Competitive Advantage
“Slow and steady” does not always win the race in business. Companies operate in fast-paced, competitive markets where customer preferences, technology, prices, and competitors can change quickly. To succeed, businesses need a clear strategy for reaching their goals and creating value.
A strategy is a plan or approach for reaching a goal. A business strategy explains how a company uses its capabilities and resources in a competitive market to achieve goals such as growth, profitability, or competitive advantage. A company’s core values, or what it stands for, and its core competencies, or what it does best, can help leaders decide whether to compete through cost, differentiation, or focus. For more about business planning and SWOT analysis, see How to Plan for Business Success (201).
What is competitive advantage?
Competitive advantage is the ability of a business to outperform its rivals in the same market. A strong competitive advantage can help a business attract more customers, increase its market share, and potentially earn higher profits. Businesses can seek competitive advantage through lower costs, differentiation, or by focusing on a specific market or customer group. How competitive the market is can influence which strategy a business uses to gain an advantage.
Price Cutting
A low-cost strategy means finding ways to operate efficiently enough to offer lower prices while remaining profitable. From the perspective of the entire organization, companies have a competitive advantage when they can get their operations and production lines more efficient, and so it costs them less to produce whatever they’re selling. If it costs one company A $3 to produce a product, but it costs company B $5 to make the same product, company A will have a big competitive advantage in a price war.
This type of competition is especially common in commodity markets, such as agricultural goods, where products may be very similar. In these markets, businesses often compete by producing efficiently and offering the lowest sustainable price.
For more about how operations and supply chains support a low-cost advantage, see Operations, Supply Chains, and Competitive Advantage.
Product Differentiation
If a company does not want to compete mainly on price, it can seek an advantage by making its product or service more valuable to customers than competing alternatives. This is called product differentiation. In markets with differentiated products, businesses can compete through higher quality, unique features, better customer service, lower prices, stronger branding, or more effective marketing. For example, a company might introduce features its competitors do not offer, build a reputation for excellent customer service, or use marketing to show customers why its product provides greater value.
For more about how operations and supply chains can support quality and differentiation, see Operations, Supply Chains, and Competitive Advantage.
Core competencies
A company’s core competencies are the capabilities, skills, knowledge, and expertise it performs especially well and that can help it outperform competitors. Core competencies can include innovation, customer service, communication, ethical behavior, technological expertise, and efficiency. For companies such as Google and Apple, core competencies include technology, research and development, brand reputation, and differentiated products.
Google is known for its fast and efficient search engine, and Apple keeps renovating its products so that customers keep coming back. Microsoft became the world’s largest software company through its ability to be flexible and adapt to changing technologies and customer wants. Facebook was able to create its own niche in social media and gain a massive user base. Walmart got the edge over others in the retail industry by providing low priced goods and services whereas IKEA went a step ahead by not just providing cheap furniture but excellent customer service.
Companies need to be able to focus on their core competencies. Walmart would have a hard time launching a new high-end limited line of fashion, for example, because they’re not known as a luxury brand. Their brand reputation specializes in cost cutting and wide distribution, which are not seen as valuable to the fashion industry.
Barriers to Entry
A barrier to entry is an obstacle that makes it difficult or expensive for new competitors to enter a market. Examples include patents and intellectual property, government regulations, control over important suppliers, high startup costs, and economies of scale that allow large companies to maintain very low prices.
Businesses may deliberately build or strengthen barriers to entry to protect their market position. For example, a company might patent an invention, build strong brand loyalty, or enter exclusive agreements with suppliers or distributors.
For more about how exclusive supplier and distributor agreements can create competitive advantage, see Operations, Supply Chains, and Competitive Advantage.
Analyzing competitive advantage
These are just a few of the tools analysts use to look at the competitive advantage held by certain companies.
VRIO Framework
Competitive advantage comes from superior performance which comes from a company having the right combination of resources. Resources can be both tangible and intangible. Tangible resources are physical things like land and machinery, whereas intangible resources are more abstract like intellectual property and goodwill. Companies can determine if it has the right combination of resources to be at a competitive advantage by using the VRIO framework.
This framework determines if the firm’s resources, capabilities, or competencies are valuable (V), rare (R) and costly to imitate (I), and if the firm is organized to capture value (O). If the company says yes to all four, then it has a competitive advantage. If it satisfies just one or no conditions, then it is at a competitive disadvantage, which means that it is worse off than its rivals. If it satisfies the first two conditions, then it is at competitive parity, which indicates that it is at par with its rivals. Checking three of the four factors, puts the business in a temporary competitive advantage, so they need to work on checking the 4th item before one of their competitors catch up.
Porter’s Five Forces
Porter’s Five Forces is a framework businesses can use to assess the level of competition in an industry and how attractive or potentially profitable that industry may be.
Rivalry Among Existing Firms
This force looks at how intensely existing businesses compete with one another. Rivalry tends to be stronger when there are many similar competitors, industry growth is slow, or customers can easily switch companies. Rivalry may be weaker when products are highly differentiated or customer loyalty is strong.
Threat of New Entrants
This force considers how easily new competitors can enter the market. The threat is stronger when startup costs and barriers to entry are low. It is weaker when patents, regulations, high startup costs, strong brand loyalty, or economies of scale make entry difficult.
Threat of Substitutes
A substitute is a different product or service that satisfies the same customer need. The threat of substitutes is stronger when customers have many affordable alternatives and can easily switch between them. It is weaker when few practical alternatives exist or switching is difficult.
Buyer Power
Buyer power refers to the influence customers have over businesses. Buyer power tends to be stronger when a business depends on a small number of major customers, competing products are similar, or switching costs are low. It tends to be weaker when businesses have many customers, products are strongly differentiated, or switching costs are high.
Supplier Power
Supplier power refers to the influence suppliers have over businesses. Supplier power tends to be stronger when only a few suppliers provide an important product or resource and there are few alternatives. It tends to be weaker when businesses can choose from many suppliers or easily switch to alternatives.
In general, stronger competitive forces make an industry less attractive and can reduce profitability, while weaker forces can make an industry more attractive and potentially more profitable.
Why Financial Ratios Matter
Managers and investors need ways to compare a company’s performance with its competitors and determine whether its strategy is working. Financial ratios provide useful measures for comparing areas such as profitability, liquidity, efficiency, and debt across businesses and industries.
For a more detailed look at financial ratios and evaluating business performance, see How To Check a Business’s Financial Health.
Technology and Competitive Advantage
Businesses can use current industry technologies to streamline specific tasks, improve productivity, and operate more efficiently, which can create a direct competitive advantage. Technology can also support differentiation by helping businesses provide better products or services.
However, businesses should assess the practical value of emerging technologies before adopting them. New technology should improve efficiency or strengthen differentiation rather than result in unnecessary spending.
Personal Finance Trends and Demand
Changes in how consumers save, borrow, and pay can affect what they expect from businesses. Current trends such as digital payments, buy-now-pay-later services, and mobile wallets have increased demand for convenient and flexible financial options.
Businesses can analyze these shifts to anticipate how customer demand may change. For example, consumers may increasingly expect payment options to be integrated directly into the apps and websites they use. A business that anticipates this trend could adapt its products, pricing, or services before its competitors do.
Open-Ended Challenge
Choose a business and develop a simple plan for how it could achieve a competitive advantage in its market. Would you recommend a cost, differentiation, or focus strategy? Identify one barrier to entry or one of Porter’s Five Forces that matters most to your plan and explain why.