- Compete To Survive
As a small business marketing consultant, I always try to assess the competitive advantage of my clients – competitive advantage holds the key to effective marketing messages that will grow your business.
Types Of Competitive Advantage
Basically the three main 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 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 reengineer some of their production processes to work more efficiently.
All of these are worth doing of course – you should always be on the look out 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
So, assuming we stick with the wider market, being able to deliver benefits that exceed those of competing products, that is, a differentiation strategy, will provide a much 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.
Today we’ll draw on some of Porter’s ideas to show you how competition actually works in the business world, 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 there are five factors that drive competition in an industry and that therefore need to be considered when looking at gaining a competitive advantage.
- Porters Model
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?
- and,
- 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 a number of situations as outlined on the slide. 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 B&Q 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 to 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 a number of 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 setting up a business, so there can be no new entrants in the market unless they have very good financial backing.
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.
Bullet Proofing The Barrier
If you are already provided 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.
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.
But 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.
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, Aldi is a terrific example of cost leadership (http://www.aldi.com.au/index.php?choice=about_aldi). They carry only 700 products compared to the 10,000 carried by many supermarket chains. They pack them on pallets in wide aisles. Their stores are very basic and in cheap areas outside of town centres or major retail areas. Their cost base is low as a result, so they can charge lower prices and remain competitive and profitable.
Cost Leadership Risks
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 5 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 article. 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.
Resources:
Grow Your Business With Unique Core Differentiators
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