CHAPTER 3

Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability

SYNOPSIS OF CHAPTER
The goal of this chapter is to explore the basis of competitive advantage at the level of the individual company. Put another way, the central question with which the chapter deals is why, within a given industry, some companies do better than others. This is a very important chapter because it introduces a framework for understanding competitive advantage that will be used throughout the rest of the book. The chapter opens with a presentation of a basic model of competitive success. The text asserts that, to gain a competitive advantage, the firm must adopt an effective strategy, which will lead to the formation of distinctive competencies, or firm-specific strengths. The distinctive competencies arise from the firms resources and capabilities. Successful firms adopt strategies that build upon existing competencies or develop new competencies. Next, the text explains that companies use their competencies to offer superior value to customers. The relationship between pricing, demand, costs, and differentiation is explored, as they relate to the creation of superior value. The discussion of the value chain aims to show students how the different value-creation activities of a company fit together. A point strongly emphasized here is that each of the value chain activities is a potential source of value creation. The chapter then examines the role of distinctive competencies in helping to achieve the four generic building blocks of competitive advantage: superior efficiency, quality, innovation, and customer responsiveness. Companies that have superior performance in one or more of these areas are able to differentiate their products and/or reduce costs, which leads to value creation and higher profitability. The financial calculation of superior value (profitability) is explored in detail. The durability of competitive advantage is the focus of the next section, which argues that the durability of a companys competitive advantage is a function of three factors: the height of barriers to imitation, the capability of competitors, and the general dynamism of the industry environment. Finally, the chapter addresses the reasons why formerly successful companies fail, focusing on organizational inertia, past strategic commitments, and the Icarus paradox. The concluding section of the text mentions ways that companies can avoid competitive failure and sustain a competitive advantage.

TEACHING OBJECTIVES
1. 2. 3. 4. 5. 6. Examine the internal causes of competitive success and failure. Show how effective strategies create distinctive competencies, including resources and capabilities, which then aid a firm in achieving competitive advantage. Describe the process of value creation, using the concepts of pricing, demand, costs, and differentiation. Familiarize students with the concept of the value chain, and show how the different value-creation activities of a company fit together. Explain how distinctive competencies lead to superior efficiency, quality, innovation, and responsiveness to customers, which in turn allow a company to differentiate its products and lower its costs. Describe how competitive advantage leads to higher profitability, using financial measures.

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7. 8. 9.

Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability Identify the factors that influence the durability of a companys competitive advantage, including the height of barriers to imitation, the capability of competitors, and industry dynamism. Explain the role played by organizational inertia, past strategic commitments, and the Icarus paradox in the failure of many formerly successful companies. Discuss the steps that companies can take to avoid failure and sustain a competitive advantage.

OPENING CASE: BJS WHOLESALECOMPETITIVE ADVANTAGE

The Opening Case describes the competitive advantages enjoyed by BJs Wholesale, a membership-based discount retailer that uses a business model similar to that of Costco or Sams Club. The firms in this industry provide a limited selection of products in a no-frills environment, keeping costs low, and allowing them to sell a high volume of low-priced products. BJs is the smallest of the big three competitors, but the most rapidly growing and the most profitable. BJs competitive advantages include a location clustering strategy for efficiency, a focus on markets with lower entry costs such as suburbs and small towns, a retail customer orientation that allows them to charge slightly higher prices, and an information system that lowers costs and further increases efficiency. Teaching Note: This case provides an overview of many of the important concepts of this chapter, including resources and capabilities, distinctive competencies, competitive advantage, profitability and other performance measures, and the role of strategic choice in developing distinctive competencies. The Opening Case also provides several examples of value chain functional area, including location selection (infrastructure), high volume ordering (materials management), and acceptance of credit cards (customer service).

LECTURE OUTLINE
I. Overview A. The choice of industry affects firm performance but, within any given industry, some companies are more profitable than others. Why do some companies do better than their competitors? What is the basis of competitive advantage? B. Internal analysis leads to the identification of a firms strengths and weakness, and especially its distinctive competencies, including its resources and capabilities. C. Distinctive competencies enable firms to create superior value for customers, by helping them to achieve the four main building blocks of competitive advantage: efficiency, quality, innovation, and responsiveness to customers. D. Superior value creation is driven by a firms ability to differentiate its products or reduce its expenses. When firms are able to create superior value, they experience higher profitability. E. Its also important for firms to sustain their competitive advantages over time, to maintain their competitive advantage, and to take steps to avoid competitive failure. Distinctive Competencies and Competitive Advantage A. A company has a competitive advantage when its profit rate is higher than the average for its industry, and it has a sustained competitive advantage when it is able to maintain this high profit rate over a number of years. B. Competitive advantage derives from a firms distinctive competencies, which are of two types: resources and capabilities. 1. Resources refer to the financial, physical, human, technological, and organizational resources of the company. They can be divided into tangible resources, such as land, buildings, plant, and equipment; and intangible resources, such as brand names, reputation, patents, and technological or marketing knowledge. a. Resources that are firm-specific and difficult to imitate are unique. Resources that create a strong demand for the firms products are valuable. b. Unique and valuable resources lead to a distinctive competency. 2. Capabilities refer to a companys skills at coordinating its resources and putting them to productive use. a. These skills reside in the way a company makes decisions and manages its internal processes.

II.

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Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability b. 3.

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Capabilities are, by definition, intangible. They reside not so much in individuals as in the way individuals interact, cooperate, and make decisions within the context of an organization. The distinction between resources and capabilities is of the utmost importance in understanding the source of a distinctive competency. A company may have unique and valuable resources, but unless it has the capability to use those resources effectively, it may not be able to create or sustain a distinctive competency. Thus, unique and valuable resources are helpful in creating distinctive competencies, but capabilities are essential. Show Transparency 15 Figure 3.2: Strategy, Resources, Capabilities, and Competencies

C.

A companys profit rate and hence competitive advantage is determined by the value customers place on the companys goods or services, the price the company charges for the products or service, and the companys costs of production. 1. Value is assigned by customers based on product attributes such as performance, design, and quality. The more value a company creates, the more flexibility it has in assigning a price. 2. The price a company charges is typically less than the value assigned by the consumer. The customer captures that difference in value as a consumer surplus, which occurs because the company is competing with other companies and so must charge a lower price than it could as a monopoly supplier. 3. Another factor that causes the price to be lower than the value is the impossibility of segmenting the market so that the company can charge each customer a price that reflects that individuals reservation price (their assessment of the value of a product). Show Transparency 16 Figure 3.3: Value Creation per Unit 4. Looking at Figure 3.3, the companys profit margin is equal to the difference between price and costs (PC), whereas the consumer surplus is equal to the difference between value and price (VP). The company makes a profit so long as the price is greater than the cost. Its profit rate will be greater the lower costs are, relative to the price. The lower the competitive intensity, the greater the difference that can exist between price and value. Looking at Figure 3.4, a company can create more value for its customers in two ways. a. Under Option 1, a company can make the product more attractive, raising costs (C) but also raising value (V). Customers are then willing to pay a higher price (P increases). b. Under Option 2, a company can lower its price (P), creating a higher value (V), more demand, and increased volume of sales. Economies of scale realized because of the increased volume allow the company to reduce its costs (C). Show Transparency 17 Figure 3.4: Value Creation and Pricing Options

5.

D.

Low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry. Competitive advantage (and higher profits) goes to those companies that can create superior valueand the way to create superior value is to drive down the cost structure of the business and/or differentiate the product in some way so that consumers value it more and are prepared to pay a premium price. Show Transparency 18 Figure 3.6: The Roots of Competitive Advantage

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III.

Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability The Value Chain A. A companys value chain is a sequence of interrelated activities for transforming inputs into outputs that customers value. The process consists of a number of primary activities and support activities, each of which can add value to the product. Show Transparency 19 Figure 3.7: The Value Chain 1. Primary activities have to do with the design, creation and delivery of the product, its marketing, and with its support and after-sales service. There are four primary activities: research and development, production, marketing and sales, and service. a. Research and development (R&D) is concerned with the design of products and production processes. R&D occurs in manufacturing enterprises as well as service companies. By superior product design, R&D can develop superior product designs, which increase the functionality of products, making them more attractive to consumers. Alternatively, R&D may develop more efficient production processes, lowering costs. b. Production is concerned with the creation of a good or service. For physical products, production means manufacturing. For services, production takes place when the service is actually delivered to the customer. The production function creates value by performing its activities efficiently so that lower costs result. Production can also create value by performing its activities in a way that is consistent with high product quality, which leads to differentiation and lower costs. c. Marketing and sales functions create value through brand positioning and advertising, which increase the perceived product value. They also create value by discovering consumer needs and communicating them to the R&D function of the company, which can then design products that better match those needs.

STRATEGY IN ACTION 3.1: VALUE CREATION AT PFIZER

Prozac, introduced by Eli Lilly, was the market leader in antidepressant drugs. But in 1992, rival Pfizer introduced its own antidepressant, Zoloft, which is very similar to Prozac and has been gaining share from Lilly. Zolofts success is due to an aggressive marketing and sales campaign designed to convince physicians that Zoloft is a safer drug. Pfizer salespeople also logged more face time with physicians than Lillys, and Pfizer focused on visits to primary care physicians, who increasingly prescribe antidepressants but are less familiar with them than are psychiatrists. Pfizer has enjoyed rapidly increasing revenues and market share and, therefore, a greater return on the companys investment in developing Zoloft. Teaching Note: This case describes Pfizers ability to create value for customers through the value chain function of marketing and sales. The case notes several specific actions taken by the firm to differentiate their products from those of their competitors. The actions included publishing the results of safety comparisons describing Zoloft as safer than Prozac, spending more time on physicians visits, and focusing on the more malleable primary care physicians, rather than psychiatrists. One good discussion point would be to ask students whether these actions might be expensive or difficult for other firms to imitate. Students can then predict whether these actions would be likely to lead to a sustained competitive advantage for Pfizer. The role of the customer service function is to provide after-sales service and support. This function can create a perception of superior value in the minds of consumers by solving customer problems and supporting customers after they have purchased the product. The support activities of the value chain provide inputs that allow the primary activities to take place. a. The materials management function controls the transmission of physical materials through the value chain, from procurement through production and into distribution. The efficiency with which this is carried out can significantly lower cost, thereby creating more value. d.

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Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability b.

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IV.

The human resource function helps to create value by ensuring that the company has the right mix of skilled people to perform its value creation activities effectively. It is also the job of the human resource function to ensure that people are adequately trained, motivated, and compensated to perform their value creation tasks. c. Information systems refer to the (largely) electronic systems for managing inventory, tracking sales, pricing products, selling products, dealing with customer service inquiries, and so on. Information systems, when coupled with the communications features of the Internet, are holding out the promise of being able to alter the efficiency and effectiveness with which a company manages its other value chain activities. d. The final support activity is the company infrastructure, or the company-wide context within which all the other value-creation activities take place. The infrastructure includes the organizational structure, control systems, and organizational culture. Because top management can exert considerable influence in shaping these aspects of a company, they should also be viewed as part of the infrastructure of a company. The Generic Building Blocks of Competitive Advantage A. Four generic factors build competitive advantage by allowing companies to better differentiate their products or become more efficient in reducing costs: efficiency, quality, innovation, and responsiveness to customers. They are generic because they represent actions that any company can adopt, irrespective of industry. The factors are all highly interrelated. Show Transparency 20 Figure 3.8: Generic Building Blocks of Competitive Advantage B. Efficiency is measured by the cost of inputs required to produce a given output. 1. The more efficient a company, the lower the cost of inputs required to produce a given output. Thus efficiency helps a company attain a low-cost competitive advantage. 2. One of the keys to achieving high efficiency is utilizing inputs in the most productive way possible. Companies with high employee productivity and capital productivity will have low costs of production.

STRATEGY IN ACTION 3.2: SOUTHWEST AIRLINES LOW COST STRUCTURE

Southwest Airlines has consistently achieved the lowest costs in the industry, enabling it to grow market share by offering lower prices, and helping the firm to weather industry downturns. A major contributor to the low costs is the companys high employee productivity, enabling them to serve more passengers with fewer personnel. High productivity is due to a number of factors, including care in hiring. The firm is known for hiring only those with positive attitudes and good teamwork skills. Incentives such as profit sharing also encourage hard work and cooperation. Another contributor is its no-frills operations, with only one type of aircraft, no meals, no assigned seats, and no paper tickets. Operations costs are further reduced because the firm only flies point-to-point, and doesnt use a hub system, as most of the other major carriers do, reducing the need for a large number of gates and personnel. Teaching Note: This case illustrates a number of ways in which Southwest Airlines has fostered high employee productivity and high capital productivity. Southwest has scrutinized each area of airline operations, from ticketing to baggage handling to food service to aircraft maintenance to route scheduling, for opportunities to drive down costs. Southwests efficiency creates a challenge for competitors. Classroom discussion of the case could center on the question of whether any firm could hope to imitate Southwests low-cost competitive advantagethe answer would probably be negative, at least in the short term. A follow-up question could address the possibility of a successful competitive attack by an airline pursuing a different strategy. What resources and capabilities would be required for such an attack, and how might it lead to changes in the airline industry? C. Quality products are goods and services that have attributes that customers perceive as desirable. On important attribute is reliability, meaning that the product does the job it was designed for and does it well. Quality applies equally to goods and to services. 1. Providing high-quality products creates a brand-name reputation for a companys products. In turn, this enhanced reputation allows the company to charge a higher price for its products.

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Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability 2. Higher product quality can also result in greater efficiency, with less employee time wasted fixing defective products or services. This translates into higher employee productivity, which means lower unit costs.

STRATEGY IN ACTION 3.3: CONTINENTAL AIRLINES GOES FROM WORST TO FIRST

In 1994, Gordon Bethune became CEO of Continental Airlines, which had the lowest customer satisfaction and on-time ratings of any U.S. air carrier. Bethune felt that the firm had cut costs too low, and decided to spend more in order to improve quality. He set a goal for reliability improvement and gave bonuses when this goal was met. Within a year, the firm ranked in the top three in reliability, and it still does. In addition, Bethune empowered front-line employees to handle contingency situations as they saw fit. The increased flexibility and decentralization has had a tremendous impact on customers perception of the quality of service they receive at Continental. Teaching Note: This case provides an excellent example of the ways in which higher quality can contribute to higher efficiency. Continental experienced a dramatic increase in employee productivity, and that higher level of effort by employees led to improved on-time performance and higher customer satisfaction. Through the changes described in this case, Continental was able to both reduce costs and increase differentiation. Ask students to consider the information in this case in conjunction with that presented in Strategy in Action 3.2, about Southwest Airlines. Which of the two firms has the greatest competitive advantage? Why? How long will that competitive advantage endure? What will it take for other firms to successfully imitate or bypass that advantage? Process innovation occurs if there is anything new or novel about the way a company operates. Product innovation occurs if there is anything new or novel about the companys products. Thus innovation includes advances in the kinds of products, production processes, management systems, organizational structures, and strategies developed by a company. 1. Successful innovation gives a company something unique that its competitors lack (that is, until imitation occurs). This uniqueness allows a company to differentiate and charge a premium price. 2. Successful innovation may also allow a company to reduce its unit costs. E. Achieving customer responsiveness requires that a company give its customers exactly what they want when they want it. It involves doing everything possible to identify customer needs and to satisfy those needs. 1. One way to increase customer responsiveness is to improve the efficiency production processes and the quality of products. 2. Another way to increase responsiveness is to develop new products that have features currently not incorporated in existing products. 3. Another way to increase responsiveness is to customize goods and services to the unique demands of individual customers. 4. Another way to increase responsiveness is to reduce customer response time, or the amount of time it takes for a good to be delivered or a service to be performed. F. In summary, superior efficiency enables a company to lower its costs; superior quality enables a company both to charge a higher price and to lower its costs; superior innovation can lead to higher prices or lower unit costs; and superior customer responsiveness enables a company to charge a higher price. Analyzing Competitive Advantage and Profitability A. Managers must understand the financial impact of their strategies. They can compare their processes and outcomes to competitors, using benchmarking. B. The most widely used measure of financial performance is profitability. 1. Profitability can be measured in different ways, but return on invested capital (ROIC) is one of the most widely used. Show Transparency 21 Figure 3.10: Drivers of Profitability (ROIC) D.

V.

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Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability 2.

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C.

ROIC is calculated as net profits divided by invested capital. ROIC represents the effectiveness with which a company is using the funds it has available for investment. 3. ROIC can be decomposed into two parts. Return on Sales is calculated as net profit divided by revenues, and represents how effectively the company converts sales revenues into profits. Capital turnover is calculated as revenues divided by invested capital, and represents how effectively the company uses its invested capital to generate revenues. Managers can increase profitability by increasing return on sales, either by reducing expenses for a given level of sales, or by increasing sales revenues faster than expenses. They can also increase profitability by getting more sales revenue from their capital investment.

RUNNING CASE: DRIVERS OF PROFITABILITY FOR DELL COMPUTER AND COMPAQ

Dell enjoys a low-cost competitive advantage, leading to an ROIC of 38 percent, as compared to Compaqs ROIC of 13 percent. Dells COGS is higher than Compaqs, but its SG&A expenses are lower, due to Dells use of a direct sales model, with much lower sales, distribution, and retailing expenses. In addition, Dells focus on low cost PCs helps to keep its expenses low, while Compaqs expenses are greater because it is trying to differentiate its products with proprietary technology. Also, Dells PPE expenses are just one-third of Compaqs, as a result of Dells low inventory, efficient manufacturing processes, and web-based information system. [Compaq was acquired by Hewlett Packard in 2001.] Teaching Note: Dells low-cost, direct sales business model has been remarkably successful, giving the firm an ROIC that is three times greater than its nearest competitors. Dell has reduced expenses in many areas of its operations, as evidenced by the figures quoted in the case. You can ask students to consider whether Compaq will ever be able to successfully imitate Dells low-cost strategy. They are likely to decide that Compaq cannot. Next, ask students whether that implies that Compaq will ultimately fail, or whether they could succeed by adopting a different strategy. Classroom discussion could include ideas for alternative strategies that might be useful to Compaq in competing against Dell. This case, like several in this chapter, has an important but veiled message about the impact of strategy on performance. You should make sure that students understand this point: Strategies can give firms a powerful, sustained advantage, however, there are always other strategies that could also lead to success. Managers must seek out alternate strategies if they want their firms to succeed against powerful rivals. VI. The Durability of Competitive Advantage A. Durability refers to the length of time that a competitive advantage lasts, once it has been created. Successful companies earn above-average returns, which send a signal to competitors. B. Three factors lead to durability: high barriers to imitation, poor capability of competitors, and low dynamism in the industry. 1. Barriers to imitation are factors that make it difficult for a competitor to copy a companys distinctive competency. The longer it takes to imitate a companys distinctive competency, the greater is the opportunity for the company to improve on that competency or build other competencies. a. The easiest distinctive competencies to imitate are those based on firm-specific tangible resources such as buildings, plant, and equipment, which are visible to competitors and can be readily purchased. b. Intangible resources are more difficult to imitate. Brand names symbolize a companys reputation, and are protected by law. c. Marketing and technological know-how are intangible resources that are relatively easy to imitate. (1) Marketing strategies are visible to competitors, and the movement of marketing personnel between companies facilitates the diffusion of know-how. (2) Technological know-how should be protected by patents, but in practice, it is often possible to invent around patents. d. Imitation of capabilities is more difficult than imitation of resources. Capabilities are often invisible to outsiders, and are based on the way in which decisions are made and processes managed deep within a company. Also, a companys capabilities are not dependent upon one individual, but are the product of how numerous individuals interact

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Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability

within a unique organizational setting. Thus, no one person can duplicate capabilities, and therefore personnel movement will not be as useful in imitating capabilities. 2. When a company is committed to a particular way of doing business based on a set of resources and capabilities, the company will find it difficult to respond to new competition if doing so requires a break with this commitment. This influence on the durability of competitive advantage is called capability of competitors. a. A related concept is absorptive capacitythat is, the ability of an enterprise to identify, assimilate, and utilize new knowledge. Firms with a low absorptive capacity may experience an internal inertia that slows their ability to innovate and imitate. b. Therefore, when innovations reshape the rules of competition in an industry, value often migrates away from established competitors and toward new enterprises that are operating with new business models. 3. Industry dynamism refers to the rate of product innovation. A high dynamism (rapid rate of innovation) means that product life cycles are shortening and that competitive advantage can be very transitory. Durability of competitive advantage is difficult for any company to sustain in a highly dynamic industry. VII. Avoiding Failure and Sustaining Competitive Advantage A. Failing companies are not just below average; they earn very low or negative profits. Three related reasons for failure are explored here: inertia, prior strategic commitments, and the Icarus paradox. 1. The inertia argument is that companies find it difficult to change their strategies and structures in order to adapt to changing competitive conditions. a. An organizations capabilities contribute to inertia, because they are difficult to change. Changing capabilities would require a redistribution of power and influence among the key decision makers, and therefore will be resisted. Turf battles may result. b. Thus, capabilities can provide competitive advantage and also competitive disadvantage. 2. Prior strategic commitments, such as investments in specialized resources, may also contribute to competitive failure, because the resources are not well suited for other, evolving uses. Changing resources is difficult and expensive. 3. The Icarus paradox is based on the Greek myth of Icarus, who made himself a pair of wings from wax and feathers, then flew so well that he went too close to the sun, melting the wings and plunging to his death. The paradox is that his greatest asset, his ability to fly, gave rise to his demise. a. Many successful companies become so dazzled by their own early success that they believe that pursuing the same course of action is the way to future success. They may pursue strategies such as craftsmen, builders, pioneers, and salesmen. b. This attitude, however, leads a company to become so specialized and inner-directed that it loses sight of market realities and the fundamental requirements for achieving a competitive advantage. Sooner or later failure ensues.

STRATEGY IN ACTION 3.4: THE ROAD TO RUIN AT DEC

By 1990, DECs superiority in producing high quality VAX minicomputers made it one of the largest corporations in the world. However, the companys success carried the seeds of its destruction. An increasingly narrow focus on engineering capability led to a neglect of other functions, and the firm became dangerously out of touch with changing customer needs and industry conditions. DEC went through a terrible change of fortune in the early 1990s, returning to profitability only with the ouster of CEO Ken Olsen and a drastic change in strategy. DEC was acquired by Compaq in 1998. [Compaq was acquired by Hewlett Packard in 2001.] Teaching Note: This case provides a striking example of how successful firms can lose their competitive advantage, through strategic mis-steps. To facilitate classroom discussion, you can ask students to describe the causes of DECs failure, using the terms identified in section VII above. Students will see that DEC suffered from all three of the major causes of failure. The firms large size led to inertia, making it more difficult for DEC to adapt, and CEO Olsen was one of the worst offenders in terms of protecting his turf from changes proposed by others. DEC also had prior strategic commitments, in the form of specialized engineering know-how, which made change less likely. Finally, DEC suffered from the Icarus paradox. Dazzled by its early success, it became so specialized and inner-directed that it lost sight of customers and competitors, leading to strategic failure.

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Chapter 3: Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability B.

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To avoid failure, companies can focus on the building blocks of competitive advantage, institute continuous improvement and learning, track best industrial practice and use benchmarking, and overcome inertia. Managers can also learn to exploit luck. 1. Maintaining a competitive advantage requires a company to continue focusing on the four generic building blocks of competitive advantageefficiency, quality, innovation, and customer responsivenessand to do whatever is necessary to develop distinctive competencies that contribute toward superior performance in these areas. 2. In todays dynamic and fast-paced environments, the only way that a company can maintain a competitive advantage over time is to continually improve its efficiency, quality, innovation, and customer responsiveness. The most successful firms are those that continually learn, seeking out ways of improving their operations and constantly upgrading the value of their distinctive competencies or creating new competencies. 3. One of the best ways to develop distinctive competencies is to identify best industrial practice and to adopt it. Only by doing so will a company be able to build and maintain the resources and capabilities that underpin excellence in productivity, quality, innovation, and customer responsiveness. 4. The ability to overcome the inertial barriers to change within an organization is one of the key requirements for continuing to maintain a competitive advantage. 5. Luck can play a critical role in determining competitive success and failure, but it is an unconvincing explanation for the persistent success of a company. It is difficult to imagine how sustained excellence could be the product of anything other than conscious effort, that is, of strategy. However, companies can be flexible and prepared to exploit lucky breaks as they occur.

STRATEGY IN ACTION 3.5: BILL GATES LUCKY BREAK

Bill Gates, founder of Microsoft, benefited from luck in the companys first product, the MS-DOS operating system. He knew that Seattle Computer had developed a PC operating system. Through his mothers business contacts, he knew that IBM was looking to acquire such a system. His father, a prominent Seattle attorney, was able to loan Gates the $50,000 to acquire the system from Seattle Computer, which was then licensed to IBM for a tremendous profit. There were several elements of luck in this beginning, but Microsofts continued high performance has been mainly due to Gates astute use of that initial profit to acquire resources and capabilities that would lead to enduring success. Teaching Note: Many students will enter the classroom with the idea that success is largely a matter of luck: knowing the right people, being in the right place at the right time, or experiencing a sudden and undeserved windfall. They have heard this idea many times in our popular culture and media. However, its important to stress to students that a sustained success over determined rivals is unlikely to be result of mere luck; rather, it is the logical result of a series of thoughtful and deliberate plans and actions. This case acknowledges the relatively limited role that luck can play in organizational success, while focusing attention on the ways in which planning has contributed to Microsofts more recent successes. To spark a classroom discussion, you can ask students to describe other examples of organizations that benefited from luck, such as a helpful change in tax policy or the development of a new product just as demand grew. Describe the benefits that came to the organization as a result of luck. Then, ask students to consider how long those benefits endured. Students will see that luck is useful, but transitory.

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