Credit: Shutterstock photoAs we read through financial reports, it is very common to read a management's description of their competitive advantage. Now, if all the companies state that they possess an advantage, how is it possible that we encounter long-term superior results from some, but mediocre results from most of them? One of the most thought-provoking books on this topic is "Competition Demystified," by Bruce Greenwald. In the book, he states that there are only a few real sources of competitive advantages that if we take into account, will help us identify the most-likely winners in their respective sector.
"Strategic analysis should begin with two key questions: In the market in which the firm currently competes or plans to enter, do any competitive advantages actually exist? And if they do, what kind of advantages are they? The analysis is made easier because there are only three kinds of genuine competitive advantage:
Supply. These are strictly cost advantages that allow a company to produce and deliver its products or services more cheaply than its competitors. Sometimes the lower costs stem from privileged access to crucial inputs, like aluminum ore or easily recoverable oil deposits. More frequently, cost advantages are due to proprietary technology that is protected by patents or by experience-know-how-or some combination of both.
Demand. Some companies have access to market demand that their competitors cannot match. This access is not simply a matter of product differentiation or branding, since competitors may be equally able to differentiate or brand their products. These demand advantages arise because of customer captivity that is based on habit, on the costs of switching, or on the difficulties and expenses of searching for a substitute provider.
Economies of scale. If costs per unit decline as volume increases, because fixed costs make up a large share of total costs, then even with the same basic technology, an incumbent firm operating at large scale will enjoy lower costs than its competitors."
Greenwald mentions that some competitive advantages may arise from government protection, but that these are rare and very specific. In my experience, this array of simple, yet powerful heuristics, allow me to quickly navigate through peers across sectors and industries. In Charlie Munger ( Trades , Portfolio )'s terminlogy, this is a powerful mental model that plays a critical role in understanding the long-term competitive advantages of a competitor.
Thinking about supply, it is common that a company has reached certain agreements with a raw material provider, or better yet, has a natural and better access to certain inputs. In other industries, such as technology, having patents and the correct know-how provide an important long-term advantage that can be exploited to generate better-than-average results.
Thinking about demand, I believe that the author's comments are critical in the habit and differentiation aspects. I believe that the demand category is able to explain Warren Buffett's comments on Coca-Cola ( KO ), or the impressive performance of Apple ( AAPL ) and its products.
When thinking about economies of scale, I believe it is a combination
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
