What is Competitive Advantage?

In this video we discuss the important concept of Competitive Advantage!

VIDEO SUMMARY

When you talk about business strategy, people talk a lot about competitive advantage. I feel this is a buzzword that people say a lot, but I wanted to dive deep into this idea and discuss what competitive advantage really means. This is an important concept to understand if you are making business decisions or understanding financial statements.

Competitive Advantage is an attribute that allows you to outperform competitors. What I want to emphasize is the financial element of competitive advantage. The whole point of studying this, is it shows up in your financial statements as profit. The goal here is to focus on the attributes in your business that enable you to earn a higher profit than your competition.

For example, imagine two companies that sell a similar type of product. Company A sells that product for $2, and company B sells that product for $1. Both companies can make that product for $0.50. So company A is making much more profit. Our job is to figure out, “what is the competitive advantage of company A versus company B?” Let us imagine the reason is that company A has a perception in the market for higher quality. We have all experienced situations like this. We might go into a store to purchase an item, and you see a line of similar items on a shelf. If one of those items has a reputation for better quality, you are going to be willing to pay a higher price for that item. In this example, quality is the competitive advantage.

What is so interesting about studying competitive advantage, is that there are so many different options. It can be almost anything that gives your business an edge. There are many of these, but I am going to list out just a few.

• Low cost leader
• High quality
• First mover status
• Unique technology
• Customer loyalty
• Economies of scale
• Vertical integration
• Government regulation

All of these are different reasons you might have a competitive advantage. I could talk for ages on each one of these, but I want to focus on the reason competitive advantage is so important. Whatever situation your business is in, if you have the awareness of your competitive advantage, it makes your business decisions so much easier. Every business out there only has so many resources. If you can take your resources and focus them on the area your business adds the most value to the market, you will make more profit.

Let us use another example. Imagine you own your business, and you sell ten different products. When you look at those ten products, imagine that only one product was a source of competitive advantage. You are able to make a lot of profit for that one product, but your other products have a lot of competition that keeps your profits lower. In that situation, you are better off by taking the resources in your business and focus them on the one product that is adding value to your market. You can probably increase your profit, and decrease your costs.

That is the basics… but we are going to take this to another level. When you study business strategy, what you quickly realize is that competitive advantage is not enough. What you really want to achieve is “sustainable competitive advantage.” You want your profit to last for years. A term you will hear people say is “economic moat.” You can imagine your business is a castle in the Middle Ages. One of the defenses of castles was a moat that was full of water. Your business is just like a castle, where you have competitors who are trying to take over your market position. The larger your economic moat, the harder it will be for someone to impact your company profits.

You will hear stock investors talk about this. What is a company’s economic moat? What they are saying is “What is the company’s sustainable competitive advantage?” If they are going to buy stock in a company, they are looking at that company’s profit, because that profit will get paid out as dividend payments. So they want to know those profits will continue in future years. As a business leader, you will need to be able to communicate exactly what drives your competitive advantage, and how it is sustainable.

This idea is why “Get Rich Quick Schemes” never work. Let us say you find an opportunity to build a new business and make $1 Million in six months. It sounds very attractive. The problem with this scenario is always that if you can do it in six months, that means that someone else can do it in six months and steal all your customers. So you end up putting all your energy into building a business that will only last six months. The alternative is to invest in areas that are a sustainable competitive advantage.

Let us use the example of restaurants. Restaurants are a competitive business. It is hard to get people to come spend more money at your restaurant, rather than all the other restaurants in your town. But imagine you had a recipe for a secret sauce, and it is delicious. You are the only one who knows how to make this sauce, and no other restaurant has it. People will seek you out, and pay you top dollar to eat food with your secret sauce. If you protect that recipe, no one can copy you and take your customers. That is your sustainable competitive advantage.

This is the goal of business strategy. Figure out your business’ secret sauce. Invest in your business’ secret sauce. When you have a focused business strategy around an area of sustainable competitive advantage, it will make your business more effective.

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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.