The Illusive Concept of Competitive Advantage

A few years ago, when I took over an executive role at a company, I started a strategy-as-design process to help me understand the company’s strategic position within the competitive landscape and eventually decide a course of action or a strategy to achieve the desired results. I had learned strategy during my MBA times prior, so I wanted to apply the learning to a real-world situation. After analysing the company environment, the macro environment, the industry, and the market, I went on to delve into analysing the company through the identification of its strengths and weaknesses. The whole process seemed appealing, rational, and helped further my understanding of the business’s endogenous and exogenous factors that contribute to the company’s survival and, ultimately, success.

With hindsight, the whole enterprise was intellectually engaging and enticing to the whole team, despite its fundamental flaws that were basically hard to see if one is not familiar with the epistemological foundation of designing a strategy. I will not go into the details though since I have reserved the effort for writing a whole section in my forthcoming book. However, there was one aspect in the whole exercise that, in light of my own business experience, required a bit of debunking. I have tried to find any literature that supports what I have learned from my experience and the subsequent hypothesis but couldn’t find any. It’s a notion that is so central to the way companies conduct their business and, in the grand scheme of the market economy, its centrality seemed to be unquestionable. It is the notion of competitive advantage, which, according to business literature, is the features displayed by a company through its product and service that differentiate them from those of the competition. It’s about being a better product or service based on some inherent characteristics. It’s about the speed with which these are delivered to customers. It’s about the type of customer relationship the company displays. And last, it’s the price tag. A competitive advantage becomes a differential advantage when these dimensions are truly valued by customers. So, if a customer values speed, the company that shows the fastest delivery will outcompete the rest. At least, that’s what the theory says. If the product is the cheapest, it will succeed in a price-sensitive market. Price and differentiation became tools that companies play with to inform their strategies. Just take these two factors and add, for example, the competitive scope—large or narrow—and one winds up with a 2-by-2 matrix that can inform the type of strategy. This was what Michael Porter did in the early 1980s, and it became the standard model for deciding which strategy to pursue.

Going back to my own experience, I remember asking the team what our competitive advantages were. We weren’t the cheapest, so we wandered off into the quality landscape to try to identify the features that made us different. Some said we were better, others closer to customers and their needs, and others faster to deliver the services. One, of course, can challenge these statements because we had no way to confirm one or the other feature. We didn’t have perfect knowledge of our competition, and our feedback from customers was sparse, difficult to pinpoint, and rationalise. Even if we had that knowledge, it would have been hard to construe. If you send a survey to your customers and they reply by saying you had better service, does it really mean that they compared all available options and made their decision accordingly? Not entirely. This lack of perfect knowledge of one’s environment—whatever that means—is something that most small and medium-sized companies must grapple with. Even if one has the means to know what there is to know, there is no guarantee that, besides a few tangible features of products and services, companies will perfectly understand what makes their product different, as customer perspective is as fleeting as it gets. More later.

On the flip side, how many products and services are out there that appear to be much better, much faster, and much closer to customers—and even sometimes cheaper—and still do not benefit from the success that the conventional theory predicts? I have talked to many executives who are not happy with their suppliers or service providers and still continue with the relationship, despite the presence of many alternatives. Similarly, many startups—some of which I know very well—struggle to penetrate the market despite being “competitively advantageous.” They have a much better product than the incumbent and sometimes even the cheapest. One might think that working with startups entails a risk that many companies are not willing to take—the risk of change, the risk of newness, the risk of innovation, the financial risk, and so on and so forth. That can be true, but how does that get factored into the conventional competitive advantage theory? If it does, this would mean that an incumbent company has a competitive advantage because it’s the incumbent. It becomes a tautological statement. The reasoning becomes nonsensical if we say that we will build a competitive advantage just through acquiring customers and keeping them.

I have grappled with the issue for many years after being confronted with the reality of the business and startup worlds. To go back to my initial question—I asked my team the question of why customers choose us—the most probable and robust answer would be because we have been working together for some time, and we are not very expensive, and the relationship is pretty ok. This, however, does not seem to fit the competitive advantage narrative nor the designed strategy that one can build out of it. It’s because the problem lies with the ontology of competitive advantage—along with many others—and its epistemological foundation. In other words, for the concept to work, companies need to have tangible, intelligible, and rational information about their competition and their products and services. While some products can be easily benchmarked based on a few sets of criteria, many products and services—owing to the sheer complexity of their features, even tangible ones—make it hard to compare. Sometimes this benchmarking exercise in a laboratory setting does not translate into true customer preference in the marketplace. The Fast-Moving Consumer Goods world is littered with hundreds, if not thousands, of products that made it through consumer research only to fail miserably in the market. This knowledge becomes even slipperier when one tries to understand the way competitors work and what makes their products different.

Another important variable that competitive advantage requires for it to work is perfect knowledge of customers, their behaviour, and their preferences. The theory says that when you know that, you just cater to that need. Very simple and logical. The reality is, unfortunately, more complex. Customer preferences—and how to probe them—is a very hard endeavour, as many marketers come to acknowledge. There is a difference between what we feel, what we think, what we say, and what we buy, as put by one of them. The bottom line: for the competitive advantage theory to work, you need rational agents making rational choices based on rational information and doing that whenever alternatives present themselves. Therefore, the epistemological foundation of competitive advantage theory is basically rationality. And this rationality feeds into the equilibrium between supply and demand, another important condition for competitive advantage. Meaning, if a new product or service is introduced to the market, customers would compare it rationally with others and choose what fits their needs accordingly. This does not happen all the time for multiple reasons. Equilibrium has already been debunked a long time ago, despite its pervading presence in economic theory. The economy operates in far-from-equilibrium where supply and demand are in continuous flux.  Also, the competitive advantage narrative assumes that every company out there occupies a strategic position in the competitive space that helps them benefit from and sustain it. This reliance on rationality as the principal characteristic of the economic agent has deeper roots. The whole field of neoclassical economics based its theory on the rationality of agents partaking in economic transactions. With the sophistication and academization of the management field in the 20th century, this made it to the business world, and many theories viewed customers—whether consumers or companies—as these rational agents subject to specific prescriptions, through strategy, for example. You take cost and differentiation and add the scope variable, and you end up with a two-by-two matrix informing four generic strategies, as mentioned before. The truth of the matter is that despite the beauty and logical reasoning that rationality and equilibrium entail, their assumptions are blatantly and factually flawed, as has been shown during the last few decades—and no need to dwell on the subject, as it would require more time and space.

So, if competitive advantage does not fully describe customer choices and company performance, what does? The picture is much more complex and lies in the realm of the complexity of human behaviour and social systems that are constituted by them. That complexity is even magnified when several people in a company setting get to decide whether to buy or not to buy a product or service. But the problem is not completely intractable. To go back to what makes a customer—or a company, for that matter—choose a product or service and stick with it for some time: product superiority, whatever that means, is not the sole ontology. Purchasing habits, fear of change, transition risk, personal relationships, and many other human and system factors are just as important. More importantly, the interplay between all these factors makes the whole choice even more complex.

What do you make of a superior product, in all its rational features—even recognised by customers—but requiring important risk-taking on their behalf to switch to? Many startups that develop new and innovative products and services fall into this category. Most of them find it very hard to tap into the business for the exact same reason. Or what about a product or service that every customer complains about, but continues to buy and use out of habit or something else? Sometimes the choice gets even more complicated when a combination of features—say, average service, good price, great speed, but horrendous customer intimacy—are at play. The conventional theory says to take the feature that is most valued by customers, and this will drive the choice. The real world is different, however. Customer choices cannot, unfortunately, be boiled down to a few rational or psychological features. It’s the mesh between factors and their interrelation with the environment that makes a product or a service successful. In other words, competitive advantage cannot be reduced to some fixed attribute that characterises the company’s product and service that is highly valued by customers. It’s more of the emergent interplay between them and customers that really forms the core idea of competitive advantage.

This is what makes the notion difficult to define using simplistic and rational knowledge, as strategy analysis requires. Despite the omnipresence of the idea in business literature, competitive advantage is THE outcome of the relationship between product/service and customers, not some engineered property that one can easily overoptimize. You see it when you have it, but you find it difficult to put your finger on.

This is not some trivial critique about what the standard model considers the core concept of a strategy. The repercussions are profound on what companies and startups alike ought to do to be successful. As hinted above, improving one’s own product or service on features that customers seem to appreciate is not all there is. It’s not about improving them as per customers’ needs and then marketing them, hoping to ace the deals. I would even go one step further and argue that, for example, in a service business world, owning and building the right relationship is far more important than developing a superior product. This is the harsh reality of the business world that everyone experiences, but no one seems to talk about. This is because it’s hard to rationalise and control—it removes the full agency that conventional management theory is so enamoured with. This does not mean that one should ignore product and service attributes and not improve them in light of what we think we know about customers. Or that we can’t protect what has emerged from the relationship. The problem lies within the overarching ontology of competitive advantage and the way it is portrayed in business literature and pervades the corporate world: define it, build it, improve it and you will succeed.

This is an important message for all companies and startups. The messiness of the relationship between a product/service and customers cannot be boiled down to some features whose optimisation guarantees the outcomes. Rather, it’s a playful field—one that requires thinking, assuming, developing, testing, reviewing—all in a recursive framework whose outcome sometimes leads, emergently, to wonders that no strict rationality and planning can engender. Competitive advantage is discovered, not designed.