The Risk Embedded in Competitive Advantage

The term Competitive Advantage is popular with management gurus.  On the website, QuickMBA, they describe Michael Porter’s ideas on the topic as:

A Competitive Advantage exists when a firm is able to deliver the same benefits as competitors but at a lower cost (cost advantage) or deliver benefits that exceed those of competing products (differentiation advantage).  Thus a competitive advantage enables the firm to create superior value for its customers and superior profits for itself.

This is a major objective of most firms in a capitalist system, an objective far more desirable than risk and reward.  Going into the competitive marketplace and taking risks to get profits is a commodity approach to business.  That is why Market Consistent accounting regimes seek to show this activity as less desirable by recognizing those profits later.  Profits created by competitive advantage are reported immediately.

Once a firm has found a competitive advantage, they will seek to make it a sustainable advantage.  If the advantage is significant enough, they will also seek to eliminate all risk; turning it into a pure rent seeking activity.  In many cases, the managers of the business start to think of this as a PERMANENT RISK FREE BUSINESS.  

And that is risk that is embedded in Competitive Advantage.  It is a risk that comes with long experience with a favorable outcome.  Every day that goes by collecting those rents makes it harder and harder for employees and management to even imagine that there is any risk that the gravy train will stop.

Henry Ford had that sort of position until Sloan’s General Motors took advantage of Ford’s inability to imagine a different way of doing business than his “any color you want as long as it is black” approach.  IBM had that permanent risk free look 30+ years ago when everyone said that “no one ever got fired for recommending that the company buy IBM” for its computer needs.  Microsoft looked that way 10 years ago as well.  At the time that Microsoft was losing suits about their monopolistic behaviors, Gates was predicting Microsoft’s competition.  And he was right.

A business is not safe from this just because it is not a world dominating franchise.  Companies with small niches where they dominate have the exact same situation.

this does not mean that such competitive advantages are not a good goal for a business.  But it does mean that once you find one and you do the natural thing of eliminating risk to turn that business in a pure rent collection, there is always that one risk that you cannot eliminate.

Explore posts in the same categories: Change Risk, Enterprise Risk Management


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4 Comments on “The Risk Embedded in Competitive Advantage”

  1. […] reason for higher risk adjusted returns is a competitive advantage.  Investors should be happy to hear about a competitive advantage.  They should also do their own […]

  2. I like what you guys are up too. Such intelligent work and reporting! Carry on the excellent works guys I have incorporated you guys to my blogroll. I think it will improve the value of my site :). “The bigger the information media, the less courage and freedom they allow. Bigness means weakness.” by Eric Sevareid.

  3. Max Rudolph Says:

    My thoughts on competitive advantage are nuanced a bit differently from those of RiskViews. While I agree with these comments, I also think competitive advantage arises from understanding risks better than your competitors and being able to flexibly react as circumstances change. The ability to be nimble is also a competitive advantage.

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