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What Is Competitive Advantage?

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competitive advantage

Southwest Airlines gained initial competitive advantage with a cost leadership strategy.

Photo: Boeing
Definition: A competitive advantage is what distinguishes you from the competition in the minds of your customers. Whether you are an employee, a business or a country, you need to have a clear competitive advantage and communicate it to your customers. Before you can determine your competitive advantage, you've got to know these three determinants:
  1. What you produce. Whether it's a good or service, you've got to be very clear on what you are providing. New technology can redefine that for you, so you've got to constantly stay on top of how trends affect the benefits you provide. For example, the Internet meant that newspapers had to redefine how they delivered the news.
  2. Target market. Who are your customers? You've got to know exactly who buys from you, and how you can make them happier. Newspapers found out their target market started to become older people, who weren't as comfortable getting their news online.
  3. Competition. This is not just other similar companies or products, but anything else your customer does to meet their needs. 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?
Once you are clear on these three determinants, then you can decide what benefit you provide better than the competition to your target market. Reinforce that message in every communication to your customers, including 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. Make sure your competitive advantage is reflected in your appearance, your resume, and in how your communicate.

Sustainable Competitive Advantage

Just because a company is the market leader now, doesn't mean it has a sustainable competitive advantage. A company can temporarily cut its prices to gain market share, but its competitive 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 over time. 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, which is why very few companies can create a sustainable competitive advantage.

Michael Porter: The Guru of Competitive Advantage

In 1985, Harvard Business School professor Michael Porter wrote the definitive business school textbook on the topic, called Competitive Advantage. In it, he outlined the three major ways companies achieve sustainable advantage: cost leadership, differentiation and focus. Although these main strategies were developed by researching companies, they can be useful for everyone, from employees to countries, that is seeking to stand out.

Cost leadership means you provide reasonable value at a lower price. Companies do this by continuously improving operational efficiency. They usually pay their workers less, either by providing intangible benefits such as stock options, benefits or promotional opportunities, or by taking advantage of unskilled labor surpluses. As they get larger, they can take advantage of economies of scale, and buy in bulk. Good examples of companies with sustainable cost leadership advantage are Walmart and Costco.

Differentiation means you have a strong brand that clearly communicates how you deliver product or service benefits much better than anyone else. A company can achieve differentiation by providing a unique or high-quality product, by delivering it faster, or by marketing it in a way that truly reaches customers better. Instead of being a cost leader, the company with a differentiation strategy can charge a premium price.

Companies usually achieve differentiation with innovation, quality or customer service. Innovation means you meet the same needs in a new way. A great example of this is Apple. The iPod was innovative because you can 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 is able to charge more because it's seen as the best. Customer responsiveness means going out of the way to delight the customer. Nordstrom's is known for this.

Focus means you understand and service your target market better than anyone else. You can use either a cost leadership or differentiation strategy, but you focus it on one specific target market. Often it's a tiny niche that isn't being served by larger companies. Community banks are an example of a segment that uses 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 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. This is known as national competitive advantage, or comparative advantage. For example, China uses cost leadership to export reasonably quality products at a lower price. 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 was known for cheap electronics. By the 1980s, it had was known for quality brands, such as Sony.

America's competitive advantage is innovation. U.S. companies are able to bring innovative products to market faster and more successfully than other countries. The reason for that is our large and affluent domestic consumer base. It's easy to test new product ideas, and if they catch on, they can be marketed cheaply and effectively. As Amar Bhidé, author of The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World argues, even if the U.S. starts to lag behind other countries in producing engineers, it's still more effective in bringing those innovations to market. Article updated July 7, 2012

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