Competitive Advantage Key Points

There are only 3 kinds of genuine competitive advantage (c/a henceforth): i) Supply- strictly cost advantages that allow a company to produce and deliver its products or services more cheaply, more frequently due to proprietary technology that is protected by patents or by experience, ii) Demand- some companies have access to market demand that their competitors cannot match, not simply a matter of product differentiation or branding, since competitors may equally be able to differentiate or brand their products. These demand advantages arise b/c of customer captivity that is based on habit, on the costs of switching, or on the difficulties and expenses of searching for a substitute iii) Economies of Scale- If costs per unit decline as volume increases, b/c fixed costs make up a large share of total costs, then even with the same basic technology, an incumbent with large scale will enjoy lower costs
Assessing comp. advantages: i) Identify competitive landscape in which firms operates. Which markets is it really in? Who are the competitors in each one? ii) Test for the existence of competitive advantages in each MKT. Do incumbent firms maintain stable MKT shares? Are they exceptionally profitable over a substantial period? iii) Identify the likely nature of any c/a that may exist: prop tech, captive customers, economies of scale or regulatory hurdles from which they benefit.
First Step is develop industry map that shows structure of competition in relevant markets? Map will identify the market segments that make up the industry as a whole and the leading competitors. Second step is determine for each MKT SEGMENT whether it is protected by barriers to entry. Two telltale signs of the existence of barriers to entry: stability of MKT share among firms; if companies regularly capture MKT share from each other, it is unlikely any have a protected position. If each can defend its share over time, than c/a may be protecting their individual MKT positions. Key indicator is history of dominant firm in the industry. The more turbulent the ranking and the longer list of comps, the less likely barriers to entry. Industry map: too much detail risks overwhelming the map with too many segments; too little detail risks missing important distinctions.
Identifying the likely source confirm the data on the market share stability and profitability. Even when MKT share stability and profitability is high, a close look at the business may fail to sot any clearly identifiable cost, customer captivity, or economies of scale advantages. The likely explanation is either that stability and profitability are temporary, or that they are the consequences of good management- operational effectiveness- that can be emulated by any sufficiently focused entrant.
Most companies that manage to grow and still achieve a high level of profitability due it in one of three ways: i) Replicate their local advantage in multiple markets ii) Continue to focus within their product space as that space itself becomes larger iii) Gradually expand their activities outward from the edges of their dominant market positions.
A focused company understands its markets and its particular strengths.
Starting point for any strategic analysis is MKT by MKT assessment of existence and source if competitive advantage; if none than begins and ends with operational efficiency.
For yes c/a then need to identify its nature and how to maintain… Ant/Elephant either get out if ant or look elsewhere; if incumbent advantage shrinks and barriers to entry disappear, the new firm will be one of many entrants pursuing profits on a level playing field- Grouch Marx rule not to join any club that will have him.
Elephant priority is to sustain what it has: requires recognizing and a thorough understanding of source and limits of its c/a which allows firm to reinforce and protect existing advantages and make incremental investments which can extend them, distinguishes potential areas for growth, highlights polices that extract maximum profitability from firm’s situation, spots threats that are likely to develop and identifies competitive inroads that requires strong countermeasures.
Need to know what competitors doing and anticipate competitor reactions.
Game theory: players, actions each can pursue, motives, rules- who goes when, knows wheat and when, and penalties for breaking rules… Identify c/a and analyze prisoner dilemma (price and quality) and entry/preemption behavior- play game; alternative possibilities multiply rapidly.

No barriers to entry, some firms do much better-mgmt.… Differentiation w/out barriers to entry ex. Mercedes, Cadillac, etc. make it difficult to translate power of brands into exceptionally profitable businesses- sales declined while fixed costs of their strategy-product development, advertising.
Product differentiation does not eliminate corrosive-impact of competition; if no forces interfere process of entry by competitors.
Unless something interferes with the processes of competitive entry and expansion, efficient operations in all aspects of the business are key to successful performance.
If barriers exist, then firms within barriers must be able to do things other potential entrants cannot.
Periods of oversupply last longer than periods in which demand exceeds capacity.
Barriers to entry are identical to incumbent competitive advantages; whereas entrant competitive advantages- situations where latest to arrive in MKT enjoys an edge- are of limited and transitory value.
Competitive advantages may be due to i) superior production technology and/or privileged access to resources ii) customer preferences iii) combinations of economies of scale with some level of customer preference. Production advantages weakest barrier to entry; economies of scale when combined with some customer captivity are the strongest.
Be mindful of advantages from govt. intervention, licenses, tariffs and quotas, authorized monopolies, patents, direct subsidies, and various kinds of regulation, i.e. TV broadcast licenses, yet, cost advantages based on patents are only sustainable for limited periods.
Much depends on the pace of technological change, if swift enough, it can undermine advantages that are specific to processes that quickly become outdated (in the long run everything is a toaster).
If a particular approach can be fully understood by a few employees, competitors can hire them away and learn the essentials of the process.
If cost advantages rooted in prop. Technology are relatively rare and short-lived, those based on lower input costs are rarer still.
Competitive demand advantages require that customers be captive in some degree to incumbent firms.
Software is the product most easily associated with high switching costs.
Few want to abandon a functioning system, even for one that holds vast productivity increase if it holds threat of terminating business through systemic failure.
High search costs are an issue when products or services are complicated, customized and crucial.
Taken together, habits, switching costs, and search costs create c/a’s on the demand side that are more common and generally more robust than advantages stemming from the supply or cost side. But even these advantages fade over time. New customers are unattached and available to anyone. Existing captive customers ultimately leave the scene; they move, they mature, they die.
If average costs per unit decline as a firm produces more, then smaller comps will not be able to match the costs of the large firm even though they have equal access to technology and resources so long as they cannot reach the same scale of operations. Larger firm can be profitable when smaller firm with higher avg. costs is losing money. The costs structure that underlies these economies of scale usually combines a significant level of fixed cost and a constant level of incremental variable costs. All can reach that in theory; need to have some degree of incumbent customer captivity. Incumbent can lower prices to a level where it alone is profitable and can increase share of MKT. If diligently defends, can maintain MKT share, why incumbent clearly need to understand c/a.
Local c/a more likely in non-urban area, one store can have foot traffic to survive in Nebraska, not New York.
Special purpose niche market has easier time in creating and profiting from economies of scale than the general purpose PC competing in a much larger MKT… INTC R&D edge in tech and economies of scale in advertising.
Three features of economies of scale have major implications for strategic decisions that incumbents must make. i) C/A’s based on economies of scale must be defended…If rival initiates attractive new product features, leader must adopt them quickly- MSFT- Internet Explorer. Economies of scale need to be defended with eternal vigilance ii) Pure size is not the same thing as economies of scale. Relevant market area- geographic or otherwise- in which the fixed costs stay fixed. If sales added outside the territory, fixed costs rise and economies of scale diminish. Network economies of scale gain be being part of densely populated network. In medical services 60% mkt share of doctors make AET more appealing to CI with 20%. GE always focused on relative share in particular MKT not its overall size iii) Growth of a MKT is generally the enemy of a C/A which is based on economies of scale.
The strength of this advantage is basically directly related to the importance of fixed costs. Also growth in the mkt lowers the hurdle an entrant must clear in order to become viably competitive.
Operational effectiveness can make one company much more profitable than its rivals even in an industry with no C/A’s.
Firms that are operationally effective, however, do tend to focus on a single business and on their own internal performance.
In competitive situations where a company enjoys advantages related to proprietary technologies and customer captivity, its strategy should be to both exploit and reinforce them where they can… If the source is cost advantages stemming from prop. Tech the company wants to improve them continually and to produce a successive wave of patentable innovations- need to make sure investments in R&D productive. If source is customer captivity, company needs to encourage habit formation in new customers.
C/A based on economies of scale in a class by themselves for two reasons i) tend to be longer lived than the other two types and therefore more valuable. KO most valuable brand b/c customer captivity and more importantly, local economies of scale due to advertising and distribution; can appeal to them (advertising) and serve them (distribution) at a much lower cost than competitors. ii) advantages based on economy of scale are vulnerable to gradual erosion and must be vigorously defended. Once a competitor increases size and decrease unit cost, gap shrinks and next step easier.
In a MKT with significant fixed costs but currently served by many small, an individual firms has an opportunity to acquire a dominant share; if also a degree of customer captivity that dominant share will be defensible.
Identify niches, not all of which are equally attractive. Attractive niche must be characterized by customer captivity, small mkt size relative to the fixed costs, and the absence of vigilant, dominant competitors. Ideally, would be readily extendable at the edges.
Anything due to increase fixed costs, adverting heavily, accelerate product cycles thereby upping R&D cost increases defense likelihood.
Grow and die can do the opposite; instead of defending, many sig. past failures spent copiously in MKTS where they were newcomers- growth obsessed CEO’s?
Return on capital. After tax-returns of 15-28% which equates to 23-38% pre-tax over a decade or more are clear evidence of the presence of c/a. Problem is must attempt to disaggregate multi-segment company to determine if true c/a?.
Intel example: … MKT value to estimated replacement cost of INTCs net assets has continually exceeded 3-1; each dollar invested has created 3 or more dollars in shareholder value. $1b in R&D and sells 100m chips per generation so R&D cost per chip $10 vs. Apple/MOT/IBM alliance $100 per chip… MSFT ROIC still above 40% if back out cash.
Wal-Mart example: Merchandise purchase major part of COGS, also inbound logistics, getting goods from vendor to stores or warehouses, WMT spent 2.8% vs. industry 4.1%, shrinkage 1.3% vs. industry 2.2%, extra-margin from single store towns .9% higher than KMT, lower rental by .3% of sales and payroll expenses by 1.1% (south). Both economies of scale and customer cap.
Rule of thumb: if can’t count top firms in industry on fingers of one hand, chances are good no barriers to entry.
Box makers did not have high fixed cost/low marginal cost structure that gives rise to economies of scale. The component cost of the last machine to come off the line was not much lower than the first, and components accounted for most of the costs.
A company that makes life much better for its customers gets handsomely rewarded, provided it can separate itself from competitors offering similar benefits.
It is naïve to think that the bottom line is everybody’s primary concern; always an incentive for individual competitors to deviate from ostensibly superior outcomes. Game theory subjectivity.
History of attempts to enter virgin territory has not been a happy one for either the first mover or its slightly later competitors, especially true in the case of unoccupied territories, which often turn out to be lawless frontiers.
Airlines: newcomers not restricted by the expensive and restrictive labor contacts that had been the norm during the regulated period.
Percentage of industry profits: smaller (niche) yet customer captivity higher likelihood of success then large share of industry profits, i.e. Nintendo vs. game makers.
Ill-conceived initiatives that ignore the structure of competitive advantage and competitive interactions is a leading cause of business failure. However, strategy is not the whole story. An obsession with strategy at the expense of the pursuit of operational excellence is equally damaging.
If there are no barriers to entry then there will be no ‘economic profit’- returns equal the cost of the invested capital. Globalization suggests that competitive advantages and barriers to entry will disappear, but this macro view misses one essential feature of competitive advantages, that competitive advantages are almost always grounded in ‘local’ circumstances. Establishing local dominance and then expanding into related territories accounts for two of the other great corporate achievements of the modern period, although in these cases the geography in question is product market space, not physical territory (MSFT expanded at edges, INTC started with memory and microprocessors).

Focus and Hydra funds will often run higher cash balances than traditional fund s in order to be in a position to benefit nevitable occurrences.

Competitive Advantage Key Points

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A focused company understands its markets and its particular strengths.

Starting point for any strategic analysis is MKT by MKT assessment of existence and source if competitive advantage; if none than begins and ends with operational efficiency.

Need to know what competitors doing and anticipate competitor reactions.

Game theory: players, actions each can pursue, motives, rules- who goes when, knows wheat and when, and penalties for breaking rules… Identify c/a and analyze prisoner dilemma (price and quality) and entry/preemption behavior- play game; alternative possibilities multiply rapidly.

No barriers to entry, some firms do much better-mgmt.… Differentiation w/out barriers to entry ex. Mercedes, Cadillac, etc. make it difficult to translate power of brands into exceptionally profitable businesses- sales declined while fixed costs of their strategy-product development, advertising.

Product differentiation does not eliminate corrosive-impact of competition; if no forces interfere process of entry by competitors.

Unless something interferes with the processes of competitive entry and expansion, efficient operations in all aspects of the business are key to successful performance.

If barriers exist, then firms within barriers must be able to do things other potential entrants cannot.

Periods of oversupply last longer than periods in which demand exceeds capacity.

Barriers to entry are identical to incumbent competitive advantages; whereas entrant competitive advantages- situations where latest to arrive in MKT enjoys an edge- are of limited and transitory value.

Be mindful of advantages from govt. intervention, licenses, tariffs and quotas, authorized monopolies, patents, direct subsidies, and various kinds of regulation, i.e. TV broadcast licenses, yet, cost advantages based on patents are only sustainable for limited periods.

Much depends on the pace of technological change, if swift enough, it can undermine advantages that are specific to processes that quickly become outdated (in the long run everything is a toaster).

If a particular approach can be fully understood by a few employees, competitors can hire them away and learn the essentials of the process.

If cost advantages rooted in prop. Technology are relatively rare and short-lived, those based on lower input costs are rarer still.

Competitive demand advantages require that customers be captive in some degree to incumbent firms.

Software is the product most easily associated with high switching costs.

Few want to abandon a functioning system, even for one that holds vast productivity increase if it holds threat of terminating business through systemic failure.

High search costs are an issue when products or services are complicated, customized and crucial.

Local c/a more likely in non-urban area, one store can have foot traffic to survive in Nebraska, not New York.

Special purpose niche market has easier time in creating and profiting from economies of scale than the general purpose PC competing in a much larger MKT… INTC R&D edge in tech and economies of scale in advertising.

The strength of this advantage is basically directly related to the importance of fixed costs. Also growth in the mkt lowers the hurdle an entrant must clear in order to become viably competitive.

Operational effectiveness can make one company much more profitable than its rivals even in an industry with no C/A’s.

Firms that are operationally effective, however, do tend to focus on a single business and on their own internal performance.

In a MKT with significant fixed costs but currently served by many small, an individual firms has an opportunity to acquire a dominant share; if also a degree of customer captivity that dominant share will be defensible.

Identify niches, not all of which are equally attractive. Attractive niche must be characterized by customer captivity, small mkt size relative to the fixed costs, and the absence of vigilant, dominant competitors. Ideally, would be readily extendable at the edges.

Anything due to increase fixed costs, adverting heavily, accelerate product cycles thereby upping R&D cost increases defense likelihood.

Grow and die can do the opposite; instead of defending, many sig. past failures spent copiously in MKTS where they were newcomers- growth obsessed CEO’s?

Return on capital. After tax-returns of 15-28% which equates to 23-38% pre-tax over a decade or more are clear evidence of the presence of c/a. Problem is must attempt to disaggregate multi-segment company to determine if true c/a?.

Rule of thumb: if can’t count top firms in industry on fingers of one hand, chances are good no barriers to entry.

Box makers did not have high fixed cost/low marginal cost structure that gives rise to economies of scale. The component cost of the last machine to come off the line was not much lower than the first, and components accounted for most of the costs.

A company that makes life much better for its customers gets handsomely rewarded, provided it can separate itself from competitors offering similar benefits.

It is naïve to think that the bottom line is everybody’s primary concern; always an incentive for individual competitors to deviate from ostensibly superior outcomes. Game theory subjectivity.

History of attempts to enter virgin territory has not been a happy one for either the first mover or its slightly later competitors, especially true in the case of unoccupied territories, which often turn out to be lawless frontiers.

Airlines: newcomers not restricted by the expensive and restrictive labor contacts that had been the norm during the regulated period.

Percentage of industry profits: smaller (niche) yet customer captivity higher likelihood of success then large share of industry profits, i.e. Nintendo vs. game makers.

Ill-conceived initiatives that ignore the structure of competitive advantage and competitive interactions is a leading cause of business failure. However, strategy is not the whole story. An obsession with strategy at the expense of the pursuit of operational excellence is equally damaging.