How to innovate business strategy and create sustainable competitive advantage?

How can companies that primarily focus on products, especially those with limited differentiation, or companies struggling to enhance their value chain, create a sustainable competitive advantage and build new values that customers seek?

In many industries today, upstream activities such as supply chain sourcing, manufacturing, and logistics are becoming standardized or outsourced, while downstream activities aimed at reducing customer costs and risks are emerging as drivers of value creation and competitive advantage.

Consider a consumer purchasing a can of Coca-Cola at a grocery store or a retail membership club, or buying a 24-can pack for about 25 cents per can. The same consumer, on a hot summer day at a park, happily purchases a chilled Coca-Cola from a vending machine for $2. The 700% price difference is not due to a superior or distinct product but rather the added convenience of acquiring the product. What the customer values here is not having to buy a whole pack, carrying around a single can all day, and finding a way to keep the remaining Coca-Cola cold until desired.

• Upstream involves understanding and addressing customer challenges. This is done by segmenting the market and determining how to serve customer needs.
• Downstream encompasses strategic planning. It determines advertising strategies, brand building, promotions, and communication to sell the product.

Downstream activities, such as tailoring product distribution for specific use cases, increasingly drive customer preference for a particular brand and lay the foundation for customer loyalty. They also represent a significant portion of companies’ costs. In essence, the focus of most companies has shifted downstream.

However, business strategies are still influenced by remnants of the Industrial Revolution, which persist long after factories ceased to be the primary source of competitive advantage. Companies still revolve activities around their production processes and products, with success measured based on units sold. Production-related activities are optimized to maximize speed, and efficient management is rewarded. The challenge is that everyone else is doing the same.

The strategic question driving business activities today is not “What else can we do?” but “What else can we do for our customers?” It’s no longer about the factory or the product; now, customers and the market are at the core of business operations. This new focus requires rethinking some core aspects of strategy:

1. Competitive advantages now lie outside the company, accumulating over time rather than depleting as competitors catch up. It expands with experience and knowledge.
2. How you compete changes over time. Downstream activities are no longer about having a superior product; it’s about focusing on customer needs and how your offerings compare to their purchasing criteria. Where you stand in the current market landscape and which competitors you’re contending with matter.
3. The speed and growth of today’s market are driven by changing customer buying criteria, rather than just product or technological improvements.

Let’s take a closer look at how companies can leverage downstream activities to create a competitive advantage, with marketing being the backbone to reinforce traditional strategies.

Is competitive advantage an internal advantage of a company?

In the quest for upstream competitive advantage, companies strive to establish unique resources and capabilities and then seek ways to protect them from leaking to competitors. You can determine which activities a company considers a competitive advantage by observing how well they are safeguarded: If a company believes its advantage lies in its production process, factory tours will be tightly controlled. If they consider R&D their differentiator, there will be heightened security around research labs and a team of lawyers to protect patents. And if they value talent, you’ll find a premium workspace for employees, gourmet lunches, yoga rooms, nap corners, flexible work hours, and more.

Conversely, downstream competitive advantage exists outside the company, within external linkages to customers, channel partners, and supplementary product providers. It often resides within processes of customer interaction, market intelligence, and customer behavior.

A classic thought experiment in the branding world is to consider what would happen to Coca-Cola’s financial mobilization and recovery if all their physical assets worldwide mysteriously burned down overnight. Most business-minded individuals would conclude that while there would be additional time, effort, and money required to recover from the failure, Coca-Cola’s competitive advantage would remain largely unchanged. The brand would easily attract investors seeking future profitability.

The second part of the experiment is to envision what might occur if 7 billion global consumers woke up one morning with amnesia so severe that they couldn’t recall the name Coca-Cola or any of its affiliations. Past habits would be disrupted, and customers would no longer reach for Coca-Cola when thirsty. In this scenario, most entrepreneurs agree that despite Coca-Cola’s physical assets remaining intact, the company would struggle to generate revenue for reoperation. This illustrates that losing downstream competitive advantage—in this case, the consumer connection to the brand—would be a heavier blow than losing all upstream assets.

Establishing and nurturing market linkages creates loyalty—meaning customers (or supplementary product providers) are unwilling or unable to switch to a competitor even if they offer equivalent or superior value. Millions, or even billions, of individuals opting to remain loyal to a brand or company forge a true competitive advantage.

Do you need to listen to customers?

By technical definition, a market-oriented company excels in the art of listening to customers, understanding their needs, and developing products and services that meet those needs. The belief is that this process will lead to a competitive advantage, prompting companies to invest billions in deep consumer research, surveys, and social media communication. “The voice of the customer” is the highest driver of decisions related to product, pricing, packaging, store location, promotion, and positioning.

However, the reality is that successful companies are increasingly achieving their success not by catering to stated customer preferences but by identifying what customers are seeking and shaping their “buying criteria.” When asked about market research during the development of the iPad, Steve Jobs famously responded, “No. It’s not the consumers’ job to know what they want.” And even when consumers do know what they want, asking them might not be the best way to learn. Zara, the fast-fashion retailer, places a relatively small number of products on its shelves for a short period—only hundreds per month compared to the thousands per season of a typical retailer. The company was designed to respond to actual buying behavior, quickly producing thousands more items and eliminating products that don’t sell.

“The customers don’t know what they want.” – Steve Jobs

Indeed, today’s market leaders are those who define what performance matters for the respective product portfolios: Volvo set safety standards, shaping customer expectations for features from seat belts to airbags to collision protection and pedestrian detection systems; Febreze redefined how customers perceive a clean home; Nike has made customers believe in themselves. Buyers are increasingly using the criteria set by companies not only to choose a brand but also to understand and connect with the market.

These criteria are also becoming the basis for companies to segment the market, define their brand positioning, and develop strategic market positions as sources of competitive advantage. Therefore, strategic objectives for downstream business activities impact how consumers perceive relative importance of key criteria when making purchase decisions and introduce more relevant new criteria.

Will competitive advantage disappear over time?

The traditional upstream perspective suggests that when competing companies catch up, competitive advantage gradually diminishes. However, for downstream competitors, the advantage grows over time or with the number of customers served—meaning it accumulates.

For instance, you won’t find Facebook’s competitive advantage locked away in its glitzy Menlo Park offices or other surrounding areas. Its intelligent and highly efficient employees aren’t the key to the company’s success. More accurately, it’s the billion-plus users on the platform representing the most valuable downstream asset. For Facebook, their advantage is all about network effects: people wanting to connect, wanting to be where everyone else is. Facebook does everything it can to maintain its dominant platform position on the internet: user data posted on Facebook doesn’t transfer to any other site; timelines, events, games, and apps create tight interconnections. The more users remain on Facebook, the higher the likelihood their friends will stay too.

Network effects create a classical downstream competitive advantage: they exist in the market, are distributed (you can’t point, draw, or lock down a group), and are hard to replicate. Brands also carry network effects. BMW and Mercedes advertise on TV and other media, even though less than 10% of viewers might be in their target market, because the more people interested in these brands, the more potential buyers in their target market willing to pay for them.

Indeed, the nature of network effects is to always accumulate. But other downstream competitive advantages—especially those related to data accumulation and deployment—are also cumulative. Consider Orica, a explosives company facing a crisis in the commodity business in Australia. The top concern of customers—quarry operators for use in landscaping and construction—is to meet specific technical specifications while minimizing costs. Since products on the market are nearly indistinguishable, quarry operators have no reason to pay insurance premiums for Orica’s explosives or any other company’s. Meanwhile, Orica knew that explosives weren’t as simple as they appeared. Multiple factors influenced the success of a blast: the shape of the rock face, the location, depth, and diameter of drill holes, even the weather. The complex explosives formula blew profitability away.

Orica recognized that customers always worried about handling explosives without accidents, not to mention transporting and storing them safely. If it could reduce costs and risks, it would bring substantial new value to quarries—far exceeding any discount competitors could offer. So, Orica’s engineers began collecting data on hundreds of blasts across multiple quarries, uncovering surprising patterns that helped them understand the decisive factors for blast outcomes. Using experimental models and testing, Orica developed strategies and processes to significantly minimize uncertainty. Now, they can predict and control the size of rock fragments resulting from a blast and explain to customers their strengths that competitors lack: guaranteed results within regulatory tolerance for blasting. Quarries quickly shifted to Orica, despite the competitor’s lower prices. The company not only outperformed competitors but also accumulated a competitive advantage: as Orica accumulated more data, the company improved the precision of blast predictions further and gained an advantage over competitive peers.

Can you choose your own competitors?

Usually, it is believed that companies are primarily stuck with the competitors they have, or they will emerge independently through their own efforts. However, when competitive advantage moves downstream, three important decisions can determine, or at least influence, who a business competes against: how you position your product in the minds of customers, how you place yourself against competing rivals in distribution channels, and your pricing.

If you are in the beverage business and have developed a rehydration drink, you can choose how to position it: as a digestive health aid, a sports drink for athletes, or as an anxiety-relief potion.

In each case, customers perceive different benefits and can compare the product with a different group of competing products.

In choosing how to position a product, managers tend to focus on the scale and growth of the market, while overlooking the intensity and nature of competition. In downstream activities, you can either actively position yourself within a group of competitors or distance yourself from it. For example, Brita filters compete with other filters when they are placed in the kitchen appliances section of supermarkets. However, Brita changes both the comparison set and the economic calculus in consumer decision-making when the filters are placed in the bottled water aisle of supermarkets. Here, Brita filters have a competitive advantage in cost, delivering several gallons of clean water per dollar compared to bottled water. Of course, not all bottled water consumers buy solely based on price (some may buy for convenience, for instance), but for those who do, Brita becomes an appealing choice.

Brita changes its competitive setup when placed in the bottled water aisle at a supermarket instead of kitchen appliances at a department store.

If you don’t want to be compared to any other brands and want to build a competitive advantage for yourself, it’s best to market, distribute, and package your product in ways that differ from familiar cues. Go to a grocery store or browse online catalogs to see how packaging for many similar products is designed: Most yogurt brands are sold in identical-sized and formatted containers, and their contact information is often indistinguishable to the point where consumers can’t remember the brand after seeing an advertisement. Lack of differentiation will encourage competition, and many brands in this situation are best advised to avoid that.

Ultimately, pricing strongly influences who you compete against. When Infiniti introduced its comeback vehicle, the G35, in 2002, it was praised as a BMW competitor. Based on the legendary Nissan Skyline, it was on par with the BMW 5-Series in terms of interior space and engine power, but it would struggle to compete for a few reasons: the 5-Series targeted experienced BMW buyers—or at least buyers who had previously owned a luxury car. Additionally, the 5-Series was quite expensive, and when customers spent that amount, they were not looking for value but a well-established brand and value proposition. Instead, Infiniti positioned the G35 against the BMW 3-Series. The appropriate pricing achieved that goal: many consumers, especially car buyers, use pricing as a significant criterion in their considerations.

While avoiding direct competition with rivals can minimize direct competition, there’s no guarantee that you won’t still have to compete with unwanted or unintended competitors. However, if you have prepared and established market dominance through setting buying criteria, even competing rivals will position themselves at a disadvantage if they choose to follow your lead.

Surprisingly, it’s easier to identify your competitors if you’re trying to gain a competitive advantage as a latecomer to the market rather than if you’re creating an entirely new playing field. Latecomers can choose to directly compete with the incumbents or differentiate themselves, while incumbents depend on the decisions of latecomers. But an incumbent company is not powerless: it can get ahead of competing rivals by continuously redefining the market and introducing new buying criteria.

“If you have prepared and established market dominance through setting new buying criteria, competing rivals will also position themselves at a disadvantage if they choose to follow your lead.”

Innovation does not always mean a better product or technology.

Similar to prime real estate in a bustling city, the mental space of customers is increasingly scarce and valuable as brands proliferate with various forms, and existing brands are “fragile.” Companies compete fiercely with each other not to prove superiority, but to establish uniqueness and create a competitive advantage. Volvo doesn’t claim to make a better car than BMW, nor vice versa — just a different one. In the minds of customers, Volvo is associated with safety, while BMW emphasizes joy and excitement in driving. Because the two car manufacturers emphasize different buying criteria, they attract very different customers. In a global study to understand what “excitement” means to customers, respondents were asked to “describe the most exciting day in your life.” When the results were examined, BMW users described exciting things they had done — rowing in Colorado, attending a Rolling Stones concert. Conversely, the most exciting day so far in the lives of Volvo customers was the birth of their first child. Competing brands persuade customers about the core values of their brand.

This does not mean that upstream activities related to creating safer or faster cars are not important. The product still remains an essential component in expressing the brand positioning on the chosen criteria. The product and its features turn the invisible, abstract promises of the brand into tangible benefits. Volvo’s product improvements truly make their cars safer, reinforce a long-lasting brand connection with customers, and affirm a competitive advantage. However, the product itself does not hold a more privileged position in the marketing mix, such as communication or appropriate distribution.

Is innovation really needed to create a competitive advantage?

With a persistent belief that innovation mainly builds better products and technologies, managers often overemphasize upstream activities and tools. However, a downstream perspective suggests that managers should focus on market-facing activities and tools. Competing battles are won by offering innovations that reduce the cost and risk for customers throughout the entire buying, consuming, and disposing process.

Consider the case of Hyundai and how they created a competitive advantage during the 2008-2009 Great Recession. During the economic downturn, Americans’ job prospects seemed uncertain, and consumers delayed purchasing durable goods. Car sales plummeted. The long-standing financial problems of GM and Chrysler resurfaced, and both companies sought government bailout packages. Hyundai, which primarily targeted lower-income customers, was severely impacted. The company’s U.S. sales dropped by 37%.

Amid declining demand, most car companies immediately responded with price reductions through dealer incentives and other promotions. Hyundai considered these options as well, but ultimately took a different approach: They asked potential customers, “Why aren’t you buying?” The answer was “The risk of buying during a financial crisis is too high when I could lose my job at any time.”

Instead of discounting, Hyundai devised a way to mitigate that risk, addressing the primary concern of potential buyers: “If you lose your job or income within a year of purchasing, you can return the car without penalty to your credit score.” Called the Hyundai Assurance, the guarantee functioned like a put option, addressing the key reason why a buyer would hesitate to commit to a new car purchase. Launched in January 2009, Hyundai’s sales that month nearly doubled, while the industry’s sales dropped by 37%, the largest January drop since 1963. That month, Hyundai outsold Chrysler, a company with four times the number of dealerships. Competitors could have easily adopted Hyundai’s Assurance commitment, but they didn’t. They continued to discount and offer cash incentives. Hyundai Assurance was a downstream innovation. Hyundai didn’t innovate to sell better cars—they innovated by finding ways to sell cars better. As a result, they efficiently created a competitive advantage for themselves.

Reducing costs and risks for customers is the focus of any downstream tilt—indeed, it’s the primary means to create downstream value. It’s no surprise that many cases we’ve examined show: Facebook reduces the cost of customer interaction with friends; Orica minimizes the risk of mine blasting; Coca-Cola lowers customer costs when seeking a refreshing, thirst-quenching beverage.

Does the pace of innovation depend on the R&D Lab?

Innovating the treadmill product is a necessity. In fact, technological innovations are sometimes seen as the biggest threats to competitive advantage. But such changes in the market are only fitting if they leverage downstream competitive advantage. You don’t need to break a sweat for every new product launch and the introduction of a rival’s new features—just focus on those trying to control customer buying criteria. After all, it wasn’t the advent of digital photography that destroyed Kodak; it was the company’s failure to align with changing consumer buying criteria.

Conversely, after more than a century of innovating shaving technology, Gillette still holds sway and maintains a solid competitive advantage as the market transitions to razor and blade cartridge systems. Although for three decades, competing rivals knew that Gillette’s next product generation would add an extra blade and perhaps a pivoting or vibrating capability, they never introduced a third, fourth, or fifth blade. Because they had so little to gain from primacy. While Gillette owns the customer criteria—and trust—so an extra blade only becomes trustworthy and feasible when Gillette decides to introduce it with a billion-dollar launch campaign. Four blades are better than three, but only when Gillette says so. In other words, technological innovation doesn’t drive the pace of change in the industry—the influence of marketing activities does.

The high failure rate of new products indicates that companies are continuing to invest heavily in product innovation in an attempt to gain a competitive advantage, but they are unable to change customer buying criteria.

Market changes can take the form of evolution, generation, or revolution, and each type can be understood in terms of consumer psychology. Evolutionary changes push the boundaries of existing buying criteria, such as higher horsepower or better fuel efficiency for cars, faster processing speeds for semiconductor chips, or more potent drugs.

Generational changes introduce new additional criteria alongside existing ones, often opening up new market segments. For instance, the introduction of sugar-free soft drinks, hybrid cars, extended-wear diapers, or once-daily medications.

Revolutionary changes not only introduce new criteria but also render old criteria outdated. The new electronic game controller from Nintendo Wii changed how people interacted with their games; touchscreens and multi-touch interfaces transformed customer expectations of smartphones; vaccines for diseases like tuberculosis, AIDS, or malaria might render current treatment methods nearly obsolete within a few decades.

The power required to drive a revolutionary change through a market is greater than that needed for a generational change, and that power is greater than the market power needed to drive an evolutionary change.

In each case, the quality of product innovation — the added benefits over existing products — contributes to changing the market, but it doesn’t guarantee change. The high failure rate of new products across many industries suggests that companies are heavily investing in product innovation but struggle to change customer buying criteria. Technology is a necessary condition but not sufficient to create a competitive advantage in market development. It’s the downstream activities that move customers through evolutionary, generational, and revolutionary changes.

Prioritizing Downstream

The shift toward downstream is happening as industries question deep-seated assumptions about competitiveness, competition, and innovation.

The downstream shift has a particular convergence effect on three types of companies: First, those operating in product-obsessed industries, such as technology and pharmaceuticals. The downstream value-creation potential and competitive advantage-building opportunities tend to expand for such companies. Second, companies in emerging industries with increasingly commoditized and undifferentiated products. These companies seek alternative sources of differentiation that don’t rely on easily copied or production-based advantages. Third, companies looking to enhance their value chain. Downstream activities offer a way to create new customer value propositions and enduring differentiation.

The locus of value and competitive advantage increasingly resides outside the company rather than within. Activities that attract customers by reducing their costs and risks and push back rivals by constructing nonreplicable differentiation are the keys to downstream competition. The downstream playing field has its own set of rules, and managers who understand this game will gain the edge.

You and your business are on a path to create a distinct competitive advantage, but have not yet achieved significant success? Contact Metta at phung.metta@metta.com.vn to discover solutions for building a leading brand in your industry.

Source: Harvard Business Review