create value for the firm’s customers. Overall the “How to win?” question addresses the firm’s search for a sustainable competitive advantage.

Considering how a firm’s resources, capabilities, and core competencies can be marshalled to create and sustain a competitive advantage leads to a series of new questions that will help a company define how to win in its specific strategies that are embedded into business-level strategies at the strategic business unit level.

1. Which of these resources, capabilities, and core competencies make a firm truly unique?
2. Where and how can a firm find its unique selling proposition (USP), which is the essence of what makes the firm’s product or service better than its competitors?
3. What does the firm do both well and in a superior way?
4. What do the company’s customers want?
5. What does the firm do better than its competitors?
6. What are the main sources and drivers for the firm’s competitive differentiation?

A helpful framework to find answers to these critical strategy questions is the VRIO framework, which is based on the resource-based view of a firm.

According to the resource-based view, a firm can achieve a sustainable competitive advantage if it possesses resources, capabilities, and core competencies that are:

• Valuable
• Rare
• Hard to imitate (inimitable)
• Organized to capture value

A resource, capability, or core competency that meets all four requirements can provide a sustainable competitive advantage around which the firm should build its strategy.

Analyze the Internal Environment of a Firm Using the VRIO Framework

The VRIO framework is a flowchart.

The first step in using the VRIO framework is to identify a firm’s resources, capabilities, and core competencies and list these in the lefthand column of the table, as shown in figure 5.5. Assess each resource, capability, and core competency to determine whether it is valuable, rare, hard to imitate, and organized to capture value. Stop when you answer “no” to the resource, capability, or core competency being valuable, rare, or costly to imitate. Do not continue along the flowchart once you have answered “no” for anything. Use the VRIO decision tree to analyze resources, capabilities, and core competencies, not a firm’s products, services, or the firm.

After learning what a VRIO analysis is and how to analyze the internal environment of a firm, the chapter walks you through an example using a VRIO analysis.

Valuable

The first criterion in the VRIO framework is value. When you analyze a firm’s internal environment using a VRIO framework, the question to consider is whether a resource, capability, or core competency is valuable.

If a firm has no resources, capabilities, and core competencies that are valuable to the customer, the firm will fail. If customers do not see value in what the company brings to the market, they will simply walk away from the company and give their business to the organization’s competitors that offer something that the customers value; in this case, the firm is at a competitive disadvantage. The strategic conclusion is that, if a firm does not have valuable resources, capabilities, and core competencies, the company cannot formulate differentiating strategies that are embedded into business-level strategies at the strategic business unit level, and therefore does not have a strategic right to win. The firm needs to internally develop or externally acquire resources, capabilities, and core competencies that its customers value.

It is unlikely that you’ll analyze a firm with no resources, capabilities, or core competencies, as it is impossible to survive in the market if none of these elements are valuable. When you analyze a firm’s internal environment using a VRIO framework, it is more likely that you may find a particular resource, capability, or core competency that is not valuable. If you assess that a resource, capability, or core competency is not valuable, then place a “no” in the flowchart under “Valuable” and stop. This places the company at a competitive disadvantage.

When you assess the resource, capability, or core competency as valuable, then place a “yes” in the flowchart under “Valuable” and move on to assess whether that resource, capability, or core competency is rare.

Rare

The second criterion in the VRIO framework is rarity. When you analyze a firm’s internal environment using a VRIO framework, the second question to consider is whether a resource, capability, or core competency is rare. You consider this question only for those resources, capabilities, and core competencies that are valuable.

If a firm’s competitors also command resources, capabilities, and core competencies that offer the same value for customers, the firm does not offer anything unique and differentiating but only matches competitor offerings. This puts the firm at competitive parity with its competitors. While this is surely a better strategic position than not offering any value at all, the company has followed a “me too” strategy, and that is not enough to drive competitive differentiation. It is not recommended that a firm builds its strategy around resources, capability, and core competencies that are valuable but not rare, as this only leads to competitive parity in the market. The strategic conclusion is that a firm needs to develop or acquire resources, capabilities, and core competencies that are unique in the market and that truly drive competitive differentiation that is perceivable by the firm’s customers. If a firm has no resources, capabilities, and core competencies that are rare, then the whole firm is at competitive parity. It is unlikely to survive long.

When you analyze a firm’s internal environment using a VRIO framework, it is more likely that you find some particular resources, capabilities, and core competencies that are rare and some that are not. If you assess that one of these elements is valuable but not rare, then place a “no” in the flowchart under “Rare” and stop. This resource, capability, or core competency places the company at a competitive parity. When you assess the resource, capability, or core competency as rare, then place a “yes” in the flowchart under “Rare” and move on to assess whether that resource, capability, or core competency is hard to imitate.

Hard to Imitate (Inimitable)

The third criterion in the VRIO framework is being hard to imitate, or inimitable. When you analyze a firm’s internal environment using a VRIO framework, the third question to consider is whether a resource, capability, or core competency is hard to imitate. You consider this question only for those resources, capabilities, and core competencies that are valuable and rare.

When a firm has resources, capabilities, and core competencies that are valued by the customer and rare, this is obviously much better than the “me too” strategy mentioned earlier. The firm enjoys a temporary competitive advantage because it offers something that its competitors do not currently offer. However, in a dynamic and highly competitive market environment, competitors constantly monitor the success of the firm. Competitors do not want to lose market share, and if they have the opportunity to quickly emulate and imitate the successful offering of the firm, they will do this to catch up and regain lost market share. This means the company only enjoys a temporary competitive advantage as long as competitors have not yet imitated their successful approach. As soon as competitors emulate, duplicate, and imitate their solutions, the firm will lose its competitive advantage. The strategic conclusion is that a firm needs to command resources, capabilities, and core competencies that are rare, valuable, and hard to copy by competitors.

If a firm has no resources, capabilities, and core competencies that are hard to imitate, it will remain competitive only until competitors imitate these elements. When you analyze a firm’s internal environment using a VRIO framework, it is more likely that you may find particular elements that are not hard to imitate and some that are hard to imitate. If you assess that a resource, capability, or core competency is not hard to imitate, then place a “no” in the flowchart under “Inimitable” and stop. Being hard to imitate places the company at a temporary competitive advantage. When you assess the resource, capability, or core competency as hard to imitate, then place a “yes” in the flowchart under “Hard to Imitate” and move on to assess whether that resource, capability, or core competency is organized to capture value.

Organized to Capture Value

The fourth and final criterion in the VRIO framework concerns whether a firm is organized to capture value. You consider this question only for those resources, capabilities, and core competencies that are valuable, rare, and hard to imitate. A resource, capability, or core competency is organized to capture value when the firm has organizational systems, processes, and structures in place to capitalize on the resource, capability, or core competency for a competitive advantage.

A firm that commands resources, capabilities, or core competencies that are valuable, rare, and hard to imitate is in a better strategic position than those that do not have such characteristics. However, the presence of valuable, rare, and hard to imitate factors is not enough for long-term success. Companies that have valuable, rare, and hard to imitate resources, capabilities, or core competencies have yet to fully realize their full competitive advantage. They have an unrealized competitive advantage.

The firm also needs to leverage those and translate them into specific activities and strategic action. It needs to organize its business model in a way that enables the firm to translate the valuable, rare, and hard to imitate resources into a competitive advantage and superior firm performance. The company does this by having organizational systems, processes, and structures in place to capitalize on the resource, capability, or core competency for a competitive advantage.

The strategic conclusion is that a firm needs to make good use of its valuable, rare, and hard to imitate resources, capabilities, or core competencies. It takes leadership effort, strategic insight, and decisive managerial action to leverage the potential of winning in the market into truly superior financial performance. Only when resources, capabilities, and core competencies meet all the VRIO criteria does the firm have a sustainable competitive advantage to build a winning strategy.

Just as it is unlikely that a firm only no resources, capabilities, and core competencies that are valuable, it is also unlikely that one hundred percent of a firm’s characteristics meet all four criteria of valuable, rare, hard to imitate, and organized to capture value. When you analyze a firm’s internal environment using a VRIO framework, it is more likely that you may find a particular resource, capability, or core competency that does not meet all four criteria and some that do. If you assess that a resource, capability, or core competency is not organized to capture value, then place a “no” in the flowchart under “Organized to capture value” and stop. This resource, capability, or core competency gives the company an unrealized competitive advantage. The firm has the potential to move that resource, capability, or core competency into a sustainable competitive advantage if it can organize to capture the value of that resource, capability, or core competency.

When you assess the resource, capability, or core competency to be organized to capture, then place a “yes” in the flowchart under “Organized to capture value.” This places the firm at a sustainable competitive advantage.

Using the VRIO framework helps companies to identify all of their resources, capabilities, and core competencies and the few truly differentiating ones that are the source of sustainable competitive advantage. These few resources, capabilities, and core competencies form the basis of a winning strategy.

A VRIO analysis instrument is offered below to support your analysis.

Now let’s take an example of one of your favorite restaurants. Perhaps it is a place you go to hang out with your friends.

Figure 5.7: VRIO of your favorite restaurant

Imagine that your favorite restaurant has outdoor dining. You and everyone you know loves this. This is valuable. Now let’s consider if outdoor dining is rare. Because you attend university in a small university town in a favorable climate, outdoor dining is not rare. Most restaurant in town offer outdoor dining. Therefore, the competitive implication for outdoor dining is that it affords the restaurant competitive parity with other restaurants in town. This is important information for the restaurant because they need to maintain outdoor dining to remain competitive in this town. Imagine the restaurant is faced with a decision to expand their indoor seating at the expense of no longer offering outdoor dining. This is an unwise choice because that would put them at a competitive disadvantage in relation to their competitors. Now imagine that your favorite restaurant is in a large city with weather seldom favorable to outdoor dining. In that context, your assessment of outdoor dining would be different. When using a VRIO framework, your analysis is always context specific.

Now let’s say the restaurant has a secret sauce that has a bit of local notoriety. It is valuable and rare because no other local restaurant has a similar sauce, even though it is not hard to imitate. Do you like to try to make something at home that you have eaten in a restaurant? If another local restaurant wanted to invest in replicating or even improving upon the secret sauce, they could. The secret sauce is not inimitable, and the competitive implication is that the secret sauce is a temporary competitive advantage.

Imagine your favorite restaurant occasionally has fresh ocean seafood but not on a regular day of the week and without a consistent selection. You and your friends love fresh ocean seafood and often go to your favorite restaurant hoping there will be a fresh ocean seafood offering that day. Often you are disappointed. Your small university town is not near the ocean, and there are currently no food services delivering fresh seafood to the area. Fresh ocean seafood is valuable, rare, and hard to imitate. However, the restaurant has not organized to capture the full value of this resource because of the insufficient supply chain. This is an unrealized completive advantage. Understanding this, your favorite restaurant decides to start internally sourcing fresh ocean seafood. They buy a refrigerated truck and employ someone to drive once a week to the ocean and bring back a reliable menu of fresh ocean seafood. Once they have established the viability and profitability of this approach, the restaurant gradually adds more days. They have now organized to capture the full potential of this menu item and have the potential to change this unrealized competitive advantage to a sustained competitive advantage.

Now let’s say that your favorite restaurant has a strong local reputation. It is not only your and your friends’ favorite restaurant but also a favorite spot for most locals. This is valuable, rare, hard to imitate, and organized to capture value. The restaurant’s strong consistently positive local reputation is a sustained competitive advantage. The restaurant needs to continue to focus on and invest in this to be sure it maintains this market position. Once reputation is tarnished, it is hard to recover it.

When you conduct a VRIO analysis, use the VRIO analysis instrument to structure your analysis, interpretation, and evaluation. The goal is not to find an example of each of the possible competitive implications but to list the firm’s resources, capabilities, and core competencies and then evaluate them.

5.5 Isolating Mechanisms

The VRIO framework shows the importance of protecting a firm’s competitive advantage. Building a firewall or a “moat” around the firm’s “castle” (its competitive advantage), moves the firm’s strategic position from temporary or unrealized to sustainable competitive advantage. Isolating mechanisms are important ways of sustaining a firm’s competitive advantage and making it hard or, for a certain time, even impossible or illegal for competitors to imitate the winning offerings of the firm.

Isolating Mechanisms and Their Significance in Business Strategy

The primary objective of a firm is to achieve a sustainable competitive advantage, where a unique resource, capability, or core competency provides a lasting edge over competitors. The duration of this advantage varies by industry. In rapidly evolving sectors like information technology or fast fashion, maintaining a competitive advantage for even a year can be considered successful. Conversely, in more stable industries, a sustainable competitive advantage may endure much longer. However, no firm can maintain a competitive advantage indefinitely with its current resources, capabilities, and core competencies since competitors are always striving to gain their own competitive advantage.

To prolong a competitive advantage, a firm must prevent competitors from replicating the resource, capability, or core competency that provides this edge. To do this, a firm needs to utilize isolating mechanisms, which are crucial for firms to sustain competitive advantage. Isolating mechanisms, also known as barriers to imitation, explain why firms can maintain a stable stream of economic profits and why intra-industry differences persist over time. They protect individual firms from competition within a particular strategic group or while the firms are uniquely positioned in the industry.

Isolating mechanisms include intellectual property, social complexity, and path dependence, all of which reduce the likelihood of imitation and help firms maintain their competitive advantage longer. Integrating purposeful decisions regarding isolation mechanisms into the development of a firm’s strategy ensures that key decisions concerning resource acquisition, development, and allocation cannot be easily imitated, thereby prolonging and sustaining the firm’s competitive advantage.

Intellectual Property

Intellectual property (IP) is one of the most important and impactful ways of creating isolating mechanisms. It refers to creations of the mind, such as inventions, literary and artistic works, designs, symbols, names, and images used in commerce. It encompasses the legal rights that individuals or organizations have over their intellectual creations, granting them control and protection from unauthorized use by others. Intellectual property refers to the legal rights concerning intellectual activity in the industrial, scientific, literary, and artistic fields. These rights allow creators or owners to benefit financially from their creations, providing a vital incentive for innovation and creative output.

In the context of business strategy, IP plays a crucial role in building competitive advantage. By securing exclusive rights to new technologies, designs, and creative works, companies can protect their market positions and prevent competitors from replicating their products or services, making this advantageous resource, capability, or core competency hard to imitate. Protecting intellectual property is especially important for companies whose business strategy includes a focus on differentiation, formulating and implementing a strategy to distinguish itself in the market by responding to consumer preferences for luxury items. The company competes primarily by offering products or services that are perceived as unique or superior by customers. Protecting intellectual property also is important for companies where innovation plays an important role. These companies invest significant resources into innovative products, services, and other solutions to drive competitive differentiation, and they obtain a significant return on investment through their intellectual property rights.

There are four important types of intellectual property that firms use to sustain and protect competitive advantage: patents, trademarks, copyrights, and trade secrets.

Patents

A U.S. patent gives the inventor the right to exclude others from making, using, offering for sale, or selling an invention or importing it into the U.S. (uspto.gov). A patent grants property rights by a sovereign authority to an inventor. In the U.S., the U.S. Patent and Trademark Office (USPTO) is this responsible authority and has issued more than ten million patents. U.S. patents are effective only within the U.S. and its territories and possessions. They do not protect U.S. firms operating abroad. Globally operating U.S. firms must research the intellectual property rights of other nations and apply for protection to their governing authorities.

The patent provides the inventor exclusive rights to the patented process, design, or invention for a designated period in exchange for a comprehensive disclosure of the invention. Patents protect inventions from direct imitation for a limited period of time. Most patents are valid for twenty years in the U.S. from the date the application was filed with the USPTO.

Patents can be further categorized into utility patents, design patents, and plant patents. Utility patents, or patents for invention, issue legal protection to people who invent a new and useful process, an article of manufacture, a machine, or a composition of matter. Utility patents are the most common type of patent, with more than 90 percent of patents issued by the U.S. government belonging to this category. Design patents are patents issued for original, new, and ornamental designs for manufactured products. Design patents protect the design or look of something. The invention to which the design belongs must be original. Plant patents go to anyone who produces, discovers, and invents a new kind of plant capable of reproduction.

The number of patents successfully filed by a company is a good indicator of its innovation power. For example, German chemical company BASF spent more than $2.3 billion on research and development and filed more than a thousand patents in 2023 (BASF.com).

In the pharmaceutical industry, IP is so important that the strength of a company’s innovation pipeline drives the company evaluation. Intellectual property is a critical asset and strategic resource in business, company valuation, mergers, acquisitions, and partnerships. Companies with strong IP portfolios are often valued higher because their intangible assets can generate sustained revenue streams and superior financial performance. Effective management of IP, including obtaining, defending, and licensing intellectual property rights, is essential for any knowledge-based business aiming to maintain long-term profitability and growth.

Examples of patents include Apple’s iPhone, whose patent referred to it only as “electronic device.” The patent for the signature device of the twenty-first century tells you almost nothing about it. In its entirety, Apple’s patent for the original iPhone, listed simply as an “electronic device,” says only that it is an “ornamental design of an electronic device, as shown and described” (popularmechanic.com).

If we look way back, Thomas Edison is one of the most famous inventors in history, and his work still has a significant mark on the world. The light bulb is one of the most famous inventions. He also worked with the phonograph, motion picture camera, and storage battery. Thomas Edison was awarded 1,093 U.S. patents (2,332 if you include his foreign patents). Edison's record wasn’t surpassed until 2003, 72 years after Edison’s final patent application, by Shunpei Yamazaki who holds over 12,587 patents worldwide as of 2024. Yamazaki is the president and founder of a research and development firm in Tokyo, Semiconductor Energy Laboratory Co., Ltd. As of 2024, Samsung is the company that holds the most patents granted, with over 6,377 in the U.S. For decades, IBM has been a leader in U.S. patents applications, filing over 10,000 U.S. patent applications.

Trademarks

Despite the lack of words, you immediately recognize the two trademarks in figure 5.8. You also have various associations right away when you see them. You may think of late-night food after a night out with friends and a technology company that sells leading-edge gadgets that you want and need. This example shows you the importance of trademarks as a way to differentiate a firm from its competitors.

A trademark is a type of intellectual property consisting of a recognizable sign, design, or expression that identifies a product or service from a particular source and distinguishes it from others. A trademark owner can be an individual, business organization, or any legal entity. Trademarks are important because they help an organization stand out and build an identity in the marketplace. They are not only well known; they also play a crucial role in brand identity and consumer recognition.

Copyright

Copyright is a type of intellectual property that grants the creator of an original work exclusive rights to its use and distribution for a specified amount of time. This legal right allows the creator to control how the work is used, including reproduction, distribution, adaptation, and public performance.

Below are some important examples of copyrights in the U.S.

• Literary works like novels, poems, articles, and other written content
• Musical works like compositions, including any accompanying lyrics
• Dramatic works like plays and scripts
• Pictorial, graphic, and sculptural works like paintings, drawings, sculptures, and photographs
• Motion pictures like movies, TV shows, and videos
• Sound recordings like music, spoken word, and other sounds
• Architectural works like designs of buildings and structures

These examples illustrate the broad scope of copyright protection, which is essential for safeguarding the rights of creators and promoting creativity and innovation.

Trade Secrets

A trade secret is a type of intellectual property that consists of confidential business information which provides a company with a competitive edge. This information can include formulas, practices, processes, designs, instruments, patterns, or compilations of information that are not generally known or readily ascertainable by others. The owner of a trade secret must take reasonable measures to keep this information secret to maintain its economic value.

Below are some important examples of trade secrets in the U.S.

• Coca-Cola’s Recipe: The formula for Coca-Cola is one of the most famous trade secrets. It has been kept confidential since the drink was invented in 1863.
• Google’s Search Algorithm: Google’s algorithm for ranking web pages is a closely guarded secret that gives the company a significant advantage in the search engine market.
• KFC’s Secret Blend of Herbs and Spices: The recipe for KFC’s chicken, which includes a blend of eleven herbs and spices, is another well-known trade secret.
• McDonald’s Big Mac Special Sauce: The recipe for the special sauce used in McDonald’s Big Mac is also a trade secret.

Trade secrets are crucial for businesses, as they protect valuable information that can give them a competitive advantage in the market. By keeping this information confidential, companies can maintain their unique position and continue to innovate.

Social Complexity

Social complexity is another isolating mechanism. The web of relationships within a firm, as well as connections, relationships, and partnerships of the organization with key external stakeholders like customers and suppliers, can be tough for competitors to replicate. For instance, the vital relationships that firm members establish with strategic suppliers or the long-standing relationships of the firm’s account managers with procurement managers can create a unique condition that rivals cannot duplicate. Building trust, mutual understanding, and alignment makes it easier to do business. This social capital serves as an enabler of productive relationships that lowers transaction costs between the firm and other stakeholders. This social complexity acts as a barrier to imitation and can extend a firm’s competitive edge. Such complexity can arise from networks and partnerships both on an organizational level and on the level of individual relationships between key members of the firm and its stakeholders.

Path Dependence

Path dependence is also an isolating mechanism. The journey a firm undertakes to achieve a competitive advantage can also act as a barrier to imitation. Past decisions that have shaped a firm’s current position can be challenging for other firms to replicate. The accumulated learning and experience gained along this historical path are not easily duplicated. This concept, known as path dependence, serves as an isolating mechanism, preventing competitors from attaining the same market position. For instance, Warby Parker’s early decision to build relationships with various suppliers and adopt a “buy one, give one” strategy, where a pair of glasses is donated for every pair sold, created a loyal base of suppliers and customers in the online eyewear industry. Replicating this strategy would likely be prohibitively expensive for competitors.

5.6 Analyze the Value Chain

A value chain represents the full life cycle of a product or service, usually in the form of a series of consecutive steps detailing the creation of a finished product, from its initial design to its arrival at a customer’s door. The chain identifies where value is added at each step in the process. The term was introduced by Harvard Business School professor Michael Porter in his 1985 book Competitive Advantage: Creating and Sustaining Superior Performance. A value chain framework is a model that describes the series of activities a business undertakes to create and deliver a product or service to a customer.

Value chain analysis (VCA) is another important tool of internal analysis. It provides a systematic overview of all major business functions of the company. When you analyze the value chain, divide business functions into primary activities and support activities.

Primary activities include the business activities that are immediately necessary and basic for any business to operate. This includes inbound logistics of raw materials being purchased and warehoused until they are used in the manufacturing process during business operations. After producing their respective products, they are shipped to the customer using outbound logistics supported by marketing and sales and by customer service as customer-facing key activities.

In contrast to primary activities, business support activities are not immediately customer-facing or related to the core business operations. Support activities include the management of the company, financing, and legal activities as part of the firm’s infrastructure. Business support activities also involves human resource management, innovation management, and technology development, which includes research and development. Finally, procurement is an important support activity.

All primary and support activities need to be well aligned for a company to be successful in the market and to generate positive margins and profits.

Figure 5.9 depicts an overview of a company’s primary and support activities.

There are three main steps to conducting a value chain analysis.

• Identify primary and support activities that add value to the firm’s final product or service.
• Analyze all primary and support activities with the objective of reducing costs or increasing value through appropriate and strategy-supporting activities.
• Recognize the most valuable activities. Today, competitive advantage is often derived from technological improvements or innovation.

A pragmatic approach for using value chain analysis for strategy formulation is “cost out, value in,” which indicates a focus on bringing costs down while building the value it delivers to customers. Executives use value chain analysis to implement best practices throughout the firm, particularly for high value activities that drive strategic success and competitive differentiation. Products, components, processes, and activities can be redesigned to facilitate speedier and more economical manufacturing or assembly. High-cost activities can be reallocated and outsourced to external value chains to be performed more cheaply and efficiently by vendors and contractors. Resources can also be reallocated to address activities tied to the most important purchase criteria for the firm’s customers. Finally, productivity-enhancing and cost saving technological improvements can be adopted in support of margins and productivity.

It is important and critical to identify firm-specific strengths and weaknesses through the process. Primary and support activities that affirm key strengths need to be exploited and leveraged, enhancing their ability to effectively drive competitive differentiation as a key element of strategy.

On the other hand, primary and support activities that have been identified as key weaknesses need to be addressed as well. Weaknesses that are success-critical and that impact competitive positioning and customer expectations need to be corrected by internal development or the external acquisition of needed resources, capabilities, and core competencies. Weaknesses in business functions that are not success-critical do not necessarily need to be addressed internally, as they possibly present an opportunity to outsource the weak elements to third party suppliers that are better suited for them because they are specialized in those areas.

A good example of such an outsourcing process is that many companies outsource their payroll activities to a third-party supplier. Unless you are a payroll services provider, payroll is neither a core competency of companies nor a factor that is important for winning in the market. Hence, there are opportunities to save money by outsourcing non-key activities to third-party suppliers. This process is covered by a long-standing strategic trend of companies focusing on their core competencies. Not every company can be the best in performing all primary and support functions of the value chain. As a consequence, companies focus on the business functions that are critical for winning in the market and that are mainly customer-facing, while outsourcing and reallocating resources away from non-key activities in its value chain.

Use the value chain analysis instrument when you analyze a firm’s value chain.

Analyzing a firm’s internal environment using the VRIO analysis instrument and the value chain analysis instrument gives you a full assessment of a firm’s strengths and weaknesses. The value chain analysis reveals the ways a firm is organized to capture value—one of the criteria in the VRIO analysis. Strengths that have been identified in the value chain analysis become possible candidates for a sustainable competitive advantage. The VRIO analysis answers whether strengths identified in the value chain analysis meet all criteria to constitute a sustainable competitive advantage.

5.7 Conclusion 

Resources, capabilities, and core competencies are the backbone of strategy development in terms of how a firm can win in its chosen markets. If these elements are unique, customer-perceivable, and relevant for customers’ buying decisions, the company will win. If a company has resources, capabilities, and core competencies that provide a sustainable competitive advantage, the company has a strategic right to win and should build its strategy around these few unique characteristics. The resource-based view and the VRIO analysis help companies to identify these few success-critical and truly differentiating strategy drivers.

Isolating mechanisms are powerful elements of resources, capabilities, and core competencies that often meet all VRIO criteria. Value chain analysis provides a systematic analysis of all primary and support business functions that help the company to identify strengths that can be leveraged and weaknesses that need to be addressed in the development of a new strategy. A focus on core competencies helps companies to position themselves for success with a guideline of “costs out, values in.”

Figure Descriptions

Figure 5.5: Table illustrating the VRIO framework. Columns are labeled “V,” “R,” “I,” and “O.” and shown in blue. Rows are labeled “Competitive disadvantage,” “Competitive party,” “Temporary competitive advantage,” “Unrealized competitive advantage,” and “Sustainable competitive advantage.” Each cell in the table contains either a checkmark or an “X,” indicating whether the characteristic is met. Competitive disadvantage: not valuable. Competitive party: valuable but not rare. Temporary competitive advantage: valuable and rare but not inimitable. Unrealized competitive advantage: valuable, rare, and inimitable, but not organized. Sustainable competitive advantage: valuable, rare, inimitable, and organized.

Figure 5.6: Blue flowchart to determine type of competitive advantage based on characteristics of the resource or capability. If the resource or capability is valuable, rare, and costly to imitate and the firm is organized to capture value, then it’s sustained competitive advantage. If the resource is not valuable, it’s competitive advantage. if the resource is valuable but not rare, it’s competitive parity. If the resource is valuable and rare but not costly to imitate, it’s temporary competitive advantage. If the resource is valuable, rare, and costly to imitate but the firm is not organized to capture value, it’s unrealized competitive advantage.

Figure 5.9: Support activities: Firm Infrastructure (management, finance, legal, planning), Human Resource Management (professional development, employee relations, performance appraisals, recruiting, competitive wages, training programs), Technology Development (integrated supply chain system, real-time sales information), Procurement (real-time inventory, communication with suppliers, purchase supplies and materials). Primary activities: Inbound logistics (real-time inbound inventory data, location of distribution facilities, trucks, material handling, warehouse), Operations (standardized model, access to real-time sales and inventory system), Outbound Logistics (order processing, full delivery trucks), Marketing and Sales (pricing, communication, promotion, products based in community needs, low prices), Service (delivery, installation, repair, greeters, customer service focus). Support activities are stacked on top of Primary activities. Both sections have a Margin on the right in the shape of an arrow. This graphic is blue.

Figure References

Figure 5.1: BASF. Afrank99. 2006. Public domain. https://en.m.wikipedia.org/wiki/File:BASF-Logo_bw.svg

Figure 5.2: P&G. KarimKoueider. 2019. Public domain. https://en.wikipedia.org/wiki/File:Procter_%26_Gamble_logo.svg

Figure 5.3: Unilever. Sean Biehle. 2006. CC BY-SA 2.0. https://flic.kr/p/agZWP

Figure 5.4: Coca-Cola. Sean. 2008. CC BY-ND 2.0. https://flic.kr/p/4PR8Xw

Figure 5.5: The VRIO framework. Kindred Grey. 2025. CC BY.

Figure 5.6: VRIO framework flowchart. Kindred Grey. 2025. CC BY.

Figure 5.8: Easily recognizable trademarks. Left: McDonald’s. 2006. Public domain. https://commons.wikimedia.org/wiki/File:McDonald%27s_Golden_Arches.svg. Right: Rob Janoff. 1978. Public domain. https://en.m.wikipedia.org/wiki/File:Apple_logo_black.svg

Figure 5.9: Primary and support activities. Kindred Grey. 2025. CC BY.