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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.