The SWOT Model May Be Wrong

13 May 2006 at 9:20 am 23 comments

| Nicolai Foss |

One of the basic, indeed foundational, frameworks of strategic management, the SWOT model, may be fundamentally flawed. The “model” advises managers to align their Strengths of their company to the Opportunities of the environment, while simultaneously safeguarding the company’s Weaknesses from the Threats of the environment.

This very basic idea — it is only in B Schools that it is called a “model” — is no doubt the most universally used planning tool in companies and is often used in the public sector. Students (and, one suspects, managers) love it on account of its extreme simplicity. Many textbooks are written on a SWOT formula: The first part deals with the external environment — i.e., industry analysis — and the second part then deals with the firm level, i.e., competitive advantage. I myself have always used the SWOT framework intensively in my strategic management teaching, and I have endorsed countless student papers and theses that argued that resource-based and industry analysis approaches are, after all, consistent because they can be aligned under the SWOT umbrella.

A recent paper by Richard Makadok of Emory University, “The Competence/ Collusion Puzzle and the Four Theories of Profit: Why Good Resources Go to Bad Industries,” suggests that the SWOT framework (at least in its usual interpretation) gets it wrong. How can something so simple, even trivial, as the SWOT framework be wrong?

The problem, Makadok explains, is that the relationship between the two drivers of profitability is presented as additive. Thus, in order to earn a high profit, a firm should seek attractive markets and position the firm to have a competitive advantage. However, this “advice is simple, intuitive and wrong” (p.9), because there is an inherent tension between “seeking attractive markets” (thereby advocating a collusion-based approach) and “position to gain competitive advantage” (which implies beating or dominating rivals). In fact, Makadok argues using a simple duopoly model, that the two profitability drivers are likely sub-additive rather than additive. A paper that definitely rocks the boat!

Entry filed under: - Foss -, Management Theory, Recommended Reading, Strategic Management.

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23 Comments Add your own

  • 1. p  |  13 May 2006 at 10:17 am

    Note that he cites Alchian and Demsetz 72.

  • 2. Bo Nielsen  |  15 May 2006 at 12:44 pm

    Interesting indeed. I have hear similar arguments about tacit knowledge and how the management of tacit knowledge is contradictory if you study the literature and follow the argumentation:

    From a RBV knowledge is the most important asset yet more difficult to protect than more tangible resources. The attraction of stocks of tacit knowledge is precisely the natural protection against imitation that is provided by the tacitness of knowledge. However, not all tacit knowledge assures a firms sustainable competitive advantage; only tacit knowledge that is also rare, valuable and with few strategically equivalent substitutes can lead to this advantage (Barney, 1991).

    Now, assuming that a piece of tacit knowledge meets all of Barneys four criteria, then how can a firm really manage these for advantage? a) By converting them into explicit knowledge or b) by managing the people who possess it. Both seem highly problematic, since the former results in the potential loss of its competitive advantage by rendering knowledge imitable, and the latter strategy provides no guarentee for any competitive advantage whatsoever, much less of the sustainable kind! Indeed, much of the KM literature seems to be preoccupied with how to avoid attrition as human assets leave the organization.

    Hence, the conclusion seems to be that managing tacit knowledge is counter-productive in that it appears to weaken a firm’s competitive advantage. Rewording Barney (1991) we can conclude that in order for tacit knowledge to be a firm’s source of sustainable competitive advantage, the firm should avoid trying to manage it (as they must maintain an imperfect understanding of the link between the resources controlled by the firm and its competitive advantage – barney p. 109)..

    These types of paradoxes (here that tacit knowledge is the source of competitive advantage yet it is unmanageable unless it is made explicit, by which process it’s ability to generate competitive advantage is destroyed) seem to be abundant in the literature and it made me wonder if this is due to the aforementioned gap between theory and practice? In order for us (academics) to make sense of the world we have to reduce its complexity and develop constructs and abstractions of it that may not adequately capture reality. Are these constructs and dimensions really additive, sub-additive, complementary or co-dependent or? In this case, it would seem that it is far more useful to think of tacit and explicit knowledge as a duality. In the SWOT example, I think we need to think of it in more systemic terms. Either way, reducing managerial complexity to a two-by-two seems inherently flawed and any manager (or academic) using these tools would be wise to investigate their limitations..

  • 3. Nicolai Foss  |  15 May 2006 at 12:53 pm

    Bo,

    I think you are much too hasty here.

    1) The RBV does not really discriminate between types of assets per se in terms of their contribution to SCA. In fact, this is one of the critiques of Miller and Shamsie (1996, AMJ).

    2) Knowledge may — perhaps — be particularly attractive because it is — perhaps — more difficult to imitate. But there is more than the "S" to "SCA". Value also needs to be created. Many contributors to the RBV has been overly occupied with sustainability (which may not really be that interesting; a lot of money in one period may be much better than a small amount for the infinite future).

    3) I don't understand why there should be any difficult problems of managing human capital assets where much of the relevant knowledge is tacit. This is what managers do every day. Just because somebody knows something that neither he nor you can formalize doesn't mean that you cannot have an idea of the knowledge this employee possesses and how it may best be utilized. (This is a common non sequitur in the KM literature).

    4) For this reason, there is no "paradox".

    I will soon post on these myths of strategic management and related fields.

  • 4. Bo Nielsen  |  15 May 2006 at 2:01 pm

    OK – KBV then..

    anyway, I do see your logic that sustainability is not the only important thing but even so I think there is somewhat of a paradox in the question of managing tacit knowledge. While managers manage human capital assets every day they do not necessarily do so effectively and efficiently. Moreover, the way they tend to go about managing tacit knowledge is by attempting to make it explicit. At the same time the turnover literature is preoccupied with the potential risk and cost of turnover and ways of reducing knowledge attitrion and spilover etc. My point here is simply that the literature tends to emphasize the value of tacit knowledge as a unique source of competitive advantage (even in the short term – R&D, innovation etc) while its management seems to imply the destruction (to a certain degree) of the very foundation of this tacitness and advantage..

    You seem to propose that we can manage (effectively) tacit knowledge without making it explicit, without formalizing it and without even fully understanding it. Maybe so, but in reality this seems rather unrealistic to me and certainly not efficient. I agree that KM has existed for millenia – however, only recently have organizations focused on knowledge (in its different forms and with its different characteristics) systematically in an attempt to make its use more effective and efficient in the pursuit of an advantage. Only very recently have we begun to unlock the nature of knowledge – creation, development, retention, organization, and utilization and as such we have realized that many of the traditional economic assumptions fit rather poorly with knowledge (for instance the fact that some knowledge seems to become even more valuable when used and shared).

    Alas, the question of sustainability of CA (and resources) is an interesting one..I look forward to your critique of management myths..

  • 5. Nicolai Foss  |  15 May 2006 at 2:10 pm

    Bo,

    I do indeed think that "we can manage (effectively) tacit knowledge without making it explicit, without formalizing it and even without fully understanding it."

    1. Management is very much about forming judgment of people's capabilities, as Knight argued. We can form a judgment of somebody's tacit knowledge, and his ability to make sensible actions based on that knowledge.

    2. Are you sure that "tacit knowledge" is really the key issue here? Why not just "private knowledge"? Why is the tacitness issue so crucial? Because it means that the principal cannot know the full action set of the employee? If tacitness really isn't that important, but private knowledge is, agency theory suggests numerous ways in which we may manage (those who hold) such knowledge.

    3. Even if tacit knowledge is at stake, why are incentive pay, partial ownership, etc. efficient ways of managing those who hold tacit knowledge?

    We need to be spefic about such things before we can evaluate weeping claims about "paradoxes" etc.

  • 6. Bo Nielsen  |  15 May 2006 at 3:22 pm

    I do think that tacitness is at stake here and to me, at least, there is a fundamental difference between private and tacit knowledge.

    Perhaps part of the problem here lies in our poor understanding and definitions of knowledge and tacitness. Agency theory seems to assume that knowledge is privately held within the individual and thus you need to simply find ways of managing these individuals. Make them sing to the same tune etc. However, what if knowledge also resides in processes and practices at the firm level. Moreover, what if knowledge resides between individuals (interaction) and thus is not privately held? Moreover, since knowledge is only valuable when used in connection with and by people this raises all kinds of problems in terms of attaching a value to knowledge, protecting knowledge etc..

  • 7. Nicolai Foss  |  15 May 2006 at 3:44 pm

    I think you are evading the issue here.

    1) If tacit knowledge can privately held, tacit knowledge at least overlaps with private knowledge.

    2) I fail to see the relevance of the rather problamatic notion of "firm-level knowledge." Do you imply that such knowledge must inherently be tacit?

    3) Granting for the moment that there may be something called "firm-level knowledge", surely the way to manage it is by managing individual persons/knowledge-holders. If indeed it is meaning to speak of collective knowledge, it is supervenient on individually held knowledge.

    4) Hey, check out Teppo Felin's forthcoming paper in AMR (with Bill Hesterly) on some of these issues.

  • 8. Bo Nielsen  |  15 May 2006 at 4:49 pm

    Yes – firm-level knowledge is inherently tacit and it is not simply the sum of all the knowledge held by the individuals within the organization. Knowledge residing in processes, practices, rules, norms, corporate culture etc are examples. KM is about creating processes that allow for the individual-level private knowledge to become embedded and institutionalized so as to create an advantage.

  • 9. Nicolai Foss  |  16 May 2006 at 12:20 am

    @Bo,

    1. Why should “firm-level knowledge” be “inherently tacit”? There is no argument for why this should be so. What about (fully explicit) standard operating procedures? And why “inherently”? What is “non” or “less” “inherently” tacit knowledge?

    2. “so as to create an advantage” — if taken to mean that it is a necessary condition for advantage that knowledge is somehow made to be “firm-level” (whatever it means; presumably just “shared”), this is wrong.

  • 10. Teppo  |  16 May 2006 at 1:46 am

    Bo and Nicolai: This is quite an exchange to jump into – wow – it might require an Academy session or journal special issue to sort out…A couple brief thoughts nonetheless:

    For me the critical issue in sorting out much of the above is our assumptions about where knowledge resides. It seems that Bo you are making fairly strong assumptions about the organization as a (the?) critical level (culture, knowledge between individuals etc.), while I think there is now some good academic work out there questioning this logic from a theoretical and epistemological point of view.

    For one, you might look at the levels-of-analysis literature (Dansereau et al., 1999) which has begun to wrestle with the question of what exactly is meant for something to exist (emerge?) at the collective level, independent of individuals. For my purposes the more important sources of variance (thinking about this from a variance decomposition perspective and recognizing that all levels add something) reside, inherently, at the individual level. We make this argument in the paper that Nicolai cites above.

    There seems to be much in the KBV view that is rather taken-for-granted, and deserves more careful scrutiny. Matters such as tacitness, practices, community-of-practice – all fall into this camp. I think we have somewhat unnecessarily invented a whole set of language to describe rather vacuous matters, without first resolving such fundamentals as – where does knowledge mostly reside?

  • 11. Nicolai Foss  |  16 May 2006 at 3:16 am

    @ Bo, I completely agree with Teppo. To be a self-serving, you may also check out the joint Felin & Foss papers which make other points than the Felin & Hesterly paper that Teppo cites.

  • 12. Bo Nielsen  |  16 May 2006 at 10:24 am

    I agree that we need more research on where knowledge really resides but I do not see that this solves the “paradox” or contradiction observed initially. Tacit knowledge presents a theoretical and analytical problem – perhaps this problem is more academic than practical though since it seems that firms are (and always have been) doing quite well (at least according to themselves).

    Nevertheless, KBV to me does not seem to add much to the discussion and seem little different than RBV in its core arguments. I will read all your self-citations (again because I must have read some of these before) and see if this convinces me that this issue is as black or white as you seem to suggest. Thanks.

  • 13. Nicolai Foss  |  16 May 2006 at 11:05 am

    @ Bo, You shifted the terms of the debate by arguing that tacit knowledge was problematic particularly when it was located at the firm level (in response to my argument that individual level tacit knowledge may not be that problematic to manage). Of course, I therefore argue that it is crucial where knowledge resides.

    Frankly, you are the one who argue things are “black and white” here: Ttacit knowledge is a management problem. Period. There is a paradox. Period. Tacit knolwedge is primarily firm-level. Period. The KBV is really the same as the RBV. Period. And so on. I am trying to an analytical approach and ask, Is it really so?

  • 14. Bo Nielsen  |  16 May 2006 at 1:41 pm

    Oh – well then you misuderstood me. I am certainly not suggesting this is black or white. In fact, as I wrote above, knowledge resides BOTH at the individual and firm level and these levels are most likely related. Moreover, I also suggested that tacit and explicit knowledge is a duality – that is all tacit knowledge has an explicit component and vice versa. I am suggesting there MAY be somewhat of a paradox in the way we theoretically argue for the value of tacit knowledge in connection with competitive advantage. This whole discussion was actually meant as a support to your notion of the problems with SWOT analysis – this problem seems only to apply to the practical use of this model and this was what spurred me to (admittedly a bit clumsy) suggest that similar types of potential problems exist just about everywhere in our academic world.

    KBV versus RBV is a longer discussion which we may have to start a new string to discuss separately if need be. Perhaps this will be one of your fallacies as well? :)

    Bo

  • 15. Bo Nielsen  |  16 May 2006 at 2:43 pm

    I am having difficulty locating the Felin/Hesterly paper (AMR) – perhaps due to the fact that my AOM membership seems to have expired. This is a forthcoming article? Anyone have a copy?

  • 16. Peter Klein  |  16 May 2006 at 2:48 pm

    Teppo has a copy here.

  • […] Nicolai Foss at Organizations and Markets highlights recent research by Rich Makadok (a former Emory colleague) which essentially suggests that one of the dearest and most taught (though rather simple) models (the SWOT model) in strategic management may in fact be wrong. […]

  • 18. David Hoopes  |  4 April 2007 at 11:29 am

    This debate is fascinating. However, it remains pretty abstract. And, as the debate shows quite well, we often have some pretty important assumptions buried in our perspectives. “Knowledge” does not always do what we think it will in organizations. So, for example Anne Marie Knott in a 2003 SMJ paper found that even when presented with a codified set of routines owner/managers often would choose to avoid implementing accetped best practice. For example, many simply did not want to conduct cold sales calls. Steve Postrel and I in our 1999 SMJ paper find that what would seem to be very un-sticky knoweldge, still has trouble getting from one place in the organization to another (leading to one type of “glitch”). The point is, that tacit or codified, knowledge does not move about as costlessly as we might supose. Thus, heterogeneous preferences, beliefs, and utility can allow knowledge that is codified or codifiable to remain impacted between groups within firms and between competitors. Knowledge does not need to be tacit to be a component of competitive advantage or competitive heterogeneity.

  • 19. David Hoopes  |  4 April 2007 at 11:38 am

    Post script. I agree with Rich. I’ve inherited a text that has SWOT analysis in it and I replace SWOT with a Value – Cost approach a la Brandenberger (sp?) and Stuart’s JEMS paper and Steve Postrel who has used a V-C framework for quite a while I think.

  • 20. John Mathews  |  16 May 2007 at 6:48 pm

    I too find the exchange between Bo and Nicolai fascinating. But what if we start somewhere different – and instead of always asking whether a competitive advantage based on ‘knowledge’ can be sustainable (when in practice we know that all competitive advantages have to be competed away eventually, or there would be no economic progress) why not start from the much more interesting question: how do challengers acquire the knowledge they need to break into established industries? This is where the differences between tacit and explicit knowledge have a cutting edge. If you take the semiconductor industry as benchmark, then challengers like Samsung Electronics and Micron in the 1980s scrambled to secure the knowledge needed. Micron was a US firm established away from Silicon Valley and was thus able to hire engineers from the Valley who brought the explicit procedures of IC fabrication with them plus the tacit knowledge that acted as the ‘glue’ to bring the procedures together to a standard that was competitive with incumbents. Samsung across in Korea was able to do the same by hiring Japanese and US engineers (during an industry downturn, when such ‘resources’ became available) but was also able to secure the explicit knowledge found in a chip design – by licensing a design from none other than Micron.

    So to bring this example to bear on the debate between Bo and Nicolai, I would point to the need for the challenger to secure the explicit knowledge that is the necessary condition for entry to the targeted industry – without the minimum of explicit knowledge, there can be no prospect of entry. This is knowledge that resides in explicit and codified routines, in designs, and in processes that are embodied in equipment that can be purchased and sometimes in patents and other forms of intellectual property. But to be implemented in anything like competitive time, in a way that can result in anything like a competitive product, of course the explicit knowledge has to be complemented by the tacit knowledge in engineers’ heads. This is why Samsung was prepared to pay such high salaries to integrated circuit engineers when it was setting up its operations in the mid-1980s – salaries up to twice those paid to the senior executives. If there is a measure of the value of tacit knowledge, then what a company is prepared to pay for it must rank as a good one. Samsung was in a race to turn this tacit knowledge into some form of explicit codified knowledge that could be passed from one group of engineers to another. At one stage Samsung had engineers working on three generations of memory chip simultaneously – the 64K DRAM (outgoing chip in 1985), the 256K DRAM (current chip) and 1M DRAM (next generation chip) – and rotating the engineers from one group to another to ensure the build-up of codified routines for trouble-shooting the immense complexity of moving a chip from pilot production to the intensity of mass production.

    So I agree with Nicolai that firm-level knowledge can be explicit – indeed, for the challenger, that is the entire object of the game, to turn the tacit knowledge recruited from ‘slack’ resources into competitive, codified knowledge. But I also agree with Bo that it is not the knowledge in individuals’ heads that is of prime significance, but the speed with which that idiosyncratic knowledge can be converted into organizational knowledge that counts. With all respect to agency theory Nicolai, I suggest you ask Samsung whether they respected the ‘private’ knowledge in people’s heads or whether they saw their goal as moving it into codified form as fast as possible. This after all is the supreme challenger goal – to master what the incumbents do as fast as possible and to do so with some advantage such as lower costs. If there were no firms able to succeed in this, there would be no diffusion of innovations and no economic progress.

  • […] educators continue to discuss risk-taking as a major characterestic of entrepreneur. Similarly, on his blog Professor Foss highlights a recent research by Professor Richard Makadok of Emory Univers… which finds that the popular SWOT model which is taught in all book schools and is included in […]

  • 22. Richard Makadok  |  26 March 2010 at 7:52 pm

    After getting bounced at two other journals (mostly my fault for making bad choices in framing and organizing it), a slimmed-down version of this paper has finally been published at Management Science. Here’s the reference…

    Makadok, R. 2010. The Interaction Effect of Rivalry Restraint and Competitive Advantage on Profit: Why the Whole Is Less Than the Sum of the Parts. Management Science, 56(2): 356–372.

    Thanks,
    Rich

  • […] many times have you seen a SWOT analysis tilting to one side because the Threats and Weaknesses outweighed the Strengths and Opportunities? […]

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