Gap analysis

What Is Gap Analysis?

Gap analysis is a strategic management tool used to compare an organization's current performance with its desired future state. It falls under the broader umbrella of Strategic Management and Financial Planning, helping entities identify the "gap" between their current capabilities and their target objectives. By conducting a gap analysis, businesses can determine what resources, processes, or actions are needed to bridge this disparity, thereby improving overall Financial Performance and operational efficiency. This analytical process is fundamental to effective planning across various sectors.

History and Origin

While the precise origin of "gap analysis" as a formal concept is not attributed to a single individual, the underlying principles of comparing current states to desired states for improvement have long been integral to strategic thinking. The methodology gained prominence with the rise of modern Corporate Strategy and management consulting in the mid-20th century. For instance, frameworks like the McKinsey 7S Model, developed by McKinsey consultants Tom Peters, Robert Waterman, and Julien Phillips in the 1980s, inherently utilize a form of gap analysis to assess the alignment of seven key organizational elements (strategy, structure, systems, shared values, skills, staff, and style) with desired outcomes. This model, among others, helped popularize the systematic identification of gaps to achieve organizational effectiveness⁸.

Key Takeaways

• Gap analysis compares an organization's current state with its desired future state.
• It identifies the disparity, or "gap," and outlines the necessary steps to bridge it.
• The analysis is crucial for effective strategic planning, resource allocation, and Target Setting.
• It can be applied across various domains, including financial, operational, and performance management.
• The primary goal of gap analysis is to inform actionable strategies for improvement and growth.

Formula and Calculation

While gap analysis is primarily a qualitative assessment, it can incorporate quantitative elements, especially when dealing with measurable objectives. The "formula" is conceptual rather than a strict mathematical equation:

[
\text{Gap} = \text{Desired State} - \text{Current State}
]

Where:

• Desired State: The target goal or objective, often defined by specific Key Performance Indicators (KPIs).
• Current State: The present performance level, measured against the same KPIs.

For example, if a company aims for a 15% Return on Investment (Desired State) but is currently achieving 10% (Current State), the gap is 5%. The analysis then focuses on identifying the actions needed to increase the ROI by 5 percentage points. This often involves detailed Performance Measurement.

Interpreting the Gap Analysis

Interpreting gap analysis involves more than just identifying the numerical difference. It requires a deep dive into the root causes of the gap and understanding its implications. A positive gap (desired state is higher than current state) indicates an area for growth and improvement. A negative gap might suggest overperformance in some metrics, but more commonly, it indicates a shortfall or an area where the current state is significantly behind the desired.

The interpretation process typically involves:

1. Quantifying the Gap: Numerically expressing the difference where possible.
2. Qualifying the Gap: Understanding the underlying factors contributing to the gap, such as process inefficiencies, lack of resources, market shifts, or competitive pressures.
3. Prioritizing Gaps: Determining which gaps are most critical to address based on strategic importance, feasibility, and potential impact.
4. Developing Action Plans: Formulating specific strategies and initiatives to close the identified gaps. This often ties into Capital Allocation and resource deployment.

Hypothetical Example

Consider a hypothetical manufacturing company, "Widgets Inc.," that aims to reduce its production costs.

Current State: Widgets Inc.'s average cost per widget is $1.50.
Desired State: The company's strategic Budgeting plan targets an average cost per widget of $1.20 within the next fiscal year.

Gap Calculation:
Desired Cost: $1.20
Current Cost: $1.50
Gap: ( $1.20 - $1.50 = -$0.30 )

The gap is -$0.30 per widget, meaning Widgets Inc. needs to reduce its production cost by $0.30 per unit to meet its target.

Analysis and Action:
Widgets Inc. would then conduct a detailed operational analysis to understand why costs are $0.30 higher. This might reveal:

• Outdated machinery increasing maintenance and waste.
• Inefficient supply chain management leading to higher raw material costs.
• Suboptimal labor utilization.

Based on this gap analysis, the company might decide to invest in new machinery, renegotiate supplier contracts, implement Business Process Reengineering on the assembly line, or undertake specific Project Management initiatives to address these issues.

Practical Applications

Gap analysis is widely applied across various domains in finance and business:

• Financial Planning and Budgeting: Companies use gap analysis to compare actual financial results against projected budgets or long-term financial goals, identifying shortfalls in revenue or excesses in expenditure. For instance, the International Monetary Fund (IMF) utilizes a Revenue Administration Gap Analysis Program (RA-GAP) to assess the "tax gap" between potential revenues and actual collections for corporate and personal income taxes, helping countries identify areas of non-compliance and under-collection⁷,⁶.
• Risk Management: In financial institutions, gap analysis is a core component of Asset-Liability Management (ALM), particularly for managing Interest Rate Risk. Banks analyze the gap between rate-sensitive assets and liabilities over various time horizons to understand their exposure to interest rate fluctuations. This helps them determine if they are "asset sensitive" or "liability sensitive" to changes in interest rates, impacting their net interest margin⁵. The Federal Reserve also monitors interest rate risk in the financial system, with reports highlighting bank exposures to changes in rates⁴,³.
• Strategic Planning: Organizations conduct gap analysis to align their current capabilities and resources with their long-term strategic objectives. This could involve assessing the gap in market share, product offerings, technological capabilities, or human capital needed to achieve a competitive advantage.
• Performance Management: Businesses often use gap analysis to evaluate employee or departmental performance against established benchmarks or goals, identifying areas for training, development, or process improvement.
• Compliance and Regulatory Affairs: Entities assess their current compliance status against regulatory requirements to identify gaps and ensure adherence to legal and industry standards. This is particularly relevant in areas like Fiscal Policy.

Limitations and Criticisms

While a powerful tool, gap analysis has limitations:

• Focus on the Past and Present: Gap analysis typically relies on historical and current data to project future needs. It may not fully account for unforeseen future changes, disruptive innovations, or rapid market shifts that could alter the "desired state" or render current strategies obsolete.
• Subjectivity in Desired State: Defining the "desired state" can be subjective and may not always reflect realistic or achievable goals. Overly ambitious or poorly defined targets can lead to an impractical gap and ineffective action plans.
• Difficulty in Quantifying Qualitative Gaps: While useful for quantitative measures, it can be challenging to apply gap analysis effectively to qualitative aspects, such as organizational culture or brand perception, which are harder to measure precisely.
• Risk of Incomplete Analysis: Without a comprehensive understanding of all internal and external factors influencing the gap, the analysis may lead to superficial conclusions or misdirected efforts. A common reason for strategic execution failure is an incomplete understanding of risks or a lack of organizational support². Companies that fail to adapt their Risk Management to external factors like emerging technologies or evolving customer needs often experience strategic planning failures¹.

Gap Analysis vs. Variance Analysis

While both gap analysis and Variance Analysis involve comparing actual results to planned or expected outcomes, their primary focus and application differ.

In essence, gap analysis helps an organization determine "where we want to be and how to get there," while variance analysis helps answer "why are we not where we expected to be?"

FAQs

What are the main steps in conducting a gap analysis?

The main steps typically include identifying the current state, defining the desired future state, analyzing the gap (the difference between the two), determining the causes of the gap, and developing an action plan to bridge it.

Who uses gap analysis?

Gap analysis is used by a wide range of professionals and organizations, including corporate executives, financial managers, project managers, consultants, and government agencies. It is a versatile tool for any entity seeking to improve its current situation relative to a desired outcome.

Is gap analysis only for large corporations?

No, gap analysis is scalable and can be applied to organizations of any size, from small businesses and non-profits to large multinational corporations. Individuals can also use a form of gap analysis for personal Financial Planning or career development.

How does gap analysis contribute to strategic planning?

Gap analysis is fundamental to strategic planning as it helps an organization understand the distance between its current position and its strategic objectives. By identifying these gaps, organizations can prioritize initiatives, allocate resources effectively, and formulate specific strategies to achieve their long-term vision, ensuring better Capital Allocation and more effective execution.