WHAT IS COMPETITIVE ADVANTAGES

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COMPETITIVE ADVANTAGES
Investors often fall into the trap of only researching quantitative factors in evaluating potential investments. However, it's important to remember that a share of stock also represents a share of a business, so you should be interested in how the company as a whole performs.

Successful companies come in all shapes and sizes but they tend to have one thing in common: they all have some significant competitive advantage. This advantage allows them to ward off competitors and stick around for a long period of time.
Why are competitive advantages so important? Well, mostly because they can ensure that a company earns excess returns for a longer period of time. By increasing the life of a company, the value of the stock is enhanced.

Competitive advantages don't just come in one form. Also, companies can have multiple competitive advantages; in fact, the more the merrier. For the purpose of this article, we'll outline five areas where companies can stand out and ensure their long-term success: establishing market share, strong brand management, enjoying the network effect, having certain trademarks and patents, being cost effective, and creating high switching costs.
Competitive advantage is a position that a firm occupies in its competitive landscape.[1] A competitive advantage, sustainable or not, exists when a company makes economic rents, that is, their earnings exceed their costs, including cost of capital. That means that normal competitive pressures are not able to drive down the firm's earnings to the point where they cover all costs and just provide minimum sufficient additional return to keep capital invested. Most forms of competitive advantage cannot be sustained for any length of time because the promise of economic rents invites competitors to duplicate the competitive advantage held by any one firm.
A firm possesses a sustainable competitive advantage when it has value-creating processes and positions that cannot be duplicated or imitated by other firms that lead to the production of above-normal rents.
Analysis of competitive advantage is the subject of numerous theories of strategy, including the five forces model pioneered by Michael Porter of the Harvard Business School.
“Competitive Advantage” is a depiction that the company or its products are each doing something better than their competition in a way that could benefit the customer.
Competitive Advantage
When a firm sustains profits that exceed the average for its industry, the firm is said to possess a competitive advantage over its rivals. The goal of much of business strategy is to achieve a sustainable competitive advantage.
Michael Porter identified two basic types of competitive advantage:
• cost advantage
• differentiation advantage
A competitive advantage exists when the firm is able to deliver the same benefits as competitors but at a lower cost (cost advantage), or deliver benefits that exceed those of competing products (differentiation advantage). Thus, a competitive advantage enables the firm to create superior value for its customers and superior profits for itself.
Cost and differentiation advantages are known as positional advantages since they describe the firm's position in the industry as a leader in either cost or differentiation.
A resource-based view emphasizes that a firm utilizes its resources and capabilities to create a competitive advantage that ultimately results in superior value creation. The following diagram combines the resource-based and positioning views to illustrate the concept of competitive advantage:
A Model of Competitive Advantage

Resources


Distinctive
Competencies



Cost Advantage
or
Differentiation Advantage


Value
Creation


Capabilities



Resources and Capabilities
According to the resource-based view, in order to develop a competitive advantage the firm must have resources and capabilities that are superior to those of its competitors. Without this superiority, the competitors simply could replicate what the firm was doing and any advantage quickly would disappear.
Resources are the firm-specific assets useful for creating a cost or differentiation advantage and that few competitors can acquire easily. The following are some examples of such resources:
• Patents and trademarks
• Proprietary know-how
• Installed customer base
• Reputation of the firm
• Brand equity
Capabilities refer to the firm's ability to utilize its resources effectively. An example of a capability is the ability to bring a product to market faster than competitors. Such capabilities are embedded in the routines of the organization and are not easily documented as procedures and thus are difficult for competitors to replicate.
The firm's resources and capabilities together form its distinctive competencies. These competencies enable innovation, efficiency, quality, and customer responsiveness, all of which can be leveraged to create a cost advantage or a differentiation advantage.
Cost Advantage and Differentiation Advantage
Competitive advantage is created by using resources and capabilities to achieve either a lower cost structure or a differentiated product. A firm positions itself in its industry through its choice of low cost or differentiation. This decision is a central component of the firm's competitive strategy.
Another important decision is how broad or narrow a market segment to target. Porter formed a matrix using cost advantage, differentiation advantage, and a broad or narrow focus to identify a set of generic strategies that the firm can pursue to create and sustain a competitive advantage.



Value Creation
The firm creates value by performing a series of activities that Porter identified as the value chain. In addition to the firm's own value-creating activities, the firm operates in a value system of vertical activities including those of upstream suppliers and downstream channel members.
To achieve a competitive advantage, the firm must perform one or more value creating activities in a way that creates more overall value than do competitors. Superior value is created through lower costs or superior benefits to the consumer (differentiation).

REFERENCES

• Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter, Free Press, 1998 (1985)
• Gabriel Steinhardt (2008). "Concept of Marketing" (PDF). 2.0. Blackblot. Retrieved on 2008.
• Porter, Michael E., Competitive Advantage: Creating and Sustaining Superior Performance