When talking about business, competitive advantage refers to the factors or attributes that allow a given company to produce more affordable or higher quality services or products than its competitors.
Learn more about competitive advantage, what it means, and why business owners should aim to identify what sets them apart from their opponents.
What Is Competitive Advantage?
A competitive advantage is what makes an entity's goods or services superior to all of a customer's other choices. While the term is commonly used for businesses, the strategies work for any organization, country, or individual in a competitive environment.
How Competitive Advantage Works
To create a competitive advantage, you've got to be clear about these three determinants.
What Benefits Does Your Company Provide?
What is the real benefit your product provides? It must be something that your customers truly need. It must also offer real value. You must know your product's features, its advantages, and how they benefit your customers. You must stay up to date on the new trends that affect your product which includes new technology.
For example, newspapers were slow to respond to the availability of free news on the internet. They thought people would continue to pay for news delivered on paper once a day.
Determine Your Target Market
Who are your customers? What are their needs? You've got to know exactly who buys from you and how you can make their life better. That’s how you create demand, the driver of all economic growth. Newspapers' target market shrank to those older people who weren't comfortable getting their news online.
Identify Your Competitors
Have you identified your real competitors? They aren't just similar companies or products. They also include anything else your customer could do to meet the need you can fulfill. Newspapers thought their competition was other newspapers until they realized it was the internet. They didn't know how to compete with a news provider that was instant and free.
To be successful, you need to be able to articulate 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 sales aids. It even includes your storefront and employees.
Michael Porter and Sustainable Competitive Advantage
In 1985, Harvard Business School Professor Michael Porter wrote "Competitive Advantage," the definitive business school textbook on the topic which helps companies to create a sustainable competitive advantage.
In his book, Porter explained that a company must create clear goals, strategies, and operations to build sustainable competitive advantage. The corporate culture and values of the employees must be in alignment with those goals.
Porter researched hundreds of companies to identify the three primary ways companies achieve a sustainable advantage: cost leadership, differentiation, and focus.
Cost leadership means companies provide reasonable value at a lower price. Firms do this by continuously improving operational efficiency. That usually means paying their workers less. Some compensate for lower wages 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 benefit from economies of scale and buy in bulk.
Walmart and Costco are good examples of cost leadership. This is because they sometimes pay their workers less than the cost of living, but higher minimum wage laws threaten their advantage.
Differentiation means companies deliver better benefits than anyone else. A firm 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, which means it usually has a higher profit margin.
Companies typically achieve differentiation with innovation, quality, or customer service.
Innovation means they meet the same needs in a new way. An excellent example of this is Apple. The iPod was innovative because it allowed users to play whatever music they wanted, in any order. Quality means the firm provides the best product or service. Tiffany's can charge more because patrons see it as far superior to other jewelry stores.
In short, customer service means going out of the way to delight shoppers, like Nordstrom's that was the first to allow returns with no questions asked.
Focus means the company's leaders understand and service their target market better than anyone else. They either use cost leadership or differentiation to do that. The key to a successful focus strategy is to choose a very 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, and customers 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, a practice that's called national competitive advantage or comparative advantage. For example, China uses cost leadership by exporting low-cost products at a reasonable quality level. China can do this because its standard of living is lower, meaning it can pay its workers less.
India started as a cost leader but is moving toward differentiation. It provides skilled, technical, English-speaking workers at a reasonable wage. Japan also changed its competitive advantage. In the 1960s, it was a cost leader that excelled at cheap electronics. By the 1980s, it had shifted up to differentiation in quality brands, such as Lexus.
America's competitive advantage stems from its innovative practices as a nation. For example, U.S. companies are known for bringing products to the market at a more efficient pace than many other nations.
While innovation is driven by many factors, it's clear that the U.S. has benefitted from its diverse makeup as a country. In fact, there's scientific evidence, which shows that diversity, and maintaining a diverse workplace, helps to drive innovation and market growth forward.
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 innovations to market. That's just one of the ways natural resources boost America's advantage.
How Individuals Use Competitive Advantage
You can use the theory of competitive advantage to advance your career. If you are an employee, work as if you were in business for yourself. Your target market is your employer. Your benefit is how you increase the company's profit. Your competition is other employees and technology.
Communicate your competitive advantage in your appearance, your resume, and your interview. Once you've got the job, continuing communicating your advantage in your work performance.
- Competitive advantage refers to the attributes that allow a company to produce cheaper or better quality products than its competitors.
- As a business owner, you want to identify what your company's competitive advantage is.
- Heads of businesses should think about which benefits their entities provide, while also determining their target market and competitors.
- Harvard Business School Professor Michael Porter defined competitive advantage in order to help companies to create a sustainable competitive advantage.
- Individuals can use the theory of competitive advantage to advance their careers.