The Value of Competitive Advantage
In this chapter I explain how competitive advantage is quantified, how it is turned into added value, and how added value is reflected in conventional measures of financial performance, such as cash flow, profits, and returns to shareholders.
Competitive advantage is, necessarily, relative--a competitive advantage is something that one firm has over another. When I talk of competitive advantage without making a specific comparison, the implicit comparison is with a normal or representative firm--perhaps the weakest competitor, or a hypothetical entrant to the market in which the firm concerned holds its competitive advantage. The expected costs and revenues of that representative firm provide a benchmark against which the competitive advantages of other firms in the same market can be measured. In a contestable market, where it is easy for firms to enter or leave, the added value created by each firm will be exactly equal to the size of its competitive advantage. But if entry is costly, firms with little competitive advantage may nevertheless succeed in adding value, and if there is excess capacity in an industry there may be no added value even for firms which have competitive advantages. These relationships between the competitive advantages of different firms and the ability of any or all to add value are the subject of the first part of the chapter.
In the second part of the chapter, I explain how added value underpins all the principal measures of corporate performance, including cash generation, accounting profitability, and shareholder value. I demonstrate the fundamental equivalence between all these measures in the long run and show how each offers a valid but distinct perspective on corporate success.
The success of corporate strategy is generally measured by financial measures of corporate performance. There are many alternative financial measures. Some commentators emphasize profitability and earnings per share, others cash flow and returns to shareholders.