Every company, whether large or small, should strive to create a competitive advantage. A competitive advantage sets the business apart from its competitors and gives it a unique position in the market that is superior to its competition. It is what makes customers want to buy from one business rather than from its competitors.
Warren Buffet often talks about sustainable competitive advantage and he looks for companies who have it before investing in them. Sustainable competitive advantage is defined as an advantage that is likely to continue in the future. He often refers to sustainable competitive advantage as a moat, as it is a barrier to entry for other businesses. The moat analogy is a good one as a moat’s sole purpose is to dissuade a siege on the castle by rival forces. If forces want to take the castle, they can of course, but the potential cost in casualties as a result of the moat is often significant enough to keep them from trying.
Starbucks has a sustainable competitive advantage in location. By picking locations near bus stations and train stations they promise to be the first coffee location that consumers encounter.
Safeco’s sustainable competitive advantage is in cost of production. By removing the insurance agent and dealing directly with customers, costs are kept significantly lower than those of the competition.
Tesco’s sustainable competitive advantage is their distribution system. With one of the most advanced supply chain systems in the world, they are able to deliver the right product to the right store at the right time in a cost effective and timely manner.
Two myths surround the creation of a competitive advantage. The first is that most good business opportunities are already gone. The second is that small firms cannot compete well with big companies. Both of these ideas are false!
Before a competitive advantage or sustainable competitive advantage can be developed, the entrepreneur needs to understand the basic nature of the competition he or she faces in the marketplace.
To understand the nature of the competition, the entrepreneur must understand the level of competition within his or her respective industry. Michael Porter, in his book, Competitive Advantage, identifies five factors that determine the nature and degree of competition in an industry:
• Bargaining power of buyers
• Threat of substitutes
• Bargaining power of suppliers
• Rivalry among existing competitors
• Threat of new competitors
To a large extent, these five market forces collectively determine the ability of a firm, whether large or small, to be successful. Obviously, all industries are not alike; therefore, each force has varying impact from one situation to the next. Porter identifies numerous elements of industry structure that influence these five factors. Without going into a detailed explanation of them, these factors influence the creation of a competitive advantage as follows:
Buyer power influences the prices that firms can charge, for example, as does the threat of substitution. The bargaining power of suppliers determines the cost of raw materials and other inputs. The intensity of rivalry influences prices as well as the costs of competing in areas such as product development, advertising and sales force. The threat of entry places a limit on prices and shapes the investment required to deter entrants.
The more entrepreneurs understand the forces of competitive pressure, the better they will be able to determine the market opportunities or threats facing their ventures. Which forces dominate industry competition depend on the particular industry and circumstances. It is up to entrepreneurs to recognize and understand these forces so that their business venture is positioned to best cope with the industry environment and to succeed in the marketplace.
Theresa Freihoefer is a business professor at Central Oregon Community College.