The Sources of Competitive Advantage

It was Michael Porter who first viewed competitive strategy from the perspective of economics.With his famous Five Forces framework, Porter provided a paradigm which allowed firms to understand the structure of their industry and the nature of the forces which shape industry profitability.

A criticism of Porter’s thinking was that he failed to carry his ideas through to practical implementation. In response to that criticism, Porter advanced the idea of the value chain – the extended set of activities a firm uses to create value for its customers. Most importantly, Porter developed the idea that, because it is the firm’s value creation system, the activities which comprise a firm’s value chain are the source of its competitive advantage.

Activities are synonymous to some degree with processes. A process is a set of activities, or operations, that are carried out to transform inputs into outputs. It is processes, and their member activities, which create the value which a firm carries to the marketplace.

As noted in my last blog, most firms believe that to gain a competitive advantage, they must become the best in their industry. Accordingly, firms tend to emphasize excellence of execution in their business processes and activities. Such firms believe that to win in business, they must pursue a strategy of operational effectiveness, or what Porter calls OE. The emphasis on OE is evident in the plethora of management programs and fads that have come and gone over the years, including Total Quality Management (TQM), Six Sigma, and Lean Manufacturing or Service.

As Porter notes, OE is not a strategy. A competitive strategy is not about being the best, it is about being unique and different from the competition. If your value chain is the same as the competition’s, then you are no different from them. In such cases,the ability to price lowest, often at reduced margin, becomes the main competitive differentiator.

A good competitive strategy emphasizes creating a competitive advantage through building a relative price or cost differential from competitors. The source of this price or cost differential is the activities (or processes) that a firm chooses for its value chain. Of course, these activities need to be well-executed, but the primary source of the competitive advantage is in the choice of the activities, not in how well they are performed. Knowing which activities to perform, as well as not to perform, is the key insight which is often overlooked.

Value chain configuration is therefore a key component of competitive strategy. Remember, a price or cost advantage finds in source in the value chain and nowhere else.

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