How to create a competitive advantage

There is no clear classification of competitive advantages, and there is no definitive list of them. As the economy and business develop, new business models emerge, and with them new types of competitive advantages. Companies build competitive advantages by strengthening their brands, achieving economies of scale, or lobbying governments for special status. In return, they can gain customer loyalty, effective pricing opportunities, and legal protection. All this makes it much more difficult for other companies to compete with them.

In the 20th century, the largest companies built their competitive advantages primarily on the basis of economies of scale or government support. For example, Standard Oil built its monopoly by buying up competitors' smaller refineries and creating a global distribution network. As a result, the company controlled about 90% of all oil refineries and pipelines in the United States and could set its own prices.

However, today competition is based primarily on other types of advantages. These include achieving network effects, data ownership, and customer re-engagement based on business models for re-engagement in the consumption of a product or service (eg subscription).

In this article I will focus on such competitive advantages as

• network effect,
• cost reduction effect,
• the effect of access to resources and a number of new types of competitive advantages.

A product has a network effect when its value to consumers increases in proportion to the frequency of its use and the number of users using it.

For example, the telephone was not very useful when it was used by a very limited number of consumers. However, the more people bought phones, the more useful they became. When almost every home had a telephone, it became indispensable.

The same logic has led to the rise of social media companies. If all your friends and acquaintances are registered on the network, its value for all participants will be undeniable. And a network with few participants is useless.

Because network effects promote rapid and widespread adoption of a product or service, they create highly effective competitive advantages. A product with a strong network effect is extremely difficult to force out of the market.

NETWORK EFFECT OF TWO-SIDED MARKET

The network effect of a two-sided market occurs when a company connects customers and suppliers on its platform.

Combining supply and demand for a product or service creates a network growth effect. As more providers enter the market, customers receive more efficient and less expensive service. And as the customer base grows, the market becomes more attractive to suppliers. The increase in the number of suppliers encourages further competition and expansion of the platform.

THE NETWORK EFFECT OF DATA OWNERSHIP

The network effect of data ownership occurs when a company can gain a competitive advantage by collecting user data and making that data more valuable.

In such a business, a database is formed that characterizes consumers, their preferences and behavior. The more people register in this database, the more valuable it becomes. Companies can use this data both to attract other users to the platform and to create better algorithms for selling or improving their product or service.

NETWORK EFFECT OF THE PLATFORM

Platform network effects occur when a company creates a lasting competitive advantage by maintaining user participation in its product ecosystem.

This competitive advantage typically builds on a single product—an iPhone or Windows, for example—that becomes the core of the user's life or work. New products released, such as the App Store or Microsoft Office, enhance the original value of the core product and layer additional value on top of it.

Each successful new product makes being in the ecosystem more valuable, increases switching costs, and keeps users' attention and money on the platform.

DURABILITY IS THE KEY TO THE SUCCESS OF NETWORK ADVANTAGE

These three methods—connecting suppliers and customers, collecting valuable data, and building a product ecosystem—do not always lead to sustainable competitive advantage. History knows many companies that created temporary advantages based on network effects, then lost everything.

The longevity of online competitive advantage depends on a number of factors, including:

• Efficiency and dynamics of attracting and retaining users: can the company reduce the cost of attracting new users, customers or suppliers as the business scales; Is it possible to retain existing consumers, clients or suppliers and motivate them to make repeat purchases?
• Cost levelchallenges customers face when switching to competitors: Will switching to another company for the same service be burdensome or easy for customers?
• Emergence of habitual use: whether the product becomes more attractive and familiar as its consumer properties develop and its customer base expands.

All three of these factors help maintain and expand the customer base and reduce its tendency to switch to competitors, ensuring the strengthening of online competitive advantages.

EXAMPLES

Two-sided market: Amazon

Amazon's main competitive advantage is based on its broad platform that connects buyers and suppliers. A large number of competing suppliers and Amazon services make it possible to optimize prices, the low price attracts consumers and, as a result, more and more suppliers and consumers are included in the Amazon system. This is how Ozon and Avito build a competitive advantage

Data: Google

Google's original competitive advantage is based on its efficient Internet search technology. As this advantage developed, the company was able to collect data on the behavior of search service consumers. Based on this data, the company further expanded its competitive advantages to include new business areas such as advertising, delivery and sales. Yandex builds its competitive advantages in a similar way.

Platform: Apple

The iPhone has certainly won consumer preference. But the basis of its success lay in its operating system and the ecosystem of services that the company built on top of it. It is this that forms the habit of using the product and makes it difficult to switch to other platforms.

HOW TO CREATE COMPETITIVE ADVANTAGE THROUGH COST MANAGEMENT

Costs for production, distribution, or other business activities that are lower than those of competitors allow a company to charge lower prices for products or services, creating consumer price preferences. On the other hand, by maintaining the market price, the cost advantage allows for higher profits, which can be invested in developing demand, building a brand, or developing new products or services. The focus here is not necessarily on the product, but on how much it costs to produce or distribute it. Consumers are attracted by saving their money resources.

Costs can be minimized in a variety of ways. Some companies, such as Nissan, have years of experience in producing cars in a very cost-effective manner. Other companies use offshore manufacturing to reduce the cost of their products.

Companies may also receive government subsidies, cash grants or loans allocated to activities that they want to promote or consider as a public good. They help reduce costs for their clients.

Technology companies such as BMW, Lexus and Boeing use product design and reengineering to create efficient and cost-effective products.

Finally, some companies are creating a new way to deliver their product or service, resulting in significant cost savings that they can share with their customers. Many airlines have installed self-check-in kiosks, and supermarkets now offer self-service checkouts.

Another relatively new trend in cost reduction is that companies deliberately reduce the quality of the goods or services they offer. This is clearly illustrated by various types of discounters. For example, Ryanair is removing two of its three toilets on every plane to increase the number of seats and reduce ticket prices. This is an extreme way to cut costs and requires very careful determination of how much reduced quality will still be attractive to consumers due to the low price.

Cost Competitive Advantage - Allows a company to leverage its skilled workforce, low-cost raw materials, controlled costs and efficient operations to create maximum value for customers. Under this strategy, the company focuses on improving operational efficiency, which in turn reduces unit costs. For example, it may try to minimize the number of workers, introduce new processes and improve supply chain efficiency.

CREATE A BARRIER TO CUSTOMER CHURCH BY INCREASING THE COST OF TRANSITION TO ANOTHER SUPPLIER

The difficulties, costs and losses that accompany customers when switching to another supplier of goods and services also form a competitive advantage. These are the costs incurred by the consumer as a result of changing brands, suppliers or products. Switching costs may include significant time and effort required to change suppliers, the risk of business disruption during the transition period, high contract cancellation fees, or the inability to obtain adequate replacement products or services.

High switching costs are a great defense to your customer base. And companies that have been able to build such a competitive advantage can use it to maximize profits by increasing the prices of their products until customers' switching costs do not exceed the benefit of using a competing supplier's products or services. And even in cases where the cost of switching is lower than the benefits, the habit factor often comes into play, especially in the corporate market.

Firms strive to make switching costs as high as possible for their customers, which allows them to retain customers and raise prices annually without worrying that their customers will find better alternatives with similar features or at a similar price.

Switching costs can be divided into two categories: low-cost and high-cost switching. The company has the opportunity to set a premium price depending on the complexity of the transition, as well as the availability of similar products or services from a competitor.

Companies that offer products or services that competitors can very easily duplicate at comparable prices have low switching costs. For example, clothing companies, unless they have a strong brand, have very low switching costs and consumers easily find alternative deals by comparing prices and moving from one store to another. The increase in the number of online stores, the development of try-on delivery and the ability to quickly compare prices across multiple online platforms makes it less important to use the cost of switching to a new supplier as a competitive advantage.

Companies that create unique products that are difficult or impossible to replace and that require significant effort to replicate the quality of their services have high switching costs and enjoy significant competitive advantages. For example, companies such as the American Intuit Inc. or Russian 1C, offer their clients various software solutions for accounting. Because learning to use and maintain these companies' applications requires significant time, effort, and training costs, few users and partners are willing to abandon their products.

Businesses that use the services of such companies may face disruption to their operations and the risk of financial mistakes if they decide to abandon their software. These factors create high switching costs and the lack of alternatives to such products. As a result, companies are able to charge higher prices and earn higher profits.

There are many ways to increase switching costs and keep your customers from switching to a competitor. I will list the most common ones...

Convenience: A company may have many stores or products, making it easier for customers to purchase its products. If a competitor has cheaper products but is further away and difficult to get to, customers may choose the more expensive product because of its convenience.

Emotional habit: Many companies continue to do business with their suppliers only because the emotional costs of finding a new counterparty, building new relationships and meeting new people can be high. This is similar to why a person may choose to stay in one job rather than leave for another, where the salary may be slightly higher. The person knows his boss and his colleagues, and therefore the emotional cost of switching may be too high.

Exit Fee: Many companies charge an exit fee. These fees are not typically fees for additional services, but companies add them to make it harder for customers to leave. The Company may classify these fees at its sole discretion. For example, these could be administrative fees for closing an account, or withdrawing money, which financial institutions often resort to.

Time-consuming: If it takes a long time to switch from one brand to another, customers often give up. For example, if a person needs to call the company to confirm the cancellation of the service, but it is difficult to get through or needs to wait a long time for an answer on the line, or he needs to come to the office to close his account and cancel the service, or in order to do this, he needs fill out the paperwork, he may find that the time spent isn't worth it. 

SURGENCY COSTS – FORCED CUSTOMER LOYALTY

Sunk costs refer to money that has already been spent and cannot be recovered. These costs arise because some activities require specialized assets that cannot be easily repurposed for other purposes. Therefore, markets for the reuse of such assets are limited. This creates a high barrier to entry for other companies and firmly ties the consumer to a specific supplier.

A competitive advantage based on sunk costs is formed by receiving significant one-time or recurring payments from the client, the size of which is quite large. It is difficult for a client to make the decision to lose these costs, refuse goods or services already paid for, and switch to another supplier. In this case, the customer's perception of "choice" is limited to the initial investment they have already made in the product, creating a buyer lock-in.

There are a couple of typical examples of sunk costs being used as an advantage that creates a barrier to entry for competitors or churn. Sunk costs as a competitive advantage are typical in the computer hardware market with specific operating systems. After a company purchases and installs a system from a certain manufacturer, switching to another manufacturer means practically writing off the costs of its purchase and the significant costs of implementing a new system.

The second example is the business model of the Gilette company. When Gillette first began selling its safety razors with disposable blades in 1903, the innovation of replaceable blades immediately made shaving more convenient by eliminating the need to send blades out for sharpening. It was also the beginning of a powerful business model built on the principle of sunk costs.

The “blade and razor business model,” as it is now called, refers to any business that operates on a combination of low and high margin purchasing. The price of a low-margin product is low enough to attract as many people as possible, while the price of a high-margin product is high enough to ensure a healthy profit.

Repetition is key here. Once a buyer makes a low-margin purchase, he must continually make a high-margin purchase. The initial investment psychologically encourages customers to continue buying because they have already spent money.

In other words, people who buy cheap Gillette razors tend to continue to buy Gillette blades. This creates a competitive advantage. In exactly the same way, the competitive advantage of companies selling printers and consumables for them, capsule coffee machines and capsules for them, and so on is formed.

To protect such a competitive advantage, a company must constantly strive to improve the quality of its product or service, offer new products, and increase its brand awareness.

DIFFERENTIATION

Competitive advantage in the form of differentiation is expressed in the ability of a company to use a unique selling advantage to differentiate itself from its competitors. It could be a different value proposition than competitors. For example, a company may charge a higher price if its outlet has a unique location. Customer convenience will help justify the higher price tag.

Companies operating with a differentiation strategy are often the first to exploit new trends in the market. For example, Apple built its advantage by creating the iPhone, which changed the way we consume media and entertainment. Through its approach to differentiation, the company has established itself as a global leader in the smartphone market and has also strengthened its brand image.

Differentiation can come in many forms, some of which include high quality, superior customer service, better features, or reliability.

Although a differentiation strategy helps differentiate a company from its competitors, it is not enough. For example, a new restaurant might serve the best spare ribs in the country, but could very well go out of business within a year. The reason is that no one knows what the best dish is. Therefore, without a successful marketing campaign that highlights the unique selling point for customers, this strategy may not be as successful.

Some examples of typical areas of differentiation:

• Customer service. When customers buy a product and have to return it due to a fault or some other reason, they will have to go through customer service. This experience can be so painful that clients may never return. However, if the process goes smoothly and customers receive refunds quickly and reliably, it can strengthen the brand and enhance its reputation.
• Availability of an effective delivery and distribution system allows the company to deliver goods to suppliers and customers in a timely manner. This can be critical, especially for perishable goods. By quickly delivering these goods to suppliers and consumers, companies can gain a significant lead over their competitors. For example, Amazon revolutionized online shopping by offering next-day delivery through Amazon Prime. Millions of people around the world pay an annual subscription for this benefit - all thanks to Amazon's sophisticated distribution network. This network has become such a huge asset for Amazon that it is probably the company's biggest competitive advantage. This is something that few people can replicate, especially in a short period of time.
• Location. Location can help reduce costs if a firm is located near a supplier. This can help reduce lead times and improve efficiency by reducing breakdowns and shipping costs. Similarly, firms may find themselves in the unique position of being the only supplier in the immediate area. For example, a hotel restaurant.
• Unique technology may include an invention, recipe or formula or business process, and so on from a patented iPhone design to the secret formula of Coca-Cola. The unique technology provides a reliable competitive advantage for its owner.
• Legal terms create a competitive advantage by providing the company with protection through legal factors, including special rules established by the state or large companies (for their partners), providing the opportunity to use natural, financial or other resources that are not available to other market participants. This kind of advantage lasts as long as the political leadership of the country or the management of the company decides to maintain such an arrangement.

FOCUS

This method of creating a competitive advantage can use all the methods of creating competitive advantages described above. But its difference is that at the same time The company focuses its work on niche markets. Examples include left-handed stores, animal-free products, pet cafes, and so on.

This type of strategy specifically targets a specific demographic in the market that has specific needs. Generally speaking, these are small markets that new companies can enter and take advantage of due to the lack of competition. In turn, this gives small companies the opportunity to operate without the intense competition from large firms that can compete on price.

Firms using a focus strategy tend to gain a competitive advantage by targeting the specific needs of their customers rather than their price sensitivity. Due to the market's small size, this means it is often underserved, leading to consumers being willing to pay higher prices. At the same time, competition is also limited and in some cases can be classified as a natural monopoly.

Examples of firms using a focus strategy include Bakon Vodka, a company that sells bacon-flavored vodka. There are also a number of companies that sell jewelry specifically for cats or dogs. This category also includes airlines that serve local short-haul flights. A striking example is the companies providing transport links between the islands of countries such as the Maldives, the so-called air taxis.

Not all companies build their competitive advantages on the basis of the structural factors described above. Many build their competitive position on intangible factors such as brand and tradition.

Such competitive advantages protect a company from competition through its unique value proposition, its corporate image and communication with its customers.

In this case, customers buy goods or services based on factors other than price, and sometimes even beyond the direct value of the product - they buy based on the signaling (information) function of the purchase, which allows them to demonstrate their belonging to a certain social group, certain socio-cultural values, image or lifestyle. There are many examples of such brands - Chanel, Porsche, Rolex, Harley Davidson, National Geographic, etc. 

By having a strong, recognizable and valuable brand, companies can motivate their customers to pay more for their products and come back for repeat purchases. 

Today, information technology and the Internet open up wide opportunities for organizing dialogue with your clients and building a brand.