Vision Statement

Business' core goal.

Definition

Vision
is a statement that expresses organization’s ultimate objectives.

Understanding the tool

It is very important for any organization to have clear and attainable long-term vision; the statement that
guides every chief executive, manager or employee in achieving the same organizational objective. A vision
statement asks ‘What does our business want to become?’ and usually is a one sentence, inspirational, clear
and memorable statement that expresses company’s desired long-term position. It motivates employees to
make extra effort and usually results in higher performance. Because money rewards only partly motivates
employees, it is important to use other tools such as vision statement to increase their motivation.

The statement also indicates what resources, competencies and skills will be needed to achieve the future
objective. This way it guides decision-making and resource allocation more effectively.

Vision is closely related with a term ‘strategic intent’ – a desired leadership position that is currently
unachievable due to the lack of resources and capabilities.

Vision Statement Assessment:

 May be Unrealistic
 No available resources
 No time frame
 No commitment to achieve it
 Precedes the mission

Difference between vision and mission statements

Vision and mission statements are often developed and used together for the same purpose. This confuses
many people into thinking that vision and mission could be used interchangeably, when actually they can’t.

Differences between vision and mission

Vision Mission
Purpose
Tells what an organization aims to achieve. States what a company is currently doing.
Answers the question
What do we want to become? What do we do?
Includes
 Customers
 Products/Services
 Markets
 Objectives
 Technology
 Values
 Concern for survival
 Philosophy
 Self-Concept
 Concern for public image
 Differences between vision and mission
Vision Mission
 Concern for employees

Future or present time?

Talks about the future Talks about the present
To whom it is developed?
Employees, customers, suppliers, distributors,
Employees of the company
partners and communities
Which one is created first?
Developed first Developed only when vision is available
How often does it change?
Product-oriented missions change every time when a
Rarely changes because it takes years to achieve most
company decides to venture into a new product
of the objectives
market.

There are clear differences between the two statements that should not be neglected.

Benefits

Not all the visions are equally good. Some of them are very generic or focus on financial objectives and as a
result, poorly motivates employees. But if a company puts enough efforts in creating vision statement, it
results into following benefits:

 Motivates and inspires employees

 Provides one purpose to work for
 Sets the stretch goals (goals that are impossible to achieve with current resources and capabilities)
 Guides managers in effectively allocating resources

Writing the statement

Creating a vision is an important first step in strategic management process. We identified these steps and
guidelines to help you write an effective statement.

Step 1. Gather a team of managers, employees and shareholders. Vision is the statement that must be
understood by employees of all levels. As many people as possible should be involved in the process
because involvement leads to stronger commitment to company’s vision. After choosing the people that will
be involved you should also distribute several articles to them about what is organization’s vision and ask
everyone to read them as a background.

Step 2. Ask everyone to write their own version of vision. The next step is to ask everyone to write his or
her own version of the statement and submit it to the responsible team. After receiving the statements, the
team should try to combine draft vision out of all the submissions. This is also a great opportunity to resolve
any conflicting views about firm’s ultimate objective.

Step 3. Revise the statement and present the final version. The draft statement should be distributed to
the members again for their last revision. Upon receiving the feedback, the final version of the vision should
be created and presented to every employee.

Don’t forget that a vision should be a one sentence clear, inspirational and memorable statement.
Vision statement examples

The best way to learn creating a vision is to look at the currently available good and bad examples.

Good visions
Chevron: To be the global energy company most admired for its people, partnership and performance.
Feeding America: A hunger-free America
Habitat for Humanity: A world where everyone has a decent place to live.
Microsoft: A computer on every desk and in every home
Save the Children: Our vision is a world in which every child attains the right to survival, protection,
development and participation.
Bad visions
General Motors: To design, build and sell the world’s best vehicles. (Best in what? GM should have
specified their objective)
Ikea: At Ikea our vision is to create a better everyday life for the many people. (This is impossible to
achieve)
Samsung: Inspire the World, Create the Future. (The statement is too vague and doesn’t set any objectives)
Toyota: Toyota will lead the way to the future of mobility, enriching lives around the world with the safest
and most responsible ways of moving people. Through our commitment to quality, constant innovation and
respect for the planet, we aim to exceed expectations and be rewarded with a smile. We will meet our
challenging goals by engaging the talent and passion of people, who believe there is always a better way. (It
is too long and sounds more like a mission than a true vision)

Microsoft Case – Int. business group – Mahmoud Karim

Vision : We will become the core of Microsoft global business and technological development through
innovative, socially responsible and commercially visible manner

Mission Statement for Success

Business mission.

Definition

Mission statement
is a description of what an organization actually does – what its business is – and why it does it.
[1]

Understanding the tool

Often called the “credo”, “philosophy”, “core values” or “our aspirations”, organization’s mission is the
statement that defines its core purpose or reason for being. [2] It tells who a company is and what it does.
According to P. Drucker, often called the father of modern management, a mission is the primary guidance
in creating plans, strategies or making daily decisions. It is an important communication tool that conveys
information about organization’s products, services, targeted customers, geographic markets, philosophies,
values and plans for future growth to all of its stakeholders. In other words, every major reason why
company exists must be reflected in its mission, so any employee, supplier, customer or community would
understand the driving force behind organization’s operations.
There are two types of statements:[1]

 Customer-oriented missions. Customer-oriented missions define organization’s purpose in terms of

meeting customer needs or providing solutions for them. They provide more flexibility than product-
oriented missions and can be easily adapted to changing environment. For example, Nokia’s
statement “connecting people” is customer-oriented. It does not focus on mobile phones or
smartphones only. It provides a solution to customer needs and could easily have worked 50 years
ago, and will continue to work in the future. It also gives more strategic flexibility for the company.
In Nokia’s case, it may start providing VoIP software to allow calls to be made over the internet and
its mission would still be valid.
 Product-oriented missions. Product-oriented missions focus on what products or services to serve
rather than what solutions to provide for customers. These statements provide less flexibility for the
company because most products have short life cycle and offer limited market expansion. The
company that defines its business as “providing best health insurance products” may struggle to grow
to other insurance product categories.

For a mission to be effective it must include the following 9 components:

 Customers. Who are your customers? How do you benefit them?

 Products or services. What are the main products or services that you offer? Their uniqueness?
 Markets. In which geographical markets do you operate?
 Industry
 Technology. What is the firm’s basic technology?
 Beliefs and values
 Competitive edge.
 Public Image
 Suppliers
 Environment

Why creating a mission is important?

Many studies have been conducted to find out if having and communicating mission statement helps an
organization to achieve higher performance.[3] The results were mixed. Some studies found positive
relationship between written statements and higher organizational performance, while other studies found
none or even negative relationship. One of the reasons might be that most of the companies create mission
statement only because it’s fashionable to do so and little effort is made to actually communicate that
mission to its stakeholders. David[2] argues that if an organization constantly revises its mission and treats it
as a living document, it achieves higher performance than its competitors. Nonetheless, all of the authors
agree that mission brings the following benefits[3][4]:

 Informs organization’s stakeholders about its plans and goals;

 Unifies employees’ efforts in pursuing company goals;
 Serves as an effective public relations tool;
 Provides basis for allocating resources;
 Guides strategic or daily decision making;
  Shows that a company is proactive.

Writing a mission

Creating a mission statement is an important first step in clearly identifying your business’ reason for being.
It’s hard to do it right. Therefore, we identified these steps and guidelines to help you write an effective
statement.

Step 1. Gather a team of managers, employees and shareholders. Mission is the statement that must be
understood by employees of all levels. Involving more people will let you find out how each of them sees an
organization and its core purpose. In addition, employees will support organization’s mission more if they
will be involved in the process of creating it.

Step 2. Answer all 9 questions for effective mission. Many practitioners and academics agree that a
comprehensive statement must include all 9 components. Only then creating a mission can benefit a
company. At this stage, try to honestly answer all the questions and identify your customers, markets, values
etc. It may take a lot of time but it’s worth it.

Step 3. Find the best combination. Collect the answers from everyone and try to combine one mission
statement out of them. During this step, you can make sure that everyone understands company’s reason for
being and there are no conflicting views left.

Following guidelines (all taken from various studies) should also be helpful in writing an effective mission
statement:

 ‘Public image’, ‘concern for employees’, ‘philosophy’ and ‘customers’ are the most important
components of a mission;
 ‘Citizenship’, ‘teamwork’, ‘excellence’ and ‘integrity’ are the values used most often by the
companies with effective missions;
 Influential statements include words such as: ‘communities’, ‘customers’, ‘employees’, ‘ethics’,
‘global’ and ‘quality/value’;[4]
 Statement should be customer-oriented;
 Use less than 250 words;
 Be inspiring and enduring.

NOTE! Every mission must be communicated to organization’s stakeholders to have any positive impact.
It must be constantly revised and adjusted to meet any changing situation.

Mission statement examples

The best way to learn creating an influential mission is to look at the existing examples. In the following
table, we provide 3 mission statement examples and examine them using the previous guidelines.

FedEx mission
"FedEx Corporation will produce superior financial returns for its shareowners(5) by providing high value-
added(7) logistics, transportation and related information services(2) through focused operating companies.
Customer(1) requirements will be met in the highest quality manner appropriate to each market segment
served(3). FedEx Corporation will strive to develop mutually rewarding relationships with its employees(9),
partners and suppliers. Safety will be the first consideration in all operations(9). Corporate activities will be
conducted to the highest ethical and professional standards.(6)"
FedEx mission lacks the answers about technologies (4) and social responsibilities (8), which is one of the
key characteristics that have to be in successful statement. It also lacks all the values pointed out in the
guidelines that are used by successful companies in their statements. It is also product-oriented.
Intel mission
"Delight our customers(1), employees(9), and shareholders(5) by relentlessly delivering the platform and
technology(2,4) advancements that become essential to the way we work and live."
Intel’s mission is poor because it lacks 4 components: markets(3), philosophy(6), self-concept(7) and public
image(8). It is customer-oriented but does not use any of the top 4 values and is too short.
Toyota mission
Toyota will lead the way to the future of mobility, enriching lives around the world(3) with the safest and
most responsible(6) ways of moving people(1). Through our commitment to quality, constant
innovation(4,7) and respect for the planet(8), we aim to exceed expectations and be rewarded with a smile.
We will meet challenging goals (5) by engaging the talent and passion of people(9), who believe there is
always a better way.(6)
Toyota has only missed to mention its products. Their mission is customer-oriented, inspiring and enduring
but it doesn’t clearly mention its customers or social responsibilities.

Microsoft Case – Int. business group – Mahmoud Karim

Mission : Developing our business and society by investing in our employees, partners and technologies to
deliver real value to our clients and reshape the future of South Africa

PEST & PESTEL Analysis

PEST is a political, economic, social, technological analysis used to assess the market for a business or
organizational unit.

Definition

PEST analysis
is an analysis of the political, economic, social and technological factors in the external environment
of an organization, which can affect its activities and performance.
[1]

PESTEL model
involves the collection and portrayal of information about external factors which have, or may have,
an impact on business.
[2]

Understanding the tool

PEST or PESTEL analysis is a simple and effective tool used in situation analysis to identify the key
external (macro environment level) forces that might affect an organization. These forces can create both
opportunities and threats for an organization. Therefore, the aim of doing PEST is to:

 find out the current external factors affecting an organization;

 identify the external factors that may change in the future;
 to exploit the changes (opportunities) or defend against them (threats) better than competitors would
do.

The outcome of PEST is an understanding of the overall picture surrounding the company.

PEST analysis is also done to assess the potential of a new market. The general rule is that the more negative
forces are affecting that market the harder it is to do business in it. The difficulties that will have to be dealt
with significantly reduce profit potential and the firm can simply decide not to engage in any activity in that
market.

PEST variations

PEST analysis is the most general version of all PEST variations created. It is a very dynamic tool as new
components can be easily added to it in order to focus on one or another critical force affecting an
organization. Although following variations are more detailed analysis than simple PEST, the additional
components are just the extensions of the same PEST factors. The analysis probably has more variations
than any other strategy tool:

STEP = PEST in more positive approach.

PESTEL = PEST + Environmental + Legal
PESTELI = PESTEL + Industry analysis
STEEP = PEST + Ethical
SLEPT = PEST + Legal
STEEPLE = PEST + Environmental + Legal + Ethical
STEEPLED = STEEPLE + Demographic
PESTLIED = PEST + Legal + International + Environmental + Demographic
LONGPEST = Local + National + Global factors + PEST

Using the tool

The process of carrying out PEST analysis should involve as many managers as possible to get the best
results. It includes the following steps:

 Step 1. Gathering information about political, economic, social and technological changes + any
other factor(s).
 Step 2. Identifying which of the PEST factors represent opportunities or threats.

Gathering PEST, PESTEL and STEEPLED information

In order to perform PEST (or any other variation of it) managers have to gather as much relevant
information as possible about the firm’s external environment. Nowadays, most information can be found on
the internet relatively easy, fast and with little cost. When the analysis is done for the first time the process
may take a little longer and as a beginner you may find yourself asking “What changes do I exactly look for
in politics, economic, society and technology?” The following templates might be useful when gathering
information for PEST, PESTEL and STEEPLED analysis.

NOTE: PEST covers all macro environment forces affecting an organization. Therefore, when doing
PESTEL or STEEPLED analysis, legal, environmental, ethical and demographic factors may overlap with
PEST factors.

PEST analysis template

Political factors Economic factors
 Government stability and likely changes  Growth rates
 Bureaucracy  Inflation rate
 Corruption level  Interest rates
 Tax policy (rates and incentives)  Exchange rates
 Freedom of press  Unemployment trends
 Regulation/de-regulation  Labor costs
 Trade control  Stage of business cycle
 Import restrictions (quality and quantity)  Credit availability
 Tariffs  Trade flows and patterns
  Competition regulation  Level of consumers’ disposable
 Government involvement in trade unions and income
agreements  Monetary policies
 Environmental Law  Fiscal policies
 Education Law  Price fluctuations
 Anti-trust law  Stock market trends
 Discrimination law  Weather
 Copyright, patents / Intellectual property law  Climate change
 Consumer protection and e-commerce
 Employment law
 Health and safety law
 Data protection law
 Laws regulating environment pollution

Socio-cultural factors Technological factors

 Health consciousness
 Education level
 Attitudes toward imported goods and services
 Attitudes toward work, leisure, career and retirement
 Attitudes toward product quality and customer
service
 Attitudes toward saving and investing  Basic infrastructure level
 Emphasis on safety  Rate of technological change
 Lifestyles  Spending on research & development
 Buying habits  Technology incentives
 Religion and beliefs  Legislation regarding technology
 Attitudes toward “green” or ecological products  Technology level in your industry
 Attitudes toward and support for renewable energy  Communication infrastructure
 Population growth rate  Access to newest technology
 Immigration and emigration rates  Internet infrastructure and penetration
 Age distribution and life expectancy rates
 Sex distribution
 Average disposable income level
 Social classes
 Family size and structure
 Minorities

PESTEL analysis template

Political Economic
Socio-cultural Technological
+
Environmental (ecological) Legal
 Weather
 Climate change  Anti-trust law
 Laws regulating environment pollution  Discrimination law
 Air and water pollution  Copyright, patents / Intellectual property
 Recycling law
 Waste management  Consumer protection and e-commerce
 Attitudes toward “green” or ecological products  Employment law
 Endangered species  Health and safety law
 Attitudes toward and support for renewable  Data Protection
energy
 STEEPLED analysis template
Political Economic
Socio-cultural Technological
Environmental (ecological) Legal
+
Ethical Demographic
 Population growth rate
 Immigration and emigration
rates
 Ethical advertising and sales practices  Age distribution and life
 Accepted accounting, management and marketing standards expectancy rates
 Attitude towards counterfeiting and breaking patents  Sex distribution
 Ethical recruiting practices and employment standards (not  Average disposable income
using children to produce goods) level
 Social classes
 Family size and structure
 Minorities

Identifying opportunities and threats

Gathering information is just a first important step in doing PEST analysis. Once it is done, the information
has to be evaluated. There are many factors changing in the external environment but not all of them are
affecting or might affect an organization. Therefore, it is essential to identify which PEST factors represent
the opportunities or threats for an organization and list only those factors in PEST analysis. This allows
focusing on the most important changes that might have an impact on the company.

PEST analysis example

The following table shows PEST analysis example. It lists opportunities and threats that are affecting a firm
in its macro environment.

PEST analysis example

Political
 Government has passed legislation which
requires further reductions of CO2, HC
and NC emissions for vehicles until 2015
 New political forces, which are against
tax reductions, may be elected in the next
years’ elections
 Import restrictions will increase in 2013
 Government is increasing its funding to
‘specific’ industry
 Government is easing regulations for
employment
 Increasing tensions between our
government and our major export
partner’s government
Economic
 GDP will grow by 3% in 2013
 Availability of credit for businesses will slightly
grow or remain unchanged in 2013. The same
applies for the cost of credit in the 1 half of the
year
 Unemployment is expected to decrease to 7%
 Inflation will fall to 3% or 2% in 2013
 Corporate tax rate will decrease by 2% next year
to 23%
 Dollar exchange rates are expected to decrease
compared to euro
 Disposable income level will decrease
 Metal and oil prices will increase by 5% and 6%
respectively in 2013

Socio-cultural Technological
 Positive attitude towards “green” vehicles  New machinery that could reduce production
 Number of individuals and companies costs by 20% is in development
 buying through the Internet is 67% and
45% respectively and is expected to grow
 Immigration is increasing
 Increasing attitude toward jobs with
shorter work hours
 People tend to buy more domestic rather
than foreign products
 People change their eating habits and now
tend to eat healthier food
 Country’s major telecom company announced its
plans to expand its internet infrastructure and
install new optic fiber cables
 Driverless cars may be introduced in the near
future
 “New” type of table will be introduced into the
market next year

Porter's Five Forces

Five external industry forces affecting an organization.

Definition

Porter’s five forces model

is an analysis tool that uses five industry forces to determine the intensity of competition in an
industry and its profitability level.

Understanding the tool

Five forces model was created by M. Porter in 1979 to understand how five key competitive forces are
affecting an industry. The five forces identified are:

These forces determine an industry structure and the level of competition in that industry. The stronger
competitive forces in the industry are the less profitable it is. An industry with low barriers to enter, having
few buyers and suppliers but many substitute products and competitors will be seen as very competitive and
thus, not so attractive due to its low profitability.
It is every strategist’s job to evaluate company’s competitive position in the industry and to identify what
strengths or weakness can be exploited to strengthen that position. The tool is very useful in formulating
firm’s strategy as it reveals how powerful each of the five key forces is in a particular industry.

Threat of new entrants. This force determines how easy (or not) it is to enter a particular industry. If an
industry is profitable and there are few barriers to enter, rivalry soon intensifies. When more organizations
compete for the same market share, profits start to fall. It is essential for existing organizations to create high
barriers to enter to deter new entrants. Threat of new entrants is high when:

 Low amount of capital is required to enter a market;

 Existing companies can do little to retaliate;
 Existing firms do not possess patents, trademarks or do not have established brand reputation;
 There is no government regulation;
 Customer switching costs are low (it doesn’t cost a lot of money for a firm to switch to other
industries);
 There is low customer loyalty;
 Products are nearly identical;
 Economies of scale can be easily achieved.

Bargaining power of suppliers. Strong bargaining power allows suppliers to sell higher priced or low
quality raw materials to their buyers. This directly affects the buying firms’ profits because it has to pay
more for materials. Suppliers have strong bargaining power when:

 There are few suppliers but many buyers;

 Suppliers are large and threaten to forward integrate;
 Few substitute raw materials exist;
 Suppliers hold scarce resources;
 Cost of switching raw materials is especially high.

Bargaining power of buyers. Buyers have the power to demand lower price or higher product quality from
industry producers when their bargaining power is strong. Lower price means lower revenues for the
producer, while higher quality products usually raise production costs. Both scenarios result in lower profits
for producers. Buyers exert strong bargaining power when:
  Buying in large quantities or control many access points to the final customer;
 Only few buyers exist;
 Switching costs to other supplier are low;
 They threaten to backward integrate;
 There are many substitutes;
 Buyers are price sensitive.

Threat of substitutes. This force is especially threatening when buyers can easily find substitute products
with attractive prices or better quality and when buyers can switch from one product or service to another
with little cost. For example, to switch from coffee to tea doesn’t cost anything, unlike switching from car to
bicycle.

Rivalry among existing competitors. This force is the major determinant on how competitive and
profitable an industry is. In competitive industry, firms have to compete aggressively for a market share,
which results in low profits. Rivalry among competitors is intense when:

 There are many competitors;

 Exit barriers are high;
 Industry of growth is slow or negative;
 Products are not differentiated and can be easily substituted;
 Competitors are of equal size;
 Low customer loyalty.

Although, Porter originally introduced five forces affecting an industry, scholars have suggested including
the sixth force: complements. Complements increase the demand of the primary product with which they
are used, thus, increasing firm’s and industry’s profit potential. For example, iTunes was created to
complement iPod and added value for both products. As a result, both iTunes and iPod sales increased,
increasing Apple’s profits.

Using the tool

We now understand that Porter’s five forces framework is used to analyze industry’s competitive forces and
to shape organization’s strategy according to the results of the analysis. But how to use this tool? We have
identified the following steps:

 Step 1. Gather the information on each of the five forces

 Step 2. Analyze the results and display them on a diagram
 Step 3. Formulate strategies based on the conclusions

Step 1. Gather the information on each of the five forces. What managers should do during this step is to
gather information about their industry and to check it against each of the factors (such as “number of
competitors in the industry”) influencing the force. We have already identified the most important factors in
the table below.

Porter's Five Forces Factors

Threat of new entry
 Amount of capital required
 Retaliation by existing companies
 Legal barriers (patents, copyrights, etc.)
 Brand reputation
 Product differentiation
 Access to suppliers and distributors
 Economies of scale
 Sunk costs
  Government regulation

Supplier power
 Number of suppliers
 Suppliers’ size
 Ability to find substitute materials
 Materials scarcity
 Cost of switching to alternative materials
 Threat of integrating forward

Buyer power
 Number of buyers
 Size of buyers
 Size of each order
 Buyers’ cost of switching suppliers
 There are many substitutes
 Price sensitivity
 Threat of integrating backward

Threat of substitutes
 Number of substitutes
 Performance of substitutes
 Cost of changing

Rivalry among existing competitors

 Number of competitors
 Cost of leaving an industry
 Industry growth rate and size
 Product differentiation
 Competitors’ size
 Customer loyalty
 Threat of horizontal integration
 Level of advertising expense

Step 2. Analyze the results and display them on a diagram. After gathering all the information, you
should analyze it and determine how each force is affecting an industry. For example, if there are many
companies of equal size operating in the slow growth industry, it means that rivalry between existing
companies is strong. Remember that five forces affect different industries differently so don’t use the same
results of analysis for even similar industries!

Step 3. Formulate strategies based on the conclusions. At this stage, managers should formulate firm’s
strategies using the results of the analysis For example, if it is hard to achieve economies of scale in the
market, the company should pursue cost leadership strategy. Product development strategy should be used if
the current market growth is slow and the market is saturated.

Although, Porter’s five forces is a great tool to analyze industry’s structure and use the results to formulate
firm’s strategy, it has its limitations and requires further analysis to be done, such as SWOT, PEST or Value
Chain analysis.

Example

This is Porter’s five forces analysis example for an automotive industry.

 Porter's Five Forces Evaluation
Threat of new entry (very weak)
 Large amount of capital required
 High retaliation possible from existing companies, if new entrants would bring innovative products
and ideas to the industry
 Few legal barriers protect existing companies from new entrants
 All automotive companies have established brand image and reputation
 Products are mainly differentiated by design and engineering quality
 New entrant could easily access suppliers and distributors
 A firm has to produce at least 5 million (by some estimations) vehicles to be cost competitive,
therefore it is very hard to achieve economies of scale
 Governments often protect their home markets by introducing high import taxes

Supplier power (weak)

 Large number of suppliers
 Some suppliers are large but the most of them are pretty small
 Companies use another type of material (use one metal instead of another) but only to some extent
(plastic instead of metal)
 Materials widely accessible
 Suppliers do not pose any threat of forward integration

Buyer power (strong)

 There are many buyers
 Most of the buyers are individuals that buy one car, but corporates or governments usually buy large
fleets and can bargain for lower prices
 It doesn’t cost much for buyers to switch to another brand of vehicle or to start using other type of
transportation
 Buyers can easily choose alternative car brand
 Buyers are price sensitive and their decision is often based on how much does a vehicle cost
 Buyers do not threaten backward integration
 Threat of substitutes (weak)
 There are many alternative types of transportation, such as bicycles, motorcycles, trains, buses or
planes
 Substitutes can rarely offer the same convenience
 Alternative types of transportation almost always cost less and sometimes are more environment
friendly

Competitive rivalry (very strong)

 Moderate number of competitors
 If a firm would decide to leave an industry it would incur huge losses, so most of the time it either
bankrupts or stays in automotive industry for the lifetime
 Industry is very large but matured
 Size of competing firm’s vary but they usually compete for different consumer segments
 Customers are loyal to their brands
 There is moderate threat of being acquired by a competitor

SWOT Analysis - Do It Properly!

Definition

Swot analysis
involves the collection and portrayal of information about internal and external factors which have,
or may have, an impact on business.
[2]

SWOT
is a framework that allows managers to synthesize insights obtained from an internal analysis of the
company’s strengths and weaknesses with those from an analysis of external opportunities and
threats.
[3]

Understanding the tool

What is SWOT analysis? The answer to the question is simple: it’s a tool used for situation (business or
personal) analysis! SWOT is an acronym which stands for:

Strengths: factors that give an edge for the company over its competitors.
Weaknesses: factors that can be harmful if used against the firm by its competitors.
Opportunities: favorable situations which can bring a competitive advantage.
Threats: unfavorable situations which can negatively affect the business.

Strengths and weaknesses are internal to the company and can be directly managed by it, while the
opportunities and threats are external and the company can only anticipate and react to them. Often, swot is
presented in a form of a matrix as in the illustration below:
Swot is widely accepted tool due to its simplicity and value of focusing on the key issues which affect the
firm. The aim of swot is to identify the strengths and weaknesses that are relevant in meeting opportunities
and threats in particular situation. [4]

Benefits

Swot tool has 5 key benefits:

 Simple to do and practical to use;

 Clear to understand;
 Focuses on the key internal and external factors affecting the company;
 Helps to identify future goals;
 Initiates further analysis.

Limitations

Although there are clear benefits of doing the analysis, many managers and academics heavily criticize or
don’t even recognize it as a serious tool.[2] According to many, it is a ‘low-grade’ analysis. Here are the main
flaws identified by a research:[2][5]

 Excessive lists of strengths, weaknesses, opportunities and threats;

 No prioritization of factors;
 Factors are described too broadly;
 Factors are often opinions not facts;
 No recognized method to distinguish between strengths and weaknesses, opportunities and threats.

How to perform the analysis?

Swot can be done by one person or a group of members that are directly responsible for the situation
assessment in the company. Basic swot analysis is done fairly easily and comprises of only few steps:

Step 1. Listing the firm’s key strengths and weaknesses

Step 2. Identifying opportunities and threats
Strengths and Weaknesses

Strengths and weaknesses are the factors of the firm’s internal environment. When looking for strengths, ask
what do you do better or have more valuable than your competitors have? In case of the weaknesses, ask
what could you improve and at least catch up with your competitors?

Where to look for them?

Some strengths or weaknesses can be recognized instantly without deeper studying of the organization. But
usually the process is harder and managers have to look into the firm’s:

 Resources: land, equipment, knowledge, brand equity, intellectual property, etc.

 Core competencies
 Capabilities
 Functional areas: management, operations, marketing, finances, human resources and R&D
 Organizational culture
 Value chain activities

Strength or a weakness?

Often, company’s internal factors are seen as both, strengths and weaknesses, at the same time. It is also
hard to tell if a characteristic is a strength (weakness) or not. For example, firm’s organizational structure
can be a strength, a weakness or neither! In such cases, you should rely on:

Clear definition. Very often factors which are described too broadly may fit both strengths and weaknesses.
For example, “brand image” might be a weakness if the company has poor brand image. However, it can
also be a strength if the company has the most valuable brand in the market, valued at $100 billion.
Therefore, it is easier to identify if a factor is a strength or a weakness when it’s defined precisely.

Benchmarking. The key emphasize in doing swot is to identify the factors that are the strengths or
weaknesses in comparison to the competitors. For example, 17% profit margin would be an excellent margin
for many firms in most industries and it would be considered as a strength. But what if the average profit
margin of your competitors is 20%? Then company’s 17% profit margin would be considered as a
weakness.

VRIO framework. A resource can be seen as a strength if it exhibits VRIO (valuable, rare and cannot be
imitated) framework characteristics. Otherwise, it doesn’t provide any strategic advantage for the company.

Opportunities and threats

Opportunities and threats are the external uncontrollable factors that usually appear or arise due to the
changes in the macro environment, industry or competitors’ actions. Opportunities represent the external
situations that bring a competitive advantage if seized upon. Threats may damage your company so you
would better avoid or defend against them.

Where to look for them?

PESTEL. PEST or PESTEL analysis represents all the major external forces (political, economic, social,
technological, environmental and legal) affecting the company so it’s the best place to look for the existing
or new opportunities and threats.

Competition. Competitor’s react to your moves and external changes. They also change their existing
strategies or introduce new ones. Therefore, the company must always follow the actions of its competitors
as new opportunities and threats may open at any time.
Market changes. The most visible opportunities and threats appear during the market changes. Markets
converge, starting to satisfy other market segment needs with the same product. New geographical markets
open up allowing the firm to increase its export volumes or start operations in a new country. Often niche
markets become profitable due to technological changes. As a result, changes in the market create new
opportunities and threats that must be seized upon or dealt with if the company wants to gain and sustain
competitive advantage.

Opportunity or threat?

Most external changes can represent both opportunities and threats. For example, exchange rates may
increase or reduce the profits gained from exports. This depends on the exchange rate, which may rise
(opportunity) or fall (threat) against the home country currency. The organization can only guess the
outcome of the change and count on analysts’ forecasts. In such cases, when organization cannot identify if
the external factor will affect it positively or negatively, it should gather unbiased and reliable information
from the external sources and make the best possible judgement.

Guidelines for successful SWOT

The following guidelines are very important in writing a successful swot analysis. They eliminate most of
swot limitations and improve it's results significantly:

 Factors have to be identified relative to the competitors. It allows specifying whether the factor is a
strength or a weakness.
 List between 3 – 5 items for each category. Prevents creating too short or endless lists.
 Items must be clearly defined and as specific as possible. For example, firm’s strength is: brand
image (vague); strong brand image (more precise); brand image valued at $10 billion, which is the
most valued brand in the market (very good).
 Rely on facts not opinions. Find some external information or involve someone who could provide
an unbiased opinion.
 Factors should be action orientated. For example, “slow introduction of new products” is action
orientated weakness.

SWOT analysis example A

This is a basic example of the analysis:

SWOT analysis of Company "A"

Strengths
1. Second most valuable brand in the world
valued at $76 billion
2. Diversified income (5 different brands
earning more than $4 billion each)
3. Strong patents portfolio (15,000 patents)
4. Investments in R&D reaching 4 billion a
year.
5. Competent in mergers & acquisitions
6. Have an access to cheap cash reserves
7. Effective corporate social responsibility
(CSR) projects
8. Localized products
9. Highly skilled workforce
10. Economies of scale or economies of scope
Weaknesses
1. Investments in R&D are below the industry
average
2. Very low or zero profit margins
3. Poor customer services
4. High employee turnover
5. High cost structure
6. Weak brand portfolio
7. Rigid (bureaucratic) organizational culture
impeding fast introduction of new products
8. High debt level ($3 billion)
9. Brand dilution (the firm has too many brands)
10. Poor presence in the world's largest markets

Opportunities Threats
 1. Market growth for the main firm's product
1. Corporate tax may increase from 20% to 22%
2. Growing demand for renewable energy
in 2013
3. New technology, that would drive
2. Rising pay levels
production costs by 20% is in development
3. Rising raw material prices
4. Our country accession to EU
4. Intense competition
5. Changing customer habits
5. Market is expected to grow by only 1% next
6. Disposable income level will increase
year indicating market saturation
7. Government's incentives for 'specific'
6. Increasing fuel prices
industry
7. Aging population
8. Economy is expected to grow by 4% next
8. Stricter laws regulating environment pollution
year
9. Lawsuits against the company
9. Growing number of people buying online
10. Currency fluctuations
10. Interest rates falling to 1%

IFE & EFE Matrices

Definition

Internal Factor Evaluation (IFE) Matrix

is a strategy tool used to evaluate firm’s internal environment and to reveal its strengths as well as
weaknesses.

External Factor Evaluation (EFE) Matrix

is a strategy tool used to examine company’s external environment and to identify the available
opportunities and threats.

Understanding the tool

The internal and external factor evaluation matrices have been introduced by Fred R. David in his book
‘Strategic Management’[1] (at least I found them there and couldn’t trace their origins anywhere else).
According to the author, both tools are used to summarize the information gained from company’s external
and internal environment analyses. The summarized information is evaluated and used for further purposes,
such as, to build SWOT analysis or IE matrix. Even though, the tools are quite simplistic, they do the best
job possible in identifying and evaluating the key affecting factors. Both tools are nearly identical so we’ll
only show an example of an EFE matrix right now.

External Factor Evaluation Matrix

Weighted
Key External Factors Weight Rating
Score
Opportunities
1. New trade agreement that lifts the ban of imported food is signed with a
0.11 3 0.33
neighboring country.
2. Signing a contract with a new supplier. 0.09 1 0.09
3. Processed food market growing by 15% next year in our largest market. 0.24 2 0.48
4. Incorporating a new company in neighboring country, where the tax rate
0.10 1 0.10
is decreasing by 3% next year.
Threats
5. The contract with the main customer expires in 2 months. 0.17 4 0.68
6. Extreme cases of natural disasters occurring next year. 0.03 2 0.06
7. New law, requiring decreasing the amount of sugar in the food by 20%,
0.14 3 0.42
could be passed next year.
 External Factor Evaluation Matrix
Weighted
Key External Factors Weight Rating
Score
8. Competitors opening 3 new stores in the town. 0.12 2 0.24
Total 1.00 - 2.40

Key External and Internal Factors

EFE Matrix. When using the EFE matrix we identify the key external opportunities and threats that are
affecting or might affect a company. Where do we get these factors from? Simply by analysing the external
environment with the tools like PEST analysis, Porter’s Five Forces or Competitive Profile Matrix.

IFE Matrix. Strengths and weaknesses are used as the key internal factors in the evaluation. When looking
for the strengths, ask what do you do better or have more valuable than your competitors have? In case of
the weaknesses, ask which areas of your company you could improve and at least catch up with your
competitors?

The general rule is to identify 10-20 key external factors and additional 10-20 key internal factors, but you
should identify as many factors as possible.

Weights

Each key factor should be assigned a weight ranging from 0.0 (low importance) to 1.0 (high importance).
The number indicates how important the factor is if a company wants to succeed in an industry. If there were
no weights assigned, all the factors would be equally important, which is an impossible scenario in the real
world. The sum of all the weights must equal 1.0. Separate factors should not be given too much emphasis
(assigning a weight of 0.30 or more) because the success in an industry is rarely determined by one or few
factors.

Weights have the same meaning in both matrices.

In our first example, the most significant factors are ‘Processed food market growing by 15% next year in
our largest market.’ (0.24 points), ‘The contract with the main customer expires in 2 months.’ (0.17 points)
and ‘New law, requiring decreasing the amount of sugar in the food by 20%, could be passed next year.’
(0.14 points).

Ratings

The meaning of ratings is different in each matrix, so we’ll explain them separately.

EFE Matrix. The ratings in external matrix refer to how effectively company’s current strategy responds to
the opportunities and threats. The numbers range from 4 to 1, where 4 means a superior response, 3 – above
average response, 2 – average response and 1 – poor response. Ratings, as well as weights, are assigned
subjectively to each factor. In our example, we can see that the company’s response to the opportunities is
rather poor, because only one opportunity has received a rating of 3, while the rest have received the rating
of 1. The company is better prepared to meet the threats, especially the first threat.

IFE Matrix. The ratings in internal matrix refer to how strong or weak each factor is in a firm. The numbers
range from 4 to 1, where 4 means a major strength, 3 – minor strength, 2 – minor weakness and 1 – major
weakness. Strengths can only receive ratings 3 & 4, weaknesses – 2 & 1. The process of assigning ratings in
IFE matrix can be done easier using benchmarking tool.
Weighted Scores & Total Weighted Score

The score is the result of weight multiplied by rating. Each key factor must receive a score. Total weighted
score is simply the sum of all individual weighted scores. The firm can receive the same total score from 1
to 4 in both matrices. The total score of 2.5 is an average score. In external evaluation a low total score
indicates that company’s strategies aren’t well designed to meet the opportunities and defend against threats.
In internal evaluation a low score indicates that the company is weak against its competitors.

In our example, the company has received total score 2.40, which indicates that company’s strategies are
neither effective nor ineffective in exploiting opportunities or defending against threats. The company
should improve its strategy and focus more on how take advantage of the opportunities.

Benefits

Both matrices have the following benefits:

 Easy to understand. The input factors have a clear meaning to everyone inside or outside the
company. There’s no confusion over the terms used or the implications of the matrices.
 Easy to use. The matrices do not require extensive expertise, many personnel or lots of time to build.
 Focuses on the key internal and external factors. Unlike some other analyses (e.g. value chain
analysis, which identifies all the activities in the company’s value chain, despite their importance),
the IFE and EFE only highlight the key factors that are affecting a company or its strategy.
 Multi-purpose. The tools can be used to build SWOT analysis, IE matrix, GE-McKinsey matrix or
for benchmarking.

Limitations

 Easily replaced. IFE and EFE matrices can be replaced almost completely by PEST analysis, SWOT
analysis, competitive profile matrix and partly some other analysis.
 Doesn’t directly help in strategy formation. Both analyses only identify and evaluate the factors but
do not help the company directly in determining the next strategic move or the best strategy. Other
strategy tools have to be used for that.
 Too broad factors. SWOT matrix has the same limitation and it means that some factors that are not
specific enough can be confused with each other. Some strengths can be weaknesses as well, e.g.
brand reputation, which can be a strong and valuable brand reputation or a poor brand reputation.
The same situation is with opportunities and threats. Therefore, each factor has to be as specific as
possible to avoid confusion over where the factor should be assigned.

Using the tool

Step 1. Identify the key external/internal factors

EFE matrix. Do the PEST analysis first. The information from the PEST analysis reveals which factors
currently affect or may affect the company in the future. At this point, the factors can be either opportunities
or threats and your next task is to sort them into one or the other category. Try to look at which factors could
benefit the company and which ones would harm it.

You should also analyze your competitors’ actions and their strategies. This way you would know what
competitors are doing right and what their strategies lack.

IFE matrix. In case you have done a SWOT analysis already, you can gather some of the factors from there.
The SWOT analysis will usually have no more than 10 strengths and weaknesses, so you’ll have to do
additional analysis to identify more key internal factors for the matrix.
 IFE Matrix Example

Look again into the company’s resources, capabilities, organizational structure, culture, functional areas and
value chain analysis and recognize the strong and weak points of the organization.

Step 2. Assign the weights and ratings

Weights and ratings are assigned subjectively. Therefore, it is a more difficult process than identifying the
key factors. We assign weights based on industry analysts’ opinions. Find out what the analysts say about
the industry’s success factors and then use their opinion or analysis to assign the appropriate weights. The
same process is with ratings. Although, this time you or the members of your group will have to decide what
ratings should be assigned. Ratings from 1-4 can be assigned to each opportunity and threat, but only the
ratings from 1-2 can be assigned to each weakness and 3-4 to each strength.

EFE Matrix Example

Weighted
Key External Factors Weight Rating
Score
Opportunities
1. New immigration laws abolish the restrictions for
0.02 1 0.02
immigrants to live and work freely in the country.
2. A government increases budget spending for our products. 0.17 4 0.68
3. New product market, worth $1 billion a year, could be
0.05 4 0.20
introduced for the consumers.
4. Consumers are 20 % more likely to by the products that
0.12 4 0.48
share the same ecosystem.
5. We have patented the technology that increases the quality
of our products and lowers the amount of the materials needed 0.03 3 0.09
to produce it.
6. Our largest competitor is selling their subsidiary in TV
0.14 2 0.28
market.
Threats
7. Tax rates will increase by 10% for the polluting companies. 0.06 2 0.12
8. Due to the fast economic growth credit availability will
0.04 4 0.16
tighten.
9. Credit rates are growing by 5%. 0.02 2 0.04
10. Natural disasters disrupt our suppliers’ or our operations. 0.08 3 0.24
11. Rivalry in the market is intensifying. 0.12 4 0.48
12. Competitor is pursuing horizontal integration strategy. 0.10 3 0.30
13. Inflation has increased to 6%. 0.05 2 0.10
Total 1.00 - 3.19
 Weighted
Key Internal Factors Weight Rating
Score
Strengths
1. Diversified income (5 different brands earning more than
0.10 4 0.40
$4 billion each)
2. Brand reputation valued at $35 billion 0.08 3 0.24
3. Strong patents portfolio (13,000 patents) 0.07 4 0.28
4. Excellent employee management 0.02 3 0.06
5. Competency in mergers and acquisitions 0.06 3 0.18
6. Extensive distribution channels 0.11 4 0.44
7. Strong product ecosystem 0.08 4 0.32
Weaknesses
8. High debt level ($3 billion) 0.10 1 0.10
9. Over-dependence on sales from U.S. 0.13 2 0.26
10. Too low net profit margin 0.07 2 0.14
11. Competition based on prices 0.09 2 0.18
12. Rigid (bureaucratic) organizational culture impeding fast
0.04 1 0.04
introduction of new products
13. Negative publicity 0.05 2 0.10
Total 1.00 - 2.74

BCG growth-share matrix

The four quadrants of the growth-share matrix.

Definition
BCG matrix
(or growth-share matrix) is a corporate planning tool, which is used to portray firm’s brand portfolio
or SBUs on a quadrant along relative market share axis (horizontal axis) and speed of market growth
(vertical axis) axis.
Growth-share matrix
is a business tool, which uses relative market share and industry growth rate factors to evaluate the
potential of business brand portfolio and suggest further investment strategies.

Understanding the tool

BCG matrix is a framework created by Boston Consulting Group to evaluate the strategic position of the
business brand portfolio and its potential. It classifies business portfolio into four categories based on
industry attractiveness (growth rate of that industry) and competitive position (relative market share). These
two dimensions reveal likely profitability of the business portfolio in terms of cash needed to support that
unit and cash generated by it. The general purpose of the analysis is to help understand, which brands the
firm should invest in and which ones should be divested.
Relative market share. One of the dimensions used to evaluate business portfolio is relative market share.
Higher corporate’s market share results in higher cash returns. This is because a firm that produces more,
benefits from higher economies of scale and experience curve, which results in higher profits. Nonetheless,
it is worth to note that some firms may experience the same benefits with lower production outputs and
lower market share.

Market growth rate. High market growth rate means higher earnings and sometimes profits but it also
consumes lots of cash, which is used as investment to stimulate further growth. Therefore, business units
that operate in rapid growth industries are cash users and are worth investing in only when they are expected
to grow or maintain market share in the future.

There are four quadrants into which firms brands are classified:

Dogs. Dogs hold low market share compared to competitors and operate in a slowly growing market. In
general, they are not worth investing in because they generate low or negative cash returns. But this is not
always the truth. Some dogs may be profitable for long period of time, they may provide synergies for other
brands or SBUs or simple act as a defense to counter competitors moves. Therefore, it is always important to
perform deeper analysis of each brand or SBU to make sure they are not worth investing in or have to be
divested.
Strategic choices: Retrenchment, divestiture, liquidation

Cash cows. Cash cows are the most profitable brands and should be “milked” to provide as much cash as
possible. The cash gained from “cows” should be invested into stars to support their further growth.
According to growth-share matrix, corporates should not invest into cash cows to induce growth but only to
support them so they can maintain their current market share. Again, this is not always the truth. Cash cows
are usually large corporations or SBUs that are capable of innovating new products or processes, which may
become new stars. If there would be no support for cash cows, they would not be capable of such
innovations.
Strategic choices: Product development, diversification, divestiture, retrenchment

Stars. Stars operate in high growth industries and maintain high market share. Stars are both cash generators
and cash users. They are the primary units in which the company should invest its money, because stars are
expected to become cash cows and generate positive cash flows. Yet, not all stars become cash flows. This
is especially true in rapidly changing industries, where new innovative products can soon be outcompeted by
new technological advancements, so a star instead of becoming a cash cow, becomes a dog.
Strategic choices: Vertical integration, horizontal integration, market penetration, market development,
product development
Question marks. Question marks are the brands that require much closer consideration. They hold low
market share in fast growing markets consuming large amount of cash and incurring losses. It has potential
to gain market share and become a star, which would later become cash cow. Question marks do not always
succeed and even after large amount of investments they struggle to gain market share and eventually
become dogs. Therefore, they require very close consideration to decide if they are worth investing in or not.
Strategic choices: Market penetration, market development, product development, divestiture

BCG matrix quadrants are simplified versions of the reality and cannot be applied blindly. They can help as
general investment guidelines but should not change strategic thinking. Business should rely on management
judgement, business unit strengths and weaknesses and external environment factors to make more
reasonable investment decisions.

Advantages and disadvantages

Benefits of the matrix:

 Easy to perform;
 Helps to understand the strategic positions of business portfolio;
 It’s a good starting point for further more thorough analysis.

Growth-share analysis has been heavily criticized for its oversimplification and lack of useful application.
Following are the main limitations of the analysis:

 Business can only be classified to four quadrants. It can be confusing to classify an SBU that falls
right in the middle.
 It does not define what ‘market’ is. Businesses can be classified as cash cows, while they are actually
dogs, or vice versa.
 Does not include other external factors that may change the situation completely.
 Market share and industry growth are not the only factors of profitability. Besides, high market share
does not necessarily mean high profits.
 It denies that synergies between different units exist. Dogs can be as important as cash cows to
businesses if it helps to achieve competitive advantage for the rest of the company.

Using the tool

Although BCG analysis has lost its importance due to many limitations, it can still be a useful tool if
performed by following these steps:

 Step 1. Choose the unit

 Step 2. Define the market
 Step 3. Calculate relative market share
 Step 4. Find out market growth rate
 Step 5. Draw the circles on a matrix

Step 1. Choose the unit. BCG matrix can be used to analyze SBUs, separate brands, products or a firm as a
unit itself. Which unit will be chosen will have an impact on the whole analysis. Therefore, it is essential to
define the unit for which you’ll do the analysis.

Step 2. Define the market. Defining the market is one of the most important things to do in this analysis.
This is because incorrectly defined market may lead to poor classification. For example, if we would do the
analysis for the Daimler’s Mercedes-Benz car brand in the passenger vehicle market it would end up as a
dog (it holds less than 20% relative market share), but it would be a cash cow in the luxury car market. It is
important to clearly define the market to better understand firm’s portfolio position.
Step 3. Calculate relative market share. Relative market share can be calculated in terms of revenues or
market share. It is calculated by dividing your own brand’s market share (revenues) by the market share (or
revenues) of your largest competitor in that industry. For example, if your competitor’s market share in
refrigerator’s industry was 25% and your firm’s brand market share was 10% in the same year, your relative
market share would be only 0.4. Relative market share is given on x-axis. It’s top left corner is set at 1,
midpoint at 0.5 and top right corner at 0 (see the example below for this).

Step 4. Find out market growth rate. The industry growth rate can be found in industry reports, which are
usually available online for free. It can also be calculated by looking at average revenue growth of the
leading industry firms. Market growth rate is measured in percentage terms. The midpoint of the y-axis is
usually set at 10% growth rate, but this can vary. Some industries grow for years but at average rate of 1 or
2% per year. Therefore, when doing the analysis you should find out what growth rate is seen as significant
(midpoint) to separate cash cows from stars and question marks from dogs.

Step 5. Draw the circles on a matrix. After calculating all the measures, you should be able to plot your
brands on the matrix. You should do this by drawing a circle for each brand. The size of the circle should
correspond to the proportion of business revenue generated by that brand.

Examples
Corporate ‘A’ BCG matrix
% of corporate Largest rival’s Your brand’s Relative Market
Brand Revenues
revenues market share market share market share growth rate
Brand
$500,000 54% 25% 25% 1 3%
1
Brand
$350,000 38% 30% 5% 0.17 12%
2
Brand
$50,000 6% 45% 30% 0.67 13%
3
Brand
$20,000 2% 10% 1% 0.1 15%
4
This example was created to show how to deal with a relative market share higher than 100% and with
negative market growth.

Corporate ‘B’ BCG matrix

% of corporate Largest rival’s Your brand’s Relative Market
Brand Revenues
revenues market share market share market share growth rate
Brand
$500,000 55% 15% 60% 1 3%
1
Brand
$350,000 31% 30% 5% 0.17 -15%
2
Brand
$50,000 10% 45% 30% 0.67 -4%
3
Brand
$20,000 4% 10% 1% 0.1 8%
4

SPACE Matrix Strategic Management Method

The SPACE matrix is a management tool used to analyze a company. It is used to determine what type of a
strategy a company should undertake.

The Strategic Position & ACtion Evaluation matrix or short a SPACE matrix is a strategic management
tool that focuses on strategy formulation especially as related to the competitive position of an organization.

The SPACE matrix can be used as a basis for other analyses, such as the SWOT analysis, BCG matrix
model, industry analysis, or assessing strategic alternatives (IE matrix).

What is the SPACE matrix strategic management method?

To explain how the SPACE matrix works, it is best to reverse-engineer it. First, let's take a look at what the
outcome of a SPACE matrix analysis can be, take a look at the picture below. The SPACE matrix is broken
down to four quadrants where each quadrant suggests a different type or a nature of a strategy:
  Aggressive
 Conservative
 Defensive
 Competitive

This is what a completed SPACE matrix looks like:

This particular SPACE matrix tells us that our company should pursue an aggressive strategy. Our company
has a strong competitive position it the market with rapid growth. It needs to use its internal strengths to
develop a market penetration and market development strategy. This can include product development,
integration with other companies, acquisition of competitors, and so on.

Now, how do we get to the possible outcomes shown in the SPACE matrix? The SPACE Matrix analysis
functions upon two internal and two external strategic dimensions in order to determine the organization's
strategic posture in the industry. The SPACE matrix is based on four areas of analysis.

Internal strategic dimensions:

Financial strength (FS)

Competitive advantage (CA)

External strategic dimensions:

Environmental stability (ES)

Industry strength (IS)

There are many SPACE matrix factors under the internal strategic dimension. These factors analyze a
business internal strategic position. The financial strength factors often come from company accounting.
These SPACE matrix factors can include for example return on investment, leverage, turnover, liquidity,
working capital, cash flow, and others. Competitive advantage factors include for example the speed of
innovation by the company, market niche position, customer loyalty, product quality, market share, product
life cycle, and others.

Every business is also affected by the environment in which it operates. SPACE matrix factors related to
business external strategic dimension are for example overall economic condition, GDP growth, inflation,
price elasticity, technology, barriers to entry, competitive pressures, industry growth potential, and others.
These factors can be well analyzed using the Michael Porter's Five Forces model.

The SPACE matrix calculates the importance of each of these dimensions and places them on a Cartesian
graph with X and Y coordinates.

The following are a few model technical assumptions:

- By definition, the CA and IS values in the SPACE matrix are plotted on the X axis.
- CA values can range from -1 to -6.
- IS values can take +1 to +6.

- The FS and ES dimensions of the model are plotted on the Y axis.

- ES values can be between -1 and -6.
- FS values range from +1 to +6.

How do I construct a SPACE matrix?

The SPACE matrix is constructed by plotting calculated values for the competitive advantage (CA) and
industry strength (IS) dimensions on the X axis. The Y axis is based on the environmental stability (ES)
and financial strength (FS) dimensions. The SPACE matrix can be created using the following seven steps:

Step 1: Choose a set of variables to be used to gauge the competitive advantage (CA), industry strength
(IS), environmental stability (ES), and financial strength (FS).

Step 2: Rate individual factors using rating system specific to each dimension. Rate competitive
advantage (CA) and environmental stability (ES) using rating scale from -6 (worst) to -1 (best). Rate
industry strength (IS) and financial strength (FS) using rating scale from +1 (worst) to +6 (best).

Step 3: Find the average scores for competitive advantage (CA), industry strength (IS), environmental
stability (ES), and financial strength (FS).

Step 4: Plot values from step 3 for each dimension on the SPACE matrix on the appropriate axis.

Step 5: Add the average score for the competitive advantage (CA) and industry strength (IS) dimensions.
This will be your final point on axis X on the SPACE matrix.

Step 6: Add the average score for the SPACE matrix environmental stability (ES) and financial strength (FS)
dimensions to find your final point on the axis Y.

Step 7: Find intersection of your X and Y points. Draw a line from the center of the SPACE matrix to
your point. This line reveals the type of strategy the company should pursue.

SPACE matrix example

The following table shows what values were used to create the SPACE matrix displayed above.
Each factor within each strategic dimension is rated using appropriate rating scale. Then averages are
calculated. Adding individual strategic dimension averages provides values that are plotted on the axis X
and Y.

Where do I go next?

The SPACE matrix can help to find a strategy. But, what if we have 2-3 strategies and need to decide which
one is the best one? The Quantitative Strategic Planning Matrix (QSPM) model can help to answer this
question.

Competitive Profile Matrix (CPM)

The key question in analysing the competition.

Definition
The Competitive Profile Matrix (CPM)
is a tool that compares the firm and its rivals and reveals their relative strengths and weaknesses.

Understanding the tool

In order to better understand the external environment and the competition in a particular industry, firms
often use CPM. The matrix identifies a firm’s key competitors and compares them using industry’s critical
success factors. The analysis also reveals company’s relative strengths and weaknesses against its
competitors, so a company would know, which areas it should improve and, which areas to protect. An
example of a matrix is demonstrated below.

CPM Table
Company A Company B Company C
Critical Success Factor Weight Rating Score Rating Score Rating Score
Brand reputation 0.13 2 0.26 3 0.39 1 0.13
Level of product integration 0.08 4 0.32 3 0.24 1 0.08
Range of products 0.05 3 0.15 1 0.05 2 0.10
Successful new introductions 0.04 3 0.12 3 0.12 3 0.12
Market Share 0.14 2 0.28 4 0.56 4 0.56
Sales per employee 0.08 1 0.08 2 0.16 3 0.24
Low cost structure 0.05 1 0.05 3 0.15 4 0.20
Variety of distribution channels 0.07 4 0.28 2 0.14 2 0.14
Customer retention 0.02 2 0.04 4 0.08 1 0.02
Superior IT capabilities 0.11 3 0.33 4 0.44 4 0.44
Strong online presence 0.15 3 0.45 3 0.45 4 0.60
Successful promotions 0.08 1 0.08 2 0.16 1 0.08
Total 1.00 - 2.44 - 2.94 - 2.71

Critical Success Factors

Critical success factors (CSF) are the key areas, which must be performed at the highest possible level of
excellence if organizations want succeed in the particular industry. They vary between different industries or
even strategic groups and include both internal and external factors. In our example, we have included 11
CSF, which is usually not enough. The more critical success factors are included the more robust and
accurate the analysis is. The following list provides some of the general CSF, but the list is not definite and
you should include industry specific factors in your matrix:

Market Share Union relations Power over suppliers

Product Quality Skilled workforce Access to key suppliers
Clear strategic direction Location of facilities Efficient supply chain
Customer service Production capacity Supply chain integration
Customer loyalty Added product features On time delivery
Brand reputation Price competitiveness Strong online presence
Effective social media
Customer satisfaction Low cost structure
management
Experience and skills
Financial position Variety of products
in e-commerce
Management qualification
Cash reserves Complementary products
and experience
Innovation in products and
Profit margin Level of product integration
services
Inventory turnover Successful product promotions Innovative culture
Employee retention Superior marketing capabilities Efficient production
Income per employee Superior advertising capabilities Lean production system
Innovations per employee Superior IT capabilities Strong supplier network
Cost per employee Size of advertising budget Strong distribution network
R&D spending Effectiveness of sales distribution Product design
Strong patent portfolio Employee satisfaction Level of vertical integration
Effective corporate social
New patents per year Effective planning and budgeting
responsibility programs
Revenue per new product Variety of distribution channels Sales per outlet
Successful new introductions Power over distributors Parent company support

Weight
Each critical success factor should be assigned a weight ranging from 0.0 (low importance) to 1.0 (high
importance). The number indicates how important the factor is in succeeding in the industry. If there were
no weights assigned, all factors would be equally important, which is an impossible scenario in the real
world. The sum of all the weights must equal 1.0. Separate factors should not be given too much emphasis
(assigning a weight of 0.3 or more) because the success in an industry is rarely determined by one or few
factors. In our first example, the most significant factors are ‘strong online presence’ (0.15), ‘market share’
(0.14), ‘brand reputation’ (0.13).

Rating
The ratings in CPM refer to how well companies are doing in each area. They range from 4 to 1, where 4
means a major strength, 3 – minor strength, 2 – minor weakness and 1 – major weakness. Ratings, as well as
weights, are assigned subjectively to each company, but the process can be done easier through
benchmarking. Benchmarking reveals how well companies are doing compared to each other or industry’s
average. Just remember that firms can be assigned equal ratings for the same factor. For example, if
Company A, Company B and Company C, have the market share of 25%, 27% & 28% accordingly, they
would all receive the rating of 4 rather than receiving ratings 2, 3 & 4.

Score & Total Score

The score is the result of weight multiplied by rating. Each company receives a score on each factor. Total
score is simply the sum of all individual score for the company. The firm that receives the highest total score
is relatively stronger than its competitors. In our example, the strongest performer in the market should be
Company B (2.94 points).

Benefits of the CPM:

 The same factors are used to compare the firms. This makes the comparison more accurate.
 The analysis displays the information on a matrix, which makes it easy to compare the companies
visually.
 The results of the matrix facilitate decision-making. Companies can easily decide which areas they
should strengthen, protect or what strategies they should pursue.

Using the tool

Step 1. Identify the critical success factors

To make it easier, use our list of CSF and include as many factors as possible. In addition, following
questions should be helpful identifying industry’s CSF:

 Why consumers prefer Company A over Company B or vice versa?

 What resources, capabilities and competences firms possess?
 What sustainable competitive advantages companies have in the industry?
 Why some companies succeed and others fail in the industry?

Step 2. Assign the weights and ratings

The best way to identify what weights should be assigned to each factor is to compare the best and worst
performing companies in the industry. Well performing companies will usually undertake activities that are
significant for success in the industry. They will put most of their resources and energy into those activities
as compared to low performing organizations. Weights can also be determined in discussion with other top-
level managers.
Ratings should be assigned using benchmarking or during team discussions.

Step 3. Compare the scores and take action

You should compare the scores on each factor to identify where company’s relative strengths and
weaknesses are. In our first example, Company A had relative strength in ‘level of product integration’,
‘product range’ and ‘variety of distribution channels’. Therefore, Company A should protect these areas
while trying to improve its weaknesses in ‘sales per employee’ and ‘market share’.
The company should also improve its strategy to become more successful in the industry.

Example
This is competitive profile matrix example of smartphones operating systems. The main competitors:
Google’s Android OS, Apple’s iOS and Microsoft’s Windows Phone operating systems will be compared to
each other to find out their relative strengths and weaknesses.

CPM Example
Android OS iOS Windows Phone
Critical Success Factor Weight Rating Score Rating Score Rating Score
Market share 0.13 4 0.52 2 0.26 2 0.26
Number of apps in store 0.10 4 0.40 4 0.40 2 0.20
Frequency of updates 0.06 3 0.18 4 0.24 2 0.12
 Design 0.07 3 0.21 3 0.21 3 0.21
Product brand reputation 0.05 3 0.15 3 0.15 2 0.10
Distribution channels 0.11 4 0.44 2 0.22 3 0.33
Usability 0.11 3 0.33 3 0.33 3 0.33
Customization features 0.04 4 0.16 2 0.08 2 0.08
Marketing capabilities 0.04 2 0.08 4 0.16 2 0.08
Company brand reputation 0.10 4 0.40 4 0.40 3 0.30
Openness 0.02 4 0.08 2 0.04 2 0.04
Cloud integration 0.12 4 0.48 2 0.24 2 0.24
Rate of OS crashes 0.08 1 0.08 4 0.32 3 0.24
Total 1.00 - 3.51 - 3.05 - 2.53

The CPM analysis reveals that Android is the strongest player in the industry with relative strengths in
market share, distribution channels, customization features, openness and cloud integration. On the other
hand, iOS prevails in frequency updates, marketing capabilities and the rate of OS crashes. Windows Phone
is the weakest of them all and doesn’t have any relative strengths against its rivals. The companies should
create their strategies according to their strengths and weakness and improve their ratings in the most
significant industry’s areas.

Competitive advantage
The key component for business success.

Definition
Competitive advantage
means superior performance relative to other competitors in the same industry or superior
performance relative to the industry average.

What is competitive advantage?

There is no one answer about what is competitive advantage or one way to measure it, and for the right
reason. Nearly everything can be considered as competitive edge, e.g. higher profit margin, greater return on
assets, valuable resource such as brand reputation or unique competence in producing jet engines. Every
company must have at least one advantage to successfully compete in the market. If a company can’t
identify one or just doesn’t possess it, competitors soon outperform it and force the business to leave the
market.

There are many ways to achieve the advantage but only two basic types of it: cost or differentiation
advantage. A company that is able to achieve superiority in cost or differentiation is able to offer consumers
the products at lower costs or with higher degree of differentiation and most importantly, is able to compete
with its rivals.

An organization that is capable of outperforming its competitors over a long period of time has sustainable
competitive advantage.

The following diagram illustrates the basic competitive advantage model, which is explained below in the
article:
How a company can achieve it?
An organization can achieve an edge over its competitors in the following two ways:

 Through external changes. When PEST factors change, many opportunities can appear that, if
seized upon, could provide many benefits for an organization. A company can also gain an upper
hand over its competitors when its capable to respond to external changes faster than other
organizations.
 By developing them inside the company. A firm can achieve cost or differentiation advantage
when it develops VRIO resources, unique competences or through innovative processes and
products.

External Changes

Changes in PEST factors. PEST stands for political, economic, socio-cultural and technological factors
that affect firm’s external environment. When these factors change many opportunities arise that can be
exploited by an organization to achieve superiority over its rivals. For example, new superior machinery,
which is manufactured and sold only in South Korea, would result in lower production costs for Korean
companies and they would gain cost advantage against competitors in a global environment. Changes in
consumer demand, such as trend for eating more healthy food, can be used to gain at least temporary
differentiation advantage if a company would opt to sell mainly healthy food products while competitors
wouldn’t. For example, Subway and KFC.

If opportunities appear due to changes in external environment why not all companies are able to profit from
that? It’s simple, companies have different resources, competences and capabilities and are differently
affected by industry or macro environment changes.
Company’s ability to respond fast to changes. The advantage can also be gained when a company is the
first one to exploit the external change. Otherwise, if a company is slow to respond to changes it may never
benefit from the arising opportunities.

Internal Environment

VRIO resources. A company that possesses VRIO (valuable, rare, hard to imitate and organized) resources
has an edge over its competitors due to superiority of such resources. If one company has gained VRIO
resource, no other company can acquire it (at least temporarily). The following resources have VRIO
attributes:

 Intellectual property (patents, copyrights, trademarks)

 Brand equity
 Culture
 Know-how
 Reputation

Unique competences. Competence is an ability to perform tasks successfully and is a cluster of related
skills, knowledge, capabilities and processes. A company that has developed a competence in producing
miniaturized electronics would get at least temporary advantage as other companies would find it very hard
to replicate the processes, skills, knowledge and capabilities needed for that competence.

Innovative capabilities. Most often, a company gains superiority through innovation. Innovative products,
processes or new business models provide strong competitive edge due to the first mover advantage. For
example, Apple’s introduction of tablets or its business model combining mp3 device and iTunes online
music store.

Two basic types

M. Porter has identified 2 basic types of competitive advantage: cost and differentiation advantage.

Cost advantage. Porter argued that a company could achieve superior performance by producing similar
quality products or services but at lower costs. In this case, company sells products at the same price as
competitors but reaps higher profit margins because of lower production costs. The company that tries to
achieve cost advantage is pursuing cost leadership strategy. Higher profit margins lead to further price
reductions, more investments in process innovation and ultimately greater value for customers.

Differentiation advantage. Differentiation advantage is achieved by offering unique products and services
and charging premium price for that. Differentiation strategy is used in this situation and company positions
itself more on branding, advertising, design, quality and new product development rather than efficiency,
outsourcing or process innovation. Customers are willing to pay higher price only for unique features and
the best quality.

The cost leadership and differentiation strategies are not the only strategies used to gain competitive
advantage. Innovation strategy is used to develop new or better products, processes or business models that
grant competitive edge over competitors.
Benchmarking
Definition
Benchmarking
is a strategy tool used to compare the performance of the business processes and products with the
best performances of other companies inside and outside the industry.
Benchmarking
is the search for industry best practices that lead to superior performance.

Understanding the tool

Comparing your own business to a rival is essential when competing. Without it, you would never know
how successful your performance is in a market or whether you perform one or another task better than your
competitor does. For example, 85% customer satisfaction might look great for you or even compared to your
industry’s average, but what if some other companies (not necessarily rivals) easily achieve 97% rate? In
this situation, your 85% satisfaction rate doesn’t look that brilliant. To better understand your situation and
improve company’s performance, the managers use benchmarking.

Some form of comparison in the companies was used, since 1800s, and mainly included product’s quality
and feature comparison. This type of comparison was scarcely used and didn’t become a valuable
management tool until late 1980s and 1990s, when Xerox introduced the process benchmarking technique.[2]
This type of comparison proved very beneficial and Xerox, AT&T and other companies began comparing
the performance of their processes to the best standards in the industry. The following table shows how
benchmarking evolved into a modern strategy tool:

Benchmarking history
1950-1975 Reverse engineering
1976-1986 Competitive benchmarking
1982-1986 Process benchmarking
1988+ Strategic benchmarking
1993+ Global benchmarking
Source: J. Blakeman, University of Wisconsin-Milwaukee[3]

According to Camp,[1] benchmarking is simply “Finding and implementing the best business practices”.
Managers use the tool to identify the best practices in other companies and apply those practices to their own
processes in order to improve the company’s performance. Improving company’s performance is, without a
doubt, the most important goal of benchmarking.

It’s a very important tool in strategic management, because it often reveals how well your organization
performs compared to rivals.

Other uses of the tool:

 To reveal successful business processes. It is often unclear how successful companies achieve
superior performance. By observing and scrutinizing such companies you can identify the processes,
skills or competences that contribute to organization’s success and then apply the same practices to
your own company.
 To facilitate knowledge sharing. The knowledge acquired about other businesses can be easily
transferred to your own organization.
 To gain competitive advantage. The company can gain a competitive advantage if it applies the
best practices from other industries to its own industry. For example, a small family owned farm
 selling its own agricultural products online could apply the same social media strategies as internet
blogs to attract attention and gain new customers. This would be a new way to gain customers and
may result in at least temporary competitive advantage.

Popularity

The tool is one of the most recognized and widely used tools of all the business strategy tools. The survey
done by The Global Benchmarking Network[4] reveals that adaptation of the tool in organizations vary from
68% for informal benchmarking to 49% and 39% for performance and best practice benchmarking,
respectively. In addition, annual surveys from Bain & Company’s[5] indicate similar results.

Source: Bain & Company[5]

The graph shows that, although, the satisfaction of the tool is high, the usage of it has declined since the
heights in 1999. Still, benchmarking remained the 4th top used tool by businesses in the world in 2013.[6]

Types

There are different types of benchmarking the managers can use. Tuominen[7] and Bogan & English[8]
identified these 3 major types:

 Strategic benchmarking. Managers use this type of benchmarking to identify the best way to
compete in the market. During the process, the companies identify the winning strategies (usually
outside their own industry) that successful companies use and apply them to their own strategic
process. It is also common to compare the strategic goals in order to spot new strategic choices.
 Performance benchmarking. It is concerned with comparing your company’s products and
services. According to Bogan & English[8] the tool mainly focuses on product and service quality,
features, price, speed, reliability, design and customer satisfaction, but it can measure anything that
has the measurable metrics, including processes. Performance benchmarking determines how strong
our products and services are compared to our competition.
 Process benchmarking. It requires to look at other companies that engage in similar activities and to
identify the best practices that can be applied to your own processes in order to improve them.
Process benchmarking is a separate type of benchmarking, but it usually derives from performance
benchmarking. This is because companies first identify the weak competing points of their products
or services and then focus on the key processes to eliminate those weaknesses. For example, an
organization using performance comparison identifies that their product ‘X’ is superior in features,
manufacturing quality and design, but pricier than competitor’s product ‘Y’. Then the company
determines, which processes add the most to the cost of the product and seek how to improve them
by looking at similar, but less cost heavy processes in other companies.
Approaches

In addition to the types, there are four ways you can do benchmarking. It is important to choose the optimal
way because it reduces the costs of the activity and improves the chances to find the ‘best standards’ you can
rely on.

 Internal benchmarking. In large organizations, which operate in different geographic locations or

manage many products and services, same functions and processes are usually performed by
different teams, business units or divisions. This often results in processes performed very well in
one division but poorly in another. Internal benchmarking is used to compare the work of separate
teams, units or divisions to identify the ones that are working better and share the knowledge
throughout the company to other teams to achieve higher performance. It is usually employed by the
companies that have recently expanded geographically, but haven’t yet created proper knowledge
sharing systems between divisions. If such systems are in place, there’s no need to use internal
benchmarking to look for best practices.
 External or competitive benchmarking. Some authors use these terms interchangeably but there
are a few differences between them. First, competitive benchmarking refers to a process when a
company compares itself with the competitors inside its industry. Whereas external benchmarking
looks both inside and outside the industry to find the best practices, thus, including competitive
benchmarking.[9] Second, competitive benchmarking, in my opinion, will only be used with
performance benchmarking to compare your products and services. Strategic or process
benchmarking won’t be viable options, because it’ll be very hard to find a competitor, who wants to
share sensitive information with you and you’ll never outcompete your rival if you’ll be using his
strategy or processes. Besides, external benchmarking is a more beneficial approach to use due to
higher possibilities of finding the best practices.
 Functional benchmarking. Managers of functional departments find it useful to analyze how well
their functional area performs compared to functional areas of other companies. It is quite easy to
identify the best marketing, finance, human resource or operations departments, in other companies,
that excel in what they do and to apply their practices to your own functional area. This way the
companies can look at a wide range of organizations, even unrelated ones, and instead of improving
separate processes, they can improve the whole functional areas.
 Generic benchmarking. According to Kulmala,[9] it refers to comparisons, which “focus on
excellent work processes rather than on the business practices of a particular organization”. For
example, your company tries to improve its marketing capabilities and benchmarks itself against
company ‘A’. While observing company’s ‘A’ marketing processes you also notice how well their
human resources are managed using ‘big data’ analytics. This gives you an idea to implement the
data collecting and analysis team in your own company to significantly improve its overall
performance.
The other example of generic benchmarking would be to compare your processes against generally
accepted best standards. For example, every organization strives to become a learning organization,
because such an organization is better equipped to overcome challenges and adapt to the market
changes. By comparing your company to some general standards, which would indicate that your
company is a learning organization, you would be using generic benchmarking.

The following diagram summarizes the types and approaches to benchmarking:

Advantages

 Easy to understand and use.

 If done properly, it’s a low cost activity that offers huge gains.
 Brings innovative ideas to the company.
 Provides you with insight of how other companies organize their operations and processes.
 Increases the awareness of your costs and level of performance compared to your rivals.
 Facilitates cooperation between teams, units and divisions.

Disadvantages

 You need to find a benchmarking partner.

 It is sometimes impossible to assign a metric to measure a process.
 You might need to hire a consultant.
 If your organization is not experienced at it, the initial costs could be huge.
 Managers often resist the changes that are required to improve the performance.
 Some of best practices won’t be applicable to your whole organization.

Using the tool

Benchmarking is used extensively by organizations, but no universal process of how to conduct it is
established. Each organization designs its own way of using the tool. Before revealing some of the
examples, we provide you with the guidelines[3] to make the process easier.

Guidelines:

1. Only choose the products, services or processes, which perform poorly. Comparing the processes
you are good at will be a waste of time and money, and won’t bring the desired results.
2. Define the specific metrics or processes to measure. Be careful not to choose too broad processes
that can’t be measured as you won’t be able to compare it properly.
3. Prepare your company for change. Your organization must overcome the resistance to change to
implement new best practices.
4. Choose the team that is qualified. Although benchmarking is easy to use, you shouldn’t pick up just
anybody to do it. Include the people that will be responsible for implementing the changes and the
people that are skilled at it.
5. Participate in benchmarking networks and use the appropriate software to facilitate the process.
There are various benchmarking networks, where participating companies can find benchmarking
 partners or gather the data for the metrics they need. Such participation facilitates the process
significantly by reducing the costs and time spent looking for the right data.
6. Look for the best standards and ideas even in unrelated areas. Many significant discoveries will be
made by observing the companies that are completely unrelated to your organization.

Benchmarking Wheel

The benchmarking wheel model introduced in article “Benchmarking for Quality”[10] is a 5 stage process
that was created by observing more than 20 other models.

It’s fairly simple and comprises of following stages:

1. Plan. Assemble a team. Clearly define what you want to compare and assign metrics to it.
2. Find. Identify benchmarking partners or sources of information, where you’ll be able to collect the
information from.
3. Collect. Choose the methods to collect the information and gather the data for the metrics you
defined.
4. Analyze. Compare the metrics and identify the gap in performance between your company and the
organization observed. Provide the results and recommendations on how to improve the
performance.
5. Improve. Implement the changes to your products, services, processes or strategy.

Xerox Process

Xerox has popularized benchmarking and was one of the first companies to introduce the process of doing it.
This 5-phase and 12-step process was created by Camp, R. the manager of Xerox responsible for
benchmarking.[3]
Most of the processes are similar to the examples above and can be applied to any company or non-profit
organization that strives to achieve superior performance using benchmarking.

Example
Company ‘A’ has used performance benchmarking to compare its product ‘X’ with the competitor’s product
‘Y’ and found out that the product ‘X’ is priced slightly lower, but it also has fewer features than product
‘Y’. The company recognized that in order to win a larger market share and establish itself in the market, it
has to increase the number of features in its product while keeping the price at the same level or even
decreasing it.

To achieve this, the company ’A’ has set up a team that investigated product ‘X’ value chain analysis. The
team identified that the activities adding the most to the cost are marketing and purchasing parts in an open
market. The team also identified that by buying standards parts in the market, the company has little room to
introduce new features as this would require customized parts for its product ‘X’. The next step was to
assign the proper metrics to marketing and purchasing activities and gather the required data. The company
joined the benchmarking network and in a few weeks gathered enough data to compare the performance of
its processes.

The results indicated that the marketing activities could be improved significantly. The team recognized that
many businesses in the industry were able to attract new customers profitably through heavy advertising
online. Yet, further observations of the companies outside the industry showed that the average returns on
advertising weren’t so huge compared to the returns when attracting customers through social media.
Therefore, the team decided to rely on social media rather than advertising to attract more customers, while
reducing its costs by 20%.

The next activity analyzed was the purchase of parts in the open market. While this was a convenient way to
conduct the business it was costing more and didn’t allow customizing the product. The team identified that
this activity could be improved by manufacturing the parts inside the company or by establishing long term
relationships with suppliers. The collected data and the experience of other similar businesses showed that
the best option would be to establish long term relationships with suppliers. It would cost less than
manufacturing the parts inside the company or buying them in an open market. It would also allow ordering
customized parts that were needed for the new features.

By engaging in benchmarking activities, the team has identified the gaps in company’s performance and
introduced new ways to improve the current processes to achieve the higher performance.

GE McKinsey Matrix
Business portfolio prioritization.

Definition
GE-McKinsey nine-box matrix
is a strategy tool that offers a systematic approach for the multi business corporation to prioritize its
investments among its business units.
GE-McKinsey
is a framework that evaluates business portfolio, provides further strategic implications and helps to
prioritize the investment needed for each business unit (BU).

Understanding the tool

In the business world, much like anywhere else, the problem of resource scarcity is affecting the decisions
the companies make. With limited resources, but many opportunities of using them, the businesses need to
choose how to use their cash best. The fight for investments takes place in every level of the company:
between teams, functional departments, divisions or business units. The question of where and how much to
invest is an ever going headache for those who allocate the resources.

How does this affect the diversified businesses? Multi business companies manage complex business
portfolios, often, with as much as 50, 60 or 100 products and services. The products or business units differ
in what they do, how well they perform or in their future prospects. This makes it very hard to make a
decision in which products the company should invest. At least, it was hard until the BCG matrix and its
improved version GE-McKinsey matrix came to help. These tools solved the problem by comparing the
business units and assigning them to the groups that are worth investing in or the groups that should be
harvested or divested.
In 1970s, General Electric was managing a huge and complex portfolio of unrelated products and was
unsatisfied about the returns from its investments in the products. At the time, companies usually relied on
projections of future cash flows, future market growth or some other future projections to make investment
decisions, which was an unreliable method to allocate the resources. Therefore, GE consulted the McKinsey
& Company and as a result the nine-box framework was designed. The nine-box matrix plots the BUs on its
9 cells that indicate whether the company should invest in a product, harvest/divest it or do a further
research on the product and invest in it if there’re still some resources left. The BUs are evaluated on two
axes: industry attractiveness and a competitive strength of a unit.

Industry Attractiveness

Industry attractiveness indicates how hard or easy it will be for a company to compete in the market and
earn profits. The more profitable the industry is the more attractive it becomes. When evaluating the industry
attractiveness, analysts should look how an industry will change in the long run rather than in the near
future, because the investments needed for the product usually require long lasting commitment.

Industry attractiveness consists of many factors that collectively determine the competition level in it.
There’s no definite list of which factors should be included to determine industry attractiveness, but the
following are the most common: [1]

 Long run growth rate

 Industry size
 Industry profitability: entry barriers, exit barriers, supplier power, buyer power, threat of substitutes
and available complements (use Porter’s Five Forces analysis to determine this)
 Industry structure (use Structure-Conduct-Performance framework to determine this)
 Product life cycle changes
 Changes in demand
 Trend of prices
 Macro environment factors (use PEST or PESTEL for this)
 Seasonality
 Availability of labor
 Market segmentation
Competitive strength of a business unit or a product

Along the X axis, the matrix measures how strong, in terms of competition, a particular business unit is
against its rivals. In other words, managers try to determine whether a business unit has a sustainable
competitive advantage (or at least temporary competitive advantage) or not. If the company has a sustainable
competitive advantage, the next question is: “For how long it will be sustained?”

The following factors determine the competitive strength of a business unit:

 Total market share

 Market share growth compared to rivals
 Brand strength (use brand value for this)
 Profitability of the company
 Customer loyalty
 VRIO resources or capabilities (use VRIO framework to determine this)
 Your business unit strength in meeting industry’s critical success factors (use Competitive Profile
Matrix to determine this)
 Strength of a value chain (use Value Chain Analysis and Benchmarking to determine this)
 Level of product differentiation
 Production flexibility

Advantages

 Helps to prioritize the limited resources in order to achieve the best returns.
 Managers become more aware of how their products or business units perform.
 It’s more sophisticated business portfolio framework than the BCG matrix.
 Identifies the strategic steps the company needs to make to improve the performance of its business
portfolio.

Disadvantages

 Requires a consultant or a highly experienced person to determine industry’s attractiveness and

business unit strength as accurately as possible.
 It is costly to conduct.
 It doesn’t take into account the synergies that could exist between two or more business units.

Difference between GE McKinsey and BCG matrices

GE McKinsey matrix is a very similar portfolio evaluation framework to BCG matrix. Both matrices are
used to analyze company’s product or business unit portfolio and facilitate the investment decisions.

The main differences:

 Visual difference. BCG is only a four cell matrix, while GE McKinsey is a nine cell matrix. Nine
cells provide better visual portrait of where business units stand in the matrix. It also separates the
invest/grow cells from harvest/divest cells that are much closer to each other in the BCG matrix and
 may confuse others of what investment decisions to make.

 Comprehensiveness. The reason why the GE McKinsey framework was developed is that BCG
portfolio tool wasn’t sophisticated enough for the guys from General Electric. In BCG matrix,
competitive strength of a business unit is equal to relative market share, which assumes that the
larger the market share a business has the better it is positioned to compete in the market. This is
true, but it’s too simplistic to assume that it’s the only factor affecting the competition in the market.
The same is with industry attractiveness that is measured only as the market growth rate in BCG. It
comes to no surprise that GE with its complex business portfolio needed something more
comprehensive than that.

Using the tool

There are no established processes or models that managers could use when performing the analysis.
Therefore, we designed the following steps to facilitate the process:
Step 1. Determine industry attractiveness of each business unit

 Make a list of factors. The first thing you’ll need to do is to identify, which factors to include when
measuring industry attractiveness. We’ve provided the list of the most common factors, but you
should include the factors that are the most appropriate to your industries.
 Assign weights. Weights indicate how important a factor is to industry’s attractiveness. A number
from 0.01 (not important) to 1.0 (very important) should be assigned to each factor. The sum of all
weights should equal to 1.0.
 Rate the factors. The next thing you need to do is to rate each factor for each of your product or
business unit. Choose the values between ‘1-5’ or ‘1-10’, where ‘1’ indicates the low industry
attractiveness and ‘5’ or ‘10’ high industry attractiveness.
 Calculate the total scores. Total score is the sum of all weighted scores for each business unit.
Weighted scores are calculated by multiplying weights and ratings. Total scores allow comparing
industry attractiveness for each business unit.

Industry Attractiveness
(1/2)
Business Unit 1 Business Unit 2
Factor Weight Rating Weighted Score Rating Weighted Score
Industry growth rate 0.25 3 0.75 4 1
Industry size 0.22 3 0.66 3 0.66
Industry profitability 0.18 5 0.90 1 0.18
Industry structure 0.17 4 0.68 4 0.68
Trend of prices 0.09 3 0.27 3 0.27
Market segmentation 0.09 1 0.09 3 0.27
Total score 1.00 - 3.35 - 3.06
Industry Attractiveness
(2/2)
Business Unit 3 Business Unit 4
Factor Weight Rating Weighted Score Rating Weighted Score
Industry growth rate 0.25 3 0.75 2 0.50
Industry size 0.22 2 0.44 5 1.10
Industry profitability 0.18 1 0.18 5 0.90
Industry structure 0.17 2 0.34 4 0.68
Trend of prices 0.09 2 0.18 3 0.27
Market segmentation 0.09 2 0.18 3 0.27
Total score 1.00 - 2.07 - 3.72

This is a tough task and one that usually requires involving a consultant who is an expert of the industries in
question. The consultant will help you to determine the weights and to rate them properly so the analysis is
as accurate as possible.

Step 2. Determine the competitive strength of each business unit

‘Step 2’ is the same as ‘Step 1’ only this time, instead of industry attractiveness, the competitive strength of
a business unit is evaluated.

 Make a list of factors. Choose the competitive strength factors from our list or add your own factors.
  Assign weights. Weights indicate how important a factor is in achieving sustainable competitive
advantage. A number from 0.01 (not important) to 1.0 (very important) should be assigned to each
factor. The sum of all weights should equal to 1.0.
 Rate the factors. Rate each factor for each of your product or business unit. Choose the values
between ‘1-5’ or ‘1-10’, where ‘1’ indicates the weak strength and ‘5’ or ‘10’ powerful strength.
 Calculate the total scores. See ‘Step 1’.

Competitive Strength
(1/2)
Business Unit 1 Business Unit 2
Factor Weight Rating Weighted Score Rating Weighted Score
Market share 0.22 2 0.44 2 0.44
Relative growth rate 0.18 3 0.48 2 0.38
Company’s profitability 0.14 3 0.42 1 0.14
Brand value 0.10 1 0.10 2 0.20
VRIO resources 0.20 1 0.20 4 0.80
CPM Score 0.16 2 0.32 5 0.80
Total score 1.00 - 1.96 - 2.74
Competitive Strength
(2/2)
Business Unit 3 Business Unit 4
Factor Weight Rating Weighted Score Rating Weighted Score
Market share 0.22 4 0.88 4 0.88
Relative growth rate 0.18 4 0.64 2 0.36
Company’s profitability 0.14 3 0.42 3 0.42
Brand value 0.10 3 0.30 3 0.30
VRIO resources 0.20 4 0.80 4 0.80
CPM Score 0.16 5 0.80 5 0.80
Total score 1.00 - 3.92 - 3.56

Step 3. Plot the business units on a matrix

With all the evaluations and scores in place, we can plot the business units on the matrix. Each business unit
is represented as a circle. The size of the circle should correspond to the proportion of the business revenue
generated by that business unit. For example, ‘Business unit 1’ generates 20% revenue and ‘Business unit 2’
generates 40% revenue for the company. The size of a circle for ‘Business unit 1’ will be half the size of a
circle for ‘Business unit 2’.

Step 4. Analyze the information

There are different investment implications you should follow, depending on which boxes your business
units have been plotted. There are 3 groups of boxes: investment/grow, selectivity/earnings and
harvest/divest boxes. Each group of boxes indicates what you should do with your investments.

Investment implications
Box Invest/Grow Selectivity/Earnings Harvest/Divest
Invest or Definitely Invest if there’s money left and the situation Invest just enough to keep the
not? invest of business unit could be improved business unit operating or divest

Invest/Grow box. Companies should invest into the business units that fall into these boxes as they promise
the highest returns in the future. These business units will require a lot of cash because they’ll be operating
in growing industries and will have to maintain or grow their market share. It is essential to provide as much
resources as possible for BUs so there would be no constraints for them to grow. The investments should be
provided for R&D, advertising, acquisitions and to increase the production capacity to meet the demand in
the future.

Selectivity/Earnings box. You should invest into these BUs only if you have the money left over the
investments in invest/grow business units group and if you believe that BUs will generate cash in the future.
These business units are often considered last as there’s a lot of uncertainty with them. The general rule
should be to invest in business units which operate in huge markets and there are not many dominant players
in the market, so the investments would help to easily win larger market share.

Harvest/Divest box. The business units that are operating in unattractive industries, don’t have sustainable
competitive advantages or are incapable of achieving it and are performing relatively poorly fall into
harvest/divest boxes. What should companies do with these business units?
First, if the business unit generates surplus cash, companies should treat them the same as the business units
that fall into ‘cash cows’ box in the BCG matrix. This means that the companies should invest into these
business units just enough to keep them operating and collect all the cash generated by it. In other words, it’s
worth to invest into such business as long as investments into it doesn’t exceed the cash generated from it.

Second, the business units that only make losses should be divested. If that’s impossible and there’s no way
to turn the losses into profits, the company should liquidate the business unit.

Step 5. Identify the future direction of each business unit

The GE McKinsey matrix only provides the current picture of industry attractiveness and the competitive
strength of a business unit and doesn’t consider how they may change in the future. Further analysis may
reveal that investments into some of the business units can considerably improve their competitive positions
or that the industry may experience major growth in the future. This affects the decisions we make about our
investments into one or another business unit.

For example, our previous evaluations show that the ‘Business Unit 1’ belongs to invest/grow box, but
further analysis of an industry reveals that it’s going to shrink substantially in the near future. Therefore, in
the near future, the business unit will be in harvest/divest group rather than invest/grow box. Would you still
invest as much in ‘Business Unit 1’ as you would have invested initially? The answer is no and the matrix
should take that into consideration.

How to do that? Well, the company should consult with the industry analysts to determine whether the
industry attractiveness will grow, stay the same or decrease in the future. You should also discuss with your
managers whether your business unit competitive strength will likely increase or decrease in the near future.
When all the information is collected you should include it to your existing matrix, by adding the arrows to
the circles. The arrows should point to the future position of a business unit.

The following table shows how industry attractiveness and business unit competitive strength will change in
2 years.

Business Unit 1 Business Unit 2 Business Unit 3 Business Unit 4

Industry attractiveness Decrease Stay the same Stay the same Increase
Business unit competitive strength Decrease Increase Increase Decrease
Step 6. Prioritize your investments

The last step is to decide where and how to invest the company’s money. While the matrix makes it easier
by evaluating the business units and identifying the best ones to invest in, it still doesn’t answer some very
important questions:

 Is it really worth investing into some business units?

 How much exactly to invest in?
 Where to invest into business units (more to R&D, marketing, value chain?) to improve their
performance?

Doing the GE McKinsey matrix and answering all the questions takes time, effort and money, but it’s still
one of the most important product portfolio management tools that significantly facilitate investment
decisions.

McKinsey 7s Model
Arrows illustrating poor alignment of organizational elements.

Definition
McKinsey 7s model
is a tool that analyzes firm’s organizational design by looking at 7 key internal elements: strategy,
structure, systems, shared values, style, staff and skills, in order to identify if they are effectively
aligned and allow organization to achieve its objectives.

Understanding the tool

McKinsey 7s model was developed in 1980s by McKinsey consultants Tom Peters, Robert Waterman and
Julien Philips with a help from Richard Pascale and Anthony G. Athos. Since the introduction, the model
has been widely used by academics and practitioners and remains one of the most popular strategic planning
tools. It sought to present an emphasis on human resources (Soft S), rather than the traditional mass
production tangibles of capital, infrastructure and equipment, as a key to higher organizational performance.
The goal of the model was to show how 7 elements of the company: Structure, Strategy, Skills, Staff, Style,
Systems, and Shared values, can be aligned together to achieve effectiveness in a company. The key point of
the model is that all the seven areas are interconnected and a change in one area requires change in the rest
of a firm for it to function effectively.

Below you can find the McKinsey model, which represents the connections between seven areas and divides
them into ‘Soft Ss’ and ‘Hard Ss’. The shape of the model emphasizes interconnectedness of the elements.
The model can be applied to many situations and is a valuable tool when organizational design is at
question. The most common uses of the framework are:

 To facilitate organizational change.

 To help implement new strategy.
 To identify how each area may change in a future.
 To facilitate the merger of organizations.

7s factors

In McKinsey model, the seven areas of organization are divided into the ‘soft’ and ‘hard’ areas. Strategy,
structure and systems are hard elements that are much easier to identify and manage when compared to soft
elements. On the other hand, soft areas, although harder to manage, are the foundation of the organization
and are more likely to create the sustained competitive advantage.

7s factors
Hard S Soft S
Strategy Style
Structure Staff
Systems Skills
Shared Values

Strategy is a plan developed by a firm to achieve sustained competitive advantage and successfully compete
in the market. What does a well-aligned strategy mean in 7s McKinsey model? In general, a sound strategy
is the one that’s clearly articulated, is long-term, helps to achieve competitive advantage and is reinforced by
strong vision, mission and values. But it’s hard to tell if such strategy is well-aligned with other elements
when analyzed alone. So the key in 7s model is not to look at your company to find the great strategy,
structure, systems and etc. but to look if its aligned with other elements. For example, short-term strategy is
usually a poor choice for a company but if its aligned with other 6 elements, then it may provide strong
results.
Structure represents the way business divisions and units are organized and includes the information of
who is accountable to whom. In other words, structure is the organizational chart of the firm. It is also one of
the most visible and easy to change elements of the framework.

Systems are the processes and procedures of the company, which reveal business’ daily activities and how
decisions are made. Systems are the area of the firm that determines how business is done and it should be
the main focus for managers during organizational change.

Skills are the abilities that firm’s employees perform very well. They also include capabilities and
competences. During organizational change, the question often arises of what skills the company will really
need to reinforce its new strategy or new structure.

Staff element is concerned with what type and how many employees an organization will need and how
they will be recruited, trained, motivated and rewarded.

Style represents the way the company is managed by top-level managers, how they interact, what actions do
they take and their symbolic value. In other words, it is the management style of company’s leaders.

Shared Values are at the core of McKinsey 7s model. They are the norms and standards that guide
employee behavior and company actions and thus, are the foundation of every organization.

The authors of the framework emphasize that all elements must be given equal importance to achieve the
best results.

Using the tool

As we pointed out earlier, the McKinsey 7s framework is often used when organizational design and
effectiveness are at question. It is easy to understand the model but much harder to apply it for your
organization due to a common misunderstanding of what should a well-aligned elements be like. There is a
useful paper from excellencegateway.org.uk, which provides examples showing how effective and
ineffective elements look like. Yet, separate elements that are effective on their own do not necessarily lead
to optimal organizational alignment.

We provide the following steps that should help you to apply this tool:

Step 1. Identify the areas that are not effectively aligned

During the first step, your aim is to look at the 7S elements and identify if they are effectively aligned with
each other. Normally, you should already be aware of how 7 elements are aligned in your company, but if
you don’t you can use the checklist from WhittBlog to do that. After you’ve answered the questions outlined
there you should look for the gaps, inconsistencies and weaknesses between the relationships of the
elements. For example, you designed the strategy that relies on quick product introduction but the matrix
structure with conflicting relationships hinders that so there’s a conflict that requires the change in strategy
or structure.

Step 2. Determine the optimal organization design

With the help from top management, your second step is to find out what effective organizational design you
want to achieve. By knowing the desired alignment you can set your goals and make the action plans much
easier. This step is not as straightforward as identifying how seven areas are currently aligned in your
organization for a few reasons. First, you need to find the best optimal alignment, which is not known to you
at the moment, so it requires more than answering the questions or collecting data. Second, there are no
templates or predetermined organizational designs that you could use and you’ll have to do a lot of research
or benchmarking to find out how other similar organizations coped with organizational change or what
organizational designs they are using.
Step 3. Decide where and what changes should be made

This is basically your action plan, which will detail the areas you want to realign and how would you like to
do that. If you find that your firm’s structure and management style are not aligned with company’s values,
you should decide how to reorganize the reporting relationships and which top managers should the
company let go or how to influence them to change their management style so the company could work
more effectively.

Step 4. Make the necessary changes

The implementation is the most important stage in any process, change or analysis and only the well-
implemented changes have positive effects. Therefore, you should find the people in your company or hire
consultants that are the best suited to implement the changes.

Step 5. Continuously review the 7s

The seven elements: strategy, structure, systems, skills, staff, style and values are dynamic and change
constantly. A change in one element always has effects on the other elements and requires implementing
new organizational design. Thus, continuous review of each area is very important.

Example
We’ll use a simplified example to show how the model should be applied to an existing organization.

Current position #1

We’ll start with a small startup, which offers services online. The company’s main strategy is to grow its
share in the market. The company is new, so its structure is simple and made of a very few managers and
bottom level workers, who undertake specific tasks. There are a very few formal systems, mainly because
the company doesn’t need many at this time.

Alignment

So far the 7 factors are aligned properly. The company is small and there’s no need for complex matrix
structure and comprehensive business systems, which are very expensive to develop.

McKinsey 7s Example (1/3)

Aligned?
Strategy Market penetration Yes
Structure Simple structure Yes
Few formal systems. The systems are mainly concerned with customer support
Systems and order processing. There are no or few strategic planning, personnel Yes
management and new business generation systems.
Few specialized skills and the rest of jobs are undertaken by the management (the
Skills Yes
founders).
Few employees are needed for an organization. They are motivated by successful
Staff business growth and rewarded with business shares, of which market value is Yes
rising.
Style Democratic but often chaotic management style. Yes
Shared Values The staff is adventurous, values teamwork and trusts each other. Yes
Current position #2

The startup has grown to become large business with 500+ employees and now maintains 50% market share
in a domestic market. Its structure has changed and is now a well-oiled bureaucratic machine. The business
expanded its staff, introduced new motivation, reward and control systems. Shared values evolved and now
the company values enthusiasm and excellence. Trust and teamwork has disappeared due to so many new
employees.

Alignment

The company expanded and a few problems came with it. First, the company’s strategy is no longer viable.
The business has a large market share in its domestic market, so the best way for it to grow is either to start
introducing new products to the market or to expand to other geographical markets. Therefore, its strategy is
not aligned with the rest of company or its goals. The company should have seen this but it lacks strategic
planning systems and analytical skills.

Business management style is still chaotic and it is a problem of top managers lacking management skills.
The top management is mainly comprised of founders, who don’t have the appropriate skills. New skills
should be introduced to the company.

McKinsey 7s Example (2/3)

Aligned?
Strategy Market penetration No
Structure Bureaucratic machine Yes
Order processing and control, customer support and personnel management
Systems No
systems.
Skills related to service offering and business support, but few managerial and
Skills No
analytical skills.
Staff Many employees and appropriate motivation and reward systems. Yes
Style Democratic but often chaotic management style. No
Shared Values Enthusiasm and excellence No

Current position #3

The company realizes that it needs to expand to other regions, so it changes its strategy from market
penetration to market development. The company opens new offices in Asia, North and South Americas.
Company introduced new strategic planning systems hired new management, which brought new analytical,
strategic planning and most importantly managerial skills. Organization’s structure and shared values
haven’t changed.

Alignment

Strategy, systems, skills and style have changed and are now properly aligned with the rest of the company.
Other elements like shared values, staff and organizational structure are misaligned. First, company’s
structure should have changed from well-oiled bureaucratic machine to division structure. The division
structure is designed to facilitate the operations in new geographic regions. This hasn’t been done and the
company will struggle to work effectively. Second, new shared values should evolve or be introduced in an
organization, because many people from new cultures come to the company and they all bring their own
values, often, very different than the current ones. This may hinder teamwork performance and
communication between different regions. Motivation and reward systems also have to be adapted to
cultural differences.
 McKinsey 7s Example (3/3)
Aligned?
Strategy Market development Yes
Structure Bureaucratic machine No
Order processing and control, customer support, personnel management and
Systems Yes
strategic planning systems.
Skills Skills aligned with company’s operations. Yes
Employees form many cultures, who expect different motivation and reward
Staff No
systems.
Style Democratic style Yes
Shared Values Enthusiasm and excellence No

We’ve showed the simplified example of how the Mckinsey 7s model should be applied. It is important to
understand that the seven elements are much more complex in reality and you’ll have to gather a lot of
information on each of them to make any appropriate decision.

The model is simple, but it’s worth the effort to do one for your business to gather some insight and find out
if your current organization is working effectively.

Value Chain Analysis

A broken chain link illustrating poorly managed business' value chain.

Definition
Value chain analysis (VCA)
is a process where a firm identifies its primary and support activities that add value to its final
product and then analyze these activities to reduce costs or increase differentiation.
Value chain
represents the internal activities a firm engages in when transforming inputs into outputs.

Understanding the tool

Value chain analysis is a strategy tool used to analyze internal firm activities. Its goal is to recognize, which
activities are the most valuable (i.e. are the source of cost or differentiation advantage) to the firm and which
ones could be improved to provide competitive advantage. In other words, by looking into internal activities,
the analysis reveals where a firm’s competitive advantages or disadvantages are. The firm that competes
through differentiation advantage will try to perform its activities better than competitors would do. If it
competes through cost advantage, it will try to perform internal activities at lower costs than competitors
would do. When a company is capable of producing goods at lower costs than the market price or to provide
superior products, it earns profits.

M. Porter introduced the generic value chain model in 1985. Value chain represents all the internal activities
a firm engages in to produce goods and services. VC is formed of primary activities that add value to the
final product directly and support activities that add value indirectly.

Although, primary activities add value directly to the production process, they are not necessarily more
important than support activities. Nowadays, competitive advantage mainly derives from technological
improvements or innovations in business models or processes. Therefore, such support activities as
‘information systems’, ‘R&D’ or ‘general management’ are usually the most important source of
differentiation advantage. On the other hand, primary activities are usually the source of cost advantage,
where costs can be easily identified for each activity and properly managed.

Firm’s VC is a part of a larger industry VC. The more activities a company undertakes compared to industry
VC, the more vertically integrated it is. Below you can find an industry value chain and its relation to a firm
level VC.

Using the tool

There are two different approaches on how to perform the analysis, which depend on what type of
competitive advantage a company wants to create (cost or differentiation advantage). The table below lists
all the steps needed to achieve cost or differentiation advantage using VCA.

Competitive advantage types

Cost advantage Differentiation advantage
This approach is used when organizations try to The firms that strive to create superior products or
compete on costs and want to understand the sources services use differentiation advantage approach.
 Competitive advantage types
Cost advantage Differentiation advantage
of their cost advantage or disadvantage and what
factors drive those costs.
 Step 1. Identify the firm’s primary and
support activities.  Step 1. Identify the customers’ value-creating
 Step 2. Establish the relative importance of activities.
each activity in the total cost of the product.  Step 2. Evaluate the differentiation strategies
 Step 3. Identify cost drivers for each activity. for improving customer value.
 Step 4. Identify links between activities.  Step 3. Identify the best sustainable
 Step 5. Identify opportunities for reducing differentiation.
costs.

Cost advantage

To gain cost advantage a firm has to go through 5 analysis steps:

Step 1. Identify the firm’s primary and support activities. All the activities (from receiving and storing
materials to marketing, selling and after sales support) that are undertaken to produce goods or services have
to be clearly identified and separated from each other. This requires an adequate knowledge of company’s
operations because value chain activities are not organized in the same way as the company itself. The
managers who identify value chain activities have to look into how work is done to deliver customer value.

Step 2. Establish the relative importance of each activity in the total cost of the product. The total costs
of producing a product or service must be broken down and assigned to each activity. Activity based costing
is used to calculate costs for each process. Activities that are the major sources of cost or done inefficiently
(when benchmarked against competitors) must be addressed first.

Step 3. Identify cost drivers for each activity. Only by understanding what factors drive the costs,
managers can focus on improving them. Costs for labor-intensive activities will be driven by work hours,
work speed, wage rate, etc. Different activities will have different cost drivers.

Step 4. Identify links between activities. Reduction of costs in one activity may lead to further cost
reductions in subsequent activities. For example, fewer components in the product design may lead to less
faulty parts and lower service costs. Therefore identifying the links between activities will lead to better
understanding how cost improvements would affect he whole value chain. Sometimes, cost reductions in
one activity lead to higher costs for other activities.

Step 5. Identify opportunities for reducing costs. When the company knows its inefficient activities and
cost drivers, it can plan on how to improve them. Too high wage rates can be dealt with by increasing
production speed, outsourcing jobs to low wage countries or installing more automated processes.

Differentiation advantage

VCA is done differently when a firm competes on differentiation rather than costs. This is because the
source of differentiation advantage comes from creating superior products, adding more features and
satisfying varying customer needs, which results in higher cost structure.

Step 1. Identify the customers’ value-creating activities. After identifying all value chain activities,
managers have to focus on those activities that contribute the most to creating customer value. For example,
Apple products’ success mainly comes not from great product features (other companies have high-quality
offerings too) but from successful marketing activities.
Step 2. Evaluate the differentiation strategies for improving customer value. Managers can use the
following strategies to increase product differentiation and customer value:

 Add more product features;

 Focus on customer service and responsiveness;
 Increase customization;
 Offer complementary products.

Step 3. Identify the best sustainable differentiation. Usually, superior differentiation and customer value
will be the result of many interrelated activities and strategies used. The best combination of them should be
used to pursue sustainable differentiation advantage.

Example This example is partially adopted from R. M. Grant’s book ‘Contemporary Strategy
Analysis’ p.241. It illustrates the basic VCA for an automobile manufacturing company that competes on
cost advantage. This analysis doesn’t include support activities that are essential to any firm’s value chain,
thus the analysis itself is not complete.

Value Chain Analysis Example

Step 1 - Firm's primary activities
Purchasing
Design and Testing and Sales and Distribution and
materials and Assembly
engineering quality control marketing dealer support
components
Step 2 - Toal cost and importance
$164 M $410 M $524 M $10 M $384 M $230 M
less important very important very important not important important less important
Step 3 - Cost drivers
 Size of
 Order
advertisi  Number of
size
 Number  Scale of ng dealers
 Average
and plants  Level of budget  Sales per
value of
frequenc  Capacity quality  Strength dealer
purchase
y of new utilizatio targets of  Frequency
s per
models n  Frequency existing of defects
supplier
 Sales per  Location of defects reputatio requiring
 Location
model of plants n repair
of
 Sales recalls
suppliers
Volume

Step 4 - Links between activities

1. High-quality assembling process reduces defects and costs in quality control and dealer support
activities.
2. Locating plants near the cluster of suppliers or dealers reduces purchasing and distribution costs.
3. Fewer model designs reduce assembling costs.
4. Higher order sizes increase warehousing costs.

Step 5 - Opportunities for reducing costs

1. Create just one model design for different regions to cut costs in designing and engineering, to
increase order sizes of the same materials, to simplify assembling and quality control processes and
to lower marketing costs.
2. Manufacture components inside the company to eliminate transaction costs of buying them in the
market and to optimize plant utilization. This would also lead to greater economies of scale.
Resource Based View
A question summarizing RBV approach.

Definition
The resource-based view (RBV)
is a model that sees resources as key to superior firm performance. If a resource exhibits VRIO
attributes, the resource enables the firm to gain and sustain competitive advantage.

What is a resource based view?

RBV is an approach to achieving competitive advantage that emerged in 1980s and 1990s, after the major
works published by Wernerfelt, B. (“The Resource-Based View of the Firm”), Prahalad and Hamel (“The
Core Competence of The Corporation”), Barney, J. (“Firm resources and sustained competitive advantage”)
and others. The supporters of this view argue that organizations should look inside the company to find the
sources of competitive advantage instead of looking at competitive environment for it.

The following model explains RBV and emphasizes the key points of it.

Improve your management style, hire a business speaker

According to RBV proponents, it is much more feasible to exploit external opportunities using existing
resources in a new way rather than trying to acquire new skills for each different opportunity. In RBV
model, resources are given the major role in helping companies to achieve higher organizational
performance. There are two types of resources: tangible and intangible.

Tangible assets are physical things. Land, buildings, machinery, equipment and capital – all these assets are
tangible. Physical resources can easily be bought in the market so they confer little advantage to the
companies in the long run because rivals can soon acquire the identical assets.

Intangible assets are everything else that has no physical presence but can still be owned by the company.
Brand reputation, trademarks, intellectual property are all intangible assets. Unlike physical resources, brand
reputation is built over a long time and is something that other companies cannot buy from the market.
Intangible resources usually stay within a company and are the main source of sustainable competitive
advantage.

The two critical assumptions of RBV are that resources must also be heterogeneous and immobile.

Heterogeneous. The first assumption is that skills, capabilities and other resources that organizations
possess differ from one company to another. If organizations would have the same amount and mix of
resources, they could not employ different strategies to outcompete each other. What one company would
do, the other could simply follow and no competitive advantage could be achieved. This is the scenario of
perfect competition, yet real world markets are far from perfectly competitive and some companies, which
are exposed to the same external and competitive forces (same external conditions), are able to implement
different strategies and outperform each other. Therefore, RBV assumes that companies achieve competitive
advantage by using their different bundles of resources.

The competition between Apple Inc. and Samsung Electronics is a good example of how two companies that
operate in the same industry and thus, are exposed to the same external forces, can achieve different
organizational performance due to the difference in resources. Apple competes with Samsung in tablets and
smartphones markets, where Apple sells its products at much higher prices and, as a result, reaps higher
profit margins. Why Samsung does not follow the same strategy? Simply because Samsung does not have
the same brand reputation or is capable to design user-friendly products like Apple does. (heterogeneous
resources)

Immobile. The second assumption of RBV is that resources are not mobile and do not move from company
to company, at least in short-run. Due to this immobility, companies cannot replicate rivals’ resources and
implement the same strategies. Intangible resources, such as brand equity, processes, knowledge or
intellectual property are usually immobile.

VRIO framework
(Please visit our article on VRIO framework for more information.)

Although, having heterogeneous and immobile resources is critical in achieving competitive advantage, it is
not enough alone if the firm wants to sustain it. Barney (1991) has identified VRIN framework that
examines if resources are valuable, rare, costly to imitate and non-substitutable. The resources and
capabilities that answer yes to all the questions are the sustained competitive advantages. The framework
was later improved from VRIN to VRIO by adding the following question: “Is a company organized to
exploit these resources?”

VRIO framework adopted from Rothaermel’s (2013) ‘Strategic Management’, p.91

Question of Value. Resources are valuable if they help organizations to increase the value offered to the
customers. This is done by increasing differentiation or/and decreasing the costs of the production. The
resources that cannot meet this condition, lead to competitive disadvantage.

Question of Rarity. Resources that can only be acquired by one or few companies are considered rare.
When more than few companies have the same resource or capability, it results in competitive parity.

Question of Imitability. A company that has valuable and rare resource can achieve at least temporary
competitive advantage. However, the resource must also be costly to imitate or to substitute for a rival, if a
company wants to achieve sustained competitive advantage.

Question of Organization. The resources itself do not confer any advantage for a company if it’s not
organized to capture the value from them. Only the firm that is capable to exploit the valuable, rare and
imitable resources can achieve sustained competitive advantage.

Difference between resource-based and industrial organization

views
RBV holds that sustained competitive advantage can be achieved more easily by exploiting internal rather
than external factors as compared to industrial organization (I/O) view. While this is correct to some degree,
there isn’t definite answer to which approach to strategic management is more important. The chart [1] below
shows how industry, firm and other effects explain firm’s performance. From ~30% to ~45% of superior
organizational performance can be explained by firm effects (resource based view) and ~20% by industry
effects (I/O view). This indicates that the best approach is to look into both external and internal factors and
combine both views to achieve and sustain competitive advantage.

VRIO Framework
A question summarizing VRIO resource.

Definition
VRIO framework
is the tool used to analyze firm’s internal resources and capabilities to find out if they can be a source
of sustained competitive advantage.

Understanding the tool

In order to understand the sources of competitive advantage firms are using many tools to analyze their
external (Porter’s 5 Forces, PEST analysis) and internal (Value Chain analysis, BCG Matrix) environments.
One of such tools that analyze firm’s internal resources is VRIO analysis. The tool was originally developed
by Barney, J. B. (1991) in his work ‘Firm Resources and Sustained Competitive Advantage’, where the
author identified four attributes that firm’s resources must possess in order to become a source of sustained
competitive advantage. According to him, the resources must be valuable, rare, imperfectly imitable and
non-substitutable. His original framework was called VRIN. In 1995, in his later work ‘Looking Inside for
Competitive Advantage’ Barney has introduced VRIO framework, which was the improvement of VRIN
model. VRIO analysis stands for four questions that ask if a resource is: valuable? rare? costly to imitate?
And is a firm organized to capture the value of the resources? A resource or capability that meets all four
requirements can bring sustained competitive advantage for the company.
Adopted from Rothaermel’s (2013) ‘Strategic Management’, p.91

Valuable
The first question of the framework asks if a resource adds value by enabling a firm to exploit opportunities
or defend against threats. If the answer is yes, then a resource is considered valuable. Resources are also
valuable if they help organizations to increase the perceived customer value. This is done by increasing
differentiation or/and decreasing the price of the product. The resources that cannot meet this condition, lead
to competitive disadvantage. It is important to continually review the value of the resources because
constantly changing internal or external conditions can make them less valuable or useless at all.

Rare
Resources that can only be acquired by one or very few companies are considered rare. Rare and valuable
resources grant temporary competitive advantage. On the other hand, the situation when more than few
companies have the same resource or uses the capability in the similar way, leads to competitive parity. This
is because firms can use identical resources to implement the same strategies and no organization can
achieve superior performance.

Even though competitive parity is not the desired position, a firm should not neglect the resources that are
valuable but common. Losing valuable resources and capabilities would hurt an organization because they
are essential for staying in the market.

Costly to Imitate
A resource is costly to imitate if other organizations that doesn’t have it can’t imitate, buy or substitute it at a
reasonable price. Imitation can occur in two ways: by directly imitating (duplicating) the resource or
providing the comparable product/service (substituting).
A firm that has valuable, rare and costly to imitate resources can (but not necessarily will) achieve sustained
competitive advantage. Barney has identified three reasons why resources can be hard to imitate:

 Historical conditions. Resources that were developed due to historical events or over a long period
usually are costly to imitate.
 Causal ambiguity. Companies can’t identify the particular resources that are the cause of competitive
advantage.
 Social Complexity. The resources and capabilities that are based on company’s culture or
interpersonal relationships.

Organized to Capture Value

The resources itself do not confer any advantage for a company if it’s not organized to capture the value
from them. A firm must organize its management systems, processes, policies, organizational structure and
culture to be able to fully realize the potential of its valuable, rare and costly to imitate resources and
capabilities. Only then the companies can achieve sustained competitive advantage.

Using the tool

Step 1. Identify valuable, rare and costly to imitate resources

There are two types of resources: tangible and intangible. Tangible assets are physical things like land,
buildings and machinery. Companies can easily by them in the market so tangible assets are rarely the
source of competitive advantage. On the other hand, intangible assets, such as brand reputation, trademarks,
intellectual property, unique training system or unique way of performing tasks, can’t be acquired so easily
and offer the benefits of sustained competitive advantage. Therefore, to find valuable, rare and costly to
imitate resources, you should first look at company’s intangible assets.

Finding valuable resources:

An easy way to identify such resources is to look at the value chain and SWOT analyses. Value chain
analysis identifies the most valuable activities, which are the source of cost or differentiation advantage. By
looking into the analysis, you can easily find the valuable resources or capabilities. In addition, SWOT
analysis recognizes the strengths of the company that are used to exploit opportunities or defend against
threats (which is exactly what a valuable resource does). If you still struggle finding valuable resources, you
can identify them by asking the following questions:

 Which activities lower the cost of production without decreasing perceived customer value?
 Which activities increase product or service differentiation and perceived customer value?
 Have your company won an award or been recognized as the best in something? (most innovative,
best employer, highest customer retention or best exporter)
 Do you have an access to scarce raw materials or hard to get in distribution channels?
 Do you have special relationship with your suppliers? Such as tightly integrated order and
distribution system powered by unique software?
 Do you have employees with unique skills and capabilities?
 Do you have brand reputation for quality, innovation, customer service?
 Do you do perform any tasks better than your competitors do? (Benchmarking is useful here)
 Does your company hold any other strengths compared to rivals?

Finding rare resources:

 How many other companies own a resource or can perform capability in the same way in your
industry?
 Can a resource be easily bought in the market by rivals?
 Can competitors obtain the resource or capability in the near future?
Finding costly to imitate resources:

 Do other companies can easily duplicate a resource?

 Can competitors easily develop a substitute resource?
 Do patents protect it?
 Is a resource or capability socially complex?
 Is it hard to identify the particular processes, tasks, or other factors that form the resource?

Step 2. Find out if your company is organized to exploit these resources

Following questions might be helpful:

 Does your company has an effective strategic management process in organization?

 Are there effective motivation and reward systems in place?
 Does your company’s culture reward innovative ideas?
 Is an organizational structure designed to use a resource?
 Are there excellent management and control systems?

Step 3. Protect the resources

When you identified a resource or capability that has all 4 VRIO attributes, you should protect it using all
possible means. After all, it is the source of your sustained competitive advantage. The first thing you should
do is to make the top management aware of such resource and suggest how it can be used to lower the costs
or to differentiate the products and services. Then you should think of ideas how to make it more costly to
imitate. If other companies won’t be able to imitate a resource at reasonable prices, it will stay rare for much
longer.

Step 4. Constantly review VRIO resources and capabilities

The value of the resources changes over time and they must be reviewed constantly to find out if they are as
valuable as they once were. Competitors are also keen to achieve the same competitive advantages so they’ll
be keen to replicate the resources, which means that they will no longer be rare. Often, new VRIO resources
or capabilities are developed inside an organization and by identifying them you can protect you sources of
competitive advantage more easily.

VRIO example
Google’s capability evaluated using VRIO framework

Google's VRIO capability

Excellent employee management
Valuable? Rare? Costly to Imitate? Is a company organized to exploit it?
Yes Yes Yes Yes
Result: sustained competitive advantage

Google’s ability to manage their people effectively is a source of both differentiation and cost advantages. Unlike
other companies, which rely on trust and relationship in people management, Google uses data about its employees to
manage them. This capability allows making correct (data based) decisions about which people to hire and the best
way to use their skills. As a result, Google is able to hire innovative employees that are also very productive ($1
million in revenue per employee). Besides being valuable, it is also a rare capability because no other company uses
data based employee management so extensively. Is it costly to imitate? It is costly to imitate, at least, in the near
future. First, companies should build the highly sophisticated software, which is both costly and hard to do. Second,
HR managers should be trained to make data based decisions and forget their old management methods. Is Google
organized to capture value from this capability? Certainly, it has trained HR managers that know how to use the data
and manage people accordingly. It also has the needed IT skills to collect and manage the data about its employees.