Essays on Management: Creating competitive advantage

Managing organisations means marshalling resources to deliver value to those external to the organisation and from this creating competitive advantage.  There is no standard formula for this.  Much business competitive advantage is akin to a Ricardian opportunity cost story.  Competitive advantage can be absolute advantage where you offer something superior to competitors’ offerings.  Comparative advantage is relative while competitive advantage is absolute.  Sometimes there are not so much competitors as different options and solutions.  In a complex world competitive advantage can involve a near infinite number of combinations or product variants in complex international markets where billions of people respond to the world in different ways.

Much advantage can come from labour-augmenting or displacing technology and how that changes relationships people have with technology.  Labour-displacing technology has transformed New Zealand agriculture and can do so in forestry and horticulture as well.  This will mean labour force demands are for integrators and operational managers.

Advantage can come from adoption of new technology.  This is a social and organisational challenge rather than a purely technical engineering one.  It means thinking through the organisational design, skill needs and therefore people requirements and how these can be marshalled for the business purpose.

Competitive advantage may involve added functionality or new product features.  It may create new demand and deliver its fulfilment.  It may also produce the same products more cheaply, and this is a fundamental though unglamorous driver of economic growth and prosperity.

Sometimes it is best to be product and input-oriented not outcome-oriented.  BP learnt this lesson when it tried to move from being an oil company to an energy company, only to discover its core competencies were not fit for this purpose.  Diversification or business integration must leverage a company’s value chain connections and core competencies, not because different things “go well together” or have the same customers.

Sometimes advantage can come not from a business’s component parts but how they fit together as a system.  A systemic advantage involves lots of things fitting together so a competitor has to match each of these things and rarely succeeds in doing so.

Businesses need to deliver results and not gloss this over with sophisticated financial engineering.  Ultimately you cannot make a business better by being colourful with numbers.  You do not make money over time unless you add value to customers.  Businesses must give their customers a complete through-life picture of what they are offering.

This is why you should always be wary when behaviour is bribed or incentivised in ways that suggests either product short-comings are being glossed over, or instrumentalism, where individuals are manipulated to pursue others’ ends.  Businesses can try to bribe customers with discounts, extended warranties and loyalty cards that mask the low inherent value of product or service offerings.  Governments encourage high risk entrepreneurship even though most entrepreneurs fail.  Scholarships can be offered to encourage people into a field, masking the low working life benefits from that field.  Temporary financial inducements to train for teaching is a common example.  These are not necessarily bad policies, however individual and social interests often diverge in ways individuals may not be aware of.

Competitive advantage can come from the “mundane” as well as the “bright shiny objects”.  Over the last century or so the biggest economic gains have come from innovation that has made food, clothing, housing, warmth and lighting, indoor plumbing and safe water supplies available to billions of people.  These have been far greater contributions to well-being than clever electronic gadgets.  Much American productivity gains have come from such mundane innovations as Wal-Mart achieving purchasing and logistical scale economies and the disintermediation that eliminated middlemen.

It is a myth that commodities are less profitable and that all businesses should aim for highly differentiated “quality” products, where quality implies sophisticated products for exclusive, high price niches.  The New Zealand dairy industry has increased its productivity and still sells largely commodities into international markets.   These commodities are supported with bundles of services such as food safety, surety and product traceability, and are engineered to high technical tolerances.

An end commodity product such as milk powder or a mutton chop may appear unsophisticated, however it is an end unsophisticated output from sophisticated technological inputs.  Quality when it means end product differentiation is often low margin – Kirkcaldie and Stains makes less money than Pak n’ Save. 

Quality is fitness for the purpose of a particular customer or user.  Some of our big dairy and seafood commodity businesses are more profitable than their differentiated counterparts.  Further processing of seafood and fruit tends to destroy rather than create value.  Quantity is derided yet is often the fundamental competitive advantage.  As Joseph Stalin said in World War Two (when throwing millions of poorly-led and equipped men into battle), “quantity has a quality of its own.”

For commodity businesses, competitive advantage often depends on being large in relation to your market, and if the market is growing you need to grow with it or risk losing relative scale economies in production and marketing.  In some industries such as dairy processing you have to be very large, or very small and flexible and there is not much room in between.

Size in relation to markets is also important in many differentiated businesses.  Jack Welch ensured General Electric was number one or two in every business it was in, or it had to exit from that business.

Competitive advantage can come from being faster and this often means being smaller.  Smaller entrants to an industry often do better than incumbents because they have not built up organisational fat and management laziness.  Larger organisations can retain management jobs rather than force redundancies, and they can carry poor performers due to sentimentality or inertia.  Incumbent businesses and industries also suffer from endowment effects.  People value what they have more than what they can aspire to.  As a result it is difficult to reduce salaries and other entitlements even when economic logic demands it.

Small organisations faced with acquisition or being subsumed within a larger organisation often perform beyond expectations.  They are analogous to the most successful small countries such as Singapore, Finland, Israel and South Korea that border larger nations posing an existential threat to them.  This strengthens their internal identity and forces them to compete and stand up for themselves economically, culturally and militarily. Some small New Zealand government agencies have performed beyond expectations because of this psychology, and have not tolerated poor performance acceptable in larger agencies.

The sources of competitive advantage, the structure to support it and the levers to pull are as diverse as human individuality.  They are shaped by industry structure, competitors, the wider institutional and commercial environment, technology, and socio-economic and demographic change.  In the 1960s the dominant restraint on the retail sector became time, more women began working in the paid labour market and people in general came to have less time for shopping.  Now it is ageing populations that are starting to drive change in much of the hospitality, retail and social services sectors.

In searching for competitive advantage, it is important to decide on the customer or market to serve, and this may mean thinking what potential customers can be created.  It is also important not to confuse the industry with the market.  Fisher and Paykel Healthcare does not sell in the world market or in country or regional markets but rather sells to intensive care specialists in sliver markets in many countries. Multinational corporations often focus on market share rather than profit maximisation.  Paradoxically, becoming multinational often forces businesses to focus and concentrate rather than diversify.

Business models internationally are diverse and some appear non-market in nature.  Some business models such as the John Lewis partnership share profits equitably with employees.  The Spanish Mondragon cooperatives and dairy and other cooperatives internationally turn highly atomistic ownership into collective power.  New business models and individual behaviour often arise because of external threats.  Some Central Asian women may wear gold to insulate themselves from rules dispossessing them of all but portable property in the event of divorce.  Jewish people insulated themselves from local violence, including by making themselves mobile.  Rothschild’s business model responded to anti-semetic predation by creating stocks, bonds and debts that could be moved around.  This helped create impersonal markets where economic goods were increasingly property right abstractions and claims rather than physical goods.

A business may have a tight market focus and disparate and multi-faceted technological and skills inputs that need to be drawn together to service its customers and markets.  Or it may have narrowly defined technologies and skills that service multiple markets.  It will rarely, if ever, have both.  In whatever case, it is important to sustain some form of glue that binds disparate parts of a business together and unifies them to deliver on a purpose.

The glue may arise from a technical need, such as milk’s perishability meaning farmers need to control its processing.  It may be iwi organisations with a shared whakapapa.  It may be the way a business configures itself in relation to customers.  A New Zealand engineering business producing metal products has a five year order list and categorizes its customers into A, B and C classes.  It chooses which customers it will work for.  The owner cites good manners as his most important business skill.  He opposes achieving scale and prefers more trust-based relationships and niche orientation rather than scale.

A glue that holds an organisation together might be its core competencies.  Core competencies may be cross-cutting, so management must look not just at individual product divisions but the cross-cutting ties that bind.  Lou Gerstner who took over IBM in 1993 opposed breaking it up and realised its key strength was its overview of a complex and fragmented IT industry.  Any core competency assessment has to intersect with analysis of a business’s product offerings.  Businesses need to look at all their products in relation to what they contribute and what overheads they incur rather than looking at them in isolation.

Competitive strategy requires a clear delineation of cost structures within a business and in the industry it is competing in.  In the services sector the distinction between fixed and variables costs is illusive.  In services, increased capital might require more labour, while in manufacturing more capital usually gets rid of labour.

Competitive advantage can lead to high returns, and when it is on a high a business should cost cut, while it should expand or create new opportunities when things are grim.  This is because in hard times it is easy to break from the past, to focus effort on leading change, and because there are often low cost assets (whether businesses or talented people) which are easier to acquire.

When a business is in a growth phase it is vulnerable to running out of cash or of the administrative capabilities to hold it all together.   Some businesses fail not because they are static but because they are growing too fast.  All growing businesses need the ability to evolve and change both mission and structure in accord with changes in scale, in markets and in technology.

An organisation that is growing rapidly has to change its organisational structure to accommodate this growth and how it impinges on competitive advantage.  Fast growing organisations have to evolve or change their unique mission and this creates risks.  When firms grow fast with lots of sales they may not develop the administrative structure to support it.  They may be achieving great sales but not the cash flow needed to remain solvent.  For all businesses, cash flow and cash in the bank are therefore key.  The finances of a business also need to be matched to a business’s nature, for example equity is not appropriate to finance a fruit grower’s seasonal financial fluctuations.

Business strategies for competitive strategy should take a long term view.  Market share growth over time may tell us more than sales volume.  Through-life costs and life cycle analysis may be more important than end product nature or functionality.  Many Japanese and Korean businesses sacrificed profits to build market share, achieve scale economies and therefore to create barriers to competitive entry.    Ray Kroc expanded McDonalds by systematising fast food production and applying standard operating procedures to it, and then by leveraging real estate assets to build a global company.

Once a business is established it is vulnerable to decline and that is why competitive advantage must always be changing and moving forward.  Business competitiveness depends on differentiation, and creating a leadership position from this.  Any leadership position is transitory and therefore continuous renewal and innovation is needed.  This means any business (and public sector organisation) must be continuously learning from the external environment.

Learning for competitive advantage involves not data and information collection but the creation of knowledge motivating beneficial change.  Information only becomes productive when it is turned into knowledge.  Important questions for any organisation are, “what knowledge is needed for this organisation to do its job, where does this come from and how is it translated into action.  Answering these questions can be a source of competitive advantage.

Business and other organisational strategy can depend on luck.  “Stuff happens”, and it is important to capitalise on chance, including opportunities that arrive when things unexpectedly go wrong.  Luck is often associated with risky and individualistic opportunities.  Disneyland’s opening in 1955 coincided with a US baby boom. Luck is a variable and not always a helpful one.  However, luck favours the prepared mind, and luck is often important in competitive advantage.

Rockerfeller was in the right country in a growth phase based on new resources and technological advances that turned resources into new economic space.  He needed to recognise the opportunities and exploit them.  Andrew Carnegie became a steel magnate largely through rapid adoption of the new Bessemer steel-making process.  Thomas Edison was able to attract investment support from J. P. Morgan.  Tesla was able to raise funding for his innovation through George Westinghouse.  Bill Gates was there when hardware power created the platform for software to have multiplicative effects on productivity.  All these men created great wealth and transformed society because they applied technology and complex businesses were built around them.  All of these men enjoyed coincidence of events, technologies, markets and opportunities, however critically they were prepared to exploit them to create competitive advantage.

THE END

 

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About Peter Winsley

I’ve worked in policy and economics-related fields in New Zealand for many years. With qualifications and publications in economics, management and literature, I take a multidisciplinary perspective to how people’s lives can be enhanced. I love nature, literature, music, tramping, boating and my family.
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One Response to Essays on Management: Creating competitive advantage

  1. Dilip says:

    A brilliant article Peter. An organization and its strategist need to be adept at dealing with ambiguity and uncertainty for sustainable competitive advantage!

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