by Barry Marcus

Created on: December 04, 2008   Last Updated: November 26, 2009

A business that enjoys a competitive advantage can earn greater than normal profits in an industry. Strategy formulation is conducted to improve the standing of the company in the marketplace, to carve out a market niche and to increase its market penetration and profitability. Kenichi Ohmae defines strategy formulation as the quest for competitive advantage. Competitive advantage is the basis for a firm to earn above-average profits or to achieve a position of market dominance.

A business can gain a competitive advantage within an industry, within a geographic location or within a market segment, through cost leadership or differentiation. Taken a step further, competitive advantage may be gained by becoming a best-cost producer, a focussed cost leader or focussed differentiation.

A company that uses a cost leadership strategy focuses on providing the lowest cost product or service. These products and services are not necessarily the best, but its products are affordable. The company is placed in a prime position. Examples include a burger chain that may achieve market dominance through a low cost strategy. In recent years Chinese clothing manufacturers have dominated the world's mass clothing market because of their ability to distribute clothing at very low prices.

A differentiation strategy directs a company's products and service towards a more selective audience. The product or service is differentiated because it is different or special. A product is targeted at a specific niche or aimed at an exclusive market. Designer clothes and luxury cars such as the Porsche or Ferrari are examples of upmarket differentiation. Sports clothing, health foods and other specialised goods fall within specific niche markets.

Cost leadership has to some extent been replaced by a more focussed best-cost leadership approach. Best-cost leadership provides the customer with the greatest value for money. Cost leadership traditionally focussed on a no frills' approach, but new production methods have provided companies with the ability to provide quality products at low cost. During the seventies and eighties the Japanese motor industry focussed on improving the production processes to eliminate defects and reduce costs. Western manufacturers were forced to follow suit to stay in business.

Michael E. Porter's Five Forces model focuses on positioning a firm within a competitive environment. The five powerful forces present in the environment consist of:

> The bargaining power

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