314. How to maximize competitive advantage

Speaker A: A company that has a better understanding of its competitive advantage knows how to avoid wasting money, funding things that will not pay out or building capabilities that customers care about. And companies that have a better insight will invest that capital into things that will pay out.

Speaker B: For McKinsey and company, I'm Sean Brown and welcome to Inside the Strategy Room. That was Laura labersch who joins us today along with Matt Banholzer to talk about their latest research into one of strategy's biggest blind spots, the erosion of competitive advantage. Their analysis finds that misperceptions about the reach and durability of competitive advantage are hurting many companies profits. In fact, as few as 10% of the organizations they recently surveyed have full alignment on what their competitive advantage actually is. Meanwhile, competition has never been fiercer. More than 60% of industries over the past decade have seen an 11% increase in their shuffle rate, which is a measure of how quickly market leaders and laggards change places. So to help organizations maximize their edge over their peers, Matt and Laura propose that CEOs and their teams develop a more granular understanding of their company's attributes, assets and synergies to capture outsized growth at lower risk. Matt is a senior partner in our Chicago office and global leader of our strategic growth and innovation practice. And Laura, a senior expert in the practice based in our Connecticut office. Matt. Laura, welcome to the podcast.

Speaker C: Great to be here. Thanks.

Speaker A: Thanks, Sean. Great to be here.

Speaker B: Uh, Matt, I thought you might set the scene for us. The topic of competitive advantage is by no means new. And I know that you and your colleagues have recently published an article on the erosion of competitive advantage, which we'll include a link to in the episode description. That's a really interesting title. It implies that something is shifting or decreasing. And so what is it about the current environment that means we need to talk about this right now?

Speaker C: Yeah, of course. Thanks, Sean. We think about competitive advantage. It's one of these quintessential business topics. Everyone likes to talk about what their competitive advantage is. I think rapidly though, if you talk to different individuals, either in your, in your own company, institution or across them, everyone has a little bit of a different definition of what it is. Some are inward looking somewhere, expert looking. You know, everyone has their favorite framework that have, you know, popped up over the last few decades. But if you think about it, there's really been a whole sea change, as we all know, in the advent of AI and the ability to look through structured and unstructured data, qualitative data, et cetera. And some of this qualitative data is, you know, where competitive advantage really, you know, can start to come out if you can know where to look. I think there's been a lot of research in the last 10 or 20 years or so on the quantitative side of this. Like how does total share over return, you know, correlate to moves? You can look on a balance sheet or a P and L statement in terms of capital allocation, cost of goods sold, M and A, et cetera. But now's the time to actually look at like, well, what are the root causes upstream of that? What are the things that are going on with the company that change, like how they work? Right. This can be things like some people say culture is an advantage or what does that really mean? Some people say our intellectual property is an advantage. What does that look like? And so I think we're going to get into that whole discussion here today, you know, and also just make sure that, you know, what we talk about is truly data driven and also does correlate to actual economic profit and outcomes. Because at the end of the day, you know, what we don't want to do is just make this another exercise that creates one more framework. Want to make sure this is truly data driven and linked to what's out there. So that's what we're excited to talk about here today and where we're going to go.

Speaker B: Right? So there's a lot more data out there about companies and how they're interacting with their customers. And technology is shifting the way that companies can use that data to build competitive advantage. But Matt, maybe you can say a little bit more about how the competitive context for companies has also changed.

Speaker C: You know, everyone always likes to talk about the current environment, which is always funny because the current environment can be defined as geopolitical tension. You know, AI revolution 10 years ago would be, you know, the aftermath of the, you know, financial crisis. Five years on, you know, 20 years ago, it would be the aftermath of the dot com bubble and burst. You can always pick your favorite thing that is changing the world, but think there's something here around, um, like, well, hey, am I growing or shrinking and why? And I do think we've seen a lot of shifts in a lot of companies in terms of the nature of how they grow is changing. There was a whole era where the growth platform was a little bit more straightforward. You did global expansion, geographic expansion, moving to an adjacent market. But things are really changing. And one of the big drivers of AI that's changing things is the ability to use your advantage in new Contexts everyone likes to talk about, you know, infamous quotes like software is needing the world, etc. I think a lot of that is actually though, um, an observation of the fact that a lot of maybe digital or software companies, for instance, are taking what makes them special, their own competitive advantage and finding new spots of where to put it. And so when we think about growth and outcomes, that this is really, I think, how you unlock that next tranche of it.

Speaker B: Got it. And so change is a constant. But within that context, how do you identify the factors that will maximize your competitive advantage? And what are you looking for? And what kinds of questions should you be asking? Maybe Laura, you could take us through that.

Speaker A: So to Matt's point, there are, no matter what context you're in, there are always parts of your business that are going to be performing well. High growth, low, highly profitable, and other parts that are less profitable. And as long as you can see them at a granular enough level, you'll see this spread come out in your business. And in order to optimize your economic outcomes, ideally what a company would do is they would get under the hood of why. So am I experiencing high growth in these specific markets because the overall market is expanding? Is it because I am actually outperforming, uh, my peers and do I understand why that is and is it sustainable, or, or do I have just an amazing manager who's just crushing it in that specific place, but it's not scalable? And then similarly for where you're underperforming, do you know why? And the reason the why is important is you would make different decisions depending on what that is. So if the overall market is declining and you are losing relative to your peers, you might exit that. If you have a manager that's just crushing it, you're going to see, well, can I scale that across my business and increase my performance in other areas and get them out of the red or out of the, you know, gray and into the green. But the problem with that has been that most companies don't have this granular of a view. We did some research earlier in the year and 2/3 of companies are really only tracking this variance at the business unit level, right? So they don't even see the variance to, to a precise enough degree that they can do something about it. And the second is, to Matt's point earlier, they don't have agreement on what is competitive advantage. Why are they winning the customers they have Today only about 10% of companies really have full alignment of this across their, their organizations. So they're sort of flying blind on this. And this has been true for a very long time. Which is why competitive advantage has historically been you could deploy it in sort of the bet the company moves, but not the more monthly quarterly decisions that you might make more operationally. And the question is, you know, for better or worse, there's a lot more data out there about companies and how they interact with their customers and also uh, huge step function changes in the ability to analyze things quickly and efficiently. And so the question is, is competitive advantage now usable to make these types of decisions?

Speaker B: Well, it does beg the question, how do you even define competitive advantage or align on what it even within your own company's context?

Speaker C: Yep. Competitive advantage um, really consists of the distinct set of hard to replicate assets and operating models that a company creates that earn superior returns over time. Um, the idea would be like, hey, these are not just general strengths that you have. These have to be differentiable. If everyone can do what you do, that's the beauty of capitalism. You're not going to actually out compete, you're not going to create economic outperformance. Uh, it's not really an advantage. You know, it's just parody. If it's something you do really well, but the market isn't paying for it, nobody really cares. It's not really an advantage. It's just something that you can do that's unique. So unique is not the same as hard to replicate superior returns and over time means this idea is it's durable. I think a lot of companies, you know, start with an advantage potentially they have like a breakthrough product or IP or whatnot. But if they don't find a way to replicate that over time, it's not really a long term advantage they should bet an enterprise on. It's a bit more of a flash in the pan and we want to make sure that these are durable over time. When people think about companies with durable or competitive advantage, it's measured not in months or even like a couple years, but it's measured in decade plus.

Speaker B: Matt, if we think about that definition, what level of granularity should we be considering? There could be enterprise level advantages, but Laura actually talked about digging deeper than the business unit level to seek out where you are doing well or underperforming. How do you determine how far down to go?

Speaker C: That's a great question. And it's one of these things that actually gets to people having their own personal definition as um, time goes on. Some of them are quite specific. Like I've been talking about Intellectual property, whether it's you know, patents or you know, um, trade secrets. Obviously that's very detailed. When you're a young company that could be synonymous with the company if you have a breakout product. But if you are an established, you know, multi decade long company, any one product is not going to make or break, you know, your overall longevity. So then the question is, how do you actually think about other types of advantage that are more enterprise wide? You know, the ability to allocate capital, for instance, um, you know, a little bit of things of that nature. And so the answer is actually it's both. And what we're actually finding in the research is that a lot of types of competitive advantages cluster together quite naturally. Um, there are ways that you know, uh, if you have one advantage but not another, you actually can't realize the advantage.

Speaker B: Super. So Laura, can you tell us a little bit more about the research and what sort of themes emerged around sources or elements of competitive advantage?

Speaker A: So as Matt alluded to, the whole idea of having a definition for competitive advantage is only useful if you can actually see some of this outside in. Otherwise it's just going to be the same problem in the past. If you have a framework and by the time you go in my, you know, dig up all the data and analyze it, the market's shifted and it's useless. So we ran through the top 5,000 global companies to look at. Would we be able to see markers of competitive advantage externally? And in order for that to be usable it had to sort of pass three tests. The first is there had to actually be differences within an industry. It wouldn't be helpful if every, for example mining company looked the same. Uh, because competitive advantage is only relevant when you're comparing yourself to your actual peers. It doesn't make sense if you know, mining companies comparing themselves to Google. The second is are they specific enough that you could do something about them or learn something about them? And then the third is obviously are they right. So in this, like I said, we looked at um, the top 5,000 global companies across all industries. But we wanted to pick some test cases to dive deep on to make sure that they would pass the test. So we picked metals and mining as one of them. Right. Because that is, that's a hard industry outside in it's commodity, it's B2B. It's not an industry where the majority of players are household names. And we wanted to see are they all clustered the same. And the answer was no. So it passed the first test. There was actually a huge Spread of what these companies looked like in terms of what came back as their markers for why did they win the business that they were in. And this, we looked at, you know, over 180 companies and so pass the first test. Great. Are they specific? Yes, some of these were extremely specific to the level of this particular metal, this particular mine, but also broader, like do we have government relationships, et cetera. And then are they right? And we looked again for the companies that we did know or had experts on, and where they weren't perfectly right, sometimes they were defensible and at least spurred the thinking in the right direction, which is, you know, for an outside in 10 minute scan, about as good as you can get. What we noticed about these though is they did cluster into seven broad themes. And these themes actually held up across industries. It went from exploring, you know, your innovation and IP capabilities, your customer access or channel, your brand or reputation, et cetera. And all of these had elements of them to varying degrees of specificity that mattered for every industry, but not always for the same company. So as Matt mentioned, there are recipes, right? There are groupings of certain flavors of these that interact. But this framing allows us to make sure we're looking at the right set of data so that whatever an individual company's play might be, they will also be seeing other companies competing in potentially different ways that they still need to respond to.

Speaker B: Okay, so you found these common elements and you're seeing them hold across different types of industries. So Matt, what were some of the broader insights that came out of this then? And I wonder if you could share some other examples now.

Speaker C: Uh, you might have noticed that Laura kind of talked about this in the metals and mining industry and we kind of did that to just prove to ourselves we could do it anywhere. Because you would think that the metals and mining industry is relatively straightforward in some ways and that if you have the best assets, you have the best copper deposits in the last case, or you just run it more than those cheaply, you win and lot of stuff doesn't matter and it's swamped by a market, supply and demand trends. But the fact that we saw this clustering was quite interesting. Um, and of course we saw this again in many other industries. But what's interesting is a change to buy industry. And what we found is every industry had a range that was a advantage where a company was out competing versus the peers, back to our definition, as well as a parody with its peers, as well as a deficit range. So we looked at, for instance, to pick two more Industries. Again, we did this, um, across dozens of industries. Automotive components versus medical technology. You start to see how these things look a little bit different. Right. You know, the same seven or so categories still persisted across sectors, but the relative importance changed. So for instance, when you look at medical technology, the brand strength and reputation, that's really because, for instance, in that industry, if you have a reputation for poor quality, you just, you don't, you don't survive in the market. Right. You know, medical technology is so important. It's high consequence. You know, no doctor, no physician is going to want to use your products if it feels like it doesn't perform as well because they care so much about patient outcomes. You know, it just doesn't work. Um, and your brand strength is an important piece of that. Right. It also has some things around your brand are easy to work with or whatnot too.

Speaker B: Right.

Speaker C: If you can't get reimbursed for your products, again, that's kind of, you know, deadly. There's different levels of strengths versus weakness of where true advantage comes, like how good you need to be for true advantage. Right. So, you know, innovation and IP also has a higher premium in medical technology than automotive components. Right? There's still innovation. Automotive components, cars continue to still get better year over year, you know, but it isn't, you know, as wide of a advantage range. You have to be really, really good to truly make that a differentiated point that your customer is going to pay for versus a medical technology. You actually have a lot more, um, space to be innovative if it does outperform. And a difference of a few percentage points or a few outcomes, you know, does actually move the needle here. And that just becomes really interesting to us as we see through this, because it gives us a sense that there is something underneath this that's industry specific. And it also starts to tell the case of, uh, it's not just about out competition in your strengths. It's also about you cannot underperform any one level. You actually be creating excess economic profit in industry. You have to have an advantage and you have to be good enough on everything else. If you have the best intellectual property or product in the world, but your sales team really underperforms and they can't get the product to market or in front of customers, it doesn't matter, right? You know, no one's going to be aware of your product and intellectual property and it's not going to sell. And so there's a piece of that you need to think about as you go through this now, implicit in What I just said here is that, you know, you're going to make money, you're going to have economic profit, customers are going to pay for it. So the question really then becomes, well, this is nice. We can think about what people consider advantage or not end in sector. Does it really correlate to outperformance?

Speaker B: And how do you keep an eye on these dynamics over time? What are some of the indicators that might suggest you actually need to revisit the fundamentals of your competitive advantage? If we take that automotive industry example, um, how does the emergence of a new product like electric vehicles perhaps change things?

Speaker A: So it depends a little bit on the nature of the disruption. Right? So for EVs in particular, there were elements about electric vehicles that really were outside of the sweet spot that traditional combustion engine automotive manufacturers had, right? The whole notion of battery technology, charging stations versus gas stations, and how do you work with those? The whole concept of vehicle performance and torque profiles were very different, especially early days of EVs versus combustion engines. So the way that you would position your brand would be very different on those. And so there can be disruptions that change overall market perception, uh, really pivot what even customers are looking for from you, as well as require infrastructure changes. All of those can feed into it. And then there are others that can be quite fast and cut across things in a much shorter timeframe, um, that require maybe, uh, less of an infrastructure pivot and more of an individual sort of point pivot. So the long and the short answer of this is it varies a lot and you need to be really looking for both near term and longer term disruptions. But the good news is AI lets you do that.

Speaker B: Now that is good news indeed. So what differences might you see by region or market in addition to what you see at the sector level? If we stick with EVs, for example, some countries have had a lot more electric vehicle uptake than others. So as you're thinking about those ranges of competitive advantages, perhaps they differ, um, in the by country. Is that another level of granularity that one needs to consider?

Speaker C: I mean, the short answer is, I think we do see that. We tend to see that yes, there are local variances that matter. And um, this analysis has been basically you, you run this analysis by aggregating, you run this for every individual company, basically, and then you aggregate the results up, right? And so it's easy to take a subset of, you know, the university companies that you consider in your peer, or to constrain the information to a specific region or area. I think you'd start to see some of this stuff move. There are real differences, you know, especially when you start getting into consumer, you know, facing industries versus um, B2B where that tends to be a bit more globally homogeneous in terms of, what, you know, companies want. But we do start to see those trends as we go.

Speaker A: Yeah. And also just having deployed this at a few different organizations. Right. There's very frequently differences in, for example, the strength of your sales coverage or customer relationships by geography that can vary even if the individual customer needs don't. And your ability to, you know, if you have manufacturing facilities in one region versus another. Right. So the granularity of that is going to depend on the nature of the business and which company you're in. But almost always there is a geographic shift in many of the levers. Access to talent too.

Speaker B: Thank you. And Laura, coming back to this correlation between competitive advantage and economic profitability, one would assume that more, um, competitive advantage would directly result in more economic profit. Is that what you found in terms of the relationship

Speaker A: so. Well, I mean, as Matt alluded, uh, to this already, you know, the key thing is our ability to assess competitive advantage is only interesting if it actually correlates to the companies that are winning. And so when we looked at this, we found you. Yes, in fact it did. The way that we were scanning these and analyzing these, using the outside in data did pick the companies that were the best at, ah, actually creating value with their investments, which was critical to show. And we were glad that it worked out because the whole point of this is a company that has a better understanding of its competitive advantage knows how to avoid wasting money, funding things that will not pay out, or building capabilities that customers care about. And companies that have a better insight will invest that capital into things that will pay out.

Speaker B: Maybe you could step through the characteristics of competitive advantage now and what CEOs should be thinking about in terms of making the right decisions to generate value from it.

Speaker A: What we really want to understand in terms of competitive advantage is three things. So the first is how can I be more efficient with the way I allocate my capital to the point that Matt was making earlier, There are things that you can invest in where if you're good enough, you start to differentiate and then actively draw customers to you. Right. You can go too far and hit a diminished returns area. Right. Where now you're over engineering your products. And so you, you really need to understand the difference between being good at something and having that matter enough that customers choose you because of it. So that you don't over invest in things that don't matter. And then on the flip, you want to make sure that you're not ignoring something to the extent that it actually starts to destroy the value you've created by building out some other strength. And so really understanding for your business, how do these different capabilities or components of advantage interact so that you're not funding things that don't matter, but you're also not ignoring things that get bad enough that they destroy the work you've done. So that's on sort of efficiency, on durability. You want to make sure that once you have achieved, you know, some level of competitive advantage, you know how long that's likely to last. Are there trends that are about to topple you? Are you, have you taken your foot off the gas and your competitors are catching up? Are you monitoring that? And do you know on the time frame of which you're likely to be able to maintain the lead you have in the business that you have? And then the third is extendability. So wherever your advantage is right now, can it be taken somewhere else? Are there adjacencies that you could explore but you know, aren't just based on, hey, here's an attractive market, I want to go and win it. Right. You know, a cement company can't usually win successfully moving into software. Right. It's just, it, it doesn't work that way. You have to really understand where do you have competitive advantage? And not only does that help with your feasibility in terms of moving into an adjacency that you're likely to be successful at, and, uh, a lot of moves fail because, you know, they don't have this visibility. But it also helps you choose adjacencies where what you're good at is valued, so you can get more return from being good at that thing rather than entering in a market that might not value it. And it's sort of commoditizing. So those are sort of the three different types of organizational decisions that we think need to be informed, formed by competitive advantage, and that now can be, uh, in a way that is much easier and practicable than it was even five years ago.

Speaker B: And Laura, is this the kind of thing that you need to revisit annually or more frequently? And how do you integrate this with the traditional strategic planning process?

Speaker A: We looked at this, um, and the cadence for the companies that do this really well and grow very well is much faster than annually. It's usually quarterly, uh, or monthly. Um, and pieces of this decision can be Made even more frequently. But it's not like they're clean sheeting how they're allocating things or you know, starting from scratch. It's more that they're tracking this and they're making sure that as things start to spike, they see them with enough lead time that they can do something about it.

Speaker B: And do you need to look at durability, extendability and efficiency all at once? Sort of consider them together or is there perhaps a sequential aspect to how you approach them?

Speaker A: Yeah, yeah, no, I think they all interrelate. So I think that what you're looking at is across the seven markers, uh, of advantage. And as you see things start to shift, that will inform the decisions you make on all of these. Um, but you know, the extendability, like moving into an adjacency, might be something that typically companies revisit slightly less frequently unless there's a disruption than just their ongoing operating rhythm within the company.

Speaker B: And Matt, do you see this in your work with clients as well?

Speaker C: Yeah, I think so. And I think, um, when we think about this approach here, um, you know, this is, we're talking a lot about some of the research that kind of comes to this, um, you know, like these overall ideas of the economic profit and power curve. But I think what a lot of people are ask, probably thinking in the back of their mind here is what do I do about this? And I think like this is trying to get to the idea is like, well, hey, are there things you need to do just to reallocate resources efficiently? Which tends to be what a really high performing executive team does. But oftentimes it's worth actually testing and saying what are the things that are really hampering us? Like what are the. I know we always talk about at a personal level, strengths based growth. Like you do the thing that you are the best and you're going to outperform as an individual when you focus on your strengths versus trying to be the same as everybody else. What we're finding at an enterprise level, you do need to actually though, um, think about addressing your weaknesses because it will hamper your strengths.

Speaker B: Okay, so what about relating this to where you sit relative to your actual competitors? What can companies do with that knowledge?

Speaker A: The important thing is to understand that competitive advantage, by its definition, it's relative to your competitors. And so you need to always understand where you are relative to your peers. And that can often vary by market. And the fact that you can now see so many of these indicators outside in means that you can have a better view of what are your competitors doing? We're already hearing of companies who are using this to, in the B2B context, when they're going in in response to a proposal, they can mock out what they think their competitor is likely to pitch on versus their own and inform their own pitch to counter that preemptively with a lot better success than they might have been able to do without really understanding their strengths versus their peers and being able to think about when should you exit a business or a market and move into a new one. You always want to frame that relative to the companies that are already there or likely to go with you. And the best way to make sure that you stay on top of this to maximize your economic outcomes is to take what you understand about your competitive advantage and use it to inform your resource allocation. Use it to inform capability investments that might deliver moats or extend your strategic distance. And use it to inform whether or not you enter an adjacency. Even if that, uh, adjacency looks attractive, you want to know, are you likely to actually win it?

Speaker B: Thank you. Laura and Matt, do you see a correlation between economic profit and different areas or categories of competitive advantage within a company? Um, does that relate to the efficiency piece, for example?

Speaker C: Yeah, um, I think when we talk about the efficiency and the resource allocation, and this is something that kind of came out of our research a little bit here, which was you looked at the economic profit power curve, where the companies that had more advantage outperformed in their industry with some outliers. We'll come back to some of the outliers in a second. You know, I'd mentioned this idea of, you know, strengths versus weaknesses. You know, a company that had strong competitive advantage across four areas of differentiation really outperformed quite a bit. Only one area didn't, um, which was kind of interesting to us. And what that started to actually, you know, suggest is that, you know, these advantages start to work together synergistically. It's not just a random smattering of, oh, it will pick any three or four network. They tend to correlate with each other a little bit. Uh, conversely, when we actually looked at the cost of underperformance, we looked at companies that had no deficit areas independent of how many advantages they had, and they tended to do all right. They didn't, you know, drastically outperform, but they did okay. But the drop off is significant and severe. Like if they have a deficit in one of the seven areas, you know, economic profit goes from slightly positive to massively negative. And if they have two more, you know, almost doubles again. And so I think this gets to that concept we talked about with this idea of, you know, again, these are correlated. You have to meet the certain minimum bar, what your customers expect in a sector or, you know, industry, or they're not going to consider you at all. If you have great customer access and a strong brand, those tend to work together. For instance, if you also have unique assets and resources like access to oil fields, access to mines, and you are operationally excellent to make the most of it. And you have scale, you've done that at large. Those work together really well. And so that becomes really interesting to see how these things fit together. And so when we think about this efficient frontier, this, this three axis, um, approach that Laura mentioned, I think when we start to think about, you know, are we strong where it matters for an industry, are we over investing where it doesn't matter, that becomes a failure. Because people we've worked with, a couple companies, worked with a chemical company for instance, that thought they were the very best at a specific type of polymer innovation, but they were over delivering on that one piece. And what they really needed to do was bring the rest of the parity and fix a deficit on um, the route to market. And so it was really, they were misallocating resources, um, because they were, it's like human nature. Everyone likes to talk about what they're good about and not really focus on their weaknesses. And you really need that cold eye view to drive this or you're going to have underperformance as time goes on.

Speaker B: And just on that idea of competitiveness through sort of a longer term perspective, Laura, I understand your research found that about 60% of industries have actually seen a decrease in the durability of competitive advantage. Could you tell us a little bit more about that?

Speaker A: Yep. So as we talked about earlier, economic profit is a bit of a lagging indicator. And there are a lot of organizations that we've seen where they don't see that their competitive gap is closing until it already topples. So you know that, that famous quote from Hemingway. Right. How did you go bankrupt? Very slow and then very fast. Right. So it, it was, you know, we see this play out in industries a lot. And so what we wanted to be able to do was to find a way to get some earlier warning sign that things might be shifting. And there was a company that has been performing super well, but then recently they had a lot of operational issues that were popping up. You could argue maybe that will be short term. Maybe it won't, but it's definitely something that is large enough that it was taking them out of how we were viewing them in terms of competitive advantage. Because that had been a strength and now it was not a strength, might be a weakness. And similarly, if you have an advantage but you're not using it. So, for example, financial strength, where you have these, you know, enormous cash assets, right, but you're not actually using that for anything. You're either just repaying it out as dividends or you're just sitting on it. You're not using it to expand or to make acquisitions, then that wouldn't really be a competitive advantage. You're not deploying it. And that can be true for any of the seven that we talked about. And the reason that this notion of durability is so important is that overall, on average, more industries are seeing a, uh, declining of the durability of competitive advantage than are seeing, you know, it extend or expand. And there's a lot of reasons for this. Some, um, more macro, like the overall porosity of industry barriers really mixing up who you're competing with and what your customers are expecting, um, as well as some specific things like AI disruption. But more companies than not, more industries than not, are seeing their competitive advantage erode faster than it used to. And we can see this in terms of corporate longevity as well. There have been things that, you know, we and others have written about with that, but it's becoming more and more important to actually understand what is your advantage and how is it changing.

Speaker B: And Laura, this comes back to that question of how often do you need to revisit your sources of competitive advantage? Because to your analogy of how losing competitive advantages, like the quote about going bankruptcy, first it's slow, but then it's really, really fast. What are some of the early indicators and ways that you help clients think about the durability of their advantage in their particular industry or region?

Speaker A: Yeah, it's a good question. And you know, we're seeing almost an exponential, uh, increase in the level of sophistication of what companies are doing to track this. So there are some things that are, you know, batch mode, where, you know, once a quarter, once a month, once a year, you might run some sort of analysis to scan for new patents or new, uh, you know, competitive offerings or shifts in different capital expenditures by your direct competitors and what that might mean. But then there's always on type of things, right, where you can have just tracking of spikes in startup activity, spikes in, uh, shifts in regulatory news and There are ways of setting that up so that there are triggers that are cascaded through the business that they hit how your scenarios look like, your strategic scenarios. They hit indicators for should we revisit our resourcing decisions? Let's make those more frequently and maybe even not just once a quarter, but on demand. And there's a big spread in how different companies are using this right now. But the, the rate of learning is really phenomenal. And of course with learning comes failures. So you, you know, before you just deploy something, you want to make sure that it, you vet it and you understand what the potential errors and the, the sources of that data are. But it's not just a once a year process anymore.

Speaker B: Laura, thanks for clarifying. This is a more regular process. But now maybe we can talk a little bit about AI. It's obviously an era defining disruption. What impact is it having or going to have on um, what we're talking about today with regards to competitive advantage? Is it broader or deeper than some of the disruptions that we've seen in the past, for example, like the industrial or computing revolutions? How does this compare?

Speaker A: Yeah, no, definitely the way that AI is playing out, I wouldn't say it's broader or deeper necessarily than some of these other changing innovations that have happened in the past. But you can't argue that it's not faster, right? It is, it is much faster and it is hitting each of the seven elements that we talked about of competitive advantage in different ways. But, and so depending on your business model and your own specific, specific recipe for competitive advantage, the nature that AI will, uh, or will not disrupt your business model is, is going to change. So for example, with brand and reputation, the way that AI is affecting the importance of trust, right, or on scale, these, the, the difference of ecosystems and the breadth of that and the scale, how fast you can access that, um, and what those ecosystems are even comprised of are changing and all of these come together and the nature of operations, right. Um, different types of operations. So for example, in pharmaceuticals, where for so long it was, you know, laboratory based experimentation which was core to the R and D, their R and D function. And now while some of that is definitely still true, more and more of that is going to innovation and R and D through simulations and AI. And how is that disrupting and changing the core competencies required there? So depending on the business you're in, it's going to hit you differently. But those are all knowable things and you can track those now to see what is gaining momentum and what Parts of your business should you be concerned about.

Speaker B: Super. And I, I'd imagine these dynamics are going to continue to evolve over time which will provide even more of a reason to get good at this notion of granularity. I was hoping now you could talk us uh, through an example or two that illustrate how even something that might be seemingly a small advantage could impact or perhaps become a moment of opportunity for a company that's able to recognize it quickly.

Speaker A: Yeah, no, definitely. So here's an example that's not AI based. So this was back in the day with blood glucose monitoring, right. So for a long time it was finger prick and strips and there were a few very dominant players that had the majority of the industry. They had a very well trodden pathway with the payers that would reimburse these things and a, ah, network sort of branded on these strips and customers knowing that they could get reimbursed for them and have access to them. And it was a, and a lot of the money was made on the consumable strips. Right. And the fingerprint meters. But then out of nowhere came continuous blood glucose monitoring which involved data, data, ecosystems, a very different type of device that was embedded and a different reimbursement model. So if you were looking at, if you were some of these big incumbents and wanting to track, what should I be paying attention to? Right. There were early days where there were signs of this new technology and the innovation that came online. But to be fair, uh, there were lots of new technologies always coming online. Not everything wins, not everything scales. The key tipping points started to be when you got some of the regulatory changes passed and the reimbursement permissions changed and that preceded the massive tip by a few years. Enough time that you can try to pivot or decide the exit and different of the incumbents made different choices. And those are all strategic decisions that you make when you have enough lead time to see what's coming and then understand how does your model compare to someone else's. And so this is the type of thing that when you see these, it affects the overall performance, the overall durability of an advantage. Because it just in this one it changed the structure of what actually was the product, how is it delivered and how do customers interact with it.

Speaker B: Fascinating. So Laura, maybe you can now share an example of the flip side of that where a company has identified an area of strength and extended their advantage further with a pivot into an adjacent growth area.

Speaker A: So in this example it was an automotive and assembly player and they made tiny Low vibration quiet motors and they deployed those into combustion engines. And that market was relatively flat and didn't have necessarily the best growth outlook. And they were really interested in exploring where else could they take these two. But they didn't want to just move into sort of a commodity space for it. They wanted to actually get a premium for their expertise. So they wanted to really understand where could it value, where would it be valued? And normally if you did the old school way of just looking at industries and adjacent industries, their options were pretty limited. But when you deploy a, uh, competitive advantage lens, then all of a sudden they found out that things like the tiny motors and heart pumps and med devices, which had a much higher growth rate, that actually was a perfect fit for what they knew how to do. Now it was a perfect fit for their tiny, low vibration quiet motors. But the dynamics of med devices compared to automotive and assembly are quite different. So they didn't have any reputation at all in the medical space. Right. They would have to overcome that. They didn't have any of the relationships with the overall sort of the equivalent of the OEM in med devices and they had to build those relationships. Um, the rate of innovation is higher in med devices. Like they were kind of king of the hill for their niche within automotive and assembly, but it was at a totally different metabolic, um, rate in uh, med, in med devices. And so it's, they had to take all of that into account when they made their move. And you know, they did it successfully but it's just if you, if they didn't have the information on what was changing and what did they need to compensate for and really evaluate before making that move, it would have been a much riskier move.

Speaker B: So Matt, now I'd love to ask, given the specificity that we need to be looking at competitive advantage with, and we've talked a lot about getting granular across it, how should a company think about tracking and evaluating this on a more holistic level across the entire company? Yep.

Speaker C: Obviously I don't think it's like, you know, reasonable for every company to have a whole research database, a competitive advantage for themselves and their peers. But as you once, uh, you understand what you think are the most important ones to you and you know, also you've stopped fooling yourself, so to speak. You know, you've taken a cold eye view and you make sure you're focusing on things that move the needle m and not just pushing the strength over the edge. There is something around looking at the milestone and markers that correlate to that to that strength, right? You know, if you have resource access and assets as an advantage, you know, obviously looking at, you know, if you're in a materials based industry, you know, energy industry, you know, your core advantage is always trying to find where to do exploration and production. That's just core to what your business is and you got to keep doing it. Likewise, if you're a consumer company, doing go to market really matters and you kind of keep milestone posts on that. The other thing I want to raise though is in the age of AI, you know, one thing that we're seeing companies do a lot more is really think about this idea of like a semantic layer or you know, what us and others have called an ontology really to think through. How do you really codify what makes your business unique and special in the core? While everyone can start to think about running AI agents and getting more efficient with their workflows, every company still has their own unique way to think about how they run the place, right? If your advantage is how you manage your supply chain, there are real decisions you probably do make in terms of which plant gets allocated, which resource, how you do SNLP planning, how you prioritize, which customers. Likewise, if you're in finance, you know, you have your own advantage, you think you do underwriting, you know, if you're an insurance, for instance. And all of that can be encoded in, you know, what's called a, you know, ontology with a semantically, which is like, hey, like how do you map the connections of how decisions flow through the organization? What people takes what decision to do, what, what asset moves what you know, um, particular resource from one place to another. There are ways to map that in a digital way almost think about it as a digital twin to your operating model or your business model. And if you do that, that is hard to replicate. If you have that, it creates the railroad tracks, so to speak, that underpin how different AI agents can navigate and add, you know, efficiency to your workflows to prevent hallucination. It can actually create, you know, the right guardrails for when you do advanced analytics to optimize a particular business process. It's doing it in the right way. And basically what you're really doing is encoding your advantage into this type of digital network. And a lot of companies, for instance, are facing a talent cliff where for instance, they have a lot of great people who are retiring soon. You know, how do you encode their knowledge into them while you also train the next generation, Right? So this approach is really quite useful. Down the, you know, as we see a lot of companies taking this up and it's how they really kind of find what's their ineffable, hard to replicate advantage and encoding it in a more digitally native way so they can make the most of it. And by the way, if you have this, it's easy to apply that agent to a new market, a new industry, which can be part of what you need to do.

Speaker B: Matt, I think we might end up having to do an entire episode just on this topic.

Speaker C: Indeed.

Speaker B: Awesome. So before we wrap up, Laura, I'd love for you to share some key questions in your work with executive teams that should be asked if those teams are interested in identifying and activating their competitive advantage as soon as possible across those three dimensions of efficiency, durability, and extendability.

Speaker A: So there's five different questions that we typically we work with companies on to help them think through this. So the first is do you actually know what matters to your customers? You might be surprised because we've often found that companies think it's something and either their customers don't agree that they're good at it or they're good at it, but the customer doesn't care. The second is do you know how good is good enough? So you don't need to win on absolutely everything and it isn't efficient to spend money on things that your customers don't care about or that you will never actually be able to successfully positively differentiate against your competitors at now you don't want to negatively differentiate against them either. So you just have to understand where is that zone where you don't need to over invest. Then when you think about durability, do you know, you know, are you gaining or losing round relative to your competitors in the plays that you're currently in? And do you understand trends? What trends? You know, Sean, to the questions you were asking, what trends should you be monitoring and do you need to be monitoring them continuously or just twice a year? Do you understand what that rate of change in your business is and how to get at that data? And then finally, when you look at making a move, are you using competitive advantage to inform it?

Speaker B: Super. Matt, Laura, thank you so much for taking the time with us today. Really appreciate it.

Speaker A: Thanks Sean.

Speaker C: Thank you.

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