When a company’s profits consistently exceed the average for its industry, the company is said to possess a sustainable competitive advantage over its rivals. The goal of much of business strategy is to achieve this from a competitive advantage.
Michael Porter of Harvard Business School has identified two basic ways of gaining a competitive advantage; cost leadership and differentiation leadership.
A company can gain a cost advantage by becoming the lowest cost producer in its industry. The sources of cost advantage may include economies of scale, a particular proprietary technology, preferential access to raw materials, and other factors. An example is Southwest Airlines. All its activities are geared towards minimising costs: Fast turnaround so planes are in the air longer
Standardised fleet of aircraft leading to lower maintenance costs Use of secondary airports with lower fees
No travel agent reservations
Southwestern is an extremely difficult company to compete with because of the cost leadership imbedded in the corporate culture and the pricing power this affords them. It is important to note that being a low cost company is not the same as being a low price company. A cost leader can choose to undercut the opposition (and sell more) or sell at the same price (and make more profit per unit).
In a differentiation strategy, a company seeks to be unique in its industry in a way that is widely valued by customers. It selects one or more attributes that many customers in an industry perceive as important, and uniquely positions itself to meet those needs. Differentiation can be based on the product itself, the delivery system by which it is sold, the marketing approach, or a broad range of other factors. It is rewarded for its uniqueness with a premium price. An example, again from the airline industry, is British Airways: Projects an image of comfort and luxury
Global airline with a large varied fleet, flying to most major destinations Comprehensive service and professional attendants
Significant business class capacity
A firm that can achieve and sustain differentiation will be an above-average performer in its industry if its price premium exceeds the extra costs incurred in being unique.
A number of companies have successfully managed to combine sustainable low cost and differentiation leadership to gain industry leadership. For example Dell not only has a direct sales, low cost structure but developed a reputation for customer satisfaction, with the lowest complaint rate in the industry.
How This Relates To Your Business
You need to develop a strategy that will give your business a competitive advantage. Two ways of doing this are to reduce your costs or create a product that is differentiated from your competitors’. The ideal situation is to combine both strategies, although this is more difficult and may end up achieving neither.