What is Competitive Advantage? Definition, Strategies, Porter’s Five Forces Model, Factors, How to Build

What is Competitive Advantage?

Competitive advantage refers to a situation that puts an organization in a favorable or superior business position. In other words, competitive advantage can be defined as the specific advantage possessed by the organization over its competitors existing in the external environment. It helps the organization to increase sales or profit margins and retain the maximum number of customers.

It also helps in differentiating the organization from competitors and results in providing value to the organization as well as to stakeholders. Organizations should focus on sustaining the competitive advantage to make it difficult for competitors to take the edge of the market.

Competitive Advantage Definition

According to Michael Porter, Competitive advantage grows out of the value a firm can create for its buyers that exceed the firm’s cost of creating it. Value is what buyers are willing to pay, and superior value stems from offering lower prices than competitors for equivalent benefits or providing unique benefits that more than offset a higher price. There are two basic types of competitive advantage: cost leadership and differentiation.

Harvard Business Review defines competitive advantage as “the ability to create and sustain a profitably higher market share than the average competitor.”

The book “Blue Ocean Strategy” by W. Chan Kim and Renée Mauborgne defines competitive advantage as “creating new market space where competition is irrelevant.”

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Generic Competitive Strategies

Thus, according to Porter, a competitive advantage can be achieved either by providing comparable buyer value at a lower cost than the competitors or by performing activities at a comparable cost but in differentiated ways that provide buyers more value than competitors. Thus, you can achieve a competitive advantage either by being low-priced or by being unique. Considering this, there are two main types of competitive advantage:

• Cost Advantage: An organization can provide similar benefits of products or services at a lower cost compared to competitors in the market.
  
  
• Differentiation Advantage: To achieve a differentiation-based competitive advantage, an organization needs to offer products or services to customers with enhanced features and benefits than those of the competitors.

Thus, the competitive advantage helps the organization to provide valued products/services to customers with increased profit margins. According to Porter, competitive advantage depends largely on the industry structure and positioning of an organization within the industry.

He presented the ‘Five Forces Model’ to define the rules of competition in any industry. The model presents a structured and systematic analysis of the market structure and competitive situation. It suggests that to formulate a competitive strategy, an organization needs to analyze the industry in which it operates.

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Porter’s Five Forces Model

The five competitive forces that determine the intensity of competition in an industry are the threat of new entrants, the bargaining power of suppliers, the bargaining power of buyers, the threat of substitute products, and competitive rivalry among existing competitors. In Porter’s words, the collective strength of these forces determines the ultimate profit potential of an industry—Porter’s Five Forces Model.

The competitive advantage gained by an organization needs to be sustained in the market to cope with competitors. An organization, to achieve a sustainable competitive advantage needs to focus on the following features:

• Focus on creating a durable core competency that tends to sustain in the market. For this, organizations should focus on continuous R&D to come up with value-generating inventions that are unique and provide a long-term sustainable competitive edge to the organization.
  
  
• Focus on creating competitive strategies that cannot be imitated or copied by competitors very easily. This helps organizations maintain their position in the market in the long run.

• Threat of New Entrants
  
• Bargaining Power of Suppliers
  
• Bargaining Power of the Buyers
  
• Threat of Substitute Products
  
• Competitive Rivalry Among Existing Competitors

Threat of New Entrants

It refers to the ease with which potentially new entrants can enter an industry. The degree of threat of new entrants in an industry depends on the entry barrier of the industry. The lower the entry barrier, the higher is the threat of new entrants, and vice versa. A low entry barrier attracts new players to enter an industry, which, in turn, puts pressure on the price level. Therefore, a low entry barrier limits the profit potential of an industry.

Take example of the beverage industry in India, where entry barriers are relatively low. This encourages new brands to appear in the market with similar prices than the dominant market players like Coke and Pepsi.

Bargaining Power of Suppliers

It refers to the ability of suppliers to manipulate the price of products supplied to an organisation. If suppliers have a high bargaining power, the profit potential of the industry would be relatively low. Suppliers enjoy a high bargaining power if there are a few suppliers catering to a large number of organisations in the industry. In addition, if a product or service is unique in nature, and there is no other substitute of the product; even then the suppliers have an upper hand.

If we take the example of Coke or Pepsi, the main ingredients for soft drink include carbonated water, phosphoric acid, sweetener and caffeine. Here suppliers are neither concentrated nor differentiated. Thus, Coke or Pepsi appear to be the biggest customers of any of these suppliers.

Bargaining Power of the Buyers

It affects the profitability of an industry substantially. The bargaining power of buyers refers to the ability of buyers to bring down the price of products and services offered by an organisation. If the bargaining power of buyers is high, the profitability of the industry is adversely affected. Buyers enjoy a high bargaining power if they purchase a significantly large portion of the product or service of the‰organisation. In addition, the bargaining power of buyers is high if a similar product is available with other organisations.

For example, individual buyers may have no pressure on Coke or Pepsi. However, large retailers, such as Walmart and Food Bazaar may have considerable bargaining power because of the large order quantity they place to Coke and Pepsi.

Threat of Substitute Products

This force plays a vital role in determining the profitability of an industry. Substitute products refer to products that satisfy the same need of customers as oth- er products. For example, laptop is a substitute of the Personal Computer (PC). The availability of substitutes limits the prof- it potential of an industry as the organisation cannot charge a higher price for its product. For example, if the prices of Pepsi increase, consumers would easily switch to Coke.

Competitive Rivalry Among Existing Competitors

It refers to the intensity of competition among different organisations in an industry. According to Porter, the intensity of competition within an industry depends on a number of factors. These factors are the number of competitors, growth rate of the industry, nature of the product or service, product diversity and exit barriers.

Higher the intensity of competition; lower is the profitability of an industry. Currently, Coke and Pepsi are the biggest opponents in the market with a range of predominant carbonated beverages

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Competitive Advantage Factors

Competitive advantage helps to distinguish organizations from their competitors. To be successful, organizations should have a clear competitive advantage, which can be gained based on various factors, some of which are explained as follows:

• Delivering Consistent Quality Products/ Services
  
• Managing Promises
  
• Maintaining Reliability
  
• Focusing on Target Customers
  
• Analysing Competition

Delivering Consistent Quality Products/ Services

Delivering quality products/services consistently gives a competitive edge to organizations. It requires an understanding of customer’s expectations regarding the product/service quality level. This can help organizations consistently meet and exceed the expectations of customers and gain a competitive advantage in the market.

Managing Promises

It is one of the important steps in achieving a competitive edge. To successfully meet the expectations of customers, organizations should promise only what they are confident of delivering rather than making promises which are difficult for them to fulfill. For example, if a retailer promises to provide home delivery within 24 hours, but fails to do so, the retailer will lose the customer.

Therefore, organizations should make an honest representation of their capacity to deliver the product/service through explicit means, such as personal selling and advertising, and implicit means such as the price of the product/service and appearance of the facilities.

Maintaining Reliability

Customers give extensive importance to the reliability factor associated with an organization. Organizations that fail to deliver reliable products/services fail in gaining the trust of their customers. On the other hand, an organization that emphasizes and designs its operations in a way that could gain the reliability of customers may achieve a competitive advantage.

Focusing on Target Customers

An organization to achieve a competitive advantage requires focusing on its target customers who buy its products/ services. This will help in developing a more focused operations strategy for the target customers, thereby keeping them happier and more satisfied.

Analysing Competition

Organizations need to understand market competition. This is necessary because, to gain an advantage, organizations first require knowing where their competitors stand, and what their strengths and weaknesses are.

Once an organization is clear on these factors to gain a competitive advantage, it may decide on a relevant strategy that can help not only benefit the business but also in creating an edge over its competitors.

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How to Build a Competitive Advantage

A competitive advantage is built through the strategic management of resources, capabilities, and core competencies. It also depends on how well an organization responds to opportunities and threats in the external environment, utilizes strengths, and overcomes weaknesses. To build a competitive advantage, an organization should follow certain steps, explained as follows:

• Define the Purpose of Your Business
  
• Examine Internal and External Environmental Factors
  
• Identify Your Skills and Competencies
  
• Define the Size and Market Standing of Your Business
  
• Define a Strategic Approach to Competitive Advantage
  
• Implement Strategies to Achieve a Competitive Advantage

Define the Purpose of Your Business

The first step to achieving a competitive advantage is to define the purpose of the business. The purpose of the business is often reflected through its vision, mission, goals, and objectives. This step also focuses on defining the values that the business aims to create for customers. Here, it is important to identify the target customers and their needs/problems, and how your product/service will satisfy/solve them.

Examine Internal and External Environmental Factors

An organization needs to identify and analyze various internal and external environmental factors. Internal factors help the organization in identifying its strengths and weaknesses and external factors help in recognizing the threats and opportunities present in the market.

Identify Your Skills and Competencies

At this step, businesses are required to identify the core competencies that could help them in gaining a competitive advantage. Identifying skills and competencies is important as they provide the organization access to a wide variety of markets, value to the selling product/ service, and differentiating attributes to the organization’s operations to make it difficult for competitors to imitate. The core competency of an organization could be anything. Let’s take examples of the world’s leading companies.

Apple is one of the most valued companies in the world. Its core competency is ‘unique design’. Outstanding designs of products give Apple the ability to enter various markets with huge success. Google is another company with core competency in ‘the understanding and developing of algorithms. Their ability to create great algorithms gave them a unique position in almost every market of the world, where they operate.

Netflix is another example of core competency in ‘content delivery’. The company specializes in and provides streaming media and video-on-demand online and DVD by mail. Thus, it is important to identify your strength and develop it as your core competency. You will study the concept of core competency in detail in the next section.

Define the Size and Market Standing of Your Business

An organization, to avoid becoming a marginal player in the marketplace, must define the scale of operations, sales volume, and revenue required to maintain profitability. The organization also requires identifying the number of facilities, equipment, and human resource for producing the needed volume.

Define a Strategic Approach to Competitive Advantage

This step aims at defining strategies that may help the organization in achieving a competitive advantage. For example, an organization to achieve a differentiation advantage may select a focused differentiation strategy in broad markets.

Implement Strategies to Achieve a Competitive Advantage

As the organization is now clear about its core competencies and the target market, it could focus on developing and implementing strategies to position itself in the market. Proper implementation of strategies could lead the organization to build a competitive advantage in the market.

Here, you should note that there is no fixed design to build a competitive advantage. Different organizations, even if they belong to the same industry, follow their approach to position themselves in the market. However, the aforementioned steps are some general guidelines that may help an organization build a competitive advantage in a basic manner.

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Cost Advantage and Differentiation Advantage

Competitive advantage is created by using resources and capabilities to achieve either a lower cost structure or a differentiated product. A firm positions itself in its industry through its choice of low-cost or differentiation. This decision is a central component of the firm’s competitive strategy.

Another important decision is how broad or narrow a market segment is to target. Porter formed a matrix using cost advantage, differentiation advantage, and a broad or narrow focus to identify a set of generic strategies that the firm can pursue to create and sustain a competitive advantage.

Value Creation

The firm creates value by performing a series of activities that Porter identified as the value chain. In addition to the firm’s value-creating activities, the firm operates in a value system of vertical activities including those of upstream suppliers and downstream channel members.

To achieve a competitive advantage, the firm must perform one or more value-creating activities in a way that creates more overall value than competitors. Superior value is created through lower costs or superior benefits to the consumer (differentiation).

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Features of Competitive Advantages

Not Sustainable for Long

It is not always possible for companies to sustain individual sources of competitive advantage for long (rivals copy and do everything possible to wipe out the edge through their innovations). So, the best way to maintain leadership is to continually seek new forms of advantage through constant experimentation, innovative efforts, and investments in the latest technology.

According to Kotler, competitive advantages are not sustainable but leverageable. A leverageable advantage is one that a company can use as a springboard to new advantages, much as Microsoft has leveraged its operating system to Microsoft Office and then to networking applications. Therefore, a company that hopes to endure must be in the business of continuously inventing new advantages.

Relevant Advantage

To implement the chosen strategy, a firm must have a relevant competitive advantage. To become a global player, for example, a cement company can buy or take controlling stakes in competing firms (as in the case of Gujarat Ambuja Cements). However, unless the company has some relevant competitive edge over its rivals (in terms of pricing, transport costs, distribution network, location of units in cement deficit states, etc) the acquisition strategy may not pay off in the long run. In the rush to become a major player, a firm, therefore, should not throw caution to the wind and extend its arms over the market beyond a point (remember India Cements case in the Cement industry?).

Backbone of Strategy

A successful strategy is always built around a competitive advantage. Without such a distinct advantage, it is not possible to achieve corporate objectives successfully. It becomes difficult to outwit competitors. The firm may not be in a position to price its products flexibly.

Where there is a distinct edge, as in the case of Maruti Udyog Limited (for instance in terms of sales, price advantage, cost advantage owing to its massive scale of operations, monopoly status in the lower income segment, etc.), the firm could breathe easily by playing on the price, cost, early bird status, monopoly position, brand image and a host of other factors. Likewise Bajaj Auto in scooters, and Telco in the heavy vehicles segment have acquired competitive advantages by building strong entry barriers (scale of operations, lower costs, etc.).

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Competitive Advantage Factors

Marketing

• Market Standing and Market Share (say Bajaj Auto in sports bikes, Hero Honda in motorcycles, Reliance Industries in textiles and petrochemicals, Maruti in small cars).
  
  
• Innovations in Marketing (Birla 3M, LG Electronics credit card operations of Citi Bank).
  
  
• Customer Service (Washing machine segment where each player tries to extend the warranty period by a few months).
  
  
• New Product Development (Citi Bank, HDFC Bank, Ranbaxy, Dr Reddy Labs).
  
  
• Price (Maruti Udyog in small cars, Exide Industries in batteries, Moser Baer in data storage products, Archies in the Greeting card segment, etc.).
  
  
• Distribution Channel (Hindustan Lever, Bata India, Britannia Industries, Asian Paints).
  
  
• Personnel Selling or Sales Force Effectiveness (Eureka Forbes Limited which has achieved unique success in vacuum cleaners and water purifiers through personnel selling).
  
  
• Product in terms of quality, design, technological strength, differentiation, brand image, etc.

Finance

• Assets (asset-rich companies like Reliance, TISCo, ONGC, IPCL, GAIL, IOC, etc.).
  
  
• Cash Flows (Infosys, Punjab Tractors, Aurobindo Pharma).
  
  
• Profitability (HDFC Bank, Britannia, Ranbaxy, Hindustan Inks and Resins, etc. which have earned fat profits despite the slowdown).
  
  
• Gearing and leverage (Engineers India, NMDC, Castrol, HLL, Novartis).
  
  
• Cost consciousness (ability to cut costs and adopt strategies that help companies improve their input-output ratio: Godrej Foods, Whirlpool, ITC Agrotech, ACC, Bharat Forge, MRF, etc.).

Research and Development

• Research capabilities (Cipla, Dr. Reddy Labs, Ranbaxy, Sun Pharma, Pfizer).
  
  
• Research personnel (Dr. Reddy Labs, Ranbaxy).
  
  
• The number of patents generated (Dr. Reddy Labs, Ranbaxy).
  
  
• Speed of research efforts, leading to new product launches, etc.

Personnel

• Quality of personnel (in terms of the latest knowledge, core skills, and critical experience as can be found in people working in Wipro, Infosys, Satyam, Polaris, Cipla, Dr Reddy Labs, etc.).
  
  
• Satisfaction of personnel (low attrition rates that characterize companies that have liberal stock option plans and exciting security and welfare schemes such as Infosys, Polaris, NIIT, etc.).
  
  
• Labor costs (most software producers in India).
  
  
• Industrial relations (Sundaram Fasteners, Sundaram Clayton).

Production

• The scale of operations (Reliance, BHEL, ONGC, Ranbaxy).
  
• Capacity utilisation.
  
• Productivity (Foreign banks).
  
• The extent of automation (Maruti, Hero Honda).
  
• Locational benefits (ACC, Gujarat Ambuja).