Competitive Advantage- Part-4 :Common source
Now in this article we explain A common source of competitive advantage
- Network economics,
- Brand loyalty,
- Patents,
- Regulatory licenses,
- Switching costs,
Network Economics:
If a product or service become more valuable if more customers use it then the business benefits from network economics. When telephones first came out, not everyone had one, but as more people acquired telephones the network become more valuable. The customer was part of the service itself (another node on the network), which meant an increase ability to connect to more people.
To monitor network advantages you need to closely trade the number and quality of users. If you see the number of users increasing but more valuable users moving to another network this might indicate a deteriorating advantage.
A network effect is not always sustainable.
Brand loyalty:
A brand can give a business tremendous advantage over competitors when customers remain loyal to the brand and when a business can charge a premium price for the brand. This often results in pricing power for the business.
The degree to which brand strength will lead to a competitive advantage varies by the type of product or service. For example bath and shower accessories have less brand loyalty than beverages.
Start by asking what the brand stands for with customers. Certain brand names are synonymous with user experience.
To build a brand, businesses must continually strengthen the brand in the minds of customer. Once a business stops investing in its brand it is likely the value of the brand will decline. Management will discount the price of its product in order to sell its excess inventory which can cause the value of a brand to deteriorate in the minds of customers.
Patents:
Patents can be a source of protection because they legally protect the products or services of a business from competitors over a 17 to 20 years period.
The best way to determine whether a period valuable is to understand if it has any commercial value as evidenced by any product or licensing revenues.
The easier patents to research and understand are those in the pharmaceutical industry, because there is a lot of information as to the potential market size of a drug. The more difficult patents to evaluate are those based on technology.
Patents provide protection, they have a finite life and you need to be cautions not to assign too much value to them.
The problem is that a long period of patent protection is not useful because a never technology will displace it. Therefore the more innovation there is or more technology changes there are in an industry, the less value a patent will have as a source of protection (of a sustainable competitive advantage.)
Regulatory Licenses
Regulatory licenses and approvals can also create sustainable competitive advantages by limiting competition.
If the source of advantage is regulatory, spend your time closely monitoring legislative threats from the entity that regulates it.
First determine whether the license or approval in regulated by the state, local or federal gave or a combination.
Next determine what types of power each regulatory entity exerts on the business such as the ability to regulate the price charged for good or service or the number of units a business can sell.
The competitive advantages strengths depend on how much power the regulatory entity has over pricing.
If the regulatory entity controls the prices a business can charge customers then the competitive advantage is weaker.
A single rule change could have disastrous effects on the future profitability of the industry.
Switching costs
Why would you not buy a cheaper product of the same quality or a better product for the same price?
The answer is that there may be an additional cost associated with changing products or a reduction in the benefit you stand to receive. These are often called switch costs like those you incur if you change cell phone providers.
The strength level of switching costs is determined by how embedded the product or service is with the customer or the amount of training needed to use it. Think about how much training you face when learning new software: if you have to retrain yourself or your employees when changing products you have encountered a switching cost.
In order to learn if the protection produced by switching costs is deteriorating or improving you need to closely monitor a company’s customer retention rates.
Cost advantages
Cost advantages include such factors as economies of scale and advantages locations. The more structural a cost advantage is the more sustainable it is.
For example lowering costs by moving a call center to India will help a business but most of its competitors can narrow this advantage by doing the same.
Economics of scale are a more structural kind of advantage. As a business with fixed costs grows; it is able to take advantage of lower per-unit costs. This way it is able to charge lower prices for its products or services compared to competitors. This widens the competitive advantage and makes it more sustainable.
There is various ways for a business to create advantage based on economies of scale, including increasing efficiencies by consolidating a fragmented industry.
To learn more about competitive advantage, read more articles.
- Part-1:Understand
- Part-2:Importance in Stock Investing
- Part-3: Finding competitive advantage
- Part-5:Various types of competitive advantage?
Best wishes and keep investing.🙋🙋🙋🙋🙋🙋🙋💰💰💰💰💰🤑🤑
Disclaimer: This blog is exclusively for educational purposes and does not provide any advice/tips on Investment or recommend buying and selling any stock
