Back in the early 1960s, the great Boston Consulting Group founder and strategy theorist Bruce Henderson asserted that there was only one way to successfully compete: gain a relative market share advantage over all competitors so as to have lower costs than all of them. The payoff is that it puts the firm in a position to drive those relative costs even lower as competition unfolds due to the learning curve advantage.
One then became two in 1980, when Michael Porter pointed out that there is another way to compete: differentiation. His view of the generic strategies for advantage gained considerable traction both in classrooms and boardrooms.
To someone like me, a micro-economist by training and at heart, the idea that all competition can be classified in terms of these two generic strategies corresponds well to the fundamental demand dynamics that companies face.
In the world of business generally, there are only two demand conditions a firm can face with respect to an offering: a flat demand curve or a downward sloping one. (Yes, one might argue that for some luxury goods in some situations, demand can rise as price rises, but it is the exception that proves the rule.)
In the former case, customers see the value to them of the firm’s offering as indistinguishable from those of other competitors and hence the firm is simply a price taker, at whatever level the market sets. In such a market there was, is, and always will be only one generic way to gain competitive advantage and that is to have the low-cost position among those making offers to customers in that market. Of course, there are myriad ways to put oneself at the bottom of the delivered cash cost curve in such a market, but they all deliver the same competitive advantage: low cost.
The other situation is one in which the firm faces a downward sloping demand curve — by which if the firm charges a higher price, the demand for its offering is lower and if it charges a lower price, the demand is higher.
Why does it have that characteristic? It is because customers think to varying degrees that there is something about the firm’s offering that is distinct from other offerings; to them, it is not “the same” as those of competitors. In making a purchase decision, therefore, they make a trade-off between the perceived value of the distinctiveness and the price. Those who value the distinctiveness more are prepared to pay a higher price.
This situation can give rise to a successful differentiation strategy if the firm is able keep more or less the same costs as less differentiated competitors and can convince customers that it is meaningfully different from the competition. As with cost leadership, there are myriad ways to achieve differentiation advantage. However, in such a market, there was, is, and will always be one fundamental kind of competitive advantage.
So the idea that there are just two ways of competing is theoretically compelling based on the underlying microeconomics. But has anything changed since 1980 to fundamentally alter the implication of those economics? Let’s look at the main features that distinguish competition today from previous decades:
No one can deny that attacks against both the low cost and differentiation advantages of incumbents happen more quickly and are fiercer than they were as of 1980. Global competition, better access to capital, and greater information transparency has made it harder for firms to maintain their competitive advantages. This is why you get people arguing that we are witnessing “The End of Competitive Advantage.”
But anyone mounting that argument has some problematic data to explain. For example, in 1996 I helped Porter on an HBR article called “What is Strategy?” The article chronicled the strategies of a number of companies that as of 1996 had already achieved impressive advantage — Southwest Airlines, Progressive Insurance, Vanguard, and IKEA. Another nineteen years later, their competitive advantages are going strong. It seems implausible in the face of that (and myriad other) data to maintain that competitive advantage is no more.
New Business Models
The second argument that people mount in claiming that strategy today is different is based on the fact that there are many cool new business models for achieving competitive advantage that weren’t around in 1980, especially in the software/Internet arenas.
Are the models actually that new? Lots of them are “two-sided” markets or platforms in which the firm gets paid for putting two other groups together. Think eBay, Match.com, or Uber. But two-sided markets have actually been with us for centuries. In fact, if you read academic work on the subject, many authors will use credit cards as a major example. What’s different today about platforms is just that they are much easier and cheaper to scale with the help of the Internet.
I’ve noticed that many people equate “two-sided market” with automatic competitive advantage. A couple of students who wanted me to invest in their start-up (which I often do) pitched me an investment a couple of months ago. I told them I wouldn’t take up the invitation because I couldn’t see that their idea would create competitive advantage. “Of course it has competitive advantage,” they protested. “It is a two-sided market.” But the fact that a platform is two-sided doesn’t mean that it doesn’t face competition — perhaps of a superior variety.
The Rise of the Ecosystem
The third feature of the modern economy is that firms are increasingly finding that their competitive advantage comes from collaboration with other firms and individuals rather than solely through their own efforts. This is where all the talk about “ecosystems” comes from. But once again, although it may be getting more popular as an approach, it is not something entirely new. Japan has had keiretsu for a long time. What’s more, the fact that companies may obtain competitive advantage through building ecosystems doesn’t change what the competitive advantage is that they obtain from building them: either the ecosystem enables their differentiation or generates a cost advantage.
For me, the bottom line is this. Yes, some things have changed — competitive advantages have become more fragile, and there are new recipes in the strategy cookbook to bake low cost or differentiation advantages. But in acknowledging that, it’s important not to lose sight of the fact that there are still just two fundamental forms of competitive advantage. The leaders who understand this clearly, I think, will prosper most in the coming years.