Competitive advantage enables a firm to perform at a higher level than others in the same industry or market — or with anyone competing for the customer’s limited budget. Competitive advantage can serve as a powerful catalyst for your business.
Competitive advantage enables you to outsell, outprofit, and outperform others in the same industry or market. When you’re analyzing the strength of a business, if you look only at competitive advantage, your analysis will be incomplete.
People often mistakenly use the term competitive advantage as a synonym for the term business model. The reality is that competitive advantage is a portion of your business model, but not all of it. A business model is more encompassing than your competitive advantage.
For instance, you can have excellent competitive advantage but still have a weak business model. If Starbucks decided to maximize coffee poundage sales by lowering the price of a cup of coffee to $0.50, its competitive advantage may rise slightly. However, the lower price would result in a significantly different, and worse, business model for Starbucks.
According to Michael Porter, the Harvard professor responsible for the concept, competitive advantage is obtained through cost leadership, differentiation, and/or focus.
Cost leadership means your firm has the ability to deliver similar goods or services as your competitors for a lower cost. This doesn’t mean a lower sales price, but a lower cost of goods sold. If your firm has the ability to deliver a widget at a cost of $8 and it costs another firm $10 to deliver a similar widget, you have a cost advantage.
If your cost advantage is the best in your industry, you have cost leadership. You can gain cost leadership in countless ways; here are just a few:
Access to natural resources: China’s stranglehold on rare earth minerals or cheap labor
Scale: Walmart can buy Pampers cheaper than anyone else
Vertical integration: Intel designs, fabricates, and markets chips
Technological leverage: Many analysts attribute Walmart’s rise in the 1980s to technological superiority in logistics
Proprietary processes: Rolls-Royce uses a secret metallurgy process to make super-durable jet engine blades
Differentiation means that the customer believes that your product has superior and different attributes than the competition. Customers pay much more for a cup of Starbucks coffee than for a cup of joe at the diner because they view Starbucks coffee as a differentiated product.
Many times, you can charge extra for the differentiated attributes of your offering, creating additional margin. Businesses can create differentiation by using any of the following tactics:
Superior branding (Coach, Tiffany’s, Rolex)
Unique supplier relationships (Eddie Bauer Edition Ford Explorer)
First mover advantage (iPad, Walkman, Crest toothpaste)
Location (remember the retail mantra “location, location, location”?)
Scale (not many companies can build an airplane or a skyscraper)
Intellectual property (iPod circular controls, Hemi engines, Intel Inside)
You can also gain competitive advantage through your focus. A business can’t serve too many masters. You can translate intense focus on a market, niche, or attribute into a significant advantage. Examples include the following:
Tesla’s focus on only electric automobiles
Taiwan Semiconductor’s exclusive focus on fabrication
Amgen’s focus on biopharmaceuticals (rather than all types of drugs)
Starbucks’ focus on coffee rather than becoming just another restaurant
Amazon’s initial focus on books
Rally’s focus on drive-through hamburgers
A doctor’s focus on heart surgery