What is a Competitive Advantage

Robinhood Learn
Democratize finance for all. Our writers’ work has appeared in The Wall Street Journal, Forbes, the Chicago Tribune, Quartz, the San Francisco Chronicle, and more.
Definition:

A competitive advantage is a characteristic or condition that allows a company to perform better than its competitors.

🤔 Understanding a Competitive Advantage

A company has a competitive advantage when it has a leg up on rivals. This may be because it offers lower prices, makes superior products, has a strong brand identity, or targets a niche group of customers. A competitive advantage is hard for competitors to copy quickly. Gaining a competitive advantage can help companies earn higher profit margins than others in the market. To obtain a competitive advantage, firms have to identify their target market, the benefits they offer, and who their competitors are.

Example

Suppose two competing coffee shops open in a small town. Both have great locations, top-notch management, and delicious food. But one of the shops serves better coffee, which leads to more customers visiting every day. The cafe’s superior coffee gives it a competitive advantage over the other shop, likely resulting in higher profits.

Takeaway

Competitive advantage is like being favored to win in the college basketball playoffs…

Imagine a college basketball team has a great season. Its players consistently perform better than everyone else, which gives them a leg up on their competitors. The team is known for its outstanding coaching and ability to recruit excellent players. A company with a competitive advantage is like being the team that’s favored to win: It has an edge that helps it beat its rivals.

Ready to start investing?
Sign up for Robinhood and get stock on us.Certain limitations apply

New customers need to sign up, get approved, and link their bank account. The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. Stock rewards not claimed within 60 days may expire. See full terms and conditions at rbnhd.co/freestock. Securities trading is offered through Robinhood Financial LLC.

Tell me more…

What are the types of competitive advantage?

There are three main types of competitive advantage:

Comparative advantage

Comparative advantage refers to the edge a company has when it can provide a good or service at a lower cost than competitors. Specifically, companies with this type of advantage can produce at a lower opportunity cost (meaning the value of what they could have produced instead). Companies have the lowest opportunity cost when they specialize in the goods they can make most efficiently.

For example, let’s say two companies make the same article of clothing and sell it for $25. Company A can produce the item for $10 apiece, while it costs Company B $13. Company A’s profit margin is $3 higher than Company B’s.

That doesn’t sound like a lot. But if both companies sell 1,000 of the item, Company A makes $3,000 more in profit.

Companies with comparative advantage don’t always sell the same product as competitors. The company with comparative advantage may in fact offer an inferior product that is cheaper and faster to make. This concept underlies the business model of the fast fashion industry, for example.

Differential advantage

A company has a differential advantage when it makes itself unique based on attributes it knows are important to its target market.

In some cases, this differential advantage may come from having a superior product. Suppose two local restaurants sell similar food, but one only uses high-quality, organic ingredients, while the other buys the cheapest ingredients available. Consumers can tell the difference, and the restaurant that uses better ingredients is more successful. It has a differential advantage over its competitor.

A company can also have a differential advantage because of a brand’s image. For example, luxury jewelry retailer Tiffany & Co. sells a sterling silver clothespin for $515. It seems unlikely that this clothespin is more effective than a wooden one on sale at your local hardware store, but some customers are willing to pay more because the company’s brand name gives it a differential advantage.

Focus advantage

A company gains a focus advantage when it concentrates efforts on a particular target market. One type of focus advantage involves offering prices that suit the target market.

For example, suppose two companies sell briefcases for successful women. One charges low prices, while the other prices its products considerably higher. The company with more expensive goods might have a cost-focus advantage, because the target client is a successful businesswoman used to spending more on a nicer product. If the briefcases targeted women just starting their careers, the lower-priced product would likely have the cost-focus advantage.

The other type of focus advantage — differentiation focus — refers to the edge a company has when its product caters more narrowly its target audience. For example, briefcases with a certain design and brand image might appeal more to high-powered women.

What are examples of competitive advantage?

Sometimes a company’s competitive advantage comes from outside factors. These can include access to natural resources others don’t have or a unique location. For example, suppose there are two hotels in a city. One has beautiful views of the nearby lake, while the other looks out on a taller building next door. The location of the first hotel might give it a competitive advantage.

Companies can also work to create a competitive advantage. They can do this by attracting talent, developing or acquiring innovative technology, finding ways to cut costs, or boosting brand recognition. For example, Google’s brand name is so synonymous with online search that people often use “Google” as a verb.”

How do you determine your competitive advantage?

Figuring out how your company can outperform rivals involves identifying a few important pieces of information:

  • Your target market: Who are your existing or potential customers, what do they need, and how can you provide it?
  • The benefits you offer: It’s not enough to know the ins and outs of the product or service you sell. You also need to determine what value these bring to people’s lives and how you can communicate that clearly.
  • The competition: To figure out what makes you better than your rivals, you need to know your competition. By identifying who you’re up against, you can see what they excel at and what you can do better.

What are some strategies for gaining a competitive advantage?

Harvard Business School professor Michael Porter, a leading expert on competitive advantage, offers three ways companies can obtain it:

Cost leadership

Companies can create an advantage in the market by pricing products lower than competitors do. All else being equal, the law of demand says that, as the price of a product decreases, demand for it increases.

Companies can gain a cost advantage by finding more efficient ways to produce goods. They can use cheaper raw materials, develop better technology, or achieve economies of scale.

Sometimes creating a cost advantage may not be in the best interest of customers. For example, using cheaper materials in the manufacturing process can sometimes harm the health of a product’s users. Cutting costs can also harm employees, for example by reducing wages or slashing health or retirement benefits.

Seeking a cost advantage works better for some companies than others. E-commerce sites such as Amazon succeed in part by offering products at lower prices than other retailers. On the other hand, a luxury car brand isn’t out to have the lowest price on the market.

Differentiation

Another way companies can create a competitive advantage is by standing out from competitors and making themselves more appealing to consumers.

One route is creating a higher-quality product or service. That can mean sourcing superior inputs, using better design, or offering an excellent customer experience. Another option is to disrupt the market with innovative offerings.

For example, Uber disrupted the transportation market by offering services no other company provided at the time. Hailing a ride through the Uber app was more convenient for many consumers than chasing down a cab or calling a dispatcher.

Companies can also differentiate themselves through the way they portray themselves to customers. They can do this through advertising, sponsorships, events, marketing emails, and more. Apple, for example, has differentiated itself from other tech companies through a strong brand identity that many of its competitors lack.

Focus advantage

Companies can create a competitive advantage by narrowing their focus to a target market. By truly understanding the needs of its customers, a company can create products they’re likely to buy again and again. In general, smaller companies have more focus advantage because they can cater to a single demographic.

Suppose you’re a dog-owner. Your local Walmart sells everything you could ever need — food, treats, toys, leashes, and more. But down the street is a local pet store that only sells custom collars. Because the pet store has a focus advantage, you may find yourself going there when you need a special collar for your dog.

The internet and social media have made it easier for mass retailers to create a focus advantage. With the power of targeted online marketing, retailers like Amazon can advertise specific products to people based on their interests and demographics.

Ready to start investing?
Sign up for Robinhood and get stock on us.Certain limitations apply

New customers need to sign up, get approved, and link their bank account. The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. Stock rewards not claimed within 60 days may expire. See full terms and conditions at rbnhd.co/freestock. Securities trading is offered through Robinhood Financial LLC.

20200407-1141871-3433238

Related Articles

You May Also Like

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC (member SIPC), is a registered broker dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’).

1771482

© 2022 Robinhood. All rights reserved.
Follow us on

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Robinhood Financial LLC (member SIPC), is a registered broker dealer. Robinhood Securities, LLC (member SIPC), provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. All are subsidiaries of Robinhood Markets, Inc. (‘Robinhood’).

1771482

© 2022 Robinhood. All rights reserved.