competitive advantage

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Competitive advantage is what enables a business organization to thrive. It is the objective of strategy. It is the combination of elements in the business model which enables a business to better satisfy the needs in its environment, earning economic rents in the process.

Resource-based vs. positional view of advantage --
In the realm of strategy, there are roughly two views of the basic source of competitive advantage, the resource-based view and the positional view. The first sees the capabilities of the firm as its primary source of advantage while the latter contends that position within an industry is the source of advantage. Michael Porter is associated with the positional view. Gary Hamel and C. K. Prahalad are associated with the resource view. The resource based view has tended to dominate strategy since the late 1980s with the attention placed on capabilities, core competencies, distinctive competencies, dynamic capabilities, and organization evolution. As dominant companies also shape industries, there is the possibility that resources shape position as well. See positional view of strategy and resource view of strategy.

Advantage and sustained advantage (Barney, 1991) --
A firm has a competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitors. A firm has a sustained advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitors and when these other firms are unable to duplicate the benefits of this strategy. A firm enjoying a sustained competitive advantage may experience these major shifts in the structure of competition, and may see its competitive advantages nullified by such changes. However, a sustained competitive advantage is not nullified through competing firms duplicating the benefits of that competitive advantage.

To have the potential of sustained competitive advantage, a firm resource must have four attributes --

  • it must be valuable, in the sense that it exploit opportunities and/or neutralizes threats in a firm's environment
  • it must be rare among a firm's current and potential competition
  • it must be imperfectly imitable. This can be due to three reasons: 1) the ability of a firm to obtain a resource is dependent upon unique historical conditions, 2) the link between the resources possessed by a firme and a firm's sustained competitive advantage is causally ambiguous, or 3) the resource generating a firm's advantage is socially complex, such as cultural factors that enable a unique synergy amongst managers.
  • there cannot be strategically equivalent substitutes for this resource that are valuable but neither rare but neither rare or imperfectly imitable.

These attributes of firm resources can be thought of as empirical indicators of how heterogeneous and immobile a firm's resources are and thus how useful these resources are for generating sustained competitive advantages. Note that physical resources are not on the list. Physical technology, evne complex physical technology, is generally imitable.

Finally, sustainable advantage most likely cannot arise from a formal planning process, but is due to emergent strategy.

Demand-based perspective of competitive advantage --
Adner and Zemsky (2007) present an analysis of sustainable competitive advantage emphasizing the demand-side factors. In particular, the effects of decreasing marginal utility and consumer heterogeneity across market segments is shown to affect the sustainability of competitive advantage through shifts in consumer willingness to pay.

    Competitive advantage definition -- The authors define competitive advantage as superior value creation -- with the firm's ability to sustain competitive advantage equivalent to its ability to sustain added value.

The demand-side drivers are 1) marginal utility from performance improvements, 2) consumer taste for quality, and 3) the extent of consumer heterogeneity. At the level of firm resources, competitive advantage erodes not only because imitation undermines the uniqueness of resources, but also because consumer valuation of firm differences declines due to effects of decreasing marginal utility. At the level of firm positions, strategic heterogeneity is shown to be rooted not only in differences between firms' internal resources but also in the extent of consumer heterogeneity in the firms' demand environment.

The Principle of Competitive Advantage --
Success is based on inventing an offering that addresses a real scarcity in the world, charging a price for it, and inventing a way of making it available that is cheap enough to leave a high margin.
-- Kees van der Heijden, Back to basics: exploring the business idea, Strategy & Leadership, 29.3, 2001

Sources of Competitive Advantage --
Differentiation that commands an attractive price or a structurally lower cost to produce a non-differentiated product.
-- Porter

Specialization and capabilities (Kay, 2004) --

  • Specialization -- Specialization, with its division of labor, produces economies of scale. Specialization can overrun its usefulness, such as when seeking further scale becomes a disadvantage, as was the case for Ford in the first half of the 20th century. As firms have often reached and exceeded the limits of specialization in providing value, they have shifted to capabilities.
  • Capabilities -- Capabilities, intrinsic capabilities, or distinctive capabilities include secrets of value, established business networks, brands, general management skills, engineering competency, innovation which is not easily copied or ongoing innovation which is not easily caught up with. Unique capabilities provide an opportunity to provide unique value and receive the gains from providing that value.

Indicator of Competitive Advantage --
A business organization with a competitive advantage is more profitable than its rivals while this profitability exceeds its cost of capital. Profits in excess of the cost of capital are called economic rent. Sustained economic rents are prima facie evidence of a competitive advantage.

Elements of Competitive Advantage --

  • Uniqueness - finding unique opportunities and solutions is about imagination, insight, foresight, and the courage to pursue it. Unique is new, different, but most important of all, untested and unproven. By the time a unique solution is validated as profitable, it is no longer unique for the next company. Also, if it is a unique business model or business capability, it is likely unapproachable, in the short-term, by competitors.
  • Strategic Focus - Strategic focus comes about from marrying distinctive competency and purpose to form a superior value proposition. Strategic focus is about developing a longer view of competitive advantage with a combination of purpose, competency, and value proposition. This creates an internal environment that has the confidence and implicit support to continue to perfect and develop that focus through creating stronger competencies and further perfecting the value proposition.
  • Strategic Intent/Vision/BHAGs - Strategic intent challenges and guides the organization to achieve the unachievable by having a clear focus on outlandish objectives which require the development of new capabilities to achieve.
  • Innovation - Innovation is inventiveness put into profitable practice. In an evolving economy, the business organization must innovate at a rate that meets or exceeds its environment in order to sustain a competitive advantage.
  • Continual Innovation - Making innovation as an ongoing process on all fronts.
  • Democratic Principles - Democratic principles are needed to fully engage the active participation of diverse thinkers from across the organization. Broad and diverse participation improves innovation.
  • Strategic Management as a self-improving learning process - Strategic management must become, amongst other things, a learning and self-improvement process for the organization.
  • Dynamic Capabilities - Sustainable competitive advantage is ultimately based on dynamic capabilities, the capability to produce and utilize new capabilities on a continuous basis.

John Kay; competitive vs. comparative advantage --
Competitive advantage is an absolute advantage of a business organization to offer greater value to its customers. Businesses should seek to find their competitive advantage, as opposed to their comparative advantage. They should focus on what they can do better than any other business. This may be something different than what they are best at doing. This maximizes the value of a business's economic function.

Porter's framework for competitive advantage
Environmental determinants of advantage (Porter, 1991) --
Firms create and sustain competitive advantage because of the capacity to continuously improve, innovate, and upgrade their competitive advantages over time. Upgrading is the process of shifting advantages throughout the value chain to more sophisticated types, and employing higher levels of skill and technology. Successful firms are those that improve and innovate in ways that are valued not only at home but elsewhere. Competitive success is enhanced by moving early in each product or process generation, provided that the movement is along a path that reflects evolving technology and buyer need, and that early movers subsequently upgrade their positions rather than rest upon them. In this view, firms have considerable discretion in relaxing external and internal constraints.

Four broad attributes of the proximate environment of a firm have the greatest influence on its ability to innovate and upgrade. These attributes shape the information firms have available to perceive opportunities, the pool of inputs, skills and knowledge they can draw upon, the goals that condition investment, and the pressures on the firm to act. The environment is important in providing the initial insight that underpins competitive advantage, the inputs needed to act on it, and to accumulate knowledge and skills over time, and the forces needed to keep progressing.

  • Factor conditions -- general, specialized, generic, local, global, natural resources, labor
  • Firm strategy , structure, and rivalry -- intensity of competition, susceptibility to substitutes, actual rivalry, potential rivalry
  • Demand conditions -- customer demands, sophistication, fickleness
  • Related and supporting industries -- suppliers, customers, synergy, dependency

Early (1960s) answers to the determinants of a firm's success (Porter, 1991) --

  • internally consistent set of goals and functional policies that collectively define the business's position in the market
  • this internally consistent set of goals and policies aligns the firm's strengths and weaknesses with the external (industry) opportunities and threats -- aligning the company with its environment
  • a firm's strategy be centrally concerned with the creation and exploration of its so called distinctive competencies -- unique strengths a firm possesses.

Solving the cross-sectional problem of strategy, getting to an operational understanding of competitive advantage (Porter, 1991) --
The cross-sectional problem refers to having the understanding of what underpins a competitively advantageous position in an industry.

Success requires the choices of --

  • a relatively attractive position given industry structure
  • the firm's circumstances
  • the positions of competitors, and
  • bringing all the firm's activities into consistency with the chosen position.

Competitive advantage grows out of discrete activities. A firm's strategy is manifested in the way it configures and links the many activities in its value chain relative to its competitors. Discrete activities are part of an interdependent system in which the cost and effectiveness of one activity can be affected by the ways others are performed. These interdependencies are called linkages. Knowing this still does not operationalize competitive advantage. For that, the competitive advantage drivers of the activities must be identified.

Drivers of competitive advantage in an activity --

  • scale
  • cumulative learning in the activity
  • linkages between the activities and others
  • the ability to share the activity with other business units
  • the pattern of capital utilization in the activity over the relevant cycle
  • the activity's location
  • the timing of investment choices in the activity
  • the extent of vertical integration in performing the activity
  • institutional factors affecting how an activity is performed such as government regulations
  • the firm's policy choices about how to configure the activity independent of other drivers

Solving the longitudinal problem of strategy, getting to an operational understanding of competitive advantage (Porter, 1991) --
The cross-sectional solution solves the problem of achieving a desirable, competitively advantageous, position. That leaves the longitudinal problem of getting to advantage again and again, even initially. There are two factors at work here -- initial conditions and managerial choices. Since initial conditions have come about from past managerial choices, ultimately the longitudinal problem is solved only by managerial choices. This requires management that is competent to achieve a competitive advantage. Their strategic thinking, strategic management framework, and strategic management process execution are key factors of management's strategic management competency.

Rumelt's framework for competitive advantage
See firm theory of for Rumelt's explanation of competitive advantage in the context of his strategic theory of the firm.

Competitive advantage factors --
For an in depth list of competitive advantage factors to stimulate activity design, see competitive advantage factors.

Measuring Competitive Advantage --
See enterprise value and the Barney reference there.