What sets a company apart, allowing it to consistently outperform its industry peers? What allows a business to maintain superior profitability, even in the face of intense competition and over extended periods? The answer lies in competitive advantage.
Competitive advantage is at the heart of a company’s ability to outpace its competition and generate above-average returns. It provides a firm the leverage required to benefit from innovation, perform at peak levels, and prosper amidst business cycles and economic fluctuations.
This article aims to simplify and explain the core principles of competitive advantage. It covers:
Mastering these fundamentals will equip executives with a strategic blueprint to supercharge their company’s performance. While the journey can be challenging, the rewards for companies that master the intricacies of strategy are substantial.
What Is Competitive Advantage?
Competitive advantage is a company’s ability to generate greater economic value than competitors. This advantage can be achieved by differentiating the company from its competitors, earning above-average returns, operating at lower costs, or a combination of these factors.
At its core, competitive advantage is about creating value. Companies generate value by transforming inputs into products and services that command a higher market price than the input costs. This value added is the source of superior profitability.
Competitive advantage enables a company to consistently earn returns above the industry average. The advantage may come from:
The key characteristics of competitive advantage include:
Sources of Competitive Advantage
Superior profitability is the result of two complementary factors: the attractiveness of the industry and a company’s relative position within that industry. The structure of the industry sets the baseline profit potential for all competitors. A company then builds its competitive advantage by designing a unique value chain that shifts buyer value or cost position in its favor.
Industry Structure and Attractiveness
Industry structure consists of the economic, technological, and competitive conditions that influence the “rules of the game” and the baseline profitability of an industry. It is shaped by five key forces - rivalry, barriers to entry, threat of substitutes, buyer power, and supplier power.
While companies have little control over industry structure, analyzing these dynamics provides insight into profit potential and the factors that impact value capture versus value creation.. Industries with weak forces and limited rivalry allow companies to retain more of the value they create.
However, an attractive industry alone does not guarantee profitability. Outperformance comes from establishing competitive advantage relative to rivals.
Tailored Value Chains and Activities
Competitive advantage emerges from the multitude of activities a company performs to design, produce, market, deliver, and support its products. . These activities include product development, manufacturing, marketing, service, logistics, and support functions.
The selection of activities and how they are performed determine the relative cost position and uniqueness. The value chain forms the link between competitive advantage and financial performance.
Strategic positioning involves shaping a tailored value chain to deliver the chosen value proposition. Successful companies reshape their value chains over time through trade-offs and fit to build sustainable advantage.
Operational Effectiveness vs. Strategy
All companies strive for operational effectiveness (OE), which involves performing similar activities better than rivals. However, Operational Effectiveness only provides a temporary advantage. True competitive advantage comes from performing different activities than competitors or performing similar activities in different ways.
Operational effectiveness improvements target individual activities. Strategy, on the other hand, interconnects the pieces. Tailoring activities in a way that competitors cannot replicate leads to sustainable advantage and superior profitability.
In summary, an attractive industry structure creates profit potential. Tailoring the value chain transforms that potential into a competitive advantage. Together, these provide the recipe for earning persistent returns above the industry average.
Analyzing Your Value Chain
A value chain reveals sources of uniqueness and cost position. Here are the key steps to conduct value chain analysis:
Value chain analysis highlights high-impact activities to focus improvement efforts. It provides the fact base to to reconfigure activities into a tailored system that can outperform competitors.
Differentiation or Low Cost Strategy?
Competitive advantage requires shifting uniqueness or cost position in a company’s favor.
Companies able to combine differentiation and low cost reap maximum advantage. A careful alignment of activities activates this dual benefit.
Common techniques to achieve both uniqueness and cost leadership include:
Sustaining Competitive Advantage
Competitive advantage should yield superior profitability over an extended period of time. Short-lived periods of higher profits are not enough. True strategy involves maintaining the competitive advantage in the face of imitation, volatility, and change.
Key factors that drive sustainable competitive advantage:
• Making strategic trade-offs to prevent prevent competitors from straddling positions or easily imitating a successful strategy.
• Tight fit between activities creating synergies and amplifying competitive advantage.
• Continuity of strategy allowing constant improvement
• Strategic innovation reinforcing differentiated positions
Innovating for Competitive Advantage
Innovation plays a key role in developing and maintaining a competitive advantage. The introduction of new technologies, processes, and ideas can enhance differentiation or reduce costs. However, the relationship between innovation and strategy is often misunderstood.
Not all innovation is strategic. Many innovations focus on improving operational effectiveness – doing activities better versus differently. These best practices diffuse rapidly and are adopted by rivals.
Strategic innovation is driven by industry foresight and reinforces uniqueness. It tailors innovation to extend strategically differentiated value chains making imitation difficult. Disruptive changes become opportunities.
Innovation must align with and enhance chosen positions and trade-offs. Creativity should funnel into reinforcing advantages embedded in a tailored value chain.
Case Example: Bang & Olufsen
Bang & Olufsen (B&O) is a high-end audio equipment and consumer electronics company renowned for outstanding engineering and cutting-edge design. However, by the early 2000s falling sales indicated B&O was losing its competitive advantage.
B&O used strategic innovation to resurrect its position. It leveraged advances in digital technology to create sleek, wall-mounted, multifunctional entertainment systems with touchscreen remotes. B&O opened flagship stores in premium locations providing personalized customer experiences unavailable from big-box retailers.
These innovations enhanced B&O’s differentiated position, while the company maintained its focus on advanced engineering that competitors struggled to replicate. Sales rebounded by aligning innovation with continuity of strategic position.
Avoiding Pitfalls and Mistakes
Developing competitive advantage is challenging and managers often make faulty assumptions:
Avoiding pitfalls involves committing to a unique value proposition, protecting trade-offs, and reinforcing fit between tailored activities over time. Patience is required for complex systemic advantages to emerge.
Avoiding pitfalls and maintaining strategic focus requires:
Gaining and maintaining competitive advantage is the essence of business strategy. While many factors make up a successful company, superior profitability vis-à-vis competitors is the definitive indicator of competitive advantage. This requires a commitment to being unique. Companies must resist the temptation of imitating rivals and engaging in zero-sum competition. By performing a tailored set of activities differently, companies can shift relative cost and differentiation in their favor.
Developing competitive advantage does not happen overnight. It emerges over years of making integrated choices, embedding advantage in a system of tailored activities reinforced with tight linkages. Continuity enables the time required to hone and elevate uniqueness and cost position.
At its core, competitive advantage grows out of insight into economic value creation and what is needed to capture that value. It flows from comprehending the sources of uniqueness and cost position in the value chain.
While simple in concept, successfully competing on uniqueness proves challenging. It requires creativity, discipline, and persistence to achieve. But for those able to master strategy’s principles, the rewards of competitive advantage fully justify the effort.
ABOUT THE AUTHOR(s)
Roland Tannous is managing partner and lead strategy and digital transformation consultant at GravityThink.