Competitive Advantage through Differentiation
For a business to achieve earnings superior to the average in the industry it must have a competitive advantage. Without possessing a competitive advantage a business is doomed to depend on the economic fluctuations in the markets. When the economic conditions are favourable it does well, and when the economy is poor it suffers. I suggest that depending the economy is looking for scapegoats. The real weakness is commoditization of the business. In good times and in bad times having a competitive advantage will earn superior returns.
Last month I discussed the importance of achieving a competitive advantage through having a low cost advantage. In today’s post I discuss differentiation as the source of competitive advantage.
Without differentiating a business we will earn the average income in its industry. For some high paying industries like cardiac surgery or specialized dentistry the average industry income may be satisfactory, however that is not the case for most businesses. The average lawyer, accountant, dry cleaner, renovator, wine grower, or graphic designer will make an average living for their industry. Their income may be at times satisfactory but is never spectacular, unless they possess a competitive advantage achieved through differentiation.
Differentiation means providing a unique benefit to customers. Being unique means the benefit is not available elsewhere. If we do not differentiate our business then we are commoditized and no different from others, and the customer will search out the cheapest alternative.
Differentiation allows for superior pricing, larger sales and stronger loyalty. The last item is particularly important to professional service businesses, where customers don’t really understand and trust the services being provided and frequently skip from one provider to another.
Differentiation is the result of the value chain activities that we provide. It does not have to be about our product being better or our service being more competent. It may occur at any point in the value chain. It could be a result of our human resource policies concerning recruitment and compensation, incentives and training. It could be because of our infrastructure dealing with response time to customers, our having proprietary knowledge and software, or our financial strength and the ability to provide special terms to customers.
Selecting where to differentiate should be based on creating value for our customers, and understanding buyer value means understanding the buyer value chain. Our products /services are an input to their value chain. A business creates value for a buyer that justifies their paying a premium price, or it creates value through lowering buyer cost or raising performance, thus creating a competitive advantage for the buyer.
The buyer then acquires their competitive advantage through:
- achieving a lower cost position
- achieving a lower financing cost
- our providing installation and support
- our providing training
- achieving a lower overhead
- reducing direct labour
- reducing failure rate
Providing a competitive advantage for our customers provides our business with a strong competitive advantage. This competitive advantage will keep our business thriving in good times and healthy in lean years.