Thursday, December 11, 2014

Competitive advantage


To avoid being lost amongst a mass of rival product or service suppliers, businesses should decide what can give them a competitive advantage. We can look at three different strategies for gaining such a competitive advantage - cost, specialisation or differentiation.

Today we will begin by talking about cost. Being the lowest cost producer is typically also related to volume. Investment in tooling, design for high volume production and cost effective routes to market are all factors in delivering the product at a low price. One company I  worked for, identified markets that needed high volumes of products. This suited a manufacturing strategy that enabled investment in specialised tooling, automated machinery and finely tuned assembly lines to turn out high volumes of products at the lowest cost in the market. Interestingly tenders were often won not on price, but due to the capability to deliver high volumes to customer timescales that competitors not set up for volume production couldn't meet. This not only generated a higher unit percentage gross margin , but also translated into higher cash earnings on the contract. And thanks to investment in production, usually a better quality, more consistent and reliable product than their competitors too.

In service industries the cost of supplying that service can be scrutinised at every stage in the process,  which may result in major changes to the way in which that service is delivered. Airlines provide an interesting example, where in recent years the established carriers have met tough challenges from low fare airlines. Referred to as disruptive innovation, South West Airlines developed a business model which others such as Ryanair and Easyjet have followed to grow into market leaders and at the same time expand the market by bringing  in customers who could not afford the fares set by the established carriers. By operating one type of aircraft, a point to point route structure, dispensing with inclusive passenger services such as meals and seat reservation, using smaller airports, fast turn arounds and many other cost-saving ideas, the cost of providing the service is significantly lower.

Interestingly, offering the basic product or service at a low price point results from stripping out all the so called 'frills'. The purchaser can then decide to buy these as an option. Things such as accessories that make the core product more useful which usually carry much higher margins than the the product itself. For airline passengers, buying food, checking in hold luggage, reserving seats rapidly rack up the total price of the ticket.

In short, low cost as a competitive advantage does not mean low margin. In fact the investment and volume can be a barrier to entry for other would be competitors, allowing the disruptive innovator to gain big shares of the market. The temptation is to try to take more of the market - the areas occupied by premium brands or businesses that specialise such a in custom products. That is a mistake that will confuse the customers.

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