Do you have a Competitive Advantage?

“Competitive advantage” is one of the most commonly used terms in business. A search on Google for the term reveals 5.7 million results. Despite its frequent use, a clear explanation of what competitive advantage is and why it’s important remains elusive. In this post, I will define the term “competitive advantage” and explain why it’s of great importance to your company.

Let’s start with a definition. A company has achieved a competitive advantage for a product over a competing product when there exists a greater wedge between (a) the value delivered to a customer and (b) the cost to the company for producing this value. [1]

Let me provide a concrete example. Suppose I visit Costco looking for an external hard drive to store my videos, songs, and photos. The key feature of importance to me is storage space. At Costco, I see two hard drives, a 640GB drive produced by Company A and a 500GB drive produced by Company B. These two drives are identical on every dimension of importance to me, including price, except for the noted difference in storage space. For me, the choice is clear, I choose Hard Drive A because it offers more value than Hard Drive B (i.e., an extra 140 GB of storage). Now let’s consider the cost side of the equation. Let’s assume that the costs for Company A to produce the 640GB drive are 10% lower than the costs for Company B to produce the 500GB drive. These cost savings might result from lower raw material costs, labor costs, higher productivity, etc. In short, Company A has a competitive advantage with its 640GB drive over Company B’s 500GB drive because Company A’s drive delivers more value (140GB more value) at a lower cost (10% lower cost). [2]

To explain why competitive advantage is of great importance, let’s introduce the notion of price. Needless to say, price refers to how much a company charges a customer for a product. A company with a competitive advantage for a product can adjust price to increase market share and/or obtain higher margins. In other words, a competitive advantage enables a company to increase top line revenues or bottom line profitability for a particular product.

To make this clear, let’s revisit the hard drive example. Remember Company A has a competitive advantage with its 640GB hard drive over Company B with its 500GB drive. The 640GB drive delivers more value (140GB more value) at a lower cost (10% lower). If Company A opts to charge the same price for its drive as Company B’s drive, it will not only increase its market share (due to the 140GB of more storage), but also earn higher margins (due to the 10% lower costs). Of course, Company A can choose to charge customers a higher or lower price, depending on whether its main goal is growth in market share or higher margins.

There you have it. Now you have a clear definition of competitive advantage and why it’s important for your company. Now if you want to create or increase a competitive advantage for a product at your company, the broad objectives are clear: enhance the value that your product delivers to customers (e.g., increase quality) and/or reduce the costs for producing this value (e.g., reduce costs of raw materials). [3]

I will follow up in subsequent posts on the different forms of competitive advantage, the sources of competitive advantage, and what makes a competitive advantage sustainable over time.

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[1] When you are ascertaining the value that a product or service delivers to customers, you need to think beyond just the focal product. Consider other factors such as  service and support, complementary products, brand, etc. I will follow up in a subsequent post on the different factors that deliver value to customers.

[2] This is considered a dual advantage. There are two other forms of competitive advantage, a value advantage and cost advantage. I will further explain these different forms of advantage in a subsequent post.

[3] Companies typically need to choose whether to compete on value or cost for a particular product because increasing value (e.g., product performance) often necessitates additional costs (e.g., research and development). The key is to increase value without a commensurate increase in cost.