Innovation and competitive advantage
You may wonder why is the title of this article “competitive advantage”? Aren’t we supposed to be talking about innovation management? What do the words “competitive advantage” and “innovation” have in common? These words describe two different conceptions, but they are connected indeed. How do you get competitive advantage in business? First by examining your business, and looking for areas (you remember 4 P’s of innovation), where you can bring in and exploit new ideas, and in the process make your company better than others. From our previous “E-magazine” articles on innovation management, we have learned that this is also definition of the innovation process. By innovating you get your “competitive advantage” over your competition.
What is competitive advantage?
When a firm sustains profits that exceed the average for its industry, the firm is said to possess a competitive advantage over its rivals. The goal of much of business strategy is to achieve a sustainable competitive advantage. (Harvard Business School - Institute for Strategy and Competitiveness - www.isc.hbs.edu)
You can see the word “sustainable”, and of course you may ask: “How can you maintain sustainability in the global marketplace, when conditions in your business environment are changing every day?” The answer is: “By constantly adopting to these changes – or innovating”.
Warren Buffett, the most famous private investor in the world, emphasizes that he wants to buy businesses with prospects for sustainable value creation. He suggests that buying a business is like buying a castle surrounded by a moat—a moat that he wants to be deep and wide to fend off all competition.
How would you measure your company’s moat. How would you make it deeper and wider to defend your company? Or, how would you recognize your current environmental conditions and react properly? Before we get into practical methodology, lets look into the meaning of “competitive advantage” concept.
Professor Michael Porter from Harvard University identifies two basic types of competitive advantage: (1) Cost advantage (2) Differentiation advantage. When a company is able to deliver the same benefits to their customers as their competition at the lower price it is “cost advantage”, or if they are able to deliver benefits that exceeds those of their competitive products it is “differentiation advantage. These are called “positioning” advantages. They describe the company as industry leader in either “cost” or “differentiation”.
There is also a resource-based view that emphasizes the company utilizing its resources and capabilities to create a competitive advantage that ultimately results in superior value creation. According to this view the company must have the resources and capabilities that are superior to that of its competition. They are called “distinctive competencies”. These competencies enable innovation, efficiency, quality, and customer responsiveness, all of which result in a cost advantage or a differentiation advantage.
Professor Michael Porter says:
“In addition to the firm's own value-creating activities, the firm operates in a value system of vertical activities including those of upstream suppliers and downstream channel members. To achieve a competitive advantage, the firm must perform one or more value creating activities in a way that creates more overall value than do competitors. Superior value is created through lower costs or superior benefits to the consumer (differentiation).”
We can see the word “value” repeating over and over again. What are these “value creating activities”? If we get back to our 4 P’s of innovation (Price, Process, Paradigm and Position), we can see that new ideas, implemented and exploited in a way to increase profitability, directly or indirectly lead to value creation. That qualifies them as innovation, applied at any of the 4 P areas of your business mentioned above. Increased value may be reflected in the bigger profits, but also better positioning in your customers minds, or more efficient business processes. In short, they are any innovation activities that make your business better (more competitive).
How do we begin to create superior value and how do we make this process sustainable. Industry analysis is the appropriate place to start an investigation into sustainable value creation. The first step is getting a lay of the land - understanding your businesses’ environmental conditions, or perform the industry analyses.
We can define an industry as: “A group of companies offering products or services that are substitutes for each other”. Some industries are more profitable than others. We could assume that profitability of an industry is the result of seven forces. They are:
Force one: Political forces
Here in Serbia, these forces probably have the most dominant effect on any business. They have influence on how much taxes you have to pay, how fast and easy you can export or import, get permissions to build, start a new business, and so on. The political instability, causes high credit rates, low foreign capital investments, slow economy and everything else we currently see happening in Serbia. Can you predict how stable will be the political environment tomorrow, or a year from now?
Force two: Non transferable costs
Your non transferable (to the end user) costs of doing business. The globalized economy has made it easier to find new suppliers, but these suppliers could also find more buyers. They need to sell at higher prices to compete with their competitors. Today, its not easy to bay cheap and sell expensive. Are you sure you will be paying the same percentage of your income for your supplies, or other costs of doing business?
Force three: New entrants
A profitable industry always attracts new entrants. You may feel comfortable at the moment but new entrant may come in and drive down your profit margins. They may bring in new superior products or services. To stay on top, you must constantly scan your industry for new arrivals. Is there a new entrant in your industry now, capable of producing superior value?
Force four: Rivalry
Everybody agrees that market economy is good. Yes, but good for the consumer, not always for the provider of goods or services. Too much rivalry, price cutting and giving in to consumer can cause the whole industries to become unprofitable. Are you competing with your competitors at the price of being profitable?
Force five: Customer resistance
Educated customer is good for business, but only up to the certain level. If they know exactly what to expect from your product and at the exact price, your profit margin will go down. You and your competitors will be forced to constantly offer better product value. Do you give too much to your customers? If so, is your industry still profitable?
Force six: Customer base
The size, wealth and accessibility of the customer base affect industry profitability. What is your customer base? How easily can you access them? How easily they spend their money on your products? These are all variables, and they change in time. Are you aware what is going on with them right now?
Force seven: Alternatives
There are industries that have seen their business swept away by alternative products or services. Think about old photo cameras, and photo film industry. Today everything is digital. Kodak has tremendous troubles staying in business, and only ten years ago it was the undisputed industry leader. On the market, is there a better alternative to your own product?
This seven forces model may help you see where industry threats are present, so that your company can begin to answer the question: "Where do we need new ideas to reduce or eliminate these threats?"
How would you use the industry analyses model? First you would need to build the assessment tool, comprising of questionnaires that ask specific questions on each of the seven forces mentioned above. Competitive advantage is too important issue for your company’s survival and profitability, so you would need to get everybody involved. Innovation management methodology is essentially pure interactive communication. New ideas do not come easily. But if you get the right people to bring these good ideas out in the open, and use them to create superior value, you will gain competitive advantage, and stay (profitable) in business.
Miodrag Kostic, CMC
Director of VEZA d.o.o.
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"It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change."
-- Charles Darwin