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.

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

  1. Pingback: The Value of Business Advisors and Consultants to SMEs « Anthony Pratt

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