How to Create and Sustain Superior Profits

A goal of every business should be to achieve superior profit.

The Business Owner defines superior profit as:

1. Profit margins that exceed those earned by competitors
2. Real-dollar profits that rise at rates that exceed the growth of the industries served

By earning superior profits, your ability to compete grows each day because you have greater resources to invest in building stronger barriers to competition and bridges to higher profits.

The path to superior profit over the long term is finding and developing a competitive advantage over your competitors. A company enjoys a competitive advantage over its competitors when it possesses a superior ability to deliver value to customers. Such ability is gained through successful execution of an appropriate and achievable competitive strategy.

Value is delivered to customers in one of two ways:

1. Cost Leadership - Ability to offer products and services that deliver value comparable to the offerings of competitors, but at lower prices.
2. Differentiation - Ability to offer products or services that deliver unique benefits that more than offset higher cost to produce and premium price charged.

Competition is at the core of the success or failure of every company. Your competition determines which strategies are more profitable. Competitive strategy is the search for a favorable competitive position in your industry - the arena where competition occurs. Competitive strategy is the search for competitive advantage.

Basic Strategy Option 1: Cost Leadership

If your product or service is similar or identical to that of your competitors, or perceived by your customers to be so, then the price you receive will be the lowest at which your competitors sell. If your costs are identical to your competitors', and they are willing to accept break-even profitability, then your hopes for profit will go unfulfilled. If your costs are higher than your competitors', then you have a problem - at whatever price sales are being made, your competitors will gain on you financially. In sum, with products that have no real uniqueness to the buyer, the only way for you to earn superior profits is to have lower costs.

When a company pursues cost leadership, all energy is focused on delivering a product that has value to customers at least on par with that offered by competitors - but at lower cost. This strategy requires that cost be wrung out of the system at all levels - sourcing, operations, packaging, marketing, sales, distribution and service. Of course, if it is possible to offer a product with more value than that offered by competitors but at lower cost, all the better - but this is rarely achievable. This is referred to as "stuck in the middle."

Generally, companies with sizeable market share are better able to attain cost leadership. This is because volume offers purchasing power and heightened opportunities for efficiency. As such, a cost leadership strategy is often not a viable tack for companies that face larger, high-volume competitors.

Basic Strategy Option 2: Differentiation

Unless a company's products or services are perceived by customers to have features or benefits that are superior, customers will not be willing to pay a premium. When this is the case, the competitor that can deliver acceptable value at the lowest price will win. The company with the lowest cost structure is the one that can afford to sell at the lowest price. The firm that sells a "me too" product against a low-cost provider will avoid extinction only by successfully developing competitive advantage. If low-cost provider status is not achievable, as is often the case for firms with inferior market share, then a differentiation strategy is the only option.

A differentiation strategy requires that the firm develop ways to deliver value, or perceived value (aside from price) exceeding that offered or perceived to be offered by competitors. Developing such value typically requires added cost in the form of additional product development, expanded service, heightened training or additional marketing.

Potential sources of differentiation are everywhere in a firm. Common strategies include sourcing product of higher quality and "selling" to the customer the benefits of such (e.g., Colombian-grown coffee beans). It might entail more precision, higher resistance, easier access, lower defects, longer life or better after-sales service and training. All of these efforts require added expenditure, so the efforts must command a higher price - one that exceeds the added cost incurred. This is the goal of differentiation.

When differentiation is the strategy, customer perception is the reality. In fact, it is possible to develop the perception of differentiation, and thus a heightened ability to compete (i.e., competitive advantage), when none in fact exists, through branding. Branding is developing an image or perceived value using highly focused marketing and advertising. Are Colombian coffee beans really better, or do we just perceive them to be so due to branding efforts of those with a financial interest in such things?

Although branding can be used as a means for creating competitive advantage by differentiation, it is generally more sustainable and defensible when the subject product or service offers features and benefits of real value and uniqueness to buyers. If differentiation is not real, rather based on perceived differences, there is always risk that customers, through experience, may learn that no real additional value exists to justify the premium price.

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This article is based on the published work of Michael E. Porter, particularly Competitive Strategy and Competitive Advantage, as interpreted by David L. Perkins, Jr.