Chapter 4

Internal Environment Analysis

Syllabus

-Resource to competitive advantage pyramid

-Internal analysis approach/methods/techniques;
i. Value chain analysis
ii. Functional approach
iii. Resource based view
-Benchmarking

Internal Environment
Internal Environment of Business is that part of Business which consists of the resources and practice of
that particular organization. It is also called the firm’s resource environment. It is that environment
which is too quite extent controllable and manageable in the long run. In this environment, a systematic
analysis of firm’s STRENGTHS & WEAKNESSESS is required.
An efficient internal environment highly contributes to increasing competitive advantage of the
business.

Some of the components of Internal Environment are;

-Organizational goals, objectives & Policies
-Organizational resources (4M+I)
-Organizational Culture(norms, values, ethics, rules & regulations)
-Organizational Structure (Hierarchy, division of work, departmentalization, authority, responsibility,
Management philosophy, centralization &decentralization practice etc)
-Management functions etc.

Internal Environment Analysis

For a strong Strategic Management process, internal environment analysis is a must. It refers to the
proper analysis and evaluation of the internal resource and capabilities of an organization.
An internal env. Analysis is an exploration of your own organizational competency.
The data generated by the internal environmental analysis is important because you can use it develop
strategic planning to grow your business.

Internal analysis answers the following questions;

-Is our strategy good enough and working accurately?

-What is the current situation?
-What are our strengths and weaknesses?
-Do we have adequate resources?
Internal analysis is the process that determines the strategic capability level of an organization.

Process of Internal Environment Analysis

-Clear Vision Misison goals objectives policies and strategies
-Strengths & Weaknesses analysis
-Identification of unique resources
-Identification of Core competency
-Locating strategic advantage

Internal Analysis methods/Approaches/techniques

The following are the methods of doing internal analysis;

A. Value chain analysis

B. Functional Approach
C. Resource Based View (RBV)

A.Value chain analysis

This was developed by Michael Porter in 1985, also known as Porter’s Value chain Analysis.

Here, a business is seen as a chain of activities that transforms inputs into outputs delivering value to
customers. Ultimately it is the value that customers desire in a product or service.

Therefore, this value chain analysis method tries to find out how a business creates or can create
customer value which is the contribution of all the interrelated/interdependent business activities.
And while doing so, this value chain analysis method understands the operational efficiencies and
inefficiencies of the business.

Value chain analysis (VCA) is a process where a firm identifies its primary and support activities that
add value to its final product and then analyze these activities to reduce costs or increase differentiation.

Value chain represents the internal activities a firm engages in when transforming inputs into outputs.
i.e. from a raw material to the final product in the hands of the customers.

The strength of this analysis is its approach. It focuses on the systems and business activities with
customers as the central principle rather than on departments and accounting expense categories.

It links systems and activities to each other and demonstrates what effect this has on costs and profit
margins. Consequently, the Value Chain Analysis makes clear where the sources of value and the losses
can be found in the organization.
Value chain analysis is a strategy tool used to analyze internal firm activities. Its goal is to recognize,
which activities are the most valuable (i.e. are the source of cost or differentiation advantage) to the
firm and which ones could be improved to provide competitive advantage. In other words, by looking
into internal activities, the analysis reveals where a firm’s competitive advantages or disadvantages are.

The firm that competes through differentiation advantage will try to perform its activities better than
competitors would do. If it competes through cost advantage, it will try to perform internal activities at
lower costs than competitors would do. When a company is capable of producing goods at lower costs
than the market price or to provide superior products, it earns profits.

M. Porter introduced the generic value chain model in 1985. Value chain represents all the internal
activities a firm engages in to produce goods and services. VC is formed of primary activities that add
value to the final product directly and support activities that add value indirectly.

Activities in value chain analysis

A. Primary Activities
B. Support Activities

Primary activities have an immediate effect (cost advantage) on the production, maintenance, sales and
support of the products or services to be supplied.

These activities consist of the following elements:

Inbound Logistics

These are all processes that are involved in the receiving, storing, and internal distribution of the raw
materials or basic ingredients of a product or service. The relationship with the suppliers is essential to
the creation of value in this matter.

Production

These are all the activities (for example production floor or production line) that convert inputs of
products or services into semi-finished or finished products. Operational systems are the guiding
principle for the creation of value.

Outbound logistics

These are all activities that are related to delivering the products and services to the customer. These
include, for instance, storage, distribution (systems) and transport.

Marketing and Sales

These are all processes related to putting the products and services in the markets including managing
and generating customer relationships. The guiding principles are setting oneself apart from the
competition and creating advantages for the customer.

Service

This includes all activities that maintain the value of the products or service to customers as soon as a
relationship has developed based on the procurement of services and products.

Support activities of the Value Chain Analysis

Support activities within the Porter’s Value Chain Analysis assist the primary activities and they form
the basis of any organization.

In the figure below dotted lines represent linkages between a support activity and a primary activity.

A support activity such as human resource management for example is of importance within the primary
activity production but also supports other activities such as service and outbound logistics.

Firm infrastructure

This concerns the support activities within the organization that enable the organization to maintain its
daily operations. Line management, administrative handling, financial management are examples of
activities that create value for the organization.

Human resource management

This includes the support activities in which the development of the workforce within an organization is
the key element. Examples of activities are recruiting staff, training and coaching of staff and
compensating and retaining staff.

Technology development

These activities relate to the development of the products and services of the organization, both
internally and externally.

Examples are IT, technological innovations and improvements and the development of new products
based on new technologies. These activities create value using innovation and optimization.
Although, primary activities add value directly to the production process, they are not necessarily more
important than support activities. Nowadays, competitive advantage mainly derives from technological
improvements or innovations in business models or processes.
Therefore, such support activities as ‘information systems’, ‘R&D’ or ‘general management’ are usually
the most important source of differentiation advantage. On the other hand, primary activities are
usually the source of cost advantage, where costs can be easily identified for each activity and properly
managed.

B.Functional Approach

Every organization of a given type must perform certain jobs in order do its work. For example, key
functions of a manufacturing company include production, purchasing, marketing, accounting, and
personnel. The functions of a hospital include surgery, psychiatry, nursing, housekeeping, and billing.
Using such functions as the basis for structuring the organization may, in some instances, have the
advantage of efficiency.
Grouping jobs that require the same knowledge, skills, and resources allows them to be done efficiently
and promotes the development of greater expertise.

Functional approach of organizational analysis takes into account various functional areas and evaluates
these for’ identifying strengths and weaknesses. The major functional areas are production/operations,
marketing, finance and accounting, and human resources. Each of these major areas is divided into
subareas, for example, marketing Is divided into sales promotion, physical distribution, sales volume,’
and so on. Similar is the case with other functional areas. Besides these functional areas, organization’s
general management factors are also taken into, consideration. Thus, in functional approach of
organisational analysis, following factors are evaluated to identify strengths and weaknesses:

 Production/operations,
  Marketing,
 Finance,
 Human resources, and
 Research & Development

A.Finance:
The important element in internal analysis of a firm is evaluating its financial health. A thorough analysis
of financial statements can provide much information about an organization and will identify symptoms
of basic problems occurring within an organization. The trends in sales, profits, capital employed etc.
show whether the firm is improving or worsening in its performance.
Financial policies, financial position and capital structure are important internal factors affecting
business performance, strategies and decisions.
The financial analysis typically evaluates:
(a) Profitability – ability to utilize assets to produce profit.
(b) Liquidity – ability to convert assets into cash to meet current financial needs.
(c) Leverage – balance between debt and equity.
(d) Operating efficiency – performance of various operating subunits relative to inputs utilized.

The typical list of strengths in financial efficiency includes:

(a) Favourable attitude of shareholders, debenture-holders and potential investors
(b) Easy access to low cost funds
(c) Cooperation from financial institutions and banks
(d) Efficient management information system, as well as, budgetary control system

B.Marketing &Distribution
Marketing has been defined as human activity directed at satisfying needs and wants through exchange
processes, satisfying the customers’ needs and wants; involves an examination of product mix, price,
promotion and channels of distribution. Product demand and market segments serves as important
sources of profit. The marketing capability depends on industry attractiveness, product competitive
position, and product market profitability to keep it on the growth path.
The marketing capability depends on emergence of new customer segments, changes in customer
habits, preference and buying behaviour, product differentiation, product positioning, product pricing,
packing and distribution, sales promotion and advertising, marketing mix, marketing channels, branding
etc. The changes in the technological, regulatory, social or economic environment of the industry that
either have an impact on the product, market scope of the firm or help it to cut costs and improve
productivity and enhance profitability.
Distribution is another important element of marketing strategies. Distribution begins with the producer
and ends with the ultimate consumer. The channels of distribution are the set of institutions that
perform the activities needed to move the product and its title from production to consumption. A
thorough analysis of distribution system will reveal the weaknesses existing in it. The marketing and
distribution strategies needed to be modified depending on the findings in internal analysis.
A typical list of strengths in the marketing and distribution capability include:
(a) Established brand image
(b) Most feasible marketing channel partners
(c) Favourable attitude of consumers towards product quality
(d) Most efficient distribution logistic system
(e) Wide range of products
(f) Market oriented product pricing
(g) Effective sales promotion and advertising
(h) Effective feed-back of market information

C.Operations
The operation function is performed by that group of persons in a business who are responsible for
producing the goods or providing the services that the business offers to the public. Operations
management has been defined as managing the resources required to produce the products or services
provided by an organization.
The operations management consists of decisions in five areas viz., process, capacity, inventory, human
resource and quality. Production strategies relating to decisions on quality, product design, production
cost, production efficiency, capacity management, productivity of labour and machines, operating
personnel, maintenance etc.

The economies of scale can be achieved through mass production and it will reduce the overall unit cost
of production. The operations management enables the company to focus on low cost as well as
product differentiation.
The strategic management of operations concentrates on the following issues:
(a) The selecting and designing of products or services to meet customer needs;
(b) Designing and updating production facilities so that products or services are produced efficiently; and
(c) Controlling of the scheduling of machines and labour so that products or services are available on
schedule and in the quantities and quality required to meet customer needs.

D.Human Resources
The human resources management functions relates to the centralized management of personnel, their
activities, development and control for the whole organization. In modern business environment,
personnel are considered as resources through which strategies are developed and implemented.
Quality of human resource management can contribute much to organizational performance. Human
resource management consists of five important strategic decision areas viz., employment, human
resource development, compensation, human relations and industrial relations.
Human resources activities basically consist of the following three areas:
(a) Job Analysis:
i. Job description
ii. Job specs
iii. Forecasting labour needs
iv. Predicting labour market conditions
(b) Procurement of Human Resources:
i. Recruitment planning
ii. Employee selection and training
iii. Affirmative action
(c) Maintenance of Human Resources:
i. Performance appraisal
ii. Compensation and benefits
iii. Career planning and development
iv. Employee relations
v. Communications and grievances
The human resource management will influence the direct and indirect labour cost of the organization,
which shows impact on overall profitability of the organization. The strategic issues like engagement of
part-time employees, contract workers, job workers, outsourcing, autonomous work teams, cross
functional work teams etc. are also resolved. The skill, interests and aptitudes of employees influence
the strategies selected. The labour turnover and attrition rates need to be constantly monitored.

E.Research &Development
The research activities relates to searching for new products, new manufacturing process, improvement
of existing products, processes or equipment. The development activities involve putting research on
commercial basis. The research and development strategies covers the areas like searching new
product, improve the existing product, finding new production methods, improving existing technologies
etc.
The research costs are incurred for carrying basic research or applied research. But the development
costs start with decision taken to produce new product or improved product and when decision is taken
to adopt new technologies and new production methods. The objective in carrying basic research is to
improve the existing scientific and/or technical knowledge. But the applied research is carried for the
purpose directed towards a specific practical aim or objective.
The R&D strategies should address:
(a) The focus of R&D activities (pure and applied research)
(b) The relationship of R&D activities to other functional areas (e.g. operations and marketing)
(c) The aggressiveness of the firm’s R&D posture
(d) The time horizon for results expected from R&D department.

C. Resource Based View

RBV is an approach to achieving competitive advantage that emerged in 1980s and 1990s.
According to this approach of internal analysis, organizational performance is primarily determined by
internal resources which may be grouped into three categories;

-Physical Resources (raw materials, plant & machineries, location, technology)

-Human Resources (skilled, unskilled, semi-skilled)
-Organizational Resources (organizational structure, functions of management, patents,
trademarks, copyrights, database)

The supporters of this view argue that organizations should look inside the company to find the sources
of competitive advantage instead of looking at competitive environment for it.

As per this view, firm’s resources should be considered first while developing strategies to ensure
sustainable development.
It involves in developing and exploiting a firm’s unique resources and capabilities and also strengthening
and maintaining those resources.
According to this view, the firm’s resources should possess the following characteristics/attributes
(VRIO)

i. Value-Does your resource provide customer value?

ii. Rareness-Does your competitors possess it?
iii. Imitate-Can your competitors imitate it? If yes would it be costly to imitate or not?
iv. Organization-Is your firm organized to capture or exploit the resource
 Value: Do you offer a resource that adds value for customers? Are you able to exploit an opportunity or
neutralize competition with an internal capability?
o No: You are at a competitive disadvantage and need to reassess your resources and capabilities to
uncover value.
o Yes: If value is established, move on in your VRIO analysis to rarity.

 Rarity: Do you control scarce resources or capabilities? Do you own something that’s hard to find yet in
demand?
 o No: You have value but lack rarity, putting your company in a position of competitive parity. Your
resources are valuable but common, which makes competing in the marketplace more challenging
(but not impossible). It’s recommended to go back one step and reassess.
o Yes: With value and rarity identified, your next hurdle is imitability.

 Imitability: Is it expensive to duplicate your organization’s resource or capability? Is it difficult to find an

equivalent substitute to compete with your offerings?
o No: If your resource has value and rarity, but is affordable or easy to copy, you have a temporary
competitive advantage. It will require considerable effort to stay ahead of competitors and
differentiate your services—go back one step and reassess.
o Yes: You offer something that’s valuable, rare, and hard to imitate—now the focus is on your
organization.

 Organization: Does your company have organized management systems, processes, structures, and
culture to capitalize on resources and capabilities?
o No: Without the internal organization and support, it will be difficult to fully realize the potential of
your valuable, rare, and costly-to-imitate resources. Your company will have a unused competitive
advantage and will need to reassess how to attain the needed organization.
o Yes: Your company has achieved the ultimate goal of sustained competitive advantage when it has
successfully identified all four components of the VRIO framework.

Benchmarking
Benchmarking is simply a process to measure the performance and situation of the organization against
the best business practice or the industrial standard or against the toughest competitors.

It is a process of open learning, as it helps to point out the loopholes and shortcomings/weaknesses of
the organization compared to the best practice going on.

Benchmarking can be simply put as an evaluation of something by comparison with a standard.

For example, suppose it takes 30 minutes to produce your product. Is the 30-minute measurement good
or bad? The only way for you to know is to compare against other data, such as the time it takes another
organization to produce a similar product. If another organization can produce the same type of product
in less than 30 minutes, you can use their time as a benchmark for measuring your own processes and
procedures.

Example

An airline company may hire a consultant benchmark the CUSTOMER SATISFACTION index against its
key competitors.
 An e-commerce company may benchmark its delivery efficiency against the best practice in business.

A nation may benchmark the quality of life index of its citizen to other countries in the world.

A hospital may benchmark the success rate of surgery against its competitors.

A television station may benchmark the TRP(television rating point) with the best in the business.

The objective of benchmarking is to use the data gathered in your benchmarking process to identify
areas where improvements can be made by:

 Determining how and where other companies are achieving higher performance levels than your
company has been able to achieve.
 Comparing the competition’s processes and strategies against your own.
 Using the information you gather from your analyses and comparisons to implement changes that will
improve your company’s performance, products, and services.

In conclusion,

Benchmarking is a process where you measure your company’s success against other similar companies
to discover if there is a gap in performance that can be closed by improving your performance. Studying
other companies can highlight what it takes to enhance your company’s efficiency and become a bigger
player in your industry.

Benchmarking reasons/importance

A. Competitive analysis

By identifying areas you wish to improve on in the business and benchmarking your existing
performance against competitors, your business can work toward enhancing your execution in a much
better way . Using benchmarking this way has allowed businesses to gain strategic advantages over
competitors and grow industry averages

B. Monitor performance

Benchmarking involves looking at current trends in data and projecting future trends depending on what
you aim to achieve. In order to know you have been successful, benchmarking needs to be a continuous
process. Monitoring performance is an inherent characteristic of it. Continuous monitoring means
continnuous blockage/restriction of potential weaknesses.

C. Continuous improvement
As well as monitor performance, continuous improvement is an essential attribute of benchmarking.
This is because the aim of benchmarking is to improve a certain element of business. This improvement
should not merely be something that improves once and is forgotten, but something that improves over
time and is continuous.

D. Planning and goal setting

Once benchmarking has been carried out, goals and new performance standards are set in order to
improve performance. These goals are new, more competitive targets for a company but they must be
achievable. If goals are unrealistic to achieve teams become demotivated and goals are destined to
remain unfulfilled.

E. Encourages sense of ownership

When companies look at their processes and standards they need to ask hard questions to get all the
answers they need. This includes talking to everyone in the business and understanding their roles. By
asking these questions and gaining a better understanding of everyone’s role, ownership for processes
and performance is encouraged. This means the workers will take pride iin their jobs and what they do
leading to higher qualities.

F. Understand your company’s advantages

Benchmarking identifies where your company is right now compared to the best industrial practice or
your toughest competitors. Therefore, this comparison may help to understand what advantages are
you gaining that your competitors lack.

Process of Benchmarking

1. Select a subject to benchmark

Executives and other senior management should be involved in deciding which processes are critical to
the company’s success. The processes should then be prioritized based on which metrics/standards are
most important to all stakeholders. After prioritizing, select and define the measures you want to
collect.

2. Decide which organizations or companies you want to benchmark with

Determine if you are going to benchmark processes within your own company, a competitor, or a
company outside of your industry. It may be hard to collect all the data you want if you benchmark a
direct competitor. So you should select several different organizations to study in order to get the data
you need. Gather information from several sources to get the most detailed information about the
organization you select to study.

3. Document your current processes

Map/Identify out your current processes so you can identify areas that need improvement and more
easily compare against the chosen organization.

4. Collect and analyze data

This step is important—but it can prove difficult when you are trying to gather data from a competitor
because a lot of that information may be confidential. Gather information through research, interviews,
casual conversations with contacts from the other companies, and with formal interviews or
questionnaires.

You can also collect secondary information from websites, reports, marketing materials, and news
articles. However, secondary information may not be as reliable.

After you have collected enough data, get all stakeholders together to analyze the data.

5. Measure your performance against the data you’ve collected

Look at the data you’ve collected side by side with the metrics you gathered from your analysis of your
own processes. You may want to layer your performance metrics on top of your process diagrams or
map out your competitor’s processes to more easily see where you’re falling behind.

As you analyze the comparisons, try to identify what causes the gaps in your process. For example, do
you have enough people and are they sufficiently trained to perform assigned tasks? Brainstorm ideas to
effectively and efficiently fill those gaps.

6. Create a plan

Create a plan to implement changes that you have identified as being the best to close performance
gaps. Implementation requires total buy-in from the top down. Your plan must include clearly defined
goals and should be written with the company’s culture in mind to help minimize any pushback you may
get from employees.

7. Implement the changes

Closely monitor the changes and employee performance. If new processes are not running smoothly as
expected, identify areas that need to be tweaked. Make sure all employees understand their jobs, are
well trained, and have the expertise to complete their assigned tasks.

Document all processes and make sure all employees have access to documentation and instructions so
that all are on the same page working toward the same goal.

8. Repeat the process

After successfully implementing a new process, it’s time to find other ways to improve. Review the new
processes you’ve implemented and see if there are any changes that need to be made. If everything is
 running smoothly, look to other areas or more ambitious projects that you may want to benchmark and
start the process again.

Types of Benchmarking

There are two primary types of benchmarking:

o Internal benchmarking: comparison of practices and performance between teams, individuals or groups
within an organization
o External benchmarking: comparison of organizational performance to industry peers or across
industries

These can be further distilled/classified as follows:

Process Benchmarking: Demonstrate how top performing companies accomplish the specific process in
question. Such benchmarking is collected via research, surveys/interviews, and site visits. By identifying
how others perform the same functional task or objective, people gain insight and ideas they may not
otherwise achieve. Such information affirms and supports decision-making by executives.

Strategic Benchmarking: Identify the fundamental lessons and winning strategies that have enabled
high performing companies to be successful in their marketplaces. Strategic benchmarking examines
how companies compete and is ideal for corporations with a long-term perspective.

Functional Benchmarking-(Explained in figure)

Product Benchmarking-(Explained in figure)

Competitor Benchmarking-(Explained in figure)

Some other Benchmarking approaches are

-Historical Benchmarking-It is the internal Benchmarking method where the company compares its
present performance status with its own past performance status.

-Industry Benchmarking-It is the external benchmarking where the company compares its performance
standards with the competitors in the SAME industry.

-Best in class Benchmarking-It is also an external Benchmarking where the comparison is done with
whoever does the best practice wherever it may be found. It doesn’t necessarily need to be in the same
industry.

Resource to Competitive Advantage pyramid

As we know resources are the strong basis for competitive advantage. These resources which are the
source of competitive advantage can be step wise put in a pyramid which is known as Resource to
Competitive Advantage pyramid.
Company Resource

Firm resources include all assets, capabilities, organizational processes, firm attributes, information, and
knowledge. Resources can be characterized as the blood of organization. Without blood nothing can be
organized and executed for the benefit of organization. It can be tangible and intangible. They serve as
input. They provide strength and enable to exploit opportunities.

Competitive Capabilities

A capability means the capacity of resources to perform a task or an activity. The efficiency of
organization is due to resource and capabilities.

Resources are the basis of capabilities. If resources and capabilities are Valuable Rare, difficult to Imitate
and Organized then competitive advantage is guaranteed.

The capabilities which are vital in outperforming your competitors are said to be competitive
capabilities. They are based on various functions. Competitive capabilities are based on how you can use
your unique resource to the best possible way.

Core and distinctive Competencies

Competency is something a company is expert at performing. It is an activity that an organization has

learned to perform well.

A core competency is the sum of competencies that the organization has developed over a period of
time. It is something that the organization can extraordinarily perform well. Core competencies are the
major source of competitive advantage. It can be related to;

-Core competency in high quality production at minimal cost

-Core competency in customer service

-Core competency in Supply chain management etc.

A core competency is a result of inter departmental knowledge and expertise and not a work or output
of a single department.

IF A CORE COMPETENCY IS SUPERIOR TO THAT OF A COMPETITOR IT IS CALLED DISTINCTIVE

COMPETENCY.

Strategic Asset

Strategic assets are, the set of difficult to trade and imitate, scarce, appropriable, and specialized
resources and capabilities that provide the firm's competitive advantage.
Strategic assets are resource and capability which are scarce, uneasily traded, inimitable, durable and
can be used to convert the value become profit.” An entity needs these assets for maintaining its ability
to attain future outcomes. A company’s future wellbeing can be in danger without these assets. These
assets can be divided into larger groups, like physical assets, financial assets, intangible assets,
technological assets, and human assets. So, the market leaders should integrate their capability and
resources into strategic assets to achieve a competitive advantage for maintaining their strong
existence.

They include plant and equipment, location, brands, patents, customer data, a highly qualified staff, and
distinctive partnerships. A particularly valuable strategic asset is a company’s brand. Starbucks, for
example, has worked hard to build the image of its brand, and it would take an enormous effort for
another coffee retailer to achieve this same level of brand recognition.

Competitive Advantage

Competitive advantage can be attained if the current strategy is value-creating. Consequently,

in order for something to be value creating means that the competitive advantage cannot be
imitated by existing competitors. The competitive advantage is the outcome of effective and
efficient strategy, which is not an easy task for organizations because in the era of fast changing
environment competition is very strong. The strategic scope of every organization is to gain the
competitive advantage over competitors. Thus, the source of competitive advantage cannot be
imitated by competitors in the future. Competitive advantage can be gained from adoption of
advance technology, excellent service, low cost production, or selling of unique products.
However, hyper-competition might eliminate this advantage and as a result systematic and
continuous efforts may prove to be ineffective.