What is 'Competitive Advantage'
Competitive advantages are conditions that allow a company or country to produce a good or service at a lower price or in a more desirable fashion for customers. These conditions allow the productive entity to generate more sales or superior margins than its competition. Competitive advantages are attributed to a variety of factors, including cost structure, brand, quality of product offerings, distribution network, intellectual property and customer support.
BREAKING DOWN 'Competitive Advantage'Competitive advantages provide an edge over rivals and an ability to generate greater value for a firm and its shareholders. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage. The two main types of competitive advantages are comparative advantage and differential advantage.
Comparative advantage is generated by a firm's ability to produce a good or service at a lower cost than its competitors. This gives the firm the ability sell its goods or services at a lower price than its competition or to generate a larger margin on sales. Rational consumers will choose the cheaper of any two perfect substitutes offered. If the effects of comparative advantage are partially offset by imperfect substitution, higher margins for the lowest-cost producers will eventually benefit shareholders through superior returns or provide the company with more resources for marketing, research and development or administrative infrastructure improvements to support future growth.
Comparative advantage can be derived from economies of scale, more efficient internal systems, location in geographies with low labor or low property expenses. These do not always imply the company can produce a better product or service, but rather they can offer a product or service for a lower price. In the context of international trade economics, comparative advantages are determined by opportunity cost, and any part has a comparative advantage at something. Amazon.com Inc. is an example of a company focused on building and maintaining comparative advantage. The e-commerce platform, its vendor relationship and its shipping network provide a level of scale and efficiency that is difficult for retail competitors to replicate. Amazon has risen to prominence largely through price competition.
A differential advantage is created when a firm's products or services differ from its competitors and are seen as superior than a competitive offering. Differential advantages can be driven by more advanced technology, patent-protected products or processes, superior personnel, or a strong brand identity. These factors support wide margins and large market shares. Apple Inc. is famous for creating innovative products like the iPhone and supporting their market leadership with savvy marketing campaigns to build an elite brand. Major drug companies can also market branded drugs at high price points due to patent protection.