In most industries, success can only be achieved by finding the strategy that gives and sustains a competitive advantage.
That would require controlling and exploiting competitive forces of barriers to entry, threats from substitutes, bargaining power of suppliers, industry rivalry and bargaining power of buyers.
These forces determine profitability by influencing pricing, investment requirements and cost structure in any industry.
Profitability is a product of selecting the right strategy that gives a business the competitive advantage.
What is competitive advantage?
A competitive advantage is anything that pushes a business’s profit rate higher than the industry rate. That is, a business achieves competitive advantage when it’s gross profit margin is higher than the industry average.
The gross profit margin is given as (total revenues) – (total costs)/(total costs).
Achieving a gross profit margin in excess of the industry depends on the occurrence of at least one of the following;
The business’s unit price must be higher than that of the industry average. And the unit cost must be equal to that of the industry average.
The business’s unit cost must be lower than that of industry average. And the unit price must be the equivalent of the industry’s average.
The business must have both a lower than industry average unit cost and a higher than industry average unit price.
As mentioned above, a business needs a strategy to achieve a sustainable competitive advantage. Any strategy chosen must not overlook four interrelated relevant factors for building a competitive advantage.
These factors are quality, efficiency, customer responsiveness and innovation.
Conscious of these factors, a business may create and use any of the following strategies (by Michael E Porter) to gain and sustain a competitive advantage;
- Focus strategy: This strategy is adopted by a business that selects segments within an industry and focuses all its efforts to serve them to the exclusion of other segments.
It’s the pursuit of a differentiation advantage in a narrow segment of maybe, types of buyers or geographical locations of buyers.
2. Cost-leadership strategy: This strategy is adopted when a business chooses the path of establishing itself as the lowest cost producer within an industry.
For a business to achieve success with this strategy, it must stand out clearly as the cost leader. And also offer products or services which could be compared to those of competitors.
3. Differential strategy: The differential strategy is adopted by a business that wants to make a name for itself by offering products with a unique attribute.
Such an attribute must be different from those offered by competition. It should also be significant enough to justify a premium price that exceeds costs of differentiating.