Competitive

Advantage
Instructor: Nawaf Alabduljader, PhD
Review: Competitive Advantage
• The essence of strategy is creating a competitive
advantage:
• Finding an integrated set of choices that distinguishes a firm
from its rivals

• To create a competitive advantage:

• Firms must configure itself to do something unique and
valuable
• The full range of activities must fit together (act in harmony)
• Strategy requires choice & coordination
Economic Value Creation
• Superior value stems from:
a) Having lower costs than competitors for equivalent
benefits
• Similar willingness to pay, lower cost

b) Providing unique benefits that more than offset a higher

price.
• Higher willingness to pay, similar cost
Economic Value Creation
• Competitive advantage grows fundamentally out of
value a firm is able to create for its buyers that exceeds
the firm's cost of creating it.
• When value (willingness to pay) minus cost is higher than
competitors, there is a competitive advantage.
• Competitive Advantage: Value – C > competitors
• Competitive Parity: Value – C = competitors
• Competitive Disadvantage: Value – C < competitors
Competitive Advantage
• A firm has a competitive advantage over it’s rivals if it
has driven a wide gap (wider than competitors)
between:
a) The amount its customers are willing to pay, and
b) The costs it incurs

• A firm with a competitive advantage will earn superior profits in

the industry
Willingness to pay (WTP) & Costs
• Willingness to pay (WTP): the maximum amount a
customer is willing to pay for a product/service
• This is based on customer perception of benefits
• The perceived value of a good, for example, is assigned by
customers based on the product’s features, performance,
design, quality, and so on.

• Company costs: costs required to produce, sell, and

deliver a good/service
Economic Value Creation
• The relationship between economic value creation and
competitive advantage is fundamental in strategic management.

• It provides the foundation upon which to formulate a firm’s

competitive strategy of cost leadership or differentiation

• It is important to note that a firm has a competitive advantage

when it creates more economic value than rival firms.
• What does that mean?
Economic Value Creation
• Economic value created: the difference between a buyer’s
willingness to pay for a product or service (Value) and the firm’s
total cost to produce it

• Example: Buy a watch, budget of 1,200 KWD

• Two options:
• Watch A: You value it at 1,000 (maximum you are willing to pay for it)
• Watch B: You value it at 1,200 because it is more ‘cool’
• Cost for both companies to produce watch is 400KWD
• Watch B has a competitive advantage, because it creates more (200) value
but has the same cost.
Breaking Down Economic Value
Creation
• Example 1:
• Firm B has a competitive advantage (creates higher economic
value) because it has higher willingness to pay at same costs
• Economic value created = Willingness to pay – cost
• Economic value created = (V-C)
• Firm A: ECV = 1,000 – 400 = 600
• Firm B: ECV = 1,200 – 400 = 800
Example 1: Competitive Advantage
Firm B has a Competitive Advantage
1500

1200

900
Economic Economic 800
Willingness
Value 600 Value to pay:
600
Created Willingnes Created 1,200
s to pay:
300 1,000
Cost 400 Cost 400

0
Watch A Watch B
Firm Cost Economic Value Created
Example 2: Which firm has a
Competitive Advantage?
Competitive Advantage
1500

1200

900 Economic 600

Economic
800 Value
Value
Created Willingnes
600 Created Willingnes
s to pay:
s to pay:
1,200
1,200
300 600
Cost 400 Cost
0
Watch A Watch B
Firm Cost Economic Value Created
Economic Value Created
• Total Perceived Value: customer willingness to pay (price you attach
to a good/service)
• Determined by perceived benefits

• Cost: matters little to consumer but a lot to producer (company)

• Total perceived value (WTP) is split into economic value created and
total unit cost
• Willingness to pay = Economic value creation + Cost
• Economic value created = Willingness to pay – Cost
• Economic value created = V – C
• Willingness to pay = Economic value created + Cost
• V = (V-C) + C
Summary: C0mpetitive Advantage
as economic value creation
• If the economic value created is greater than that of its
competitors, the firm has a competitive advantage;
• Superior performance relative to competitors

• If economic value created is equal to the competitors, the

firms are said to have competitive parity;
• Same performance relative to competitors

• If economic value created it lower than its rival firms, the firm
has a competitive disadvantage.
• Underperformance relative to competitors
How can firms create economic
value?
• Competitive advantage goes to the company that
creates largest economic value, which is the difference
between consumer willingness to pay (V) and cost (C)
• This can enable the firm to make more profit by
raising prices, or gain more market share by
lowering costs

• The goal of strategy therefore is to maximize V-C

(economic value creation).
Profit
• Simply
• Profit = Revenue – Cost
• Revenue = Total Quantity Sold * Price per
unit
• Revenues thus are a function of value
created for customers and the volume of
goods sold
• Cost = cost per unit sold
• In other words:
• A measure of competitive
advantage is whether a company
creates higher profits due to
higher price and similar cost, or
similar price but lower cost.
How to create economic value
• If we take a closer look at the equation P = R- C, where
R = P*Q, we realize that firm profitability depends,
simply put, on three factors:
1. Perceived value created for customers (willingness to
pay);
2. The price of the product or service; and
3. The total costs of producing the product or service.
Adding price to Economic Value
Created
• Producer Surplus (Profit) = Price (P) – Cost (C)
• Consumer surplus = WTP (V) – Price (P)

• So if you are willing to pay 1,200 KWD for a watch, and the price of the
watch is 900 KWD, which costs the company 400 KWD
• Company A
• Profit (Producer Surplus) = 900 – 400 = 500
• Consumer surplus = 1,000 – 900 = 100

• Company B
• Profit (Producer Surplus) = 900 – 400 = 500
• Consumer surplus = 1,200 – 900 = 300

• Economic value creation = consumer surplus + profit

• = (P – C) + (V – P)
• =V–C
Competitive Advantage
Competitive Advantage
1500

1200
Consumer Surplus: 300 Willingness to pay:
Price: 900 1,200
900
Economic
Value
Created: Producer
600
800 Surplus: 500

300
Cost:
400
0
Watch A
Firm Cost Economic Value Created
How can firms create economic
value?
• Therefore, strategy is about creating economic
value, and capturing as much of it as possible
• The value created either goes to producers or
consumers
Creating competitive advantage
• Companies achieve competitive advantage when both
sides (sellers and buyers) benefit

• That is because buyers generally value the goods they

buy at a higher dollar amount than they actually pay
for it.

• Sellers, on the other hand, generally sell their products

or services above cost.
WP=1200, Price = 500, Cost = 150.
Economic Value created = 1200 – 150 =
1,050.

700.00
Economic Value
Willingness to pay:
Created:
1,200
1,050

350.00

150.00

Value
Cost Price-Cost Value-Price
Creating Economic Value
• There are two ways to increase economic value relative
to competitors
• Increase willingness to pay
• Reduce costs
Fixed price of 500.

Competitive Advantage
1,500‫ك‬.‫د‬.

1,200‫ك‬.‫د‬.
:Willingness to pay :Willingness to pay
Consumer 1,200 1,200
900‫ك‬.‫د‬.
Surplus 700‫ك‬.‫د‬.
Consumer 700‫ك‬.‫د‬.
Surplus
600‫ك‬.‫د‬.

Producer Producer
300‫ك‬.‫د‬. Surplus 350‫ك‬.‫د‬. Surplus 400‫ك‬.‫د‬.

0 ‫ك‬.‫د‬. Cost
150‫ك‬.‫د‬. Cost 100‫ك‬.‫د‬.
Firm A Firm B
Cost P-C V-P
Fixed costs of 100. Increase price 50, by increasing
willingness to pay by 50.
Value created=1,250-150=1,100

Competitive Advantage
1,400‫ك‬.‫د‬.

:Willingness to pay
1,050‫ك‬.‫د‬. :Willingness to pay 1,250
1,200 700‫ك‬.‫د‬.
700‫ك‬.‫د‬.
Economic Value Economic Value
700‫ك‬.‫د‬.:Created
:Created
1,050 1,100
350‫ك‬.‫د‬. 350‫ك‬.‫د‬. 400‫ك‬.‫د‬.

150‫ك‬.‫د‬. 150‫ك‬.‫د‬.
0 ‫ك‬.‫د‬.
Firm A Firm B
Cost P-C V-P
Competitive Advantage and
Economic Value Creation
(V – P) = Competitive Advantage
(V – C) = Consumer exists when economic
Surplus value creation is
V= Total Economic greater than
Perceived Value (P – C) = competitors.
Customer Created Firm
Benefits Profit (V-C) > Competitors
=
Maximum
Willingnes C= C=
s to Pay Firm
Firm
Costs Costs
Competitive Advantage Achieved as long as
V-C > Competitors
Firm A has Competitive Advantage Achieved by Lower Costs
1500

1200

Economic Value
Total
900 Total Perceived 600 Created = 600
Consumer 800 Economic Value Perceived
Benefit= Created = 800 Consumer
Benefit=
600 Maximum
Maximum
Willingness to
Willingness
Pay = 1200
300 to Pay = 600
400 1200
Firm Cost Firm Cost
0 = 400 = 600
Firm A Firm B
Cost Economic Value Created
Competitive Advantage Achieved as long as
V-C > Competitors
Firm B has Competitive Advantage Achieved by Increasing Willingness to Pay
1500

1200

Economic Value
900 Total Created = 800
Total Economic Value Perceived 800
Perceived 600 Created = 600 Consumer
600 Consumer Benefit=
Benefit= Maximum
Maximum Willingness
300
Willingness to Pay =
to Pay =
400 1200 400
Firm Cost Firm Cost
1000 = 400 = 400
0
Firm A Firm B
Cost Economic Value Created
Forms of Competitive Advantage
Cost
Advantage

Similar Product
Competitive At Lower Cost
Advantage

Differentiation
Advantage
Price Premium
From Unique
Product

2
8
Summary of Lessons learned
• Competitive advantage simply means having superior
performance relative to competitors
• It is always relative
• Competitive advantage is achieved when economic
value created is higher than competitors
• Economic value created = value (willingness to pay) - costs
• Willingness to pay is based on customers’ perception
• Economic value created is divided into
• Consumer surplus (value – price)
• Producer surplus (price – cost)
Summary of Lessons learned
• Competitive advantage requires
• increasing value without incurring much costs (differentiation
strategy), or
• Reducing costs without sacrificing much value (low-cost
strategy)