US & World Economies Economic Theory What Is Competitive Advantage? By Kimberly Amadeo Updated on January 29, 2022 Reviewed by Erika Rasure Reviewed by Erika Rasure Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest. learn about our financial review board In This Article View All In This Article Definition and Example of Competitive Advantage How Competitive Advantage Works Types of Competitive Advantage Photo: fizkes / Getty Images Definition Competitive advantage refers to the factors or attributes that allow a given company to produce more affordable or higher quality services or products than its competitors. Definition and Example of Competitive Advantage Competitive advantage is what makes an entity's goods or services superior to all of a customer's other choices. While the term is commonly used for businesses, the strategies work for any organization, country, or individual in a competitive environment. For instance, a retailer that offers the lowest prices around has a competitive advantage over other retailers whose prices are higher. The low prices can make that retailer's products more attractive than other, higher-priced options. How Competitive Advantage Works To create a competitive advantage, a business must provide a clear benefit to its target market that's better than what the competition offers. Consider: What is the real benefit this product or service provides? It must be something that customers need, and it must offer real value. Business owners also need to stay up to date on the new trends that affect the product, including any new technology. For example, in the early days of the internet, newspaper owners were slow to respond to the availability of free news online. They thought people would continue to pay for news delivered on paper once a day. By not staying up to date on the advance (and advantages) of the internet, they allowed their competitive advantage to slip away. A business also needs to be closely attuned to its target market to create demand, the driver of all economic growth. They need to know exactly who their customers are and how they can make their lives better. In the example above, newspapers' target market shrank to older people who weren't comfortable getting their news online. Finally, it's important to identify competitors. Competitors aren't just similar companies or products. They also include anything else your customer could do to meet the need you can fulfill. Newspapers thought their competition was other newspapers until they realized it was the internet. They didn't know how to compete with a news provider that was instant and free. Note Emphasize your competitive advantage, and reinforce the message in every communication to your customers. That includes advertising, public relations, sales aids, and even your storefront. Types of Competitive Advantage The Balance / Melisaa Ling In 1985, Harvard Business School Professor Michael Porter wrote Competitive Advantage, the definitive business school textbook on the topic, which helps companies to create a sustainable competitive advantage. In his book, Porter explained that a company must create clear goals, strategies, and operations to build sustainable competitive advantage. The corporate culture and values of the employees must be in alignment with those goals. Porter researched hundreds of companies to identify the three primary ways that companies achieve a sustainable advantage: cost leadership, differentiation, and focus. Cost Leadership Cost leadership means that companies provide reasonable value at a lower price. Firms do that by continuously improving operational efficiency. They might pay their workers less. Some firms compensate for lower wages by offering intangible perks such as stock options, benefits, or promotional opportunities. Others take advantage of unskilled labor surpluses. As these businesses grow, they can benefit from economies of scale and buy in bulk. Note Walmart and Costco are two examples of cost leadership gained by sometimes paying their workers less than the cost of living. Higher minimum-wage laws threaten this advantage. Differentiation Differentiation means companies deliver better benefits than anyone else. A firm can achieve differentiation by providing a unique or high-quality product. Another method is to deliver it more quickly. A third is to market in a way that reaches customers better. A company with a differentiation strategy can charge a premium price, which means it usually has a higher profit margin. Note Companies typically achieve differentiation with innovation, quality, or customer service. Innovation means they meet the same needs in a new way. An excellent example of this is Apple. The iPhone was innovative because it provided a simple handheld device with the power of a computer. Quality means that the firm provides the best product or service. Tiffany's can charge more because patrons see it as far superior to other jewelry stores. In short, customer service means going out of the way to delight shoppers, like in the case of Nordstrom's, which was the first to allow returns with no questions asked. Focus Focus means the company's leaders understand and service their target market better than anyone else. The key to a successful focus strategy is to choose a very specific target market. Often it's a tiny niche that larger companies don't serve. For example, community banks use a focus strategy to gain sustainable competitive advantage. They target local small businesses or high-net-worth individuals. Their target audience enjoys the personal touch that big banks might not be able to give, and customers are willing to pay a little more in fees for that service. National Another form of competitive advantage is used by nations, in a practice called "national competitive advantage" or "comparative advantage." For example, China uses cost leadership by exporting low-cost products at a reasonable quality level. It can do because its standard of living is lower, which means it can pay its workers less. India started as a cost leader but is moving toward differentiation. It provides skilled, technical, English-speaking workers at a reasonable wage. Japan also changed its competitive advantage. In the 1960s, it was a cost leader that excelled at cheap electronics. By the 1980s, it had shifted up to differentiation in quality brands, such as Lexus. America's competitive advantage stems from its innovative practices as a nation. For example, U.S. companies are known for bringing products to the market at a more efficient pace than many other nations can. While innovation is driven by many factors, it's clear that the U.S. has benefited from its diverse makeup as a country. In fact, there's scientific evidence showing that diversity, and maintaining a diverse workplace, help to drive innovation and market growth forward. Amar Bhidé makes a good point in "The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World." Even if the United States starts to lag behind other countries in producing engineers, it's still better at bringing innovations to market. That's just one of the ways natural resources boost America's advantage. Individual There can be individual competitive advantage, too. For instance, at work, you can use the theory of competitive advantage to advance your career. If you are an employee, work as if you were in business for yourself. Your target market is your employer, your benefit is how you increase the company's profit, and your competitors are other employees and technology. Communicate your competitive advantage in your appearance, your resume, and your interview. Once you've got the job, continuing communicating your advantage in your work performance. You can use your advantage to differentiate yourself from your peers and move ahead. Key Takeaways "Competitive advantage" refers to the attributes that allow an entity to succeed over its competitors."Competitive advantage" is a term that is usually used in business, but it can apply to countries, organizations, and individuals, too.Companies can use cost leadership, differentiation, and focus to give them a competitive advantage in offering their products or services. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. U.S. Department of State Young African Leaders Initiative. "Action Your Business Growth: Competitive Advantage." Accessed Dec. 4, 2021. Harvard Business Review. "How Diversity Can Drive Innovation." Accessed Dec. 4, 2021. Amar Bhidé. "The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World," Page 294. Princeton University Press, 2008. Accessed Dec. 4, 2021.