3

Resources and capabilities

Introduction and objectives  82 Appraising the relative strength of a firm’s
resources and capabilities  103
Opening Case: Harley‐Davidson, Inc.  83
Developing strategy implications  106
The role of resources and capabilities in Exploiting key strengths  106
strategy formulation  87 Managing key weaknesses  107
Basing strategy on resources and capabilities  87 What about superfluous strengths?  107
Choosing the industry context  108
Identifying the organization’s resources and
Summary  110
capabilities  89
Further reading  112
Identifying resources  89 Self-study questions  112
Identifying organizational capabilities  93
Closing Case: Wal‐Mart Stores, Inc.  114
Appraising resources and capabilities  100 Notes  117
Appraising the strategic importance of resources
and capabilities  100

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82 Introduction and objectives
In this chapter, we shift our focus from the external environment to the internal environment.
F O U N DAT I O N S O F S T R AT E G Y

We look within the firm and concentrate our attention on the resources and capabilities that
firms possess. In doing so, we build the foundations for our analysis of competitive advantage
which began in Chapter 2 with the discussion of key success factors.
By the time you have completed this chapter, you will be able to:

●● appreciate the role a firm’s resources and capabilities play in formulating strategy;
●● identify and appraise the resources and capabilities of a firm;
●● evaluate the potential for a firm’s resources and capabilities to confer sustainable
competitive advantage;
●● use the results of resource and capability analysis to formulate strategies that exploit
internal strengths while defending against internal weaknesses.

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 83

Opening Case

CHAPTER 3
Harley‐Davidson, Inc.
In 2014, Harley‐Davidson, Inc. was not only the world’s oldest motorcycle company but also,
after recovering from the trauma of the financial crisis of 2008/9, the world’s most financially

R e s o u rce s a n d capa b i l i t i e s
successful producer of motorcycles. Since its management buyout in 1981, it had grown its
annual sales of motorcycles from 40 000 to 260 000 and its revenues from $0.5m to $5727m.
Its sales margin and return on equity exceeded that of all its major rivals, and in heavyweight
motorcycles it was the market leader in the US, Canada, Japan and Brazil. How was it possible
that a company that had been on the brink of bankruptcy during the early 1980s could have
outperformed the motorcycle divisions of automotive giants such as Honda and BMW? And,
with its retro‐styling and lack of leading‐edge technology, could Harley‐Davidson sustain its
remarkable performance into the future (Table 3.1)?

Table 3.1  Indicators of Harley‐Davidson performance: 1994–2013.

2013 2012 2011 2010 2009 2008 2007 1994
Total shipments (‘000s)  260  248  233  213  232  316  342   96
of which International (‘000s)   95   87   81   79   78   97   89   22
Revenue ($m) 5900 5581 5311 4859 4781 5594 5727 1159
Operating income ($m) 1154 1000  829  559  197 1029 1426  154
of which Financial services ($m)  283  285  268  181 (117)   83  212    2
Net income ($m)  734  624  599  146  (55)  655  934  104
Operating margin (%)   25   18    4   12   16   18   20   13
Return on equity (%)   24   24   25    7   (3)   31   39    2

A brief history of Harley‐Davidson: 1903–2013

Harley‐Davidson, Inc. was founded in 1903 by William Harley and the Davidson brothers.
In 1909, Harley introduced its throaty, V‐twin engine, which has become the distinctive
feature of Harley motorcycles to this day. With import competition, first from the British
(BSA, Triumph and Norton) and then the Japanese (Honda, Suzuki, Yamaha and Kawasaki),
Harley became sole survivor of the US motorcycle industry and was acquired by AMF, a US
conglomerate.
In 1981, Harley’s senior managers led a leveraged buyout and struggled for several
years to keep the newly independent Harley‐Davidson afloat in the midst of heavy debt and
a declining market. After drastic cost cutting to stabilize Harley’s finances, the management
team embarked on a systematic rebuilding of the company. Production methods and working
practices were revolutionized using lessons from the Japanese auto industry such as just‐
in‐time scheduling and materials management, total quality management and worker–
management cooperation.
Harley paid increasing attention to product development with a particular emphasis
on reintroducing and updating traditional designs, improving paintwork and finish, making
▲

incremental engineering improvements and upgrading quality and reliability. It expanded

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84
its range of models around a standardized set of major components such as engines, frames,

▲
F O U N DAT I O N S O F S T R AT E G Y

suspension systems and fuel tanks. It based its product strategy on the notion that every Harley
rider should have the possibility of owning a unique personalized motorcycle. To that end, it
created a wide range of customization opportunities and each year offered limited‐edition,
customized versions of some of its most popular models.
During this period, the demographic and socio‐economic profile of its customers
continued to shift. In the early years, its customers were primarily blue‐collar youngsters, but
by the 1990s, they were mainly middle‐aged and upper income. To meet the preferences of
these customers, the dealership network was overhauled. Harley dealerships were required
to be exclusive and to offer a retail experience appropriate to the sale of high‐priced leisure
products to sophisticated customers.
Despite premium pricing (in 2014, US retail prices for Harley motorcycles ranged from
$8250 to $32 500), Harley’s share of the super‐heavyweight market (over 850cc) grew from
about 30% in 1986 to over 60% in 1990. The 1990s saw uninterrupted growth in the heavyweight
motorcycle market and a continued increase in Harley’s market share. The company’s biggest
challenge became that of systematically expanding production capacity to meet the surging
demand for its products.
However, when Keith Wandell took over the reins as CEO in May 2009, Harley had
suffered dramatic deterioration in its fortunes. The onset of the financial crisis of 2008/9 had
radically shifted the balance of supply and demand: between 2007 and 2009, motorcycle
shipments plunged from 342 100 to 232 400 and net income from $934m to a loss of $55m.
After decades of customer waiting lists and capacity shortages, Harley‐Davidson found itself
in a very different position. In response Wandell laid off staff, instituted radical cost cutting,
amalgamated plants to cut capacity and disposed of assets that were not central to Harley’s
core business.

Harley‐Davidson in 2014
Some of the key features of Harley’s business in 2014 included:

●● The product portfolio: Compared to other motorcycle producers, Harley served a narrow
market niche. Within the heavyweight segment (> 500cc), it was present only in super‐
heavyweight bikes (> 750cc) and here Harley produced only ‘cruisers’ (macho‐styled,
low‐riding bikes for urban leisure use) and touring bikes (designed for long‐distance
travel). Performance motorcycles, the largest part of the heavyweight segment, Harley
left to Japanese and European manufacturers. Harley’s past efforts to expand into
performance bikes and smaller models had been unsuccessful: in 2009, it closed its Buell
motorcycle business and sold off the Italian motorcycle company, MV Agusta, that it
had acquired a few years earlier. Within its model range, Harley remained committed
to traditional designs and traditional technologies: its large capacity, V‐twin, air‐cooled
engines made limited concessions to modern automotive technology. In addition, its
focus on traditional bikes limited Harley’s ability to grow its market share at the expense
of rivals. Harley already accounted for more than 50% of the US heavyweight motorcycle
market. Indeed, Harley’s own market was vulnerable to competition. While no other
company could replicate the emotional attachment of riders to the ‘Harley Experience’,
younger motorcycle riders sought a different type of experience and became more

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 85
attracted to the highly engineered sports models produced by European and Japanese

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manufacturers.
●● The brand: Harley‐Davidson’s brand and the loyalty it engendered among its customers
were its greatest assets. The famed spread eagle signified not just the brand of one of the
world’s oldest motorcycle companies but also an entire lifestyle and was an archetype

R e s o u rce s a n d capa b i l i t i e s
of American style. Harley had a unique relationship with American culture. The values
that Harley represented – individuality, freedom and adventure – could be traced back
to the cowboy and frontiersman of yesteryear and before that to the quest for space and
liberty that had brought people to America in the first place. As the sole survivor of the
once‐thriving American motorcycle industry, Harley‐Davidson represented a tradition of
US engineering and manufacturing.

  The appeal of the brand was central not just to Harley’s marketing but also to its
strategy as a whole. Harley‐Davidson had long emphasized that it was not in the
business of selling motorcycles: it was selling the ‘Harley Experience’. A critical question
for Harley was: ‘How broad is the appeal of the brand and the Harley Experience?’
Harley’s core market was US white male baby‐boomers: could the Harley image have the
same appeal to younger generations and in overseas markets?
●● Operations: Despite expanding capacity and upgrading its manufacturing operations,
Harley’s low production volumes and dispersed plants limited its access to scale
economies. It also lacked the buying power of its bigger rivals. To offset its lack of
purchasing power Harley fostered close relations with its key suppliers and placed
purchasing managers at senior levels within its management structure.
●● Distribution: In the past, Harley dealerships had been operated by enthusiasts, with
erratic opening hours, poor stocks of bikes and spares and indifferent customer service.
Recognizing that it was in the business of selling a lifestyle and an experience and that
its dealers played a pivotal role in delivering that experience, Harley transformed its
dealership network. Its dealer programme provided extensive support for dealers while
requiring high standards of pre‐ and after‐sales service. Dealers were obliged to carry a
full line of Harley replacement parts and accessories and to perform services on Harley
bikes. Training programmes helped dealers meet the higher service requirements and
encouraged them to recognize and meet the needs of the professional, middle‐class
clientele that formed the bulk of Harley’s customer base by offering test ride facilities,
rider instruction classes, motorcycle rental and assistance in customizing bikes. About
85% of Harley’s US dealerships were exclusive – far more than for any other motorcycle
manufacturer.
●● Sales of related products: Sales of parts, accessories and ‘general merchandise’
(clothing and collectibles) represented 20% of Harley’s total revenue in 2008 –
much higher than for any other motorcycle company. Clothing sales included not
just traditional riding apparel but also a wide range of men’s, women’s and children’s
leisurewear. Almost all clothing, accessories, giftware, jewellery, toys and other products
were produced by third‐party manufacturers who paid licensing fees to Harley‐Davidson.
▲

To expand sales of licensed products, Harley opened a number of secondary retail

86
locations that sold clothing, accessories and giftware, but not motorcycles. In

▲
F O U N DAT I O N S O F S T R AT E G Y

addition, Harley‐Davidson Financial Services supplied credit, insurance and extended

warranties to Harley customers and loans to Harley dealers. During the 2008/9
financial crisis, Harley’s financial services subsidiary was hit by rising defaults and,
unable to securitize its customer loans, was forced to retain many of these loans on
its own balance sheet. However, by 2013 financial services were, once again, Harley’s
most profitable business.

Looking ahead: Threats and opportunities

Despite the confidence expressed by Keith Wandell in the strength of Harley‐Davidson’s
recovery from the crisis of 2008/9 and its prospects for the future, while quality and effectiveness
of its dealer network were key determinants of the strong demand for Harley’s products, the
market environment that Harley faced in 2014 presented several challenges.
With 54% of the US market for heavyweight motorcycles, a market share that had been
fairly stable for 20 years, Harley had limited potential to grow within its core segment. As
a result, Wandell’s key strategic goal was ‘to grow retail sales outside the U.S. faster than
retail sales inside the U.S. and then to grow U.S. retail sales to outreach customer segments
– women, young adults between 18 and 34, African Americans and Hispanics – faster than
retail sales to our core customers’. To this end, the company introduced a new range of
touring motorcycles, tagged with the ‘project Rushmore’ label that offered significantly
improved functionality and announced the launch of a new range of ‘Street’ bikes aimed
at younger, urban motorcyclists. Their emphasis remained on styling, customization, sound
and reliability as sources of competitive advantage and the company viewed the availability
of parts, accessories and ancillary services (such as finance, customer ‘clubs’ and social events
delivered in partnership with dealers) to be vital in maintaining and enhancing a competitive
advantage.
At the same time as extending the product range, the company endeavoured to open
up new markets overseas by establishing more dealerships in Asia and Latin America and by
running marketing campaigns with a stronger multigenerational and multicultural slant. On
the operations side of the business, Harley reorganized its manufacturing to improve flexibility
and reduce costs. However, international success remained elusive. Despite its strength in
Japan and Australia and growing sales in Brazil, the Harley brand and image in overseas
markets was weaker than in the US. In Europe, Harley’s share of the heavyweight market
was 12%: many European riders regarded Harley‐Davidson motorcycles as unsophisticated,
technologically backward and unwieldy compared to those supplied by its Japanese and
European rivals.
Harley’s pre‐eminence within the US was also far from assured. Would Harley’s macho
image have the same appeal to upcoming generations of Americans as it had to baby‐
boomers? Indeed, would motorcycling maintain its appeal as a leisure activity? Even within
its core segment, Harley faced increasing competition. All the major motorcycle producers
offered V‐twin cruiser bikes that imitated Harley’s traditional style (but at significantly lower
prices). In addition, several specialist suppliers had entered Harley’s market space – most
notably Polaris, which offered its Victory motorcycles and had acquired the resuscitated
Indian brand.

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The role of resources and capabilities in strategy formulation 87
We saw in Chapter 1 that strategy is concerned with matching a firm’s resources and capabilities
to the opportunities that arise in the external environment. In Chapter 2, our emphasis was on

CHAPTER 3
the identification of profit opportunities in the external environment of the firm. In this chapter,
our emphasis shifts from the interface between strategy and the external environment towards
the interface between strategy and the internal environment of the firm – more specifically,
the relationship between strategy and the resources and capabilities of the firm (Figure 3.1).

R e s o u rce s a n d capa b i l i t i e s
Moving from the external to the internal is a logical way of proceeding with our exploration
of strategy that also resonates with a theme we noted in Chapter 1: the trend over time from
seeing sources of profit as lying mainly in the external environment to seeing sources of profit
being located within firms. Competitive advantage rather than industry attractiveness is the
primary source of superior profitability.

Basing strategy on resources and capabilities

During the 1990s, ideas concerning the role of resources and capabilities as the principal basis
for firm strategy and the primary source of profitability merged into what has become known
as the resource‐based view of the firm.1
To understand why the resource‐based view has had a major impact on strategy thinking,
let us go back to the starting point for strategy formulation, typically some statement of the
firm’s identity and purpose (often expressed in a mission statement). Conventionally, firms
have answered the question ‘What is our business?’ in terms of the market they serve: ‘Who are
our customers?’ and ‘Which of their needs are we seeking to serve?’ However, in a world where
customer preferences are volatile and the identity of customers and the technologies for serving
them are changing, a market‐focused strategy may not provide the stability and constancy of
direction needed to guide strategy over the long term.2 When the external environment is in a
state of flux, the firm itself, in terms of its bundle of resources and capabilities, may be a much
more stable basis on which to define its identity.
The emphasis on resources and capabilities as the foundation of firm strategy was
popularized by C.K. Prahalad and Gary Hamel in their landmark paper ‘The Core Competence
of the Corporation’.3 The potential for capabilities to be the ‘roots of competitiveness’, the
sources of new products and the foundation for strategy is exemplified be several companies,
for example:

THE FIRM THE INDUSTRY

Goals and Values ENVIRONMENT
Resources and STRATEGY Competitors
Capabilities Customers
Structure and Systems Suppliers

The The
Firm–Strategy Environment–Strategy
Interface Interface

Figure 3.1  Analysing resources and capabilities: The interface between strategy
and the firm.

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 Honda Motor Company is the world’s biggest motorcycle producer and a lead supplier
88 of cars, but it has never defined itself either as a motorcycle company or as a motor vehicle
company. Since its foundation in 1948, its strategy has been built around its expertise in the
F O U N DAT I O N S O F S T R AT E G Y

development and manufacture of engines; this capability has successfully carried it from
motorcycles to a wide range of gasoline‐engine products.
Canon, Inc. had its first success producing 35mm cameras. Since then it has gone on
to develop fax machines, calculators, copy machines, printers, video cameras, camcorders,
semiconductor manufacturing equipment and many other products. Almost all Canon’s
products involve the application of three areas of technological capability: precision mechanics,
microelectronics and fine optics.
3M Corporation expanded from sandpaper into adhesive tapes, audio and videotapes,
road signs, medical products and floppy disks. Its product list now comprises over 30 000
products. Is it a conglomerate? Certainly not, claims 3M. Its vast product range rests on
a foundation of key technologies relating to adhesives, thin‐film coatings and materials
sciences supported by outstanding capability in the development and launching of new
products.
In general, the greater the rate of change in a firm’s external environment, the more likely
it is that internal resources and capabilities rather than external market focus will provide
a secure foundation for long‐term strategy. In fast‐moving, technology‐based industries,
basing strategy upon capabilities can help firms outlive the lifecycles of their initial products.
Microsoft’s initial success was the result of its MS‐DOS operating system for the IBM PC.
However, by building outstanding capabilities in developing and launching complex software
products and in managing an ecosystem of partner relationships, Microsoft extended its
success to other operating systems (e.g. Windows), to applications software (e.g. Office) and to
Internet services (e.g. Xbox Live). Similarly, Apple’s remarkable ability to combine technology,
aesthetics and ease of use has allowed it to expand beyond its initial focus on desktop and
notebook computers into MP3 players (iPod), smartphones (iPhone) and tablet computers
(iPad).
Conversely, those companies that when faced with radical technological change attempted
to maintain their market focus have often experienced huge difficulties in building the new
technological capabilities needed to serve their customers.
Eastman Kodak is a classic example. Its dominance of the world market for photographic
products was threatened by digital imaging. From 1990 onwards, Kodak invested billions of
dollars developing digital technologies and digital imaging products. Yet, in January 2012,
continuing losses on digital products and services forced Kodak into bankruptcy. Might
Kodak have been better off by sticking with its chemical know‐how, allowing its photographic
business to decline while developing its interests in specialty chemicals, pharmaceuticals and
healthcare?4
Olivetti, the Italian manufacturer of typewriters and office equipment, offers a similar
cautionary tale. Despite its early investments in electronic computing, Olivetti’s attempt to
recreate itself as a supplier of personal computers and printers was a failure. Might Olivetti
have been better advised to deploy its existing expertise in electrical and precision engineering
in other products?5 This pattern of established firms failing to adjust to disruptive technological
change within their own industries is well documented: in typesetting and in disk drive
manufacturing, successive technological waves have caused market leaders to falter and have
allowed new entrants to prosper.6

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Identifying the organization’s resources and capabilities 89
The first stage in the analysis of resources and capabilities is to identify the resources and
capabilities of the firm – or, indeed, any organization since the analysis of resources and

CHAPTER 3
capabilities is as applicable to not‐for‐profit organizations as it is to business enterprises. It is
important to distinguish between the resources and the capabilities of the firm: resources are the
productive assets owned by the firm; capabilities are what the firm can do. Individual resources
do not confer competitive advantage; they must work together to create organizational

R e s o u rce s a n d capa b i l i t i e s
capability. Capability is the essence of superior performance. Figure 3.2 shows the relationships
between resources, capabilities and competitive advantage.
Our discussion of key success factors (KSFs) – the sources of competitive advantage within
an industry – in Chapter 2 offers a starting point for our identification of key resources and
capabilities. Once we have identified the KSFs in an industry, it is a short step to identifying the
resources and capabilities needed to deliver those success factors. For example:

●● In budget airlines the KSF is low operating cost. This requires a standardized fleet of fuel‐
efficient planes; a young, motivated, non‐unionized workforce; and a culture of frugality.
●● In pharmaceuticals the KSF is the discovery and launch of new drugs. This requires high‐
quality researchers and drug‐testing, marketing and distribution capability.

However, as we shall see, identifying KSFs is only a starting point. To develop a

comprehensive picture of an organization’s resources and capabilities we need systematic
frameworks for identifying and classifying different resources and capabilities.

Identifying resources
Drawing up an inventory of a firm’s resources can be surprisingly difficult. No such document
exists within the accounting or management information systems of most corporations. The

COMPETITIVE INDUSTRY
STRATEGY
ADVANTAGE KEY SUCCESS
FACTORS

ORGANIZATIONAL
CAPABILITIES

RESOURCES

TANGIBLE INTANGIBLE HUMAN

Financial (cash, Technology Skills/know-how
securities, borrowing (patents, copyrights, Capacity for
capacity) trade secrets) communication
Physical (plant, Reputation (brands, and collaboration
equipment, land, relationships) Motivation
mineral reserves) Culture

Figure 3.2  The links between resources, capabilities and competitive advantage.

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 corporate balance sheet provides a limited view of a firm’s resources; it comprises mainly
90 financial and physical resources. To take a wider view of a firm’s resources it is helpful to
identify three principal types of resource: tangible, intangible and human resources.
F O U N DAT I O N S O F S T R AT E G Y

Featured Example 3.1

Focusing strategy around core capabilities: Lyor Cohen on
Mariah Carey
2001 was a disastrous year for Mariah Carey. Her first movie, Glitter, was a flop, the soundtrack
was Carey’s most poorly received album in a decade, her $80 million recording contract was
dropped by EMI and she suffered a nervous breakdown.
Lyor Cohen, the aggressive, workaholic chief executive of Island Def Jam records was
quick to spot an opportunity: ‘I cold‐called her on the day of her release from EMI and I said, I
think you are an unbelievable artist and you should hold your head up high’, says Cohen. ‘What
I said stuck on her and she ended up signing with us.’
His strategic analysis of Carey’s situation was concise: ‘I said to her, what’s your competitive
advantage? A great voice, of course. And what else? You write every one of your songs –
you’re a great writer. So why did you stray from your competitive advantage? If you have this
magnificent voice and you write such compelling songs, why are you dressing like that, why
are you using all these collaborations [with other artists and other songwriters]? Why? It’s like
driving a Ferrari in first – you won’t see what that Ferrari will do until you get into sixth gear.’
Cohen signed Carey in May 2002. Under Universal Music’s Island Def Jam Records, Carey
returned to her core strengths: her versatile voice, song‐writing talents and ballad style. Her
next album, The Emancipation of Mimi, was the biggest‐selling album of 2005 and in 2006 she
won a Grammy award.

Source: ‘Rap’s Unlikely Mogul’ Financial Times (August 7, 2002). From the Financial Times © The Financial Times
Ltd. 2002.  All rights reserved.

TANGIBLE RESOURCES  Tangible resources are the easiest to identify and evaluate: financial
resources and physical assets are identified and valued in the firm’s financial statements. Yet,
balance sheets are renowned for their propensity to obscure strategically relevant information
and to under‐ or overvalue assets. Historical cost valuation can provide little indication of
an asset’s market value. For example, Disney’s movie library had a balance sheet value of
$5.4 billion in 2008, based on production costs. Its land assets (including its 28 000 acres in
Florida) were valued at a paltry $1.2 billion.
However, the primary goal of resource analysis is not to value a company’s assets but
to understand their potential for creating competitive advantage. Information that British
Airways possessed fixed assets valued at £8 billion in 2013 is of little use in assessing the
airline’s strategic value. To assess British Airways’ ability to compete effectively in the world
airline industry we need to know about the composition of these assets: the location of land
and buildings, the types of plane, the landing slots and gate facilities at airports and so on.

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 Once we have fuller information on a company’s tangible resources we explore how we
can create additional value from them. This requires that we address two key questions: 91

●● What opportunities exist for economizing on their use? It may be possible to use fewer

CHAPTER 3
resources to support the same level of business, or to use the existing resources to support
a larger volume of business. In the case of British Airways, there may be opportunities
for consolidating administrative offices and engineering and service facilities. Improved
inventory control may allow economies in inventories of parts and fuel. Better control of

R e s o u rce s a n d capa b i l i t i e s
cash and receivables permits a business to operate with lower levels of cash and liquid
financial resources.
●● What are the possibilities for employing existing assets more profitably? Could British
Airways generate better returns on some of its planes by redeploying them into cargo
carrying? Should British Airways seek to redeploy its assets from Europe and the North
Atlantic to Asia‐Pacific? Might it reduce costs in its European network by reassigning
routes to small franchised airlines?

INTANGIBLE RESOURCES  For most companies, intangible resources are more valuable than
tangible resources. Yet, in company financial statements, intangible resources remain largely
invisible. The exclusion or undervaluation of intangible resources is a major reason for the
large and growing divergence between companies’ balance sheet valuations (‘book values’)
and their stock market valuations (Table 3.2). Among the most important of these undervalued
or unvalued intangible resources are brand names. Table 3.3 shows companies owning brands
valued at $15 billion or more.
Brand names and other trademarks are a form of reputational asset: their value is in
the confidence they instil in customers. The brand valuations in Table 3.3 are based upon
the operating profits for each company (after taxation and a capital charge), estimating the
proportion attributable to the brand and then capitalizing these returns.

Table 3.2  Large companies with the highest valuation ratios, April 2014.
Valuation Valuation
Company ratio Country Company ratio Country
Hindustan Unilever 46.6 India Alexion Pharma. 11.9 US
Tesla Motors 37.7 US Starbucks 11.8 US
Colgate‐Palmolive 26.3 US ITC Ltd. 11.7 India
Altria 18.3 US MasterCard 11.4 USA
AbbVie 16.7 US Roche Holding 11.3 Swz.
Yum! Brands 15.4 US GlaxoSmithKline 11.0 UK
Regeneron Pharma. 15.0 US Salesforce.com 11.0 US
Amazon 14.9 US Hermes Intl. 11.0 France
British Sky Broadcasting 14.0 UK ARM Holdings 10.7 UK
United Parcel Service 13.8 US CSL 10.6 Australia
Note: the table shows companies from the FT Global 500 with the highest ratios of market capitalization to balance sheet
net asset value (‘market‐to‐book’ ratios).
Source: Google Finance, Financial Times.

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 Table 3.3  The world’s most valuable brands, 2013.
92
Rank Brand Value in 2013 ($ billion) Change from 2012 Country of origin
F O U N DAT I O N S O F S T R AT E G Y

 1 Apple 98.3 +28% US

 2 Google 93.3 +34% US
 3 Coca‐Cola 79.2 +2% US
 4 IBM 78.8 +4% US
 5 Microsoft 59.5 +3% US
 6 GE 46.9 +7% US
 7 McDonald’s 42.0 +5% US
 8 Samsung 39.6 +20% South Korea
 9 Intel 37.2 –5% US
10 Toyota 35.3 +17% Japan
11 Mercedes‐Benz 31.9 +6% Germany
12 BMW 31.8 +10% Germany
13 Cisco 29.0 +7% US
14 Disney 28.1 +3% US
15 Hewlett‐Packard 25.8 –1% US
16 Gillette 25.1 +1% US
17 Louis Vuitton 24.9 +6% France
18 Oracle 24.1 +9% US
19 Amazon 23.6 +27% US
20 Honda 18.5 +7% Japan

Note: Brand values are calculated as the net present value of future earnings generated by the brand.
Source: Interbrand.

The value of a company’s brands can be increased by extending the range of products
over which a company markets its brands. Johnson & Johnson, Samsung and General Electric
derive considerable economies from applying a single brand to a wide range of products. As a
result, companies that succeed in building strong consumer brands have a powerful incentive
to diversify, for example Nike’s diversification from athletic shoes into apparel and sports
equipment.
Like reputation, technology is an intangible asset whose value is not evident from most
companies’ balance sheets. Intellectual property – patents, copyrights, trade secrets and
trademarks – comprises technological and artistic resources where ownership is defined in
law. Over the past 20 years, companies have become more attentive to the value of their
intellectual property. For IBM (with the world’s biggest patent portfolio) and Qualcomm (with
its patents relating to CDMA digital wireless telephony), intellectual property is the most
valuable resource they own.

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HUMAN RESOURCES  Human resources of the firm comprise the expertise and effort
offered by employees. Like intangible resources, human resources do not appear on the 93
firm’s balance sheet – for the simple reason that the firm does not own its employees;

CHAPTER 3
it purchases their services under employment contacts. The reason for including human
resources as part of the resources of the firm is their stability. Although employees are free
to move from one firm to another – most employment contracts require no more than a
month’s notice on the part of the employee – in practice most employment contracts are
long term. In the US the average length of time an employee stays with an employer is

R e s o u rce s a n d capa b i l i t i e s
four years; in Europe it is longer: 8.4 years in Britain to 13 and 11.7 in France and Italy
respectively.7
Most firms devote considerable effort to appraising their human resources. This
appraisal occurs at the hiring stage when potential employees are evaluated in relation to the
requirements of their job and as part of an ongoing appraisal process of which annual employee
reviews form the centrepiece. The purposes of appraisal are to assess past performance for
the purposes of compensation and promotion, set future performance goals and establish
employee development plans. Trends in appraisal include greater emphasis on assessing results
in relation to performance targets (e.g. management‐by‐objectives) and broadening the basis
of evaluation (e.g. 360‐degree appraisal).
Over the past decade, human resource evaluation has become far more systematic and
sophisticated. Many organizations have established assessment centres specifically for the
purpose of providing comprehensive, quantitative assessments of the skills and attributes of
individual employees, and increasingly appraisal criteria are based upon empirical research
into the components and correlates of superior job performance. Competencies modelling
involves identifying the set of skills, content knowledge, attitudes and values associated with
superior performers within a particular job category and then assessing each employee against
that profile.8 An important finding of research into HR competencies is the critical role of
psychological and social aptitudes in determining superior performance; typically these factors
outweigh technical skills and educational and professional qualifications. Interest in emotional
intelligence reflects the recognition of the importance of interpersonal skills and emotional
awareness.9 Overall, these findings explain the trend among companies to ‘hire for attitude;
train for skills’.
The ability of employees to harmonize their efforts and integrate their separate skills
depends not only on their interpersonal skills but also on the organizational context. This
organizational context as it affects internal collaboration is determined by a key intangible
resource: the culture of the organization. The term organizational culture is notoriously ill
defined. Sebastian Green defines organizational (or corporate) culture as ‘an amalgam of
shared beliefs, values, assumptions, significant meanings, myths, rituals, and symbols that are
held to be distinctive’.10 The observation that companies with sustained superior financial
performance are frequently characterized by strong organizational cultures has led Jay Barney
to view organizational culture as a firm resource of great strategic importance that is potentially
very valuable.11

Identifying organizational capabilities

Resources are not productive on their own. A brain surgeon is close to useless without a
radiologist, anaesthetist, nurses, surgical instruments, imaging equipment and a host of other
resources. To perform a task, a team of resources must work together.

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94
Case Insight 3.1
F O U N DAT I O N S O F S T R AT E G Y

Illustrative examples of resources classified by type for

Harley‐Davidson, Inc.
Resource(s) Illustrative example Strategic relevance
Tangible Headquarters and product Harley’s production of 260 000 units is dispersed
development is in Milwaukee across six plants in three states; plants in Brazil
(WI); production plants are and India assemble knocked‐down motorcycles
in York (PA), Kansas City (MI), from the US; Harley’s plants emphasize quality
Milwaukee County (WI), Manaus and flexibility; Harley lacks the scale economies of
(Brazil) and Bawal (India) its rivals (Honda produced 17.2m bikes in 2013)
Harley has 765 North American, Harley’s dealership network is central to the
full‐service dealerships and Harley Experience, reinforcing the brand image
693 in the rest of the world. In and supplying a wide range of services. Outside
addition 154 retail outlets sell North America Harley’s reach is limited by its
other Harley‐branded products sparse dealer network – just 14 in China
Intangible Brand: the Harley brand, and The Harley brand forms the cornerstone of its
the loyalty it engenders, is strategy. At the core of the ‘Harley Experience’ is
Harley’s most valuable asset Harley’s statement of purpose to ‘fulfil dreams of
personal freedom’
Technology: annual R & D Harley is unable to compete on technology (Honda
expenditure of $152m in 2013 spent almost $6 billion on R & D in 2013) but has
made a virtue out of necessity by emphasizing the
authenticity of its traditional motorcycles
Human In 2013, Harley had 5800 Harley’s employees, including managers, play
employees in its motorcycle a key role in reinforcing Harley’s traditions and
segment and 600 in financial image, e.g. through participating in HOG events.
services. Harley emphasizes Despite emphasis on open communication,
training and employee loyalty, team working and self‐management Harley has
commitment, initiative and experienced labour relations tensions (including
flexibility a 2007 strike)

An organizational capability is a ‘firm’s capacity to deploy resources for a desired end

result’.12 Just as an individual may be capable of playing the violin, ice skating and speaking
Mandarin, so an organization may possess the capabilities needed to manufacture widgets,
distribute them globally and hedge the resulting foreign exchange exposure. We use the terms
‘capability’ and ‘competence’ interchangeably.13
Our primary interest is in those capabilities that can provide a basis for competitive
advantage. Selznick uses distinctive competence to describe those things that an organization
does particularly well relative to its competitors.14 Prahalad and Hamel coined the term
‘core competencies’ to distinguish those capabilities fundamental to a firm’s strategy and
performance.15 Core competencies, according to Hamel and Prahalad, are those that:
●● make a disproportionate contribution to ultimate customer value, or to the efficiency
with which that value is delivered; and
●● provide a basis for entering new markets.16

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 Prahalad and Hamel criticize US companies for emphasizing products over capabilities.
Global leaders are those companies that develop core competencies over the long term. 95
Individual products may succeed or fail; the key is to learn from both success and failure in

CHAPTER 3
order to build capability.

CLASSIFYING CAPABILITIES  Before deciding which organizational capabilities are ‘distinctive’

or ‘core’, a firm needs to take a comprehensive view of its full range of organizational
capabilities. To identify a firm’s capabilities, we need to have some basis for classifying and

R e s o u rce s a n d capa b i l i t i e s
disaggregating its activities. Two approaches are commonly used:

1 A functional analysis identifies organizational capabilities in relation to each of the

principal functional areas of the firm. Table 3.4 classifies the principal functions of
the firm and identifies organizational capabilities located within each function, giving
examples of firms that are widely recognized for their capabilities in particular functions.

Table 3.4  A functional classification of organizational capabilities.

Functional area Capability Exemplars

Corporate Financial control Exxon Mobil, PepsiCo
  Management development General Electric, Shell
  Strategic innovation Google, Haier
  Multidivisional coordination Unilever, Shell
  Acquisition management Cisco, Systems, Luxottica
  International management Shell, Banco Santander
Management information Comprehensive, integrated Walmart, Capital One, Dell Computer
management information systems
linked to managerial decision making
Research and development Research IBM, Merck
  Innovative new product development 3M, Apple
  Fast‐cycle new product development Canon, Inditex (Zara)
Operations Efficiency in volume manufacturing Briggs & Stratton, YKK
  Continuous improvements in Toyota, Harley‐Davidson
operations
  Flexibility and speed of response Four Seasons Hotels
Product design Design capability Nokia, Apple
Marketing Brand management Procter & Gamble, Altria
  Building reputation for quality Johnson & Johnson
  Responsiveness to market trends MTV, L’Oréal
Sales and distribution Effective sales promotion and PepsiCo, Pfizer
execution
  Efficiency and speed of order L. L. Bean, Dell Computer
processing
  Speed of distribution Amazon
  Customer service Singapore Airlines, Caterpillar

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 In Case Insight 3.2, we illustrate how this functional approach could be used to audit
96 Harley‐Davidson’s capabilities. In some areas, Harley’s capabilities are equivalent to those
of other motorcycle manufacturers; in others, Harley has developed capabilities that are
F O U N DAT I O N S O F S T R AT E G Y

distinctive. We refer to capabilities that are common to all motorcycle manufacturers as

‘threshold capabilities’ because they comprise the essential set of capabilities that any firm
needs to compete and survive in its chosen industry.

Case Insight 3.2

Some illustrative examples of Harley‐Davidson’s capabilities by
function
Function Illustrative capability
Product design Consumer‐led design: until recently, the company has stuck with classic
styling and traditional technologies but has developed a strong capability in
customizing designs to customers’ requirements. Product upgrades are based on
extensive market research and feedback from customers and dealers
Engineering A threshold capability: Harley has made a virtue out of necessity by sticking
to traditional technology and traditional design. Its smaller corporate size
and inability to share R & D across cars and bikes (unlike Honda and BMW)
has limited its ability to invest in new technology and implement the latest
developments in engineering. In recent years it has started to access more up‐to‐
date technologies through alliances with other companies
Operations Flexible production: Harley has sought to enhance the flexibility of its
manufacturing operations by introducing ‘surge production’ practices, moving
away from model‐dedicated production lines to lines that can produce multiple
models and by strengthening its ‘build to order’ capability
Marketing and Enhanced retail service: Harley has recognized the central role that dealers
Distribution play in the relationship between the company and its customers so it places
considerable emphasis on its relationship with dealers. Dealers are the vehicle
through which Harley delivers add‐on services such as test ride facilities, rider
instruction classes, customization option, finance etc. Dealers receive support
and training through the Harley‐Davidson University, which was established to
‘enhance dealer competencies in every area’
Customer Customer relationship management: the appeal of the Harley motorcycle is tightly
Service bound up with the image it conveys and the lifestyle it represents. Harley has
tried to ensure that the reality lives up to the image by enhancing its customers’
riding experience by establishing an owners’ group, by organizing social and
charity rallies and rides and creating a sense of community

2 Value chain analysis separates the activities of the firm into a sequential chain and
explores the linkages between activities in order to gain insight into a firm’s competitive
position. Michael Porter’s representation of the value chain distinguishes between
primary activities (those involved with the transformation of inputs and interface with
the customer) and support activities (Figure 3.3). Porter’s generic value chain identifies

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 FIRM INFRASTRUCTURE SUPPORT
ACTIVITIES
97
HUMAN RESOURCE MANAGEMENT

CHAPTER 3
TECHNOLOGY DEVELOPMENT

PROCUREMENT

R e s o u rce s a n d capa b i l i t i e s
INBOUND OPERATIONS OUTBOUND MARKETING SERVICE
LOGISTICS LOGISTICS AND SALES

PRIMARY ACTIVITIES

Figure 3.3  Porter’s value chain.

Source: Adapted with the permission of Simon & Schuster Publishing Group from the Free Press edition of Competitive
Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by Michael E.
Porter. All rights reserved.

a few broadly defined activities that can be separated to provide a more detailed
identification of the firm’s activities (and the capabilities that correspond to each
activity). Case Insight 3.3 shows how this could look for firms like Harley‐Davidson
operating in the motorcycle industry. Thus, marketing can include market research, test
marketing, advertising, promotion, pricing and dealer relations. By exploring different
activities and, most crucially, the linkages between them, it is possible to gain a sense of
an organization’s main capabilities.

THE NATURE OF CAPABILITY  Drawing up an inventory of a firm’s resources is fairly

straightforward. Organizational capabilities are more elusive, partly because they are
idiosyncratic – every organization has features of its capabilities that are unique and difficult
to capture using simple functional and value chain classifications. Consider Apple’s product
design and product development capabilities. Apple has a remarkable ability to combine
hardware technology, software engineering, aesthetics, ergonomics and cognitive awareness to
create products with a superior user interface and unrivalled market appeal. But identifying the
components of this product design/development capability and establishing where and with
whom within Apple this capability is located is no simple task. Let us explore more closely the
nature and the determinants of organizational capability.

FROM RESOURCES TO CAPABILITIES: ROUTINES AND INTEGRATION  Capabilities are based

upon routinized behaviour. Routinization is an essential step in creating organizational
capability – only when the activities of organizational members become routine can tasks
be completed efficiently and reliably. In every McDonald’s hamburger restaurant, operating
manuals provide precise directions for a comprehensive range of tasks, from the placing

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98
Case Insight 3.3
Using Porter’s value chain to explore the capabilities of firms in the
F O U N DAT I O N S O F S T R AT E G Y

motorcycle industry
Illustrative examples of activities and
Generic value chain associated capabilities required in the
Type of activity activity motorcycle industry
Primary activities Inbound logistics Purchasing
Supply chain management
Component manufacture
Operations Design and product development
Assembly
Flexible manufacturing
Quality control
Outbound logistics Distribution coordination and support
Dealer relationships and management
Marketing and sales Market research
Test marketing
Advertising
Promotion
Pricing
Service Warranty and servicing arrangements
Parts
Recycling
Support activities Infrastructure Strategic management
Managing external relations
Financial and risk management
Legal affairs
Human resource management Training and skills development
Staff recruitment and retention
Staff appraisal and performance management
Technology development Technology‐managed design and
manufacturing
Integrated management information systems
Technology linked manufacture and sales
Procurement Database management and IT controlled
purchasing of parts and sub‐assemblies
Inventory management
Supply chain integration and coordination

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of the pickle on the burger to the maintenance of the milkshake machine. In practice,
personnel are routinized through continual repetition, meaning operating manuals are 99
seldom consulted.
These organizational routines – ‘regular and predictable behavioral patterns [comprising]

CHAPTER 3
repetitive patterns of activity’17 – are viewed by evolutionary economists as the fundamental
building blocks of what firms do and who they are. It is through the adaptation and
replication of routines that firms develop. Like individual skills, organizational routines
develop through learning by doing. Just as individual skills become rusty when not

R e s o u rce s a n d capa b i l i t i e s
used, so it is difficult for organizations to retain coordinated responses to contingencies
that arise only rarely. Hence, there tends to be a trade‐off between efficiency and flexibility.
A limited repertoire of routines can be performed highly efficiently with near‐perfect
coordination. The same organization may find it extremely difficult to respond to novel
situations.18
Creating organizational capability is not simply a matter of allowing routines to
emerge. Combining resources to create capability requires conscious and systematic actions
by management. These actions include: bringing the relevant resources together within an
organizational unit, designing processes, creating motivation and aligning the activity with the
overall strategy of the organization.

THE HIERARCHY OF CAPABILITIES  Whether we start from a functional or value chain

approach, the capabilities that we identify are likely to be broadly defined: operational
capability, marketing capability, supply chain management capability. However, having
recognized that capabilities are the outcome of processes and routines, it is evident that
these broadly defined capabilities can be broken down into more specialist capabilities. For
example, marketing capabilities can be separated into market research capability, product
launch capability, advertising capability, pricing capability, dealer relations capability – and
others too. We can also recognize that even broadly defined functional capabilities integrate
to form wider cross‐functional capabilities: new product development, business development,
the provision of customer solutions. What we observe is a hierarchy of capabilities where
more general, broadly defined capabilities are formed from the integration of more specialized
capabilities. For example:

●● A hospital’s capability in treating heart disease depends on its integration of capabilities

relating to patient diagnosis, physical medicine, cardiovascular surgery, pre‐ and post‐
operative care, as well as capabilities relating to training, information technology and
various administrative and support functions.
●● Toyota’s manufacturing capability – its system of ‘lean production’ – integrates
capabilities relating to the manufacture of components and sub‐assemblies, supply
chain management, production scheduling, assembly, quality control procedures,
systems for managing innovation and continuous improvement and inventory
control.

Figure 3.4 offers a partial view of the hierarchy of capabilities of a telecom equipment
maker. As we ascend the hierarchy, capabilities become progressively more difficult to develop:
higher‐level capabilities require the broadest integration of know‐how, typically across different
functional departments.

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100 CROSS- New product Customer Quality
FUNCTIONAL development support management
CAPABILITIES capability capability capability
F O U N DAT I O N S O F S T R AT E G Y

BROAD R & D and Marketing HR

Operations MIS
FUNCTIONAL design and sales management
capability capability
CAPABILITIES capability capability capability

ACTIVITY- Materials Process Product Test

Manufacturing
RELATED management engineering engineering engineering
capability
CAPABILITIES capability capability capability capability
(Operations
related only)

SPECIALIZED Printed
Telset System
CAPABILITIES circuit-board
assembly assembly
(Manufacturing assembly
related only)

SINGLE-TASK Automated
Manual Surface
CAPABILITIES through-hole Wave
insertion of mounting of
(Only those component soldering
components components
related to PCB insertion
assembly)

INDIVIDUALS’ SPECIALIZED KNOWLEDGE

Figure 3.4  The hierarchy of organizational capabilities at a telecom equipment

manufacturer.

Appraising resources and capabilities

Having identified the principal resources and capabilities of an organization, how do we
appraise their potential for value creation? There are two fundamental issues: first, what is the
strategic importance of different resources and capabilities and, second, what are the strengths
of the focal firm in these resources and capabilities relative to competitors?

Appraising the strategic importance of resources and capabilities

Strategically important resources and capabilities are those with the potential to generate
substantial streams of profit for the firm that owns them. This depends on three factors:
establishing a competitive advantage, sustaining that competitive advantage and appropriating
the returns from the competitive advantage. Each of these is determined by a number of
resource characteristics. Figure 3.5 shows the key relationships.

ESTABLISHING COMPETITIVE ADVANTAGE  For a resource or capability to establish a

competitive advantage, two conditions must be present:

●● Scarcity: If a resource or capability is widely available within the industry, it may

be necessary in order to compete but it will not be a sufficient basis for competitive

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 THE EXTENT OF
THE COMPETITIVE
Scarcity 101
ADVANTAGE
ESTABLISHED

CHAPTER 3
Relevance

Durability

THE PROFIT-EARNING
SUSTAINABILITY OF
POTENTIAL

R e s o u rce s a n d capa b i l i t i e s
THE COMPETITIVE Transferability
OF A RESOURCE OR
ADVANTAGE
CAPABILITY
Replicability

Property rights

Relative
APPROPRIABILITY
bargaining power

Embeddedness

Figure 3.5  Appraising the strategic importance of resources and capabilities.

advantage. In oil and gas exploration, technologies such as directional drilling and 3D
seismic analysis are widely available – hence they are ‘needed to play’ but they are not
‘sufficient to win’.
●● Relevance: A resource or capability must be relevant to the KSFs in the market. British
coal mines produced some wonderful brass bands, but these musical capabilities
did little to assist the mines in meeting competition from cheap imported coal and
North Sea gas. As retail banking shifts towards automated teller machines and online
transactions, so the retail branch networks of the banks have become less relevant for
customer service.

SUSTAINING COMPETITIVE ADVANTAGE  Once established, competitive advantage tends

to diminish over time; three characteristics of resources and capabilities determine the
sustainability of the competitive advantage they offer:

●● Durability: The more durable a resource, the greater its ability to support a competitive
advantage over the long term. For most resources, including capital equipment and
proprietary technology, the quickening pace of technological innovation is shortening
their lifespans. Brands, on the other hand, can show remarkable resilience to time. Heinz
sauces, Kellogg’s cereals, Guinness stout, Burberry raincoats and Coca‐Cola have been
market leaders for over a century.
●● Transferability: Competitive advantage is undermined by competitive imitation. If
resources and capabilities are transferable – they can be bought and sold – then

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 any competitive advantage that is based upon them will be eroded. Some resources,
102 such as finance, raw materials, components, machines produced by equipment
suppliers and employees with generic skills are transferable and can be bought
F O U N DAT I O N S O F S T R AT E G Y

and sold with little difficulty. Other resources and most capabilities are not easily
transferred – either they are entirely firm‐specific or their value depreciates on
transfer. Some resources are immobile because they are specific to certain locations
and cannot be relocated. A competitive advantage of the Laphroaig distillery and
its 10‐year‐old, single malt whisky is its water spring on the Isle of Islay, which
supplies water flavoured by peat and sea spray. Capabilities, because they combine
multiple resources embedded in an organization’s management systems, are also
difficult to move from one firm to another. Another barrier to transferability is
limited information regarding resource quality. In the case of human resources, hiring
decisions are typically based on very little knowledge of how the new employee
will perform. Sellers of resources have better information about the performance
characteristics of resources than buyers do. This creates a problem of adverse
selection for buyers.19 Jay Barney has shown that different valuations of resources
by firms can result in their being either underpriced or overpriced, giving rise to
differences in profitability between firms.20 Finally, resources are complementary:
they are less productive when detached from their original home. Typically, brands
lose value when transferred between companies: the purchase of European brands
by Chinese companies – Aquascutum by YGM, Cerruti by Trinity Ltd., Volvo by
Geely – risks the diminution of brand equity.
●● Replicability: If a firm cannot buy a resource or capability, it must build it. In financial
services, most new product innovations can be imitated easily by competitors. In
retailing, too, competitive advantages that derive from store layout, point‐of‐sale
technology and marketing methods are easy to observe and easy to replicate. Capabilities
based on complex organizational routines are less easy to copy. Federal Express’s
national, next‐day‐delivery service and Singapore Airlines’ superior in‐flight services are
complex capabilities based on carefully honed processes, well‐developed HR practices
and unique corporate cultures. Even when resources and capabilities can be copied,
imitators are typically at a disadvantage to initiators.21

Appropriating the returns to competitive advantage  Who gains the returns

generated by superior resources and capabilities? Typically, the owner of that resource or
capability. But ownership may not be clear‐cut. Are organizational capabilities owned by the
employees who provide skills and effort or by the firm which provides the processes and
culture? In human‐capital‐intensive firms, there is an ongoing struggle between employees and
shareholders as to the division of the rents arising from superior capabilities. This struggle is
reminiscent of the conflict between labour and capital to capture surplus value described by
Karl Marx. The prevalence of partnerships (rather than shareholder‐owned companies) in law,
accounting and consulting firms is one solution to this conflict over rent appropriation. The
less clear are property rights in resources and capabilities, the greater the importance of relative
bargaining power in determining the division of returns between the firm and its members. The
more deeply embedded are individual skills and knowledge within organizational routines,
and the more they depend on corporate systems and reputation, the weaker the employee is
relative to the firm.

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 103
Case Insight 3.4

CHAPTER 3
Building and sustaining competitive advantage at Harley‐Davidson
Harley‐Davidson’s strategy is built around its brand and its ability to maintain and enhance its
American pioneering image. The company’s stated vision22 is that of ‘fulfilling its customers’
dreams of personal freedom’ and it endeavours to do this through its ‘commitment to

R e s o u rce s a n d capa b i l i t i e s
exceptional customer service’ in everything it does. To that end the company makes it easy
for customers to personalize their bikes, invests in its dealer network, offers financing and
ancillary merchandise and organizes social events for owners.
But how sustainable is Harley’s advantage? While the design, engineering, manufacturing
and sales capabilities that Harley has are widely available throughout the industry, its
marque is unique and has proved very enduring. The Harley‐Davidson brand is rooted in
the company’s history and protected by a portfolio of trademarks, copyrights and patents.
The gradual development and enhancement of the brand over time makes it difficult for
others to achieve similar levels of brand awareness quickly or easily. The uniqueness of the
company’s image is reinforced by the complementarity and fit that Harley has achieved
between different parts of its organization. It has built up complex organizational routines
and relationships over time and integrated these into a unique company culture. Harley’s
competitive advantage, therefore, appears durable and difficult to acquire or imitate. The
challenge, however, is whether the brand will transfer easily to new markets and market
segments.

Appraising the relative strength of a firm’s resources and capabilities

Having established which resources and capabilities are strategically most important, we need
to assess how a firm measures up relative to its competitors. Making an objective appraisal of
a company’s resources and capabilities relative to its competitors’ is difficult. Organizations
frequently fall victim to past glories, hopes for the future and their own wishful thinking. The
tendency toward hubris among companies, and their senior managers, means that business
success often sows the seeds of its own destruction.23 Royal Bank of Scotland’s acquisition‐
fuelled growth during 2000–2007 was based upon its perceived excellence in targeting and
integrating acquisitions. This perception, rooted in the success of its first major acquisition,
NatWest Bank, culminated in the disastrous takeovers of Citizens Bank of Ohio in 2004 and
ABN Amro in 2007.24
Benchmarking is ‘the process of identifying, understanding, and adapting outstanding
practices from organizations anywhere in the world to help your organization improve its
performance’.25 Benchmarking offers a systematic framework and methodology for identifying
particular functions and processes and then for comparing their performance with other
companies’. By establishing performance metrics for different capabilities, an organization
can rate its relative position. The results can be salutary: Xerox Corporation, a pioneer of
benchmarking during the 1980s, observed the massive superiority of its Japanese competitors
in cost efficiency, quality and new‐product development. Subsequent evidence showed wide
gaps in most industries between average practices and best practices.26

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104
Featured Example 3.2
F O U N DAT I O N S O F S T R AT E G Y

Appropriating returns from superior capabilities: Employees vs. owners

Investment banks offer an illuminating arena to view the conflict between employees and
owners to appropriate the returns to organizational capability. Historically, Goldman Sachs was
widely regarded as possessing outstanding capability in relation to merger and acquisition
services, underwriting new issues and proprietary trading. These capabilities combine
several resources: a high level of employee skill, IT infrastructure, corporate reputation and
the company’s processes and culture. All but the first of these are owned by the company.
However, the division of returns between employees and owners suggests that the former has
had the upper hand in appropriating rents (Table 3.5).

Table 3.5  Profits, dividends and employee compensation at Goldman Sachs.

2008 2009 2010 2011
Net profits  $4440m $13 390m  $8354m  $4442m
Dividends to ordinary shareholders   $638m   $579m   $819m   $780m
Total employee compensation $20 237m $16 190m $15 380m $12 200m
Compensation per employee $344 900 $498 000 $430 000 $366 360

In professional sport, it would appear that star players are well positioned to exploit
the full value of their contribution to their team’s performance. The $27.8 million salary paid
to Kobe Bryant for the 2012/13 NBA season seems likely to fully exploit his value to the Los
Angeles Lakers.
Similarly with CEOs. Disney’s CEO, Robert Iger, was paid $31.4 million in 2011. But
determining how much Iger contributed to Disney’s 2011 net income of $5260 million as
compared with that of Disney’s other 156 000 employees is unknown.
The more an organization’s performance can be identified with the expertise of an
individual employee, the more mobile is that employee, and the more likely that the
employee’s skills can be deployed with another firm, the stronger is the bargaining position
of that employee.
Hence, the emphasis that many investment banks, advertising agencies and other
professional service firms give to team‐based rather than individual skills. ‘We believe our
strength lies in … our unique team‐based approach,’ declares audit firm Grant Thornton.
However, employees can reassert their bargaining power through emphasizing team mobility:
in September 2010, most of UBS’s energy team moved to Citi.

However, benchmarking carries risks. Dan Levinthal points to the danger of looking at
specific practices without taking account of interdependencies with other processes and the
organizational context more broadly: ‘Companies should be cautious about benchmarking
or imitating certain policies and practices of other firms … the implicit assumption in this
thinking is that the policy that is benchmarked and adopted is independent of what my firm is

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already doing. The best human resource management practice for Nordstrom may not be the
best for McDonald’s. It may actually be dysfunctional.’27 105
The authors’ own experiences with companies point to the need for benchmarking to

CHAPTER 3
be supplemented by more reflective approaches to recognizing strengths and weaknesses. It
is useful to get groups of managers together to ask them to identify things that the company
has done well in recent years and things that it has done badly, and then to ask whether any
patterns emerge.

R e s o u rce s a n d capa b i l i t i e s
Case Insight 3.5
Appropriating the returns from competitive advantage
As Figure 3.6 illustrates, the results posted by Harley‐Davidson from the mid‐1990s onwards
suggest that the company has been successful in appropriating the superior returns it
earns from its unique resources and capabilities. The company’s motorcycles sell at a
premium price and its share price, revenue and net income have (the recent economic
downturn apart) shown an upward trajectory. The strike at the York manufacturing plant
in 2007 illustrates the struggle that is present in many companies between employees and
shareholders as to the division of ‘rents’ between different stakeholders but, across the
piece, Harley has a track record of harmonious relationships with its employees, suppliers
and dealers.

8.0B
HOG Price
HOG Revenue 70 7.0B
HOG Net Income
60 6.0B
$58.7
$5.6B

50 5.0B

40 4.0B

30 3.0B

20 2.0B

10 1.0B
$6.23.9M

0 0.0B

–10 –1.0B
1995 2000 2005 2010

Figure 3.6  Harley‐Davidson’s share price, revenue and net income: 1995–2013.
Source: www.gurufocus.com.

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