#21 Success factor no. 1: competitive advantage or core competence?
This episode was recorded in German.
Cost leader, differentiator, or better to rely on your own core competencies?
In the jungle of strategy approaches, models and tools, the people responsible for strategy often ask themselves: what good is all that dry theory from textbooks or business school in the real day-to-day of running a company? And when in doubt, can't I (or don't I have to) do everything at once to stay competitive?
To shed some light on this question too, Strategy Coach Christian Underwood and Professor Dr. Jürgen Weigand, Deputy Dean of WHU (Otto Beisheim School of Management), discuss what really counts. Listen to the new episode of our podcast HOPE IS NOT A STRATEGY #21 "Success factor no. 1: competitive advantage or core competence?" And find out what dry theory can actually mean for your practice, and which strategic mistakes you can avoid by engaging with the strategy classics beyond the surface.
SHOW NOTES:
Christian Underwood:https://www.linkedin.com/in/christianunderwood/
Prof. Jürgen Weigand:https://www.linkedin.com/in/j%C3%BCrgen-weigand/andhttps://www.juergenweigand.com
Underwood GmbH:https://www.underwood.de
Detailed episode description:
Competitive advantage and core competencies: inside out or outside in?
The simplest definition of the dazzling term "competitive advantage," without loading it up with additional meaning, is this: customers are more likely to buy from your company than from a competitor. If that's the case, then the company has an advantage somewhere, and understanding that advantage is part of strategy.
Inside out means looking at the market from within the company. The goal is to find the best position for your own company and your own products. You think proactively about how to shape the company so that it establishes itself in the market as successfully as possible.
Outside in, by contrast, means first examining what's happening in the market and then considering where the company can be positioned within it. That's a more reactive process.
The dry theory: on one side there's the market-based approach developed by Harvard professor Michael Porter, on the other the resource-based approach. To this day, both are absolute classics of strategy theory.
They can be seen as complementary, because both approaches have to work hand in hand to achieve a strategic fit. A strategic fit means the company operates in tune with what's happening in the market and with its market environment.
Theories are meant to explain the phenomena we observe. Just as in the natural sciences, that's what happens in strategic management as well. Michael Porter, the guru of strategy, developed ideas about this a long time ago: how things are connected across different industries, sectors and markets. To generalize, you need a suitable approach that allows you to generalize and helps you identify the relevant influencing factors.
But since reality is too complex and not all factors are equally important, you have to abstract from reality to a certain degree. So in building a theory, you have to consider which influencing factors are decisive for the target variables, such as a company's profitability.
Porter's five competitive forces
Porter's approach is about the forces within an industry and an analysis of industry structure. That gives you a tool you can start analyzing with right away. His approach also deals with the attractiveness of the industry. He describes five competitive forces that help a company position itself correctly. These famous five market forces have two dimensions: the horizontal and the vertical.
The horizontal dimension describes what is actually going on in the industry and in your own company. It addresses which companies are direct and indirect competitors, whether there are possible substitutes, who sits on the supply and demand side, and the company's competitive position. According to Porter, this is what's known as industry rivalry. At this level, it's mainly about the demand side: customer preferences and needs are examined. Beyond current competition, though, future prospects are also considered. On the horizontal level, barriers to market entry and market exit play a particularly important role here.
The vertical dimension, on the other hand, deals with the value chain. It addresses where the input factors come from and who ultimately captures the value that's created. It also explains which parties participate in value creation. That refers to the upstream side, the suppliers, and the downstream side, the sales side. The automotive industry is a good example here. Automakers are usually better able to appropriate part of the value created than their suppliers, who tend to be smaller and hold less market power. So it comes down to who ends up with the biggest piece of the pie.
Porter's generic competitive strategies
In Porter's classic view, there are three different types of strategy.
First, there's cost leadership: keeping costs as low as possible and leading the competition on that dimension. Second, there's differentiation, which often happens through innovation. And finally there's focus, so-called niche strategies.
Many companies try in vain to apply all three types of strategy to their projects at once. Trying to be the innovation leader and the cost leader at the same time fails. One simple explanation: a company only has limited resources and capabilities. So in the short term, you can't succeed at everything simultaneously. Certain things can be developed later on, though.
Toyota is one example, a company that moved from a cost-reduction position into innovation. That was a sequential process. Toyota did not pursue cost leadership and innovation leadership at the same time; it was a development that took many decades.
Their cost advantage let them offer lower prices than the competition and produce the corresponding volumes. That generated cash flow, which they reinvested and then used for innovation. By now, Toyota has become an innovation leader in two respects. On the one hand in production processes, with new concepts such as just-in-time delivery. On the other hand in the market as well: Toyota has produced a lot of innovation, especially in electric vehicles. In short, sequential makes sense, but simultaneous is difficult given limited resources. You have to decide and focus.
Core competencies, using Apple as an example
Apple's outstanding core competence is generating product ideas. The iPod and the iPhone, for instance, weren't radical new inventions. Steve Jobs was able to filter out the best of many things and put it together in a new way. The iPod was the modern version of a Sony Walkman, and in the iPhone's design you can see parallels to a Braun calculator from the 1950s and 1960s.
As Joseph Schumpeter, an Austrian economist, put it back at the start of the 20th century, innovation means "doing things differently," which he understood as combining things that already exist to create something new. Many people hear the word innovation and think of something truly radical, something never seen before. But most innovations come from combining things that already exist, and that's what makes it so interesting. So if a company wants to become the innovation leader, the first step is to define what innovation means for that company and in that industry. Only then can other things run in parallel. Of course, the cost side always matters a great deal to companies, which is why they keep looking for more efficient resources. Still, you can clearly observe that companies like Apple, whose core competence lies in new products and who are strong in design and marketing, invest heavily. All of that has to be financed, and it also has to be covered through volume.
Apple gains an advantage by outsourcing its entire production to specialists. The company focuses primarily on marketing and product innovation. As a result, most of the steps in Porter's value chain don't happen at Apple at all: they've been outsourced.
The core competence portfolio: the resource-based approachThe approach developed by Gary Hamel and C. K. Prahalad assumes that products and services which are hard to imitate, along with potential access to a variety of markets, are a key factor in delivering customer value as a core competence.
The model illustrates this as a tree. The company's core competence forms the roots, which are then carried into as many large markets as possible.
You can see this model at work at Apple, too. The company uses a linear business model. That means if it wants to sell more smartphones, it has to win more customers. That's a very direct relationship between Apple and its customers. On the other hand, much like in the tree model, Apple has introduced a clever platform model. The advantage is that the company doesn't have to handle every task itself. The Apple stores are a good example: others produce for this platform and Apple participates in every respect. So the traditional linear business model was very successfully transformed into a platform business.
Realizing potential with limited resourcesCompanies are often deeply entrenched in their business areas, yet they still have to identify remaining potential in existing markets with existing products in order to drive new growth. That's a major challenge for corporate strategists. And the resources available to raise current potential further and develop new potential are limited. So you have to decide which projects to pursue and whether the company can actually realize something genuinely new within its existing organization.
This process usually gets harder as a company grows, which is why large corporations often try to spin off their labs, hoping that creativity will be higher at a different location so something new can emerge. That's one of the main challenges: steering things internally in a way that allows for genuinely free thinking, and above all thinking beyond the familiar horizon. The longer a company has succeeded with its current strategy, the harder it becomes to break out of it. There are what's known as path dependencies, and people are reluctant to leave them behind. They become especially critical when they aren't recognized in time. Nokia and Kodak are classic examples. But private life is full of habits too that have settled in over a long period and will therefore most likely continue in the future. Finding a way out of path dependency is hard.
Different strategic approaches: market-based or resource-based?
We live in a highly volatile world. On one side there's the fight against Covid, on the other, cost inflation is rising massively and the availability of materials has declined across many manufacturing industries. Add to that the ongoing shortage of skilled workers, to name just a few examples. When a company sets out to develop a new strategy, it often faces competing strategic perspectives and the question of whether to take a market-based or resource-based approach.
As a first step, a company should always carry out an honest situation analysis and face the truth. You need to examine where the company stands today and what environment it operates in. People like to talk about markets, sectors and industries here, which in most cases are interwoven. So it has to become clear what the operational and strategic environment is today and what it could be in the future. Another important point is examining how today's situation came about: what has generated the company's successes, and will those drivers still define success in the future? An even more fundamental question to ask: why is the company relevant at all, and why did customers choose this particular product? Customer surveys can help here to find out honestly how easily replaceable your own products are for your customers. That question of relevance is existential for the company, and it's the core of any situation analysis. This analysis shouldn't be sugarcoated. Bad results are bad, and if the results are good, you have to ask whether they could have been better, or whether they're only good because things happened in the environment in your favor that were never examined at all. So: a clear analysis focused on honest, truthful results about what's really going on in the company right now, how it stands externally in the market and internally.
Choosing the right approach
There are plenty of tools on the market, such as Michael Porter's market-based tool. On top of that, there are many well-known internal strengths and weaknesses analyses. The challenge often lies in simply getting started.
It's important to choose a structured approach and a systematic process. Careful work is a must here, and you should avoid skipping individual steps to save time. That's the only way to find out what expectations and needs your customers have and where the company really stands. Various approaches can be used for this. It should be clearly visible which developments are currently underway in the company and whether they emerged from reactive or proactive behavior or from customer pressure. The pieces have to be brought together, and you need clarity about your resources, which is the resource-based approach. You also have to decide which markets the company wants to be active in and what it needs to get there.
As Michael Porter described it, strategy, and competitive strategy in particular, is about being different from your competitors. Being different means being better than the competition and attracting and retaining customers who are profitable for your company. So competitive strategy is first and foremost differentiation. You should set yourself apart from other companies and turn that into a winning proposition. This point often gets neglected in value proposition design. The decisive factor is achieving a superior profit, higher than your competitors', to stay ahead.
This is also where the famous unique selling proposition or unique value proposition comes in. In this case we talk about a value promise. By consuming the company's products or services, the customer is promised a benefit greater than what competing products deliver. But this requires an equivalent on the cost side: a paying proposition. The business has to be profitable, because only then can the company generate that value and realize the benefit. It has to focus on which customers it wants to win and how that will make it profitable.
In this context, Jürgen and Christian cite a classic line from Michael Porter: "The essence of strategy is choosing what not to do." That focus, that awareness of limited resources and of the competition, is decisive. If a company wants to become the innovation leader, it can't be the cost leader at the same time. Cost leadership means keeping everything to a minimum with the resources you have. Innovation, on the other hand, requires investment and creativity. And that creativity usually needs time and room to breathe, which has to be paid for.
Christian and Jürgen's tip: the courage to look at your own reality honestly
To close, Christian and Jürgen share tips on how to approach a process like this and how to pick the right tool from the wide range of strategic analysis methods.
One tip is the situation analysis, an essential building block and a core module of the StrategyFrame® that Christian and Jürgen developed and that will be published in their book "Hope Is Not a Strategy" in October.
Jürgen also recommends going in without preconceptions and really putting the chosen thinking framework on the table, whichever one it is. Ideally in physical form, so everyone can touch it and see it, and then work on filling it in. Finding answers to the questions that come up, having the courage to look at your own reality completely honestly, and daring to step back to see the bigger picture: that's what makes for success.