“If you don’t have a competitive advantage, don’t compete.” - Jack Welch
A company has a competitive advantage when its profit rate is higher than the average for its industry, and it has a sustained competitive advantage when it is able to maintain this high profit rate over a number of years. Maintaining a competitive advantage requires a company to continue focusing on the four generic building blocks of competitive advantage – efficiency, quality, innovation, and customer responsiveness – and to do whatever is necessary to develop distinctive competencies that contribute toward superior performance in these areas.
“Competitive advantage is at the heart of a firm’s performance in competitive markets. After several decades of vigorous expansion and prosperity, however, many firms lost sight of competitive advantage in their scramble for growth and pursuit of diversification. Today the importance of competitive advantage could hardly be greater. Firms throughout the world face slower growth as well as domestic and global competitors that are no longer acting as if the expanding pie were big enough for all.” – Michael porter, 1985
Low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry. Competitive advantage (and higher profits) goes to those companies that can create superior value—and the way to create superior value is to drive down the cost structure of the business and/or differentiate the product in some way so that consumers value it more and are prepared to pay a premium price.
Competitive advantage, in order to be valuable, needs to be long-lasting. From an economic point of view, a competitive advantage is similar to a monopoly that the company creates for itself and which gives the company a profit advantage (an economic rent). This happens only if this monopoly is not immediately destroyed before imitation.
Conditions for Sustainable Competitive Advantage
The sustainability of competitive advantage depends on three conditions.
- The first is the particular source of the advantage. There is a hierarchy of sources of competitive advantage in terms of sustainability. Lower-order advantages, such as low labor costs or cheap raw materials are relatively easy to imitate. Higher-order advantages, such as proprietary process technology, product differentiation, brand reputation and customer relationships are more durable. Higher-order advantages involve more advanced skills and capabilities such as specialized and highly trained personnel, internal technical capability and often close relationships with leading customers. Such advantages also demand sustained and cumulative investment in physical facilities and specialized intangible assets.
- The second determinant of sustainability is the number of distinct sources of advantage a firm possesses. If there is only one advantage, competitors can more easily nullify this advantage. Firms which sustain leadership over time, tend to proliferate advantages throughout the value chain.
- The third, and most important basis for sustainability is constant improvement and upgrading. A firm must keep creating new advantages at least as fast as competitors can replicate old ones. The firm must improve relentlessly its performance against its existing advantages. This makes it more difficult for competitors to nullify them.
Developing a Sustainable Competitive Advantage
In today’s dynamic and fast-paced environments, the only way that a company can maintain a competitive advantage over time is to continually improve its efficiency, quality, innovation, and customer responsiveness. The most successful firms are those that continually learn, seeking out ways of improving their operations and constantly upgrading the value of their distinctive competencies or creating new competencies.
One can generally distinguish three ways of achieving a sustainable Competitive Advantage.
- Customer loyalty
- Positive feedback’s
- Pre-emption of capabilities.
Customer Loyalty creates sustainability when customers keep coming back to a company by choice, because the product or service provided to them is unique or more valuable than competition. It can also be due to a brand that has imprinted an association of uniqueness to the product or service in the mind of the customer. It can also be due to high switching costs that customers would incur if they changed products or services: in that case the customer is locked-in. An example of uniqueness or superior value is provided by Schlumberger, which commands nearly 70 per cent of the world market for logging, a highly specialized service of control for oil exploration. Coca Cola or Louis Vuitton are among the most characteristic examples of sustainable competitive advantages coming from a strong brand. A high switching costs example is given by Microsoft, whose operating system is so dominant that a customer wishing to shift to a competitive system like Linux or Apple would have tremendous application software adaptation costs.
Positive Feedback’s are advantages that follow the logic of ‘success brings success’ and produce increasing returns. There are two kinds of positive feedback: ‘network externalises’ and ‘experience effects’. Network externalises exist when the customer base of a product or service is such that it induces other products or services providers to adopt it in their own value proposition. In turn, the fact that other products or services use the original product increases the value for new customers to buy the original product or service. This virtuous circle creates a positive loop that reinforces the company’s competitive position. The classic example of network externalities has been provided by the battle of standards between VHS and Betamax. Because JVC, the inventor of VHS, opened its licence to many consumer electronic manufacturers, it made VHS more readily available. This, in turn, induced video producers and distributors to put more movies on the VHS standard, inducing more consumers to buy VHS machines, given the large number of VHS movies available. Microsoft DOS and Windows or Microsoft Office followed the same path: more software available with Windows or more users of Microsoft Office attracts more customers to buy Windows personal computers and to become users of Microsoft Office which in turn induces more Windows-based software, thereby attracting more customers. Betamax cassettes disappeared, Macintosh computers were pushed into a small market niche and Lotus 123 or WordPerfect nearly collapsed. In the end, network externalities create a situation in which the `winner takes it all’, meaning that the company which has developed a competitive advantage based on network externalities has reached a quasi-monopolistic situation.
Pre-Emption Of Capabilities is a type of competitive advantage based on the appropriation by one company of key resources or assets that competitors will find difficult to access, or to the development of competencies that are `time incompressible’. Appropriation of resources or assets applies to the privileged access to natural resources such as location or mining concessions. It may apply to access to skills and talents when they are in limited supply, as is the case in many emerging markets such as the Internet-related sectors. It may apply to the right to do business, such as the obtaining of licenses, as in telecommunications, or landing rights in air transport. Patenting is a form of preemption since it gives the patent holder a period during which it has the proprietary right to exploit the patent. It applies to distribution networks, partnerships or access to favorable locations, as in the retail or hospitality industries. Time incompressibility is a competitive advantage based on competencies, which are time-consuming to imitate. For instance, Toyota obtained a sustainable advantage by developing the `kanban’ and the `just-in-time’ processes. Those processes have been built up over time, through trial and error. When Western automobile manufacturers discovered the power of such processes in the 1980s they also discovered that they were not so easy to imitate given the complexity of the social relationships involved. They had to take the time to go through the same type of trial and error that Toyota had experienced in the first place.
The national context of a country influences the competitiveness of companies based within that nation. Despite the globalization of production and markets, many of the most successful companies in certain industries are still clustered in a small number of countries. Individual companies need to understand the link between national context and competitive advantage in order to identify where their most significant competitors are likely to come from and to identify where they might want to locate certain productive activities. More and more, to achieve a competitive advantage and maximize performance, a company has to expand its operations outside the home country. Global strategy addresses how to expand operations outside the home country. Read More: Competitive Advantage of Internationalization Strategies.