When formulating a strategy, one of the most important choices is to do with competitive advantage. Essentially, this is about clearly articulating why you will be better than your competition; in other words, why consumers will buy your products and services rather than those of your competitor.

Seven generic sources of competitive advantage are worth exploring, and they can typically be divided into three groups: product differentiation, feature differentiation, and game changers.

In product differentiation, a company leverages a core product or service in order to differentiate its offering in the market; that is, the fundamental functionality of the product and/or service.

In feature differentiation, a company can deliver a product that, from a functionality perspective, looks very similar to those of its competitors. The differentiation in this case comes from the feature of the product rather than the fundamental functionality. For example, this may include attributes such as price, quality or brand.

The third category of differentiation possibilities is game changers, which are based on a company’s ability to re-invent a market and/or an industry in order to fundamentally challenge and re-define the current paradigm that controls how, for example, money flows in an industry.

Product differentiation

#1: Product/service

For some companies and at certain points in time, it is possible to compete in the market with a core offering. An example of this is when a company innovates a new product or service and is able to take that offering to the market before anybody else. The ability to differentiate with a product/service’s core functionality comes through a customer’s appreciation of it (that is to say, if customers do not appreciate the functionality of a unique product, there is little value in differentiating on it) and the company’s ability to protect the uniqueness of the products/service (for example, through patents).

Dr. Wallace Carothers (1896–1937) worked as a researcher at DuPont and focused primarily on the field of polymers. In 1935, he discovered a particularly strong polyamide fiber, a fabric that later was commercialized as “nylon” through full-scale production facilities in Seaford, Delaware (1).

The invention of nylon enabled DuPont to bring a unique and novel product to the market – women’s hosiery based on synthetic material.  The introduction was a huge success, so much so that a second product facility was established 1941 in Martinsville, Virginia to meet demand. In 1950, DuPont granted its first license to another company for production on nylon (1).

#2: Product/service bundle

While differentiating with a unique product/service is clearly a strong and attractive model, the ability to bundle products that already exist in the market to unique propositions is often overlooked as an opportunity to create a competitive advantage. Companies that try to differentiate through bundles in the market will need to possess a unique understanding of the customer’s needs.

Bundles have become an effective lever with which to compete in telecommunications and in TV. If you live in the UK, for instance, you have the option to sign-up for a bundle from Virgin, BT, or SKY. All of the offers are bundles of TV, Internet, and telephony, often called a “triple-play.”

The triple-play bundle is an effective way of competing with companies that offer only one of the three services. Furthermore, the bundles in the UK market vary slightly, which can be seen as an attempt by the triple-play providers to differentiate their bundle from those of their competitors. BT, for instance, includes an internet security service in their bundle, which the other two providers do not. In order to further raise the level of competition through bundles, Virgin is planning to include mobile broadband and/or mobile phone packages into their bundle (5).

Feature differentiation

#3 Price

When a product and/or service are commoditized, the typical evolution of an industry is to turn competition into a war on price. One of the reasons for this is the customers’ ability to measure and compare, and price is a very transparent lever for differentiation.

Furniture is a highly commoditized product in terms of its core functionality. Therefore, while it might be possible to compete with the design of a product, it is very difficult to compete with its actual functionality. For commoditized products, price tends to become one of the key purchasing criteria for the consumers. One furniture retailer that has been particularly successful in leveraging price as a competitive advantage is IKEA (Ingvar Kamprad Elmtaryd Agunnaryd), which was founded in Sweden in 1934 by Ingvar Kamprad. Right from its early days, IKEA made a decision to distribute its furniture in flat-packs, which leads to cost effectiveness in its operations, such as in production, distribution, and inventory costs. IKEA has made itself known as a provider of affordable furniture; in reality competing effectively with price as the key lever.

Today IKEA is the world’s largest furniture retailer (2), operates through more than 300 stores in over 35 countries, and generates revenue of more than 20B Euros, with a profit margin greater than 10 percent (3).

#4 Quality

Another factor that can be leveraged in order to differentiate an otherwise commoditized product is quality. Specifically, while the fundamental functionality of the product remains the same, the quality of the product can be unique. Through a product with unique quality, a company can effectively sustain a price level or even claim a premium price based on the quality features delivered.

Quality as a competitive lever is less about ISO 9000, Six Sigma or any other quantitative measure of quality and more about consumers’ perception of the quality.

In 1914, at Ernst Leitz Optische Werke in Wetzlar, Germany, Oskar Barnack built the first Leica camera. It was one of the first 35 mm cameras to extend the frame size to 24 x 36 mm (6). Ever since then, Leica has been closely associated with high quality and has been used by well-known photographers such as Henri Cartier-Bresson (1908–2004), Robert Capa (1913–1954) and Diane Arbus (1923–1971).

Today, a digital Leica M9 Rangefinder camera body retails for $6995 (7), while you can get a Nikon D700 camera body for professional use for as little as $2349 (8). Whether the Leica produces pictures of better quality than the Nikon may be open to debate. However, the quality of the Leica camera is beyond question, or at least the perception of quality.

#5 Brand

The brand of a product can sometimes be an effective lever with which to differentiate a product. The brand can help differentiate an otherwise generic product offering, but in most cases it takes some time to establish.

The Coca-Cola Company and PepsiCo are head-to-head competitors when it comes to carbonated beverages, primarily the Coca-Cola and Pepsi soft drinks. They both represent a product that largely could be characterized as a commodity product.

As part of a marketing campaign, PepsiCo introduced the Pepsi Challenge in Dallas, Texas in 1975 as a national campaign. As part of the campaign, consumers around US were given the opportunity to select their preferred choice between Pepsi and Coca-Cola in a blind test; a majority of the consumers chose Pepsi (13).

When brand is added to the equation, however, consumers clearly chose Coca-Cola. Coca-Cola is currently the market leader for carbonated cola, far ahead of Pepsi in much of the US, South America and Europe, with market share above 50 percent or even above 75 percent in certain markets. This is clearly a result of having gained a competitive edge through a significantly strong brand (11).

Coca-Cola is ranked number one among best global brands in terms of brand value, worth $66 667 million, while the Pepsi brand is valued at $13 249 million, which ranks it 26th (12). In order to maintain this position, however, the Coca-Cola Company invests around $3 billion on advertising each year (9).

Coca-Cola is an example of a brand being effectively used to create a competitive edge. Today, sales of the Coca-Cola Company are close to $31 billion, with a gross margin of more than 64 percent and an operating margin above 25 percent (14).

#6 Service

In some markets and in certain situations, service will provide a good opportunity for a company to differentiate itself from its competition, even when the product being delivered is fundamentally the same. This lever could effectively be leveraged to turn a commodity product into a premium product. In other words, the product is differentiated through the service that comes with the product rather than the fundamental functionality of the product.

Hotelier Cesar Ritz (1850–1918) broke new ground in terms of defining the concept of customer service. Ritz, who was known as the “King of hoteliers and hotelier of the kings,” founded several hotels, the most famous of which are the Hôtel Ritz in Paris and The Ritz Hotel in London (17).

Today, the luxury hotel chain Ritz-Carlton has become known for outstanding service and is an example of how to effectively leverage service as a means of differentiating an otherwise commoditized product.

Ritz-Carlton has established what it calls the “Gold Standards,” which is essentially a series of statements that define the type of company it aspires to be and contains several components that outlines the importance of outstanding service. The “Gold Standards” is divided into the Credo, the Motto, the three Steps of Service, Service Value, the 6th Diamond, and the Employee Promise. In the Credo, for instance, the aim of the service concept becomes clear:

We pledge to provide the finest personal service and facilities for our guests who will always enjoy a warm, relaxed, yet refined ambience.

The Ritz-Carlton experience enlivens the senses, instills well-being, and fulfills even the unexpressed wishes and needs of our guests.” (15)

Furthermore, the Service Value, with its 12 statements, is a very important component of the Ritz-Carlton service concept. It clarifies how individual employees should deliver on the service promise, as the extract below illustrates (15):

2. I am always responsive to the expressed and unexpressed wishes and needs of our guests.

3. I am empowered to create unique, memorable and personal experiences for our guests.

6. I own and immediately resolve guest problems.

However, the Service Values are more than 12 theoretical statements; they are a set of principles that Ritz-Carlton work to implement continuously. Every day at every Ritz-Carlton, employees gather for a 15-minute “line-up”. The purpose of the line-up is to resolve possible issues, but it is also used as an effective vehicle to implement and improve the service concept. Every day, a new success story is shared at every Ritz-Carlton, the same story in all places. The story describes one or a few employees who have made an outstanding effort to deliver exceptional service to Ritz-Carlton customers. The story told at the line-ups clearly signals the importance of service, helps employee understand how to live the service concept and provides recognition to individuals who have managed to deliver on the Service Values (16).

Today Ritz-Carlton operates 73 hotels in 24 countries and employs 38,000 people (15).

Game changer

#7 Business model

One lever for gaining a competitive edge in the market is through evolution and revolution of business models used in the industry. This is perhaps the most powerful way of competing, yet it is often overlooked by companies seeking to differentiate a product or a service.

Newspapers typically used to earn revenues from subscription fees and advertisements, until some players challenged the ruling business model and started providing daily newspapers for free, relying solely on revenue from advertisements.

The Palo Alto Daily News was launched in 1995 as a free daily newspaper and became profitable within nine months of its launch (18). In the same year, Metro was founded, a daily newspaper that was distributed through the public transportation system in Stockholm, Sweden. Today, Metro has 56 editions in 18 countries and is published in 15 languages around the world. According to Guinness World Records, it is the “world’s largest international newspaper” (19).

Financially, Metro has suffered from the costs of expansion. However, CEO Per Mikael Jensen says it became profitable in 2010 and will soon reach its targets of a 15 percent operating margin (20).

A market evolution scenario

Whether all seven sources of competitive advantage are relevant in all industries at all times is a good question. Typically, as an industry evolves, the applicability of sources of competitive advantage evolves with it.

A completely new market can be created through a product innovation; a new product or service can be brought to the consumers to meet a previously unmet need. The player who brings the product to the market typically gains an edge from the core product offering and there is usually less focus on price, brand, and other levers.

Once a market matures, the product or service becomes commoditized as there will be several players with the ability to deliver more or less the same generic product. In this situation, companies typically try to leverage one of the levers from the feature differentiation category, namely brand, price, service, and/or quality. Competition frequently turns to price as a point of differentiation, although this is not always successful for all companies involved.

Markets can continue with competition leveraging feature levers for a long time. Changes appear when one of the companies in the market successfully applies a game changer and/or when a company manages to innovate a new product or service.

Competitive advantage is about choice

Because no company can excel in all seven dimensions, strategy is about choosing exactly how to compete in the market. Therefore, one of the key decisions a company must take as part of the strategy process is the choice of which differentiation lever to use.

Once the choice is made, realization needs to be in focus. Realization of a competitive advantage is often fundamental and will need to impact the full scope of the company. For instance, if a company attempts to differentiate on price – that is, become the cost leader – this needs to be reflected in everything the company does: Design to cost to arrive at a cost-competitive BOM, world-class sourcing to drive down material costs, manufacturing in a low-cost country, effective organization to keep OPEX under control, offices in low-cost areas, etc.

Companies that typically suffer from not being able to change way of competing in the market as a change of competitive edge will often require a fundamental restructuring of the company. In other words, changing a company that used to be competing on cost into a service leader involves a fundamental remake of the whole company. This also explains why many innovation companies fail to survive in a maturing marketplace.

About insight on strategy

Strategy is one of the most overused and misused words in the business community. It is a term that everybody loves to use, but few dare to explain. 2by2 publishes Insights “On Strategy” to help companies improve their ability to create value through strategy by better understanding what strategy actually is, by learning how to spot the difference between a good strategy and a not-so-good strategy, and by gaining perspectives on the most common pitfalls when developing a strategy.

Previously published articles in this series:

• A definition: http://www.2by2.se/insight-on-strategy-a-definition/

Sources:

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13. PepsiCo; http://www.pepsico.com/Company/Our-History/1976.html
14. The Coca-Cola Company 10-K 2009
15. Ritz-Carlton; http://corporate.ritzcarlton.com/en/About/GoldStandards.htm
16. Business Week; http://www.businessweek.com/smallbiz/content/feb2007/sb20070213_171606.htm?campaign_id=nws_insdr_feb17&link_position=link15
17. http://www.caesar-ritz.ch
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19. Metro.lu; http://www.metro.lu/about
20. Mediawatch.dk; http://mediawatch.dk/artikel/forventet-overskud-hos-metro