What are the factors affecting the intensity of rivalry in the industry in which your company is competing? Would you characterize the rivalry and jocke

71Chapter 4 Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 71

Copyright © 2025 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

Strategy: Core Concepts and Analytical Approaches

An e-book marketed by McGraw Hill LLC

Arthur A. Thompson, The University of Alabama 8th Edition, 2025–2026

71

Chapter 4 Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully

Before executives can chart a new strategy, they must reach common understanding of the company’s current position. —W. Chan Kim and Renée Mauborgne

Organizations succeed in a competitive marketplace over the long run because they can do certain things their customers value better than can their competitors. —Robert Hayes, Gary Pisano, and David Upton

A new strategy nearly always involves acquiring new resources and capabilities. —Laurence Capron and Will Mitchell

Chapter 3 described how to use the tools of industry and competitive analysis to assess a company’s external environment and lay the groundwork for matching a company’s strategy to its external situation. This chapter discusses techniques for evaluating a company’s internal situation, with emphasis on its

collection of resources and capabilities, the competitiveness of its prices and internal operating costs, and its competitive strength versus rivals. The analytical spotlight is trained on six questions:

1. How well is the company’s present strategy working?

2. What are the company’s important resources and capabilities, and do they have enough competitive power to produce a competitive advantage over rival companies?

3. What are the company’s competitively important strengths and weaknesses and how well-suited are they to capturing its best market opportunities and defending against the external threats to its future well-being?

4. Are the company’s prices and costs competitive with those of key rivals, and does it have an appealing customer value proposition?

5. Is the company competitively stronger or weaker than key rivals?

6. What strategic issues and problems does top management need to address in crafting a strategy to fit the situation?

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 72

Copyright © 2025 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

In probing for answers to these questions, five analytical tools—resource and capability analysis, SWOT analysis, value chain analysis, benchmarking, and competitive strength assessment—are used. All five are valuable techniques for revealing a company’s ability to compete successfully and for helping company managers match their strategy to the company’s particular circumstances.

Question 1: How Well Is the Company’s Present Strategy Working? In evaluating how well a company’s present strategy is working, one must start with a clear view of what the strategy is. Figure 4.1 shows the key components of a single-business company’s strategy. The first thing to examine is the company’s competitive approach. What moves has the company made recently to attract customers and improve its market position—for instance, has it cut prices, improved the design of its product, added new features, stepped up advertising, entered a new foreign or domestic geographic market, or merged with a competitor? Is it striving for a competitive advantage based on low costs or an appealingly different or better product offering? Is it concentrating on serving a broad spectrum of customers or a narrow market niche? The company’s functional strategies in R&D, production, marketing, finance, human resources, information technology, and so on further characterize company strategy, as do any efforts to establish competitively valuable alliances or partnerships with other enterprises.

Figure 4.1 Identifying the Components of a Single-Business Company’s Strategy

Actions to respond to important changes in the macro-environment or in industry and competitive conditions

Planned, proactive moves to attract customers and out-compete rivals via more appealing product attributes, better product quality, wider selection, lower prices, superior service, and so on

Initiatives to build competitive advantage based on: • Lower costs and prices

relative to rivals? • A different or better

product offering? • Superior ability to serve

a market niche or specific group of buyers?

Efforts to expand or narrow geographic coverage

Efforts to build competitively valuable partnerships and strategic alliances with other enterprises

R&D, technology, product design strategy

Supply chain management strategy

Production strategy

Sales, marketing, and distribution strategies

Information technology strategy Human

resources strategy

Finance strategy

BUSINESS STRATEGY

The actions and approaches crafted

to compete successfully in a particular

business

The three best indicators of how well a company’s strategy is working are (1) whether the company is achieving its stated financial and strategic objectives, (2) whether the company is an above-average industry performer, and (3) whether the company is gaining customers and gaining market share. Persistent shortfalls in meeting company performance targets and mediocre performance in the marketplace relative to rivals are reliable warning

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 73

Copyright © 2025 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

signs that the company has a weak strategy, suffers from poor strategy execution, or both. Specific indicators of how well a company’s strategy is working include:

l Whether the firm’s sales are growing faster, slower, or at about the same pace as the market as a whole, thus resulting in a rising, eroding, or stable market share.

l How well the company stacks up against rivals on product innovation, product quality, price, customer service, and other relevant factors on which buyers base their choice of brands.

l Whether the firm’s brand image and reputation are growing stronger or weaker.

l Whether the firm’s profit margins are increasing or decreasing.

l Trends in the firm’s net profits, return on investment, and stock price and how these compare to the same trends for other companies in the industry.

l Whether the company’s overall financial strength, credit rating, key financial and operating ratios, and cash flows from operations are improving, remaining steady, or deteriorating.

l Evidence of internal operating improvements (fewer product defects, faster delivery times, increases in employee productivity, a growing stream of successful product innovations, and ongoing cost savings).

The bigger the improvements in a company’s market standing and competitive strength and the stronger its financial and operating performance, the more likely it has a well-conceived, well-executed strategy. Run-of- the-mill market results, mediocre financial performance, and sparse operating improvements are red flags that raise questions about a company’s strategy and whether radical changes in strategy or internal operations are needed.

Table 4.1 provides a compilation of the financial ratios most commonly used to evaluate a company’s financial performance and balance sheet strength.

Table 4.1 Key Financial Ratios: How to Calculate Them and What They Mean

Ratio How Calculated What It Shows

Profitability Ratios 1. Gross profit margin Sales revenues—Cost of goods sold

Sales revenues Shows the percentage of revenues available to cover operating expenses and yield a profit. Higher is better and the trend should be upward.

2. Operating profit margin (or return on sales)

Sales revenues—Operating expenses Sales revenues

or Operating income

Sales revenues

Shows the profitability of current operations without regard to interest charges and income taxes. Earnings before interest and taxes is commonly referred to as EBIT. Higher is better and the trend should be upward.

3. Net profit margin (or net return on sales)

Profits after taxes Sales revenues

Shows after-tax profits per dollar of sales. Higher is better and the trend should be upward.

4. Total return on assets Profits after taxes + Interest Total assets

A measure of the return on total monetary investment in the enterprise. Interest is added to after-tax profits to form the numerator since total assets are financed by creditors as well as by stockholders. Higher is better and the trend should be upward.

5. Net return on total assets (ROA)

Profits after taxes Total assets

A measure of the return earned by stockholders on the firm’s total assets. Higher is better and the trend should be upward.

Sluggish financial performance and second-rate market accomplishments almost always signal weak strategy, weak execution, or both.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 74

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Ratio How Calculated What It Shows 6. Return on stockholders’

equity (ROE) Profits after taxes

Total stockholders’ equity Shows the return stockholders are earning on their capital investment in the enterprise. A return in the 12–15% range is “average,” and the trend should be upward.

7. Return on invested capital (ROIC)— sometimes referred to as return on capital employed (ROCE)

Profits after taxes Long-term debt +

Total stockholders’ equity

A measure of the return shareholders are earning on the long-term monetary capital invested in the enterprise. A higher return reflects greater bottom-line effectiveness in the use of long-term capital, and the trend should be upward.

8. Earnings per share (EPS)

Profits after taxes Number of shares of

common stock outstanding

Shows the earnings for each share of common stock outstanding. The trend should be upward, and the bigger the annual percentage gains, the better.

Liquidity Ratios 1. Current ratio Current assets

Current liabilities Shows a firm’s ability to pay current liabilities using assets that can be converted to cash in the near term. Ratio should definitely be higher than 1.0; ratios of 2 or higher are better still.

2. Working capital Current assets – Current liabilities Bigger amounts are better because the company has more internal funds available to (1) pay its current liabilities on a timely basis and (2) finance inventory expansion, additional accounts receivable, and a larger base of operations without resorting to borrowing or raising more equity capital.

Leverage Ratios 1. Total debt-to-assets

ratio Total liabilities Total assets

Measures the extent to which borrowed funds (both short-term loans and long-term debt) have been used to finance the firm’s operations. A low fraction or ratio is better—a high fraction indicates overuse of debt and greater risk of bankruptcy.

2. Long-term debt-to- capital ratio

Long-term debt Long-term debt +

Total stockholders’ equity

An important measure of creditworthiness and balance sheet strength. It indicates the percentage of capital investment in the enterprise that has been financed by both long-term lenders and stockholders. A ratio below 0.25 is usually preferable since monies invested by stockholders account for 75% or more of the company’s total capital. The lower the ratio, the greater the capacity to borrow additional funds. Debt-to-capital ratios above 0.50 and certainly above 0.75 indicate a heavy and perhaps excessive reliance on long-term borrowing, lower creditworthiness, and weak balance sheet strength.

3. Debt-to-equity ratio Total liabilities Total stockholders’ equity

Shows the balance between debt (funds borrowed both short term and long term) and the amount that stockholders have invested in the enterprise. The further the ratio is below 1.0, the greater the firm’s ability to borrow additional funds. Ratios above 1.0 and definitely above 2.0 put creditors at greater risk, signal weaker balance sheet strength, and often result in lower credit ratings.

4. Long-term debt-to- equity ratio

Long-term debt Total stockholders’ equity

Shows the balance between long-term debt and stockholders’ equity in the firm’s long-term capital structure. Low ratios indicate greater capacity to borrow additional funds if needed.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 75

Copyright © 2025 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

Ratio How Calculated What It Shows

5. Times-interest-earned (or coverage) ratio

Operating income Interest expenses

Measures the ability to pay annual interest charges. Lenders usually insist on a minimum ratio of 2.0, but ratios progressively above 3.0 signal progressively better creditworthiness.

Activity Ratios

1. Days of inventory Inventory Cost of goods sold ÷ 365

Measures inventory management efficiency. Fewer days of inventory are usually better.

2. Inventory turnover Cost of goods sold Inventory

Measures the number of inventory turns per year. Higher is better.

3. Average collection period

Accounts receivable Total sales ÷ 365

or Accounts receivable Average daily sales

Indicates the average length of time the firm must wait after making a sale to receive cash payment. A shorter collection time is better.

Other Important Measures of Financial Performance

1. Dividend yield on common stock

Annual dividends per share Current market price per share

A measure of the return that shareholders receive in the form of dividends. A “typical” dividend yield is 2–3%. The dividend yield for fast-growth companies is often below 1% (maybe even 0); the dividend yield for slow-growth companies can run 4–5%.

2. Price-earnings ratio Current market price per share Earnings per share

P-E ratios above 20 indicate strong investor confidence in a firm’s outlook and earnings growth; firms whose future earnings are at risk or likely to grow slowly typically have ratios below 12.

3. Dividend payout ratio Annual dividends per share Earnings per share

Indicates the percentage of after-tax profits paid out as dividends.

4. Internal cash flow After-tax profits + Depreciation A quick and rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, and taxes. Such amounts can be used for dividend payments or funding capital expenditures.

5. Free cash flow After-tax profits + Depreciation – Capital expenditures – Dividends

A quick and rough estimate of the cash a company’s business is generating after payment of operating expenses, interest, taxes, dividends, and desirable reinvestments in the business. The larger a company’s free cash flow, the greater its ability to internally fund new strategic initiatives, repay debt, make new acquisitions, repurchase shares of stock, or increase dividend payments.

Question 2: What Are the Company’s Important Resources and Capabilities and Do They Have Enough Competitive Power to Produce a Competitive Advantage Over Rivals?

An essential element of deciding whether a company’s internal situation is fundamentally healthy or unhealthy entails examining the attractiveness of its resources and capabilities. A company’s resources and capabilities are competitive assets and determine whether its competitive power in the marketplace will be impressively strong or disappointingly weak. Companies with second-rate competitive assets are nearly always relegated to a trailing position in the industry.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 76

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Resource and capability analysis provides managers with a powerful tool for sizing up the company’s competitive assets and determining whether they can provide the foundation necessary for competitive success in the marketplace. This is a two-step process. The first step is to identify the company’s competitively important resources and capabilities. The second step is to examine them more closely to ascertain which are the most competitively important and whether they can support a sustainable competitive advantage over rival firms. This second step involves applying four tests of the competitive power of a resource or capability.

Identifying a Company’s Competitively Important Resources and Capabilities A company’s competitively important resources and capabilities are fundamental building blocks in crafting a competitive strategy.1 Broadly speaking, any asset or productive input that a firm owns or controls qualifies as a resource. Most firms have many kinds and types of resources, and these tend to vary widely in quality and competitive value. For example, a company’s brand name is a resource, whose value varies widely. Some brands like Coca-Cola, Nike, and Google are quite valuable because they are well-known globally while others are virtually unknown and have little competitive value (Turtle Beach, Kumho, Asus). Our interest here is not in cataloging every resource a company has but rather in identifying those resources that have competitive value and can enhance its competitiveness.

Identifying Valuable Company Resources. Valuable or competitively relevant resources can relate to any of the following:

l Physical resources: valuable land and real estate, state-of-the-art manufacturing plants, equipment, distribution facilities, and/or well-equipped R&D facilities, the locations of retail stores, plants, and distribution centers (including the overall pattern of their physical locations), and ownership of or access rights to valuable natural-resource deposits.

l Human assets and intellectual capital: an educated, well-trained, talented and experienced workforce, the cumulative learning and know-how of key personnel and work groups regarding important business functions and/or technologies; proven managerial and leadership skills, proven skills in operating key parts of the business efficiently and effectively.2

l Organizational and technological resources: proprietary technology and production capabilities, patents, proven R&D capabilities, strong e-commerce capabilities, proven quality control systems, state-of-the-art information and data management systems (systems for monitoring various operating activities in real-time, just-in-time inventory management systems, and business analytics capabilities), and proven software development capabilities.

l Financial resources: cash and marketable securities, a strong balance sheet and credit rating (thus giving the company added borrowing capacity and access to additional financial capital).

l Intangible assets: brand names, trademarks, copyrights, company image, reputational assets (for technological leadership or excellent product quality or customer service or honesty and fair dealing), buyer loyalty and goodwill, a strong work ethic and motivational drive that is embedded in the company’s workforce, a tradition of close teamwork and coordination across the company’s organizational units, the creativity and innovativeness of certain personnel and work groups, the trust and effective working relationships established with various external partners, and cultural norms and behaviors that promote responding quickly to changing circumstances, fast organizational learning, and continuously striving to achieve operating excellence in the performance of internal activities.

l Relationships: alliances, joint ventures or partnerships that provide access to valuable technologies, specialized know-how, or attractive geographic markets; fruitful partnerships with suppliers that reduce costs and/or enhance product quality and performance; a strong network of distributors and/or retail dealers.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 77

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Identifying Valuable Company Capabilities. A capability concerns the proficiency with which a company can perform an activity. A company’s skill or proficiency in performing different facets of its operations can range from one of minimal capability (perhaps having just struggled to perform an activity for the first time) to the other extreme of being able to perform the activity with a level of competence that exceeds any other company in the industry. In general, the competitive value of a capability depends on two factors: the competence a company has achieved in performing the activity and the role of the activity in the company’s strategy, as explained below:

1. A company’s proficiency rises from that of mere ability to perform an activity to the level of a competence when it learns to perform the activity consistently well and at acceptable cost. Usually, competence in performing an activity originates with deliberate efforts to simply develop the ability to do it, however imperfectly or inefficiently. Then, as experience builds and the company gains proficiency to perform the activity consistently well and at an acceptable cost, its ability evolves into a true competence and capability. Whether a competence has competitive value depends on whether it relates directly to a company’s strategy or competitive success or whether it concerns an activity that has minimal competitive bearing (like administering employee benefit programs or accuracy in preparing financial statements).

Some competitively valuable competencies relate to fairly specific skills and expertise (like just-in-time inventory control, low-cost manufacturing efficiency, picking locations for new stores, or designing an unusually appealing and user-friendly website for online sales). They spring from proficiency in a single discipline or function and may be performed in a single department or organizational unit. Other competencies, however, are inherently multidisciplinary and cross-functional. They are the result of effective collaboration among people with different expertise working in different organizational units. A competence in continuous product innovation, for example, comes from teaming the efforts of people and groups with expertise in market research, new product R&D, design and engineering, cost- effective manufacturing, and market testing.3 Virtually all organizational competences are knowledge based, residing in the intellectual capital of company employees and not in assets on its balance sheet.

2. A core competence is a proficiently performed internal activity that is central to a company’s strategy and competitiveness.4 A core competence is a more competitively valuable capability than a competence because of the well-performed activity’s key role in the company’s strategy and the contribution it makes to the company’s market success, competitiveness, and profitability. A core competence can relate to any of several aspects of a company’s business: expertise in integrating multiple technologies to create families of new products, skills in manufacturing a high-quality product at a low cost, or the capability to fill customer orders accurately and swiftly. Most core competencies are grounded in cross-department combinations of knowledge and expertise rather than being the product of a single department or work group. Amazon.com has a core competence in online retailing and website operations. Kellogg’s has a core competence in developing, producing, and marketing breakfast cereals. Microsoft has a core competence in developing operating systems for computers and user software like Microsoft Office®, plus it has recently developed a core competence in creating new artificial intelligence software and solutions. L’Oréal, the world’s largest beauty products company with 18 dermatologic and cosmetic research centers, a large accumulation of scientific knowledge concerning skin and hair care, patents and secret formulas for hair and skin care products, and robotic techniques for testing the safety of

CORE CONCEPT A company has a competence in performing an activity when, over time, it gains the experience and know-how to perform the activity consistently well and at acceptable cost.

CORE CONCEPT A core competence is an activity that a company performs quite well and that is also central to its strategy and competitiveness. A core competence is a more important capability than a competence because it adds power to a company’s strategy and has a bigger positive impact on its competitive success.

Chapter 4 • Evaluating a Company’s Resources, Capability, and Ability to Compete Successfully 78

Copyright © 2025 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission.

hair and skin care products, has developed a strong and competitively successful core competence in developing hair care products, skin care products, cosmetics, and fragrances.

3. A distinctive competence is a competitively valuable activity that a company performs better than its rivals.5 A distinctive competence thus signifies greater proficiency than a core competence. Because a distinctive competence represents a level of proficiency that rivals do not have, it qualifies as a competitively superior capability with competitive advantage potential. It is always easier for a company to build competitive advantage when it has a distinctive competence in performing an activity important to market success, when rival companies do not have offsetting competencies, and when it is costly and time-consuming for rivals to imitate the competence. Companies that have a distinctive competence include Google, which has a distinctive competence in search engine technology, and Walt Disney Co., which has a distinctive competence in creating and operating theme parks.

In determining whether a company has a competitively attractive collection of resources and capabilities, it is important to identify which of its skills and proficiencies qualify as a competence, which represent a core competence, and whether it may enjoy a distinctive competence in one or more activities it performs.6 Both core competencies and distinctive competencies are valuable because they enhance a company’s competitiveness. But mere ability to perform an activity well does not necessarily give a company competitive clout. Some competencies merely enable market survival because most rivals also have them—indeed, not having a competence or competitive capability that rivals have can result in competitive disadvantage. An apparel manufacturer cannot survive without the capability to produce its apparel items cost efficiently, given the intensely price-competitive nature of the apparel industry. A cell-phone maker cannot survive without the capability to introduce next-generation cell phones with appealing new features and functions that attract a profitable

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