CHAPTER 8 – COMPETITIVE ADVANTAGE

Objectives:

• Discuss how market position and internal ability sustain.

• Determine the differences in firms and how those lead to
competitive advantage
• Learn the outlined work of Michael Porter on competitive
advantage.

Firms compete for sales revenue with other suppliers of goods and services. If a firm
has a competitive advantage its products are both profitable and attractive to significant
numbers of buyers. A theory that can explain how sustainable competitive advantage is
achieved would be the philosopher’s scone of strategic management. The theories of
Michael Porter (l980, l985) were thought to offer the answer, though subsequent
research has exposed their limitations.

Features of a broad cost leadership strategy.

• The firm sets out to be the lowest cost producer (of the industry standard
product)
• The firm has a broad scope and serves many segments.
• Above average profitability is achieved by the cost leader commanding prices at
or near the industry average.
• Proximity in differentiation
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Porter also argues that in commodity industries it is not only the cost leader who gains
above average returns but also chose firms who are in the lower quartile of costs. If
firms are price takers, any firm that can produce below average costs will make above
average profits.

Features of a broad differentiation strategy

• The provision of product or service attributes that are valued by buyers
• Differentiation can be achieved in the product, its supply chain, and its
marketing

Features of a focus strategy

This strategy requires the firm to focus on a narrow segment. It is appropriate when
chose firms following broad strategies do not cater for the needs of significant segments
either on the basis of cost or differentiation.

Commentary on Porter’s Generic Strategies

Whilst Porter’s framework has been widely adopted in the teaching of strategic
management and inspired many research frameworks it is the subject of critical debate

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(e.g. Miller, l986; Hill, l988; Miller and Dess, l993; Bowman, l997; Walters and
Lancaster, l999; Campbell-Hunt, 2000). In a study of competitive strategy research
Campbell-Hunt (2000) concluded that:

• Researchers use cost and differentiation as ways of classifying strategy and

have investigated the merits of both in delivering competitive advantage.

• Presence or absence of specialization in competitive strategies cannot explain

performance in many cases. Mixed designs may be appropriate under some
conditions.

• ‘Stuck in the middle’ designs, chose strategies that seek to produce lower than
average product costs with differentiation, are possible in some circumstances.
Some resources facilitate the production of both differentiation and reduced
costs.

Campbell-Hunt also suggests that differentiation can cake on a number of forms and
can be based on marketing variables, sales variables, quality reputation variables and
product innovation variables.

Cost, Price and differentiation relationships

In order to discuss the relationship between cost, price and differentiation, the following
framework is proposed – that we describe products or services by three variables:

• Degree of differentiation.
• Relative cost to the producer.
• Relative price to the customer.

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For the sake of simplicity, a number of assumptions are made. The degree of
differentiation is measured by the number of attributes of the product that give perceived
customer benefits; the more perceived benefits the product has, the greater is its
perceived value to the customer.

Low cost, Low price, Low benefits strategies:

A number of authors have indicated that cost leadership strategies are usually
associated with price-based competition (Bowman, l997). Firms which charge average
prices for an average product can only make above average profits if its costs are lower
than average. Bowman (l997) argues that if average prices are charged then it is
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unlikely that more than average market share will be achieved. If a firm wishes to
achieve a relatively high market share using a price-based strategy it will have to charge
lower than average price.

If a firm can reduce costs via innovative product and/ or process designs that cannot be
copied then lower costs for products can be achieved without relying on scale effects.
In order to be above average performers, firms following low price market strategies for
proximate standard products need to have lower than average costs.

Porter’s Differentiation strategies

Porter argues that in order to achieve differentiation, differentiators will incur costs and
thus their costs will be higher than average. Thus, both focused and broad
differentiators will approximate to position A. The danger for differentiators is that they
may get left behind if cost-based competitors increase product features as consumer
expectations rise (consumer expectations are not static-cars now have radios and
central locking as standard features, and computer chip speed and memory are
constantly changing as suppliers both respond co and shape consumer demand) and
differentiated parcs of the market risk becoming subsumed into larger segments that are
more price competitive.

Position that indicate both Cost and Differentiation Dimensions

Market differentiation with relative low costs and a relative high price. Market
differentiation with relative low costs and a relative low price. These appear to be very
attractive positions if they can be achieved profitably. Porter suggests that this is unlikely
because of the additional costs of differentiation. An alternative perspective is also
possible if a product with a high level of benefits is produced at a low cost because the firm
has developed some skill and resource that has hitherto been unavailable, then two
possibilities exist:

• The case where the skills and resources are imitable and transferable in
some finite time. In this case the innovator of the particular resource or skill
could elect to cry to achieve market share by using cost advantages to reduce
prices and seek to change customer perceptions of the standard product. In
this way they attempt to establish a broad position based on the redefinition of
both the standard product and the nature of the market.
• The case when the skills and resources are not imitable. In this situation the
firm with this position can sustain profits unless demand for its product
subsides.

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Explaining competitive advantage: A Market perspective

People and organizations with finite amounts of money to spend have to make choices
between alternatives. Those with relatively high levels of disposable capital can elect to
purchase high price products with lower opportunity costs than chose with lower levels
(Frank, 2000).
A market may be a commodity market like agricultural markets where few segments
have appeared or like the car market where a number of segments have appeared. In
markets where segments exist, market positioning by segments is possible. In many
markets there are a number of products each having features that are designed to
appeal to particular segments. These features are perceived by users to give them
benefits.

We can hypothesize that customers in segments at the top right of Figure 8.5 are likely
to be more benefits sensitive and customers in segments at the bottom left more price
sensitive. Products that are in the middle of these positions are likely to sell on some
balance between benefits and price. However, all pricing decisions are best made with
a knowledge of price elasticity. Middle positioned products may, however, differ in the
nature of benefits they are offering so a number of viable positions may be available as
long as there are segments which have needs that match these benefits.

In order to avoid hyper-competition in segments where a number of competitors are

pursuing similar generic strategies, Porter indicates three distinct strategic positions:
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1. Variety-based Positioning: This occurs when a competitor offers a sub-set

of services that are used by a broad range of segments. He gives the
examples of Jiffy Lube, who specialized in low price fast oil changes and
Vanguard Group which specialized in low commission investment vehicles
based on comparatively secure steadily performing stocks and bonds that
incur low trading costs.
2. Need-based Positioning: This involves focusing on all the needs of a
particular segment. The example Porter gives is IKEA, who meet all the
needs of their identified segment for home furnishings at a reasonable price.

3. Access-based Positioning: This is focusing on specific customer segments

that are accessible in different ways; Porter gives the example of Carmike
Cinemas who focused on running cinemas in small US communities
(population<200,000). They adopted a low-cost approach using standard
cinema designs with fewer screens and less expensive projection technology
than that used in big-city cinemas.

A key point in Porter’s (l996) argument is that a position is only valuable if the activities
required to deliver the customer needs of that position are also different. Porter’s thesis
is that in order to have a competitive advantage two criteria must be met:

• A market position must identify customers with specific needs. The customers
can belong to a particular segment (focus strategy) or can straddle a number
of segments (broad strategy) meeting the common needs of a variety of
customers leaving specific needs co ocher suppliers.
• The market position chosen can be best delivered by a specific sec of
activities and chose activities are unique to that position. If an organization
attempts to straddle positions it finds itself unable to maximize its efforts in
any position.

Sustainable competitive advantage depends on companies being able to develop and

protect resource advantages by focusing on particular market positions.

Explaining Competitive advantage: A resource perspective

A resource-based perspective takes a slightly different view. In chis competitive

advantage accrues to firms whose internal resources are able to produce goods and
services that consumers find valuable. Unlike Porter’s unique position backed by unique

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activities, the resource-based perspective allows similar market positions to be the

focus of competition whilst attributing superior performance to the superior resources of
successful competitors.

Peteraf (l993) argues that the resource-based perspective requires that four criteria be
met if competitive advantage is to occur. These are that:

1. There is heterogeneity of resources across firms.

2. The acquisition price of assets must allow for future profits.
3. It has to be difficult/impossible for competitors co imitate or substitute profit-
yielding resources.
4. Resources should be specific to the firm such that they cannot be traded.

The acquisition of assets must allow for future profits.

Resources have to be acquired at a price below their discounted net present value in
order to yield profits, otherwise future profits will be fully absorbed in the price paid for
the resource. Economics call this ex ante (before) limits to competition.

Difficult/Impossible for Competitors to imitate or substitute profit-yielding resources

The third concept of ex post (after) limits to competition says that some resources
such as loyalty, tacit knowledge and relationships are developed over time and are built
progressively. Trying to compress these activities into shorter periods under different
conditions can prove to be unfruitful. Dierickx and Cool (l989) have suggested that there
are five mechanisms ac work that make it difficult for competitors to copy sources of
competitive advantage. These are:

1. Time compression diseconomies, as when a firm tries to learn quickly something

that cook a rival much longer to learn; or cries to build trust and loyalty with
skeptical dealers, employees or customers.

2. Asset mass efficiencies (the marginal cost of an asset falls as its level
increases): these are the basis of ‘virtuous circles’, as when learning is easier
in firms where the stock of knowledge is already high.

3. Interconnectedness among stocks of complementary assets (marginal cost

falls as levels of complementary assets increase): as when the creativity of
employees depends on how a firm is organized and on its management style.
Hamel and Prahalad (l994) define a core competence as an integrated bundle
of skills and technologies that are unlikely to reside in one person or team.

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4. Slow erosion of existing stocks of assets.

5. Causal ambiguity (uncertain knowledge of how to imitate an asset): as with

corporate cultures that facilitate productivity growth or organizational change.
Since it is possible for resources to be accumulated over time it may well be
impossible for competitors to specify which factors, and the role chose factors
play, in the accumulation process.

Bringing it together: Key success factors

An organization’s ability to succeed in a business arena depends on its ability to

develop a market position that is supported by appropriate assets and capabilities. In an
industry all successful firms must be able to do some things well:

• They must have competences and resources that allow them to meet the needs
of their customers.
• They must be able to identify and occupy an attractive market position –

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meet the needs of a significant segment.

Campbell et al. (l995) emphasize that different markets have different critical (key)
success factors and that a potential problem for corporate managers is that an
understanding of critical success factors in one industry may lead chem co wrongly
believe that the same success factors apply elsewhere.

A competence in consumer marketing is therefore important for food suppliers who sell
under their own brand, but a competence in business to business marketing is important
for manufacturers who make own label brands for supermarkets.

We have outlined the work of Michael Porter on competitive advantage. This has led us
to discuss how market position and the internal ability to sustain it, is important in
gaining competitive advantage. Firms that have distinctive competences to provide
product/service features, through either lower costs or unique benefits, which
competitors cannot match, are more likely to be superior performers. Factors that lead
to differences in firms and how chose differences can lead to competitive advantage
have been outlined.

To know more information about What Competitive Advantage is.

Please click the link: https://www.youtube.com/watch?v=PeCCT7CKpYA

To know more information about Porter’s Generic Strategies

Please click the link https://www.youtube.com/watch?v=mZeNOaO3Pzk

To know more information about Cost vs Price

Please click the link: https://www.youtube.com/watch?v=Ky5WL2IgLCA

Strategic Management and Business Analysis / David Williamson, Wyn Jenkins,

Peter Cooke and Keith Moreton

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