- Sustainable competitive advantage
- Strategic competitiveness
- Strategic analysis
- Sources for competitive advantage
- Build a competitive strategy
- Measure competitive advantage
Competitive strategy is how companies outperform competitors in serving the same consumer needs but more profitably. Sometimes, the strategy works, but not a few also fail. If successful, a company generates competitive advantage and above-average profits.
Success in beating competitors indicates a company has strategic competitiveness. Strategic competitiveness could be cost leadership, in which a company sells products at a standard price but has a lower cost structure than competitors.
Or, it’s a differentiation strategy. The company promotes uniqueness to attract customers willing to pay a higher price.
Whatever strategy is adopted, competitiveness is rooted in a company’s resources and ability to create value. Resources represent the tangible and intangible assets owned by the company. Meanwhile, capabilities mean the company’s ability to use these resources to create value.
Sustainable competitive advantage
Competitive advantage is a superior position because the company generates higher profits than other companies in the industry. How to achieve this varies between companies. Some rely on cost leadership as their competitive strategy. Others adopt a differentiation strategy.
If a company can maintain a competitive advantage over time, that is a sustained competitive advantage. That shows the company has strategic competitiveness, and its strategy allows it to maintain above-average profitability over time.
What are the indicators for measuring competitive advantage? You should see it in the bottom subheading. For now, let’s talk about strategic competitiveness, strategic analysis, and sources for a competitive advantage.
Strategic competitiveness is when companies successfully formulate and implement value-creation strategies, which enable them to outperform their competitors and produce superior performance. In other words, a company has strategic competitiveness if its value creation results in a competitive advantage. It requires companies to adopt a holistic approach in:
- Business strategy
- Financial strategy
- Technology strategy
- Marketing strategy
- Investor strategy
Business strategy requires companies to have a long-term commitment to set strategic decisions. In addition, companies also need to separate these decisions with tactical decisions to respond in the short term to current environmental changes.
Financial strategy focuses on three aspects, namely:
- Investment decisions, both capital investment and current investment.
- Financing decisions, including setting targets for critical financial ratios such as total debt to total capital and total debt to total assets.
- Dividend decision, which is about dividend growth and dividend payment.
Technology strategy requires companies to remain flexible with technological advances and leverage them in operations. For instance, they leverage social media and customer relationship management software. In operations, they embrace automation.
Marketing strategy is related to the marketing mix. Companies should examine and rethink their marketing mix to support competitiveness, including about:
- Product: quality, features, variety, design, brand name, packaging, and service.
- Price: prices, discounts, allowances, payment terms, and credit terms.
- Place: channels, scope, location, inventory, transportation, and logistics.
- Promotion: advertising, sales promotion, personal selling, public relations.
Investor strategy requires companies to build beneficial long-term relationships with investors. Investors are vital because they supply the capital to companies. Their interests generally fall into two, depending on what money they give.
- Investors in the stock market are concerned with stock prices and dividends, which affect their wealth.
- Investors in the debt market focus on interest and principal, which requires companies to have the ability to repay debt.
Strategic analysis examines the business environment to identify key factors and their implications for success. Then, it scans the current state and explores future possibilities, noting how significantly each element impacts success.
Strategic analysis includes:
- Internal strategic analysis
- External strategic analysis
Internal strategic analysis
Internal strategic analysis focuses on the company’s strengths and weaknesses. This requires us to dive into the following:
- Resources include assets, human resources, finance, organizational processes, knowledge, corporate culture, diversity, brand reputation, trademarks, and other intellectual property.
- Capability, namely the company’s ability to maximize resources for their best use.
External strategic analysis
External strategic analysis focuses on opportunities and threats in the external environment. However, not all external opportunities and threats are strategic. Thus, companies must sort them out and identify the most significant ones by considering two aspects:
- Which one has the most significant impact on the company
- Which is most likely to happen?
External opportunities and threats are strategic if they have the most significant impact and are most likely to occur. External strategic analysis generally uses PESTEL analysis to map external opportunities and threats.
Strategic analysis tools
The four essential tools for strategic analysis include:
- PESTEL analysis
- Porter’s five powers
- SWOT analysis
- Value chain analysis
We use it to scan the external environment and map strategic opportunities and threats. It requires us to examine the following factors:
- Political factors, such as political stability and democracy index.
- Economic factors include economic growth, interest, inflation, and exchange rates.
- Socio-demographic factors include population growth, population structure (age, ethnicity, religion, education, etc.), culture, tastes, preferences, and lifestyle.
- Technological factors include e-commerce, automation, wireless technology, and so on.
- Environmental factors, such as climate and green credentials.
- Legal factors, such as regulations on competition, employment, and consumers.
Porter’s five forces
Michael Porter identified five forces determining profitability in the industry. These five explain why the industry has higher profitability than other industries. The five forces include:
- Rivalry between companies. It is about the intense competition between companies in the market, which is affected by factors such as the number of players, market growth, and their competitive strategy.
- Bargaining power of suppliers. When suppliers have high bargaining power, it is in their interest to charge a high price at the standard quality for the inputs they supply.
- Bargaining power of buyers. Buyers want low prices and high quality. Thus, lower profits are a consequence if they have high bargaining power.
- Threat of substitution. Substitute products divert customer demand. Consumers will likely switch to them if they are of lower price or higher quality.
- Threat of new entrants. New entrants bring new supplies to the market, causing market prices and profitability to decrease.
SWOT analysis offers a framework for evaluating a company’s competitive position by considering the following:
- External opportunities and threats
- Internal strengths and weaknesses
Opportunity: favorable conditions in the external environment. It offers opportunities for companies to exploit to help them achieve a competitive advantage. Examples are:
- Stable political conditions
- Increase in productive age population
- High economic growth
- Low threat of substitution
- Low bargaining power of suppliers and buyers
Threats: unfavorable conditions in the internal environment. It exposes the company to risks. Examples are:
- Economic recession
- Rapid changes in consumer tastes and preferences
- Intense competition
- Low entry barrier
Strengths: the company’s advantages compared to competitors. Example are:
- Strong brand loyalty
- Strong balance sheet
- Innovative culture
- Flexible organization
Weaknesses: inhibiting factors for businesses to excel. Example are:
- Low customer retention
- Limited capital
- Outdated production techniques and technology
Value chain analysis
Value chain analysis provides guidance on the activities in which a company can create value. It differentiates the company’s activities into two:
- Primary activities comprise inbound logistics, operations, outbound logistics, marketing and sales, and services.
- Support activities include procurement, technology, human resource management, and infrastructure.
Companies must rethink how to create value in each activity. That may be by lowering costs or adding value to the product directly or indirectly.
Success in creating value in each activity supports value creation at the corporate level, which translates into a competitive advantage.
Sources for competitive advantage
How does the company achieve strategic advantage? Michael Porter proposes a generic strategy to explain it. And where does this advantage come from? Then, we can review the resource-based view to dissect it.
Porter’s generic strategy
Porter’s generic strategy provides a foundation for building a competitive advantage. Porter divides strategy into three categories based on the following:
- Where does the advantage come from?
- In which markets does the company adopt its strategy?
The three categories within Porter’s generic strategy include:
- Cost leadership strategy
- Differentiation strategy
- Focused strategy
The focused strategy includes two derivative strategies:
- Focused cost leadership
- Focused differentiation
Cost leadership strategy emphasizes low costs to achieve high profits. As a result, companies create value by satisfying customers in the same way as competitors but more efficiently.
A company offers a relatively standard product and sells the product at the average industry price. But, the company has a lower cost structure than the average competitor. Thus, the company can generate higher profits because even though the revenue is on average, it saves more costs.
Differentiation strategy focuses on uniqueness to obtain high-profit margins. Companies create value by providing unique offerings. It makes customers willing to pay a premium price. Thus, they can get high profits because the margin per unit is higher even though the production costs are the same as the average competitor.
Focused strategy caters to a market niche where customers have specific needs. If the above two strategies are applied to the main market where there are many customers and competitors, but under the focused strategy, the company targets a narrower market (niche market).
Customers in niche markets have more specific needs to be satisﬁed profitably. A niche market is small in size. Therefore, large companies are not interested in entering there because of the low economies of scale due to the small market size.
How can a company achieve profits when operating in a niche market? They could do with focused cost leadership or focused differentiation.
- Focused cost leadership provides customers with low prices. Companies compete on price. This strategy need not charge the lowest price in the industry. Conversely, the company charges a low price relative to other companies competing in the target market. In addition, with unique customers’ needs and wants, it is easier for companies to build brand awareness.
- Focused differentiation uniquely serves customers by enhancing the product with unique features to make it stand out in the marketplace. The key is the product must meet market customer requirements and be better than what competitors offer.
Competitive advantage stems from the company’s resources and capabilities. Both are determining factors for creating superior value.
- Resources are the company’s specific assets. They are unique and available limited or not owned by competitors such as patents, intellectual property, brand equity, and company reputation. Companies exploit them to create cost or differentiation advantages.
- Capability is the company’s ability to use resources effectively. It is rooted in aspects such as leadership style, innovation culture, and organizational agility. They are more difficult to imitate than resources because they are embedded in organizational routines. And they are also not documented as procedures.
Core competencies are unique resources and capabilities that differentiate a company from its competitors. It generates a competitive advantage if it contributes to creating value, is rare, and is non-substitutable.
Build a competitive strategy
Strategic management underlies the steps to create value and achieve sustainable competitive advantage. It includes formulating, implementing, and evaluating context-relevant strategies. If it successfully leads to value creation, the company has strategic competitiveness.
- Business environment analysis. Companies scan external opportunities and threats and internal strengths and weaknesses. The results become input in developing strategic plans and objectives to maximize opportunities using internal strengths and minimize external threats to company weaknesses.
- Strategy formulation. The company formulates overall long-term goals for the company and develops policies and tactics to achieve these goals.
- Strategy implementation. The company executes policies and plans across all business functions. It requires synergy between them to achieve company goals.
- Evaluation. The company establishes a mechanism to review whether strategies and their implementation are successful. In addition to taking corrective steps, evaluation is essential to ensure the strategy continues to be relevant to the external environment, which often changes from time to time. If changes are required, the process repeats back to point 1.
Measure competitive advantage
Experts propose return on invested capital (ROIC) as an indicator to measure competitive advantage. For example, suppose a company achieves a sustainable competitive advantage. In that case, its ROIC is higher than the industry average from year to year.
We calculate ROIC by dividing net profit by the capital invested in the company. Its mathematical formula is:
- ROIC = Net profit / Capital invested
In another approach, net profit might be replaced by net operating profit after tax (NOPAT). Meanwhile, invested capital equals total equity plus total debt.
ROIC above the average indicates the company has succeeded in generating higher profits for any capital contributed by investors (creditors and shareholders). The company generates high net profit, which is achieved by maximizing revenue while minimizing costs. We can relate it to Porter’s generic strategy as follows.
- Cost leadership: Revenue equals average competitors. But, costs are lower than the average competitor. Thus, profits are higher than the average competitor.
- Differentiation: Revenue is higher than the average competitor. The cost is the same as the average competitor. Thus, profits are higher than the average competitor.