Competitive Advantages

Micheal Porter is majorly credited for the theory of competitive advantages. He published a book in 1980 on Competitive Strategy in which he “proved” the five-force model.

However, this is not a scientific hypothesis. There are no empirical studies to support Porter’s theories, the whole theory is based on case studies.

The five-power model consists of customers’ bargaining power, suppliers’ bargaining power, threats from future competitors, threats from close substitutes, and the competitive situation.

The theory is that the stronger these five forces are, the less profitable the industry is. A company’s management must then work to position themselves so that they achieve the least possible disruption from these five external factors.

In fact, empirical studies in other areas may support the claim that competitive advantage is not obvious. If the hypothesis exists, larger market shares should lead to higher profitability by “exploiting” the market and achieving higher margins.

But empirical studies show the opposite: there is a negative correlation between return and M&A (mergers & acquisitions).

Although a company has delivered good results over a long period of time, it may be due to coincidence and luck, not necessarily that the company has any unique characteristics.

Coincidence means that companies without a competitive advantage can do very well even over periods of 10 years.

Now you might be thinking what does a competitive advantage consist of? It varies. It can be a natural monopoly, a statutory monopoly, brand name, customer loyalty, logistics systems, personnel, management, etc.

In the book “Three Rules for Making a Company Truly Great”, the authors Micheal Raynor and Mumtaz Ahmed conclude that there are mainly three factors that apply:

1. Quality over price: A company can compete on quality or price. Miracle Workers has far more companies competing on quality, not price. As an example, WD-40 (WDFC), the famous oil spray most men have in the garage, is a company based only on a single product that is not even patented.
2. Revenues from costs: Exceptional companies manage high returns with good growth in revenues rather than better results via cost savings. Cost leaders rarely managed better returns than those who managed to increase prices or volume.
3. They are no other rules than the first two.

The unpleasant (or simple) truth, according to the authors, is that the first two factors are mostly what counts. Some other factors affect, but it is difficult to explain how they affect the company over time.

Competitive advantages might seem obvious, but in most cases that is after the fact.