The nature and sources of competitive advantage
(Originally published on the OUBS Blog)
Competitive Advantage is defined by Grant as follows:
_When two or more firms compete within the same market, one firm possesses a competitive advantage over its rivals when it earns (or has the potential to earn) a persistently higher rate of profit._
Competitive advantage emerges from internal sources where companies have greater creative or innovative capabilities and from external sources arround changing customer demands, prices and technological change.
Any change in the external environment brings with it an opportunity for profit and entrepreneurship is the ability to identify and respond to that opporunity. With markets becoming increasingly turbulent, this ability to respond can be said to be a competitive advantage in itself, if it is a better ability in relation to other companies that is. It also means that you anticipate future changes and hence you need information (resource) and flexibility to respond (capability). This moves organizational structure, decision-making systems, job design, and culture to the center of an organizations capabilities. The faster you can respond, the less you need to rely on forecasts. The example of Dell fits well here, as they have less than 14 days of inventory and can respond to changes quickly.
Innovation is not only a competitive advantage but also a capability that allows to overturn the competitive advantage of other firms. Gary Hamel argues that business concept innovation is the foundation for value creation in the new economy. These new business concepts will, as of McKinsey and Co., often involve a reconfiguration of the value chain of the industry in question. Dell for example does not deliver Sony monitors bought via their online store. Sony does. They never become inventory for Dell.
Sustaining Competitive Advantage
The greatest threat here is imitation, hence barriers of imitation must be established. To successfully imitate a firm needs to identify the advantage and have an incentive to imitate it. Then it needs to be able to diagnose the advantage and acquire the resources needed.
A company trying to set-up barriers can use limit pricing to have such low prices as to not attract new entrants. Against incentives, deterrence (threat of retaliation) can be used but must be credible (see Microsoft). If your threat is aggressive price cuts you need to have excess capacity or inventories. Preemption is another option, meaning that a company takes up all existing and potential niches, helped with capacity build up in advance of growth or patents for example. Preemption depends on a small number of viable competitors and a first mover advantage in the market.
The more facets or dimension your competitive advantage has, the more difficult the diagnosis will be (casual ambiguity). This leads to uncertain imitability.
Where capabilities are based on organizational routines, acquiring these capabilities will take a lot of time. Resources are best if they are not mobile and take a lot of time to acquire. A first-mover advantage is linked to the adage “success breads success”. Here economies of learning, reputation, standard setting and scarce resources are important.
Competitive Advatange in Different Market Settings
In efficient markets, competitive advantage is absent. Here prices reflect all available information and information flows freely. Beating the market consistently is not possible.
In trading markets competitive advantage can come from:
\- Imperfect availability of information
\- Transaction costs
\- Systematic behavioral trends and those that best diagnose them
\- Overshooting … which often means that acting in the opposite direction to market swings is a potential for more profit
In production markets,the greater the heterogenity in the endowments of resources and capability of differnet firms the greater the potential for a competitive advantage.
\- if there is a lot of change in your industry, the potential for new competitive advantage is great.
\- The greater the choice criteria of your customers, the more likely a niche can be found
\- for sustainability you need: imperfection of information, opportuinities for deterrence and preemption, difficulties of resource acquisition
Types of Competitive Advantage
Here you have cost advantages or differentiation advantages. See Table 7.2 for more information and examples.
Michael Porter has defined three generic strategies: cost leadership, differentiation and focus. In most industires, market leadership is held by a firm that has merged differentiation with low cost. Nokia might be a good example here. Also, sometimes, in the existence of scale economies, market share leaders can improve their relative cost position.