Definition:
Most strategies are intended to maximize the value created for the stakeholders. This is most often done by maximizing the profits of the company. There are 2 primary generic strategies that maximize profits: Low-Cost provider and Differentiated provider
- What it is: Competitive Advantage is most often measured as the amount of profit that a competitor makes compared to the average competitor in the industry. To create more profits than the average a competitor must have lower costs while charging the average price or to have a higher price while maintaining average costs. By comparing the ratio of price to costs for each competitor, we can see that the most advantaged competitor is the one that has the highest ratio of price to cost and therefore the highest average profit.
- What does it do: Competitive advantage allows a competitor to make superior profits while competing in the industry. With competitive advantage, a competitor can continue to be profitable even if the industry they compete in is unprofitable on average. The goal is to make your competitive advantage sustainable as your competitors will constantly be trying to mimic your advantage to raise their profits.
Uses:
- How is it used: Competitive advantage is used to increase profits for the company or the company can use the competitive advantage to increase market share.
- Where: In most industries, there are competitors that have a competitive advantage. They have used that advantage to achieve the highest market share and therefore are the largest competitor. Or they have used their advantage to consistently have a higher average profit compared to the other competitors in the industry.
- Why: Competitive advantage will increase stock price, company profits, and assure jobs in the company. For all of these reasons, almost everyone wants to work for or invest in a competitively advantaged company.
Limitations:
- Where it shouldn't be used: Gaining a competitive advantage can be valuable but also hard to sustain over time. If you are in a commodity market (customers will not pay for differentiation) or an industry where technology or scale does not reduce average cost, it can be very difficult to sustain a competitive advantage. If you try and grow your market share or raise your price by adding "More Cheese to your Pizza", your competitors can quickly react by adding more cheese to their pizzas, therefore eliminating your advantage. Now you have the expense of paying for additional cheese on the pizza and you did not grow market share or succeed in raising your price because your competitors immediately matched you. Now everyone has to pay more to make their pizzas and get no more volume or price. Therefore the average profitability in the industry will fall for everyone. Therefore the attempt to increase competitive advantage hurt and did not help.
- Any restrictions: It is extremely difficult to have both lower costs than your competitors and a higher price. There are some examples (like those found in the book Blue Ocean Strategy) where companies have succeeded in lowering cost and raising prices, but it is a rare exception. So in most cases, it is best to focus on one or the other.
- Warnings: Competitive advantage is often fleeting. Creating a sustainable competitive advantage that is not copied by your competitors is difficult to achieve. But finding a competitive advantage that you can sustain over time is a very profitable goal.
Step-by-step process:
- Gathering data: Gather data about your competitors to determine your profitability compared to the industry average
- Identify the market share of each competitor and the price they charge for their products
- Estimate the costs associated with each competitor
- Try and identify the source of any advanatge that causes the price or cost to vary from the other competitors
- Analysis of data: Calculate the industry average profit and the profit for each competitor
- Valuable—it is of value to consumers.
- Rare—it is not commonplace or easily obtained.
- Inimitable—it cannot be easily imitated or copied by competitors.
- Non-substitutable—consumers cannot or will not substitute another product or attribute for the one providing the firm with a competitive advantage.
- Calculate industry average price and cost by multiplying each competitor's price or cost times their market share and then adding all of the market share adjusted prices or costs up. Since the market share of all competitors is 100%, the market share adjusted price each competitor will add up to the average for the industry. This will correct for one large competitor having a much different price from the other competitors.
- Are the advantages that a competitor has sustainable. Sustainability is often measured by the following factors:
- Interpretation of results: The largest competitive advantage will be the company whose profit is the highest compared to the industry average. The largest disadvantaged competitor is the one that has the largest negative differential compared to the industry average profit. Try and identify the sources of advantage and disadvantage for each competitor. Look for things like:
- Intellectual property (patents, copyrights, trademarks)
- Brand equity
- Culture
- Know-how
- Reputation
- Manufacturing or research scale
- Unique Competencies
- Presentation of results: A table will show the numeric differences in profitability, but a PowerPoint will be required to explain the source of differences in competitive position and advantage.
Competitive Advanatge Template.xlsx
