Internal firm analysis: Understanding a firm’s resources and capabilities

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Internal firm analysis – considering the resources and capabilities of the company – is an important component of strategic analysis. This article explores reasons for examining the firm’s internal resources.

Importance of building resources and capabilities

The resources and capabilities of a firm underpin the organization. They are the components, or building blocks, that allow the company to achieve its strategy. While the terms are often used interchangeably, we can think of resources and capabilities as:

  • Resources: The ‘things’ that a company has. This can include tangible resources, such as the facility, machinery, and employees, as well as intangible resources, such as culture and routines. 
  • Capabilities: What the company can do with its resources. This may be its ability to create engaging social media content, or its ability to develop innovative products. 

Having unique resources and capabilities – things that only you or a few other firms have – can allow your company to execute a different strategy than other firms. Your company can be differentiated from others, because the underlying resources and capabilities are different. 

Why managers can fail to examine the internal capabilities

While the ability of a company to compete in a market depends on its underlying resources and capabilities, it is easy for managers to overlook the internal capabilities of the firm. Building resources and capabilities is difficult – it can take many years, and repeated investments to develop resources that are comparatively rare. It requires a hard look at what the firm is good at and areas that it doesn’t lead.

Some managers are also predominantly focused on the external environment of the firm – the markets it serves and customer demands. While this is clearly important, there ultimately needs to be a match between the opportunities in the external environment and the ability of the company to capitalize on those opportunities. If a company lacks the underlying capabilities (or other firms are better positioned to take advantage of the opportunities), the company’s ability to be successful is likely to be impacted. 

The VRIO framework for examining the internal resources of a company

The VRIO framework is an important strategic framework for analyzing the internal resources of a company. The frameworks looks at analyzing key resources for the firm, asking:

  • Valuable: Is the resource valuable for the company – important for achieving the company’s strategy. 
  • Rare: Is the resource relatively unique to the company – something that few other firms have. 
  • Inimitable / Non-substitutable: Is it hard for other companies to build up this capability
  • Organization: Is the firm organized to actually take advantage of the resource and capability. 

Gaining a competitive advantage from your resources

Stepping through the questions of whether a resource is valuable, rare, hard to imitate or substitute, and whether the firm is organizationally set up to capitalize on the resource can help understand the extent to which this resource can be a source of competitive advantage for the firm. 

If a resource is not valuable to implementing the company’s strategy it is not worth talking about – potentially old equipment or a disused facility, that is not directly helping the firm, and may even be hurting it from the distraction or costs of maintaining it. 

If a resource is rare (and valuable), it starts to provide the opportunity for a competitive advantage – having something important for your strategy that other firms don’t possess can enable you to do things that they are not able to do. While it still may be necessary to have resources that are not rare (i.e., to get competitive parity with your peer companies), having rare valuable resources starts to get you a competitive advantage.

Maintaining that competitive advantage

Maintaining a competitive advantage requires that the underlying resource is hard to imitate or substitute. If the resource can easily be copied, or worked around, then the advantage that you have is likely to be temporary in nature – beneficial for the firm, but likely to erode over time as other firms start to imitate.

On the other hand, if you have resources that are hard for other firms to imitate, this competitive advantage can be sustained over a longer period of time.  

Capturing the advantage: Having an organizational setup that takes advantage of the resource or capability

It is finally important to recognize that simply having a valuable, rare, hard to imitate resource is not important in itself unless the firm actually recognizes it and takes advantage of it. There needs to be alignment between the resource and other parts of the firm, and failure to actually have an organizational setup that capitalizes on the resource has the potential to leave the possibility of a competitive advantage underexploited. 

Final thoughts: There needs to be alignment between the internal resources and the external demands of the market

Just as managers can fall into the trap of being overly focused on the market demands, it is also possible to be overly focused on internal resource development. Ultimately the abilities that the firm is developing needs to be aligned with market demands. It is ultimately important that there is a market opportunity, and that the internal resources are setup to capture upon this demand.