What Is Competitive Advantage? 3 Strategies That Work

Michael Porter speaking at a technology conference
Harvard Business School professor Michael Porter, who literally wrote the book on competitive advantage. Photo: Ross Setford/Getty Images

Definition: A competitive advantage is what makes you better than the competition in your customers' minds. Businesses were the first to adopt this method of success. But it is true for anyone, from an employee to a country.  Before determining your competitive advantage, you've got to know these three determinants.

  1. What you produce. Whether it's a good or service, you must be clear on what you are providing. It must be something that offers real value. That means you need to describe the advantages and benefits of your product or service. You've must be aware of trends that affect your product, especially new technology. For example, the Internet forced newspapers to redefine how they delivered the news.
  1. Target market. Who are your customers? You've got to know exactly who buys from you, and how you can make them happier. That increases demand, the driver of all economic growth. Newspapers found out their target market drifted to older people. That's because they weren't comfortable getting their news online.
  2. Competition. That's not just other similar companies or products. It includes anything else your customer does to meet that particular need. Newspapers thought their competition was other newspapers until they realized it was the Internet. How could they compete with a news provider that was instant and free?

Get clear on these determinants. They tell you the benefit you provide to your target market that's better than the competition. That's your competitive advantage.

You must reinforce that message in every communication to your customers. That includes advertising, public relations, and even your storefront and employees.

If you are the employee, treat yourself as if you were in business for yourself -- because you are. Communicate your competitive advantage in your appearance, your resume, and your interview.

Sustainable Competitive Advantage

Just because a company is the market leader now, doesn't mean it has a sustainable competitive advantage.

A temporary price cut to gain market share might work in the short-term. But that lead will disappear when it restores those prices to a profitable level. A company must create clear goals, strategies, and operations to sustain its competitive advantage. The corporate culture and values of the employees must be in alignment with those goals, as well. It's difficult to do all those things well. That's why few companies can create a sustainable competitive advantage.

Michael Porter: The Guru of Competitive Advantage

In 1985, Harvard Business School professor Michael Porter wrote Competitive Advantage. It is the definitive business school textbook on the topic. He outlined the three primary ways companies achieve a sustainable advantage. They are cost leadership, differentiation, and focus. Porter developed these strategies by researching companies, but anyone can use them. 

Cost leadership means you provide reasonable value at a lower price. Companies do this by continuously improving operational efficiency.

That means usually pay their workers less. Some compensate by offering intangible benefits such as stock options, benefits, or promotional opportunities. Others take advantage of unskilled labor surpluses. As these businesses grow, they can use economies of scale and buy in bulk. Walmart and Costco are good examples of this. But sometimes they pay less than the cost of living. Higher minimum wage laws threaten this advantage.

Differentiation means you deliver benefits better than anyone else. A company can achieve differentiation by providing a unique or high-quality product. Another method is to deliver it faster. A third is to market in a way that reaches customers better. A company with a differentiation strategy can charge a premium price. That means it usually has a higher profit margin.

Companies typically achieve differentiation with innovation, quality, or customer service. Innovation means you meet the same needs in a new way. An excellent example of this is Apple. The iPod is innovative because it allows you to play whatever music you want, in any order. Quality means you provide the best product or service, and so might be higher priced. Tiffany's can charge more because patrons see it as the best. Customer service means going out of the way to delight shoppers. Nordstrom is an example of this.

Focus means you understand and service your target market better than anyone else. You can use either a cost leadership or differentiation strategy. The key is to focus it on one specific target market. Often it's a tiny niche that larger companies don't serve. For example, community banks use a focus strategy to gain sustainable competitive advantage. They target local small businesses or high net worth individuals. Their target audience enjoys the personal touch that big banks may not be able to give. They are willing to pay a little more in fees for this service. These banks are using a differentiation form of the focus strategy.

How Countries Use Competitive Advantage

A country can also create competitive advantage. That's called national competitive advantage, or comparative advantage. For example, China uses cost leadership. It exports low-cost products at a reasonable quality level. It can do this because its standard of living is lower, so it can pay its workers less. It also fixes the value of its currency, the yuan, at a lower value than the dollar.

India started as a cost leader but is moving toward differentiation. It provides skilled technical, English-speaking workers at a reasonable wage. Japan changed its competitive advantage. In the 1960s, it excelled at cheap electronics. By the 1980s, it had shifted up to quality brands, such as Sony.

America's comparative advantage is innovation. U.S. companies bring innovative products to market faster than other countries. A great example is Silicon Valley, America's innovative advantage.

The reason for that is America's vast and affluent domestic consumer base. It's easy to test new product ideas and work out the bugs at home. They are marketed throughout the world once they are successful. Amar Bhidé makes a good point in The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World. Even if the United States starts to lag behind other countries in producing engineers, it's still better at bringing those innovations to market. For more, see How Natural Resources Boost America's Advantage

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