Competitive Advantage: What is it? Is it dangerous? Does it hurt? Do I really need to understand it?

In answer to these questions, “Yes it can be dangerous”. If your competitors have significant competitive advantages over you, they win business you don’t win and they take customers, you’ve previously won, away from you; and, “Yes that can hurt”. So, if you’re involved in the management of a business; then, “Yes you do need to understand it”.

As a scene setter, consider a static market for a particular widget; its neither growing nor shrinking. There are only two suppliers, A & B; both have an equal market share; both sell at the same price; both offer the same specification, quality, service etc. It’s a completely level playing field. OK it’s unrealistic; but bear with me, because it provides a baseline for what follows.

One day, A upsets the applecart. He cuts his selling price by 10% and consequently wins over some of B’s customers. He wins them because his price is lower; and so, some of B’s customers think it is to their advantage to change supplier. A has, therefore, created a competitive advantage.

B could respond by reducing his price by 10% to be the same as A’s. By doing this he would eliminate A’s competitive advantage. But, whilst this may prevent him from losing any more customers, it may not be enough to win back the customers he’d already lost, because he would not have given them a reason to return to him. He would not have created a competitive advantage over A.

Furthermore, A and B would both be selling at 10% below their original prices and both would have suffered margin erosion. For A, that may have been OK because he would have had more sales than B and greater production output. However, B would have suffered a loss of both margin and volume; so he would have to do something more, than just cut his price by 10%, if he wanted to create a competitive advantage and win back his lost customers.

B could reduce his price by 20%; and this would give him a competitive advantage over A. He would then have a good chance of not only winning back his lost customers but also stealing some of A’s own customers. Under these circumstances, B would generate the greater volume; and both A and B would suffer substantial margin erosion. But the pressure would no longer be on B; it would be A that then needed to find a competitive advantage.

There is of course a limit to how far either A or B could reduce their prices before they started making losses. A price war can, therefore, only go so far. However, if A has a lower cost base than B, A can reduce his prices further than B and still make a profit. So A’s lower cost base provides him with another competitive advantage, because ultimately he can drive B into a loss making position, whilst continuing to make profits himself. On the other hand, if B has a stronger balance sheet, with greater liquidity, he may be able to withstand making losses for longer than A; so his balance sheet would then give B a competitive advantage. He could reduce prices to the point, where both businesses were making losses, in the knowledge that he could withstand those losses for a much longer period than A.

But let’s backtrack. Let’s suppose that when A reduces his price by 10% B doesn’t reduce his price, but changes his production process, so that he can give his customers a much quicker delivery. Remember, at the start, we had a level playing field, so both suppliers were giving the same delivery period. Let’s say it was four weeks; but after his production changes, B is able to provide a two week delivery. He has now created a competitive advantage over A. The question, however, is, “does B’s shorter delivery period compensate for his higher price”? The answer, of course, isn’t straightforward. For some customers a shorter delivery period will be more important than for others; so B may win back some of his old customers from A, but not all of them. However, he may also win some of A’s customers, who need a quicker delivery and are prepared to pay more for it.

Let’s now complicate this further. Let’s say that, whilst B continues to offer a quicker delivery, his delivery vehicles are old and suffer from lots of breakdowns; so his reliability isn’t good. Whereas A has a brand new fleet of vehicles and, although his delivery period is longer, he is much more reliable. This reliability factor provides A with a competitive advantage because for some customers, reliability will be more important than a shorter delivery period.

I could continue with many further examples of these two suppliers creating competitive advantages over each other. From the original level playing field, changes in quality, price, delivery, specification, design, packaging etc. all provide opportunities to create competitive advantages. However, I’ve also highlighted issues that are not specifically product or service related, but which still provide a competitive advantage; and I mentioned the cost base, the strength of the balance sheet and the quality of the transport fleet.

What I hope the reader is beginning to see, is that competitive advantage is not just to do with product, price and service, as important as those things are. Competitive advantage can be gained in all areas of the business. State of the art production machinery, better IT systems and processes, a more effective sales force,  better marketing, a better trained workforce, better PR, better handling of complaints, better communication with customers, higher staff morale, stronger brand values; the list is endless and may differ from one type of business to another and from one market sector to another. But competitive advantage can be gained in just about every facet of the business.

Of course customers have different priorities; and what may be important to one may be less important to another. So each customer makes his/her decision based on those factors, which are important to them. But a market consists of a collection of customers selecting products and/or services from a group of suppliers; and the combined priorities of those customers creates a weighting of the combined range of competitive advantages of the suppliers. In other words, it ranks the importance of the various competitive advantages of all the suppliers. The supplier whose competitive advantages are nearest to the weighting created by the customers is, therefore, in the strongest position to exploit the market. Similarly, the supplier, whose competitive advantages are furthest from the weighting created by the customers, is in the weakest position to exploit the market.

But; and there is always a but! Nothing is constant. The weighting tends to change and can be influenced by all sorts of factors; the season, the market cycle, the economic cycle, technical innovation, fashion, political factors to name but a few. So the supplier who is in the strongest position today needs to adjust to those changes correctly, to remain in that position tomorrow. Gaining and retaining competitive advantage is, therefore, a never ending process – a journey without an end.

My final comment about competitive advantage is that it is everything that defines a business. Take any market; look at the market leaders and look at how much better they are right across the piece than those trailing at the bottom. Relative to size, they tend to have the lowest costs, sell at the highest prices and make the most money. As you move down the scale, suppliers tend to become increasingly price dependent for their sales, because price is increasingly the only competitive advantage that they have. In these difficult economic times, where there is over supply in many markets, it is inevitable that there will be a much greater focus on price; but the more businesses can build competitive advantages other than price, the greater their ability to withstand the downward pressure on price; and the greater their ability to remain profitable and sustainable.

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Organisational & leadership defects that can bring your business down

This is my last blog, in this series, of why businesses fail; and, in it, I’m looking at how the wrong organisational structure and leadership can drag a business down. I still plan to keep blogging; but on a range of different business related topics.

OK you’ve just started a new business. It’s just you; no partners, no employees; just you. You make every decision; you do everything. If you make good decisions and things work well, it’s your success. If you make bad decisions and things go wrong; it’s your fault. Now think of a huge corporate such as BP, Microsoft or  Daimler AG (Mercedes-Benz). These organisations employ tens of thousands of  people, in many different countries, throughout the world. They have complex  organisational structures, with devolved responsibilities and controlled autonomy. But at one time, when they started out, they too were little more than one man bands. But they grew, they evolved, they were driven by their leaders and their organisation structures developed. That will also happen to a few – a very few – businesses starting out today; but for most it’s a dream that will never come true. However, most small businesses, starting out, can reach a reasonable level of controlled growth and sustainability, with the right organisational structure and leadership.

Now back to the business you’ve just started. Things go well; you’re working 24/7 and you need to offload some of the work because you can’t cope; so you employ someone to do some of the more basic tasks. Things continue to go well and you employ more people to do more basic tasks. But as growth continues, you run into two problems. The first is that you are now managing a growing group of people, all performing basic tasks; and managing them is taking up more and more of your time. So you have less time to devote to the more important issues within the business. The second is that the number of more important issues is also increasing. So you’re being squeezed. And this is the first real test of leadership because you’ve now reached the point, where giving people tasks to perform is not enough. You need to delegate responsibility.

Instead of you managing some of your employs directly, you appoint a supervisor to manage them on your behalf; and, as you can’t handle some of the more important issues either, you appoint a manager to take over some of those responsibilities. So gradually an organisation structure starts to emerge. You may initially have one or two managers taking responsibility for key portfolios such as sales, production or finance & admin; and there may be one or two supervisors reporting to each of them. In time, you may appoint directors to take board responsibility for specific portfolios and they may have structures beneath them.

However, a growing organisation structure presents some significant challenges. And it’s where things can, and sometimes do, go badly wrong. So let’s consider some of them. The business is your baby; and letting go can be very hard. Giving employees tasks to perform is easy. Giving managers responsibility and accountability is much more difficult. You have to allow them freedom to do things differently from how you would do them, and then judge them on results. You have to give fewer instructions but provide more support and guidance. Furthermore you have to start managing through your managers not across them; and you need to observe protocols that mean you cannot undermine them by giving instructions directly to their subordinates. It’s a huge culture change for you; and its one that some owner managers never really make, thereby condemning their businesses to remain small, weak and vulnerable.

As the organisation grows, the skills that it needs change. For example, a very small business needs a simple bookkeeping capability. You may do this yourself; a member of your family or a friend may do it; or you may outsource it. However, as the business grows, you’ll need a full time bookkeeper. Further growth may require separate sales ledger and purchase ledger clerks. Then you may need a financial controller, as the business becomes more complex and demanding. Eventually you may appoint a financial director. Depending on the type of business, there will probably be parallel situations in other areas such as sales and production. Getting the timing of these changes right is all important. Too soon and you increase your costs unnecessarily; too late and the organisation can become dysfunctional. The choice of individual is also all important. A good bookkeeper may not be a good financial controller; and a good financial controller may not be a good financial director. The skills, whilst complimentary are different. So there is a balance to be struck between, providing career advancement to existing staff, and recruiting, from outside, to bring in the right skill sets for the business. When businesses get this largely right, they can grow and prosper; but when they get it wrong they can and do fail.

“Letting go” and the “development of the organisation” are closely linked. And some owner managers find it very difficult indeed. Some just can’t let go and continually interfere with everything, which creates chaos and low morale. Some place weak appointees in key positions so they can control them and keep the costs down; whereas the business probably needs stronger, more experienced and more independent minded people, who will probably be more expensive. Some appoint the right people but just don’t empower them. All of these mistakes can prove fatal for a business; and all are avoidable. Some businesses do create organisation structures that are right for the business, at the time, and work very well. But they then fail to adapt to changing circumstances. Systems, process and IT developments that change the way the business needs to be managed; diversification that requires different skills and a different balance of resources; strategic change, such as the outsourcing of a key function. These are all examples of changes that often require the re-appraisal of the organisation structure and where failure to adapt can have serious consequences.

The balance within the organisation can also prove problematic. I’ve quite often seen businesses owned and managed by someone with a particular skill set in, for example, sales or production, who skews the level of resourcing in favour of the area of the business he/she knows best. Consider a sales orientated owner manager, who creates a large sales organisation, whilst under resourcing other areas of the business. Lots of sales are generated but the fulfilment falls down and customers are lost. So even more resources are then put into sales to compensate, rather than address the problem of under resourcing elsewhere. Believe me, it happens and it brings businesses to their knees.

Managing a growing organisation isn’t easy because you’re dealing with the aspirations, feelings and emotions of your employees. There will always be some, who you have to disappoint because they don’t get the promotion they think they deserve. There will be the barrack room lawyers, who spend their time trying to undermine every move you make and there will be those who underestimate their true potential and need encouragement to be more ambitious.

This is where leadership is so important. Some owner managers get it badly wrong by acting the bully, by taking a cavalier attitude to hiring and firing, balling people out in public, disregarding protocols and being generally aggressive, unpleasant and over demanding. Others do the opposite. They don’t like upsetting their staff; they accede to staff demands too easily and without taking full account of the consequences. They avoid confrontation at all costs and, in effect, lose control of the business. Getting the balance right is so important because any change, be it organisational or strategic, needs the buy in of the employees and their  wholehearted support in order to make it work. Many businesses that I’ve seen fail, have been nowhere near achieving that balance.

The right organisational structure that adapts to growth and to change, within both the internal and external environment, is an essential part of maintaining a healthy sustainable business; as is strong positive leadership. But when the organisation structure is wrong and when leadership is lacking, the survival of the business will be at risk. In this series of four articles, I’ve highlighted some of the more common reasons for businesses going bust. And I’ll finish with the same message, with which I started, “Most business failures are own goals and could have been prevented”. So if you see the early signs of things going wrong, don’t ignore them. Face them head on and bring in help NOW.