SWOT Analysis

SWOT analysis

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SWOT analysis is a strategic planning method used to evaluate the Strengths, Weaknesses, Opportunities, and

Threats involved in a project or in a business venture. It involves specifying the objective of the business venture

or project and identifying the internal and external factors that are favorable and unfavorable to achieve that

objective. The technique is credited to Albert Humphrey, who led a convention at Stanford University in the 1960s

and 1970s using data from Fortune 500 companies.

A SWOT analysis must first start with defining a desired end state or objective. A SWOT analysis may be

incorporated into the strategic planning model. Strategic Planning has been the subject of much research.[citation needed]

Strengths: characteristics of the business or team that give it an advantage over others in the

industry.

Weaknesses: are characteristics that place the firm at a disadvantage relative to others.

Opportunities: external chances to make greater sales or profits in the environment.

Threats: external elements in the environment that could cause trouble for the business.

Identification of SWOTs is essential because subsequent steps in the process of planning for achievement of the

selected objective may be derived from the SWOTs.

First, the decision makers have to determine whether the objective is attainable, given the SWOTs. If the objective

is NOT attainable a different objective must be selected and the process repeated.

The SWOT analysis is often used in academia to highlight and identify strengths, weaknesses, opportunities and

threats.[citation needed] It is particularly helpful in identifying areas for development.[citation needed]

[edit] Matching and converting

Another way of utilizing SWOT is matching and converting.

Matching is used to find competitive advantages by matching the strengths to opportunities.

Converting is to apply conversion strategies to convert weaknesses or threats into strengths or opportunities.

An example of conversion strategy is to find new markets.

If the threats or weaknesses cannot be converted a company should try to minimize or avoid them.[1]

[edit] Evidence on the use of SWOT

SWOT analysis may limit the strategies considered in the evaluation. J. Scott Armstrong notes that "people who

use SWOT might conclude that they have done an adequate job of planning and ignore such sensible things as

defining the firm's objectives or calculating ROI for alternate strategies." [2] Findings from Menon et al. (1999) [3]

and Hill and Westbrook (1997) [4] have shown that SWOT may harm performance. As an alternative to SWOT,

Armstrong describes a 5-step approach alternative that leads to better corporate performance.[5]

Internal and external factors

The aim of any SWOT analysis is to identify the key internal and external factors that are important to achieving

the objective. These come from within the company's unique value chain. SWOT analysis groups key pieces of

information into two main categories:

Internal factors – The strengths and weaknesses internal to the organization.

External factors – The opportunities and threats presented by the external environment to

the organization. -

The internal factors may be viewed as strengths or weaknesses depending upon their impact on the organization's

objectives. What may represent strengths with respect to one objective may be weaknesses for another objective.

The factors may include all of the 4P's; as well as personnel, finance, manufacturing capabilities, and so on. The

external factors may include macroeconomic matters, technological change, legislation, and socio-cultural changes,

as well as changes in the marketplace or competitive position. The results are often presented in the form of a

matrix.

SWOT analysis is just one method of categorization and has its own weaknesses. For example, it may tend to

persuade companies to compile lists rather than think about what is actually important in achieving objectives. It

also presents the resulting lists uncritically and without clear prioritization so that, for example, weak opportunities

may appear to balance strong threats.

It is prudent not to eliminate too quickly any candidate SWOT entry. The importance of individual SWOTs will be

revealed by the value of the strategies it generates. A SWOT item that produces valuable strategies is important. A

SWOT item that generates no strategies is not important.

[edit] Use of SWOT analysis

The usefulness of SWOT analysis is not limited to profit-seeking organizations. SWOT analysis may be used in

any decision-making situation when a desired end-state (objective) has been defined. Examples include: non-profit

organizations, governmental units, and individuals. SWOT analysis may also be used in pre-crisis planning and

preventive crisis management. SWOT analysis may also be used in creating a recommendation during a viability

study/survey.

[edit] SWOT - landscape analysis

The SWOT-landscape systematically deploys the relationships between overall objective and underlying

SWOT-factors and provides an interactive, query-able 3D landscape.

The SWOT-landscape grabs different managerial situations by visualizing and foreseeing the dynamic

performance of comparable objects according to findings by Brendan Kitts, Leif Edvinsson and Tord Beding

(2000).[6]

Changes in relative performance are continually identified. Projects (or other units of measurements) that could be

potential risk or opportunity objects are highlighted.

SWOT-landscape also indicates which underlying strength/weakness factors that have had or likely will have

highest influence in the context of value in use (for ex. capital value fluctuations).

[edit] Corporate planning

As part of the development of strategies and plans to enable the organization to achieve its objectives, then that

organization will use a systematic/rigorous process known as corporate planning. SWOT alongside PEST/PESTLE

can be used as a basis for the analysis of business and environmental factors.[7]

Set objectives – defining what the organization is going to do

Environmental scanning

o Internal appraisals of the organization's SWOT, this needs to include an assessment

of the present situation as well as a portfolio of products/services and an analysis of

the product/service life cycle

Analysis of existing strategies, this should determine relevance from the results of an

internal/external appraisal. This may include gap analysis which will look at environmental

factors

Strategic Issues defined – key factors in the development of a corporate plan which needs to

be addressed by the organization

Develop new/revised strategies – revised analysis of strategic issues may mean the

objectives need to change

Establish critical success factors – the achievement of objectives and strategy

implementation

Preparation of operational, resource, projects plans for strategy implementation

Monitoring results – mapping against plans, taking corrective action which may mean

amending objectives/strategies.[8]

[edit] Marketing

Main article: Marketing management

In many competitor analyses, marketers build detailed profiles of each competitor in the market, focusing

especially on their relative competitive strengths and weaknesses using SWOT analysis. Marketing managers will

examine each competitor's cost structure, sources of profits, resources and competencies, competitive positioning

and product differentiation, degree of vertical integration, historical responses to industry developments, and other

factors.

Marketing management often finds it necessary to invest in research to collect the data required to perform

accurate marketing analysis. Accordingly, management often conducts market research (alternately marketing

research) to obtain this information. Marketers employ a variety of techniques to conduct market research, but

some of the more common include:

Qualitative marketing research, such as focus groups

Quantitative marketing research, such as statistical surveys

Experimental techniques such as test markets

Observational techniques such as ethnographic (on-site) observation

Marketing managers may also design and oversee various environmental scanning and

competitive intelligence processes to help identify trends and inform the company's

marketing analysis.

Using SWOT to analyse the market position of a small management consultancy with specialism in HRM.[8]

Strengths Weaknesses Opportunities Threats

Reputation in marketplace Shortage of consultants

at operating level rather

than partner level

Well established position

with a well defined

market niche

Large consultancies

operating at a minor level

Expertise at partner level in

HRM consultancy

Unable to deal with

multi-disciplinary

assignments because of

size or lack of ability

Identified market for

consultancy in areas

other than HRM

Other small consultancies

looking to invade the

marketplace

Six Forces Model

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The Six Forces Model is a market opportunities analysis model, as an extension to Porter's Five Forces Model and

is more robust than a standard SWOT analysis.

The following forces are identified:

Competition

New entrants

End users/Buyers

Suppliers

Substitutes

Complementary products/ The government/ The public

[edit] Criticisms of the 5 Force model

Porter's framework has been challenged by other academics and strategists such as Stewart Neill, also the likes of

Kevin P. Coyne and Somu Subramaniam have stated that three dubious assumptions underlie the five forces:

That buyers, competitors, and suppliers are unrelated and do not interact and collude

That the source of value is structural advantage (creating barriers to entry)

That uncertainty is low, allowing participants in a market to plan for and respond to competitive

behavior.

An important extension to Porter was found in the work of Brandenburger and Nalebuff in the mid-1990s. Using

game theory, they added the concept of complementors (also called "the 6th force"), helping to explain the

reasoning behind strategic alliances. The idea that complementors are the sixth force has often been credited to

Andrew Grove, former CEO of Intel Corporation. According to most references, the sixth force is government or

the public. Martyn Richard Jones, whilst consulting at Groupe Bull, developed an augmented 5 forces model in

Scotland in 1993, it is based on Porter's model, and includes Government (national and regional) as well as

Pressure Groups as the notional 6th force. This model was the result of work carried out as part of Group Bulle's

Knowledge Asset Management Organisation initiative.

It is also perhaps not feasible to evaluate the attractiveness of an industry independent of the resources a firm

brings to that industry. It is thus argued that this theory be coupled with the Resource-Based View (RBV) in order

for the firm to develop a much more sound strategy.

VRIO

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VRIO, the VRIO framework, is an internal tool of analysis in the context of business management. VRIO is an

acronym for the four question framework you ask about a resource or capability to determine its competitive

potential: the question of Value, the question of Rarity, the question of Imitability (Ease/Difficulty to Imitate), and

the question of Organization (ability to exploit the resource or capability).

The Question of Value: "Is the firm able to exploit an opportunity or neutralize an external threat

with the resource/capability?"

The Question of Rarity: "Is control of the resource/capability in the hands of a relative few?"

The Question of Imitability: "Is it difficult to imitate, and will there be significant cost disadvantage

to a firm trying to obtain, develop, or duplicate the resource/capability?"

The Question of Organization: "Is the firm organized, ready, and able to exploit the

resource/capability?"

PEST analysis

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PEST analysis stands for "Political, Economic, Social, and Technological analysis" and describes a framework of

macro-environmental factors used in the environmental scanning component of strategic management. Some

analysts added Legal and rearranged the mnemonic to SLEPT;[1] inserting Environmental factors expanded it to

PESTEL or PESTLE, which is popular in the United Kingdom.[2] The model has recently been further extended to

STEEPLE and STEEPLED, adding education and demographic factors. It is a part of the external analysis when

conducting a strategic analysis or doing market research, and gives an overview of the different

macroenvironmental factors that the company has to take into consideration. It is a useful strategic tool for

understanding market growth or decline, business position, potential and direction for operations.

The growing importance of environmental or ecological factors in the first decade of the 21st century have given

rise to green business and encouraged widespread use of an updated version of the PEST framework. STEER

analysis systematically considers Socio-cultural, Technological, Economic, Ecological, and Regulatory factors.

Composition

Political factors, are how and to what degree a government intervenes in the economy. Specifically,

political factors include areas such as tax policy, labour law, environmental law, trade restrictions,

tariffs, and political stability. Political factors may also include goods and services which the

government wants to provide or be provided (merit goods) and those that the government does not

want to be provided (demerit goods or merit bads). Furthermore, governments have great influence

on the health, education, and infrastructure of a nation.

Economic factors include economic growth, interest rates, exchange rates and the inflation rate.

These factors have major impacts on how businesses operate and make decisions. For example,

interest rates affect a firm's cost of capital and therefore to what extent a business grows and

expands. Exchange rates affect the costs of exporting goods and the supply and price of imported

goods in an economy

Social factors include the cultural aspects and include health consciousness, population growth rate,

age distribution, career attitudes and emphasis on safety. Trends in social factors affect the demand

for a company's products and how that company operates. For example, an aging population may

imply a smaller and less-willing workforce (thus increasing the cost of labor). Furthermore,

companies may change various management strategies to adapt to these social trends (such as

recruiting older workers).

Technological factors include technological aspects such as R&D activity, automation, technology

incentives and the rate of technological change. They can determine barriers to entry, minimum

efficient production level and influence outsourcing decisions. Furthermore, technological shifts can

affect costs, quality, and lead to innovation.

Environmental factors include ecological and environmental aspects such as weather, climate, and

climate change, which may especially affect industries such as tourism, farming, and insurance.

Furthermore, growing awareness of the potential impacts of climate change is affecting how

companies operate and the products they offer, both creating new markets and diminishing or

destroying existing ones.

Legal factors include discrimination law, consumer law, antitrust law, employment law, and health

and safety law. These factors can affect how a company operates, its costs, and the demand for its

products.

Applicability of the Factors

The model's factors will vary in importance to a given company based on its industry and the goods it produces.

For example, consumer and B2B companies tend to be more affected by the social factors, while a global defense

contractor would tend to be more affected by political factors.[3] Additionally, factors that are more likely to change

in the future or more relevant to a given company will carry greater importance. For example, a company which

has borrowed heavily will need to focus more on the economic factors (especially interest rates).[4]

Furthermore, conglomerate companies who produce a wide range of products (such as Sony, Disney, or BP) may

find it more useful to analyze one department of its company at a time with the PESTEL model, thus focusing on

the specific factors relevant to that one department. A company may also wish to divide factors into geographical

relevance, such as local, national, and global (also known as LoNGPESTEL).

Use of PEST analysis with other models

The PEST factors, combined with external micro-environmental factors and internal drivers, can be classified as

opportunities and threats in a SWOT analysis.

Porter's Four Corners Model

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Porter’s four corners model is a predictive tool designed by Michael Porter that helps in determining a

competitor’s course of action. Unlike other predictive models which predominantly rely on a firm’s current

strategy and capabilities to determine future strategy, Porter’s model additionally calls for an understanding of

what motivates the competitor. This added dimension of understanding a competitor's internal culture, value

system, mindset and assumptions help in determining a much more accurate and realistic reading of a

competitor’s possible reactions in a given situation.

edit] The Four Corners

Motivation – drivers

This helps in determining competitor's action by understanding their goals (both strategic and tactical) and their

current position vis-à-vis their goals. A wide gap between the two could mean the competitor is highly likely to

react to any external threat that comes in its way, whereas a narrower gap is likely to produce a defensive strategy.

Question to be answered here is: What is it that drives the competitor? These drivers can be at various levels and

dimensions and can provide insights into future goals.

Motivation – Management Assumptions

The perceptions and assumptions the competitor has about itself and its industry would shape strategy. This corner

includes determining the competitor's perception of its strengths and weaknesses, organization culture and their

beliefs about competitor's goals. If the competitor thinks highly of its competition and has a fair sense of industry

forces, it is likely to be ready with plans to counter any threats to its position. On the other hand, a competitor who

has a misplaced understanding of industry forces is not very likely to respond to a potential attack. Question to be

answered here is: What are competitor's assumption about the industry, the competition and its own capabilities?

Actions – Strategy

A competitor's strategy determines how it competes in the market. However, there could be a difference between

the company's intended strategy (as stated in the annual report and interviews) and its realized strategy (as is

evident in its acquisitions, new product development, etc.). It is therefore important here to determine the

competitor's realized strategy and how they are actually performing. If current strategy is yielding satisfactory

results, it is safe to assume that the competitor is likely to continue to operate in the same way. Questions to be

answered here are: What is the competitor actually doing and how successful is it in implementing its current

strategy?

Actions – Capabilities

This looks at a competitor's inherent ability to initiate or respond to external forces. Though it might have the

motivation and the drive to initiate a strategic action, its effectiveness is dependent on its capabilities. Its strengths

will also determine how the competitor is likely to respond to an external threat. An organization with an extensive

distribution network is likely to initiate an attack through its channel, whereas a company with strong financials is

likely to counter attack through price drops. The questions to be answered here are: What are the strengths and

weaknesses of the competitor? Which areas is the competitor strong in?

[edit] Strengths

Considers implicit aspects of competitive behavior

Firms are more often than not aware of their rivals and do have a generally good understanding of their strategies

and capabilities. However, motivational factors are often overlooked. Sufficiently motivated competitors can often

prove to be more competitive than bigger but less motivated rivals. What sets this model apart from others is its

insistence on accounting for the "implicit" factors such as culture, history, executive, consultants, and board’s

backgrounds, goals, values and commitments and inclusion of management's deep beliefs and assumptions about

what works or does not work in the market.[1]

Predictive in nature

Porter's four corners model provides a framework that ties competitor's capabilities to their assumptions of the

competitive environment and their underlying motivations. By looking at both a firm's capabilities (what the firm

can do) and underlying implicit factors (their motivations to follow a course of action) can help predict

competitor's actions with a relatively higher level of confidence. The underlying assumption here is that decision

makers in firms are essentially human and hence subject to the influences of affective and automatic processes

described by neuroscientists.[1] Hence by considering these factors along with a firm's capabilities, this model is a

better predictor of competitive behavior.

[edit] Use in competitive intelligence and strategy

Despite its strengths, Porter's four corners model is not widely used in strategy and competitive intelligence. In a

2005 survey by the Society of Competitive Intelligence Professionals's (SCIP) frequently used analytical tools,

Porter's four corners does not even figure in the top ten.[2]

However this model can be used in competitive analysis and strategy as follows:

Strategy development and testing: Can be used to determine likely actions by competitors in response to the firm's

strategy. This can be used when developing a strategy (such as for a new product launch) or to test this strategy

using simulation techniques such as a business war game.

Early warning

The predictive nature of this tool can also alert firms to possible threats due to competitive action.

Porter's four corners also works well with other analytical models. For instance it complements Porters five forces

model well. Competitive Cluster Analysis of industry products in turn complements Four Corners Analysis.[3]

Using such models that complement each other can help create a more complete analysis.

Porter five forces analysis

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This article needs references that appear in reliable third-party publications. Primary sources or

sources affiliated with the subject are generally not sufficient for a Wikipedia article. Please add

more appropriate citations from reliable sources. (October 2009)

A graphical representation of Porter's Five Forces

Porter's Five Forces is a framework for the industry analysis and business strategy development formed by

Michael E. Porter of Harvard Business School in 1979. It draws upon Industrial Organization (IO) economics to

derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness

in this context refers to the overall industry profitability. An "unattractive" industry is one in which the

combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one

approaching "pure competition", in which available profits for all firms are driven down to zero.

Three of Porter's five forces refer to competition from external sources. The remainder are internal threats.

Porter referred to these forces as the micro environment, to contrast it with the more general term macro

environment. They consist of those forces close to a company that affect its ability to serve its customers and make

a profit. A change in any of the forces normally, requires a business unit to re-assess the marketplace given the

overall change in industry information. The overall industry attractiveness does not imply that every firm in the

industry will return the same profitability. Firms are able to apply their core competencies, business model or

network to achieve a profit above the industry average. A clear example of this is the airline industry. As an

industry, profitability is low and yet individual companies, by applying unique business models, have been able to

make a return in excess of the industry average.

Porter's five forces include - three forces from 'horizontal' competition: threat of substitute products, the threat of

established rivals, and the threat of new entrants; and two forces from 'vertical' competition: the bargaining power

of suppliers and the bargaining power of customers.

This five forces analysis, is just one part of the complete Porter strategic models. The other elements are the value

chain and the generic strategies.[citation needed]

Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis, which he found

unrigorous and ad hoc.[1]

Contents

[hide]

1 The five forces

o 1.1 The threat of the entry of new competitors

o 1.2 The intensity of competitive rivalry

o 1.3 The threat of substitute products or services

o 1.4 The bargaining power of customers (buyers)

o 1.5 The bargaining power of suppliers

2 Usage

3 Criticisms

4 See also

5 References

6 Further reading

7 External links

The five forces

The threat of the entry of new competitors

Profitable markets that yield high returns will attract new firms. This results in many new entrants, which

eventually will decrease profitability for all firms in the industry. Unless the entry of new firms can be blocked by

incumbents, the abnormal profit rate will fall towards zero (perfect competition).

The existence of barriers to entry (patents, rights, etc.) The most attractive segment is one in which

entry barriers are high and exit barriers are low. Few new firms can enter and non-performing firms

can exit easily.

Economies of product differences

Brand equity

Switching costs or sunk costs

Capital requirements

Access to distribution

Customer loyalty to established brands

Absolute cost

Industry profitability; the more profitable the industry the more attractive it will be to new

competitors

The intensity of competitive rivalry

For most industries, the intensity of competitive rivalry is the major determinant of the competitiveness of the

industry.

Sustainable competitive advantage through innovation

Competition between online and offline companies; click-and-mortar -v- slags on a bridge[citation

needed]

Level of advertising expense

Powerful competitive strategy

The visibility of proprietary items on the Web[2] used by a company which can intensify competitive

pressures on their rivals.

How will competition react to a certain behavior by another firm? Competitive rivalry is likely to be based on

dimensions such as price, quality, and innovation. Technological advances protect companies from competition.

This applies to products and services. Companies that are successful with introducing new technology, are able to

charge higher prices and achieve higher profits, until competitors imitate them. Examples of recent technology

advantage in have been mp3 players and mobile telephones. Vertical integration is a strategy to reduce a business'

own cost and thereby intensify pressure on its rival.

The threat of substitute products or services

The existence of products outside of the realm of the common product boundaries increases the propensity of

customers to switch to alternatives:

Buyer propensity to substitute

Relative price performance of substitute

Buyer switching costs

Perceived level of product differentiation

Number of substitute products available in the market

Ease of substitution. Information-based products are more prone to substitution, as online product

can easily replace material product.

Substandard product

Quality depreciation

The bargaining power of customers (buyers)

The bargaining power of customers is also described as the market of outputs: the ability of customers to put the

firm under pressure, which also affects the customer's sensitivity to price changes.

Buyer concentration to firm concentration ratio

Degree of dependency upon existing channels of distribution

Bargaining leverage, particularly in industries with high fixed costs

Buyer volume

Buyer switching costs relative to firm switching costs

Buyer information availability

Ability to backward integrate

Availability of existing substitute products

Buyer price sensitivity

Differential advantage (uniqueness) of industry products

RFM Analysis

The bargaining power of suppliers

The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials,

components, labor, and services (such as expertise) to the firm can be a source of power over the firm, when there

are few substitutes. Suppliers may refuse to work with the firm, or, e.g., charge excessively high prices for unique

resources.

Supplier switching costs relative to firm switching costs

Degree of differentiation of inputs

Impact of inputs on cost or differentiation

Presence of substitute inputs

Strength of distribution channel

Supplier concentration to firm concentration ratio

Employee solidarity (e.g. labor unions)

Supplier competition - ability to forward vertically integrate and cut out the buyer

Ex. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it

from him.

Usage

Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a

firm's strategic position. However, for most consultants, the framework is only a starting point or "checklist" they

might use " Value Chain " afterward. Like all general frameworks, an analysis that uses it to the exclusion of

specifics about a particular situation is considered naїve.

According to Porter, the five forces model should be used at the line-of-business industry level; it is not designed

to be used at the industry group or industry sector level. An industry is defined at a lower, more basic level: a

market in which similar or closely related products and/or services are sold to buyers. (See industry information.)

A firm that competes in a single industry should develop, at a minimum, one five forces analysis for its industry.

Porter makes clear that for diversified companies, the first fundamental issue in corporate strategy is the selection

of industries (lines of business) in which the company should compete; and each line of business should develop

its own, industry-specific, five forces analysis. The average Global 1,000 company competes in approximately 52

industries (lines of business).

Criticisms

Porter's framework has been challenged by other academics and strategists such as Stewart Neill. Similarly, the

likes of Kevin P. Coyne [1] and Somu Subramaniam have stated that three dubious assumptions underlie the five

forces:

That the source of value is structural advantage (creating barriers to entry).

That uncertainty is low, allowing participants in a market to plan for and respond to competitive

behavior.

An important extension to Porter was found in the work of Adam Brandenburger and Barry Nalebuff in the

mid-1990s. Using game theory, they added the concept of complementors (also called "the 6th force"), helping to

explain the reasoning behind strategic alliances. The idea that complementors are the sixth force has often been

credited to Andrew Grove, former CEO of Intel Corporation. According to most references, the sixth force is

government or the public. Martyn Richard Jones, whilst consulting at Groupe Bull, developed an augmented 5

forces model in Scotland in 1993. It is based on Porter's model and includes Government (national and regional) as

well as Pressure Groups as the notional 6th force. This model was the result of work carried out as part of Groupe

Bull's Knowledge Asset Management Organisation initiative.

Porter indirectly rebutted the assertions of other forces, by referring to innovation, government, and

complementary products and services as "factors" that affect the five forces.[3]

It is also perhaps not feasible to evaluate the attractiveness of an industry independent of the resources a firm

brings to that industry. It is thus argued that this theory be coupled with the Resource-Based View (RBV) in order

for the firm to develop a much more sound strategy.

Resource-based view

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The resource-based view (RBV) is a business management tool used to determine the strategic resources available

to a company. The fundamental principle of the RBV is that the basis for a competitive advantage of a firm lies

primarily in the application of the bundle of valuable resources at the firm's disposal (Wernerfelt, 1984, p172;

Rumelt, 1984, p557-558). To transform a short-run competitive advantage into a sustained competitive advantage

requires that these resources are heterogeneous in nature and not perfectly mobile ([1]:p105-106; Peteraf, 1993,

p180). Effectively, this translates into valuable resources that are neither perfectly imitable nor substitutable

without great effort (Barney, 1991;[1]:p117). If these conditions hold, the firm’s bundle of resources can assist the

firm sustaining above average returns. The VRIN model also constitutes a part of RBV.

Contents

[hide]

1 Concept

2 Definitions

o 2.1 What constitutes a "resource"?

o 2.2 What constitutes a "capability"?

o 2.3 What constitutes "competitive advantage"?

3 History of the resource-based view

o 3.1 Barriers to imitation of resources

o 3.2 Developing resources for the future

o 3.3 Complementary work

4 Criticism

5 Further reading

6 See also

7 References

Concept

The key points of the theory are:

1. Identify the firm’s potential key resources.

2. Evaluate whether these resources fulfill the following criteria (referred to as VRIN):

o Valuable – A resource must enable a firm to employ a value-creating strategy, by either

outperforming its competitors or reduce its own weaknesses ([1]:p99; [2]:p36). Relevant in

this perspective is that the transaction costs associated with the investment in the resource

cannot be higher than the discounted future rents that flow out of the value-creating

strategy (Mahoney and Prahalad, 1992, p370; Conner, 1992, p131).

o Rare – To be of value, a resource must be rare by definition. In a perfectly competitive

strategic factor market for a resource, the price of the resource will be a reflection of the

expected discounted future above-average returns (Barney, 1986a, p1232-1233; Dierickx

and Cool, 1989, p1504;[1]:p100).

o In-imitable – If a valuable resource is controlled by only one firm it could be a source of a

competitive advantage ([1]:p107). This advantage could be sustainable if competitors are not

able to duplicate this strategic asset perfectly (Peteraf, 1993, p183; Barney, 1986b, p658).

The term isolating mechanism was introduced by Rumelt (1984, p567) to explain why firms

might not be able to imitate a resource to the degree that they are able to compete with the

firm having the valuable resource (Peteraf, 1993, p182-183; Mahoney and Pandian, 1992,

p371). An important underlying factor of inimitability is causal ambiguity, which occurs if the

source from which a firm’s competitive advantage stems is unknown (Peteraf, 1993, p182;

Lippman and Rumelt, 1982, p420). If the resource in question is knowledge-based or socially

complex, causal ambiguity is more likely to occur as these types of resources are more likely

to be idiosyncratic to the firm in which it resides (Peteraf, 1993, p183; Mahoney and Pandian,

1992, p365;[1]:p110). Conner and Prahalad go so far as to say knowledge-based resources

are “…the essence of the resource-based perspective” (1996, p477).

o Non-substitutable – Even if a resource is rare, potentially value-creating and imperfectly

imitable, an equally important aspect is lack of substitutability (Dierickx and Cool, 1989,

p1509;[1]:p111). If competitors are able to counter the firm’s value-creating strategy with a

substitute, prices are driven down to the point that the price equals the discounted future

rents (Barney, 1986a, p1233; sheikh, 1991, p137), resulting in zero economic profits.

3. Care for and protect resources that possess these evaluations, because doing so can improve

organizational performance (Crook, Ketchen, Combs, and Todd, 2008).

The VRIN characteristics mentioned are individually necessary, but not sufficient conditions for a sustained

competitive advantage (Dierickx and Cool, 1989, p1506; Priem and Butler, 2001a, p25). Within the framework of

the resource-based view, the chain is as strong as its weakest link and therefore requires the resource to display

each of the four characteristics to be a possible source of a sustainable competitive advantage ([1]:105-107).

Definitions

What constitutes a "resource"?

Jay Barney ([1]:p101) referring to Daft (1983)[3] says: "...firm resources include all assets, capabilities,

organizational processes, firm attributes, information, knowledge, etc; controlled by a firm that enable the firm to

conceive of and implement strategies that improve its efficiency and effectiveness (Daft,1983)."

A subsequent distinction, made by Amit & Schoemaker (1993), is that the encompassing construct previously

called "resources" can be divided into resources and capabilities[2]. In this respect, resources are tradable and

non-specific to the firm, while capabilities are firm-specific and are used to engage the resources within the firm,

such as implicit processes to transfer knowledge within the firm (Makadok, 2001, p388-389; Hoopes, Madsen and

Walker, 2003, p890). This distinction has been widely adopted throughout the resource-based view literature

(Conner and Prahalad, 1996, p477; Makadok, 2001, p338; Barney, Wright and Ketchen, 2001, p630-31).

What constitutes a "capability"?

Makadok (2001) emphasizes the distinction between capabilities and resources by defining capabilities as ‚a

special type of resource, specifically an organizationally embedded non-transferable firm-specific resource whose

purpose is to improve the productivity of the other resources possessed by the firm‛ [4](p389). ‚[R]esources are

stocks of available factors that are owned or controlled by the organization, and capabilities are an organization’s

capacity to deploy resources‛ [2]:p.35. Essentially, it is the bundling of the resources that builds capabilities. [5]

What constitutes "competitive advantage"?

A competitive advantage can be attained if the current strategy is value-creating, and not currently being

implemented by present or possible future competitors ([1]:102). Although a competitive advantage has the ability

to become sustained, this is not necessarily the case. A competing firm can enter the market with a resource that

has the ability to invalidate the prior firm's competitive advantage, which results in reduced (read: normal) rents

(Barney, 1986b, p658). Sustainability in the context of a sustainable competitive advantage is independent with

regards to the time frame. Rather, a competitive advantage is sustainable when the efforts by competitors to render

the competitive advantage redundant have ceased ([1]:p102; Rumelt, 1984, p562). When the imitative actions have

come to an end without disrupting the firm’s competitive advantage, the firm’s strategy can be called

sustainable. This is in contrast to views of others (e.g., Porter) that a competitive advantage is sustained when it

provides above-average returns in the long run. (1985).

Core competency

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A core competency is a specific factor that a business sees as being central to the way it, or its employees, works.

It fulfills two key criteria:

1. It is not easy for competitors to imitate

2. It can be leveraged widely to many products and markets.

A core competency can take various forms, including technical/subject matter know-how, a reliable process and/or

close relationships with customers and suppliers.[1] It may also include product development or culture, such as

employee dedication.

Core competencies are particular strengths relative to other organizations in the industry which provide the

fundamental basis for the provision of added value. Core competencies are the collective learning in organizations,

and involve how to coordinate diverse production skills and integrate multiple streams of technologies. It is

communication, an involvement and a deep commitment to working across organizational boundaries. Few

companies are likely to build world leadership in more than five or six fundamental competencies.

For an example of core competencies, when studying Walt Disney World - Parks and Resorts, there are three main

core competencies:[2]

• Animatronics and Show Design

• Storytelling, Story Creation and Themed Atmospheric Attractions

• Efficient operation of theme parks

The value chain is a systematic approach to examining the development of competitive advantage. It was created

by M. E. Porter in his book, Competitive Advantage (1980). The chain consists of a series of activities that create

and build value. They culminate in the total value delivered by an organization. The 'margin' depicted in the

diagram is the same as added value. The organization is split into 'primary activities' and 'support activities'.

Contents

[hide]

1 Core Competence

2 See also

3 Notes

4 References

[edit] Core Competence

A core competence is the result of a specific unique set of skills or production techniques that deliver value to the

customer. Such competences empower an organization to access a wide variety of markets. Executives should

estimate the future challenges and opportunities of the business in order to stay on top of the game in varying

situations.

In 1990 with their article titled The Core Competence of the Corporation, Prahlad and Hamel illustrated that core

competencies lead to the development of core products which further can be used to build many products for end

users. Core competencies are developed through the process of continuous improvements over the period of time.

To succeed in an emerging global market it is more important and required to build core competencies rather than

vertical integration. NEC utilized its portfolio of core competencies to dominate the semiconductor,

telecommunications and consumer electronics market. It is important to identify the core competencies because it

is difficult to retain those competencies in a price war & cost cutting environment. The author coated the example

of Vikers to demonstrate how they integrated their core competences using strategic architecture in view of

changing market requirements and evolving technologies. Management must realize the fact that stakeholders to

core competences are an asset which can be utilized to integrate and build the competencies. Competence building

is an outcome of strategic architecture which must be enforced by the top management in order to exploit its full

capacity.

In Competing for the Future, the authors Prahlad and Hamel show how executives can develop the industry

foresight necessary to proactively adapt the industry changes, discover ways of controlling resources that will

enable the company to attain goals despite of any constraints. Executives should develop a point of view on which

core competencies can be built for the future to revitalize the process of new business creation. The key to future

industry leadership is to develop an independent point of view about tomorrow's opportunities and build

capabilities that exploit them.

In order to be competitive an organization needs tangible resources but intangible resources like core competences

are difficult and challenging to achieve. It is even critical to manage and enhance the competences with reference

to industry changes and their future. For example, Microsoft has expertise in many IT based innovations where for

a variety of reasons it is difficult for competitors to replicate Microsoft's core competences.

In a race to achieve cost cutting, quality and productivity most of the executives do not spend their time to develop

a corporate view of the future because this exercise demands high intellectual energy and commitment. The

difficult questions may challenge their own ability to view the future opportunities but an attempt to find their

answers will lead towards organizational benefits.

Knowledge-based theory of the firm

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The knowledge-based theory of the firm considers knowledge as the most strategically significant resource of a

firm. Its proponents argue that because knowledge-based resources are usually difficult to imitate and socially

complex, heterogeneous knowledge bases and capabilities among firms are the major determinants of sustained

competitive advantage and superior corporate performance.

This knowledge is embedded and carried through multiple entities including organizational culture and identity,

policies, routines, documents, systems, and employees. Originating from the strategic management literature, this

perspective builds upon and extends the resource-based view of the firm (RBV) initially promoted by Penrose

(1959) and later expanded by others (Wernerfelt 1984, Barney 1991, Conner 1991).

Although the resource-based view of the firm recognizes the important role of knowledge in firms that achieve a

competitive advantage, proponents of the knowledge-based view argue that the resource-based perspective does

not go far enough. Specifically, the RBV treats knowledge as a generic resource, rather than having special

characteristics. It therefore does not distinguish between different types of knowledge-based capabilities.

Information technologies can play an important role in the knowledge-based view of the firm in that information

systems can be used to synthesize, enhance, and expedite large-scale intra- and inter-firm knowledge management

(Alavi and Leidner 2001).

Whether or not the Knowledge-based theory of the firm actually constitutes a theory has been the subject of

considerable debate. See for example, Foss (1996) and Phelan & Lewin (2000). According to one notable

proponent of the Knowledge-Based View of the firm (KBV), ‚The emerging knowledge-based view of the firm

is not a theory of the firm in any formal sense‛ (Grant, 2002, p.135).

Overview

In simplified terms, the theory of the firm aims to answer these questions:

1. Existence – why do firms emerge, why are not all transactions in the economy mediated over the

market?

2. Boundaries – why is the boundary between firms and the market located exactly there as to size

and output variety? Which transactions are performed internally and which are negotiated on the

market?

3. Organization – why are firms structured in such a specific way, for example as to hierarchy or

decentralization? What is the interplay of formal and informal relationships?

4. Heterogeneity of firm actions/performances – what drives different actions and performances of

firms?

Firms exist as an alternative system to the market-price mechanism when it is more efficient to produce in a

non-market environment. For example, in a labor market, it might be very difficult or costly for firms or

organizations to engage in production when they have to hire and fire their workers depending on demand/supply

conditions. It might also be costly for employees to shift companies every day looking for better alternatives. Thus,

firms engage in a long-term contract with their employees to minimize the cost.[2][3]

[edit] Background

The First World War period saw a change of emphasis in economic theory away from industry-level analysis

which mainly included analyzing markets to analysis at the level of the firm, as it became increasingly clear that

perfect competition was no longer an adequate model of how firms behaved. Economic theory till then had

focused on trying to understand markets alone and there had been little study on understanding why firms or

organisations exist.Markets are mainly guided by prices as illustrated by vegetable markets where a buyer is free to

switch sellers in an exchange.

The need for a revised theory of the firm was emphasized by empirical studies by Berle and Means, who made it

clear that ownership of a typical American corporation is spread over a wide number of shareholders, leaving

control in the hands of managers who own very little equity themselves.[4] Hall and Hitch found that executives

made decisions by rule of thumb rather than in the marginalist way.[5]

[edit] Transaction cost theory

Main article: Transaction cost

The model shows institutions and market as a possible form of organization to coordinate economic

transactions. When the external transaction costs are higher than the internal transaction costs, the

company will grow. If the external transaction costs are lower than the internal transaction costs the

company will be downsized by outsourcing, for example.

According to Ronald Coase, people begin to organise their production in firms when the transaction cost of

coordinating production through the market exchange, given imperfect information, is greater than within the

firm.[2]

Ronald Coase set out his transaction cost theory of the firm in 1937, making it one of the first (neo-classical)

attempts to define the firm theoretically in relation to the market.[2] One aspect of its 'neoclassicism' in presenting

an explanation of the firm consistent with constant returns to scale, rather than relying increasing returns to scale.[6]

Another is in defining a firm in a manner which is both realistic and compatible with the idea of substitution at the

margin, so instruments of conventional economic analysis apply. He notes that a firm’s interactions with the

market may not be under its control (for instance because of sales taxes), but its internal allocation of resources are:

‚Within a firm, … market transactions are eliminated and in place of the complicated market structure with

exchange transactions is substituted the entrepreneur … who directs production.‛ He asks why alternative

methods of production (such as the price mechanism and economic planning), could not either achieve all

production, so that either firms use internal prices for all their production, or one big firm runs the entire economy.

Coase begins from the standpoint that markets could in theory carry out all production, and that what needs to be

explained is the existence of the firm, with its "distinguishing mark … [of] the supersession of the price

mechanism." Coase identifies some reasons why firms might arise, and dismisses each as unimportant:

1. if some people prefer to work under direction and are prepared to pay for the privilege (but this is

unlikely);

2. if some people prefer to direct others and are prepared to pay for this (but generally people are

paid more to direct others);

3. if purchasers prefer goods produced by firms.

Instead, for Coase the main reason to establish a firm is to avoid some of the transaction costs of using the price

mechanism. These include discovering relevant prices (which can be reduced but not eliminated by purchasing this

information through specialists), as well as the costs of negotiating and writing enforceable contracts for each

transaction (which can be large if there is uncertainty). Moreover, contracts in an uncertain world will necessarily

be incomplete and have to be frequently re-negotiated. The costs of haggling about division of surplus, particularly

if there is asymmetric information and asset specificity, may be considerable.

If a firm operated internally under the market system, many contracts would be required (for instance, even for

procuring a pen or delivering a presentation). In contrast, a real firm has very few (though much more complex)

contracts, such as defining a manager's power of direction over employees, in exchange for which the employee is

paid. These kinds of contracts are drawn up in situations of uncertainty, in particular for relationships which last

long periods of time. Such a situation runs counter to neo-classical economic theory. The neo-classical market is

instantaneous, forbidding the development of extended agent-principal (employee-manager) relationships, of

planning, and of trust. Coase concludes that ‚a firm is likely therefore to emerge in those cases where a very

short-term contract would be unsatisfactory,‛ and that ‚it seems improbable that a firm would emerge without

the existence of uncertainty.‛

He notes that government measures relating to the market (sales taxes, rationing, price controls) tend to increase

the size of firms, since firms internally would not be subject to such transaction costs. Thus, Coase defines the firm

as "the system of relationships which comes into existence when the direction of resources is dependent on the

entrepreneur." We can therefore think of a firm as getting larger or smaller based on whether the entrepreneur

organises more or fewer transactions.

The question then arises of what determines the size of the firm; why does the entrepreneur organise the

transactions he does, why no more or less? Since the reason for the firm's being is to have lower costs than the

market, the upper limit on the firm's size is set by costs rising to the point where internalising an additional

transaction equals the cost of making that transaction in the market. (At the lower limit, the firm’s costs exceed

the market’s costs, and it does not come into existence.) In practice, diminishing returns to management

contribute most to raising the costs of organising a large firm, particularly in large firms with many different plants

and differing internal transactions (such as a conglomerate), or if the relevant prices change frequently.

Coase concludes by saying that the size of the firm is dependent on the costs of using the price mechanism, and on

the costs of organisation of other entrepreneurs. These two factors together determine how many products a firm

produces and how much of each.[7]

[edit] Reconsiderations of transaction cost theory

According to Putterman, most economists accept distinction between intra-firm and interfirm transaction but also

that the two shade into each other; the extent of a firm is not simply defined by its capital stock.[8] Richardson for

example, notes that a rigid distinction fails because of the existence of intermediate forms between firm and

market such as inter-firm co-operation.[9]

Klein (1983) asserts that ‚Economists now recognise that such a sharp distinction does not exist and that it is

useful to consider also transactions occurring within the firm as representing market (contractual) relationships.‛

The costs involved in such transactions that are within a firm or even between the firms are the transaction costs.

Ultimately, whether the firm constitutes a domain of bureaucratic direction that is shielded from market forces or

simply ‚a legal fiction‛, ‚a nexus for a set of contracting relationships among individuals‛ (as Jensen and

Meckling put it) is ‚a function of the completeness of markets and the ability of market forces to penetrate

intra-firm relationships‛.[10]

[edit] Managerial and behavioural theories

It was only in the 1960s that the neo-classical theory of the firm was seriously challenged by alternatives such as

managerial and behavioral theories. Managerial theories of the firm, as developed by William Baumol (1959 and

1962), Robin Marris (1964) and Oliver E. Williamson (1966), suggest that managers would seek to maximise their

own utility and consider the implications of this for firm behavior in contrast to the profit-maximising case.

(Baumol suggested that managers’ interests are best served by maximising sales after achieving a minimum level

of profit which satisfies shareholders.) More recently this has developed into ‘principal-agent’ analysis (e.g.

Spence and Zeckhauser[11] and Ross (1973)[citation needed] on problems of contracting with asymmetric information)

which models a widely applicable case where a principal (a shareholder or firm for example) cannot costlessly

infer how an agent (a manager or supplier, say) is behaving. This may arise either because the agent has greater

expertise or knowledge than the principal, or because the principal cannot directly observe the agent’s actions; it

is asymmetric information which leads to a problem of moral hazard. This means that to an extent managers can

pursue their own interests. Traditional managerial models typically assume that managers, instead of maximising

profit, maximise a simple objective utility function (this may include salary, perks, security, power, prestige)

subject to an arbitrarily given profit constraint (profit satisficing).

[edit] Behavioural approach

The behavioural approach, as developed in particular by Richard Cyert and James G. March of the Carnegie

School places emphasis on explaining how decisions are taken within the firm, and goes well beyond neo-classical

economics.[12] Much of this depended on Herbert Simon’s work in the 1950s concerning behaviour in situations

of uncertainty, which argued that ‚people possess limited cognitive ability and so can exercise only ‘bounded

rationality’ when making decisions in complex, uncertain situations.‛ Thus individuals and groups tend to

‘satisfice’—that is, to attempt to attain realistic goals, rather than maximise a utility or profit function. Cyert

and March argued that the firm cannot be regarded as a monolith, because different individuals and groups within

it have their own aspirations and conflicting interests, and that firm behaviour is the weighted outcome of these

conflicts. Organisational mechanisms (such as ‘satisficing’ and sequential decision-taking) exist to maintain

conflict at levels that are not unacceptably detrimental. Compared to ideal state of productive efficiency, there is

organisational slack (Leibenstein’s X-inefficiency).

[edit] Team production

Armen Alchian and Harold Demsetz's analysis of team production is an extension and clarification of earlier work

by Coase.[13] Thus according to them the firm emerges because extra output is provided by team production, but

that the success of this depends on being able to manage the team so that metering problems (it is costly to

measure the marginal outputs of the co-operating inputs for reward purposes) and attendant shirking (the moral

hazard problem) can be overcome, by estimating marginal productivity by observing or specifying input behaviour.

Such monitoring as is therefore necessary, however, can only be encouraged effectively if the monitor is the

recipient of the activity’s residual income (otherwise the monitor herself would have to be monitored, ad

infinitum). For Alchian and Demsetz, the firm therefore is an entity which brings together a team which is more

productive working together than at arm’s length through the market, because of informational problems

associated with monitoring of effort. In effect, therefore, this is a ‘principal-agent’ theory, since it is

asymmetric information within the firm which Alchian and Demsetz emphasise must be overcome. In Barzel

(1982)’s theory of the firm, drawing on Jensen and Meckling (1976), the firm emerges as a means of centralising

monitoring and thereby avoiding costly redundancy in that function (since in a firm the responsibility for

monitoring can be centralised in a way that it cannot if production is organised as a group of workers each acting

as a firm).[citation needed]

The weakness in Alchian and Demsetz’s argument, according to Williamson, is that their concept of team

production has quite a narrow range of application, as it assumes outputs cannot be related to individual inputs. In

practice this may have limited applicability (small work group activities, the largest perhaps a symphony orchestra),

since most outputs within a firm (such as manufacturing and secretarial work) are separable, so that individual

inputs can be rewarded on the basis of outputs. Hence team production cannot offer the explanation of why firms

(in particular, large multi-plant and multi-product firms) exist.