Competitive Advantage, Cost Advantage and Differentiation Advantage - Essay Example

Competitive Advantage Name Tutor Course Date Competitive advantage is a theory that aims at addressing some of the criticisms that are associated with the comparative advantage. The theory can be dated way back in the 1990s as it was proposed by Michael Porter and it suggests that businesses and states should endeavor in policies that aim at the creation of high quality goods to sell at the market at a high value. He puts more emphasis on the productivity growth as the main focus for national strategies. The theory upholds the notion that cheap labor is obiquitous and that the existence of the natural resources is not good for the growth and sustainability of the economy. (Dess et al 2005) For a firm to be able to posses the competitive advantage in the current strategic management situations, its business has to show that its profits exceed the average in a given industry or over its rivals. This firm puts up major goals in its business strategy to be able to achieve the competitive advantage over the rest of the firms in its line of operation. From this theory that was proposed by Michael Porter, he came up or in other words identified two basic types of competitive advantage. The two are; Cost advantage Differentiation advantage For a firm to show the existence of the competitive advantage, this firm has to be able to deliver the same benefits as those delivered by its competitor but offer it at a lower cost to be at a cost advantage. They can also do it by delivering benefits that exceed those of the products of its competitor and be able to take over the differentiation advantage. In other terms, the competitive advantage will always enable a firm to have more and superior value for its esteemed customers or consumers and at the end of the day achieve superior profits to itself. (Dess et al 2005) According to this theory buy Porter, the cost and differentiation advantages are referred to as the positional advantages since they describe the position at which the firm is t in the industry as a leader in either of the two, differentiation or cost. From the above literature, there is one thing that seems to be very evident about competitive advantage. That is, the competitive advantage will only exist when a given firm has a product or a service that is perceived by the customers of its target market as being greater, better or superior that that is provided by it’s competitor. Around the business world today, there has been a myth that has often confronted many entrepreneurs in the creation of competitive advantage. One of the myths is that there exist no good business opportunities, meaning that these opportunities are already gone. The other myth is in relation to small firms, where they are believed to be no match for the big companies. (Dess et al 2005) I tend to find the two ideas erroneous despite the fact that the market players whether big of small do not welcome competitors. (Karl H. Vesper) The big companies for this reason fight to their best to maintain the propriety shield to put off the existing and prospective competitors. It is vividly evident that for an entrepreneur to create a new competitor and attack them, he needs an entry wedge or what would be a good strategic competitive advantage to enable him have the breakthrough in the commercial activity. (Dess et al 2005) Resources and capabilities Before an entrepreneur can choose an entry wedge, there are basic things that he needs to understand about the nature of the business which he/ she will face in the market place. This is one of the ways that the competitive advantage can be developed properly. It is clear from literatures on competitive advantage that in order to develop competitive advantage, a firm requires resources and the capabilities that are by all means superior to those of the competitors for it is without this superiority that the competitors would have much ease in replicating what the firm is up to and the advantage that existed disappear in a flash. Among some of then resources that a firm requires are; (Dess et al 2005) Patents trademark Installed customer base Proprietary know-how Brand equity Reputation of the firm For the capabilities, a firm should have the ability to utilize all of the resources that it has at hand effectively. In the real situation, this means that a firm should be able to bring a product into the market in a faster pace than its competitors. These primarily in the routines of the firm since they are not documented as part of the procedures of the firms operations this makes it difficult for the competitor to replicate and blow this firm competitive advantage away. These resources and capabilities form the firm’s distinctive competencies which are responsible for enabling the firm to have efficiency, quality, innovation and customer responsiveness all of which if brought together will create a cost advantage or even the differentiation advantage to the firm. (Dess et al 2005) Cost advantage and Differentiation advantage For a firm to create competitive advantage, it has to use its resources and capabilities to be able to achieve either lower cost structure or a differentiated product. This requires that a firm position itself through its choice of differentiation or low cost in the industry. For the firm’s competitive strategy, this decision is a central component. How broad or narrow he firm’s market segment that it aims to target is another important decision, as from the matrix that Porter formed using the cost advantage, broad or narrow focus and differentiation advantage to identify a set of generic strategies that can be pursued by the firm in its aim of creating and sustaining a competitive advantage. (Dess et al 2005) Value creation Porter had identified value chain as series of activities that a firm can create value in when it performs them. This is in addition to the firm’s own activities of value creation; this means that the firm operates in a value system which includes vertical activities which include the upstream suppliers and the down stream channel members. To enable a firm achieve the competitive advantage, it has to perform one or even more value creating activities to be able to achieve a more overall value in the end than its competitors can. To achieve a superior value, superior benefits or lower costs to the consumers is applied. (Dess et al 2005) Porter’s Five Forces There are a number of factors that determine the level of competition in a given industry and there are typologies that have been identified to differentiate the competitive forces. Michael Porter in his book Competitive advantage identifies five factors that can determine the nature or the degree of competition in a given industry. These are; 1. Bargaining power of buyers 2. Threat of substitutes 3. Bargaining power of suppliers 4. Rivalry among existing competitors 5. Threat of new competitors The above five forces collectively determine the ability of a given company/ firm to a large degree whether they are large or small and determine their levels of success. Due to the fact that industries are not alike, the forces have impacts that vary from one situation to the other. According to Porter, there are numerous elements that have influence on these factors and the way these factors influence the creation of competitive advantage. Rivalry among existing competitors The degree of rivalry helps to determine the extent to which value created by a firm lead to a head to head competition. Porter suggests that while this issue is important it determines the firm’s attractiveness. (Porter 1980) Threat of new competitors The existing and the prospective competitors are found to influence a firm’s profitability. The threat that is posed by new entrants is based on the market entry barriers. Entry barriers are found to exist where it is difficult or economically feasible for a new entrant to replicate the already established firm’s position (Porter, 1980b; Sanderson, 1998). Some of the common forms of entry barriers are; Economies of scale Cost of entry Distribution channels Cost advantages not related to the size of the company Government legislations Differentiation Threat of substitutes This is dependant on the relative ratios of the price to performance of the market’s products and services to which consumers turn to satisfy their needs. The substitution threat is affected by switching costs that are incurred when a customer switches to a different type of product or service. (Porter 1980) Supplier Power Supplier power is a mirror image of the buyer power. As a result, the analysis of supplier power typically focuses first on the relative size and concentration of suppliers relative to industry participants and second on the degree of differentiation in the inputs supplied. (Porter 1980) Buyer Power Buyer power is one of the two horizontal forces that influence the appropriation of the value created by an industry (refer to the diagram). The most important determinants of buyer power are the size and the concentration of customers. (Porter 1980) Conclusion Any company needs to understand the nature of the environment in which it intends to compete in if it wants to stand a chance of being successful in the achieving of its goals ans in the establishment of its strategies. If a firm applies the Porter’s five forces then it will be in a stronger position to have a defense against the threats and in turn influence the forces with its own strategy. The Porter’s framework has received challenge from other strategists and academics as they have stated that there are assumptions that underlie the five factors, these are; The competitors, buyers and the suppliers never interact or collude therefore unrelated The source of value creates a barrier to entry from the structural advantage That there is low uncertainty and these allow the participants who are in the market to plan and respond to competitive situations. Bibliography Dess, Gregory G., G.T. Lumpkin and Marilyn L. Taylor. "Strategic Management." 2005, 2 Ed. ed. Porter, M.E. Competitive Strategy,. New York: Free Press, 1980. Center for Management and Business Administration, inc. Strategic Management;Competitive. 2007. http://www.quickmba.com/strategy/competitive-advantage/ (accessed January 6th, 2009). Olsen, Erica. Competitive Advantage - Building A Lasting Organization. 2009. http://homebusiness.about.com/od/growing/a/comp_advantage.htm (accessed January 6th, 2010). Porter, Michael. Competitve Advantage (Porter) Cost Leadership, Differentiation, and Focus. 2007. http://www.valuebasedmanagement.net/methods_porter_competitive_advantage.html. (accessed January 6th, 2009). Read More