6 Strategies to Gain Competitive Advantage from Michael Porter, the Author of “Competitive Advantage”
Competitive advantage plays a key role in business success, but not all companies know how to gain a competitive advantage and differentiate themselves in the current extremely competitive, or even cutthroat, market.
To build an edge over the competition, leaders need to be cognizant of competitors’ behavior and industry structure to be able to build sustainable value for customers. By offering something more valuable and different from what the competition is providing, companies have a chance to translate it into a sustainable competitive advantage and gain a leading place in the market.
Each successful company has found its own competitive advantage, which lies at the core of strategic management and all strategic decisions.
If you want to create and later leverage competitive advantage in your own business, you need to understand why it matters and how it works. Finding and maintaining a competitive advantage can secure a company a leading place in the industry, generating increased profit over the long term.
In this article, we’ll dive into various aspects of competitive advantage and cover the best strategies on how to build an effective competitive advantage, described by Michael Porter in his book “Competitive Advantage”.
Table of Contents
- What Is a Competitive Advantage?
- So What Does it Mean to Have a Competitive Advantage?
- Why Do Companies Need a Competitive Advantage?
- 6 Strategies How to Build a Competitive Advantage
What Is a Competitive Advantage?
Competitive advantage is a unique characteristic of a company, differentiating it in the marketplace, which gives it an edge over rival firms by providing greater value to customers through lower prices or extra benefits that justify higher prices. Competitive advantage stems from the value a firm is able to create for its buyers that contenders are not able to provide.
A competitive advantage is anything that distinguishes a company from its competitors, giving it an edge to win customers and the biggest market share.
According to Michael Porter, the author of “Competitive Advantage,” “Competitive advantage grows fundamentally out of value a firm is able to create for its buyers that exceeds the firm's cost of creating it.”
There are two basic types of competitive advantage: cost leadership and differentiation.
Competitive advantages are associated with various factors, including quality, branding, cost structure, intellectual property, technological innovation, or customer service. They enable a company to provide customers with products or services of higher value than the competition, generating higher margins or more sales.
A company can normally sustain a competitive advantage only for a limited time since there is a great number of rival firms intending to decrease the power of its competitive advantage by imitating it.Back to top
So What Does it Mean to Have a Competitive Advantage?
Successful companies are successful for a reason. Their competitive advantage is strong enough to give them an edge over the competition, attracting more and more customers and helping them build a leading position in the market.
Which brings us to the question: Why do those customers buy from this particular company rather than the competition?
Since customers are different, they have different preferences and make buying decisions for a lot of different reasons. Some of the deciding factors include quality, prestige, technological advancement, location, a wide choice of products or services, special relationships with a seller, and many more. However, for some commoditized markets with less diversified services or products, for instance, the agriculture industry, answering this question can be very tricky. In such markets, the price and volume are often the only determining factors.Back to top
Why Do Companies Need a Competitive Advantage?
Everybody wants to be unique, but few manage to stand out from the flood of copycats. Especially nowadays, when both individual and wholesale purchasers are seeking goods or services with particular characteristics, a strong and distinct competitive advantage is essential. Differentiation and niching down are the keywords that rule with a rod of iron in the current markets. Even if companies decide to copy some other businesses’ solutions, they need to offer an old product or service with a brand-new characteristic or application.
Founders of start-ups are constantly trying to outstrip each other and distinguish in the market, launching new technologies or products which are to solve some sophisticated problems of their potential customers. By implementing new ideas, they hope to provide their companies with sustainable competitive advantages. However, it is challenging and, according to the Small Business Administration, just one out of ten startups survives in the market since it’s more and more difficult to meet customers' needs as they are pickier and pickier.
As the business world is becoming more and more demanding and competitive, only a few businesses selling products or services of premium quality, with extraordinary features or offering something truly unique are able to stay on the market. A key point to understand is that competitive advantage is a make-or-break factor and it needs to be more sophisticated and value-based since gone are the days when price and volume played a crucial role in business success.
Even in the agriculture industry, previously considered as purely price and volume-driven, companies are trying to find their edge over the competition by differentiating themselves with special modes of production (i.e. organic, human, or natural) or providing value-added components such as pre-washed salads mixes.
There is a misconception that a competitive advantage once achieved is sustainable. It can be detrimental to the business since companies invest a lot of effort, money, and time in systems, people, and assets built around those advantages which can disappear in the blink of an eye. The business world is very dynamic and our contenders are actively seeking to copy our competitive advantages. Since it is extremely difficult to sustain a competitive advantage, leaders need to be ready to pivot at any moment and avoid putting all eggs in one basket.Back to top
6 Strategies How to Build a Competitive Advantage
1. Analyze the Attractiveness of the Target Industry.
To create a successful strategy on how to gain a competitive advantage, you need to scrutinize very thoroughly the target industry and understand the rules which exist there.
Michael Porter pinpoints the following 6 competitive forces which govern each industry:
- the entry of new competitors,
- the rivalry among the existing competitors,
- the bargaining power of buyers,
- the bargaining power of suppliers,
- the threat of substitutes.
Since all the listed forces influence the costs, prices - the overall industry profitability, they should be carefully analyzed before entering a particular market. According to Michael Porter, “the collective strength of these five competitive forces determines the ability of firms in an industry to earn, on average, rates of return on investment in excess of the cost of capital.”
Strong buyer power impacts the prices that companies charge, generally lowering them, however, buyers with strong negotiating power usually require premium products or services which increases companies’ costs and investments. In this case, we can observe a strong pressure that is exerted on businesses to decrease their margins, which eventually lowers their profitability. Moreover, another decisive force is the bargaining power of suppliers, which affects the price of raw materials and other basic components used for production. Also, both the power of competition and the substitution threat influence prices as well.
In terms of profitability, there are no two identical industries, therefore the power of these forces is different in different industries. There are industries, such as soft drinks or pharmaceuticals, with quite lower pressure from the competitive forces, while there are industries with very strong competitive forces where it’s quite difficult to reach profitability and enjoy hefty returns.
It happens that seemingly mundane industries may be highly profitable, whereas more prestigious, high-class, and high-technology industries are hard to break into, and while finally being inside, they may not provide its participants with high rewards in the form of superior margins or returns.
2. Lower the Costs.
Companies that set out to pursue a cost leadership strategy typically have a broad scope, serving many industry segments, or even operating in related industries. Their sources of competitive advantage based on costs reduction depend on the structure of the industry include economies of scale, proprietary technology, easy access to cheap raw materials, low overhead, low-cost labor, or full automation of production.
Low-cost producers usually try to find and exploit all sources of cost advantage by selling standard and no-frills products.
By laying an emphasis on gaining scale or cost advantages from all sources, a company can set prices that are the same or lower than its competitors’ prices and receive higher returns to become an above-average performer, and eventually a cost leader.
However, to gain a sustainable competitive advantage and land a stable position on the market, a low-cost company needs to produce not only cheap products or services but also goods that are perceived by buyers as attractive. Otherwise, a low-cost producer will be forced to discount prices well below competitors’ prices, which may significantly reduce its profits.
The key point of the strategy based on the cost leadership idea is to become the cost leader, not just one of a few companies competing for this position.
Example of the firm following a cost leadership strategy:
Founded in 1985, Ryanair is an Irish low-cost airline headquartered in Dublin which follows a cost-leadership strategy to achieve its mission of becoming the main European low-cost carrier (LCC).
3. Be Different.
A company that pursues a strategy based on differentiation wants to be exceptional in its industry in terms of some factors that are regarded by buyers as valuable. To gain an edge, it usually chooses one or more dimensions that plenty of buyers perceive as significant and tries to figure out how to approach them in a unique way, completely different from their rivals.
By meeting the buyer's needs more effectively than competitors, the firm positions itself as a market leader and top provider and can charge clients premium prices for the uniqueness of their products or services and build a sustainable business around this one or two attributes.
To gain a competitive advantage based on differentiation, a company needs to be remarkable and truly different from the competition and customers need to view it as extraordinary to be ready to pay a premium price.
Unlike a cost leadership strategy which is based solely on one attribute - price, a successful differentiation strategy may take different forms at different companies, even in the same market, as buyers value various attributes which can stand at the heart of particular strategies.
However, the key to high profitability is a premium price higher than the cost of differentiating. A firm needs to set proper prices which exceed the extra costs incurred to differentiate itself and constantly look for ways of cost-effective differentiation as an inferior cost position may nullify a competitive advantage gained due to premium, but not high enough, prices.
Example of the firm following a differentiation strategy:
Founded in 1854, Louis Vuitton, a French luxury goods company and fashion house, follows a differentiation strategy based on the generic strategy model, selling high-quality products, including luxury leather goods and ready-to-wear accessories, at premium prices.
4. Be Focused.
As the focus strategy is based on narrowing down a competitive scope within an industry, a company chooses a particular segment in the industry and optimizes its strategy for the selected sector, excluding entirely other segments. By adjusting the strategy to the target market, a firm gains a competitive advantage in its target market only due to focusing its efforts on this selected segment, even without having an overall competitive advantage.
In “Competitive Advantage,” Michael Porter wrote: “the focuser selects a segment or group of segments in the industry and tailors its strategy to serve them to the exclusion of others.”
There are two variations of the focus strategy:
- Cost Focus
- Differentiation Focus
Companies with the cost focus strategy are for cost advantage in their target sector, whereas those with the differentiation focus strategy search for differentiation in their target segment. The key attribute of both variants of the focus strategy is based on differences between a target segment and other segments in the industry.
To gain a competitive advantage successfully, buyers of the target segments need to have special needs which are markedly different from the needs of buyers in other segments. Companies following the cost focus variant exercises disparities in cost behavior, whereas those following differentiation focus will benefit from the particular buyers' needs in specific segments.
By committing to one industry segment exclusively, a company achieves a significant competitive advantage mainly due to a lack of competitors' specialization. Rival firms who try to be everything to everybody serving all segments at the same time may miss some buyers’ needs or meet them inadequately.
Additionally, they don’t present themselves as specialists commanding specialized expertise, which doesn’t improve their brand image in the eyes of customers from this particular industry segment. Consequently, it increases the odds of gaining an edge by a company with the focus strategy in place, which is able to provide much higher quality to buyers from a narrowed down segment.
As the overall differentiation strategy and the differentiation focus strategy are often mistaken, let’s explicitly set forth the difference between both strategies by providing examples.
Let’s take the IT market as an example.
IBM follows the overall differentiation strategy, focusing on widely valued attributes. Producing and selling computer software, hardware, and middleware, IBM is the overall differentiator in computers, providing a wide range of computer products and services. As a multinational technology company with substantial resources, its main focus is the computer market in the broad sense. IBM doesn’t differentiate itself even further, focusing on one market segment and chooses to stay quite a generic company in the IT market.
Whereas, Nvidia Corporation is a perfect example of the differentiation focuser, trying to satisfy the special needs of its target segment. It designs graphics processing units (GPUs) for the gaming market and systems on chip units (SoCs) for the automotive and mobile computing market. By a high level of differentiation, the company is able to meet the needs of its end-users from specific market segments much better than its broadly targeted competitors, gaining a sustainable competitive advantage over them.
5. Avoid Being Stuck in the Middle.
Some companies have very generic strategies or even no strategies at all and don’t benefit from their strategic advantages as they haven’t recognized them or haven’t created them, and as a result, they have stuck in the middle of the market. Surrounded by laser-focused competitors, they have little chance of surviving in the market.
According to Michael Porter, “becoming stuck in the middle is often a manifestation of a firm’s unwillingness to make choices about how to compete,” which may have long-term consequences. Having no clear strategy in place may be extremely dangerous, putting a company at a disadvantage and eventually out of business as competitors with clearly defined strategies have a significant competitive advantage.
It happens that companies tend to neglect their strategies in pursuit of mushroom growth, ending up with no strategy at all. It often relates to firms with the focus strategy which have dominated their target segments. To increase their sales and accelerate growth, they decide to compromise on the leading strategy, losing sight of the foundations of their success. Taking actions that are not consistent with the chosen strategy, which leads to blurring their brand image and compromising on the key pillars of their strategy.
6. Plan with a Competitive Advantage in Mind.
Much has been said about strategic planning, but without taking into account competitive advantage, carefully devised strategic plans often don’t guarantee superior performance. However, plenty of companies focus on the planning process for its own sake, instead of creating a strategic plan based on a competitive advantage resulting from an in-depth analysis of industry structure. Additionally, they tend to build their strategies focusing on prices and costs projections, which often prove to be wrong.
According to Michael Porter, “many strategic plans are lists of action steps without a clear articulation of what competitive advantage the firm has or seeks to achieve and how.”
Some companies also use market share as a benchmark for determining their competitive position, however, setting a goal of becoming a leader in the industry is not always a proper competitive strategy. Although winning a number one place in the market is usually taken at face value as desirable, but surprisingly, it may be sometimes even dangerous.
Although market share is typically associated with competitive position due to economies of scale, “industry leadership is not a cause but an effect of competitive advantage.” Firms that are in a constant quest for industry leadership may never gain a competitive advantage or even lose the one that they have as their executives tend to get entangled in never-ending discussions referring to particular strategies on how to win the biggest market share without a big picture competitive advantage in mind.
What may seem surprising, not all market leaders, for instance, Continental Illinois Bank, achieve profitability as aspiring for market leadership may divert the firm’s attention from the most relevant goal of gaining and sustaining competitive advantage.
Generally, companies shouldn’t just strive to grab the biggest market share, but most importantly, they should aim to achieve a sustainable competitive advantage in the target market.
Finding and sustaining a competitive advantage should be the main objective of each leader since it determines all further strategic decisions, and consequently, the whole firm’s future performance and profitability. Certainly, pinpointing a competitive advantage may be a challenging task, especially for startups; however, it’s well worth the effort as it may provide hefty future returns, and save lots of money.
All articles are for informational purposes only. Under no circumstances should any of these articles or any information herein be construed as business or investment advice.Back to top
Author: Justine Ilone Siporski is Editor-in-Chief & CEO of BUSINESS POWERHOUSE, the founder and CEO of LANGUAGE EMPIRE, coach, trainer, investor, and columnist dedicated to the advancement of entrepreneurs, investors and the C-suite (CEOs, CMOs, CFOs, CIOs). Her key mission is to support leaders, business people, and investors in achieving their highest potential, making the right business and investing decisions, and expanding their horizons.