Competition Demystified: Strategy and Competitive Analysis

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="For investors with a value inclination, there are few things that match a competitive advantage, or as Warren Buffett (Trades, Portfolio) calls it, a moat that protects your business. The reason is simple; companies with moats are insulated, at least to some extent, from the kind of competition that kills margins. They enjoy a near-monopoly of sorts, allowing them to deliver profits that exceed the cost of capital.” data-reactid=”11″>For investors with a value inclination, there are few things that match a competitive advantage, or as Warren Buffett (Trades, Portfolio) calls it, a moat that protects your business. The reason is simple; companies with moats are insulated, at least to some extent, from the kind of competition that kills margins. They enjoy a near-monopoly of sorts, allowing them to deliver profits that exceed the cost of capital.

How do you tell which businesses have a competitive advantage and which do not? And if a business has an advantage, will it last for the years to come? How strong is the moat, and can it withstand the assaults of new and existing competitors?

These questions are answered in a 2005 book by Bruce Greenwald and Judd Kahn entitled, “Competition Demystified: A Radically Simplified Approach to Business Strategy. ” This book is a comprehensive look at the landscape of competition in general, and competitive advantage in particular.

Sometimes called “a guru to Wall Street’s gurus,” lead author Bruce Greenwald is a professor at Columbia Business School and the academic director of the Heilbrunn Center for Graham & Dodd Investing. Judd Kahn has co-authored several books with Greenwald and is the sole author of “Imperial San Francisco: Politics and Planning in an American City, 1897-1906.”

The starting point in understanding competition is strategy, which is to say, the big, top-level decisions that involve a lot of resources and long-term commitments. Strategy proved to be a major factor in World War II, and as the authors pointed out, the choice of whether to fight first in Europe or the Pacific was the most important strategic decision of them all.

Lesser decisions are known as tactics, in which decisions are made at lower levels. Greenwald and Kahn offer the example of automotive companies in the 1980s, following the success of the Jeep. Other companies needed to decide whether they would compete in this new sport utility vehicle (SUV) segment, which were strategic decisions for them. Everything that followed involved a series of tactical decisions such as how to build them, how to market them and so on.

The art and science of competitive advantages took a leap in 1980 with the publication of Michael Porter’s book, “Competitive Strategy”. He proposed that competition was characterized by five forces, though Greenwald and Kahn argue that one of those forces is far more important than the others: barriers to entry.

Barriers are the factors that keep new firms from competing with companies that enjoy a competitive advantage. The authors wrote, “No other feature of the competitive landscape has as much influence on a company’s success as where it stands in regard to these barriers.” They also noted that barriers to entry and “incumbent competitive advantage” are the same thing.

What Greenwald and Kahn called “local circumstances” can also provide competitive advantages. For example, Walmart (NYSE:WMT) dominates most of the markets it enters, and it does that with a localizing strategy. This involved expanding incrementally outward from its geographic base, adding new stores on the periphery and then consolidating those new positions before starting the next expansion. When it expanded too far beyond its base, it suffered its few failures.

For companies, they suggest starting with two key questions: “Do any advantages exist in the market you plan to enter?” and “What kinds of advantages are available?” To analyze these questions, the authors suggest working through the three types of “genuine” competitive advantage:

• Supply, which usually refers to cost advantages, and most often results from proprietary technology (including patents)
• Demand refers to “customer captivity,” where customers are bound to suppliers by habits, switching costs or the difficulty/cost of arranging for another supplier
• Economies of scale, which refers to situations where the cost per unit goes down as volume grows

The authors reported there are other sources of competitive advantage, including government protection or better access to information, but there are only a few of these moats. To that, I would add that many companies in the healthcare industry enjoy moats thanks to government licensing and regulation.

Getting to the roots of competitive advantages is the goal of strategic analysis, which begins with a market assessment of the availability of advantages.

Start with the question of whether there is a competitive advantage available. If not, then all a company can do is focus intently on making its operations as effective and efficient as possible.

If the answer is yes, then are you the single, dominant player in the market? If not, then it may be time to make some hard choices, such as deciding if you want to continue operating in this business.