What Is Competitive Advantage? Three 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

A competitive advantage is what makes you better than the competition in your customers' minds. The term was first applied to businesses, but it works for anyone, from employees to countries.  

Before describing your competitive advantage, you've got to know these three determinants.

  1. Benefit. Whether it's a good or service, you must be clear on the benefit your product provides. It must be something that your customers truly need and that offers real value. You must know not only your product's features, but also its advantages how they benefit your customers. That means being constantly aware of new trends that affect your product, especially new technology. For example, newspapers were slow to respond to the availability of free news on the internet.
  1. Target market. Who are your customers? 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 drifted to older people who weren't comfortable getting their news online.
  2. Competition. That's more than just similar companies or products. It includes 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 fought 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 advertisingpublic relations, and sales aids.

It even includes your storefront and employees. 

If you are an employee, work as if you were in business for yourself. That's because you are. 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.

Michael Porter and Sustainable Competitive Advantage

Just because a company is the market leader now, doesn't mean it will be forever. 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. It's difficult to do all those things well. That's why few companies can create a sustainable competitive advantage.

In 1985, Harvard Business School professor Michael Porter wrote Competitive AdvantageIt is the definitive business school textbook on the topic. 

Porter outlined the three primary ways companies achieve a sustainable advantage. They are cost leadership, differentiation, and focus. Porter identified these strategies by researching companies.  

Cost leadership means you provide reasonable value at a lower price. Companies do this by continuously improving operational efficiency. That usually means paying 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 cost leadership. But sometimes they pay their workers less than the cost of living. Higher minimum wage laws threaten their advantage.

Differentiation means you deliver better benefits 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 was innovative because it allowed you to play whatever music you want, in any order.

Quality means you provide the best product or service. Tiffany's can charge more because patrons see it as the best. Customer service means going out of the way to delight shoppers. Nordstrom's was the first to allow returns with no questions asked.

Focus means you understand and service your target market better than anyone else. You can use either cost leadership or differentiation to do that. The key to focusing is to choose 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. It'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 value lower 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 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 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. America is so innovative because it has a vast and affluent domestic consumer base. It's easy to test new product ideas and work out the bugs at home. Once successful, they’re marketed throughout the world. 

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. For more, see How Natural Resources Boost America's Advantage