What is Competitive Advantage?
A competitive advantage is a unique attribute that a business can use to gain superior performance over its competitors.
Competitive advantage is critical to business profitability and long-term success. Without clear competitive advantage, businesses get caught in a zero-sum game or a race to the bottom, eroding profits and swallowing market share.
It is important to get clarity on competitive advantage, and take steps to ensure it is sustainable.
“A company can outperform rivals only if it can establish a difference that it can preserve.” - Michael E. Porter
A temporary competitive advantage may help a business in the short-term, but will not help it maintain market share and profitability in the long-term.
A clear understanding of your competitive advantage guides your business decisions, products and communications. It defines what you do, and more importantly what you do not do.
Unfortunately many small businesses race into business without a clear strategy, leading to fragmented decisions, ad-hoc marketing, and an uphill battle competing with more established organisations on the same customer benefits.
Taking time to identify your competitive advantage will reduce promotional wastage and allow you to establish your business regardless of how fierce the competition is.
Porter’s 3 Sources of Competitive Advantage
In his book, “Competitive Advantage”, Michael Porter identified three key sources of competitive advantage:
- Cost Leadership
Cost Leadership Competitive Strategy
In a cost-leadership strategy, companies are able to offer a continuously lower price by improving operational efficiency and taking advantage of economies of scale.
- Greater market share
- Economies of scale
- Reduced competition in long run
- Easily replicated by others, removing competitive advantage, and resulting in “race to the bottom” where competition continuously forces prices down, eroding profits.
- Requires a large volume of sales to leverage economies of scale.
- Reduces innovation
- Can lead to decrease in quality if costs are cut in critical areas
Best Suited To:
Large organisations with a high turnover of products. Small organisations will struggle to achieve operational efficiency and economies of scale at the level required to pull off a cost-leadership strategy.
Differentiation Competitive Strategy
A differentiation strategy delivers better value than competitors by offering a unique product or service. Differentiation can reduce price competition, meaning you can sell your product at a higher price, and are less threatened by low-cost competitors.
“Competition on dimensions other than price - on product features, support services, delivery time, or brand image, for instance - is less likely to erode profitability because it improves customer value and can support higher prices.
Consumers tend to be more price sensitive if they are purchasing products that are undifferentiated, expensive relative to their incomes, or of a sort where quality is not particularly important to them” - Michael E. Porter
However, a differentiation strategy can still be threatened by new competitors or copycats, and so the business must continuously evaluate their differentiation strategy.
- Reduced price competition
- Increased customer loyalty
- No perceived substitutes
- Many different ways to differentiate
- Copycat substitutes can appear - reducing differentiation
- Over-differentiation can dilute brand
Best Suited To:
Most businesses can benefit from a differentiation strategy, except where product decisions are not really thought about (low cost, low switching cost) e.g. dishwashing liquid.
Focus Competitive Strategy
Focus means the company's leaders understand and service their target market better than anyone else using either cost leadership or differentiation.
The key to a successful focus strategy is to choose a very specific target market - a tiny niche. Often this niche is a gap in the market that larger firms are not serving.
- Often allows for premium price point
- Increased customer loyalty
- Limited target market can be difficult to scale or generate sufficient income
Best Suited To:
Organisations that can offer a highly-specialised product to a niche audience, where that niche’s needs are not met by competitors.
3 Steps to Identifying Your Competitive Advantage Strategy
1. Analyse the Market
Look at the competitors around you. There are 5 key things to look at when analysing the market.
How many competitors are there - and how powerful are they? Do a few large competitors dominate the market, or are there many fragmented sellers with small market shares?
- New Entrants:
How easy would it be for a new competitor to enter the industry with a substitute product, better product or lower price point?
- Power of Suppliers
This affects how easily suppliers could drive your operating costs up.
- Power of Customers
This is about the power customers have to push prices down or demand new features. A few, larger customers are more influential in buying decisions than many different customers.
- Threat of Substitute Products
How likely is it that a new substitute product could be made?
By analysing the 5 market forces, you can get an idea of where your competitor’s strengths and weaknesses lie and where there are gaps in the market.
You can also identify vulnerabilities that would affect your strategy - for example, if suppliers have a high amount of power to drive up costs, running a low-cost strategy could be risky.
2. Analyse Your Strengths & Weaknesses
The next step is to identify what your organisation is good at, what its weaknesses are, and what areas it could best serve the market.
3. Identify Your Sweet Spot
The place where your strengths intersect with a market opportunity or need is your strategy sweet spot.
Remember to keep revisiting your strategy and refining it, as market circumstances can change.