Let's revisit our three steps for analyzing capabilities. We've discussed now how to identify the value chain, and use that to identify specific resourcing capabilities. The next thing we wanna ask ourself is how to assess the alignment of these capabilities, the collection of capabilities. Both internally and externally. So let me go into some deeper depth here. Internal alignment, this is a question of whether our people, processes and systems actually aligned with each other. Do they actually reinforce and build off of each other to deliver capability? We can probably all think of organizations where perhaps they didn't quite have alignment. Think about an organization that positions themselves to have an innovative capability and invests heavily in research and development and talent for creativity. But at the end of the day, doesn't celebrate creativity, doesn't reward creativity and maybe prohibits failure in the organization, which we often find that allowing some failure might be a prerequisite for creativity. In that case, we might say their system is not aligned, and it's very hard for them to have those human resource practices at the same time they're trying to build a capability to be innovative and creative. This is in the essence of what we mean by internal alignment. External alignment refers to the degree which the capabilities we possess are actually aligned with what the market demands, what customers want. The value proposition we are trying to create. One way to assess capabilities is what we call a VRIN analysis which stands for valuable, rare, inimitable, and non-substitutable. The idea being that a competitive advantage providing capability that satisfies all four of these conditions. In many ways, the external alignment question is a question about value. Does this actually provide value? Now this might seem obvious in many organizations, but we can think of some examples where there is just a complete dis-alignment between value created and the value desired by, let's say, customers. A classic example, if you go back over a hundred years, British coal mines were very famous for having these wonderful brass bands. Now I'm not sure what the story is for why they developed, this could be capability for having these wonderful brass bands. But one could imagine as a coal mining company, it's hard to argue why these valuable brass bands provided actual value for the business that they were in. So while these brass bands toured the country and were well respected, it's unclear they were externally aligned with the value proposition of the coal company. Let's consider another example, Nucor Steel. Nucor Steel is what we call a mini-mill in the larger steel industry. The steel industry itself is, like the airline industry, a highly competitive industry. We've seen numerous firms, especially in the US, go bankrupt, both large integrated steel mills, as well as mini-mills. It's an industry that we would characterize as a commodity-based industry, one in which there's really not much differentiation in terms of the products that come out. Steel is steel. However, there is the opportunity to be a lower cost provider in that industry. And as a result, that's in essence the nature of the competition. Well, Nucor Steel has been able to be a successful low-cost player within the steel industry going on 40 plus years now. And as a result, has grown to be one of the largest steel manufacturers in the world and the largest steel manufacturer in the United States. How did they achieve this? Well I would argue that they've been able to create two inter-reinforcing loops here, feedback loops, that provide them an advantage. At the end of the day their value proposition is very simply, low cost per ton of steel that they deliver. How do they do this? Well one way they do this is through what we call operating efficiency. The fact of the matter is they don't require that much labor to generate a ton of steel, lowering their cost structure. So, how do they generate operating efficiency? Well, they do it through a creative set of human resource management practices. In particular, they put in incentives, piece rate incentives and the like to encourage employees to work hard and work in a fashion that is consistent with what they are trying to achieve. What's interesting about that is, for their ability to achieve those human resource practices, they need high utilization. In other words, the plants need to be producing at near 100% capacity, and they need to be doing so on a regular basis. Otherwise these performance incentives that they're creating would not be sufficient to motivate the employees. So it creates this virtual cycle here where low cost per ton drives high utilization, allows them to adopt these progressive management practices that then drive up operational efficiency and lowers cost per ton again. Similarly, they have a very effective capital efficiency. It's a truism of a lot of manufacturers that having the latest new technology, new manufacturing plants, allows you to have a lower cost structure than older capital stock. So that ability to continually refresh and rebuild your capital, your physical plant, is very important in the steel industry. So how do they achieve this capital efficiency? Well, once again, through a set of very innovative and interesting capital resource management practices that allow them to have kind of the best technology in place at any one time. How do they achieve this? Well, what's interesting, is their ability to do this is really funded off the idea that because they're low cost, they generate excess earnings that they can then feed back into capital investment. And they've been able to keep their debt very low as a result, and they require a fairly substantial return on assets within five years of any capital investment they need. Yet again creating this virtual feedback loop here, where capital efficiency drives the low cost per ton and allows them to do rapid expansion and do effective capital resource management allocation, once again driving capital efficiency. So at the end of the day, we have a success story here with Nucor that's driven by the alignment of an underlying set of capabilities that they developed over time, that both deliver internally together. They're internally consistent. And externally as well, to the value proposition of the customers, in this case, low cost steel.
