A Firm Seeking Competitive Advantage Must Choose the Type Advantage That It Seeks

A firm seeking competitive advantage must choose the type advantage that it seeks

Introduction:

In an industry, firms compete with each other to secure market power and ultimately maximize profits. This superiority is achieved by a firm when it is competitively at a better position as compared to its industrial rivals. Such a firm is said to be at a ‘Competitive Advantage’. According to Besanko, Dranove, and Shanley (2000), “When a firm earns a higher rate of economic profit than the average rate of economic profit of other firms competing within the same market, the firm has a competitive advantage in that market.” (p. 389).

A firm’s competitive advantage allows it to outperform its competitors, by developing certain competences and performing discrete activities (Porter, 1990). These competences and activities lead to the creation of ‘value’ by a firm for its buyers. Competitive advantage requires that the value of product or service created by a firm for its buyers must exceed the cost of creating it, which can be achieved either by offering lower price than competitors for a similar product/service or a premium price for a unique product/service (Porter, 1985). According to Porter (1985), there are two types of competitive advantage: cost and differentiation. The type of competitive advantage a firm desires can be achieved by adopting one of the three generic competitive strategies defined by Porter (1985): cost leadership, differentiation and focus. These strategies are significantly shaped by Porter’s ‘five competitive forces model’ which determines the profitability and firm’s rate of return on investment to capital employed in the industry. Evolution has resulted in the emergence of another type of strategy, called the hybrid strategy (Bambang Baroto, Bin Abdullah and Wan, 2012).

The study here concentrates on Porter’s argument that a firm seeking to achieve sustainable competitive advantage must choose the type of competitive advantage it seeks by practicing one of the competitive strategies mentioned above. A brief overview of the different types of competitive strategies will be presented along with industrial examples to support the argument.

Cost leadership:

        In cost leadership strategy, a firm achieves sustainable competitive advantage in the industry by offering products or services equivalent in value to its competitors at a lower price than its competitors (Porter, 1985). The resources of a firm are exploited to attain a cost advantage (Porter, 1985). In cost leadership, firms give more attention to competitor’s prices rather than customer preferences (Frambach, et. al, 2003). This cost advantage is established through a number of factors such as low-wages or a dedicated workforce, inexpensive raw materials, economies of scale, better supply chains, and efficient operational activities.

        McDonald’s provides an excellent example of being a cost-leader in the fast-food industry. McDonald’s offer its products (burgers and sandwiches) at lower prices than its competitors such as Burger King, Wendy’s and KFC. McDonald’s sustainable competitive advantage is primarily attributed to its capability of keeping its operational costs as low as possible. McDonald’s has a scale advantage over its competitors too, with 33,510 units spread globally, more than double the number of any of its competitors (Mcdonalds.com, 2014). According to the data cited in the article, McDonald’s maintained its operating margin at 30.13% and return on assets at 15.42% which is relatively high in comparison to most of the other fast food chains (Mourdoukoutas, 2013). The high values of operating margin and return on assets can be explained by the fact that Mcdonald’s was the first fast food chain to choose strategically favourable places at reasonable leases and had an ability to provide a wide variety of products under one roof.

        In the retailing industry, Wal-Mart is regarded as the cost-leader due to the cutting-edge prices it offers to its customers as compared to competitor retailers such as Costco, Sears and Price Smart. Global 500 ranked Wal-Mart as first in terms of annual revenue, leading top corporations (Fortune, 2014). According to revenue figures shown by business week, in the year 2013 annual revenue for Wal-Mart was $466B, approximately four times higher than its immediate competitor Costco, whose revenue stood at $105B (Businessweek.com, 2014). Wal-Mart’s decades old sustained competitive advantage is derived from its capability to acquire goods from its supplier at discounted rates with high efficiency and establishing good-sized stores in relatively smaller towns (Walmart.com, 2014). Wal-Mart considerably controls its operational costs by directly managing its global procurement rather than relying on third parties. The low price image of the brand also increases the volume of sales and reduces advertising activities.

        It is evident from the examples shown above that McDonald’s and Wal-Mart achieved above-average performance by opting for cost leadership strategy for a sustained cost competitive advantage against their competitors. The selection of cost competitive advantage by these firms has resulted in higher sales and higher profits. Each of these firms exploited one or more of their competencies to achieve sustained competitive advantage. McDonald’s ability to minimize its operational costs and Wal-Mart’s ability to acquire goods at discounted rates from its suppliers have enabled them to achieve sustainable cost competitive advantage in their respective industries.

Differentiation:

        According to Porter (1985), firms that have differentiated competitive advantage through practicing the differentiation generic strategy offer distinctive products or services to their buyers at premium prices. Such firms exploit particular characteristics of the industrial product or service which have value in the eyes of their buyers (Porter, 1985). According to Mose (2010), as cited by Wen-Cheng, Chien-Hung and Ying-Chien (2011), it is difficult for a firm’s competitors to imitate characteristics such as product quality, durability, reliability, innovativeness, brand reputation and superior customer services. For firms sustaining a differentiated competitive advantage, the additional costs for differentiation should be less than the premium price to be an above-average performer in the industry (Porter, 1985).

Differentiated competitive advantage can be best illustrated by Apple’s strategy, a company that is a market leader in the IT industry. Apple has outperformed its competitors (Samsung, Hewlett-Packard and Blackberry) in the smart phone and notebook industries by sustaining a differentiation competitive advantage through its high quality elegant products and superior customer services. Figures indicate that the annual revenue for Apple in the year 2013 at $170.9B is far higher than HP at $112.2B (Markets.ft.com, 2014), its competitor in notebooks. Apple’s core competence is its integration of features of different products into one single handy product. (Magee, 2014)  Another quality that sets Apple apart is its commitment to innovation, having launching products such as iTunes media, iPod, iTunes store, iPhone and iPad in the last decade (Store.apple.com, 2014).  Apple is also able to keep its production costs low and ensure a unified work flow by having a centralized organisational structure rather than sub-units (The Huffington Post UK, 2014), contributing to its sustained competitive advantage.