Besides the economic and organizational approaches, the literature also indicates another two similar approaches being used to formulate business strategy. The two approaches are the external and the internal approaches. Of these two approaches, the external approach has a wider focus and scope. The external approach emphasizes that firms should develop their organizational strategies based on the analysis of their external business environment that consists of various environmental factors (such as political, economic, social, cultural, technology, ecology, government, legal, etc.). However, the internal approach suggests that firms should formulate their strategy based on the analysis of their internal environment (such as resources, structure and culture).
In the 1980s, it appeared that organizations had over-emphasized on the use of external analysis to develop their organizational strategies for competing as well as coping with the external business environment. More specifically, Porter [37] proposed that organizations adopt the external approach to develop their competitive strategies. The scholar emphasized that organizational strategies be formulated based on the information gathered from analyzing the industry structure as well as the competitive position of the organizations. According to Porter, organizational strategies formulated through the external approach can provide significant benefits to organizations.
However, there are scholars and experts who disagree with the external approach. Advocates of the internal approach argued that the external approach may not necessarily be the best way for organizations to formulate their strategies. This is because more often than not, the adoption of the external approach has resulted in the development of wish-driven or deliberate strategies. This approach also failed to recognize the fact that the external opportunities are just illusions for organizations that do not have the internal resources and capabilities needed to capture them. Furthermore, by using the external approach, organizations may eventually see and experience the same external threats and opportunities, as well as compete in the same manner as suggested by the economic theory of perfect competition. This in turn may lead to firms sacrificing their strategic position and long term performance.
Unlike the external approach, the internal approach emphasizes on the internal resources and capabilities of organizations to develop strategy. This approach is based on two assumptions. The first assumption is that the internal resources and capabilities provide the basic direction for a firm’s strategy. The second assumption suggests that resources and capabilities are the primary source of profit for the firm. By defining a business in terms of what it is capable of doing would offer the organization a more durable basis for formulating its business strategy.
The literature reveals that in the 1990s, faced with global competition, technological change, and threats by smaller and less hierarchical competitors, firms are driven again to look for new internal approaches to develop their business strategy. In addition, techniques such as total quality management, reengineering, core competence, competing on capabilities, and the learning organization have also been incorporated in the internal approach.
In short, the internal approach suggests that the organization develop its strategy based on the effective match between the external relationships of the organization and its own distinctive capabilities. In other words, the effectiveness of the business strategy formulated through the internal approach depends on how well it is able to exploit its distinctive capabilities. More importantly, according to this approach, strategy formulation should begin with an understanding of what the distinctive capabilities are.
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