University of Chicago
Type of paper: Thesis/Dissertation Chapter
Competitive Advantage theory
The last decades there is a brand new term going around in the world of business. Its name is Competitive Advantage. As various extremely important executives claim this factor can be the missing key, which will lead eventually a company to success. Allow me to give a first description of what I have understood, so far, of the competitive advantage term. According to what I have read and heard in lectures of the course Business Economics, I consider the C. A. to be the difference a company has from the rest of the market, which will help her to obtain not only higher profits but also longevity.
As Michael Porter in his 1985 text says that, it is about the distinct and ideally sustainable edge over the competitors. The competitive advantage is said to be based on monopoly profits and on/or the Ricardian Rents and is used to generate another important factor, the added value. The writer – expert in finance John Kay implies that the C. A. presents no stability and it is always relative for each one of the companies in all the markets of the world. It is also something measurable enough in order the executives to extract useful conclusions and plan the company strategies.
The relevant benchmark is the marginal firm in the industry. The company with the least potentials and the smallest market power is used as the baseline against which the competitive advantage of all other firms can be set. Methods of building a Competitive Advantage A general but for most people questionable claim would be that all the existing firms in a market are able to create a competitive advantage.
That on theoretical basis is correct. Significant economists have worked for ears in a row towards this goal and have elaborated strategies and methods a firm can use in order to obtain the competitive advantage. The Resource Based View of the Firm The Resource Based View of the Firm has its origins in four different significant experts of finance: Edith Penrose (1959), Birger Wernerfelt (1984), Jay Barney (1991) and last but the most important writer Margaret Peteraf (1993). M. Peteraf put together the existent elements of the work of the previous three writers and produced the well-known > in her article reprinted in Foss.
The main idea of the above-mentioned methods is that all of them give considerable importance on the resources, those that a company already possesses or the ones it procures from the outside environment. These resources must exhibit a special characteristic in order that C. A. to be produced. That is the so-called Resource Heterogeneity, meaning that they need to be rare so as not the competitors to use them and valuable in order to increase the firms efficiency and effectiveness. For example rarity could a minor of diamonds have and valuable could software program of a computer company be.
The Recourse Heterogeneity can be obtained through either Product Differentiation or Cost Advantages. As far the product is concerned when a company differ one of its products it instantly creates a heterogeneous resource and approaches the C. A. (as per Peteraf 1993). Then it can offer those products in the whole market or in some market segments. The differentiation can be on the quality and the market segments can be large, small or of special interest. The market selection must be done with extra care and attention.
The firm is in position to choose either to offer its products following the Broad Coverage Strategies e. g. unisex cosmetics and obtain Economies of Scale or produce for a specific market e. g. anti – ageing serum for the athletes of running. At this point, it needs to be mentioned that the consumer preferences and the competitor products must be taken into seriously account. As far as the Cost Advantage is regarding a firm can benefit by the lower costs. That means that the quality must be lower in order the cost of the firm to stay on low levels or to benefit by the superior technology.
Besanko in his work implies that a firm can benefit from both Cost and Benefit Advantages if and only if increased demand and output can be translated into economies of scale. Strategies of sustaining a competitive advantage The real difficulty, according the opinion of the experts of finance is not only creating an advantage over your competitors but also maintaining your economic outcome through time. The enormous effort in order to have that precious gap between your company and your rivals keep exist.
There is a variety of threats in the long term like the easy entry of the companies that have depicted a chance for making profit, the perfect information the competitors can posses and the most important the access to the companies resources which means that profits are in danger. A good number of these threats are common to all markets no matter the size, the special interest or the type, even in monopoly or oligopoly, according the economist-writer Besanko, and greater becomes the more competitive the specific market gets.
At this point, the well- known Resource Based View of the Firm and the Product Differentiation Strategies come to the rescue of the company’s competitive advantage. As it is clearly written in a good number of economic texts, firms can earn excess profits if and only if they have superior resources protected by some form of isolating mechanism like a kind of a patent. These resources in question must exhibit some characteristics such as to be valuable in order to increase the firms efficiency and effectiveness and rare so as not to be acquired by the competitors.
In addition to the previous, they have to be imperfectly imitable plus not substitutable by resources easy to be found and imitable. The serious problem is that this type of resources is hard to find and use in the production process. The alternative strategy a company can follow in order to maintain its competitive advantage is the product itself. More specific, the constant change of an existing product in the market, called product innovation. In some firms, the rate of this attempt is highly rapid.
As the economist Schumpeter argues, that is because the isolating mechanisms cannot be permanent as the new technologies arise and the tastes change or the government policy evolves. A logical consequence could be that the life of the product becomes shorter and the competitors obtain to imitate an outmoded product at the end. The continuous product innovation can be a solution but not in a permanent way for it can be relatively costly and inefficient. More, the firm must process to the Creative Destruction, in other words to destroy the existing resources of the advantage so that the rivals not to benefit by them.
Margaret Peteraf , one more time, in her 1993 article argues that the solution to the above problem is included in The Four Basic Building Blocks to creating and sustaining competitive advantage. According to her text, there are four corner stones, which lead a firm to sustain its competitive advantage. In the first place is the already mentioned and quite analyzed Heterogeneity of the resources, secondly comes the term imperfect mobility, meaning that the resources that create value cannot be bought on the open market and if they do so not to function perfectly.
Some examples can be the firm’s reputation, a highly experienced scientist, a special machine with a number of peripherals est. In the third and forth place there are the limits to competition. The economist Rumelt describe the limits as the forces which limit extends to the point an advantage can either be duplicated or neutralized. There are two types of isolating mechanisms, the early mover advantages and the impediments to imitation. The first one with its tools like the learning curve e. g. the scientific knowledge in the firm, the reputation and buyer uncertainty e. g. he willing to buy a very expensive wristwatch or a design outfit, the switching costs e. g. not to use the petroleum moving cars anymore and switch to the solar power ones and the network effects e. g. the hair – dryer device.
The second one includes the barriers a company puts between its product and the rest of the group such as legal restrictions e. g. copyrights on the product or on the resource or on the distribution channel. The Relationship between the Competitive Advantage and the Banking – Finance sector. For the most part, the firms in the globe seek to find and maintain their competitive advantage in almost any cost.
Among them are naturally the firms of the banking and finance sector. There is a plain but important difference between the firms that produce products and those producing services. The second group needs to put much more effort as regards the resources. On the one hand these firms offer a great variety of product services to their customers, from different loans and a great number of credit cards to services all over the world. On the other hand they try to benefit from the low cost prices and to use the knowledge they posses to their best.