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What is 'SWOT Analysis'

SWOT analysis is a framework used to evaluate a company's competitive position by identifying its strengths, weaknesses, opportunities and threats. Specifically, SWOT analysis is a foundational assessment model that measures what an organization can and cannot do, and its potential opportunities and threats.

BREAKING DOWN 'SWOT Analysis'

SWOT analysis is a basic, analytical framework that assesses what an entity — usually a business, though it can be a place, industry or product — can and cannot do, for factors both internal and external. Using environmental data to evaluate the position of a company, a SWOT analysis determines what assists the firm in accomplishing its objectives, and what obstacles it must overcome or minimize to achieve desired results: where the organization is today, and where it may go.

For example, back in 2015, a Value Line SWOT analysis of The Coca-Cola Company noted strengths like its well-known brand name, vast distribution network and opportunities like emerging markets, but it also noted weaknesses and threats such as foreign currency fluctuations, a growing taste for "healthy" beverages and the subsequent competition from providers of such beverages. Coca-Cola took steps to address these concerns, ramping up its marketing, advertising and promotional activities, and expanding into other beverage categories. As a result, within a year, its dividend-per-share rose from 33 to 35 cents, and its stock, which was hovering around $39 per share, climbed to $46. It's fallen since, but remains up about 13 percent over the past three-year period.

A Visual Overview

A visual overview of SWOT analysis.

Analysts present a SWOT analysis as a square with each of the four areas making up one quadrant. This visual arrangement provides a quick overview of the company’s position. Although all the points under a particular heading may not be of equal importance, there is insight in seeing how the number of opportunities measures up to the number of threats, and so forth.

Elements of a SWOT Analysis

When using SWOT analysis, an organization needs to be realistic about its good and bad points. The organization needs to keep the analysis specific by avoiding gray areas and analyzing in relation to real-life contexts. For example, how do the organization’s products and services compare to those of competing firms? SWOT analysis should be short and simple, and should avoid complexity and over-analysis because much of the information is subjective. Thus, companies should use it as a guide and not a prescription.

  • Strengths describe what an organization excels at and separates it from the competition: a strong brand, loyal customer base, a strong balance sheet, unique technology and so on. For example, a hedge fund may have developed a proprietary trading strategy that returns market-beating results. It must then decide how to use those results to attract new investors.
  • Weaknesses stop an organization from performing at its optimum level. They are areas where the business needs to improve to remain competitive: higher-than-industry-average turnover, high levels of debt, an inadequate supply chain or lack of capital.
  • Opportunities refer to favorable external factors that an organization can use to give it a competitive advantage. For example, a car manufacturer can export its cars into a new market, increasing sales and market share, if a country cuts tariffs.
  • Threats refer to factors that have the potential to harm an organization. For example, a drought is a threat to a wheat-producing company, as it may destroy or reduce the crop yield. Other common threats include things like rising costs for inputs, increasing competition, tight labor supply and so on.

Advantages of SWOT Analysis

A SWOT analysis is a great way to guide business-strategy meetings. It's powerful to have everyone in the room to discuss the company's core strengths and weaknesses and then move from there to defining the opportunities and threats, and finally to brainstorming ideas. Oftentimes, the SWOT analysis you envision before the session changes throughout to reflect factors you were unaware of and would never have captured if not for the group’s input.

A company can use a SWOT for overall business-strategy sessions or for a specific segment like marketing, production or sales. This way, you can see how the overall strategy developed off the SWOT analysis will filter down to the segments below before committing to it. You can also work in reverse with segment-specific SWOT analysis that feeds into an overall SWOT analysis.

Executing a SWOT Analysis

Pre-SWOT Homework

Before you set out to do a SWOT analysis with your management team or other group, there is preparation to go through. The first step is to take a stab at creating a company profile. This is a description of what the business does and who the main customers are. If time allows or your company is sprawling and complex, you may need to profile each segment to capture what they add to the business. It also helps to outline strengths, weaknesses, opportunities and threats you’ve perceived so you can prompt the group if needed.

Leading the Process

When performing a SWOT analysis, it is best to start with a clean chart. Lay out the four quadrants and outline the content you are looking to populate it with as above, but let the group lead off. Again, in highly segmented business you may find the leads in the separate areas have more specialized knowledge as to the strengths and weaknesses in their areas. In extreme cases, you may need to do a segment-by-segment SWOT and feed it up into the larger one. For most companies, however, a single SWOT chart captures the current condition of the business.

At first, you want to capture everything you can from the group in a rush. When the pace of input trickles off, you can go over the chart and eliminate duplicate/overlapping entries and ensure each entry is in the right category. Walk the group through your reasoning if you are outright eliminating an entry or combining concepts. This is basic courtesy and shows the company values their input. The group can also help in adding and removing entries within the SWOT chart to distill it to a mutually agreed upon core.

Working with the Chart

You will probably have an imbalance between internal and external factors now. People are much more aware of the current state within the company and less likely to think of the whole business sector's direction. If needed, you can prompt more entries under opportunities by encouraging them to think about how the company can leverage a current strength to create new opportunities or how fixing a weakness could lead to a larger opportunity. Likewise, in what situations will your current strengths and weaknesses endanger the company?

Examples of SWOT Analysis

Let's take a practical look at SWOT analysis by applying it to two fictional companies.

Al’s Ice Cream: The Case for Expansion

Al’s Ice Cream is a wholly owned ice cream shop that leverages founder Al’s food-science training to create handcrafted ice cream with local ingredients. Al’s company is profitable with strong margins on its premium-priced cones, but Al is wondering if the single store approach isn’t limiting his growth. We’ll take this first SWOT analysis in two steps so we can see how the exercise builds on itself.

Strengths and weaknesses are internal factors unique to the business in question. Some may be a result of external factors like a weak economy or tight labor market, but they are still company-specific. Here are the strengths and weaknesses of Al’s Ice Cream:

Strengths

Weaknesses

  • Superior product with unique flavors difficult to duplicate

  • Loyal customer base supplying word-of-mouth marketing

  • Strong sales and a generous profit margin

  • Limited market penetration due to a single location

  • Time and labor-intensive production process

  • Limited capital for expansion

  • Have trouble finding capable ice cream artisans

Opportunities and threats are external to the company. They represent things that could happen in the right conditions. That is an awfully broad guideline, so we can use the strengths and weaknesses above to narrow in on opportunities and threats that follow naturally from them. Here are opportunities and threats facing Al’s Ice Cream:

Opportunities

Threats

  • Increase the number of stores to access more customers

  • Focus on production and sell into retail food service

  • Buy new equipment to lower production time and labor

  • Start an artisanal ice cream class to train and recruit employees

  • Partner up to access more capital, raise it from private investors, or apply for government grants

  • Big ice cream brands are experimenting with artisanal ice cream

  • Consumers are increasingly health-conscious

  • Local ingredients may become more expensive as restaurants and other big buyers focus on local food

  • Competitors have more marketing dollars

   

The purpose of a SWOT analysis is to present routes for a company. A company can create potential strategies by combining and recombining different factors. For example, Al’s could apply for government grants to install new equipment, reducing labor needs, and then raise capital to open an additional concept store staffed with the artisanal ice cream class' graduates. This an ambitious plan – and it will probably change in implementation, but it provides Al’s Ice Cream with a potential path forward.

Ed’s Carpets: Sell More to Your Customers

Ed’s Carpets is a mature business with a warehouse and storefront. Carpets are a low-margin business that depends on value. Ed’s enjoys steady business due to his installation guarantee and high quality standards, but things aren’t as good as they were 20 years ago.

Here is the SWOT analysis:

Strengths

Weaknesses

  • Established brand with loyal customers

  • Deep knowledge of carpets and flooring

  • Dedicated and efficient employees who take pride in their work

  • Basic web presence with no inventory images or online ordering

  • Focus on carpets with a small amount of linoleum

  • Warehouse inventory ties up a lot of capital

Opportunities

Threats

  • Adopt a leaner model with less inventory on hand

  • Increase the range of flooring products offered (laminate, tile, cork, etc.)

  • Increase the range of services offered (repair, maintenance, design, etc.)

  • Use knowledge to sell carpet over the internet without installation services

  • Move toward less carpet and more diverse types of flooring

  • Consumers are more price conscious in the down economy

  • Competition from online-only stores without the same overhead costs

  • Better flooring materials are increasing the time span between flooring changes.

Again, we see natural combinations within the quadrants and even between quadrants. Ed’s Carpets can benefit from exploring several of the opportunities and some of those will help to address weaknesses. For example, adopting a leaner inventory model will address some capital concerns and wholesaling existing inventory online without installation might clear the backlog. Less carpet in the warehouse frees Ed's up to look at different flooring products for the local market.

Using SWOT Analysis to Evaluate Investments

Most commonly used as a business-planning tool, you can also use SWOT analysis as an investment tool, giving you a handy snapshot of the potential advantages or disadvantages of buying stock in a company. Broadly speaking, the strengths and weaknesses should reflect "what is" about the company today, while opportunities and threats are more about what could happen to it.

Strengths are characteristics that form the basis of above-average performance potential of shares. Not only do strengths consider what a company does well, but why or how it does it well. With a mining company, for instance, a valuable mineral asset in a politically stable country may be a strength, while a major consumer company may have some of its greatest strengths in the value of its brands. It is important to note that above-average revenue growth or superior margins are not in and of themselves strengths – it is the popularity of the products or the relative efficiency of a manufacturing process that represent the real strengths.

Weaknesses are vulnerabilities to the company's competitive position and/or opportunity to post positive returns on investment. For example, an investor would consider an industry heavily burdened with competition a potential weakness of the firm.

Opportunities represent scenarios or options where the company can meaningfully improve itself. Introducing a significant product can be an opportunity as can a restructuring or acquisition. Another type of opportunity presents itself from an untapped customer demographic. For example, if an independent pizza restaurant introduces a delivery service, it can expand its customer base beyond only those living in the neighborhood.

Threats should answer the question "what could change for the worse?" with a particular company. Like opportunities, threats may be prospective or even theoretical, but they should offer more specificity than "something might go wrong." Increased government regulation, a failure to secure approval/acceptance for a major new product, or introducing a rival product/service would all represent meaningful threats to a company's competitive standing and returns. Threats can also refer to how economic conditions affect the company if it is especially sensitive to a change in interest rates, inflation, etc.

Limits of Using SWOT for Investing

There are key limitations that investment-oriented users of SWOT analysis should understand. To start, SWOT totally ignores valuation and other significant fundamental metrics like return on capital, margins, cost of capital and so on. A SWOT analysis will not tell an investor what price is fair for a stock or if a stock is undervalued.

SWOT analysis also does not offer much scope or scale to the size or significance of various opportunities and threats. The creator of a SWOT analysis would not bother with non-material opportunities or threats, but it is important to quantify the impact of these items on a company's returns.

The largest limitation of SWOT analysis is that it is subjective and self-directed. The entire process relies solely on the analyst's knowledge and judgment, and there is an inherent potential for bias. With a biotech company, for instance, a bullish investor may well see an experimental therapy as a major opportunity while a bearish one will see a weakness or threat in the vast amounts of money spent developing a doomed therapy. Likewise, an optimist may well see an emerging brand as a major strength, while the bear sees little value in a brand and major threats from competition from more established brands/companies.

Advantages to Using SWOT for Investing

What SWOT analysis does, however, is force some discipline and systematic, quantifying thinking into the investment evaluation process. A careful and thoughtful analysis should bring into focus the balance of a company's advantages and vulnerabilities, and also give the investor a benchmark to evaluate the company in future years. On balance, SWOT analysis is best used by investors as a way of crystallizing and the thought process that goes into an investment decision. The entire process can, and should, make an investor think more deeply about the weaknesses of and threats to a company, while also helping to tease out what is important and distinctive about one company versus its rivals.

SWOT analysis also works best when done consistently. By using it regularly and keeping track of the information, SWOT analysis can allow for better comparisons across industry participants, and more frequent use can also help limit dangers of bias and selective or incomplete analysis.

Investors can look at SWOT analysis as a good screening tool for ideas and investment prospects that merit further research and as a useful means of tracking current holdings and comparing the development and evolution of those companies to the original purchase plans.

The Bottom Line

SWOT analysis provides a visual overview that prompts discussion around a company’s situation. It is a bird's-eye view meant to flesh out the viability of a concept or strategy from the inside out – a more macro review than other analytic tools, such as Porter's 5 forces.

The speed at which you can do a SWOT analysis and the flexibility of the format to evaluate different ideas and strategies are key reasons this tool remains popular in business circles and can be useful to investors.

The most important factor in successfully using SWOT analysis is the quality of the data. If you don’t accurately capture your company’s core strengths and weaknesses, then SWOT analysis won’t be much help. A SWOT analysis is only as good as the data coming in. If a company over-represents its strengths, weaknesses, opportunities or threats, SWOT analysis might provide support in the wrong direction.

The SWOT analysis is never the end goal of the discussion. The next steps for a group or an individual investor are to pull out action items from the analysis to work on further.

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