From Strategy to Success: Understanding Competitive Advantage
We are launching a new series on strategic decision making in the next set of blog entries.
In today's fast-paced business world, companies often focus on execution, but how many revisit the core strategic decisions that drive long-term success?
Companies fine tune their execution but do not often do enough revisiting their strategic decision making. Strategy is the series of decisions managers make on what markets to be present in and how to maximize long-term value. Execution is producing results in the context of those strategic decisions. Great execution is not great if it is a compromised strategy.
Competitive advantage is defined as achieving higher profitability than the industry average. Competitive advantage allows a firm to outperform its rivals by creating superior value for its customers. This advantage is measured in:
Higher profit margins (gross, operating, and net) that indicate a company’s ability to generate more profit than rivals
Higher return on assets (ROA) and return on equity (ROE) indicates how efficiently a company uses its assets and equity to generate profit. Higher ROA and ROE suggests better management and operational efficiency.
Firms must choose and make tradeoffs in arriving at a coherent strategy. What type of competitive advantage to pursue comes down to either a cost leadership position whereby goods or services are delivered at a low(est) cost or differentiation where premium prices are charged:
Cost leadership whereby the Company delivers goods or services at a low(er) cost, or;
A differentiated strategy whereby premium prices are earned
If a company takes a cost leadership position it is providing a product of acceptable quality at a lower price than the industry average. If a company takes a differentiation strategy it is producing a product of higher quality at a higher price.
In mature markets with established competitors, there are four ways for a company to pursue competitive advantage:
Firms that do not or cannot choose a strategy tend to get “stuck in the middle” and underperform[1].
With a clear understanding of competitive advantage, companies must then decide how to achieve it. Broadly, they have two paths: cost leadership or differentiation.
Firms need to make two choices:
The type of competitive advantage it seeks: cost leadership or differentiation; and,
How much of the market to serve: broad market or narrow market
Choice 1: Type of competitive advantage
Cost leadership strategy
The goal is to achieve a material cost advantage over competitors by:
Investing in assets to lower operating expenses
Delivering a product of reasonable/ok quality at the lowest cost possible
If done well, the firm may generate above average profits with low(er) prices; however, the cost leader must maintain product quality. The firm likely foregoes its ability to provide a unique and differentiated product.
Some examples include:
Southwest airlines: No frills air travel
WalMart: low prices on everyday goods
IKEA: low cost furniture, self assembly
TJMaxx: Leading brands at discount prices
Differentiation strategy
The goal is to offer a product or service that is recognized as superior in quality on at least one dimension. Features may include:
Ease of use
Higher quality
Quicker delivery
Complementary features
To achieve this, a firm must choose where to incur costs in pursuit of delivering a superior product/service. Firm must also invest in assets that allow it to create and maximize value for buyers.
Some examples include:
Whole foods: higher prices for presumed higher quality?
BMW: “Sheer driving pleasure”
Apple: Devices that work well
Cartier: “Never imitate, always innovate”
Choice 2: “How Much of the Market to Serve”, more specifically a broad versus narrow market:
Broad market: all segments that could include
All (or nearly all) geographic regions
All customer segments (or nearly all) (e.g., seniors, children, pro-sumers, professionals)
This strategic choice enables firms to take advantage of:
Economies of scale
Economies of scope
By choosing a broad scope, firms can achieve either cost or differentiation advantages.
Narrow market: targets a segment with specific or unusual needs based on:
Product attributes, or
Geographic location
Firms pursuing a narrow market strategy sacrifice incremental business, i.e., selling to additional segments; however, they benefit from the advantage of limited scope. Limited scope should enable them to achieve either a cost or differentiation advantage.
Avoid getting “stuck in the middle”
Why not pursue both a low cost and differentiation strategy? Those pursuits are generally inconsistent and incompatible with one another. For example, a moderately priced product with moderate quality will likely be outcompeted by a low-cost product and/or a high quality product.
The two decisions are summarized below with some examples of competitors who have established themselves as leaders based on their strategic positioning:
What strategic path is your company on? Is it time to revisit your approach? The right decision today could set the stage for future success.
In our next post, we will dive into the analytical tools you can use to decide between cost leadership and differentiation—so stay tuned!
[1] Michael Porter, Competitive Strategy (1980) and Competitive Advantage (1985)