Resource Based Strategy
Resources are one of the primary sources of competitive advantage. Economizing is fundamental to profitable business and is a key benefit of an organization. This note summarizes how to implement resource-based strategy and for the entire firm and how to use it to drive your profit margins at the overall firm level and your contribution margins at the operational level.
Why should I read this?
You would like to make your decisions more strategic, positioning your firm as well as you can in a competitive market, and you would like to get the most out of your valuable resources. You want to identify tactics that will increase your margins and sustain these increases.
At the business strategy level: For top management the resource based strategy perspective entails:
· Understanding the potential present and future value of resources at hand, and of resources that might be acquired
· Minimizing their waste
· Maximizing their potential
· Organizing these resources to capture their potential and put them to effective use
· Continuously nurturing, saving and growing resources and capabilities to position your business for the future.
In an influential paper, Jay Barney (1991) contributed a simple framework for a strategist to evaluate the potential of a resource to yield competitive advantage. At the firm level, management must be concerned with gathering valuable resources that are rare and hard to imitate. But that is not enough, subsequent strategists pointed out that having valuable, rare and inimitable resources is not enough. They must also be resources that can be successfully integrated into the existing operations and processes so that the value that they were supposed to bring actually gets extracted and appropriated to it strategic target (a bank account, surplus consumer value, lower production costs, community services – some visible and identifiable contribution to the mission of the organization. Barney subsequently published the “VRIO” framework for firm-level strategic management.
- V. Gather valuable resources.
- R. Try and get some valuable resources that are rare, or at least somewhat rare. Resources that everyone else you compete with does not have.
- I. Try to get some valuable and rare resources that will be especially hard or expensive or very time consuming for others to imitate.
- O. Make sure your organization and its processes can accommodate, accentuate and appropriate the value that your rare rare and hard to imitate resources contain.
The “O” is critical. Without the organization, firms are stuck with mostly unrealized potential. As any professional sports organization proves: just gathering valuable and rare and hard to imitate resources is not enough. Management must make sure the embodiment of the resource, (i.e. that implementation of the resource into the organization and situation) actually yields surplus value. Without proper strategic organization, the value of the resource will remain latent or will be appropriated by agency problems or the cost of integration difficulties.
The evidence of competitive advantage is earning above industry average economic returns. Therefore any applied understanding of strategy should be linked to profitability. There are only three ways to increase profits from your operations.
· You find you can charge a bit higher price for each product or service without selling less quantity.
· You find that it costs you a bit less to provide each product or service and still able to sell the same amount of the products or service without having to lower the price.
· You find you can sell a higher quantity of your product or service without raising your costs or lowering your prices.
At the firm-level, the brewery management should know what the operating profit/ loss is, and have a goal for where you want to get to next year, and over a longer period of time. The logic is simple. Profit margin is the standard difference between the price customers pay for your products or services and the costs of those products or services.
Operating Profit = Operating Revenue – Operating Costs
Operating profitability is often managed by knowing the profit margin percentage, that is, what percent of your operations revenue is profit? Is it 5%, is it 15%, is it 55%?
Profit margin %= (Operating Revenues -Operating Costs)/(Operating Revenues)
Strategically, managers set goals for both the $ amount and the margin percentage amount. If operating profit is currently $50,000, you might set a goal of $75,000 for next year. If operating profit margin percent is currently at 8%, we might set of goal for the year to get it to 10%.
Building competitive advantage at the tactical and operational level
Tactics are the programs and processes and policies that are put in place to reach strategic goals or to solve systematic (ongoing, repeated) organizational challenges. Good tactics yield competitive advantage. They do this by always achieving at least one of two main things:
· A good tactic reduces costs without sacrificing value (quality, effectiveness).
· A good tactic delivers more value (quality, effectiveness) without increasing costs.
The ideal tactic both delivers more value and lowers costs at the same time. This is rare.
Contribution Margins are the amounts that individual product sales or activities contribute to your operating profits. Within your operations, you offer a bunch of different product and services. Let’s say you are a brewery that produces and sells four main beers: an India Pale Ale (IPA) and an Espresso Porter (EP) all year, and rotating seasonally a Winter Wheat Ale (WWA) and a Crisp Summer Blond (CSB).
Each time you sell one unit of anything you produce, it contributes a bit to your profit margin. This is called the item’s contribution margin. You should calculate and know this contribution margin by every unit that you sell you beer: by the barrel, by the keg, by the six pack 12oz bottle, by the six pack 12ox can, by the 20oz bottle, by the pint, by the glass. If you sell t-shirts, you should know the contribution margin for those.
Contribution Margin=Item Sales Price-Item Cost
At the micro level, a good strategic management policy is to maintain focus on the margin dollar amount and avoid focus on the contribution margin percentage. We get into details of why this is true in our discussion of menu engineering.
In order to boost the overall profit margin of the business, the average contribution margin of the items you sell has to go up. If you can charge a bit more for each barrel of IPA sold, without increasing the cost per barrel incurred to produce it, the contribution margin of a barrel of IPA has gone up.
To increase overall profitability of the business, try to sell more of the items with the largest contribution margins, and try to increase the contribution margins of the items that have lower contribution margins.
Bringing it back to resources and VRIO analysis
For every tactic considered as a possible solution to a problem, a possible path toward achieving a goal, or process that increases the likelihood fulfilling the firm’s mission, it should be vetted carefully against two things. First and foremost, always, is vetting a possible tactic against the corporation’s consciously chosen values, beliefs, expectations and assumptions. The WHY of the organization, and HOW of the organization. If those tactics pass core values filter, then move on to an analysis of their long-term capability to either lower costs or add customer value, and the feasibility of having enough of the needed resources to complete the tactics.
The most critical tactical issues are often also very basic. For example: Should we make our own beer or should we outsource production of our beer? Should we grow our own hops or should be buy them? Should I hire an administrative manager or should I do it myself? Should I open a brewpub or should I just brew beer and sell it to distributors? Should I self-distribute or go through a distributor? Should I put my beer in cans, or just stick to bottles and kegs? Should I sell beer internationally?
For each tactic we ask:
· How likely is it that this tactic will work?
· Assuming it does work, how valuable is this tactic? Does it really add value, only a little, or perhaps a lot? For whom?
· How likely is it to give us competitive advantage or a sustained competitive advantage? Go back to our VRIO analysis
To operationalize a tactic, it takes resources. The typical kinds of resources required are:
If we think a tactic will work, and that it will add value, the next step is to see how many resources the tactic will likely consume/utilize, and if management has advantageous access to any of the resources that will be needed.
For each resource, we ask
· How much of that resource will be needed to operationalize the tactic?
· Do we have a rare & advantageous access to that resource?
· Is that advantage easily imitate, or is it hard to imitate and thus more durable?
· For the whole tactic, do we have the organizational capability to implement it and extract the value?
Strategic Control: Tracking and Managing Advantageous Resources
We must to keep track of each time we have identified/utilized a resource that we claim to have advantageous access to. We remember for a few important reasons:
Firstly, we may end up making action decisions based upon the assumption that we have strategic access to a particular resource, and the action decision may rely upon a further assumption that this advantage is durable. Unless this decision passes the VRIO criteria sieve, then we may well have wasted our time and effort on something that does not offer a competitive advantage.
Secondly, if we have identified a resource that when utilized in our tactics may lead to competitive advantage then we should use that resource in a number of ways.
Thirdly, we have to make sure not to over-use a resource to the extent that there is not enough of it to cover all of the strategic uses we have proposed or that it becomes exhausted too quickly diminished, or broken down.
Barney, J. 1991. Firm Resources and Sustained Competitive Advantage. Journal of Management, 17(1): 99-121.