Many businesses fail due to a lack of planning about how they’re going to capture value. A company may have great aspirations to offer the most selection, however, they fall short in running a profitable operation. The most important variable that successful enterprises have in common is a well-defined competitive strategy.
What is a Competitive Strategy?
A competitive strategy is a formulated plan to create and sustain an advantage against rivals in your industry or environment. Michael Porter, a Harvard professor of Business Administration and author of, Competitive Strategy: Techniques for Analyzing Industries and Competitors, provides a framework for understanding a company’s competitive strategy using his five forces model.
According to Porter, the five key elements to consider when formulating your competitive strategy are:
Rivalry Amongst Existing Firms
When considering starting a new business endeavor, look at the competition level of those companies already operating in a particular industry. Price wars, advertising campaigns, new products, or services are several factors that companies are utilizing to compete for market share. Accessing the potential push-back you may find in a new industry will better prepare you for how to react to such competition.
Threat of New Entrants
An environment that is heavily saturated with established firms could have a high barrier to entry, such as capital investment, technological capability, or human capital. However, maybe your company has invented a new product or drastically improved a way of doing something, in which case there would be little to no existing competition because you are creating a new market.
Gauging any hurdles to overcome from the start will let you know if you can capture value fairly easily or if you’ll need to exert a lot of resources to become profitable in the future.
Bargaining Power of Buyers
In economic terms, when there’s a high supply of a product or service and a low demand for it, buyers will have a relatively strong influence on the price and, thus, profitability.
Conversely, if there’s a low supply of a product or service (perhaps, pediatric heart surgeons) and high demand for it, buyers will essentially pay whatever the going rate is set by the suppliers. Knowing your customer’s ability to affect profitability levels should allow your company to better position its offerings.
Threat of Substitute Products or Services
Substitute products or services can be anything from tea versus coffee or one internet provider versus another. We have a variety of brands and companies to choose from, so determining your competitive advantage in an industry with a lot of substitutes available can be very important to the longevity of your business.
Bargaining Power of Suppliers
Similar to the bargaining power of buyers, mentioned above, suppliers have a competitive advantage if they are offering a product or service that is in high demand and there are relatively few suppliers in the industry.
When a company can capture a large portion of market share, becoming a top competitor in the industry, they are in a great position to influence how much they want to charge customers. Sustaining a high level of bargaining power for a supplier will allow that company to generate large profit margins, as long as the demand for their product or service remains significant.
Industry Analysis
Competitive strategy is a byproduct of the industry’s forces, as described by Porter, which then leads us to assess the environment for strengths, weaknesses, opportunities, and threats, termed a SWOT Analysis.
Strengths
What benefits of operating in a particular industry exist? Strengths can be a strong brand presence, efficient supply chain channels, or access to a specific resource that competitors may not have (ex. oil rights, patented technology, etc.).
Weaknesses
Does an industry show clear disadvantages to your company’s core competencies? Weaknesses may include being limited by your existing capabilities, capital allocation difficulties, or lack of sufficient infrastructure.
Opportunities
Can your company leverage resources or create market space better than competitors? An emerging market that is positioned within your company’s scope of business or easily adaptable to it could present a lucrative business opportunity.
Threats
Are there regulatory issues, changing technology, or potential economic shifts that could impact your company’s profitability? Being aware of the external environment will help your company assess its vulnerability to potentially negative events that occur.
Determining your Strategy
Porter outlines three fundamental competitive strategies that companies follow, cost leadership, differentiation, and focus. The focus strategy contains two variants, cost focus, and differentiation focus. Businesses that are able to define their competitive strategy and consistently adhere to it are much more likely to set themselves up for success in their industry.
Cost Leadership
A cost leadership strategy means providing your products or services for the least amount of money to your company, thus typically allowing you to charge a lower price than competitors.
The best example of a company following a cost leadership strategy is Walmart. They offer a wide variety of products at the lowest competitive prices (every day). Walmart is able to set itself apart from competitors by having one of the most efficient supply chain systems in the world, allowing it to save money on transporting goods.
Differentiation
A differentiation strategy means offering a product or service that is superior in some significant way to your opponents. These are usually luxury brands that fetch a pretty penny for their status within an industry.
Apple has several products that have unique technologies, as well as exclusive compatibility with other Apple products, so they are able to differentiate themselves in a competitive environment.
Focus
A “cost focus” strategy is essentially narrowing in on a specific niche within an industry and lowering your operating costs to be competitive amongst rivals.
Spirit Airlines is a great example of a cost focus strategy. They target budget-conscious travelers with bare-bones air travel at very low prices, focusing on specific routes and charging extra for everything beyond the base fare. This allows Spirit to offer some of the lowest base fares while maintaining profitability in their chosen market segment.
Along the same lines, a “differentiation focus” strategy is pinpointing a specialized product or service you offer to a niche market.
For example, the pediatric heart surgeon from earlier would be a focused specialty that is different from a more general cardiologist. These both resemble the broader approaches mentioned above with the simple distinction of selecting a niche to serve.
Developing Your Competitive Strategy
While understanding the importance of a competitive strategy is crucial, implementing one effectively requires careful planning and a comprehensive approach to your business. If you’re looking to develop a robust competitive strategy as part of a broader business plan, I’ve written a comprehensive guide that can help.
My ebook, “Business Plan Development: A Comprehensive Step-by-Step Guide for Entrepreneurs,” covers competitive strategy in-depth, along with all other essential aspects of creating a successful business plan. From crafting your executive summary to financial projections, this guide provides actionable insights to help you build a business that stands out in your industry.
The ebook is now available on Amazon, offering a valuable resource for entrepreneurs at any stage of their business journey. Whether you’re just starting out or looking to refine your existing strategy, this guide can help you create a roadmap for success in today’s competitive business landscape.
Explore more about it here on Amazon.
Closing Remarks
A firm’s competitive strategy is essential to its long-term success in any industry. The dynamics of an environment determine, to a large degree, the type of businesses that will be able to thrive due to their competitive advantages.
It’s nice to have a good product or offer a satisfactory service, however, those are often temporary. Having an awareness of your company’s industry and competitors will ultimately guide your business toward building a sustainable competitive strategy.
Learn More
For additional information, check out Michael Porter’s cornerstone book, Competitive Strategy: Techniques for Analyzing Industries and Competitors, and delve into the details of why it’s important to have a competitive strategy for your business.
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Sources
Porter, M. (1998). Competitive Strategy: Techniques for Analyzing Industries and Competitors.Free Press.
