Competitive Advantage?

By | June 9, 2014

Executives often issue statements that include catchphrases such as “strategic move”, “enhance our competitive advantage” and so on. What does these words mean? do the executives who use these statements really mean what they say? let’s find out…

This post is highly influenced by a book I read long time ago called The Curse of the Mogul (by Bruce Greenwald). On this post, I briefly touch upon a few types of competitive advantages that companies in any industry may enjoy and also rebuke some myths about sham sources of competitive advantage. As usual, here is the Twitter version (132 characters): “Barriers to entry: scale, customer captivity, cost, government protection. Sham advantages: brand, first mover, deep pockets, talent”

Given my recent interest in a few media companies and deals that are taking place these days, I may write a follow-up post that on that industry and some interesting events that are happening in that industry. But let’s first focus on today’s topic — competitive advantage, this post will set the foundation for later posts about what is happening in the media industry these days.

In business, barriers to entry are required to generate superior returns. If a business earns supernormal returns, sooner or later new entrants will jump on the bandwagon and try to enjoy those returns, intensifying the competition and lowering the returns that are available to all participants. Therefore, only sustainable barriers to entry can support sustainably outstanding performance.

Building on that, the term strategic should be used to describe an activity that creates long-term value for a business if and only if that activity is about establishing or strengthening barriers to entry. Simple, isn’t it? yet how many times have you heard the term strategic used to describe activities that have nothing to do with strengthening barriers to entry? I think that 95% of the times I heard CEOs use this word was to describe activities (usually M&A) that have completely nothing to do with strengthening barriers to entry…

Unfortunately, some businesses operate in industries in which there are no barriers to entry. Those businesses should waste no time talking about strategy and managers of those businesses should focus all their energy into operating as efficiently as humanly possible. No amount of strategic thought can make any difference in some industries. In the early days of Walmart, Sam Walton did not hire consultants to draw a strategy map for his company — he was too smart to do that — so he just focused all his efforts into making Walmart as low cost operation as possible. And it worked pretty well. Efficiency might not sound as sexy as strategy, but in some industries it is the way to go.

There are  four types of competitive advantages…

1. Economies of Scale (EOS) is the most common type of competitive advantage. This is not to be confused with merely being big. Unless the business has certain structural characteristics, size can be a disadvantage. First, EOS advantage can arise when a business has a high fixed costs base, in which case, the largest player can spread the fixed costs over large volumes and operate more profitably than competitors. An example for that is P&G’s laundry detergents business, where a huge fixed cost base that is spread across many units produced (in terms of both production and advertising that is required to support sales) makes it almost impossible for new entrants to make inroads into that market. P&G itself used to bleed money when it tried to enter new markets even though it had the knowhow, decades of experience and deep pockets. Second form of EOS is what’s called a network effect. This happens when each consumer makes the product or service more valuable (think Facebook or Craigslist).

2. Customer Captivity advantage may stem from:

  • Habit: in the media world think of a soap opera or a TV show you really like, once you got hooked you will probably be very loyal to it. Another example is a cigarette, once hooked, rarely do people opt for another brand.
  • High switching cost / search cost: For instance, something has to be really wrong with Yahoo Finance before I will embark on the tedious task of migrating all the watch lists I manually created there over the years to another service. If Yahoo doesn’t make a terrible mistake, I (and many others) will stay captivated.

3. Cost advantage comes in three ways:

  • Proprietary technology, like in the case of Qualcomm.
  • Path dependent learning curve: think about Google’s index of the web, it takes years over years and a huge investment to build something like that before someone can even dream about competing. Even deep pocketed would-be-competitors such as Microsoft have miserably failed to compete with Google’s search quality. It might take Microsoft years and many billions of dollars in losses just to get to where Google is today and by then, Google will probably be far ahead of the curve because it doesn’t sit idle.
  • Access to special resources: an example for this can be seen in ICL’s facilities location at the Dead Sea, which makes it a low-cost producer of Potash. In the commodity business, being a low cost producer is the only competitive advantage that one can enjoy and ICL’s location is an advantage that can’t be replicated by any of it’s competitors.

4. Government Protection: an example for that can be seen in OPAP, a company in which we had invested when debt crisis occurred in Greece. OPAP enjoys a monopoly in most segments of the Greek gambling market and this is guaranteed by the government and is part of it’s operating license. This protects OPAP from potential entrants and creates a barrier to entry that allows the company to command high market share and operate very profitably even at the toughest of times.

Sham competitive advantages

I wouldn’t be able to put it better than Bruce Greenwald, so I will just quote him:

If the universe of genuine competitive advantages is mercifully brief, the catalog of false gods worshipped by some misguided executive or investor is startlingly long.

Here is a list if the most common pitfalls, please feel free to add some stuff on the comments section as this can get really funny:

  • Brands: while brands can reinforce one or more of the real sources for competitive advantage, they do not make one in and out of themselves. This can be evident in fashion retail where brands usually become “hot” until they don’t and then the stocks of the companies that own those brands take a nosedive. The reason for that is that there are very low barriers to entry and indeed, many new entreats enjoy their time in the sun, until the sun sets on them.
  • First mover: in his book, Greenwald shows a list of companies that were first movers in their fields. The list includes names such as UNIVAC, AltaVista, Visicalc and Nokia. In case you wonder, the list of the current dominant players in those industries is IBM, Google, Microsoft Excel and Samsung, respectively. Being a first mover, in almost all cases, does not set barriers to entry and is not a competitive advantage.
  • Deep pockets: businesses that rely on deep pockets have a predictable tendency to empty those pockets over time, or to put it in Richard Branson’s words:

    The easiest way to become a millionaire is to start out a billionaire then go into the airline business.

  • Talent: here again, Bruce comes up with an amazing example from the media industry. He writes about an artist that was anonymous but his first album turned out to be a big success. The talented artist was signed on a 4-album deal before becoming famous but the record label won’t be able to enjoy the low-cost contract that was signed, or as Bruce Greenwald put it:

    If the recording company doesn’t want the second CD to be called ‘Sounds I made in the Bathroom This Morning’ it will renogotiate the deal.

    Same is true with “talented managers.” When a talented manager that used to manage a business that enjoys a competitive advantage is thrown into a competitive industry, the result might be ugly. As Warren Buffett puts it:

    When a management with reputation for brilliance meets a business with a reputation for bad economics, it is the reputation of the business that stays intact.

How can you tell if a business truly enjoys a competitive advantage?

There are two simple tests to check whether a business you are looking at enjoys a competitive advantage:

  1. High returns AND
  2. Stable or increasing market share

Simple, isn’t it?

6 thoughts on “Competitive Advantage?

  1. michael nitzan

    Hey Yaniv,

    Some thoughts regarding your post –

    1. You say that a brand is a sham advantage, but then again you also mention it as an example of advantage within what you call “customer captivity”. Would you please elaborate on this seemingly dissonance?
    In addition, how’d you explain big brands businesses’ competitive advantage – the fact of selling quite a generic product for a relatively high price and gaining market share at the same time (Gillette, Colgate, Kellogg’s, Coca-Cola, etc.) – without relying on brands’ power?

    2. You mention EOS as a competitive advantage, which eventually means (putting aside “network” effect) – correct me if I’m wrong – production at the lowest cost possible (spreading fixed costs over maximum amount of products manufactured). therefore, Wouldn’t you say that EOS is an additional type of your 3rd competitive advantage, i.e. “cost”?

    3. Pursuant to the point above, you mention “network effect” as part of EOS. Wouldn’t you agree that network effect is in fact a separate and unique advantage which exists depending on industry’s characteristics? Think of it that way – EOS advantage means lowest cost production, while network effect means better product – two different types of advantages.

    4. What about patents?

    Kind regards,


    1. Yaniv Uliel Post author

      Michael: Thanks for your comment.

      1. My reference to “a brand” (and maybe I shouldn’t have used this word on the Customer Captivity section) was just to say that customers will rarely switch for another type of cigarette. The reason for that is not the brand, but in a case of a cigarette it is the physical/psychological addiction to the product that gets the customer hooked. Or to put in another way, if Marlboro would tomorrow change its name to Coco but keep the formula unchanged those who smoke only Marlboro will more likely than not be loyal to Coco. As I wrote later, brands can reinforce that competitive advantage and amplify it, but they are not a competitive advantage in and out of themselves. So, if Marlboro were to magically change its product tomorrow so it is no longer addictive and cures any prior addiction, it doesn’t matter how strong the brand is, the company will suffer because by doing that “magic” it gives up its real source of competitive advantage.

      1b (big brands). In all the cases you stated the brand is not the source for the competitive advantage but a reinforcing factor. In the book I mentioned, Bruce mentions a study that was done on a large sample of brands over many years that showed mix results at best. That is to say, those brands as a group did not exhibit the traits of a company that enjoys a competitive advantage. One of the examples he brings is Mercedes Benz. The list of strong brands that do not enjoy one of the real sources of competitive advantage and show poor returns is very long. Just to quickly go through your list: why do you think Coca-Cola keeps its price low and super-affordable? what triggered the change in Gillette’s competitive landscape in recent years? would it have happened if Gillette would have followed Coca-Cola in its pricing strategy?

      2+4. Cost: Maybe I should have highlighted that “cost” means a structural cost advantage and “proprietary technology” means patents. The difference between a structural cost advantage and EOS is that the first is independent (or almost independent) of volume produced and does not require high volumes and high fixed cost as in the case of EOS. For instance, ICL doesn’t have to be the largest or the most efficient producer of Potash in order to enjoy a cost advantage. Of course, it can’t be oblivious to operational costs, but to some extent, since it’s location is advantageous, it can have lower total costs than competitors without being the most efficient (i.e. pay Israeli minimum wage instead of Chinese minimum wage if you compete with Potash mines in China). So while the case of EOS leads to the same end results (providing a service or product cheaper than the competition) the means to get there are different and are therefore categorized differently. Of course, you may choose to bundle them together because of the end result, but Bruce chose to keep it separate because of the differences in how this advantage is achieved and what companies should do to preserve and enhance it.

      3. I will split my answer into two:
      A. Better product is not a competitive advantage and there are plenty of examples for that: McDonald’s doesn’t make the best hamburgers, iPod wasn’t the best (tech spec wise) MP3 player, Windows is not the best desktop OS and the list goes on. Let’s zoom-in on MS Windows: anyone who used Mac OS and Windows can attest that Windows is an inferior product, and it was especially so in the early days. So how did Microsoft succeed? It’s advantage was due to the idea to unbundle the operating system from the hardware and make sure that any IBM-clone can run its software because IBM-clones had a big market share. That way, Microsoft figured out, more software will be written for MS Windows and more users will use it and when more users use it, it would become more attractive target market for software companies, whom will write more software and you get a perfect network effect in motion.

      B. I believe that Bruce it under EOS because the same supply side dynamics exist: you need to serve/sell to a larger number of people in order to maintain that advantage. Again, others can choose to classify or group the different types of advantages in differently but that still won’t change the substance.

  2. michael nitzan

    Hey Yaniv,

    Thank you for the quick reply.

    I think that if Marlboro would’ve change it’s brand tomorrow, many consumers would buy different brands, unless Marlboro would spend quite a lot of money on telling consumers that the new brand is really the old one’s substitute with the exact same flavor, just different symbol. And if I’m right, it says that the brand has some real power over consumers. I think that what you said about the tendency to keep purchasing the same cigarette brand – “the physical/psychological addiction to the product that gets the customer hooked” – is really a nice sum up for all good brands out there (maybe without the ‘physical’ aspect, although there is no real boundaries between psychological and physical effects once the consumer is already hooked to some brand – he really does feel, with all his physicality, that this product is better).

    You’ve mentioned a study about brands which have failed eventually. Sure, no one is saying that using a brand makes your castle unapproachable and invincible. One must maintain it and strengthen it all the time. But in order to understand its power, we should look at those cases where the “brand business” don’t sell their products for cheap prices; quite the opposite – look at the cases where these businesses succeed in selling their products for premium prices, and grow, or at least maintain, their market share at the same time. Good examples are Coca-Cola, Colgate and Gillette in Israel. Other very good examples for brand power are luxury brands in fashion, such as Louis Vuitton, Chanel, Cartier, etc. (allegedly no physically addictive effect in these cases).

    I guess the bottom line here is the power of a sustainable brand, which of course takes much money and know-how to maintain; and the understanding that eventually after creating it (the brand) it does serve as a solid competitive advantage in its own right. And as there are failed businesses which had enjoyed EOS, network effect and other advantages, there are of course failed businesses which once enjoyed brand power. But the fact that they failed eventually doesn’t mean brands don’t work. It just mean they didn’t succeed in growing them.

    Regarding your comments on EOS and low cost production, what I meant is that EOS, in its commonly used meaning, is one of several ways in order to have a low cost production, side by side the other ways you’ve mentioned in the post. But as you’ve also mentioned – one can categorize these advantages as he likes. The essence would be the same.

    Regarding your comments on network effect, and its effect on the product – if you’d think of it for a moment you’l see that network effect does make the product better – not in the narrow sense of comparing one vs. the other, but in the broader-network like way. The network effect endows the product with advantages which aren’t intrinsic to the product itself (thus no point in comparing it as an individual to another) but extrinsic.

    1. Yaniv Uliel Post author

      Maybe my Marlboro example wasn’t the best one, but I invite you to read the book and the reference it has to the research. Basically, to establish a claim that “brands do not make for a competitive advantage” it is not enough to bring counter examples. The way to test for it is statistical: you take a large sample of brands and check whether or not they present the two attributes of high returns and stable/increasing market share. The results showed that this wasn’t the case with brands. Same was done with EOS, Cost etc. and the results were very conclusive. The counter examples are just for illustration but the claim is still valid regardless of the specific examples because it is based on a statistical research that was done on a large sample. Anyway, if you find another research that shows otherwise I would love to take a look. From my experience, over the years I’ve seen way more brands fail then companies that enjoy one of the other competitive advantages (EOS, Captivity, Cost, Gov’t Protection). But that’s just me.

      I think that most brands examples that you brought enjoy “real” competitive advantages or do not have a strong competitive advantage. For instance, one can argue that LVMH’s competitive advantage stems from its learning curve, vast experience and long history and that you have to handcraft bags for the French aristocracy for decades before you can command the pricing power the LVMH enjoys. If I were to start “Yaniv’s” fashion brand to compete with “Louis Vuitton” I wouldn’t be able to compete no matter how much effort I will put into branding simply because “Yaniv’s” a new brand. If I persist, handcraft luxury good for the Singaporean aristocracy for a few decades and expand from there then maybe in 50 years “Yaniv’s” will have some competitive edge 🙂 As for many other luxury retailers (and newly created sub-brands), I think that their returns over the past decade do not represent their true earning power, but the jury is still out on that one. For Coca-Cola, I think the case in Israel is not really representative. In most markets Coca-Cola is one of the cheapest drinks on the shelf and it is done on purpose — it keeps competitors at bay.

      The Gillette case is very interesting. I think that P&G pushed the price of it’s products so high that it invited many new entrants and reduced the barriers to entry. Just see the Dollar Shaving Club and other similar competitors that emerged in recent years. Not sure if you tried competing products, but the quality is similar and they manage to undercut P&G on the price because P&G raised prices for the Gillette brand too fast and enabled competitors to make products of similar quality and sell those on lower price. Buffett made a comment that P&G found out the hard way that it didn’t have the pricing power it thought it has and he reduced his holding in the company. So in the Gillette case, I believe that the advantage it enjoys is EOS and the brand definitely reinforced it and made it stronger by creating a positive feedback look (more sales, more scale, lower costs etc.). However, by thinking that their competitive advantage stems from some aura around the brand, they raised prices and unintentionally undermined their competitive advantage. Coke is smart enough to avoid the temptation for doing something similar.

      I agree with your comment about network effect and making the product better. However, it is important to bear in mind that its the network effect (competitive advantage) that makes the product better and it’s not a product is better that led to a network effect and a competitive advantage. As in the MS Windows example, in my opinion, Windows did not get the market share it did because it was better but because MS had the right strategy (creating a network effect) in mind by making sure that Windows is installed on as many computers as possible.

  3. michael nitzan

    Great discussion.

    I’ll just add some remarks:

    1. Brand power lets a business charge a premium price without losing market share.
    good example: Louis Vuitton – long history of royalty usage is part of the charm, just as NIKE’s long history with the best athletes. And still it doesn’t mean the premium price can be infinite – management can still screw up the business, that’s always true.
    I think you and the study may be right on the fact that there aren’t many sustainable brands (there are many brands with true power but only for a short while), but it doesn’t mean that the ones which are there are not really there. It (the study and the book’s notion of the issue) just means that brands are much more hard to come by, much more hard to creat and much more hard to maintain. But at the same time, a brand is one of the only ways a business can charge a premium price for its allegedly generic product without hurting its profit and without losing market share. And that’s a real advantage.

    2. EOS and other ways of low cost production let a business earn more on the market price, or even on a price a bit lower than the market price.

    Combining the advantages described in point #1 and in point #2 lets a business charge a *premium price* on a product which *costs less* (relative to peers’ cost production) to manufacture.

  4. Yaniv Uliel Post author

    Indeed an interesting and insightful discussion.

    I think we may have to agree to disagree on the brands topic. While I’m sure that there are some outliers out there who managed to keep the marketing magic up for decades without having any other competitive advantage, I believe that they are far and few in between.

    I don’t know the history of some of the companies you mentioned but I can tell you that I thought that Coke’s competitive advantage is the brand until I read a book about it’s history and I understood that there is way more than that in it. For instance, did you ever wonder how come that Coke is found on almost every corner on earth? one of the reasons is that during the Second World War Coke moved in together with the US army in order to supply American soldiers their favorite drink so Coke became well distributed in some countries before a local soft drinks industry even existed there. That is a path-dependent advantage that is not so easy to replicate. Coke also enjoys EOS thanks to the way it configured it’s activities and set its priority that bottlers, and anybody who deals with distributing Coke should make money. The brand is by all means a strong force, but there are many other factors, not less important, behind it that led to huge barriers to entry and a creation of wide moat around Coke’s business. I’m sure that other companies who enjoy the pricing power you mentioned have similar stories.

    In any case, it’s never just one factor that makes a company great and the importance of marketing and branding can’t be overestimated. All I know is that I would be willing to pay more to buy a business that enjoys one of the “real” competitive advantages over a business that touts only a brand as it’s source of high returns and a stable market share.


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