Monthly Archives: December 2014

Competitive Advantage through Differentiation

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Competitive Advantage through Differentiation

 

For a business to achieve earnings superior to the average in the industry it must have a competitive advantage. Without possessing a competitive advantage a business is doomed to depend on the economic fluctuations in the markets. When the economic conditions are favourable it does well, and when the economy is poor it suffers. I suggest that depending the economy is looking for scapegoats. The real weakness is commoditization of the business. In good times and in bad times having a competitive advantage will earn superior returns.

 Last month I discussed the importance of achieving a competitive advantage through having a low cost advantage. In today’s post I discuss differentiation as the source of competitive advantage.

 Without differentiating a business we will earn the average income in its industry. For some high paying industries like cardiac surgery or specialized dentistry the average industry income may be satisfactory, however that is not the case for most businesses. The average lawyer, accountant, dry cleaner, renovator, wine grower, or graphic designer will make an average living for their industry. Their income may be at times satisfactory but is never spectacular, unless they possess a competitive advantage achieved through differentiation.

 Differentiation means providing a unique benefit to customers. Being unique means the benefit is not available elsewhere. If we do not differentiate our business then we are commoditized and no different from others, and the customer will search out the cheapest alternative.

 Differentiation allows for superior pricing, larger sales and stronger loyalty. The last item is particularly important to professional service businesses, where customers don’t really understand and trust the services being provided and frequently skip from one provider to another.

 Differentiation is the result of the value chain activities that we provide. It does not have to be about our product being better or our service being more competent. It may occur at any point in the value chain. It could be a result of our human resource policies concerning recruitment and compensation, incentives and training. It could be because of our infrastructure dealing with response time to customers, our having proprietary knowledge and software, or our financial strength and the ability to provide special terms to customers.

 Selecting where to differentiate should be based on creating value for our customers, and understanding buyer value means understanding the buyer value chain. Our products /services are an input to their value chain. A business creates value for a buyer that justifies their paying a premium price, or it creates value through lowering buyer cost or raising performance, thus creating a competitive advantage for the buyer.

 The buyer then acquires their competitive advantage through:

  • achieving a lower cost position
  • achieving a lower financing cost
  • our providing installation and support
  • our providing training
  • achieving a lower overhead
  • reducing direct labour
  • reducing failure rate

 Providing a competitive advantage for our customers provides our business with a strong competitive advantage. This competitive advantage will keep our business thriving in good times and healthy in lean years.

Running a Business for Cash

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Running a Business for Cash

 

When faced by a financial crisis a business owner must focus on the following three important areas:

 Reassessing the business model.

  1. Changing operations to reflect the new environment.
  2. Ensuring that enough cash is available.

In my last two posts I discussed the importance of a business model, and addressed the need for a business to make operational changes. Today I will focus on the topic of running the business for cash.

 No matter how profitable a business, running out cash will lead to insolvency. Keep in mind that unless you have a successful business model and the business is run effectively the business will eventually fail. Assuming the first two criteria exist, how do we manage a business from a cash perspective?

 Understanding the various elements of a balance sheet may be helpful.

 

  • If we carry debt it may be wise to convert debt to equity. Equity is more expensive but does not require repayment and is therefore cash saving. This is easier said than done because a bank will not ordinarily agree to this arrangement, but another type of lender might.
  • The proper use of debt may save cash. Long term debt should be used to acquire capital assets and short term debt should be used to finance working capital such as receivables, inventory and trade payables. Often business owners improperly use short term debt to finance capital acquisitions.
  • Consider refinancing short term debt into long term debt to conserve cash.
  • Examine your cash cycle. A cash cycle begins with your purchase of raw materials, storing the goods in inventory, processing them into finished products and selling them. At sale time we have a receivable but only when we are paid can we pay for our purchases. Until we collect from the buyer we don’t have the cash, and so the cycle resumes.
  •  Shorten the cash cycle. The sooner we collect the receivables the sooner we pay off our debts. The lower our inventory, the lower our cash requirements.
  • Shorten the sales cycle. Speed up the time from acquiring leads to converting them into paying clients.
  • Shorten the marketing campaign cycles. Speed up the sequences from marketing decisions to advertising to leads and ultimately to customers.
  • Shorten the finance cycle. Shorten the time for finance approval, or the time from when an order is received to the time of merchandise delivery.
  • Speed up the credit approval cycle.
  • Speed up the billing cycle. Send out an invoice the same day the work is done or goods shipped.
  • Shorten the collection cycle. Review the terms of sale. Call the customer as soon as the bill is past due.
  • Deposit all payments daily.
  • Delay paying select suppliers.
  • Minimize the inventory on hand.
  • Consider deferring planned capital expenditures.

 None of the above strategies alone may be the answer to the cash flow problem, however when combined their cumulative result may make the difference between survival and insolvency.

Value Chain -Cost Advantage

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Value Chain -Cost Advantage

 

Last month I introduced the concept of the value chain. I emphasized that a successful value chain can provide a competitive advantage by creating either cost advantage or a differentiation advantage.

Today’s post focuses on the importance of creating a cost advantage.

At the outset let me say that creating a cost advantage is not merely about charging lower prices than the competition. Any price reduction is likely to be matched by others in the industry, and unless a business has a real lower cost position then lowering prices has merely created a benefit for the consumers but lower profits for the industry. Consequently, it makes little sense to lower prices unless the competition is unable to match the reduction or will be unable to match the lower price for a long period. However assessing the competitors’ value chain is definitely not a trivial matter, and I will address it in a future post.

A firm’s cost position derives from the activities that the firm performs to provide value for its customers. Provide these activities more efficiently and you have a cost advantage. For most businesses that I’m familiar with, few have a cost advantage. They all have similar activities; they purchase the same raw materials from the same suppliers at the same price and have similar staff paid at the same rate. We do not see a real cost advantage.

However, a cost advantage may be secured through making different choices. A business may choose who it wants to sell to, how it wants to market its products or services, what products or services it wants to provide and which it does not.

For example, my own firm provides advisory services as opposed to compliance services. We service business owners that need assistance with their business. We do not provide tax services or bookkeeping although we collaborate on behalf of our clients with those that do. Similarly, Wal Mart targets customers who have a hard time making their paycheck last. This is not the clientele that patronizes high end department stores.

Choices don’t need to focus only on customers. Choices may be made as to the process in creating a product or to what extent to automate a process. A choice may be made between direct and indirect sales and the advertising media used. These choices create an individual value chain with specific costs.

Other choices may involve which product features to include or do without. A choice concerning the level of service one wants to provide will impact on the level of costs. It could be a decision concerning delivery or the level of wages to pay.

A cost advantage is also obtained by performing activities more efficiently than others. However, anyone with a cost advantage will soon have imitators, so a sustainable cost advantage can only be maintained if it cannot be imitated by others.

Some of the strengths possessed by incumbents that may deter new entrants from attempting to dislodge an existing low cost provider include:

  • Economies of scale- The incumbent has a scale advantage that is not easily replicable.
  • Learning- The incumbent possesses proprietary knowledge or rights not widely available, and/or a strong business intelligence capability.
  • Integration- The incumbent has high vertical integration and thus lower costs than a competitor that must use outside vendors, manufacturers and salespeople.
  • Discretionary policies- It may be a choice of location of the manufacturing facilities.

 

To determine whether one has a real cost advantage that can be sustained a proper analysis of the drivers and their impact on costs is necessary. The analysis will determine one’s cost position and that of its competitors.