Competitive Advantage - Explained
What is a Competitive Advantage?
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Table of ContentsWhat is Competitive Advantage?What are Types of Competitive AdvantageCosts and Competitive AdvantageCompetitive Advantage in Product DifferentiationSources of product differentiationMarket Segmentation Drivers of Competitive AdvantageExamples of Competitive AdvantageStrategic Management and Competitive AdvantageSustained Competitive Advantage and StrategyAcademic Research on Competitive Advantage
What is Competitive Advantage?
Competitive advantage, as the name implies, is an advantage that a company or market participant has over other competitor market participants in a given function or industry. Plainly stated, it concerns the ability of a company to better provide a value proposition to consumers than competitors who provide the same or a similar value proposition.
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What are Types of Competitive Advantage
Competitive Advantage can be divided into two based on an analysis by Michael Porter. These two types can be further divided into two or three based on market segmentation.
- Costs Competition: This is where companies compete for lower costs. For instance, low cost airlines
- Product differentiation: Here, companies compete to offer higher quality goods at a higher price. For instance, Apple offers high quality phones and computers at a high price.
The competitive advantage concept was developed by Michael Porter in 1980. This aspect was developed to deal with the issue of comparative advantage and absolute advantage which advised countries to produce only what they are good at. Comparative advantage could see countries only engaging in primary sector production which could lead to low wages and little wealth generation.
Costs and Competitive Advantage
A company is said to have cost advantage if it produces goods more efficiently with less costs than do competitors. Cost leadership strategy will be advised when:
- The product is standardized with so many products having the same quality and offered at the same price.
- There are limited ways to achieve differentiation.
Competitive advantage in costs come experience which is linked to learning:
- Learning Effect: This effect shows that the time taken to manufacture a product decreases significantly as more products are produced. This reduction in production time reduces the cost of goods.
- Experience Effect: This is where a company gains experience in production and becomes an established brand thereby offering a strong barrier to entry. This will in turn reduce competition.
Competitive Advantage in Product Differentiation
A company is said to have competitive advantage in product/service differentiation if it offers goods/services of better value/quality or with better attributes than those of competitors. In such a case, customers are willing to pay more for the goods/services. The more the sophistication of a product, the more the positive attributes, the better the competitive advantage in product differentiation. Product differentiation comes in handy when:
- Clients are more attracted to quality in products and want to use the products to differentiate themselves socially.
- When a company can have features on products not easy to imitate.
- The company is interested in succeeding in product differentiation.
Sources of product differentiation
- Product features including size, shape, reliability, safety, technology, durability, availability of parts, and pre and after sales services.
- Market characteristics including the needs and the tastes of consumers.
- Company characteristics including the nature in which a company performs its business, its identity, values, and reputation.
The idea behind market segmentation is enable companies to learn the behavior of consumers when they are creating products or services. It tries to get companies to focus on selected markets instead of targeting all markets. Companies that target specific markets are able to meet the needs of their customers and this gives them a competitive advantage. To do this, most companies allow consumers to participate in the creation of products or services.
Drivers of Competitive Advantage
Competitive advantage generally arises in the following contexts:
- Efficiencies & Quality - A business that has a method of delivering a value proposition in a manner that is superior to other competitors may give rise to a competitive advantage. Operational efficiencies may lower cost of production/delivery, which allows for lower prices to customers or higher profit margins to the provider. For example, Wal-Mart gained a long-term competitive advantage over competitors through its real-time inventory system. Efficiencies may also give rise to a differentiated product that stands out from competitor products. For example, Mercedes-Benz depends upon quality of engineering to stand out compare to other competitor luxury automobiles?
- Knowledge & Ownership - The ability to provide something that others cannot provide (or provide well) is often linked to proprietary knowledge or ownership of a functional article, method, or design. This is generally the subject of intellectual property law. A business may establish a competitive advantage by employing a trade secret (a protected form of knowledge), such as a secret formula. Likewise, owning a trademark for a product or brand may provide a sustainable advantage over market competitors. Copyrights exclude others from reproducing a creative work that is recorded to a tangible medium. Design and utility patents allow individuals the sole right to commercialize a design or useful invention.
- Relationships - Having legal or personal relationships with suppliers of buyers to the exclusion of other competitors can give rise to a competitive advantage. For example, SouthWest Airlines achieved a competitive advantage in the market by locking in long-term contract with fuel suppliers before the price of fuel spiked. For years, US Steel Corp has exclusive supply contracts for many commercial builders (purchasers of steel).
Examples of Competitive Advantage
Examples of factors producing a competitive advantage include:
Intellectual Property or Other Strategic Assets
- Strategic assets can provide a temporary or long-term advantage over competitors. Notably, IP rights exclude others from imitating or copying a process or design. This can effectively block or hinder direct competition for the duration of the intellectual property rights.
First Mover Advantages
- First mover advantage is generally a limited competitive advantage. This position may allow you to acquire a larger percentage of the potential customer market at a rapid pace and at lower cost. Later competitors now face your business as a primary barrier to entering the market.
Business Size or Capitalization
- Business size allows for economies of scale in operations. Heavy capitalization provides the financial resources to undertake the operational and marketing tasks necessary to effectively compete with or beat other competitors. Further, it can give rise to marketing and pricing power.
- Brand recognition is a powerful temporary competitive advantage. Brand recognition reduces the future customer acquisition cost and provides operational opportunities within an established value chain. Brand recognition generally entails a level of customer loyalty that can serve as a barrier to entry for competitors.
- Geographic location can provide temporary or permanent operational advantages that effectively hinder or exclude competition. Think of a person owning land adjoining a waterway that has far more efficient ingress and egress that other options. Other times legal rights will establish a geographic advantage through contractual arrangement. A good example is the anti-encroachment rights included in many franchise agreement. This grants an exclusive right to carry on the franchise business in a given area.
- A business may have a superior operational structure that provides a temporary advantage. These operational efficiencies can arise through supply-chain agreements or long-term contracts for low-price material cost. A great example of massive success through supply-chain efficiency is Wal-Mart.
Management or Personnel
- Often individuals can be a key resource that provides a long-term or short-term competitive advantage. These individuals through intelligence, ingenuity, or other ability provide immense value to the business that is capable of duplication by competitors.
- The law may provide a barrier to entry to competitors that provides a temporary competitive advantage. Think of highly regulated industries, such as finance, medicine, and law. The regulatory hurdles in place to carrying on these types of business may make market entry difficult (prohibitively costly or complicated) for new competitors.
- Sometimes who you know means everything. Establishing close or exclusive relationships with suppliers or service providers can effectively provide a temporary or long-term competitive advantage.
The important thing to note about competitive advantages is that they are rarely sustainable. That is most competitive advantages provide only a temporary benefit over other competitors. In any event, the effect of the above attributes or resources is to effect the power struggle between the forces identified by Porter. Some of these attributes or resources are sustainable and others are not.
Strategic Management and Competitive Advantage
Strategic management is largely concerned with competitive advantage. That is, the strategic manager will plan and implement a strategy that seeks to establish, maintain, or grow the business's competitive advantage. The objective or intended result of those decisions are to exceed the profits or incur less loses than competitors.
Sustained Competitive Advantage and Strategy
Markets are, by nature, competitive. Sustained competition tends to erode any advantage that one market participant has over others. This may happen because competitors copy the advantaged competitor, or the competitors create their own unique competitive advantage that outpaces others. So, competitive advantage is generally limited in time. Managers seek to maintain, establish new, and increase competitive advantage through strategic planning. This requires the manager to constantly assess the company, the value proposition, the market, the competitors, and the customer. The manager must develop new objectives, value propositions, and methods.
Academic Research on Competitive Advantage
- Gaining and sustaining competitive advantage, Barney, J. B. (1997). This study examines different ways through which companies can gain competitive advantage against other countries. It suggests cutting down on production costs without compromising on the quality of goods/services. The study looks at different global companies and how they have been able to achieve competitive advantage.
- Asset stock accumulation and sustainability of competitive advantage, Dierickx, I., & Cool, K. (1989). Management science, 35(12), 1504-1511. This paper looks at the way companies acquire assets and how it is related to competitive advantage. It suggests that, companies that are able to accumulate stock and assets are better placed at having a competitive advantage over other companies.
- The cornerstones of competitive advantage: a resourcebased view, Peteraf, M. A. (1993). Strategic management journal, 14(3), 179-191. This paper looks at the factors involved in gaining and maintaining competitive advantage. It looks at the resources of a firm and its performance as the key pillars in gaining competitive advantage. Some of the factors it notes include superior resources, imperfect resource mobility, ex ante limits to competition and ex post limits to competition.
- The resource-based theory of competitive advantage: implications for strategy formulation, Grant, R. M. (1991). California management review, 33(3), 114-135. This paper reviews the theory that competitive advantage is linked to the resources of a company. It looks at other factors involved in gaining and sustaining competitive advantage including skills and strategies that a company puts in place to prosper. It analyzes Michael Porters analysis of company structure and how so many factors come into play before a company gains competitive advantage.
- Firm resources and sustained competitive advantage, Barney, J. (1991). Journal of management, 17(1), 99-120. This paper examines the sources of sustained competitive advantage. It supposes that, though strategic resources are attributed to the competitive advantage of a firm, there are other attributes of resources that are important in sustaining competitive advantage including rareness, imitability, value and sustainability.
- The link between competitive advantage and corporate social responsibility, Porter, M. E., & Kramer, M. R. (2006). Harvard business review, 84(12), 78-92. This paper analyzes the link between competitive advantage and corporate social responsibility. In every country, the paper observes, social responsibility by corporates is used to create competitive advantage. First, most businesses build their products for the society and second, businesses think of social responsibility in general instead of focusing on individual problems and strategies. The move towards social responsibility is brought by the pressure the government, the media and activists are placing on businesses.
- How information gives you competitive advantage, Porter, M. E., & Millar, V. E. (1985). This paper looks at the effects of new information technology on the competitive advantage of companies. It notes that information technology is shaping the nature of products, processes, companies and even industries. It shows that managers who used to treat information technology as a support system lack competitive advantage while those that took advantage IT are now enjoying competitive advantage for products or services.
- The relational view: Cooperative strategy and sources of interorganizational competitive advantage, Dyer, J. H., & Singh, H. (1998). Academy of management review, 23(4), 660-679. This paper looks at the use of critical resources in gaining competitive advantage. It shows that, for competitive advantage to last, effective governance, relation, specific assets, knowledge sharing routines and complementary resources and skills are needed. The paper reviews different studies that talk about competitive advantage for a deeper understanding of the topic.
- Organizational culture: can it be a source of sustained competitive advantage?, Barney, J. B. (1986). Academy of management review, 11(3), 656-665. This paper examines how the culture of a firm is related to its competitive advantage. If the culture of a firm has attributes that helps it generate quality and reduce cost, it is easy for such a firm to gain competitive advantage.
- Customer value: the next source for competitive advantage, Woodruff, R. B. (1997). Journal of the academy of marketing science, 25(2), 139. This paper looks at different ways of gaining competitive advantage. While conventional means look into the internal structure of a company, this paper suggests that understanding customers and offering them value will offer competitive advantage faster. The paper suggests customer value, educating customers on values and improved managerial skills as ways of building competitive advantage.
- Knowledge transfer: A basis for competitive advantage in firms, Argote, L., & Ingram, P. (2000). Organizational behavior and human decision processes, 82(1), 150-169. This paper shows that the creation and the transfer of knowledge are key players in gaining and sustaining competitive advantage. It shows that interactions between people and tools and the sharing of skills enables customers to create value and gain competitive advantage.
- From competitive advantage to corporate strategy, Porter, M. E. (1989). In Readings in strategic management (pp. 234-255). Palgrave, London. This author tries to show that for a company to perform well they must employ corporate strategy.