This is part 3 of a series on strategy fundamentals and how the concept will evolve.
Here are the previous posts in case you missed it.
Competitive advantage is one of the most talked about notions in business. Almost every investor asks questions about it yet it remains a broad & fuzzy concept. Simply put, competitive advantage exists when a business generates persistent differential returns over time. Another way to state it, be sustainably more profitable than its competitors. The obvious question is how to generate these differential returns.
Here we start with the seminal work of Michael Porter and his five forces model. Porter’s work on five forces has stood the test of time and offers the best lens for analysing the competitiveness of a market. It’s an analysis framework that allows you to understand if the market in which the company operates has conditions in which competitive advantage is achievable.
In terms of specifically creating competitive advantage, I’ve fallen in love with Hamilton Helmer’s seven powers. It’s an amazing encapsulation of competitive strategy. Here’s the quick list:
Scale economies: A business in which per unit cost declines as production volume increases. A canonical example here would be Wal-Mart.
Network economies: The value of a service to each user increases as new users join the network. This is probably the source of power most closely tied to software companies. The best work I’ve seen on the topic comes from venture capitalist firm NFX and their network effects bible. All social networks fall into this category.
Counter positioning: A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business. Think Netflix vs. Blockbuster.
Switching costs: The value loss expected by a customer that would be incurred from switching to an alternative supplier for additional purchases. If you’ve ever witnessed an ERP project, you understand why switching costs are important,
Branding: The durable attribution of higher value to an objectively identical offering that arises from historic info about the seller. Despite being a marketing guy, this is my least favorite of the seven powers because I see it as a consequence of another power. Only after having a product or service that people want, can a barrier be created with a robust brand.
Cornered resource: Preferential access at attractive terms to a coveted asset that can independently enhance value. You can argue Google and Facebook have a cornered resource by attracting strong engineering talent particularly in the field of machine learning. Distribution falls into this bucket for me as well.
Process power: Embedded company organisation and activity sets which enable lower costs and/or superior product. TSMC’s ability to produce semiconductors at a global scale is the easiest example to understand for me.
Make love not war
The term competitive advantage conjures up chess boards attacks on competitors and military style engagements. The business world is definitely competitive but it’s not always about beating your opponent. It’s also working with the right partners and sometimes creating an ecosystem that can flourish. A good definition from HBR:
They create value through relationships and networks, not through physical goods or infrastructure, so arguments built around asset ownership are equally challenging. These firms are also looking to grow the market — by increasing the flow of people and goods — rather than to capture as much of the existing market as possible.
A solid execution of an ecosystem strategy can itself be a source of power and is closely tied to network economies. I’m calling it out because of its distinct approach.
My favorite (and biased) example is Shopify. They evidently compete with other ecommerce software companies but they are laser focused on their ecosystem as well. They are heavily investing in helping their customers succeed. Stripe is another leader in building an ecosystem strategy. Their mission is to increase the GDP of the internet and are executing on it brilliantly.
Classic definitions of market share are becoming less relevant in a world with exponential growth. Ultimately, a rising tide floats all boats.
I’d love to keep learning and improving my thinking on the topic. Feedback is welcome! In the next post, we’ll move from strategy design to strategy execution and cover how to bridge hat that gap.