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Jump to: navigation, search SWOT analysis is a strategic planning method used to evaluate the Strengths, Weaknesses, Opportunities, and Threats involved in a project or in a business venture. It involves specifying the objective of the business venture or project and identifying the internal and external factors that are favorable and unfavorable to achieve that objective. The technique is credited to Albert Humphrey, who led a convention at Stanford University in the 1960s and 1970s using data from Fortune 500 companies. A SWOT analysis must first start with defining a desired end state or objective. A SWOT analysis may be incorporated into the strategic planning model. Strategic Planning has been the subject of much research.[citation needed]
Strengths: characteristics of the business or team that give it an advantage over others in the industry. Weaknesses: are characteristics that place the firm at a disadvantage relative to others. Opportunities: external chances to make greater sales or profits in the environment. Threats: external elements in the environment that could cause trouble for the business.
Identification of SWOTs is essential because subsequent steps in the process of planning for achievement of the selected objective may be derived from the SWOTs. First, the decision makers have to determine whether the objective is attainable, given the SWOTs. If the objective is NOT attainable a different objective must be selected and the process repeated. The SWOT analysis is often used in academia to highlight and identify strengths, weaknesses, opportunities and threats.[citation needed] It is particularly helpful in identifying areas for development.[citation needed]
If the threats or weaknesses cannot be converted a company should try to minimize or avoid them.[1]
Internal factors The strengths and weaknesses internal to the organization. External factors The opportunities and threats presented by the external environment to the organization. -
The internal factors may be viewed as strengths or weaknesses depending upon their impact on the organization's objectives. What may represent strengths with respect to one objective may be weaknesses for another objective. The factors may include all of the 4P's; as well as personnel, finance, manufacturing capabilities, and so on. The external factors may include macroeconomic matters, technological change, legislation, and socio-cultural changes, as well as changes in the marketplace or competitive position. The results are often presented in the form of a matrix. SWOT analysis is just one method of categorization and has its own weaknesses. For example, it may tend to persuade companies to compile lists rather than think about what is actually important in achieving objectives. It also presents the resulting lists uncritically and without clear prioritization so that, for example, weak opportunities may appear to balance strong threats. It is prudent not to eliminate too quickly any candidate SWOT entry. The importance of individual SWOTs will be revealed by the value of the strategies it generates. A SWOT item that produces valuable strategies is important. A SWOT item that generates no strategies is not important.
preventive crisis management. SWOT analysis may also be used in creating a recommendation during a viability study/survey.
The SWOT-landscape systematically deploys the relationships between overall objective and underlying SWOT-factors and provides an interactive, query-able 3D landscape. The SWOT-landscape grabs different managerial situations by visualizing and foreseeing the dynamic performance of comparable objects according to findings by Brendan Kitts, Leif Edvinsson and Tord Beding (2000).[6] Changes in relative performance are continually identified. Projects (or other units of measurements) that could be potential risk or opportunity objects are highlighted. SWOT-landscape also indicates which underlying strength/weakness factors that have had or likely will have highest influence in the context of value in use (for ex. capital value fluctuations).
Set objectives defining what the organization is going to do Environmental scanning Internal appraisals of the organization's SWOT, this needs to include an assessment of the present situation as well as a portfolio of products/services and an analysis of the product/service life cycle Analysis of existing strategies, this should determine relevance from the results of an internal/external appraisal. This may include gap analysis which will look at environmental factors Strategic Issues defined key factors in the development of a corporate plan which needs to be addressed by the organization
o
Develop new/revised strategies revised analysis of strategic issues may mean the objectives need to change Establish critical success factors the achievement of objectives and strategy implementation Preparation of operational, resource, projects plans for strategy implementation Monitoring results mapping against plans, taking corrective action which may mean amending objectives/strategies.[8]
[edit] Marketing
Main article: Marketing management In many competitor analyses, marketers build detailed profiles of each competitor in the market, focusing especially on their relative competitive strengths and weaknesses using SWOT analysis. Marketing managers will examine each competitor's cost structure, sources of profits, resources and competencies, competitive positioning and product differentiation, degree of vertical integration, historical responses to industry developments, and other factors. Marketing management often finds it necessary to invest in research to collect the data required to perform accurate marketing analysis. Accordingly, management often conducts market research (alternately marketing research) to obtain this information. Marketers employ a variety of techniques to conduct market research, but some of the more common include:
Qualitative marketing research, such as focus groups Quantitative marketing research, such as statistical surveys Experimental techniques such as test markets Observational techniques such as ethnographic (on-site) observation Marketing managers may also design and oversee various environmental scanning and competitive intelligence processes to help identify trends and inform the company's marketing analysis.
Using SWOT to analyse the market position of a small management consultancy with specialism in HRM. [8] Strengths Weaknesses at operating level rather than partner level Expertise at partner level in Unable to deal with HRM consultancy multi-disciplinary assignments because of size or lack of ability Opportunities with a well defined market niche Identified market for consultancy in areas other than HRM Threats operating at a minor level Other small consultancies looking to invade the marketplace
Jump to: navigation, search The Six Forces Model is a market opportunities analysis model, as an extension to Porter's Five Forces Model and is more robust than a standard SWOT analysis. The following forces are identified:
Competition New entrants End users/Buyers Suppliers Substitutes Complementary products/ The government/ The public
That buyers, competitors, and suppliers are unrelated and do not interact and collude That the source of value is structural advantage (creating barriers to entry) That uncertainty is low, allowing participants in a market to plan for and respond to competitive behavior.
An important extension to Porter was found in the work of Brandenburger and Nalebuff in the mid-1990s. Using game theory, they added the concept of complementors (also called "the 6th force"), helping to explain the reasoning behind strategic alliances. The idea that complementors are the sixth force has often been credited to Andrew Grove, former CEO of Intel Corporation. According to most references, the sixth force is government or the public. Martyn Richard Jones, whilst consulting at Groupe Bull, developed an augmented 5 forces model in Scotland in 1993, it is based on Porter's model, and includes Government (national and regional) as well as Pressure Groups as the notional 6th force. This model was the result of work carried out as part of Group Bulle's Knowledge Asset Management Organisation initiative. It is also perhaps not feasible to evaluate the attractiveness of an industry independent of the resources a firm brings to that industry. It is thus argued that this theory be coupled with the Resource-Based View (RBV) in order for the firm to develop a much more sound strategy.
VRIO
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Jump to: navigation, search VRIO, the VRIO framework, is an internal tool of analysis in the context of business management. VRIO is an acronym for the four question framework you ask about a resource or capability to determine its competitive potential: the question of Value, the question of Rarity, the question of Imitability (Ease/Difficulty to Imitate), and the question of Organization (ability to exploit the resource or capability).
The Question of Value: "Is the firm able to exploit an opportunity or neutralize an external threat with the resource/capability?" The Question of Rarity: "Is control of the resource/capability in the hands of a relative few?" The Question of Imitability: "Is it difficult to imitate, and will there be significant cost disadvantage to a firm trying to obtain, develop, or duplicate the resource/capability?" The Question of Organization: "Is the firm organized, ready, and able to exploit the resource/capability?"
PEST analysis
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Jump to: navigation, search PEST analysis stands for "Political, Economic, Social, and Technological analysis" and describes a framework of macro-environmental factors used in the environmental scanning component of strategic management. Some analysts added Legal and rearranged the mnemonic to SLEPT;[1] inserting Environmental factors expanded it to PESTEL or PESTLE, which is popular in the United Kingdom.[2] The model has recently been further extended to STEEPLE and STEEPLED, adding education and demographic factors. It is a part of the external analysis when conducting a strategic analysis or doing market research, and gives an overview of the different macroenvironmental factors that the company has to take into consideration. It is a useful strategic tool for understanding market growth or decline, business position, potential and direction for operations. The growing importance of environmental or ecological factors in the first decade of the 21st century have given rise to green business and encouraged widespread use of an updated version of the PEST framework. STEER analysis systematically considers Socio-cultural, Technological, Economic, Ecological, and Regulatory factors.
Composition
Political factors, are how and to what degree a government intervenes in the economy. Specifically, political factors include areas such as tax policy, labour law, environmental law, trade restrictions, tariffs, and political stability. Political factors may also include goods and services which the government wants to provide or be provided (merit goods) and those that the government does not want to be provided (demerit goods or merit bads). Furthermore, governments have great influence on the health, education, and infrastructure of a nation.
Economic factors include economic growth, interest rates, exchange rates and the inflation rate. These factors have major impacts on how businesses operate and make decisions. For example, interest rates affect a firm's cost of capital and therefore to what extent a business grows and expands. Exchange rates affect the costs of exporting goods and the supply and price of imported goods in an economy Social factors include the cultural aspects and include health consciousness, population growth rate, age distribution, career attitudes and emphasis on safety. Trends in social factors affect the demand for a company's products and how that company operates. For example, an aging population may imply a smaller and less-willing workforce (thus increasing the cost of labor). Furthermore, companies may change various management strategies to adapt to these social trends (such as recruiting older workers).
Technological factors include technological aspects such as R&D activity, automation, technology incentives and the rate of technological change. They can determine barriers to entry, minimum efficient production level and influence outsourcing decisions. Furthermore, technological shifts can affect costs, quality, and lead to innovation. Environmental factors include ecological and environmental aspects such as weather, climate, and climate change, which may especially affect industries such as tourism, farming, and insurance. Furthermore, growing awareness of the potential impacts of climate change is affecting how companies operate and the products they offer, both creating new markets and diminishing or destroying existing ones. Legal factors include discrimination law, consumer law, antitrust law, employment law, and health and safety law. These factors can affect how a company operates, its costs, and the demand for its products.
Furthermore, conglomerate companies who produce a wide range of products (such as Sony, Disney, or BP) may find it more useful to analyze one department of its company at a time with the PESTEL model, thus focusing on the specific factors relevant to that one department. A company may also wish to divide factors into geographical relevance, such as local, national, and global (also known as LoNGPESTEL).
Jump to: navigation, search Porters four corners model is a predictive tool designed by Michael Porter that helps in determining a competitors course of action. Unlike other predictive models which predominantly rely on a firms current strategy and capabilities to determine future strategy, Porters model additionally calls for an understanding of what motivates the competitor. This added dimension of understanding a competitor's internal culture, value system, mindset and assumptions help in determining a much more accurate and realistic reading of a competitors possible reactions in a given situation.
has a misplaced understanding of industry forces is not very likely to respond to a potential attack. Question to be answered here is: What are competitor's assumption about the industry, the competition and its own capabilities? Actions Strategy A competitor's strategy determines how it competes in the market. However, there could be a difference between the company's intended strategy (as stated in the annual report and interviews) and its realized strategy (as is evident in its acquisitions, new product development, etc.). It is therefore important here to determine the competitor's realized strategy and how they are actually performing. If current strategy is yielding satisfactory results, it is safe to assume that the competitor is likely to continue to operate in the same way. Questions to be answered here are: What is the competitor actually doing and how successful is it in implementing its current strategy? Actions Capabilities This looks at a competitor's inherent ability to initiate or respond to external forces. Though it might have the motivation and the drive to initiate a strategic action, its effectiveness is dependent on its capabilities. Its strengths will also determine how the competitor is likely to respond to an external threat. An organization with an extensive distribution network is likely to initiate an attack through its channel, whereas a company with strong financials is likely to counter attack through price drops. The questions to be answered here are: What are the strengths and weaknesses of the competitor? Which areas is the competitor strong in?
[edit] Strengths
Considers implicit aspects of competitive behavior Firms are more often than not aware of their rivals and do have a generally good understanding of their strategies and capabilities. However, motivational factors are often overlooked. Sufficiently motivated competitors can often prove to be more competitive than bigger but less motivated rivals. What sets this model apart from others is its insistence on accounting for the "implicit" factors such as culture, history, executive, consultants, and boards backgrounds, goals, values and commitments and inclusion of management's deep beliefs and assumptions about what works or does not work in the market.[1] Predictive in nature Porter's four corners model provides a framework that ties competitor's capabilities to their assumptions of the competitive environment and their underlying motivations. By looking at both a firm's capabilities (what the firm can do) and underlying implicit factors (their motivations to follow a course of action) can help predict competitor's actions with a relatively higher level of confidence. The underlying assumption here is that decision makers in firms are essentially human and hence subject to the influences of affective and automatic processes described by neuroscientists.[1] Hence by considering these factors along with a firm's capabilities, this model is a better predictor of competitive behavior.
(Redirected from Five forces analysis) Jump to: navigation, search This article needs references that appear in reliable third-party publications. Primary sources or sources affiliated with the subject are generally not sufficient for a Wikipedia article. Please add more appropriate citations from reliable sources. (October 2009)
A graphical representation of Porter's Five Forces Porter's Five Forces is a framework for the industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979. It draws upon Industrial Organization (IO) economics to
derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. An "unattractive" industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven down to zero. Three of Porter's five forces refer to competition from external sources. The remainder are internal threats. Porter referred to these forces as the micro environment, to contrast it with the more general term macro environment. They consist of those forces close to a company that affect its ability to serve its customers and make a profit. A change in any of the forces normally, requires a business unit to re-assess the marketplace given the overall change in industry information. The overall industry attractiveness does not imply that every firm in the industry will return the same profitability. Firms are able to apply their core competencies, business model or network to achieve a profit above the industry average. A clear example of this is the airline industry. As an industry, profitability is low and yet individual companies, by applying unique business models, have been able to make a return in excess of the industry average. Porter's five forces include - three forces from 'horizontal' competition: threat of substitute products, the threat of established rivals, and the threat of new entrants; and two forces from 'vertical' competition: the bargaining power of suppliers and the bargaining power of customers. This five forces analysis, is just one part of the complete Porter strategic models. The other elements are the value chain and the generic strategies.[citation needed] Porter developed his Five Forces analysis in reaction to the then-popular SWOT analysis, which he found unrigorous and ad hoc.[1]
Contents
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1.1 The threat of the entry of new competitors 1.2 The intensity of competitive rivalry 1.3 The threat of substitute products or services 1.4 The bargaining power of customers (buyers)
1.5 The bargaining power of suppliers 2 Usage 3 Criticisms 4 See also 5 References 6 Further reading 7 External links
The existence of barriers to entry (patents, rights, etc.) The most attractive segment is one in which entry barriers are high and exit barriers are low. Few new firms can enter and non-performing firms can exit easily. Economies of product differences Brand equity Switching costs or sunk costs Capital requirements Access to distribution Customer loyalty to established brands Absolute cost Industry profitability; the more profitable the industry the more attractive it will be to new competitors
Sustainable competitive advantage through innovation Competition between online and offline companies; click-and-mortar -v- slags on a bridge[citation
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Level of advertising expense Powerful competitive strategy The visibility of proprietary items on the Web[2] used by a company which can intensify competitive pressures on their rivals.
How will competition react to a certain behavior by another firm? Competitive rivalry is likely to be based on dimensions such as price, quality, and innovation. Technological advances protect companies from competition. This applies to products and services. Companies that are successful with introducing new technology, are able to charge higher prices and achieve higher profits, until competitors imitate them. Examples of recent technology
advantage in have been mp3 players and mobile telephones. Vertical integration is a strategy to reduce a business' own cost and thereby intensify pressure on its rival.
Buyer propensity to substitute Relative price performance of substitute Buyer switching costs Perceived level of product differentiation Number of substitute products available in the market Ease of substitution. Information-based products are more prone to substitution, as online product can easily replace material product. Substandard product Quality depreciation
Buyer concentration to firm concentration ratio Degree of dependency upon existing channels of distribution Bargaining leverage, particularly in industries with high fixed costs Buyer volume Buyer switching costs relative to firm switching costs Buyer information availability Ability to backward integrate Availability of existing substitute products Buyer price sensitivity Differential advantage (uniqueness) of industry products RFM Analysis
Supplier switching costs relative to firm switching costs Degree of differentiation of inputs Impact of inputs on cost or differentiation Presence of substitute inputs Strength of distribution channel Supplier concentration to firm concentration ratio Employee solidarity (e.g. labor unions) Supplier competition - ability to forward vertically integrate and cut out the buyer
Ex. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from him.
Usage
Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a firm's strategic position. However, for most consultants, the framework is only a starting point or "checklist" they might use " Value Chain " afterward. Like all general frameworks, an analysis that uses it to the exclusion of specifics about a particular situation is considered nave. According to Porter, the five forces model should be used at the line-of-business industry level; it is not designed to be used at the industry group or industry sector level. An industry is defined at a lower, more basic level: a market in which similar or closely related products and/or services are sold to buyers. (See industry information.) A firm that competes in a single industry should develop, at a minimum, one five forces analysis for its industry. Porter makes clear that for diversified companies, the first fundamental issue in corporate strategy is the selection of industries (lines of business) in which the company should compete; and each line of business should develop its own, industry-specific, five forces analysis. The average Global 1,000 company competes in approximately 52 industries (lines of business).
Criticisms
Porter's framework has been challenged by other academics and strategists such as Stewart Neill. Similarly, the likes of Kevin P. Coyne [1] and Somu Subramaniam have stated that three dubious assumptions underlie the five forces:
That the source of value is structural advantage (creating barriers to entry). That uncertainty is low, allowing participants in a market to plan for and respond to competitive behavior.
An important extension to Porter was found in the work of Adam Brandenburger and Barry Nalebuff in the mid-1990s. Using game theory, they added the concept of complementors (also called "the 6th force"), helping to explain the reasoning behind strategic alliances. The idea that complementors are the sixth force has often been credited to Andrew Grove, former CEO of Intel Corporation. According to most references, the sixth force is government or the public. Martyn Richard Jones, whilst consulting at Groupe Bull, developed an augmented 5 forces model in Scotland in 1993. It is based on Porter's model and includes Government (national and regional) as well as Pressure Groups as the notional 6th force. This model was the result of work carried out as part of Groupe Bull's Knowledge Asset Management Organisation initiative. Porter indirectly rebutted the assertions of other forces, by referring to innovation, government, and complementary products and services as "factors" that affect the five forces.[3] It is also perhaps not feasible to evaluate the attractiveness of an industry independent of the resources a firm brings to that industry. It is thus argued that this theory be coupled with the Resource-Based View (RBV) in order for the firm to develop a much more sound strategy.
Resource-based view
From Wikipedia, the free encyclopedia
Jump to: navigation, search The resource-based view (RBV) is a business management tool used to determine the strategic resources available to a company. The fundamental principle of the RBV is that the basis for a competitive advantage of a firm lies primarily in the application of the bundle of valuable resources at the firm's disposal (Wernerfelt, 1984, p172; Rumelt, 1984, p557-558). To transform a short-run competitive advantage into a sustained competitive advantage requires that these resources are heterogeneous in nature and not perfectly mobile ([1]:p105-106; Peteraf, 1993, p180). Effectively, this translates into valuable resources that are neither perfectly imitable nor substitutable without great effort (Barney, 1991;[1]:p117). If these conditions hold, the firms bundle of resources can assist the firm sustaining above average returns. The VRIN model also constitutes a part of RBV.
Contents
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2.2 What constitutes a "capability"? o 2.3 What constitutes "competitive advantage"? 3 History of the resource-based view
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3.1 Barriers to imitation of resources o 3.2 Developing resources for the future o 3.3 Complementary work 4 Criticism 5 Further reading 6 See also 7 References
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Concept
The key points of the theory are: 1. Identify the firms potential key resources. 2. Evaluate whether these resources fulfill the following criteria (referred to as VRIN): o Valuable A resource must enable a firm to employ a value-creating strategy, by either outperforming its competitors or reduce its own weaknesses ([1]:p99; [2]:p36). Relevant in this perspective is that the transaction costs associated with the investment in the resource cannot be higher than the discounted future rents that flow out of the value-creating strategy (Mahoney and Prahalad, 1992, p370; Conner, 1992, p131). o Rare To be of value, a resource must be rare by definition. In a perfectly competitive strategic factor market for a resource, the price of the resource will be a reflection of the expected discounted future above-average returns (Barney, 1986a, p1232-1233; Dierickx and Cool, 1989, p1504;[1]:p100). In-imitable If a valuable resource is controlled by only one firm it could be a source of a competitive advantage ([1]:p107). This advantage could be sustainable if competitors are not able to duplicate this strategic asset perfectly (Peteraf, 1993, p183; Barney, 1986b, p658). The term isolating mechanism was introduced by Rumelt (1984, p567) to explain why firms might not be able to imitate a resource to the degree that they are able to compete with the firm having the valuable resource (Peteraf, 1993, p182-183; Mahoney and Pandian, 1992, p371). An important underlying factor of inimitability is causal ambiguity, which occurs if the source from which a firms competitive advantage stems is unknown (Peteraf, 1993, p182; Lippman and Rumelt, 1982, p420). If the resource in question is knowledge-based or socially complex, causal ambiguity is more likely to occur as these types of resources are more likely to be idiosyncratic to the firm in which it resides (Peteraf, 1993, p183; Mahoney and Pandian, 1992, p365;[1]:p110). Conner and Prahalad go so far as to say knowledge-based resources are the essence of the resource-based perspective (1996, p477). Non-substitutable Even if a resource is rare, potentially value-creating and imperfectly imitable, an equally important aspect is lack of substitutability (Dierickx and Cool, 1989,
p1509;[1]:p111). If competitors are able to counter the firms value-creating strategy with a substitute, prices are driven down to the point that the price equals the discounted future rents (Barney, 1986a, p1233; sheikh, 1991, p137), resulting in zero economic profits. 3. Care for and protect resources that possess these evaluations, because doing so can improve organizational performance (Crook, Ketchen, Combs, and Todd, 2008). The VRIN characteristics mentioned are individually necessary, but not sufficient conditions for a sustained competitive advantage (Dierickx and Cool, 1989, p1506; Priem and Butler, 2001a, p25). Within the framework of the resource-based view, the chain is as strong as its weakest link and therefore requires the resource to display each of the four characteristics to be a possible source of a sustainable competitive advantage ([1]:105-107).
Core competency
From Wikipedia, the free encyclopedia
Jump to: navigation, search A core competency is a specific factor that a business sees as being central to the way it, or its employees, works. It fulfills two key criteria: 1. It is not easy for competitors to imitate 2. It can be leveraged widely to many products and markets. A core competency can take various forms, including technical/subject matter know-how, a reliable process and/or close relationships with customers and suppliers.[1] It may also include product development or culture, such as employee dedication. Core competencies are particular strengths relative to other organizations in the industry which provide the fundamental basis for the provision of added value. Core competencies are the collective learning in organizations, and involve how to coordinate diverse production skills and integrate multiple streams of technologies. It is communication, an involvement and a deep commitment to working across organizational boundaries. Few companies are likely to build world leadership in more than five or six fundamental competencies. For an example of core competencies, when studying Walt Disney World - Parks and Resorts, there are three main core competencies:[2] Animatronics and Show Design Storytelling, Story Creation and Themed Atmospheric Attractions Efficient operation of theme parks
The value chain is a systematic approach to examining the development of competitive advantage. It was created by M. E. Porter in his book, Competitive Advantage (1980). The chain consists of a series of activities that create and build value. They culminate in the total value delivered by an organization. The 'margin' depicted in the diagram is the same as added value. The organization is split into 'primary activities' and 'support activities'.
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In order to be competitive an organization needs tangible resources but intangible resources like core competences are difficult and challenging to achieve. It is even critical to manage and enhance the competences with reference to industry changes and their future. For example, Microsoft has expertise in many IT based innovations where for a variety of reasons it is difficult for competitors to replicate Microsoft's core competences. In a race to achieve cost cutting, quality and productivity most of the executives do not spend their time to develop a corporate view of the future because this exercise demands high intellectual energy and commitment. The difficult questions may challenge their own ability to view the future opportunities but an attempt to find their answers will lead towards organizational benefits.
Jump to: navigation, search The knowledge-based theory of the firm considers knowledge as the most strategically significant resource of a firm. Its proponents argue that because knowledge-based resources are usually difficult to imitate and socially complex, heterogeneous knowledge bases and capabilities among firms are the major determinants of sustained competitive advantage and superior corporate performance. This knowledge is embedded and carried through multiple entities including organizational culture and identity, policies, routines, documents, systems, and employees. Originating from the strategic management literature, this perspective builds upon and extends the resource-based view of the firm (RBV) initially promoted by Penrose (1959) and later expanded by others (Wernerfelt 1984, Barney 1991, Conner 1991). Although the resource-based view of the firm recognizes the important role of knowledge in firms that achieve a competitive advantage, proponents of the knowledge-based view argue that the resource-based perspective does not go far enough. Specifically, the RBV treats knowledge as a generic resource, rather than having special characteristics. It therefore does not distinguish between different types of knowledge-based capabilities. Information technologies can play an important role in the knowledge-based view of the firm in that information systems can be used to synthesize, enhance, and expedite large-scale intra- and inter-firm knowledge management (Alavi and Leidner 2001). Whether or not the Knowledge-based theory of the firm actually constitutes a theory has been the subject of considerable debate. See for example, Foss (1996) and Phelan & Lewin (2000). According to one notable proponent of the Knowledge-Based View of the firm (KBV), The emerging knowledge-based view of the firm is not a theory of the firm in any formal sense (Grant, 2002, p.135).
Overview
In simplified terms, the theory of the firm aims to answer these questions:
1. Existence why do firms emerge, why are not all transactions in the economy mediated over the market? 2. Boundaries why is the boundary between firms and the market located exactly there as to size and output variety? Which transactions are performed internally and which are negotiated on the market? 3. Organization why are firms structured in such a specific way, for example as to hierarchy or decentralization? What is the interplay of formal and informal relationships? 4. Heterogeneity of firm actions/performances what drives different actions and performances of firms? Firms exist as an alternative system to the market-price mechanism when it is more efficient to produce in a non-market environment. For example, in a labor market, it might be very difficult or costly for firms or organizations to engage in production when they have to hire and fire their workers depending on demand/supply conditions. It might also be costly for employees to shift companies every day looking for better alternatives. Thus, firms engage in a long-term contract with their employees to minimize the cost.[2][3]
[edit] Background
The First World War period saw a change of emphasis in economic theory away from industry-level analysis which mainly included analyzing markets to analysis at the level of the firm, as it became increasingly clear that perfect competition was no longer an adequate model of how firms behaved. Economic theory till then had focused on trying to understand markets alone and there had been little study on understanding why firms or organisations exist.Markets are mainly guided by prices as illustrated by vegetable markets where a buyer is free to switch sellers in an exchange. The need for a revised theory of the firm was emphasized by empirical studies by Berle and Means, who made it clear that ownership of a typical American corporation is spread over a wide number of shareholders, leaving control in the hands of managers who own very little equity themselves.[4] Hall and Hitch found that executives made decisions by rule of thumb rather than in the marginalist way.[5]
The model shows institutions and market as a possible form of organization to coordinate economic transactions. When the external transaction costs are higher than the internal transaction costs, the company will grow. If the external transaction costs are lower than the internal transaction costs the company will be downsized by outsourcing, for example. According to Ronald Coase, people begin to organise their production in firms when the transaction cost of coordinating production through the market exchange, given imperfect information, is greater than within the firm.[2] Ronald Coase set out his transaction cost theory of the firm in 1937, making it one of the first (neo-classical) attempts to define the firm theoretically in relation to the market.[2] One aspect of its 'neoclassicism' in presenting an explanation of the firm consistent with constant returns to scale, rather than relying increasing returns to scale. Another is in defining a firm in a manner which is both realistic and compatible with the idea of substitution at the margin, so instruments of conventional economic analysis apply. He notes that a firms interactions with the market may not be under its control (for instance because of sales taxes), but its internal allocation of resources are: Within a firm, market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur who directs production. He asks why alternative methods of production (such as the price mechanism and economic planning), could not either achieve all production, so that either firms use internal prices for all their production, or one big firm runs the entire economy. Coase begins from the standpoint that markets could in theory carry out all production, and that what needs to be explained is the existence of the firm, with its "distinguishing mark [of] the supersession of the price mechanism." Coase identifies some reasons why firms might arise, and dismisses each as unimportant: 1. if some people prefer to work under direction and are prepared to pay for the privilege (but this is unlikely); 2. if some people prefer to direct others and are prepared to pay for this (but generally people are paid more to direct others); 3. if purchasers prefer goods produced by firms.
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Instead, for Coase the main reason to establish a firm is to avoid some of the transaction costs of using the price mechanism. These include discovering relevant prices (which can be reduced but not eliminated by purchasing this information through specialists), as well as the costs of negotiating and writing enforceable contracts for each transaction (which can be large if there is uncertainty). Moreover, contracts in an uncertain world will necessarily be incomplete and have to be frequently re-negotiated. The costs of haggling about division of surplus, particularly if there is asymmetric information and asset specificity, may be considerable. If a firm operated internally under the market system, many contracts would be required (for instance, even for procuring a pen or delivering a presentation). In contrast, a real firm has very few (though much more complex) contracts, such as defining a manager's power of direction over employees, in exchange for which the employee is paid. These kinds of contracts are drawn up in situations of uncertainty, in particular for relationships which last long periods of time. Such a situation runs counter to neo-classical economic theory. The neo-classical market is instantaneous, forbidding the development of extended agent-principal (employee-manager) relationships, of planning, and of trust. Coase concludes that a firm is likely therefore to emerge in those cases where a very short-term contract would be unsatisfactory, and that it seems improbable that a firm would emerge without the existence of uncertainty. He notes that government measures relating to the market (sales taxes, rationing, price controls) tend to increase the size of firms, since firms internally would not be subject to such transaction costs. Thus, Coase defines the firm as "the system of relationships which comes into existence when the direction of resources is dependent on the entrepreneur." We can therefore think of a firm as getting larger or smaller based on whether the entrepreneur organises more or fewer transactions. The question then arises of what determines the size of the firm; why does the entrepreneur organise the transactions he does, why no more or less? Since the reason for the firm's being is to have lower costs than the market, the upper limit on the firm's size is set by costs rising to the point where internalising an additional transaction equals the cost of making that transaction in the market. (At the lower limit, the firms costs exceed the markets costs, and it does not come into existence.) In practice, diminishing returns to management contribute most to raising the costs of organising a large firm, particularly in large firms with many different plants and differing internal transactions (such as a conglomerate), or if the relevant prices change frequently. Coase concludes by saying that the size of the firm is dependent on the costs of using the price mechanism, and on the costs of organisation of other entrepreneurs. These two factors together determine how many products a firm produces and how much of each.[7]
Klein (1983) asserts that Economists now recognise that such a sharp distinction does not exist and that it is useful to consider also transactions occurring within the firm as representing market (contractual) relationships. The costs involved in such transactions that are within a firm or even between the firms are the transaction costs. Ultimately, whether the firm constitutes a domain of bureaucratic direction that is shielded from market forces or simply a legal fiction, a nexus for a set of contracting relationships among individuals (as Jensen and Meckling put it) is a function of the completeness of markets and the ability of market forces to penetrate intra-firm relationships.[10]