Successful businesses (and a lot of other organizations for that matter) are said to have a "Competitive Advantage."
And because you want your business to be successful, you'll also want one. But what exactly does the term mean? Where can we find it? Is it on Aisle "A" for Advantage or "C" for Competitive?
Let's see if we can get our arms around this idea and turn it into something useful.
A common definition suggests firms have a "Competitive Advantage" over their industry rivals when they sustain above-average profits.
This is pretty general but it's at least a starting point. Let's pick it apart.
First, notice you get an advantage over your competitors by earning "above-average profits." Having "profits" be a necessity makes sense, but it's not clear why the profits have to be "above-average."
As we'll learn when we visit "accounting-land," profits are the surplus of operating revenues over operating expenses. Income means something else and includes things that only accountants understand (who else gets excited about "non-cash adjustments?").
"Above-average" was probably included by the Economists. It's possible they felt that if a firm's profits weren't higher than the industry-average, any competitive advantage might be lost. While that's possible, there are many reasons why a firm could maintain (at least in the short run) its competitive advantage while earning "below-average" profits.
From a business manager's (that's us) perspective, the real world where we compete is more complicated than the economist's world. For our purposes, let's assume we need "profits," but not worry whether they're above- or below-average and move on to identifying the (1) types of competitive advantage and (2) the necessary components.
TYPES OF COMPETITIVE ADVANTAGE
Market share is obtained by sustaining either (1) a price advantage or (2) an "attributes" advantage or (3) some combination of price and attributes.
The first type is self-explanatory: having a price advantage means profitably delivering your product for a price lower than your competitor. In price-based competition, products are generic and substitutable. Also, an industry can have only one price "leader" at a time; otherwise a price war will break out and all participants must reduce prices.
The second type is more complex. In attribute-based competition, firms try to be unique by offering something that customers will value for reasons other than price alone. In other words, firms will emphasize attributes of their product that they perceive buyers will find important. It's easy to think of different product attributes (color, size, durability, etc.), but hard to know which attribute customers will find valuable.
The "combination" type usually aims at a narrow market segment, say, a geographic area or age group, where the competitor tailors a package of price and attributes that gives it a competitive advantage. Think here of local or regional businesses like Roth's IGA or Pizza Schmizza.
Terminology Note: What I refer to as "Price Advantage" is often called "Cost Advantage." I prefer the term price over cost because prices are what customer pay for products and costs are what producers pay to manufacture their products; customers determine which competitor has an advantage by paying (or not paying) the product's price, not its cost.
You'll also see what I refer to as "Attributes Advantage" often called "Differentiation Advantage." Shortly, we'll be looking at how competitors differentiate their products along "physical" lines which is a narrower focus than sustaining an advantage based on "attributes" which can include more than just a product's physical features.
COMPONENTS OF A COMPETITIVE ADVANTAGE
A firm needs only two components to work assemble a competitive advantage: Financial Resources and Human Resources. Think also of Cash and an Idea.
Financial Resources come in many forms: founder contributions, bank loans or investments by third-parties. Whatever their form, they all consist of cash that a firm can use to buy raw materials, patent inventions or advertise for customers. You'll sometimes see this component called just "resources." I think doing so stops short of recognizing how things really work. In order for firms to get necessary resources like, for example, trucks or Internet service, they first must have cash to pay for them.
Human Resources are the people, ideas and motivation that turn financial resources into an organization that produces something that customers want and is therefore competitively advantageous.
Thank you for wading through what has been a big dose of theory. It may not have been exciting, but it was important to getting you properly introduced to the business world.
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