Competitive Advantage

What is a Competitive Advantage?

A competitive advantage is an attribute that enables a company to outperform its competitors. This allows a company to achieve superior marginsOperating MarginOperating margin is equal to operating income divided by revenue.  It is a profitability ratio measuring revenue after covering operating and non-operating expenses of a business.  Also referred to as return on sales compared to its competition and generates valueValue AddedValue Added is the extra value created over and above the original value of something.  It can apply to products, services, companies, management, and for the company and its shareholders.

A competitive advantage must be difficult, if not impossible, to duplicate. If it is easily copied or imitated, it is not considered a competitive advantage.

Examples of Competitive Advantage

1. Access to natural resources that are restricted from competitors
2. Highly skilled labor
3. A unique geographic location
4. Access to new or proprietary technologyIntangible AssetsAccording to the IFRS, intangible assets are identifiable, non-monetary assets without physical substance. Like all assets, intangible assets are those that are expected to generate economic returns for the company in the future. As a long-term asset, this expectation extends beyond one year.
5. Ability to manufacture products at the lowest cost
6. Brand image recognition

Constructing a Competitive Advantage

Before a competitive advantage can be established, it is important to know the:

1. Benefit: A company must be clear what benefit(s) their product or service provides. It must offer real value and generate interest.
2. Target Market: A company must establish who is purchasing from the company and how it can cater to its target market.
3. Competitors: It is important for a company to understand other competitors in the competitive landscape.

To construct a competitive advantage, a company must be able to detail the benefit that they provide to their target market in ways that other competitors cannot.

Strategies for Competitive Advantage

There are three strategies for establishing a competitive advantage: Cost Leadership, Differentiation, and Focus (Cost-focus and Differentiation-focus).

#1 Cost Leadership

In a cost leadership strategy, the objective is to become the lowest-cost producer. This is achieved through large-scale production where companies can exploit economies of scale.

If a company is able to utilize economies of scale and produce products at a cost lower than that of its competitors, the company is then able to establish a selling price that is unable to be replicated by other companies. Therefore, a company adopting a cost leadership strategy would be able to reap profits due to its significant cost advantage over its competitors.

#2 Differentiation

In a differentiation strategy, a company’s products or services are differentiated from that of its competitors. This can be done by delivering high-quality products or services to customers or innovating products or services.

If a company is able to differentiate successfully, the company would then be able to set a premium price on its products or services.

#3 Focus

In a focus strategy, a company focuses on a narrow target market segment. This strategy is successful if the company is able to successfully create products/services that can cater to these customers. The focus strategy also has two variants;

1. Cost-focus: Lowest-cost producer in a narrow market segment
2. Differentiation-focus: Differentiated products/services in a narrow market segment

Competitive Advantage in the Marketplace

Three great examples include:

1. McDonald’s: McDonald’s main competitive advantage relies on a cost leadership strategy. The company is able to utilize economies of scale and produce products at a low cost and, as a result, offer products at a lower selling price than that of its competitors.
2. Louis Vuitton: Louis Vuitton’s advantage relies on both differentiation and a differentiation-focus strategy. The company is able to be a leader in the luxury market and command premium prices through product uniqueness.
3. Walmart: Walmart’s advantage relies on a cost leadership strategy. Walmart is able to offer “everyday low prices” through economies of scale.

Importance of Competitive Advantage

A competitive advantage distinguishes a company from its competitors. It contributes to higher prices, more customers, and brand loyalty. Establishing such an advantage is one of the most important goals of any company.

In today’s world, it is essential to business success. Without it, companies will find it difficult to survive.

Video Explanation of Competitive Advantage

Watch this short video to quickly understand the main concepts covered in this guide, including the definition of competitive advantage and how companies create it using various business strategies.

Other Resources

To continue learning and advancing your career, see the following free CFI resources:

• Absolute AdvantageAbsolute AdvantageIn economics, absolute advantage refers to the capacity of any economic agent, either an individual or a group, to produce a larger quantity of a product than its competitors. Introduced by Scottish economist, Adam Smith, in his 1776 work, “An Inquiry into the Nature and Causes of the Wealth of Nations,”
• Opportunity CostOpportunity CostOpportunity cost is one of the key concepts in the study of economics and is prevalent throughout various decision-making processes. The opportunity cost is the value of the next best alternative foregone.
• MonopolyMonopolyA monopoly is a market with a single seller (called the monopolist) but many buyers. Unlike sellers in a perfectly competitive market, a monopolist exercises substantial control over the market price of a commodity/product.
• Law of SupplyLaw of SupplyThe law of supply is a basic principle in economics that asserts that, assuming all else being constant, an increase in the price of goods will have a corresponding direct increase in the supply thereof.  The law of supply depicts the producer’s behavior when the price of a good rises or falls.