Business Strategy
Competitive advantage can be defined as the advantage gained or accrued by a firm or company over other firms in a competitive industry. This is done by offering customers a greater value of the purchased products and through several mechanisms (Rumelt, 2003). Such mechanisms may include low priced goods, high quality products, and after sale services that are superior to competitors. Competitive advantage may stem from several factors such as economies of scale, integration and non- integration and process based core competences (Peteraf, 1993). To further understand the concept of competitive advantage, several theories have been put forward for instance the Porter’s Diamond.
Porters Diamond of Competitive Advantage
This is a theory that incorporates the model of evaluating and determining the factors that influence national advantage. The theory argues that the national location or home base of an organization is a critical element in determining the probability of the firm of achieving advantage on a worldwide scale. In addition, this theory is placed upon the five forces of porter’s analysis that includes several components of; customers, suppliers, competitors, barriers to entry and threat of substitutes. A sixth factor is also incorporated in the five elements, which is the relative power of other stakeholders (Ahlstrom, 2010).
The threat of new entrants
A threat of new entrants increases the probability of competition to an existing firm in an industry since the new firm takes hold of a certain market share. This entry of a new firm in an already existing industry depends on the barriers of entry, which act as a hindrance and makes it difficult for a firm to enter an industry (Ahlstrom, 2010). Barriers of entry may take various forms that include:
Economies of scale
Economies of scale involve producing or purchasing large quantities of goods in a given period. Purchasing large quantity of goods saves on costs since the firm may obtain discounts and, in addition, save on other costs such as ordering. If a new firm is not able to exploit economies of scale, it may incur very high costs in its production process due to ordering and transportation costs (Hill, & Jones, 2008). This will greatly hinder its operations and ultimately be pushed out of the market due to losses.
On the other hand, if the firm is able to take advantage of the economies of scale, it is able to reduce its costs and also produce more products. High sales influence profits positively, on the assumptions that there is demand, if the costs are minimized, and thus the firm is able to overcome the economies of scale as a barrier to entry.
Product differentiation
Product differentiation also plays an important role as a barrier to entry especially in a competitive industry. This is because, a firm in such an industry tends to produce homogenous goods and for any firm to be competitive, it must be able to come up with a product that is preferred to that of its rivals. Product differentiation may involve selling a durable good, of high quality and also competing rigorously with competitors in terms of advertising and promotions. If a firm is able to come up with a differentiated product, it overcomes the barriers of entry, and thus increases the threat of entry to existing firms.
Capital requirements
Some business undertakings require a lot of financial resources at the initial stages for example, oil exploration. Lack of financial muscle by a firm seeking to enter into the oil industry hiders it from entering the industry, and thus does not pose any threat of entry to the already existing firms. If the undertaking does not require a lot of investments, then a firm can easily enter and increase the level of competition in the industry.
Switching costs
Within in an industry, a new technology may evolve with time for instance, a change from manual to digital systems within the banking industry. A digital change involves training of staff on the operations of the new technology and may involve high costs depending on the extent of the technological application. Such costs, referred to as switching costs, may act as a hindrance to entry of a new firm if the costs are very huge (Hill, & Jones, 2008). If the switching costs are not huge, a new firm is encouraged to enter the industry, increasing the threat of entry to the already existing firms.
Access to distribution channels
Access to distribution channels may hinder entry by a firm. This is observed in the supermarket industry where the cost of supermarket shelf space may be too expensive for a small and new entrepreneur to cope up with. The small entrepreneur is discouraged since he or she cannot access the distribution channel, is hindered from entering the industry, and ultimately poses no threat of entry (Ahlstrom, 2010).
Regulation
Government actions in the past and also currently have acted as a barrier to certain operations within an industry. Such actions include regulation through licensing. For instance, in the mining industry in both developed and undeveloped countries, the government has created a barrier of entry through licensing a small proportion of mining firms, consequently hindering others that may have wanted to enter the industry.
Rivalry among existing firms
This is second factor or element considered under the porter’s five forces of competitive advantage. Rivalry among firms in an industry may be intense depending on the product and other factors. A small number of competitors lead to intense competition among the firms since the firms tend to be equal and thus have to be very careful of each other’s actions (Hill, & Jones, 2008). Any decision by one firm is likely to affect others significantly such as reduction in prices of products and, therefore, the other firms have to be on standby in case of any strategic move by a rival firm.
Furthermore, the product features by a firm determines the extent of industry rivalry since consumers choose a product depending variety of selection, the price, and location of a firm. Amount of fixed costs also influences the rivals competition because, low fixed costs of a firm as compared to others means that the firm is able to offer special offers to its customers without accruing high costs relative to the whole industry.
The availability of substitutes to the products offered greatly influences the competitive advantage of a firm (Hill, & Jones, 2008). This is because; presence of a close substitute to a good places a price ceiling on the good .If the price of the good surpasses the standard price already considered by the consumers, then the consumers substitute the product with that of a rival firm ultimately reducing competitive advantage. If there are no close substitutes to a good, then the firm producing the good has a competitive advantage since consumers cannot substitute the good even if the firm charges high prices. This is evident in developing countries where electricity has no close substitute and, therefore, consumers are charged high prices.
Consumers Bargaining Power
A strong consumers’ bargaining power always limits the liberty of the producers in charging the prices of products. The consumers are able to negotiate with producers forcing prices down and at the same time obtaining high quality products. The consumers bargaining power is enhanced if buyers purchase a large proportion of the producer’s goods such that, failure of purchase leads to big loss of value to the producer (Ahlstrom, 2010). It may also be enhanced if there are many producers giving buyers the choice of buying from any of the sellers.
Moreover, if the purchased product is not critical to the buyer’s final product, and can be easily substituted, then the consumer’s power is enhanced. This is because, the buyers can do without the product and any action by the producer such as high prices will lead to significant fall in the quantity demanded. Lastly, if the buyers by purchasing a producer’s product earn very low profits, they will be very sensitive to prices charged. Any price increase will lead to decreased demand, further reducing the firm’s competitive advantage.
Suppliers bargaining power
Bargaining power of supplier is enhanced in situations where the suppliers are very few for instance, a monopoly. In this case, the monopoly can charge high prices with revenues and profits not being adversely affected. Thus, a high bargaining power of a supplier leads to enhanced competitive advantage.
Relative power of stakeholders
Other stakeholders may include local community, complimentors, trade organizations, and creditors. The power of a complimentor, one whose product influences the final products of other firms, affects the competitive advantage of firms. Withdrawal of a complimentor decreases the competitive advantage of a firm since the final product has to depend on the complimentor (Porter, 1985).
In all these factors that affect the competitive advantage of a firm or on national level, two strategies have been advocated for if a firm is to enhance its competitive advantage. That is; lower cost of products and differentiation. Lower costs involve designing, producing and marketing a product that is identical to other firm’s goods at a lower cost. This enhances the firm position in the industry way above the other firms.
Differentiation, on the other hand, involves providing a unique good and one that has a higher value than the products on sale by other firms (Porter, 1985). Buyers thus prefer the differentiated product to the common one placing the firm in a higher position than its competitors. In addition, differentiation may include peculiar features or unique after-sale services such as 1-year warranty on any product bought.
A combination of the two strategies of cost advantage and differentiation advantage is what leads to competitive advantage.
Resource Based View of Competitive Advantage
This is a method that takes into account, analyzes and interprets a firm’s internal and external resources to determine how such resources sustain competitive advantage (Peng, 2001). It is similar to porter’s analysis on several occasions though it is based on the assumption that firm 1 and 2 do not possess homogenous resources or a set of identical capabilities. This means that, resources that are valuable, rare, and imitable and cannot be substituted are the factors that facilitate business development and consequently maintain competitive advantage and superior performance of a firm.
A resource must meet the conditions of the VRIN (valuable, rare, imitability and non-sustainability) criteria in order to provide competitive advantage to a firm. A resource is said to be valuable if it gives a strategic value to a firm by assisting the firm take advantage of the market opportunities and thus accrue some benefits (Madhani, 2009). Exploiting market opportunities helps the firm reduce market threats such as entry, ensuring the firm is not overtaken by its potential rivals.
Moreover, a rare resource must be difficult to find among the potential competitors and also be unique in that, it is only owned by the firm and not any other (Coates, 2002). If the resource can be found easily, then the rival firms can also use it and thus no firm gains a competitive edge through the resource. In addition, the resource must be imitable, in that it should not be easily imitated by other firms. If it can be imitated by rival firms, all firms in that particular industry can utilize it leaving no particular firm to enjoy the resource exclusively.
Lastly, the resource should not be easily substitutable and, therefore, irreplaceable. Having close substitutes to the resource affects the competitive advantage since other firms can produce the same product using other materials leaving no uniqueness in a resource. Resources that fulfill the VRIN criteria should be able to influence high sales, low costs, and high profit margins and add to the financial value of the firm (Barney, 2001).
Under the resource based view, resources and capabilities have further been grouped into tangible and intangible resources and capabilities. Tangible resources include financial, physical, technological and organizational resources. Financial capability entails the ability to raise and generate funds to meet the financial needs of the firm (Helfat, 2003). A firm with financial capability is able to finance its expansion programs, produce more products, leading to high sales and profits in contrast to one which is not able to raise the required capital.
Physical resources involve the firms geographical location, access to raw materials needed for production, and the location of offices and plants. Technologically, a firm must be in possession of patents, trademarks, and copyrights among others in order to put limits on other firms against using its resources to further their own interests and disadvantage the firm in return.
The intangible resources and capabilities include human, innovation, and reputational resources. Intangible resources may be the organizational culture of the firm, consumers’ perception about the firm’s product, good employer, and a firm that takes its social responsibility seriously (Vogel, 2005). Consumers are confident with products that are supplied by a reputable firm and whose products have not been subject to defects. For instance, Toyota has been able to conquer other automobile makers in the market today due to its reputation as a world leading car maker and also providing differentiated products. This has given consumers a range of preference from the same producer boosting the sales of Toyota cars and high profits.
Critical evaluation of competitive advantage to strategic analysis
The resource based view to competitive advantage goes a long way in assisting managers and organization leaders in strategic process. First, it assists them evaluate and analyze valuable and not valuable resources hence choose resources that will enhance their competitive advantage. This enables them also to choose where to invest their funds to maximize on their returns, ensure growth and development, and also fend off competition from rivals.
In addition, resource based view enables the managers make production decisions as to whether to produce internally or externally (Grant, 2001). This is in terms of outsourcing or not outsourcing technology to third parties where, outsourcing raises the possibility of their advancement leaking to their rivals. Developing technologies from within enables the firm to copyright the innovation, therefore, boosting the company’s position in the market.
Moreover, the firm is also able to evaluate how imitable an innovation is and thus able to come up with technologies that are complex and cannot be easily imitated by rivals (Ciurez, 2008). Developing an innovation that is a combination of cheap technologies will not keep rivals out through patents and trademarks, and thus the firm’s competitive advantage will not be enhanced.
Lastly, competitive advantage evaluation assists the firm make decisions regarding the pricing of their products. This is because, if the firm has a product that cannot be easily imitated by its rivals, it can maximize its profits through charging a higher price margin knowing that it’s sales will not be affected (Ciurez, 2008).
On the contrast, competitive advantage which can be influenced by complimentors will require the firm to be very careful in its strategic process since any withdrawal by the complimentors would lead to losses. Thus, in general, competitive advantage affects the strategic process of the firm since it considers both the internal and external capabilities and resources and how such resources can be manipulated to derive the maximum benefits.
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