Sustaining compettive advantage

The three major ways in which you can compete in the marketplace are:

• On price
• By serving a niche market better than anybody else

and,

• On the individuality of your product or service

Which of these is the better long-term strategy? Undoubtedly a lower price than the competitor is an immediate advantage – but will it deliver a continuing competitive edge? Let’s have a look at them.

Operations reform offers a cost advantage

Many businesses focus on increasing their operational effectiveness as a way of gaining a competitive advantage based on the fact that increasing operational performance can lower production costs and these can be passed on as lower prices. If they are manufacturers, for example, they might build close relationships with suppliers so that inventory arrives just when they need it, thus cutting the cash tied up in stock. Or they might work towards zero defect production to reduce the cost of waste materials and time lost on manufacturing replacements. Or they might re-engineer some of their production processes to work more efficiently. All of these are worth doing of course – you should always be on the lookout for cheaper ways to operate.

But process reform is effective only up to a point. Over time, more and more businesses restructure their processes and increase efficiency to match what has become, in effect, the best practice in the field. This means that if all businesses in an industry are producing a similar product, and producing it efficiently, the only place they have to go for competitive advantage is through reducing prices. Their process reforms will be ‘rewarded’ with downward pressure on prices and profit margins!

Serving niche markets

If you adopt a focus strategy, as it’s called, you target a narrow market segment and service it better than anyone else, building up solid customer loyalty. As you’re a niche operator you produce or sell small volumes and have no access to economies of scale, but you hope that your tightly targeted product features will enable you to charge premium prices.

The risk here is that tastes change and niches disappear. And larger competitors might put out imitative products.

Differentiation provides a sustainable competitive advantage

Assuming we stick with the wider market, being able to deliver benefits that exceed those of competing products, which is a differentiation strategy, will provide a harder-to-match advantage for your products. This is the point made by influential Harvard professor Michael Porter, in his book Competitive Strategy: Techniques For Analyzing Industries And Competitors (Free Press 1980) – and it’s still valid.

Porter suggests that businesses only really gain a competitive advantage by differentiating themselves from their competitors. That is, it’s not enough to simply implement a good inventory management system. You have to link it to part of a package that makes you stand out from the crowd. For example, you could link your inventory management to an unusually fast and reliable delivery system. You’d aim to come up with a package of benefits that your competitors would have difficulty imitating. And then you’d be under less competitive pressure and freer to widen your profit margin.

Of course, it doesn't stop there. Today how many fast-food outlets don't offer a home delivery service?

Today we’ll draw on some of Porter’s ideas to show you how competition works in the business world, and the value of using this knowledge to perform a competitive analysis on your business, which in turn will focus you on how your products rate against those of competitors. You can then make informed decisions about the sort of strategy to use with your product to gain the best competitive advantage.

How competition works: The Five Forces

Porter suggests that five factors drive competition in an industry and that therefore need to be considered when looking at gaining a competitive advantage.

These five competitive pressures come from:

• Rivalry amongst firms in the industry
• Customer buying power
• Supplier selling power
• Attempts by outsiders to win customers over to their products
• The threat of entry of new rivals

It’s useful to be aware of these sources of competitive pressure. If you can define your sources of competitive pressure you can probably find a way to deal with them. That’s a good thing, because the lower the pressure, the higher your margins can be. Let’s look at each in turn.

Force 1: business rivalry

Most of us would work in businesses where the landscape could be characterised as containing many rivals, none of which has a significant market share. Fragmented markets like these are said to be competitive – and often we think to ourselves just too competitive for everyone’s good!

Rivalry with other businesses could get you thinking about big-picture things such as:

• Is this industry really going to grow or not?
• How strong is my brand in the marketplace?
• How tied in to this industry or particular set of customers am I, i.e. what barriers to exit are there?
• What opportunities are there to really differentiate my product by improving features and implementing innovations in the manufacturing process and in the product itself?

Force 2: customer buying power

Buyers can also exert competitive pressure in several situations. Some examples of where these might operate would be if:

• Your products are, in reality, very similar to your competitors’ products which is the case with most consumer products from soap to white goods. This one often operates in conjunction with the ability to easily switch to buying from your competitors.
• There are only a few buyers for your product and they control a significant part of the market share between them. This is the case with government contracting for instance.
• Customers tend to buy in large volumes. This can be the case with B2B transactions in particular – what influence could a distribution outlet such as Bunnings exert over power tool manufacturers for example?

Force 3: supplier selling power

A producing industry requires raw materials, a retailer needs inventory, and a services firm might need occasionally to call on expert advice from an advisor such as a lawyer or an accountant! This necessity leads to buyer-supplier relationships between the industry and the firms that provide it with the raw materials or advice used to create products and services. In this situation, if there are only a few suppliers, those suppliers hold the power and can charge a premium price. Suppliers, if powerful, can exert an influence on the producing industry, such as selling raw materials at a high price to capture some of the industry's profits. Unfortunately, you can’t always pass costs on to customers, and you might find your margins really squeezed.

Force 4: attempts by outsiders to win customers over to their products

Substitute products are another source of competitive pressure. Strictly speaking, a substitute product is a different product from what you’re selling that could be used to get the same end result. For example:

• Spectacles vs. contact lens
• Sugar vs. artificial sweeteners
• Plastic containers vs. glass vs. tin vs. aluminium
• Aspirin vs. other types of pain reliever

To deal with the potential for damage that a substitute product can cause you should always be scanning the external environment for industry developments that might threaten your existing product range.

Force 5: the threat of entry of new rivals

Here we’re talking about how easy it is to get into your industry – the barriers to entry. Barriers can be a good thing or a bad thing, depending on which side of the fence you are on – established in the industry or trying to break in.

Barriers may take many forms. For example, some businesses have very high start-up costs and may take a long time to show a profit. A lot of intensive marketing may be needed. Or there may be very high capital costs to set up a business, so there can be no new entrants in the market unless they have very good financial backing.

Competitive pressure is influenced by how hard it is for others to get into the industry. Barriers to entry include:

• High start-up costs
• Intensive marketing requirements
• Need for specific and unusual expertise
• Heavy government regulation – the cost of meeting requirements
• Brand identity
• Threat of retaliation from existing businesses

Regardless of whether or not the barriers to entry are high or low, or if you are in the industry or trying to break in, your continuing success will come down to creating a product that is clearly differentiated from your competitor’s in some way that will get you the sale.

Bulletproofing the barrier

If you are already provided with some protection by high entry barriers you should be trying to keep it that way so that nobody else gets a foothold and you outdo the other competitors you do have. As we've seen recently, the government does not like anti-competitive behaviour, but most readers will not be in that position. Product differentiation is a real strength here – you should be working to build up prestige for your brand, providing high levels of customer service and establishing high levels of customer loyalty as differentiators. It would then take a bold or very well-heeled challenger to dislodge you from your position of market leadership. You would be unlikely to lose such a good competitive advantage.

However, entry barriers can also be too low for comfort. If start-up costs are low, you might find that you are facing very many competitors who have little capital and are desperate to sell at any price, just to get some cash flow. You’d then be operating in a tough and unrewarding market. Suppose you opened a small greengrocer’s shop. And suppose some competitors were unwise enough to start up very close to you. You might soon be competing hard enough to drive each other out of business. In a situation such as this, the ability to differentiate becomes a matter of survival.

Scanning the external environment

These things don’t operate in a vacuum of course. The drivers of business rivalry and the power relations between suppliers, producers and distributors are changing all the time under the influence of many forces. New technologies, for instance, have the potential to create great business opportunities for some while causing upheaval among traditional players – think of the impact of communications technologies over recent times.

Strategic analysis begins then by looking at the major forces that impact your business through these five forces such as changes in the political climate, changes in the economy, where the industry is headed, what your competitors are up to, and, as I just mentioned, likely changes in technology. We call this sort of analysis "scanning the external environment".

I’m not going to elaborate on this but the next few paragraphs will show you the areas we specifically cover in this sort of review. As well as technology, we look at the business environment, shareholder circumstances, customers, industry and competition.

What’s happening in the business environment?

Here are a few of the areas in the general business environment that can have an impact on your competitiveness:

• Industry regulation
• Taxation structure
• Employment regulations
• Environmental regulations such as ‘green’ issues
• General growth expectations in your local economy

It can be to great advantage to check these out - a review of tax regulations for instance could reveal schemes for minimisation you weren’t aware of and provide immediate benefit and an awareness of green issues could provide some marketing ideas that emphasise your responsibility in this area and could be leveraged for brand enhancement or product differentiation.

What new technologies are emerging?

New ways of doing things in an industry can bring both threats and opportunities. As far as possible, it’s good to keep an eye on emerging technological trends, particularly in terms of:

• What new technologies are in development or on the market that could drive processes more efficiently 
• What is the cost or usefulness of implementing them?

Again, even the introduction of new technology might be a way of creating a differentiator for your product as well as improving productivity. For example, the new technology may give you the capability to more easily customise your product to a customer’s requirement in a way that is cost-effective for you and allows you to charge a premium price that your customer is happy to pay.

Where is the industry heading?

Whilst your local operations may seem safe enough you need to be aware of what is happening in the industry overall. All industries go through life cycles. The generic stages of an industry life cycle are as you see on the slide.

Where are you on your industry’s life cycle? It is important to be aware of your current position and if you’re reaching (or past) maturity, you will need to plan for the future. That might mean diversifying or moving into a new business altogether. An example of an industry that disappeared completely was the buggy whip industry which declined rapidly with the advent and subsequent mass adoption of the motor car industry.

Benefiting from competitive analysis

This sort of competitive analysis can give you early warning of threats to your business. It will also hint at opportunities for business growth where you can get ahead of your competition. It can give you greater business security and help you safeguard or build your profit margins, as you minimise competitive pressure. It can give you ideas about what already differentiates you from competitors or what you might do to introduce some differentiation. This is extraordinarily valuable information because, as I’ve been saying, it’s these differentiators that are the basis of getting your product noticed over that of your competitors.

How do you scan the external environment?

Scanning the external environment is usually referred to as SWOT analysis, where SWOT stands for Strengths, Weaknesses, Opportunities and Threats. I’m not going to go into detail about how you do this. It may seem too daunting to try yourself and that would be a shame because it will return real benefits. But you don't have to do it alone. Just remember when you get someone to help, be sure their service is both independent and thorough.

Scanning the competition

One of the first things to do in the competitive analysis is to decide who your competitors are. Sounds simple, right? Guess again. Business owners often have difficulty defining exactly who their competitors are. For instance, take my old accounting firm. If I asked you who my competitors were you might consider the local small agencies who do personal tax returns. But since IRD simplified these our choice not to aim for the ‘once a year tax return only’ type client made even more sense. We concentrated on closer long-term relationships with clients whom we could also do business development work with. So I never considered them a direct competitor. In fact, when Hnry started up we referred sole traders with no staff or stock to them. We simply couldn't offer professional services to those clients at a competitive price, and to be completely honest, we didn't want to.

Direct competition is more like, for example, if you run a pizza outlet, then other neighbourhood pizza operations are in direct competition with you. But we consider your indirect competitors also. These are not always obvious either. For example, neighbourhood supermarkets may sell frozen dinners. Although they’re not cooking pizzas, they will still be taking money away from you. Similarly, the local McDonald's offers a substitute product to your pizza and is clearly competitive with your business.

You need to keep an eye on both your direct and indirect competitors. For example, you’d like an early warning if they’re about to launch new products or diversify into areas that might take other lines of business away from you.

Identifying strengths and weaknesses

When we analyse your competitors, we’re looking primarily for their strengths and weaknesses. You don’t want to try and compete against them on their strengths unless you can match those strengths. So the focus is on outperforming them on their weaknesses.

You can get an idea of their strengths and weaknesses through their marketing where they’ll tend to foreground strengths. You can analyse their advertising in papers, magazines and brochures. You can get information from annual reports if they produce one.

What the customer has to say

So far you have been gathering pretty objective criteria, but you’d also want to rate your product according to customer perception given that their perception is what really decides a sale. You could do some market research on how customers rated the features of your product against the competition such as by running a customer advisory board or sending out a questionnaire.

• Establish what customers think – their perception is the reality
• Market research:
• Focus groups (customer advisory boards)
• Questionnaires

Identifying strengths and weaknesses

What do you do with all this information? Well, it all goes towards developing a strategy that puts your business ahead of the competition.

For each of your main competitors, list the strengths and weaknesses you have identified. You should be able to list at least five things that each of your competitors does well and five things that they do not do so well. Are they great at customer service and post-sales follow-up?; are their team well trained?; is their pricing really competitive? And so on.

You can do a similar thing with products to come up with a product comparison matrix rating the features and benefits of your product against those of the competitors.

Try to maintain some objectivity by looking at the products you are rating from the customer’s point of view.

Keep in mind that their strengths are what you might need to match if you don’t already, and their weaknesses are areas you can take advantage of in differentiating your product.

Search tor differentiators

As you review all this information keep thinking about specific differences between your product and theirs that you can exploit – or ones you could develop. We call these Unique Core Differentiators or just UCDs. Should you market to emphasise your brand? Can you make inroads on your competition by highlighting your superior customer service? Does your workforce have unique skills that you can exploit? Can you offer new features that your competitors will find hard to imitate?

Which strategy?

So, what are the relative merits of cost leadership and differentiation strategies?

Cost Leadership

A cost leadership strategy generally suits someone who produces or sells at low cost and is willing to cut prices to win market share. It’s a sustainable strategy if you have access to relatively inexpensive raw materials, have lower fixed costs, or can outsource very effectively. Cost leadership strategies are usually oriented towards a very broad market. Discount stores follow a cost leadership strategy, for example, Pah 'n Save is a terrific example of cost leadership.

They carry relatively few products compared to those carried by many supermarkets. They pack them in wide aisles. Their stores are very basic and in cheap areas outside major retail areas. Their cost base is low as a result, so they can charge lower prices and remain competitive and profitable.

If you don’t have a genuinely lower cost base a cost leadership strategy runs the risk of getting into a downward price spiral as everyone competes on price, and lives on lower and lower margins. In that scenario, the larger firms invariably win as they have the resources to stick out the fight. New technology can also introduce sudden price advantages, undermining this strategy. Or highly specialised competitors might be able to undercut you on sections of your product line. So regardless of which of the five forces you are dealing with, maintaining entry barriers, fighting off substitute products etc, a cost leadership strategy has only one string to its bow – the ability to lower prices. Well, think about it, just how sustainable can that be ongoing?

Differentiation

We’ve used the word differentiation to cover a range of meanings in this presentation. Clearly, having products that are lower in cost is a form of differentiation. But what we mean here is that you can differentiate by developing unique product or service features – the UCDs I mentioned. You hope your unique benefits will enable you to charge higher prices. You’ll rely on having a creative or innovative team, and you’ll need good marketing that effectively communicates the unique benefits your product offers.

Our observation is that in the SME market, most players in any industry are trying to cut prices AND add value through differentiation at the same time. To earn above-average profits in such a highly competitive environment you absolutely need to be ever vigilant for ways to cut costs, but your continuing competitive advantage will come from differentiation strategies.

With differentiation strategies your competitive edge relies on more than just cost – you introduce brand value and customer loyalty to minimise the opportunities for new competitors starting up or competing on price alone. You have a more sustainable strategy.

Conclusion

Competitive analysis is not something you do just once. You need to do it on a continuing basis. The commercial environment is constantly changing and you need to keep pace.

Every few months, you should do a competitive analysis to identify emerging threats. You need to look ahead and think strategically. The more clearly you have mapped out your competitive environment, the better prepared you will be to react to threats and take advantage of opportunities to build your business.