Competitive Advantage

You will know that you need to have a competitive advantage or competitive edge as the basis for your unique selling proposition.

Are you clear on the dimensions?

For years, I talked about this as the ABCD Rule.

Your Advantage needs to be Better, Cheaper or Different.

Then I came across an article I wrote on the difference between vertical differentiation and horizontal differentiation where I went further.

I said your Advantage needs to be Better, Cheaper, Different, Easier or Faster.

This became the ABCDEF Rule.

This gives you five broad directions to think about when you are considering your customer value strategy and your customer value attribute map (also known as the strategy canvas in Blue Ocean Strategy). These will help you to be clear on which factors are your order winners and which are order qualifiers.

I learnt about the Customer Value Performance Matrix from reading Customer Power by David Swaddling and Charles Miller which they called the Customer Perceived Value Performance Matrix.

It is another 2 x 2 matrix – like the Innovator’s Portfolio Matrix – that I find myself wondering “why didn’t I think of this?”

The Customer Value Performance Matrix

The customer value performance matrix lets you look at your individual customer value attributes and convert them into a SWOT analysis by identifying the strengths, weaknesses, opportunities and threats.

The two axis are:

• Relative performance which identifies good and bad attributes.
• Relative importance from the customer’s perspective.

According to Swaddling and Miler you can calculate your relative performance of each attribute based on the customer’s next best alternative. This may be difficult to determine since it requires you to crunch through the customer value numbers to determine which is the best alternative (see Managing Customer Value).

Alternative ways would be to

• Average the attributes across your main competitors and compare your performance against the average. This risks over-assessing your strengths and opportunities if there is one outstanding competitor who has a clear advantage, but if that’s the case, you can use that competitor as your benchmark in the customer value performance matrix.
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• Picking the best customer value attribute performance from all the competitors which would be a tough test.

On the other axis, Relative Importance, Swaddling & Miller draw the cut-off line at 12.5%. I believe this depends on how many attributes you track in your customer value formula. If you’ve got five attributes then the dividing line would be 20% with a possible sample of importance ratings of 35%, 25%, 15%, 15% and 10%. If you’ve got eight in your customer value formula, then the 12.5% is appropriate.

SWOT From The Customer Value Performance Matrix

Strengths – high relative performance (i.e. you’re better than your competitors) but low relative importance. The customer value strategy would be to maintain performance.

Weaknesses – low relative performance and importance are low priority improvement targets unless they are order qualifiers and performance is below the threshold or risks falling below it.

Opportunities – high relative performance and importance – these are the competitive advantages of the business, the key factors of difference.

Threats – low relative performance but high relative importance – these attributes are priorities to the customer but the company does not perform as well as competitors. These are priorities to improve the underlying capabilities.

Putting Customer Value Into Perspective

Customer value can seem a complex, intangible concept when you start working with it but techniques like the Customer Value Performance Matrix help to make it much more relevant to sceptical management since it guides priorities and decisions.

In the classic book, Competitive Advantage, strategy guru Michael Porter introduced the value chain in a stylised diagram based on a manufacturing business but many people overlook the idea of a consumer value chain.

The Consumer Value Chain

A business performs many activities to create its own products or services which it intends to sell to make a profit. The traditional value chain is a way for the strategist to look at the business to see how activities can be improved to:

• Reduce the costs of the necessary activities; or
• Improve the performance of the activities in ways that create extra value for the customer, differentiate the business and encourage the customer to pay a higher price for the products and services on offer.

The key to improving performance in ways that customers value can be found by examining the customer’s own value chain to find ways that it can:

• Reduce costs for the buyer
• Improve the buyer’s own activities and products in ways that it can increase prices and/or sell more.

The traditional value chain provides a guide to this process when the business is selling business-to-business but it doesn’t provide much guidance when the business sells to consumers.

What Michael Porter Has To Say About The Consumer Value Chain

In his book Competitive Advantage, Michael Porter says the following about the consumer value chain:

“A consumer’s value chain represents the sequence of activities performed by a household and its various members in which the product or service fits. To understand how a product fits into a household value chain it is usually necessary to identify those activities in which a product is directly or indirectly involved, typically not all the activities a household performs…. a household’s value chain reflects its members’ habits and needs.” (pages 130 & 131)

Identifying The “Consumer”

If we are to think through what a consumer wants, we need to identify who is the consumer and how that may differ between the user of the product or service and the person who makes the buying decision and who makes the economic sacrifice of paying for the item. There is also the knock-on impact onto other members of the family or household.

A child plays with a toy but it may have been chosen and paid for by the child, a brother or sister, a parent, grandparent or someone else. The child gets the pleasure while the buyer gets pleasure from having a happy child or fills a social obligation.

If the present is a set of drums (or anything else that is irritating), then the child’s pleasure comes at a cost to other members of the household.

Sometimes one person will benefit from a purchase, other times everyone in the household will get benefits (e.g. a television).

The consumer for consideration in the consumer value chain is therefore a complicated concept which will depend on the product or service that is being sold but it will be a composite of:

• The user who gets benefit from the product
• The product selector – the person who makes the choice
• The person who incurs the cost of the product
• Others affected by the product in use.

The Goal Of The Consumer

It’s easy to assume that the goal of a business is to increase profit which can be achieved by selling more products at higher prices and with lower costs.

But what is the big goal of consumers and what are the main drivers to the achievement of that goal?

That’s a big question for philosophers but I’m going to try to keep it simple here.

I believe the main goal is “happiness”. I want to be happy and I want my family to be happy.

Money helps but it’s not the big goal. It’s more of an enabler which makes life easier and more comfortable.

We do certain things to acquire money to allow us to buy or do certain things.

It’s an input and an output of the process of living as a consumer.

The three big inputs are:

• Time
• Energy
• Money

The consumer value chain needs to take into account all three.

Time is fixed. One hour spent on one activity means an hour sacrificed elsewhere. Anything that saves time therefore creates value because it means we have more time to spend on other activities.

Energy is variable but comes at a cost. Expending a lot of energy on one activity means that less is available elsewhere although the relationship isn’t as clear and absolute as time. As people get used to exercise and spending energy, their bodies normally get fitter and they are able to do more. Sometimes expending more energy saves time, sometimes it doesn’t. Reducing effort and the energy required for an activity usually creates value for consumers – we want things to be easier.

One of the ways that consumers reduce the energy and effort is to satisfice. Instead of continuing to search for the best solution, they can take action when something satisfactory is presented. This also creates customer inertia where customers are not satisfied but continue to consume because of the perceived difficulty of changing.

Money is variable and as consumers we can earn more by either working more hours, finding ways to earn more per worked hour or leveraging our time to earn more. Saving money adds value because it means that more can be spent on other activities and products.

The Consumer Value Ownership Lifecycle

The consumer is involved with the product in different ways at different times in the ownership lifecycle:

• Selection and purchase
• Delivery, installation and making the product ready for use
• Use
• Disposal

Each stage offers opportunities to save time, energy and money which can be included in the consumer value chain.

How Do You Use The Consumer Value Chain?

How do you make decisions in your family about expenditure? Do you have some kind of trade off where everyone in your family has the chance for some treats or does one person dominate the spending of any spare cash?

In his book Competitive Strategy, Michael Porter introduces the idea of generic competitive strategies and says that a business must choose between differentiation and cost leadership or risk being “stuck in the middle”, missing on the high profitability that an effective strategy for one or the other.

Differentiation Or Cost Leadership

Porter argues that businesses face a choice – differentiation or cost leadership over a broad or narrow market – if the firm wants to avoid low profitability that comes from confused customers and employees from a “blurred corporate culture”.

This is because achieving cost leadership normally involves eliminating all those little bits of extra product functionality and customer service that bump up customer value in the eyes of customers looking for a differentiated product because they cost money.

This makes a lot of sense.

Business managers intuitively know that to give the customer more, it’s going to usually cost more.

But then examples started to appear which showed successful businesses which had established a cost leadership position but which were also differentiated.

Quality Is Free

Just as Michael Porter argued that cost leadership and differentiation involved trade-offs that meant you couldn’t do both, it used to be thought that businesses had to choose between low cost and good, consistent quality.

But the total quality movement popularised by Edwards Deming, Philip Crosby and Joseph Juran showed that cost of quality had an inverse relationship. As quality improves, costs didn’t increase as had been expected but reduced.

Differentiation And Cost Leadership

In Michael Porter’s next book, Competitive Advantage, he still warned about the dangers of being stuck in the middle.

“Becoming stuck in the middle is often a manifestation of a firm’s unwillingness to make choices about how to compete. It tries for competitive advantage through every means and achieved none, because achieving different types of competitive advantage usually requires inconsistent actions.” (page 17).

On the next two pages of the book, he softens his stance by admitting that reducing costs does not always mean sacrificing differentiation because using more effective methods and technology may reduce costs and improve differentiation. He goes on to point out that reducing costs from a high position is not the same as achieving a cost leadership position. He looked at this in more detail in What Is Strategy?

Porter identifies three conditions where a business can achieve differentiation and cost leadership:

1. When competitors are stuck in the middle and don’t force the business to the point where differentiation and cost leadership are inconsistent. This may be more often than you would expect in local, fragmented markets where businesses don’t have opportunities for big differentials in input costs for materials and labour.
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   The downside is that weak competitors can make the firm complacent and leave it vulnerable to new market entrants that are better managed.
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2. When cost is strongly determined by market share or interrelationships. Large economies of scale can give the business a big enough cost advantage to allow it to spend some of its cost savings on elements to differentiate the products and still achieve cost leadership. Interrelationships may arise between elements of the industry value chain which one competitor can take advantage of and the others can’t.
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3. The business pioneers a major innovation. Innovative new process technologies may lower production costs that allow the business to invest in differentiation factors or product innovation may deliver both cost leadership and differentiation of customer value attributes. Sustaining this innovation advantage is vital because wants it gets into the general market, the business is forced into the differentiation or cost leadership trade-off. It may even find itself at a disadvantage if rival competitors improve the innovation specifically to lower costs or to create extra differentiation.

The Danger Of The Tempting Lure Of Differentiation And Cost Leadership

A business that achieves differentiation and cost leadership is in a very strong position and should be much the most profitable firm in the industry.

This is precisely why I believe that creating a strategy to achieve both is dangerous.

The lure is strong but so are the traps and being stuck in the middle remains a clear and present danger.

I agree with the conclusion Michael Porter came to in Competitive Advantage.

“A firm should always aggressively pursue all cost reduction opportunities that do not sacrifice differentiation. A firm should also pursue all differentiation opportunities that are not costly. Beyond this point, however, a firm should be prepared to choose what its ultimate competitive advantage will be and resolve the trade-offs accordingly.” (page 20 Competitive Advantage by Michael Porter)

The Value Chain And Competitive Advantage

The value chain was created to help businesses find competitive advantage and while the value chain can be criticised, the technique is very useful to look in detail at your business at the activity level and challenge each activity:

• How does this help differentiate our business from competitors in ways that matter to customers?
• How can we reduce costs in this activity without reducing customer value and service?

I was reading my good friend,  Ian Brodie’s excellent blog, and he introduced me to the term “vertical differentiation” in this article,

Ian helps consultants, coaches and other professionals to get more clients, and he was saying how difficult it is for these people to be unique.

Often these businesses provide similar services to their competitors and have little opportunity to do something new and different – what Ian calls horizontal differentiation.

Vertical Differentiation – Being Better Than Your Competitors

He selects several well known names and argues that what makes them different and successful is not that they do things different, but they do things better.

This is vertical differentiation.

The firms occupy the same horizontal places in the market but clients generally rank them as above competitors.

Vertical Differentiation And The Strategy Canvas

Just to be clear, if you use a visual technique like the strategy canvas (from the Blue Ocean Strategy book) or what I call a customer value attribute map, vertical differentiation is a higher rating on the attributes considered most important to the customer)

Vertical differentiation an interesting idea but I think relying on a strategy of being seen as better is dangerous.

Claiming To Be Better Is Dangerous

First, better is such a nebulous concept and especially for services where so much of what is provided is intangible.

How can a potential client assess whether one lawyer is better than another?

Second, even if they can make an assessment, better like beauty is in the eye of the beholder. It’s difficult to influence since it comes down to personal tastes unless you introduce factors of genuine difference.

Third, if all the professional firms look the same, then different becomes better. Standing out suddenly makes the business look more attractive.

Imagine ten identical beautiful blonde girls in a room – you’d expect each to get an equal amount of attention. Now imagine one went out of the room and came back with her hair dyed brunette.

She stands out and becomes more magnetic. She’s no more beautiful than she was before, but she is different from the others and more memorable because of it.

That little difference can help focus attention and instead of being dazzled by sameness, genuine quality differences might be perceived.

The final big concern about basing a strategy around vertical differentiation and being better is that it increases competitive rivalry. Competition is focused on a few specific attributes. As one rival improves in one dimension of customer value, another is encouraged to take actions to match or improve on that same dimension.

This is likely to create a cycle that increases costs of services but, although the customer value delivered increases, the competitors are unable to capture that value because of competitive pressure on price. Businesses are trying to move away from the customer value line to create advantage rather than along the customer value line to create a different value proposition.

Better Is Worthy But It Can Be A False Perception Of Reality

I believe being better is very worthy (we should all aim to be the best we can be) but it can lead you into a false reality.

We all tend to believe that we are better than we are.

I remember reading some research on professionals who were asked to rank their skills and knowledge compared to their peers. Something like 90% rated their skills as better than average!

How does that work?

It obviously can’t. Average means that 50% are above and 50% are below (strictly speaking that would be the median).

It does point to the problem that people generally think they are better than they are. In marketing this means relying on false hope which isn’t a strategy for success.

Even Clients Will Give You A Biased Answer

I bet you think that you can ask your clients to get an unbiased opinion but the question is rigged.

“Do you think your professional firm is better or worse than average?”

It sounds like a fair question but what’s it really asking?

“Did you make a wise, intelligent decision and use a professional firm that is better than average  or are you an idiot and have you continued to use a professional firm that is below average?”

Yes, you can expect to hear that clients made a wise decision even if they’d never think of making a referral.

If you think you’re better because you’re biased and your clients think you’re better because they are biased too, then vertical differentiation can lead to complacency and you finish up with the stalemate that you see in many professional services.

Differentiating by trying to be better sounds like a cop-out to me unless customers are rigid about their buying criteria and what they expect to experience.

Advantage – ABCDEF

I commented on Ian’s blog with a little acronym I’ve used for years.

ABCD – your Advantage can be Better, Cheaper or Different.

After I’d written it, I thought some more and wish I’d extended it to ABCDEF – your Advantage can be Better, Cheaper, Different, Easier or Faster.

The easier and faster helps to give a couple more dimensions to think about how your business impacts on the customer’s experience. Depending on your definitions, easier and faster could have come out of either the better or different categories.

I’d like to know what you think.

Is there merit in following a vertical differentiation strategy and being better than competitors rather than having horizontal differentiation?

And if it is, how can you communicate that you are better?

I was asked “Paul, what’s the difference between niche marketing and differentiation?”

I can understand the confusion because niche marketing and differentiating your business are related concepts but you can:

• use niche marketing principles and not be differentiated; or
• differentiate your business and not practice niche marketing.

Most of the time, successful businesses do both – they are differentiated within a niche market.

Let’s see how they do it.

Niche Marketing Concepts

Niche marketing means that your business focuses on particular types of customers or customer problems to the exclusion of other types of customers and problems.

It’s what I think of as bullseye marketing.

The aim is to attract customers who fit the characteristics of the bullseye in a target and the further a potential customer is away from the centre, the less mutual appeal. A customer from an outside ring isn’t interested in the business and the business isn’t interested in the customer.

The opposite of niche marketing is the problem I describe in Any Woman Will Do Says The Desperate Man.  This is casting the net wide and lacks any appeal to anyone – it’s the sign of desperate marketing.

Niche marketing is powerful because the specific needs of particular groups of customers are not being fully met by more general suppliers. Customers are being forced to buy products and services which are in the outer rings of the bullseye target because they can’t find anything better and buying is better than not buying.

Imagine you’re on holiday in a place where you expect it to be warm and sunny but when you get there, it’s cold and rainy. You may find yourself buying a coat and umbrella that don’t match your personal tastes. You wouldn’t buy them if you were at home and had plenty of time and choice but you don’t want to be cold and wet.

That’s quite an extreme example to make the point of buying “make do” products but if you consider what you’ve bought in the last few months, it may well have happened more often than you’d have liked.

The basic dimensions for establishing a niche market position are:

• Who is the target customer?
• What is the customer problem and what is the solution?
• Where is the business operating and where are the customers?

A niche market position requires a deliberate choice since it implies exclusion of customers outside the targeted area.

Many businesses only appeal to the local market because customers will only travel so far or it’s only economical for the business to travel a limited distance to customers. If all you have is a geographical restriction, then I don’t consider that you’re using niche marketing.

You can have a niche position with:

• a specific who and general what – clothes for teenagers
• a general who and specific what – hats
• a specific who and a specific what – hand made suits for male executives

These may or may not be restricted geographically. The development of e-commerce stores on the Internet has made many niche markets commercially viable precisely because the products can be sold throughout the world.

This concept of whether the niche is big enough is important and the bullseye target analogy is useful again. Market research may show the following likely sales:

• bullseye – £150,000  – no niche competition
• inner ring £750,000 – no niche competition
• middle ring £5,000,000 – two niche competitors
• outer ring £25,000,000

Imagine you’ve done your numbers work and you know that you need at least £500,000 sales to have a worthwhile business which is going to generate enough profit.

This clearly shows that the niche for the inner ring isn’t viable but the inner ring is and gives you considerable upside. It can be further extended by making small incursions with specialised products into the middle ring without destroying your position.

On the other hand, the £500,000 needed for a viable business might be right but your research shows you:

• Bullseye – £5 million – no niche competition
• Inner ring – £20 million

Here I’d say that your business opportunity looks good but I’d question whether you’ve really identified a bullseye. Your business may be vulnerable to being micro-niched.

Differentiation Concepts

Differentiating your business is about establishing clear reasons for winning buyer preference.

The biggest name guru on competitive advantage, Harvard professor Michael Porter made it clear that businesses can be:

• Differentiated in the wide market.
• Differentiated in a narrow, focused market – what we’d think of as a niche market.

Personally I think it’s much more natural to differentiate in a narrow market because you can precisely target the needs and wants of buyers.

Differentiation in broad markets is often based on either unique technology protected by patents, networking effects (thinks Windows for PCs as the de facto standard operating system) or brands.

People will buy an iPad or an iPhone because it is Apple. The basic product functionality may be very similar to other makes but the differentiating factor is the brand – “I want an Apple because my friends have an Apple and I want to be part of the in-crowd.”

They will buy a BMW car because of the prestige of the brand name and the image of the ultimate driving machine.

My blog is devoted to how to differentiate your business and you’ll see that I believe there are seven key dimensions to differentiation which you can get to by answering who, what, how, why, where, when and how many. Your answers need to be both multi-directional (e.g. who can refer to whom the customer is, who you are as the business owner, who the employees are, who the suppliers are) and specific (if you define your business with general rather than precise words, you’ll lose the power of any differentiation.)

The Difference Between Niche Market Positioning & Differentiation

The cross0ver is clear in the core questions:

Niche marketing is primarily about who, what and where.

Differentiation is about who, what, where, when, how, why and how many and takes a broader view.

You can be differentiated by staking out a clear niche position and you’ll appeal to bullseye customers e.g. think of a business expert who has identified his niche as marketing advice for accountants in the UK.

That’s very clear on the who, what and where and you can see that staff retention issues for financial advisers falls well outside the specification but it would fit a wider definition of “business advice for professional service providers”.

Any accountant who wants marketing advice is going to be attracted to the specialist. It’s a bullseye.

But what if the “marketing advice for accountants” is a big market?

It will attract new competitors who have a choice:

• Battling it out in the niche without any differentiation
• Differentiating by sub-niching and focusing on marketing advice for small accountancy practices with limited marketing budgets
• Differentiating by providing done-for-you marketing campaigns with a guaranteed return on investment of 500%

Having a niche may be enough to differentiate your business but you need to be looking for ways to go beyond it if a new competitor appears.

It’s no different from the shoe shop owner who makes a good profit in the town where he or she has a monopoly. The problems start when a new competitor moves in – and that may be another shoe shop or a supermarket superstore which sells shoes.

There has to be a clear reason for some customers to decide to buy from you.

My advice is to think “niche marketing AND differentiation.”

It’s very nice to build a business that is different and distinctive.

It gives you a feeling of superiority because you’ve created something that you can be really proud of.

But we can’t escape from the basic idea of differentiation…

Differentiation Must Be Profitable Differentiation

You differentiate your business because you believe you will make more profit than you will if you either get caught in the commodity trap or stay as a commodity and any business you win is by offering a low price.

Not all differentiation is profitable. You need to make sure you avoid the differentiation traps.

The 5 Differentiation Traps

First you can be different in ways that your customers don’t value – you don’t care whether I’m the tallest or shortest business coach in the world because my height is not one of your purchase criteria.

If you want your differentiation to be profitable, you must be different in ways that customers appreciate. I call these factors your order winners.

Second you can be genuinely different in ways that matter to your customers but you can hide your light under a bushel.

Differentiation will only create profit if the customers know about it and understand why your factors of difference create value for them through better results or a better experience.

A unique feature about your product or service only becomes a differentiating factor if customers understand the importance.

Third, you can fail the message to market test. You can have a great, well differentiated offer which is highly valued by one customer segment but if you send it to the wrong market, it will miss its target.

Different customers want different things.

Just think about clothes shops. What you want when buying clothes is very different from what your partner wants, what your teenage children want and what your parents want.

The choice of what you do has to be closely connected to whom you do it for.

To make matters more complicated, the same customer can want different things at different times.

The choice of hotels and restaurants may be very different for a business owner or manager when they are away on business than when they are buying for their family and friends.

Fourth, a classic differentiation trap is to increase your costs by more than the customer value you generate.

You do your market research and you find out that customers would love it if your product could have a longer battery life (think of a long-lasting smartphone for example). You research the market and you find that just like your products, your competitors products also need to be recharged every day.

After researching the product possibilities, you find that you can get a battery that will last 5 days. It sounds like a competitive advantage which will differentiate your product so you’re excited.

You buy the batteries, which cost £30 extra. You incorporate them into the product and you do a big marketing campaign only to find that no one buys.

The extra battery life will cost the consumer an extra £120 including sales taxes and profit for you and the distribution chain but the consumers don’t value it that much. The short battery life is an inconvenience but it’s not a critical inconvenience – it’s a “nice to have” rather than a “must have” and at an extra £120 price in the stores, it turns into a “can do without”.

The usual way to think about differentiation is to think about the price premium it can justify and higher price is certainly one way that differentiation can deliver profit.

The concept of the customer value maps makes it clear that providing extra value justifies a price increase if you stay on the fair value for money line. It can also create an irresistible offer if you move away and offer more value for money although it can trigger a price war.

The fifth way that differentiation can be a profit trap is to make promises that you can’t deliver. This is the distinction between shallow and deep differentiation.

Making big promises may convert leads into orders but failing to meet the promises won’t create a big group of customers eager to repeat the experience and buy again and again. I think the airline industry is the exception (Airlines suck).

This creates a bad experience and with social media, people love sharing their horror stories.

How To Have Profitable Differentiation

If you want profitable differentiation, you need to avoid the 5 differentiation traps

1. Differentiating on factors the customers don’t value. Instead, differentiate on the factors your target customers value highly.
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2. Having a genuine difference and not telling the customers. Be proud of your valuable differences and make sure no customer who wants what you sell, misses out through ineffective marketing.
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3. Marketing a differentiated offer to the wrong customers. Get your marketing bullseye clear in your mind.
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4. Differentiation that costs more than it earns. Make sure you are clear o the difference between nice-to-have factors and those customers really want.
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5. Not delivering consistently on the differentiation promise. Repeat business is a key to creating a profitable business and you’ll only attract customers back if they believe they have received value for money.

There are two fundamental questions that business owners and managers ask all over the world:

• Why are some companies and businesses more profitable than others?

It’s a great starting point for the second, and even more important question.

• How can we this business or company more profitable?

Profit Or Sales

We know some people focus on the wrong issue.

They look to grow the top line rather than the bottom line in the mistaken belief that high sales revenue automatically leads to high profits.

That’s nonsense of course.

The biggest corporate losses in history come from giant businesses with huge sales revenues.

There’s a famous saying, sometimes called the Banker’s Mantra:

“Turnover is vanity, profit is sanity but cash is reality”

My advice is to forget all the ideas about mergers and acquisitions that create big businesses unless a very strong case can be made for much bigger bottom line profits.

Why Are Some Companies More Profitable Than Others?

This is the question that Professor Michael Porter set out to answer in his book, Competitive Strategy in 1980.

His answer was surprisingly simple although the answers led to some very cl;ever thinking on complicated subjects.

The most profitable businesses:

• Operate in industries that are particularly profitable; and
• Have big competitive advantages that mean they can capture a bigger share of the available profits than their competitors.

Businesses can make a good profit by meeting one of those conditions.

The weaker the performance in each dimension, the worse the business will perform so the most unprofitable companies:

• Operate in a horrible industry; and
• Have big competitive disadvantages which make it difficult to win business from customers or to service any orders profitably.

That’s why strategy is concerned with both the inside and the outside issues of a business.

It’s only by looking at both aspects that a business can map out the most likely route to profitable success.

What Can You Do To Make Sure You Have A Profitable Business?

Do you have a business or are you thinking about starting a business?

If you’re starting, you need to think about?

• Is the market niche you’re thinking about entering an attractive one that can provide you with good profits or is it a potential profit trap? The Five Competitive Forces Analysis and STEP Analysis are good starting points.
• When you enter this market, will you have a competitive advantage in terms of a differentiated value proposition or lower costs?

If the answer is No to both questions, don’t waste your time and money.It’s better to find another business opportunity that excites you.

If you have two Maybe’s or a Yes and a No, I think you need to think very carefully. Consider your options. Is this a market that you’re really committed to? Can you find a better niche? Can you find a business proposition and model that offers you the chance to have a competitive advantage?

A useful article to read is Will My New Business Venture Succeed Or Fail?

If you already have a business and it’s not performing very well, I think you need to ask yourself three questions:

1. If the market is bad, can you find a more profitable niche or segment that you can move to with confidence? This is easier if you’re a general business who needs to specialise rather than a specialist who has a reputation in one field and needs to jump to another specialism.
2. Do you have a competitive advantage that you’re not making the most of (it happens) that you can promote more extensively or can you development a competitive advantage (differentiation is usually easier than cost leadership)?
3. Are things so bad that you need to leave this market by selling or closing the business? Sometimes a business that isn’t commercial viable on its own can become a profitable sideline in a better established business through synergies and shared costs.

In this article I will look at the idea of core competence as developed by CK Prahalad and Gary Hamel in their classic Harvard Business Review article The Core Competence of the Corporation and their book, Competing For The Future.

Core Competence & Resource Based Strategy

Very important work was done in the early nineties by academic strategists following the resource based view of strategy as the true origin for competitive advantages that deliver superior profits.

Unfortunately there was little agreement in terminology, so we have resources, competence, competencies and capabilities being used almost interchangeably which can create some confusion.

In this article I’ll try to stick to the Prahalad and Hamel version (but add my own thoughts on what it means for differentiation) and write further articles looking at related concepts.

Core Competence & Competencies According To CK Prahalad & Gary Hamel

If you want the full details, you should read Competing For The Future.

Core Competence & Corporate Strategy

While I have a preference for looking at competitive strategy through the lens of an individual business competing in a product-market against competitors, Gary Hamel and CK Prahalad put a convincing argument forward that corporations should be built around shared competences which open up opportunities to compete in the new markets of the future.

Since many groups manage linkages across business units badly, it is a challenge to make the most of current competencies, let alone to deliberately develop competencies which may be useful for the future, somewhere, sometime.

Any corporation that does, can expect to have created a powerful advantage if the competence can be applied.

What is A Core Competence?

Hamel and Prahald define it as…

“A core competence is a bundle of skills and technologies that enable a company to provide a particular benefit to customers.”

A common example quoted is Sony who with products like the Walkman provide the customer benefit of “pocketability” and draw on the core competence of miniaturisation.

This link between customer benefit and core competence is important. The idea is not to develop special skills for the sake of it but to establish a class leading position in a key attribute of customer value across multiple product-market opportunities.

It is a bundle of skills and technologies and not a single, discrete skill which might be more rapidly overtaken. It’s also not likely to reside with one person or a small team.

Core Competences Are Difficult To Develop

The very fact that core competences are difficult to develop and build upon both new innovations and continuous learning and development means that competitors find it difficult to imitate, providing an opportunity for building a sustainable differentiation advantage.

Competition for competencies is between corporations. Each may be competing with different corporations across different competencies.

Losing leadership in a core competence can be very damaging since it potentially undermines many current and future product-market positions. It requires commitment and efforts can be undermined by short term management decisions and constant changes in the senior management team of the corporation.

A Hierarchy Of Competencies

If you try to analyse your competencies, expect to find five to fifteen. More and you’re looking at individual skills, less and you’re probably generalising too much.

Hamel and Prahalad use Fedex to explain a hierarchy of competencies from the mega-competency of logistics, through core competencies like package tracking to constituent skills like barcoding.

The Core Competence Test

There are three tests to establish whether a competence is a core competence:

1. Does it make a disproportionate contribution to customer perceived value?
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2. Is it competitively unique (ie. not an industry wide key success factor) or does the company have a competence which is significantly better than all the other competitors or could be developed to be excellent?
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3. Can the competence be applied in multiple product-markets?

Competition For Competence

If you tend to think of competitive strategy, you’ll think of competition in terms of profit and market share but a different view is needed if you are going to use the core competencies idea.

Prahalad and Hamel argue that competition for competence happens at four levels:

1. Competition to develop skills and technologies which are the ingredients of the core competence cake.
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2. Competition to mix the core competence cake in the right proportions
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3. Competition to maximise production of an intermediate  product which embodies the core competence and can be sold to many original equipment manufacturers.
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4. Competition to maximise share in the final product-markets where the core competence brings customer benefits.

It’s number 3 that is controversial.

If you’ve successfully developed a core competence which can be applied in many product-markets, you’re now letting your competitors share in the benefits in return for a share of their profit.

This can be a difficult decision to accept since it erodes your competitive advantage in the final product-market or a more positive interpretation is that it puts pressure on your marketing and sales operations to be as good or better than your competitors rather than relying on the advantage that comes from the core competence.

If competitors don’t want to buy it, then the core competence is more in the mind of the management team than the market.

However, the big advantage of selling the intermediate product is that it extends your advantage in your core competence. It meets new challenges that create spurs for innovation, it creates extra economies of scale and pushes the business down the experience curve faster and it makes it much more difficult for a competitor to imitate.

Customers of the intermediate product can become dependent which gives the supplying business significant market power.

What Do You Think About Core Competence?

I’d like to know what you think about the core competence theory for corporate strategy put forward by Gary Hamel and CK Prahalad in their book Competing For The Future.

Theoretically I like it and I can see the logic but my bias is towards business unit strategy and the capabilities that underlie customer value benefits that apply in one product market or a series of very closely related markets.