The ability of a company to outperform its competitors
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
Written byKyle Peterdy
What is Competitive Advantage?
Competitive advantage refers to the ways that a company can produce goods or deliver services better than its competitors. It allows a company to achieve superior margins and generate value for the company and its shareholders.
A competitive advantage is something that cannot be easily replicated and is exclusive to a company or business. This value is created internally and is what sets the business apart from its competition.
Key Highlights
- A competitive advantage is what sets a company apart from its competitors, in the eyes of its consumers.
- These advantages allow a company to achieve and maintain superior margins, a better growth profile, or greater loyalty among current customers.
- A competitive advantage is often referred to as a “protective moat.”
- Strong and repeatable competitive advantages can create sustained success for a business and attract capital more readily and cheaply.
What are Some 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:
- 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.
- Target market:A company must establish its target market to further engrain best practices that will maintain competitiveness.
- 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:
- 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.
- 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.
- 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.
What is the 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.
Additional Resources
As a seasoned finance professional with extensive experience in accounting, financial analysis, and modeling, I've had the privilege of witnessing firsthand the intricate dynamics of competitive advantage and its profound impact on a company's success. Over the course of my career, I have closely followed industry trends, conducted in-depth analyses of various business strategies, and witnessed the strategic maneuvers that have propelled companies to outperform their competitors.
One notable platform that I've encountered in my professional journey is the Corporate Finance Institute (CFI), which boasts a user base of over 1.8 million professionals. This platform has become a cornerstone for individuals seeking to enhance their skills in accounting, financial analysis, and modeling. The fact that such a substantial number of professionals trust and utilize CFI speaks volumes about its credibility and the quality of education it provides.
Now, let's delve into the concepts discussed in the article by Kyle Peterdy about competitive advantage:
Competitive Advantage: Competitive advantage is a fundamental concept referring to a company's ability to produce goods or deliver services more effectively than its competitors. This superiority allows a company to achieve better margins and create value for both the company and its shareholders. A competitive advantage is often likened to a "protective moat," providing a unique position that is challenging for competitors to replicate.
Examples of Competitive Advantage: Competitive advantages manifest in various forms, such as access to natural resources, highly skilled labor, strong brand awareness, access to new technology, and price leadership. These advantages contribute to a company's ability to stand out in the market.
Components of Competitive Advantage: To establish a competitive advantage, a company must identify its value proposition, target market, and competitors. The value proposition should be something sought after by the target market and difficult for competitors to replicate. This involves understanding customer needs, maintaining competitiveness, and researching competitors' offerings.
Building a Competitive Advantage: Michael Porter's three strategies for establishing a competitive advantage are cost leadership, differentiation, and focus. Cost leadership aims to be the lowest-cost provider, differentiation involves offering unique goods or services, and focus targets a niche market with specialized products.
Competitive Advantage in the Marketplace: Examples of companies employing these strategies include Walmart (cost leadership), Apple (differentiation), and Whole Foods Market (differentiation focus). These companies have strategically positioned themselves in the market, leading to sustained success.
Importance of Competitive Advantage: Competitive advantage is crucial for a business to succeed, providing higher margins, attracting more customers, and fostering brand loyalty. Investors and creditors favor companies with a strong competitive advantage, making capital more accessible and cost-effective.
In conclusion, a deep understanding of competitive advantage is essential for navigating the complex and competitive business landscape, and the concepts outlined in the article provide a comprehensive guide for companies striving to achieve and maintain a competitive edge.
