What is the term that describes a companys ability to maintain and gain market share in its industry?

Examples of Competitive Advantage

Competitive advantages come in many shapes and sizes. They include, but are not limited to, some of the following:

• Access to natural resources not available to competitors
• Highly skilled labor
• Strong brand awareness
• Access to new or proprietary technology
• Price leadership

Components of Competitive Advantage

For a competitive advantage to be established, it is important to know the following:

1. Value Proposition – A company must clearly identify the features or services that make it attractive to customers. It must offer real value in order to generate interest.
2. Target Market – A company must establish its target market to further engrain best practices that will maintain competitiveness.
3. Competitors – A company must define competitors in the marketplace, and research the value they offer; this includes both traditional as well as non-traditional, emerging competition.

To build a competitive advantage, a company must be able to identify its value proposition that will be sought after by the target market, which cannot be replicated by competitors.

Building a Competitive Advantage

Michael Porter, the famous Harvard Business School professor, identified three strategies for establishing a competitive advantage: Cost Leadership, Differentiation, and Focus (which includes both Cost Focus and Differentiation Focus)[1].

1. Cost Leadership

The goal of a cost leadership strategy is to become the lowest cost manufacturer or provider of a good or service. This is achieved by producing goods that are of standard quality for consumers, at a price that is lower and more competitive than other comparable product(s).

Firms employing this strategy will combine low profit margins per unit with large sales volumes to maximize profit. Companies will seek the best alternatives in manufacturing a good or offering a service and advertise this value proposition to make it impossible for competitors to replicate.

2. Differentiation

A differentiation strategy is one that involves developing unique goods or services that are significantly different from competitors. Companies that employ this strategy must consistently invest in R&D to maintain or improve the key product or service features.

By offering a unique product with a totally unique value proposition, businesses can often convince consumers to pay a higher price which results in higher margins.

3. Focus

A focus strategy uses an approach to identifying the needs of a niche market and then developing products to align to the specific need area. The focus strategy has two variants:

• Cost Focus: Lowest-cost producer in a concentrated market segment
• Differentiation Focus: Customized or specific value-add products in a narrow-targeted market segment

Competitive Advantage in the Marketplace

Three notable examples are:

1. Walmart: Walmart excels in a cost leadership strategy. The company offers “Always Low Prices” through economies of scale and the best available prices of a good.
2. Apple: Apple uses a differentiation strategy to appeal to its consumer base. It provides iconic designs, innovative technologies, and, therefore, highly sought-after products; this ensures that consumers are willing to pay a premium for Apple devices. 
3. Whole Foods Market: Whole Foods Market’s advantage relies on a differentiation focus strategy. The company is a leader in the premium grocery market and charges more premium prices because its products are unique. This is appealing to a niche market with higher disposable income.

Importance of Competitive Advantage

A competitive advantage is what sets a business apart from its competitors. It is essential in order for a business to succeed, whether it’s by ensuring higher margins, attracting more customers, or achieving greater brand loyalty among existing customers. 

Higher margins, a better growth profile, and lower customer churn tend to also be very popular among both investors and creditors – making capital more readily available (and cheaper) for firms that are able to maintain a strong competitive advantage among their peers.

Video Explanation of Competitive Advantage

Watch this short video to quickly understand the main concepts covered in this guide, including the definition of competitive advantage and how companies create it using various business strategies.

Other Resources

Thank you for reading CFI’s guide to Competitive Advantage. To keep learning and advancing your career, the following resources will be helpful:

• Absolute Advantage
• Opportunity Cost
• Monopoly
• Law of Supply

Article Sources

Competitive advantage refers to factors that allow a company to produce goods or services better or more cheaply than its rivals. These factors allow the productive entity to generate more sales or superior margins compared to its market rivals. Competitive advantages are attributed to a variety of factors including cost structure, branding, the quality of product offerings, the distribution network, intellectual property, and customer service.

• Competitive advantage is what makes an entity's products or services more desirable to customers than that of any other rival.
• Competitive advantages can be broken down into comparative advantages and differential advantages.
• Comparative advantage is a company's ability to produce something more efficiently than a rival, which leads to greater profit margins.
• A differential advantage is when a company's products are seen as both unique and of higher quality, relative to those of a competitor.

Competitive advantages generate greater value for a firm and its shareholders because of certain strengths or conditions. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage. The two main types of competitive advantages are comparative advantage and differential advantage.

The term "competitive advantage" traditionally refers to the business world, but can also be applied to a country, organization, or even a person who is competing for something.

A firm's ability to produce a good or service more efficiently than its competitors, which leads to greater profit margins, creates a comparative advantage. Rational consumers will choose the cheaper of any two perfect substitutes offered. For example, a car owner will buy gasoline from a gas station that is 5 cents cheaper than other stations in the area. For imperfect substitutes, like Pepsi versus Coke, higher margins for the lowest-cost producers can eventually bring superior returns.

Economies of scale, efficient internal systems, and geographic location can also create a comparative advantage. Comparative advantage does not imply a better product or service, though. It only shows the firm can offer a product or service of the same value at a lower price.

For example, a firm that manufactures a product in China may have lower labor costs than a company that manufactures in the U.S., so it can offer an equal product at a lower price. In the context of international trade economics, opportunity cost determines comparative advantages. 

Amazon (AMZN) is an example of a company focused on building and maintaining a comparative advantage. The e-commerce platform has a level of scale and efficiency that is difficult for retail competitors to replicate, allowing it to rise to prominence largely through price competition.

A differential advantage is when a firm's products or services differ from its competitors' offerings and are seen as superior. Advanced technology, patent-protected products or processes, superior personnel, and strong brand identity are all drivers of differential advantage. These factors support wide margins and large market shares.

Apple is famous for creating innovative products, such as the iPhone, and supporting its market leadership with savvy marketing campaigns to build an elite brand. Major drug companies can also market branded drugs at high price points because they are protected by patents.

If a business can increase its market share through increased efficiency or productivity, it would have a competitive advantage over its competitors.

Lasting competitive advantages tend to be things competitors cannot easily replicate or imitate. Warren Buffet calls sustainable competitive advantages economic moats, which businesses can figuratively dig around themselves to entrench competitive advantages. This can include strengthening one's brand, raising barriers to new entrants (such as through regulations), and the defense of intellectual property.

Competitive advantages that accrue from economies of scale typically refer to supply-side advantages, such as the purchasing power of a large restaurant or retail chain. But advantages of scale also exist on the demand side—they are commonly referred to as network effects. This happens when a service becomes more valuable to all of its users as the service adds more users. The result can often be a winner-take-all dynamic in the industry.

Comparative advantage mostly refers to international trade. It posits that a country should focus on what it can produce and export relatively the cheapest—thus if one country has a competitive advantage in producing both products A & B, it should only produce product A if it can do it better than B and import B from some other country.