Which company has the advantage? Neither one. Because advantage is rooted in differences in the asymmetries among rivals, there is an uncountable number of asymmetries in real rivalry. It is the leader’s job to identify which asymmetries are critical and can turn into important advantages. This discussion is based on  Richard Rumelt’s book, “Good Strategy/ Bad Strategy.” 

Here is an example. A startup had created a fabric for clothes and was excited about it, even thinking it had the possibility of being an IPO. Their venture capital firm was not so sure. They agreed they had an excellent new product and have proved their technology, But building a textile company or clothing company was a different game. They should look at selling the company. 

No one has an advantage in everything. Teams, organizations, and even nations have advantages in certain kinds of rivalry under particular conditions. The secret to using advantage is understanding this characteristic. You must press where you have advantages and sidestep situations in which you do not. You must exploit your rivals’ weaknesses and avoid leading with your own.

Competitive advantage in business

The term competitive advantage became a term of art in business strategy with Michael Porter’s insightful book title. Warren Buffett has said he evaluates a company they are looking for sustainable competitive advantage.

The basic definition of competitive advantage is straightforward. If your business can produce at a lower cost than competitors or deliver more perceived value than competitors, or a mix of the two, you have a competitive advantage. Subtlety arrives when you realize that costs vary with product and application and that buyers differ in their locations, knowledge, tastes, and other characteristics. 

Most advantages will extend only so far. For instance, Whole Foods has an advantage over Albertson supermarkets only for particular products. And only among grocery shoppers with good incomes place a high value on organic or natural foods.

Sustaining an advantage is even more difficult.  For an advantage to be sustainable, your competitor must not be able to duplicate it. Or, more precisely, they must not be able to reproduce the resources underlying it, such as a patent. 

More common isolating mechanisms include reputations, commercial and social relationships, net worth effects, economies of scale, plus knowledge and skill gained through experience.

For example, Apple‘s iPhone business is protected by Apple and iPhone brand names, by the company‘s reputation, by the complementary iTunes service, and by the network effects of its customer group, especially for iPhone applications. 

These resources were crafted by Apple and put in place as part of a program for building sustainable competitive advantage. These resources are scarce because competitors find it difficult to create comparable resources at a reasonable cost.

Interesting advantages

How do some serial entrepreneurs create a competitive advantage time after time? The answer, according to Rumelt, was by providing more value than you avoid, and you avoid being a commodity. A serial entrepreneur and friend of Rumelt told him that he only invested in “interesting companies.” And that an interesting company is when you can see ways to increase value.  

Some advantages are more interesting than others.

There is a difference between competitive advantage and financial gain. Many people have assumed that they are the same thing, but they are not. For example, if you had a machine that made silver, it would give you value. But, there is no way for the owner to engineer an increase in its overall value. 

The machine cannot make pure silver more efficient and can not differentiate the product. One small producer cannot pump up the global demand for silver. You can not increase the value of a silver machine by buying an engineer to design a new device, just like you can not hire an engineer to increase a treasury bond. 

Competitive and advantage is interesting when one has insights into ways to increase its value. That means there must be things you can do, on your own, to increase its value. The truth is that the connection between competitive advantage and wealth is dynamic. Wealth increases when competitive advantage increases or when the demand for the resources underlying it increases. 

Increasing value requires a strategy on at least one of the following three different fronts.

1. A continuously deepening advantage and strengthening the isolating mechanisms to block replication and imitation by competitors,   

2. Broadening the extent of advantages

3. Creating higher demand for advantaged products or services. 

Deepening your advantage

Start by defining advantage in terms of surplus, the gap between buyer value and cost. Deepening an advantage means widening this gap by either increasing importance to buyers, reducing costs, or both.

First, management may mistakenly believe an improvement is a natural process or that it can be accomplished by pressure or incentives alone –It can not. For example, a bricklayer can double his capacity by moving the bricks up to chest high to use them directly. 

Today’s approach to information flows in business processes is sometimes called reengineering or business process transformation. Whatever it’s called, the underlying principle is that improvements come from re-examining the details of how work is done, not just from cost controls or incentives.

The same issues that arise in improving work processes also occur in enhancing products, except observing buyers is more complicated than examining one’s systems. Companies excel at product development and improvement and carefully study buyers’ attitudes, decisions, and feelings. They develop an extraordinary empathy for customers and anticipate problems before they occur. 

The reason firms fail to engage in the process of improvement when isolating mechanisms surrounding important methods are weak. Companies in such situations hope to catch a free ride on the progress of others. 

Therefore, to benefit from investments in improvement, improvements must be protected or embedded in a sufficiently unique business that its methods are of little value or use to rivals.

Broadening the extent of the advantage

Extending an existing competitive advantage brings it into new fields and new competition. For example, cell phone banking is a growing phenomenon, especially in foreign countries. eBay holds the necessary skills and payment systems in bedded in its PayPal business. If eBay could build on these to create a competitive advantage in cell phone payment systems, it would be extending a competitive advantage.

Extending a competitive advantage requires looking away from products, buyers, and competitors and looking instead to add unique skills and resources that underlie a competitive edge —  in other words, build on your strengths.

The idea that some corporate resources can put to good use in other products or markets is possibly the most fundamental corporate strategy. The truth is undeniable, yet it is also the source of countless errors if it engages in diversifying into products and processes they do not know. The basis for productive extensions often resides within complex pools of knowledge and know-how. 

Extensions based on customer beliefs such as brand names, relationships, and reputation may be diluted or damaged by careless extension. Value can sometimes be created by extending these resources, but a failure in the new arena can rebound to damage the core. Disney is an excellent example of this, and they can pull people into the theater just by the company name. 

The brand’s value comes from guaranteeing specific characteristics of the product. But those characteristics are not easy to define. What exactly is a Disney film? How far can the brain be stretched without losing value?

Creating higher demand

A competitive advantage becomes more valuable when the number of buyers grows and when the quantity demanded by each buyer increases. Technically it is the excellent resources underlying the advantage that increase in value. The higher demand will increase long-term profit only if a business already possesses scarce resources that create a stable competitive advantage. Engineering higher demand for the services of scarce resources is the most basic of business strategies.

 Conclusion

The basic definition of competitive advantage is straightforward. If your business can produce at a lower cost than competitors or deliver more perceived value than competitors, or a mix of the two, you have a competitive advantage. But, It is challenging to have the advantage in everything – team, technology, etc. You want to exploit it where you have it and avoid areas where you don’t have it.

Sustaining a competitive advantage is even more challenging. You need an isolating mechanism like a patent.  

There is also a difference between competitive advantage and financial gain. The connection between competitive advantage and wealth is dynamic. Wealth increases when competitive advantage increases or when the demand for the resources underlying it increases. 

Increasing value requires a strategy for progress on at least one of three different fronts. One, deepening your advantage by either increasing importance to buyers, reducing costs, or both. Two, broadening the ext

A competitive advantage becomes more valuable when the number of buyers grows and when the quantity demanded by each buyer increases. Two, bringing your advantage into new fields and against new competition. Three, A competitive advantage becomes more valuable when the number of buyers grows and when the quantity demanded by each buyer increases.

What advantages do you have over your competitors? How are you going to maintain that advantage? Use your creativity and problem-solving skills to design new advantages.

According to Richard Rumelt, Professor and author, a good strategy has an underlying structure built on a foundation based on what he calls the kernel. 

The kernel contains three parts: 

A diagnosis that defines or explains the nature of the challenge, This diagnosis  simplifies the complexity of the challenge by identifying certain aspects of the situation as critical,

A guiding policy that deals with the identified challenge. This policy is an overall approach designed to overcome the obstacles in the diagnosis.

A plan of coherent actions according to the guiding policy. These steps are coordinated with one another to work together in accomplishing the guiding policy.

For businesses, the challenge is usually dealing with change and competition.

The first step is diagnosing the specific structure of the challenge rather than simply naming goals. 

The second step defines your guiding policy to create leverage or advantage.

The third step creates your action plan to implement the guiding policy.  

This kernel is the bare-bones center of a strategy. Note: it leaves out visions, hierarchies of goals and objectives, references time or scope, and ideas about adaptation and change. All of these are necessary to support the strategy.  

Diagnosis

At a minimum, the diagnosis names or classifies the situation, linking acts into patterns and suggesting more attention required for some issues and less for other problems. An insightful diagnosis can transform one’s view of the situation and open up radically different perspectives. 

 When a diagnosis identifies a specific situation, analogous examples can become instructive. 

Starbucks coffee, for example, had declining profits in 2008. The problem was: 

diagnosis 1, An issue of managing expectations, 

diagnosis 2, A need to search for a new growth platform, 

diagnosis 3, An eroding competitive advantage. 

Each diagnosis suggests a range of things to do. But, none of these diagnoses may be correct. Therefore, diagnosis is a judgment about the meaning of facts.

Their problem, however, was il structured, meaning no one could be sure how to define the problem. There was no prominent list of promising approaches or actions, and the connections between most actions and outcomes were unclear relative to the problem. Therefore the diagnosis was an educated guess about what was determined to be necessary.

A strategic diagnosis does more than explain a situation — it also defines an area of action. The diagnosis of a good strategy promises leverage over the outcome.

A diagnosis is generally a metaphor, analog, or reference to an earlier diagnosis or framework that has already gained acceptance.

When he became CEO of IBM, Lou Gerstner changed the company’s diagnosis from focusing on too many different products to one company but focused on the customer rather than the hardware.  

The Guiding Policy

The guiding policy outlines an overall approach for overcoming the obstacles highlighted by the diagnosis. It is “guiding” because it channels action in specific directions without defining every need.

CEO Gerstner’s diagnostic of IBM is an example of a guiding policy. The guiding policies direct and constrain action without fully defining its content. Guiding policies are not goals; they represent a way to solve the problem or situation and at the same time rule out a group of possible actions.  

A good strategy is not just what you are trying to do; It is also why and how you are doing it. The guiding policy draws on the sources you can use to gain an advantage. 

A guiding policy creates an advantage by anticipating the actions and reactions of others. Reducing complexity also lets you gain leverage by concentrating your efforts.   

Coherent Action

Many people refer to the guiding policy as the strategy and stop there. Wrong. Strategy is about action. Doing something, The kernel of strategy must contain action; It doesn’t have to include all activities, but enough to implement the strategic concept.  

The planed actions within the kernel of strategy should be coherent, meaning they should be consistent and coordinated. The coordination of movement provides the most fundamental source of leverage or advantage available in strategy.

Strategic actions that are not coherent are either in conflict with one another or taken to pursue other unrelated challenges.

Conclusion

This concept of the kernel of strategy is not easy to execute and takes considerable time. But, it is critical to a company’s success and continued success over time. Don’t wait to do this later. Start from day one and keep a record. 

Remember, this initial strategy is a hypothesis and must be tested, adjusted as necessary, and validated. Also, modified as industries, technologies, markets, and customers change,

In business, inertia is a company’s unwillingness or inability to adapt to changing circumstances. 

Even with change programs in place and running, it can take a long time to change direction, and for large companies, it could take many years to change the way the company functions. If you recognize this inertia early, you can add leverage to your strategy. 

Why? Organizational inertia is the reason. A well-adapted corporation can remain healthy and efficient as long as the outside world remains unchanged. 

But another force–  entropy — is also at work. Entropy measures an organization’s degree of disorder and increases in isolated systems or organizations.  

According to Richard Rumelt, Professor and author, companies with inertia and entropy tend to become less organized and focused. Entropy makes it necessary for leaders to constantly work on maintaining an organization’s purpose, form, and methods, even if there are no changes in strategy or competition. Inertia and entropy have several important implications for strategy:

1. Successful strategies often owe a great deal of their success to the inertia and inefficiency of rivals. For example, Netflix pushed past and now bankrupt blockbuster because the latter could not or would not abandon its focus on retail stores. 
2. A company’s most significant challenge may not be external threats or opportunities but the effects of inertia and entropy. In such a situation, organizational renewal becomes a priority. 
3. Transforming a complex organization is an intensely strategic challenge. Leaders must diagnose the cause of effects of entropy and inertia, create a sensible guiding policy for effecting change, and design a set of coherent actions designed to alter routines, culture, and structure of power and influence.

Inertia

Organizational inertia generally falls into one of three categories: the inertia of routine, cultural inertia, and inertia by proxy. Each has different implications for those who wish to reduce inertia or those who seek to gain by attacking a less responsive rival.

The inertia of routine

The heartbeat of a business is the rhythm and pulse of its standard procedures for buying, processing, and marketing goods. The company may not be consciously aware of these actions but is guided by them nonetheless. As the company grows in size and age, these routines become embedded in layer upon layer of impacted knowledge and experience. It’s the way things are done here.

These familiar routines both filter and shape everyday actions and filter and shape managers’ perceptions of issues. These standard routines and methods also act to preserve the old ways of processing information.

Sudden outside shocks can reveal inertia created by standard routines: a tripling of the price of oil, the invention of the microprocessor, telecommunications deregulation, and so on. The shock changes the basis of competition in the industry, creating a significant gap between the old routines and the needs of the new regime.

With a sudden change like deregulation and leadership is convinced change is necessary, routines can change quickly.  One way is to hire people with the essential skills, hire consultants, or re-design your routines. You may also have to re-organize business units. 

The inertia of culture

The problem may not be the competence of individuals but of culture. The use of the word culture means the elements of social behavior which tend to be stable and strongly resist change. It is not realistic to think you can change a company’s culture quickly or easily.

 The first step in breaking cultural inertia is a simplification. Think about complex routines, processes, waste, and inefficiency. Strip out any unnecessary administration or operations or outsource some services. A more straightforward structure will expose inefficiency. 

After the first round of simplification, it may be necessary to break down operating units to analyze each unit in-depth and use creative thinking to improve the situation further. You may even need a new structure or business model. You will want to look at both performance and culture. Also, remember that changing units can also change work norms and related values.

 Inertia by proxy

The lack of response is not always an indication of sticky routines or a frozen culture. A business may choose not to respond to change or attack because responding might undermine values and profit streams. The streams of profit persist because of customer inertia, a form of inertia by proxy. 

For example, in 1980, the prime interest rate was 20%, and banks were free to create money market accounts. With this new freedom,  smaller banks jumped at the opportunity to create these high-interest deposit accounts. However, larger banks with long-established customers id not, 

Smaller and newer banks seeking retail growth were happy to offer this new type of high-interest deposit account. But many other banks with long-established customers did not. If their customers had been perfectly agile, quickly searching for and switching to the highest interest accounts, they would’ve had to offer higher interest accounts or disappear. But their customers were not this agile.

However, when an organization decides that adapting to change is more important than hanging onto profit streams, everything changes. And this change can happen suddenly.

Entropy

It is not hard to see entropy at work. For example, with the passage of time, great works of art blur and crumble; unless a skilled artisan can restore the artwork. In a business where the firm is not keeping its product line up to date, it can begin to crumble also. The product often becomes less focused and reduces prices, customer response times may have become longer, and eventually, profits decline.

An excellent example of entropy is General Motors. They blurred the designs of their cars,  brands, and divisions. They were essentially offering the exact vehicle under several model brand names. In 2001 they closed the Oldsmobile line of cars because Oldsmobile lost any distinction in either style or price.   

Remember, product-market fit is not a permeate status. In this Covid environment, think about how digital products are being created and changing how we live and work. Are you keeping up with technology and changing preferences?