Competitive Advantage – Investors love quality stocks that deliver high returns and low capital intensity. Having a sustainable competitive advantage is the only way a company can maintain high returns over a long period of time. But competitive advantage comes in many different forms. To help you recognize them, here are 7 different sources of competitive advantage.
Customer Loyalty
Customer loyalty is the result of consistently positive emotional experience, physical attribute-based satisfaction and perceived value of an experience. Products with high customer loyalty will have more consistent sales and potentially higher customer profitability/
Coca Cola or Gillette are examples where customer loyalty is strong.
Accumulated Learning/R&D
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This refers to products or services where it is difficult to catch up with the market leader due to their significant investment, time and experience in producing the product.
Intel has invested billions into research and development over the years. A new entrant would have to invest a significant amount just to catch up with Intel in terms of technology, ignoring economies of scale
Patents/Licenses/Regulations
Patents and licenses prevent competition from entering into a market and competing with the incumbent.
Pharmaceutical companies are the perfect example where patents allow companies to generate supernormal profits for a period of time.
Network Effect
Some products or services become more valuable when there are more customers. Demand then becomes very sustainable and it is extremely difficult for competitors to offer comparable products.
Platforms such as Facebook and AirBNB are good examples where network effect results in a sustainable competitive advantage. Other companies include Visa and Ebay.
Economies of Scale
Some companies can produce at lower cost due to their greater scale (higher volumes). This allows for lower product pricing and becomes part of a virtuous cycle as the low prices attract even more customers. New competitors will often have to incur large losses in order to match the same level of pricing.
Perhaps, the best example of this is a company like Walmart.
Competitive Advantage - Switching Cost
Certain products or services can be every expensive for the customer to switch to an alternative provider. This strong disincentive results in sustainable, recurring demand.
Examples include Oracle, Boeing and SAP.
Limited market
Some markets are only large enough to support a single company. Consequently, there are no incentives for new entrants to enter the market.
Common industries where this occurs are airports and toll roads.
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