What exactly are core competencies?

These are the collective skills and learnings in an organisation, especially those required for integrating and coordinating different technologies. Prahalad and Hamel cite the case of Casio, which coordinates its skills in miniaturisation, microprocessor design, material science, and ultra-thin precision casting to bring out a series of hit products - digital watches, miniature calculators, pockets TVs, and so on.

Why are these core skills important?

Most competitive advantages are difficult to sustain - rivals can quickly copy a company's products, buy the same machinery, and get into the same retail channels. But the ability to build key competencies and exploit them can yield a long-term competitive advantage, since organisational skills and learnings are difficult to copy.

In the Indian business press, core competence has come to be identified with firms that do not diversify, and instead stick to one product category. Selling off unrelated businesses might be an excellent idea per se, but it does not follow from Prahalad and Hamel's idea of core competence.

In fact, their article describes several firms with diversified product portfolios. Take the instance of Honda, which makes two-wheelers, cars, lawn mowers, generators, and so on. According to Prahalad and Hamel, it is Honda's skills in designing and developing engines and power trains (core competencies) that help the company make superior engines (core products), which in turn helps it sell more cars and generators (end products). Or take 3M, whose skills in substrates, coatings and adhesives makes it a winner in product categories that are as diverse as Post-It, photographic film, and projector slides.

What matters is not the number of product categories in which companies like Honda or 3M compete, but the manner in which they share, build upon and exploit critical skills. By advocating that firms should leverage their skills across businesses, the core competence theory could be said to actually support diversification.

Two conditions need to be satisfied: diversification must be into areas where these skills can provide competitive advantage, and to leverage these skills, the different businesses must be managed in an integrated fashion, not as autonomous entities (SBUs).

Prahalad and Hamel seem to suggest that there are economies of scale and economies of scope in the competencies that firms have, and that these are best exploited by related diversification.

Does not support vertical integration

The concept of core competence has little to do with vertical integration. Indian managers often think of vertically integrated firms - say, the Reliance group - as true followers of core competence. Vertical integration actually restricts the firm's ability to leverage competencies, since critical skills required in one stage of the value chain (say, purchasing skills in raw-material processing) will differ from those required in other stages (say, inventory control, or in-store promotions in retailing).

Forced to grapple with different sets of skills in different stages of its value-chain, the vertically integrated firm will not be able to reap core competence benefits.

According to the core competence theory, such firms will lose out to rivals - presumably less integrated - which can exploit common skills.
Rather than core competence, it would be more appropriate to explain vertically integrated firms' success and failure using `structural' theories - such as economies of scale, entry barriers, and so on.

Developing competencies is tough

Competing on the basis of core competence is a complex task. It takes a lot of time, money and effort to identify critical skills, create organisational mechanisms to nurture them, form joint-ventures to facilitate learning, and so on. In some of the cases mentioned by Prahalad and Hamel - NEC, Canon, Komatsu, and so on - this took nearly two decades. Unfortunately, the popular impression is that acquiring or divesting a few businesses is all it takes to develop core competence.

Even if a firm builds a few core competences, its success is not guaranteed - it must translate these into products which customers buy. This requires a robust organisation structure, functional systems, leadership, resources, and so on. Prahalad and Hamel cite the case of the Dutch multinational Philips, which developed expertise in optical-media technology but could not translate it into market share in CD players.

Only a firm that has all-round excellence will be able to convert core competencies into winning strategies. A firm with organisational weakness that attempts to develop a core competence is like a chess novice trying out Gary Kasparov's latest opening style.

Not critical in the Indian context

There are two reasons why the core competence argument is not critical in the Indian context. Firstly, we have too many market imperfections for any theory to be applied satisfactorily. As Harvard professors Krishna Palepu and Tarun Khanna argue, firms can earn abnormal profits by exploiting market imperfections in a developing economy.

Not only do market imperfections present juicier opportunities for profits, they also restrict the firm's ability to derive full mileage from its core competencies. In the relatively more 'perfect' Anglo-Saxon markets - where intense competition makes other competitive advantages unsustainable - the core competence approach could yield results. For the same reason, the Japanese cases of core competence cited by Prahalad and Hamel need to be treated with caution - Japan is hardly a perfect market, and it is quite conceivable that these firms could have benefited from some other source of competitive advantage.

Second, the key task facing Indian firms is not the development of core skills to compete globally in the year 2020, but undergoing surgery to survive in 1999. This calls for business portfolio rationalisation, organisational restructuring, financial restructuring, outsourcing, and so on.

The concept of skill-based competition is relevant only after the initial surgery is over, and the organisation is ready for more complex challenges. Core competence is desirable but not essential, at least in the medium term.

Other common misconceptions

Many managers confuse core competence with key success factors, assets and product range. Some say their core competence is in the `cement business', others see it in their `advanced machinery', and still others say their `distribution network' is their core competence. This reflects a gross misunderstanding about what constitutes a core competence - as the word indicates, core competence is all about skills.

It has nothing to do with a company's product range (cement), assets (machinery or brand image), functional systems (distribution system) or other advantages (empowered employees).

Another common error is to attribute the success of certain firms to their supposed pursuit of core competence. If the firm has actually developed and exploited its core competences, it will gain a certain amount of competitive advantage. But core competence is not the only source of competitive advantage - the firm could benefit from ‘structural’ factors, for instance.

It is the combined effect of all these sources of competitive advantage which determines whether the firm will succeed or fail. To attribute a firm's success solely to its core competence strategy is to make the same mistake as the five blind men who came across the elephant.


Source: The Strategist, Business Standard, 19 Oct 1999
(Available Online at http://www.bsstrategist.com/99oct19/5story.htm accessed on 31 Oct 2000)
The author is a consultant with A F Ferguson & Co.