There is no one answer about what is competitive advantage or one way to measure it, and for the right reason. Nearly everything can be considered as competitive edge, e.g. higher profit margin, greater return on assets, valuable resource such as brand reputation or unique competence in producing jet engines. Every company must have at least one advantage to successfully compete in the market. If a company can’t identify one or just doesn’t possess it, competitors soon outperform it and force the business to leave the market.
There are many ways to achieve the advantage but only two basic types of it: cost or differentiation advantage. A company that is able to achieve superiority in cost or differentiation is able to offer consumers the products at lower costs or with higher degree of differentiation and most importantly, is able to compete with its rivals.
An organization that is capable of outperforming its competitors over a long period of time has sustainable competitive advantage.
The following diagram illustrates the basic competitive advantage model, which is explained below in the article:
How a company can achieve it?
An organization can achieve an edge over its competitors in the following two ways:
- Through external changes. When PEST factors change, many opportunities can appear that, if seized upon, could provide many benefits for an organization. A company can also gain an upper hand over its competitors when its capable to respond to external changes faster than other organizations.
- By developing them inside the company. A firm can achieve cost or differentiation advantage when it develops VRIO resources, unique competences or through innovative processes and products.
Changes in PEST factors. PEST stands for political, economic, socio-cultural and technological factors that affect firm’s external environment. When these factors change many opportunities arise that can be exploited by an organization to achieve superiority over its rivals. For example, new superior machinery, which is manufactured and sold only in South Korea, would result in lower production costs for Korean companies and they would gain cost advantage against competitors in a global environment. Changes in consumer demand, such as trend for eating more healthy food, can be used to gain at least temporary differentiation advantage if a company would opt to sell mainly healthy food products while competitors wouldn’t. For example, Subway and KFC.
If opportunities appear due to changes in external environment why not all companies are able to profit from that? It’s simple, companies have different resources, competences and capabilities and are differently affected by industry or macro environment changes.
Company’s ability to respond fast to changes. The advantage can also be gained when a company is the first one to exploit the external change. Otherwise, if a company is slow to respond to changes it may never benefit from the arising opportunities.
VRIO resources. A company that possesses VRIO (valuable, rare, hard to imitate and organized) resources has an edge over its competitors due to superiority of such resources. If one company has gained VRIO resource, no other company can acquire it (at least temporarily). The following resources have VRIO attributes:
- Intellectual property (patents, copyrights, trademarks)
- Brand equity
Unique competences. Competence is an ability to perform tasks successfully and is a cluster of related skills, knowledge, capabilities and processes. A company that has developed a competence in producing miniaturized electronics would get at least temporary advantage as other companies would find it very hard to replicate the processes, skills, knowledge and capabilities needed for that competence.
Innovative capabilities. Most often, a company gains superiority through innovation. Innovative products, processes or new business models provide strong competitive edge due to the first mover advantage. For example, Apple’s introduction of tablets or its business model combining mp3 device and iTunes online music store.
The main challenge for business strategy is to find a way of achieving a sustainable competitive advantage over the other competing products and firms in a market.
A competitive advantage is an advantage over competitors gained by offering consumers greater value, either by means of lower prices or by providing greater benefits and service that justifies higher prices.
Porter suggested four “generic” business strategies that could be adopted in order to gain competitive advantage. The strategies relate to the extent to which the scope of a business’ activities are narrow versus broad and the extent to which a business seeks to differentiate its products.
The strategies that Porter suggested are appropriate to seek competitive advantage are summarised in the figure below:
The differentiation and cost leadership strategies seek competitive advantage in a broad range of market or industry segments.
By contrast, the differentiation focus and cost focus strategies are adopted in a narrow market or industry.
With this strategy, the objective is to become the lowest-cost producer in the industry. The traditional method to achieve this objective is to produce on a large scale which enables the business to exploit economies of scale.
Why is cost leadership potentially so important? Many (perhaps all) market segments in the industry are supplied with the emphasis placed on minimising costs. If the achieved selling price can at least equal (or near) the average for the market, then the lowest-cost producer will (in theory) enjoy the best profits. This strategy is usually associated with large-scale businesses offering “standard” products with relatively little differentiation that are readily acceptable to the majority of customers. Occasionally, a low-cost leader will also discount its product to maximize sales, particularly if it has a significant cost advantage over the competition and, in doing so, it can further increase its market share.
A strategy of cost leadership requires close cooperation between all the functional areas of a business. To be the lowest-cost producer, a firm is likely to achieve or use several of the following:
- High levels of productivity
- High capacity utilisation
- Use of bargaining power to negotiate the lowest prices for production inputs
- Lean production methods (e.g. JIT)
- Effective use of technology in the production process
- Access to the most effective distribution channels
In the differentiation focus strategy, a business aims to differentiate within just one or a small number of target market segments. The special customer needs of the segment mean that there are opportunities to provide products that are clearly different from competitors who may be targeting a broader group of customers.
The important issue for any business adopting this strategy is to ensure that customers really do have different needs and wants – in other words that there is a valid basis for differentiation – and that existing competitor products are not meeting those needs and wants.
Differentiation focus is the classic niche marketing strategy. Many small businesses are able to establish themselves in a niche market segment using this strategy, achieving higher prices than un-differentiated products through specialist expertise or other ways to add value for customers.
There are many successful examples of differentiation focus. A good one is Tyrrells Crisps which focused on the smaller hand-fried, premium segment of the crisps industry.
With differentiation leadership, the business targets much larger markets and aims to achieve competitive advantage across the whole of an industry.
This strategy involves selecting one or more criteria used by buyers in a market – and then positioning the business uniquely to meet those criteria. This strategy is usually associated with charging a premium pricefor the product – often to reflect the higher production costs and extra value-added features provided for the consumer.
Differentiation is about charging a premium price that more than covers the additional production costs, and about giving customers clear reasons to prefer the product over other, less differentiated products.
There are several ways in which this can be achieved, though it is not easy and it requires substantial and sustained marketing investment. The methods include:
- Superior product quality (features, benefits, durability, reliability)
- Branding (strong customer recognition & desire; brand loyalty)
- Industry-wide distribution across all major channels (i.e. the product or brand is an essential item to be stocked by retailers)
- Consistent promotional support – often dominated by advertising, sponsorship etc
Great examples of a differentiation leadership include global brands like Nike and Mercedes. These brands achieve significant economies of scale, but they do not rely on a cost leadership strategy to compete. Their business and brands are built on persuading customers to become brand loyal and paying a premium for their products.