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Archive for the ‘Competitive Advantage – 2’ Category

As previously discussed, I want a business, which I have predicted will have a high ROIC, to have a sustainable competitive advantage. However, I think a sustainable competitive advantage is limited to a small number of competitive advantages.[1] I think it is very useful, when deciding whether a business has a sustainable competitive advantage, to understand what is not a sustainable competitive advantage.

Greenwald and Kahn in their seminal book, ‘Competition Demystified’, have outlined the following factors, which they think, and I agree, are not a sustainable competitive advantage. They think these factors will only temporarily allow a business to have a high ROIC.[2]

Having a cost advantage based on superior technology, which cannot be patented

A business with superior technology, which cannot be patented, does not have a sustainable competitive advantage. This is because the technology will usually be either rudimentary, which its competitors can easily reproduce,[3] or technology developed by specialist third parties (like Accenture or IBM), which is likely to be sold to its competitors.[4]

The inability to make this superior technology a sustainable competitive advantage is a major problem for businesses in the services sector.

Having a cost advantage based on lower labour costs

A business with lower labour costs (for example it uses cheap labour in China or India) does not have a sustainable competitive advantage because its competitors can, and usually will, source the same cheap labour.

Having a cost advantage based on lower capital costs

This usually means getting cheap capital from a Government. Having access to cheap capital from a Government is not a competitive advantage. It is a subsidy.

Having product differentiation

Product differentiation is not a sustainable competitive advantage because if a business has a high ROIC, due to product differentiation, competitors can, and will, enter that market and sell their own differentiated product. This will cause the business’s sales volume to fall and, because its fixed costs remain the same, the lower volume will mean its profit margin also falls. Its profit margin and sales volume will continue to fall until its high ROIC disappears.[5]

Having a strong brand

Having a strong brand is not a sustainable competitive advantage.[6] Brands are assets just like property, plant, and equipment. A business must spend cash to build or buy the brand, and cash each year to offset the depreciation of the brand. A competitor can easily spend its own cash to create a brand. If a competitor has an equal opportunity to create its own brand, the business with the brand has no competitive advantage. Brand investments are, thus, no different from many other investments: they return the cost of capital and do not provide any excess return to shareholders.[7]

Being the first mover in an industry

Being the first mover in an industry is not a sustainable competitive advantage. Being the first mover may give that business learning curve cost advantages. This means that as the business moves down the learning curve it becomes more efficient and can produce the product with lower variable costs than businesses just learning how to produce the product. However, as the industry matures, and its competitors learn to be efficient, this disadvantage usually disappears. The business may even find itself at a competitive disadvantage because it now suffers from vintage effects. That is it has less efficient plant and equipment than later entrants into the industry.

Being the latest entrant in an industry

Being the latest business to enter an industry and, therefore, usually having the latest technology or the ‘hottest’ product design will not give the business a sustainable competitive advantage because these advantages are, by their nature, only temporary. Moreover, once the business enters the industry it becomes an incumbent. The same advantages it enjoyed, when it first entered the industry, will now apply to any new entrant.

Having lower variable costs from new capital expenditure

A business (in a commodity industry) which reduces its variable costs by undertaking new capital expenditure has not created a sustainable competitive advantage because its competitors can easily do the same thing.  

Good operational efficiency

Good operational efficiency is usually only a temporary competitive advantage (there are exceptions). It is usually only temporary because this operational efficiency can naturally decline, or a competitor can reproduce it.

 A business’s good operational efficiency can naturally decline because:

  1. Management dies, or retires, or is poached by other businesses; or,
  2. Management becomes sidetracked by some major internal or external issue (for example they make a takeover offer, or are involved in a major lawsuit); or,
  3. Management simply loses its drive.

 A competitor can reproduce another business’s good operational efficiency by copying the successful business’s operational practices, or by recruiting better management.


[1] Economies of Scale combined with Customer Captivity; a Network Effect, a Government Licence; Patent Protection;  and, Customer Captivity.   

[2] See Chapter 2, ‘Competitive Advantages 1’ in Competition Demystified’, Bruce Greenwald and Judd Kahn, 2005.

[3] Rudimentary technology (simple products and simple processes) is hard to patent because this technology will often look like common sense. Thus, a business with this technology will often have its competitors duplicate the technology by hiring away its the employees.

[4] Technology developed by specialist third parties (such as Accenture and IBM) is likely to be sold to any business that wants to buy it. These third parties make their living by disseminating their innovations as widely as possible. See P 29, ‘Competition Demystified’, Bruce Greenwald and Judd Kahn, 2005.

[5] Businesses which only rely on product differentiation must also be very efficient. Not only must they be very efficient with their production costs (which obviously applies to any business without a competitive advantage) but they must also be very efficient in those aspects of the business which allows it to differentiate its product (advertising, product development, service, distribution channels and a host of other functions). Inefficient businesses selling differentiated products will struggle to remain viable. See P23, ‘Competition Demystified’, Bruce Greenwald and Judd Kahn, 2005.

[6] Greenwald and Kahn believe that while a brand is not a competitive advantage, it can lower the cost of entry into another market because the business may not have to build a brand from scratch. See ‘Competition Demystified’, Bruce Greenwald and Judd Kahn, 2005.

[7] See P39, Measuring the Moat, Assessing the Magnitude and Sustainability of Value Creation’, Michael Mauboussin, 16 December 2002.

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