What is competitive advantage? Definition and meaning

Definition and meaning Competitive advantage is a feature that gives a company an edge over its competitors – something to help it compete more effectively against its rivals. It could be a superiority that a commercial enterprise gains when it is able to provide the same value as other companies can, but at a lower price or with more attractive credit terms.

In some cases, a company with a competitive advantage can charge more by providing greater value through differentiation, i.e. results of efforts to make a firm’s brand or product stand out as a provider of unique value to consumers compared to what the rest of the market is able to offer.

The term ‘competitive advantage’ can be used at individual, company or country levels. This article focuses on its meaning at company level, in which conditions allow the business to generate either greater margins or superior sales than its rivals.

Competitive advantageCompetitive advantage exists between businesses, nations, human beings, in horse-racing, and even in nature – observe the male of most animal species competing for a mate; the one with the most strength or spectacular colors or song is usually the winner.

When a company sustains profits that are greater than the average for its industry, it is said to possess a competitive advantage over its competitors. The goal of the vast majority of firms is to achieve a sustainable competitive advantage.

According to the Financial Times’ glossary of business terms, competitive advantage is:

“When a company has an advantage over another in the provision of a particular product or service. For instance, a carmaker may have a competitive advantage because its cars break down less often – in other words are of a higher quality – even though they may be more expensive.”

The term should not be confused with comparative advantage, an economic theory in which nations become wealthier by specializing and trading rather than trying to become self-sufficient.

Many reasons for a competitive advantage

A firm may have a competitive advantage due to its quality, price, brand, distribution network, location, intellectual property, customer support, cost structure, access to natural resources, supply of suitably-skilled labor, access to new technology, etc.

It provides an edge over the competition and an ability to generate more value for a business and its shareholders.

In customers’ minds, a competitive advantage is what makes a company superior to the competition. This method of success was first utilized by businesses, but can be adopted by any person or entity.

Buzz Aldrin - Competitive Advantage quoteBuzz Aldrin, who in 1969 became the second human to walk on the Moon, once said: “NASA needs to focus on the things that are really important and that we do not know how to do. The agency is a pioneering force, and that is where its competitive advantage lies.” (Image: Wikipedia)

Competitive advantage – three determinants

Before determining what your competitive advantage is, you need to know these three determinants: 1. Competition. 2. What you produce. 3. The target market.

Your Target Market: which customers should you be aiming at? It is crucial to know who exactly is currently buying and will purchase from you in the future. It is also important to determine what you need to do to make them happier, in order to boost how much they spend.

For example, today printed newspapers know that their target market is older individuals, because younger adults prefer to get their news online. Many newspapers did not prepare for this evolution and consequently died.

What You Are Providing: you must be clear on what type of product or service you are providing, only then can you focus on making sure it is something that offers real value.

You need to list all the advantages and benefits that your good or service provides consumers. For example, since the Internet emerged, retailers have had to redefine what a shopping experience is for the customer.

The Competition: you need to know everything you can about rival companies, and also everything your customers do to meet that particular need.

Major retailers thought their competition was other major retailers, however, they soon realized that it was, in fact, the online world. Suddenly, the market opened up to millions of smaller players with considerably lower costs and innovative ways of enhancing the shopper’s experience.

Make sure you are completely familiar with every aspect of these three determinants. They will help you identify the benefits that you are better able to provide to your target market than your competitors – that is your main competitive advantage.

George Soros - Competitive Advantage quoteGeorge Soros is a Hungarian-American billionaire. He is known as the ‘Man Who Broke the Bank of England’ because of his $10 billion short sale of the British pound in 1992, when he made a profit of $1 billion during the Black Wednesday currency crisis. He is among the thirty richest individuals in the world. (Image: georgesoros.com)

Value proposition

When understanding competitive advantage, value proposition is important. A value proposition is a marketing or business statement that a commercial enterprise uses to summarize why a consumer or potential customer should use a service or buy a product.

If the value is effective, it may produce a competitive advantage in the good or service.

The value proposition will also increase customer expectations and choices.

Prof. Michael PorterProf. Michael Porter has authored 18 books and several articles including Competitive Advantage, Competitive Advantage of Nations, On Competition, and Competitive Strategy. He is the most cited author in business and economics globally. (Image: thefamouspeople.com)

Two types of competitive advantage

The famous American academic, Michael Porter, the Bishop William Lawrence University Professor at Harvard Business School, known for his theories on business strategy, economics and social causes, identified two basic types of competitive advantage: 1. Cost Advantage. 2. Differentiation advantage.

Cost Advantage: exists when a company can deliver the same benefits as its competitors, but at a lower price.

This can be achieved through several factors such as superior technology, efficient processes, waste reduction or elimination, a skilled workforce, a favorable location, and access to cheaper inputs.

Differentiation Advantage: is when a business delivers benefits that exceed those of its competitors’ products. In other words, the unique features or benefits of a product or firm set it apart and above those of its competitors – in the eyes of the customer.

Prof. Porter published his book – Competitive Advantage – in 1985, as the ‘essential companion’ to his earlier work – Competitive Strategy (1980). While ‘Competitive Strategy’ looked at competition at industry level, ‘Competitive Advantage’ considered it from a company’s-eye view.

Prof Porter said:

“My quest was to find a way to conceptualize the firm that would expose the underpinnings of competitive advantage and its sustainability.”

Sustainable competitive advantage of Coca-ColaCoca-Cola is a good example of a company with a sustained competitive advantage, an extensive business model, innovation, and an intelligent and considerable distribution network. Incorporated in 1892, the Coca-Cola Company is still a leading multinational giant and is one of the most sought-after shares in the New York Stock Exchange. (Image: Adapted from blog.uprinting.com)

Is competitive advantage dead?

As often occurs when one academic coins a phrase or comes up with a new theory, a few years later another professor tries to kill it.

In 2013, Rita Gunther McGrath, a professor at Columbia Business School in New York, considered by many as a leading expert on strategy, published her book – The End of Competitive Strategy: How to Keep Your Strategy Moving as Fast as Your Business.

In her book, Prof. McGrath wrote:

“Strategy is stuck. Virtually all strategy frameworks and tools in use today are based on a single dominant idea: that the purpose of strategy is to achieve a sustainable competitive advantage. This idea is strategy’s most fundamental concept. It’s every company’s holy grail. And it’s no longer relevant for more and more companies…”

“Strategy was all about finding a favorable position in a well-defined industry and then exploiting a long-term competitive advantage. Innovation was about creating new businesses and was seen as something separate from the business’s core set of activities.”

Prof. McGrath argues that competitive advantage is not sustainable – it is transient. To operate, we need a new series of assumptions about how the global marketplace works and ‘a new playbook to compete and win when competitive advantages are transient,’ she said.

Basing one’s strategy on a new set of assumptions may not seem very appealing to those managers who are still embedded in the old economy.

According to a Forbes article written by Steve Denning, some of the executives that Prof. McGrath interviewed while writing her book “actually seemed to be having fun – rather than being defensive and debilitated, they used the pursuit of transient competitive advantages to represent a compelling and engaging call to action for their people and a spur to innovation.”

Absolute advantage refers to what one entity can produce at a better rate than another. If John Doe Inc. produces 3 shirts per worker per day and Mary Ltd. produces 4 shirts per worker per day, Mary Ltd. has an absolute advantage over John Doe.

Video – 5 competitive forces

In this Harvard Business Review video, Prof. Michael Porter talks about the five competitive forces that shape strategy. He believes that these forces make up the basis for much of modern business strategy. He explains how to put them into practice.