Competitive Advantage

Conceptual Overview

In standard industrial economic theory, competitive market analysis normally involves reference to the number and size distributions of firms, the type of products produced, the extent to which established firms control prices, the ease with which firms can enter or exit markets, and the ease with which information flows between firms and consumers and the resulting conditions facing both of these groups. An analysis of these issues gives managers, researchers, and policy makers useful information as to how buyers and sellers behave in a particular market and the implications of this for profitability and efficiency of firms, as well as for the quality and availability of products and services to consumers.

A number of the concepts developed in industrial economics have been adapted for the analysis of firm-level strategic behavior. In 1980 and 1985, Porter [Page 221]built on formal models of competitive structure to develop his “five forces” approach to analyzing industry attractiveness. These five forces include the extent and intensity of competition, the threat of entrants (new competitors), the threat of substitute products and services, the power of customers, and the power of suppliers. It is these five forces that capture the extent of competition prevailing in a particular industry at a given moment in time. Porter argues that firms develop strategies in the light of the existence and strength of such forces.

In contrast to industrial economists, management strategists have emphasized the distinct internal features of firms to explain how competitive advantage can be gained and sustained. Porter argues that competitive advantage is the value a firm is able to create in excess of costs. He introduces the concept of the “value chain,” which disaggregates a firm into its strategically relevant activities, i.e., those that reduce costs or are potential sources of differentiation. The activities of the firm can be split into primary and support activities. Primary activities are those associated with the physical creation of the product or service. Support activities are those that support the primary activities and each other, for example, by providing purchased inputs, technology, and human resources. Once the firm's value activities have been disaggregated, the process of appraising these activities can take place. Each of the support activities is linked to each of the primary activities to a greater or lesser extent. The analysis attempts to examine how these links can be improved in order to increase the margin on each product, in each of the markets in which the firm is operating. Porter argues that a firm must select and follow a generic strategy to add value and gain a competitive advantage over competitors. These generic strategies are cost leadership, differentiation, and focus.

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