Competitive Advantage & Porter's 3 Methods of Competitive Strategy

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A competitive advantage is a strategy that helps you attract customers to your business who would otherwise make a purchase from a competitor. A competitive advantage isn't just a temporary strategy like a one-time sale. Instead, it's a long-term and sustainable plan that aims to increase your market share.

Perhaps you feel like your business has managed to succeed without a specific competitive strategy. Do you really need one? You may actually have a competitive edge without realizing it, such as being the only store for miles around to sell particular products. However, what would you do if someone set up a competing store just down the road?

Identifying and understanding your company's sustainable competitive advantage will not only help you gain customers as you launch a new business but also allow you to stay relevant when new competitors arrive on the scene.

Why It's Important to Identify Advantages

With rare exceptions, all businesses experience competition. From the perspective of consumers, competition is a welcome phenomenon because it drives prices lower and increases consumers' bargaining power. Ultimately, this leads to new technologies, better products, and low prices.

Competition can also make it hard for a business to succeed for the same reasons. With other companies lowering their prices or creating innovative products, you're forced to do the same in order to keep customers happy with your brand. As long as your efforts pay off by leading to increased sales, then it's worthwhile. However, trying to be everything to everyone can cause you to spread your resources too thin, ultimately killing your business.

That's why it's important to pick a competitive strategy and stick with it. According to economist Michael Porter, business owners have three types of competitive advantage from which to choose: cost leadership, differentiation and market segmentation. Are you not sure which will work best for your business? Consider doing some competitive research to identify the strategies already being used by your closest competitors and then doing something different.

1. Cost Leadership or Low Prices

Porter's first competitive advantage is called "cost leadership". If you sell your products or services for a lower price than your competitors, people will be drawn to your company. Because price represents such a powerful factor for consumers, it also represents an incredible competitive advantage.

A cost leadership strategy will only work if you can also manage to make a higher profit after accounting for the cost of sales, fixed expenses and taxes. Maybe you've already done the math and are wondering how your competitors can keep their prices so low while also paying the bills. Several possibilities exist, including getting deals from wholesale suppliers or partnering with complementary businesses to get discounts on products and services. You can also adjust salaries, move to a location with lower rent and utilities or outsource some of your work rather than having internal teams.

Economies of scale also play an important role in keeping prices low by improving operational efficiency. Sometimes, it costs more money to make a small amount of a product than it does to increase from a small amount to a larger amount. The initial investment in production equipment can limit the production capacity of a startup, whereas an established company has had time to funnel its profit margins back into its production facility and make more products at a lower cost. As a new small business, this can make it hard to gain a competitive cost advantage over established companies.

2. Product or Service Differentiation

When a product or service differentiation strategy is in play, a company strives to have a unique selling proposition or to convince its target market that it has high-quality products worth a premium price. The key is to be innovative in some way, whether you invent new proprietary technology, use environmentally friendly packaging, allow a product to be customized or offer anything else that makes you stand apart from the crowd. When done successfully, this business strategy can create brand loyalty as well.

You can also differentiate your company via price points without necessarily using low-cost leadership as a competitive advantage. For example, maybe one of your differentiation advantage tactics is free shipping on all orders, free returns or a special rewards program (like Kohl's Cash). Each of these strategies influences the final price that a customer will pay, but it doesn't necessarily mean that your items are priced lower than your competitors' products or that you use economies of scale.

Another trending way to differentiate a company includes bringing the product or service to the customer in a special way. Think about all the subscription boxes that exist these days that eliminate the need to remember to make a recurring purchase. Also, consider the fact that groceries and fast food can now be ordered online and delivered to the buyer's doorstep. Can your business get creative and bring products or services directly to busy customers?

3. Market Segmentation or Market Focus

Porter's third type of competitive advantage is called "focus" and can be split into two subcategories: cost focus and differentiation focus. With a focus strategy, a business seeks to provide products and services to a very narrow market segment.

For example, a company that sells wheelchairs for dogs focuses on a small population of pet owners and not the entire pet-care industry. Within that niche, the company could choose to either provide the lowest-cost wheelchairs (cost focus) or to differentiate its business from other wheelchair companies, perhaps by offering heavy-duty, off-road wheels (differentiation focus).

Examples of Competitive Advantage in Action

You don't have to think hard to discover examples of competitive advantage all around you. Consider some of the top fast-food brands, like McDonald's. Why do people choose to visit McDonald's versus other fast-food chains in the same area? It's because McDonald's has relied on a cost leadership strategy; it has become known for having affordable food, and therefore, it appeals to a large audience.

There's room for other fast-food chains to exist thanks to differentiation. Anyone craving a roast-beef sandwich knows to head to Arby's, whereas KFC is the place to go for mashed potatoes and gravy. If you need a variety of meals and a variety of desserts for a family outing, Dairy Queen will have something for everyone.

However, a gap in the market still exists because people with dietary restrictions struggle to find appropriate foods at those restaurants. If you haven't heard of a new fast-food chain called Copper Branch, it may be because you aren't part of its very narrow market focus: vegetarians and vegans. If someone else wanted to launch another plant-based fast-food chain, he would have to decide whether to have a cost focus or differentiation focus in order to try to compete with Copper Branch.

Determining Your Competitive Strategy

If you've never really thought about your business's competitive strategy, now is the time to do so. Start with market research to analyze your customers' pain points and find out why some people prefer your competitors.

Try to determine the competitive advantage for which your competitors are striving. Do you think you can compete with the same strategy, or is there an opportunity to stand out thanks to a different strategy? Explore the pros and cons of all your options in order to devise a new strategy, attract more customers and increase your revenue.