Sources of competitive advantage

Competitive advantage grows out of the way firms organize and perform discrete activities. The operations of any firm can be divided into a series of activities such as salespeople making sales calls, service technicians performing repairs, scientists in the laboratory designing products or processes, and treasurers raising capital.

Firms create value for their buyers through performing these activities. The ultimate value a firm creates is measured by the amount buyers are willing to pay for its product or service. A firm is profitable if this value exceeds the collective cost of performing all the required activities. To gain competitive advantage over its rivals, a firm must either provide comparable buyer value but perform activities more efficiently than its competitors (lower cost), or perform activities in a unique way that creates greater buyer value and commands a premium price (differentiation).

The activities performed in competing in a particular industry can be grouped into categories as shown in Figure 2-3, in what I call the value chain. All the activities in the value chain contribute to buyer value. Activities can be divided broadly into those involved in the ongoing production, marketing, delivery, and servicing of the product (primary activities) and those providing purchased inputs, technology, human resources, or overall infrastructure functions to support the other activities (support activities). Every activity employs purchased inputs, human resources, some combination of technologies, and draws on firm infrastructure such as general management and finance.

Strategy guides the way a firm performs individual activities and organizes its entire value chain. Activities vary in their importance to competitive advantage in different industries. In printing presses, technology development, assembly (part of operations), and after-sale service are essential to success. In detergents, advertising is crucial while manufacturing is uncomplicated and after-sale service is next to nonexistent.

Firms gain competitive advantage from conceiving of new ways to conduct activities, employing new procedures, new technologies, or different inputs. Makita (Japan) emerged as a leading competitor in power tools because it was the first to employ new, less expensive materials for making tool parts and to produce standardized models in a single plant that it sold worldwide. Swiss chocolate companies rose to prominence by pioneering new product formulations (among them milk chocolate) and the use of new processing methods such as conging (continuous stirring) that substantially improved product quality.

A firm is more than the sum of its activities. A firm's value chain is an interdependent system or network of activities, connected by linkages. Linkages occur when the way in which one activity is performed affects the cost or effectiveness of other activities. Linkages often create trade-offs in performing different activities that must be optimized. For example, a more costly product design, more expensive components, and more thorough inspection can reduce after-sale service costs. A company must resolve

such trade-offs, in accordance with its strategy, to achieve competitive advantage.

Linkages also require activities to be coordinated. On-time delivery requires that operations, outbound logistics, and service activities such as installation should function smoothly together. Good coordination allows on-time delivery without the need for costly inventory. Coordinating linked activities reduces transaction costs, allows better information for control purposes, and substitutes less costly operations in one activity for more costly ones elsewhere. Coordinating linked activities is also an important way to reduce the combined time required to perform them, increasingly important to competitive advantage. For example, dramatic time savings are being achieved through such coordination in the design and introduction of new products and in order processing and delivery.

Careful management of linkages can be a decisive source of competitive advantage. Many linkages are not obvious, and rivals often have difficulty perceiving them. Obtaining the benefits of linkages requires both complex organizational coordination and resolution of difficult trade-offs across organizational lines, which is rare. Japanese firms have been particularly adept at managing linkages; they popularized such practices as overlapping the steps in the new product development process to improve ease of manufacturing and reduce development time, as well as more careful inspection to reduce after-sale service costs.

Gaining competitive advantage requires that a firm's value chain is managed as a system rather than a collection of separate parts. Reconfiguring the value chain, by relocating, reordering, regrouping, or even eliminating activities is often at the root of a major improvement in competitive position. A good example is in appliances, where Italian firms transformed manufacturing and exploited an entirely new channel of distribution to become world export leaders in the 1960s and 1970s. In cameras, Japanese firms became world leaders by simultaneously commercializing single lens reflex technology, transforming manufacturing into automated mass production, and pioneering mass marketing.

A company's value chain for competing in a particular industry is embedded in a larger stream of activities that I term the value system (see Figure 2-4). The value system includes suppliers, who provide inputs (such as raw materials, components, machinery, and purchased services) to the firm's value chain. On its way to the ultimate buyer, a firm's product often passes through the value chains of distribution channels. Ultimately, products become purchased inputs to the value chains of their buyers, who use the products in performing activities of their own.

Competitive advantage is increasingly a function of 'how well a company can manage this entire system. Linkages not only connect activities inside a company but also create interdependencies between a firm and its suppliers

and channels. A company can create competitive advantage by better optimizing or coordinating these links to the outside. Frequent and timely deliveries by suppliers (a practice now widely termed kanban after its Japanese innovators), for example, can lower a firm's handling costs and reduce the required level of inventory. But the opportunities for savings through coordinating with suppliers and channels go far beyond logistics and order processing, and encompass R& D, after-sale service, and many other activities. A company, its suppliers, and its channels can all benefit from better recognition and exploitation of such linkages.⁹ The ability of a nation's firms to exploit linkages with home-based suppliers and customers will prove important to explaining the nation's competitive position in an industry.

The value chain provides a tool for understanding the sources of cost advantage.¹⁰ A firm's cost position is its collective cost of performing A the required activities relative to competitors, and cost advantage can occur in any activity. Many managers view cost too narrowly and concentrate on manufacturing. Successful cost leaders, however, are often also low-cost product developers, low-cost marketers, and low-cost service providers. They draw cost advantage from throughout the value chain. Gaining cost advantage also usually requires optimizing the linkages among activities as well as close coordination with suppliers and channels.

The value chain also exposes the sources of differentiation. A firm creates value for its buyer (and hence meaningful differentiation) if it lowers its buyer's cost or raises the buyer's performance in ways the buyer cannot match by purchasing from competitors. Differentiation results, fundamentally, from the way a firm's product, associated services, and other activities affect its buyer's activities. There are many points of contact between a firm and its buyers, each of which represents a potential source of differentiation. The most obvious is the impact of the firm's product itself on the buyer activity in which it is used; for example, a computer used by the buyer for order processing or a detergent used in washing clothes. Creating value at this level can be called first-order differentiate on. But virtually all products have more complex influences on their buyers. A component assem-

bled into a buyer's product, for example, must be handled in incoming inventory and repaired as part of the buyer's product if it fails. Each of these more indirect product impacts leads to further opportunities for differentiation. In addition, almost any other firm activity can affect the buyer as well. For example, the supplier's engineering group can assist in designing the supplier's product into the buyer's product. Such higher-order connections between a firm and its buyer are potentially additional sources of differentiation.

The varying bases for differentiation in different industries will prove to be important to national competitive advantage. There are systematic differences in the types of buyer relationships in which particular nations' firms excel. Swiss, German, and Swedish firms are often successful in industries where close collaboration with buyers is required and after-sale service requirements are substantial. Japanese and American firms tend instead to prosper when products are more standardized.

The value chain allows a deeper took not only at the types of competitive advantage but also at the role of competitive scope in gaining competitive advantage. Scope is important because it shapes the nature of a firm's activities, the way they are performed, and how the value chain is configured. By selecting a narrow target segment, for example, a firm can tailor each activity precisely to the segment's needs and potentially achieve lower cost or differentiation compared to the broader-line competitors. Alternatively, broad scope may lead to competitive advantage if the firm can share activities across industry segments or even when competing in related industries. German chemical companies such as BASF, Bayer, and Hoechst, for example, compete in many chemical product industries but employ common sales forces and common production facilities across certain product groups. Similarly, Japanese consumer electronics producers like Sony, Matsushita, and Toshiba reap advantages from competing in related industries such as television sets, audio equipment, and VCRs. These firms use the same brand names and international marketing networks, take advantage of common product and process technologies, and employ joint purchasing.

A prominent reason why firms gain competitive advantage is that they choose a different scope from competitors, by focusing on a different segment, altering geographic breadth, or combining the products of related industries. Swiss hearing-aid producers, for example, concentrated on high amplification units for patients with severe hearing problems, achieving superior performance compared to less focused American and Danish competitors. Becoming one of the first companies to compete globally against domestic competitors still concentrating on their home nation is another common means of bolstering competitive advantage. The home nation plays an important role in how these differences in scope emerge.