Understanding the essential principles of competitive advantage is important for creating an effective business strategy, investing successfully, and understanding the economy on a national and global scale. Though competitive advantage is a basic economic concept, it is also one of the most important.
What Is Competitive Advantage?
Competitive advantage is a set of qualities that give businesses leverage over their competition. It allows businesses to offer their target market a product or service with higher value than industry competitors. In the long term, this boosts the business' position in their industry and drives a greater number of sales than competitors.
Competitive advantage can come in a variety of forms, ranging from expert branding to intelligently designed distribution networks. Often there are multiple factors that combine to create competitive advantage, such as:
- Product quality
- Strategic pricing
- Customer service
- Market positioning
- Distribution networks
- Innovation and access to new technologies
A variety of these elements can come together to make your product or service more desirable to your target market.
It is also important that the factors lending a business competitive advantage are sustainable. The more dependable a business' competitive advantage, the more likely it is that a business can maintain their profit levels and keep competitors from overtaking them.
How to Create Competitive Advantage
Creating competitive advantage is the goal of any successful business. If your business can create and maintain competitive advantage, then you can position yourself as a market leader. This ultimately results in making more sales and potentially higher profit margins.
Luckily, there is a known strategy for creating competitive advantage within a business. It was originally developed by Michael Porter, a professor at the Harvard Business School. Here are the methods Porter outlined for cultivating competitive advantage:
In order to stand apart from your competition, your business' product or service must provide unparalleled value to your target audience. To do this well, you should have a deep understanding of your ideal customer. You must identify what they want or need and how your offerings can make their lives better. Many businesses accomplish this by doing the following:
- Offering a higher quality product or service
- Creating distinctive branding
- Investing in intelligent marketing strategies
The differentiation strategy is difficult to execute, as the elements that make a product or service with value is dynamic and ever-changing. A business must stay ahead of industry trends and constantly adapt their offerings to suit a dynamic market. This is the only way businesses can consistently differentiate themselves from the competition and remain relevant to consumers.
Another strategy for gaining competitive advantage is by focusing on cost leadership. This strategy leans on the idea of providing the best value to the customer at the lowest cost. Many businesses accomplish this by doing the following:
- Increasing operational efficiency
- Finding more effective distribution channels
- Bargaining low prices for materials needed to create their product or service
Generally speaking, businesses that are the first in their industry to successfully strike the balance between providing high value at the lowest cost increase their market share quickly, only driving down the cost of their product or service even further. The first company to employ this strategy can generally gain competitive advantage more easily.
The focus advantage approach to gaining competitive advantage relies on narrowing down a business' target audience at the exclusion of other industry segments. Tailoring a product or service to suit a specific market's needs allows businesses to easily offer the highest value. The focus advantage is typically executed by applying either the cost or differentiation strategy to a thoughtfully selected target market.
The challenge of utilizing the focus advantage strategy lies in selecting the correct target market. The ideal market segment of focus should have abnormal needs that are not being met. While it is possible to identify these markets and offer them finely tailored solutions, it is difficult to provide value at equal or lower cost than industry alternatives.
Competitive Advantage Examples
To better understand how your business can gain competitive advantage, it is important to understand the strategies that other businesses have employed to achieve this. Here are some examples of how today's leading companies have come out far ahead of their competitors. All of the companies listed below not only have competitive advantage in their industry but also have sustained it for an extended period of time.
Tesla's Competitive Advantage
Tesla (TSLA) - Get Tesla Inc. Report is an interesting study in competitive advantage, as they are at once a luxury car and technology company. In some sense, they currently have no direct competitors. However, Tesla has positioned itself so well that when direct competitors do arise, the company will easily be able to maintain its competitive advantage.
Tesla invests the bulk of their resources into research and development. They are constantly looking into the future of personal transportation. They are continually trying to find new solutions for the inevitable fall of oil as the world's primary source of energy, as well as priming their products for the rise of automation. Their high-eco-friendly brand also differentiates them from similar companies, and likely will for the foreseeable future.
Tesla also currently leverages a focused strategy by tailoring their offerings to the needs of a luxury market. However, this will not always be the case. Their product development efforts are firmly aimed at providing personal transportation on a global scale -- including the release of more affordable products like the Model 3. This will only make Tesla's advantageous market position more defensible when more direct competitors arise.
Apple Competitive Advantage
Differentiation advantage is hugely essential to Apple's (AAPL) - Get Apple Inc. Report competitive advantage. They have a strong brand and intuitive design that sets them apart from other technology companies, giving them a large following of brand loyalists. Apple has long made a distinct impression on consumers and competitors alike with its innovative design choices. In fact, most of their competitors are now releasing products that are virtually identical to Apple designs.
Similar to Tesla, Apple has a high volume of capital to invest into research and developing new products. While they do not release products at the same volume of some of their competitors, the products they create are carefully designed to provide the best value and consumer experience. This effective use of the differentiation strategy has allowed them to sell their products at a higher price point than their competitors without sacrificing market share or gross margins.
Competitive Advantage vs. Comparative Advantage
When considering competitive advantage, it's important to understand comparative advantage as well. The two concepts heavily influence one another, but they are not one in the same.
Comparative advantage is when a business can produce goods or provide services at a lower opportunity cost than their competition. Having a lower opportunity cost means having to give up less when making a choice between two things. For example, imagine there are two clothing manufacturers that compete against one another; one business is situated in the U.S. and the other is in Bangladesh. A clothing manufacturer in Bangladesh has easy access to a cheap labor force and has lower energy costs overall, meaning that they have the ability to produce clothing at a much lower opportunity cost than the business in the U.S. In this case, the Bangladesh-based business holds comparative advantage over the business situated in the U.S. Generally speaking, comparative advantage tends to be static and does not need to be maintained. This is especially the case when a business' opportunity costs are largely determined by access to a certain kind of labor force or natural resources.
In contrast, competitive advantage is a dynamic concept. Unlike comparative advantage, which is determined by largely unchangeable factors, competitive advantage can be created. It is a more dynamic, strategic concept. By following the steps above, your business can attain the desirable qualities that will make your product or service the choice selection for your target market. While this provides a great deal of opportunity for businesses, it can also be a challenge to maintain competitive advantage over time.
Which One Is Better?
Having comparative advantage can be one element that contributes to a company's competitive advantage. However, holding comparative advantage doesn't always guarantee competitive advantage. Goods or services may be provided at a low opportunity cost, but may not be positioned properly within their market or may not have the quality that the market demands.
Neither kind of advantage is better than the other. In fact, a business that has both comparative advantage and competitive advantage is much more likely to be successful.
Global Competitive Advantage
Today, we live in a globalized economy. Businesses shouldn't just strive to have the most market share locally or even nationally, but should instead consider their position on a global scale.
There are more opportunities than ever before for businesses to internationalize and increase their market share on a global scale. Geographical barriers to international trade have been weakened thanks to the development of new technologies that have improved our ability to communicate, share information, and transport goods faster and more efficiently.
All of these factors have provided the opportunity for some companies to gain competitive advantage against their competition worldwide. How did they accomplish this? Discover three primary strategies that businesses use to successfully gain global competitive advantage.
Understanding International Markets
It is important to identify which markets would be best suited for marketing, selling, distributing, and manufacturing your product or service. Businesses can accomplish this by talking to their customers about what international competitors they utilize, asking partners about their experiences, and researching what international markets of interests have to offer. Measure your opportunity cost to effectively identify foreign market opportunities.
Cultivating International Networks
If you want to begin offering your products or services on an international scale, you will not be able to do it alone. It is crucial to find a team that can support your efforts to gain global competitive advantage. Often this will include partners in international markets of interest, including distributors, manufacturers, lawyers, government agencies, and more. One of the best ways to build cultivate your international network is to work with your current partners. Many of them already have international partners or clients working internationally that they can recommend.
Creating a Culture of Innovation
Creating a culture of innovation is important for gaining any kind of competitive advantage, particularly when utilizing a differentiation strategy. However, building an inventive culture within your business is even more essential when trying to gain global competitive advantage. More businesses than ever before are expanding into international markets, making competition more intensive. Distinguishing and communicating the value of your company's offerings against ever-riding international competitors is essential for gaining global competitive advantage and increased market share.