# What Is a Gap Analysis?

![Gap Analysis](https://www.investopedia.com/thmb/XW5wzAIeTJt89tAB207BfNPwbHU=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Gap-Analysis-Final-resized-3c7edfb1316d49ad8eb9e275fb6e62de.jpg)

*The "gaps" are the identified areas needing improvement. — Investopedia / Yurle Villegas*

> **Definition**
>
> A gap analysis examines business results to ascertain whether a company is meeting set objectives.

## What Is a Gap Analysis?

A gap analysis is a process that companies use to compare their current performance with their desired, expected performance and to create an action plan for improvement, as needed.

A gap analysis helps a company assess its current state—by measuring time, money, and labor—and compare it with its target state.

By defining and analyzing the gaps between expectation and reality, the management team can move the organization forward and fill in the performance gaps.

### Key Takeaways

*   There are five steps to a gap analysis: defining the current state of the business, clarifying its goals, identifying the gaps, preparing an action plan, and implementing change.
*   A gap analysis can identify areas in which the company is failing to use its resources, capital, or technology to their full potential.
*   By defining the gap, a firm’s management team can create and take action on a plan to move the organization forward to fill it.

## Understanding Gap Analysis

When organizations aren’t making the best use of their resources, [capital](https://www.investopedia.com/terms/c/capital.asp), and technology, they can't reach their full potential. This is where a gap analysis can help.

A gap analysis, sometimes called a needs analysis, helps companies determine where they are today—their current, actual progress—and where they want to be in the future.

If there is a gap between the two, companies can reexamine their goals to figure out whether to change them and/or how to get on the right track to accomplish them.

There are four steps in a gap analysis. These end in a compilation report that identifies areas of improvement and outlines an action plan to enhance company performance.

> **Fast Fact**
>
> The “gap” in a gap analysis is the space between where an organization is and where it wants to be in the future.

## How to Conduct a Gap Analysis

Some gap analysis models break the following steps into four processes. Others are a little more elaborate and expand the analysis into a few additional steps.

In either case, a gap analysis entails understanding your current position, determining where you want to end up, and devising a plan on how to arrive at the desired endpoint.

### Step 1: Define the State of the Business

A gap analysis starts by examining the nature of a business to discover its shortcomings.

This includes researching the products the company offers, the customers it serves, the geographical locations it covers, and the benefits it offers to its employees.

This information can be quantitative (such as financial records) or qualitative (surveys or feedback from [key stakeholders](https://www.investopedia.com/terms/s/stakeholder.asp)). 

Often, a company will perform a gap analysis because it is already aware of an issue. For example, customer feedback surveys may have generated poor results, and a company wants to investigate why and implement remedies.

Before it can reach its potential, the business must understand why these errors are happening, when issues are arising, and who the change management leaders must be.

### Step 2: Clarify the Company's Goals

The crux of gap analysis resides in this step, in which a company identifies what it wants to become. This stage must be done with great care, as the identity that a company has will dictate the strategic steps that it must take to obtain those goals.

In gap analysis, a company identifies specific, measurable goals that can yield the greatest long-term success. For example, it would do the company little good to set the goal of becoming better at customer service.

Instead, the company must identify trackable [metrics](https://www.investopedia.com/terms/m/metrics.asp), such as achieving a customer satisfaction of 90% within 12 months.

Another way of identifying the desired outcome is to analyze what competitors or other market participants are doing. Pinpoint how and when another company does something well and attempt to emulate it.

### Step 3: Identify the Gaps

With the current state and future state defined, it’s time to understand where the critical differences lie and bridge the two.

At this stage, a company may realize that it's woefully understaffed, has failed to properly train its staff, or does not have the technical capability to deal with customer contacts.

### Step 4: Prepare an Action Plan

Once a company has defined its deficiencies, it should develop a plan to reach its target state. There may be one solution or several simultaneous changes must be made.

The action plan must include quantifiable ways to measure change. For example, if customer service is the problem, improvement in customer satisfaction should be set as a goal along, with a metric that tracks improvement (such as average resolution time and the number of requests for customer service).

Other gap analysis findings such as deficiencies in [brand](https://www.investopedia.com/terms/b/brand.asp) recognition may require more creative, thoughtful solutions going forward.

### Step 5: Implement Change

Once the best ideas from Step 4 are chosen, put them into action. In this stage, the company attempts to close the gap identified in the analysis.

By putting the solutions in place, the company attempts to become better at a targeted area of business.

This implementation stage often entails following a detailed set of processes on a specific schedule.

Care must be taken to ensure that more damage isn’t caused rather than problems resolved. For example, a laborious training process could leave employees feeling overwhelmed and discouraged.

An effort to increase their performance could lead to a loss of productivity and decreased morale.

### Monitor Changes

A gap analysis isn't complete even when the plan has been carried out. The company then needs to monitor the changes over time to sustain the improvements.

Gap analysis can be a circular process in which the company regularly evaluates its current position to be certain it has achieved its goals and can sustain its success.

> **Important**
>
> A gap analysis often contains sensitive information. Companies do not often disclose their gap analysis models. The analysis could tip off competitors about the company's plans.

## Types of Gap Analysis

### Market Gap Analysis

Also called product gap analysis, market gap analysis entails studying the market and how customer needs may be going unmet.

If a company can identify areas where product [supply](https://www.investopedia.com/terms/s/supply.asp) is not meeting consumer [demand](https://www.investopedia.com/terms/d/demand.asp), the company can take measures to fill that market gap.

### Strategic Gap Analysis

Also called performance gap analysis, strategic gap analysis is a formal internal review of how a company is performing.

The analysis often entails comparing how a company has done against long-term benchmarks such as a five-year plan or a [strategic plan](https://www.investopedia.com/financial-edge/0612/the-importance-of-strategic-planning.aspx).

A strategic gap analysis may also be performed to compare how a company is faring against its competitors. This type of analysis can reveal ways that other companies are using personnel or capital in more strategic, resourceful ways.

This type of information may be hard to come by, especially if departed employees have signed nondisclosure agreements and the company does not publicly disclose much information about processes. 

### Financial/Profit Gap Analysis

A company may choose to directly analyze where it is falling short compared to its competitors by looking specifically at financial metrics. This may include pricing comparisons, margin percentages, overhead costs, revenue per labor, or [fixed vs. variable components](https://www.investopedia.com/ask/answers/032515/what-difference-between-variable-cost-and-fixed-cost-economics.asp).

The ultimate goal is to determine areas in which a competitor is more financially efficient.

### Skill Gap Analysis

Instead of looking at the financial aspects, a business may choose to look at the human element. A skill gap analysis helps determine if there is a shortfall in knowledge and expertise with current personnel.

A skill gap analysis must clearly define the goals of the company and then map how current employees fit into that design. The skill gap analysis may lead to a recommendation for training existing staff or bringing in new personnel. 

This type of analysis is especially important for innovative companies that rely on direct skill sets to compete in their industry.

### Compliance Gap Analysis

Leveraging [internal audit](https://www.investopedia.com/terms/i/internalaudit.asp) functions, a compliance gap analysis evaluates how a company is faring against a set of external regulations. For example, a company may internally evaluate its accounting and reporting functions in advance of seeking an external auditor to provide an opinion on its financial statements.

Compliance gap analysis tends to be preventative and defensive as opposed to more strategic forms of gap analysis. The intention is to follow regulations, meet reporting deadlines, and avoid fines.

### Product Development Gap Analysis

As a company manufactures new products, gap analysis can be performed to analyze where the product could fall short.

This type of gap analysis is often associated with the development of software products or items that take so long to develop that market demand may have shifted by the time they're released.

A company may also evaluate which aspects of the product or service have been successfully implemented, delayed, intentionally eliminated, or still in progress.

## Gap Analysis Tools

Companies can use an assortment of tools to assist with the gap analysis process. The tools listed below have an intended use that is best suited for a specific aspect of a gap analysis.

### SWOT Analysis

One of the more recognizable analysis tools, [SWOT analysis](https://www.investopedia.com/terms/s/swot.asp) determines a company’s strengths, weaknesses, opportunities, and threats.

With this gap analysis tool, a company can evaluate both internal and external factors that it can improve upon or realize its lead using.

In a SWOT analysis, a company evaluates its strengths and weaknesses as part of internal analysis. It may choose to divert resources from its strengths if it feels comfortable with its current market lead.

Or, a company may focus on its weaknesses. In some cases, companies may decide that weaknesses cannot be overcome due to massive capital investment requirements or consumer preferences.

Another part of a SWOT analysis relates to external forces beyond the control of a company. For example, a company may plan to capture greater [market share](https://www.investopedia.com/terms/m/marketshare.asp) by releasing a new product.

Should the threat of a government tariff on the product increase the per-unit cost, the company’s gap may be difficult to close.   

### Fishbone Diagram

A [fishbone diagram](https://www.investopedia.com/terms/i/ishikawa-diagram.asp), also called a cause-and-effect diagram or an Ishikawa diagram, can help identify what might be causing problems. It can encourage creative thinking when sizing up a business constraint.

A fishbone diagram is created by determining the main problem at hand and writing that at the center of an area. Then, major categories are written on branches that extend from the main problem.

Eventually, additional branches are added to these branches that identify why problems within each category exist.

In the end, the fishbone diagram attempts to break a large, complex problem into more approachable tasks.

### McKinsey 7-S

The [McKinsey 7-S](https://www.investopedia.com/terms/m/mckinsey-7s-model.asp) framework identifies seven elements that are key to determining how well a company performs.

The model contains three “hard elements” of strategy, structure, and systems, along with four “soft elements” of shared values, skills, style, and staff.

Using the McKinsey 7-S model, a company can identify how each area fits into prevailing gaps and how the company can influence each aspect to better conform to long-term objectives.

The McKinsey 7-S model has been in use since the 1970s, when it was introduced by management consulting company McKinsey & Co.

### Nadler-Tushman Model

The Nadler-Tushman model is used specifically to identify problems, understand how a company may be underperforming, and determine how to address that performance.

The core of the Nadler-Tushman model is the concept that aspects within a company should be aligned and work together; otherwise, the company will not be as successful.

The model is centered on components including culture, work, structure, and people. These four core principles receive data that is input (a company’s strategy) as well as output (a company’s performance).

The end goal is to determine how each of the four components is working together.

### PEST Analysis

A [PEST analysis](https://www.investopedia.com/terms/p/pest-analysis.asp) entails gauging external factors and how they may impact the profitability of a company.

PEST stands for political, economic, social, and technological. A common variation of PEST analysis is PESTLE analysis, which also incorporates legal and environmental concerns.

For example, government legislation may cause a company’s product to become much more expensive to export. In this case, a company may have a potential gap should external forces shift in a way that adversely impacts the company.

> **Tip**
>
> Companies often use a combination of gap analysis tools, as findings from one tool may contribute to the analysis of another.

## When to Use a Gap Analysis

A company should constantly evaluate the products it offers, the customers it serves, the market need it fills, and the efficiency of its operations.

However, there are times when a more formal gap analysis is warranted. These times include:

*   **During [project management](https://www.investopedia.com/terms/p/project-management.asp)**. Some products with multiyear development cycles face the risk of changing external situations. It's advisable to perform gap analysis periodically during a long-term project.
*   **Planning for strategic endeavors**. Whether forming long-term budgets, contemplating corporate restructurings, or lining up a potential acquisition, gap analysis can inform a major strategic decision. For example, expansion into a new geographical area may pose political risk, geographical risk, currency risk, and culture risk. A company should perform a gap analysis to understand how severe these risks are and what additional resources (if any) are needed to handle each area.
*   **Wanting to understand performance deficiencies**. Gap analysis can unearth areas of operations where shorter-term, day-to-day functions can improve. Although this type of use is reactionary, a company can choose to preemptively evaluate areas of its operation. For example, a cost center may come in substantially over budget; the company should find out what happened and what steps need to be taken.
*   **[Marketing](https://www.investopedia.com/terms/m/marketing.asp) to external parties**. Though gap analysis is of most benefit to internal parties, it can be used to communicate plans to external investors. The plan can then be revealed to outside parties as part of a capital investment request or seed funding round. By being open, transparent, and strategic about its shortfalls, a company may find outside parties more willing to partner and invest in its growth.   
    

## Benefits of Gap Analysis

Because gap analysis can be used in many ways, it carries a wide variety of benefits. Each benefit listed below may pertain to only one specific type of gap analysis. Still, companies performing gap analysis may experience:

*   **Improved profitability**. Companies that assess gaps and preemptively determine shortfalls are better prepared to incur spending at optimal times, have resources on hand (instead of having to pay extra capital to secure it later), and run more efficiently.
*   **Better [manufacturing](https://www.investopedia.com/terms/m/manufacturing.asp) processes**. Realizing and preventing gaps when building in the manufacturing process leads to stronger production, more efficient delivery logistics, raw materials being on-site at the correct location when they are needed, and the avoidance of bottlenecks.
*   **Increased [market share](https://www.investopedia.com/terms/m/marketshare.asp)**. By combining the first two benefits, a company can have an improved presence in the market by showing increased sales, revenue dollars, customers, and market share.
*   **Happier employees and customers**. Instead of reacting to employee or customer needs and playing catch-up, companies that perform a gap analysis can address potential issues before they happen and potentially strain relationships or cause individuals to turn to competitors.
*   **Operational efficiency**. By better understanding where it may not be operating well, a company can make changes to improve day-to-day functions. 
*   **Decreased [risk](https://www.investopedia.com/terms/b/businessrisk.asp) for long-term endeavors**. By identifying the resources needed and potential shortfalls, companies can plan for gaps and identify problems before they occur.  
    

## Gap Analysis in Finance/Asset Management

Gap analysis is also a method of asset liability management that can be used to assess [interest rate risk (IRR)](https://www.investopedia.com/terms/i/interestraterisk.asp) or [liquidity risk](https://www.investopedia.com/terms/l/liquidityrisk.asp), excluding [credit risk](https://www.investopedia.com/terms/c/creditrisk.asp).

It is a simple IRR measurement method that conveys the difference between rate-sensitive assets and rate-sensitive liabilities over time.

This type of analysis works well if assets and liabilities are composed of fixed [cash flows](https://www.investopedia.com/terms/c/cashflow.asp). Gap analysis cannot handle [options](https://www.investopedia.com/terms/o/option.asp), as options have uncertain cash flows.

Consider a company that wants to make an investment but wants to ensure that it has enough capital on hand to cover contingent situations. The company can review cash flows, determine risks, and assess where potential cash flow shortfalls may occur.

This is especially useful in long-term projects, high-risk projects, and projects sensitive to macroeconomic or external forces.

## What Are the Fundamental Components of a Gap Analysis?

Gap analysis must always start with an analysis of a company’s current position. Without understanding where it currently is, a company can’t adequately make a plan to get to where it wants to go.

In addition to identifying where it is today and where it wants to be in the future, gap analysis entails crafting a plan with implementation steps that can be tracked and measured to hold change managers accountable.

## How Do Gap Analysis and SWOT Analysis Differ?

[SWOT analysis](https://www.investopedia.com/terms/s/swot.asp#:~:text=SWOT%20analysis%20is%20a%20strategic,fresh%20perspectives%2C%20and%20new%20ideas.) is often used as part of gap analysis. With a SWOT analysis, a company identifies its strengths and weaknesses. Then, the company should understand whether those strengths and weaknesses are suitable to get the company where it wants to be.

Gap analysis is the plan that attempts to change a company’s strengths and weaknesses. The opportunities and threats identified as part of a SWOT analysis are the risks that the plan outlined as part of a gap analysis will not be successfully carried out.

## What Is Static vs. Dynamic Gap Analysis?

[Static gap analysis](https://www.investopedia.com/terms/s/static-gap.asp) looks at a firm’s sensitivity to changes in interest rates. [Dynamic gap analysis](https://www.investopedia.com/terms/d/dynamic-gap.asp) looks at the discrepancy between its assets and liabilities.

## The Bottom Line

A gap analysis is an undertaking that a company can use to evaluate its current position, decide its ideal position, and formulate a plan for how to bridge any gap in performance between the two.

A company may choose to perform a gap analysis if it is struggling operationally or if it wants to build on its successes. In either case, there are several tools such as SWOT analysis, PEST(LE) analysis, or a fishbone diagram, that can help the company formulate and execute a long-term plan.

> **Article Sources**
>
> 1.  McKinsey & Co. "[Enduring Ideas: The 7-S Framework](https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/enduring-ideas-the-7-s-framework)."