Turning comparative advantages into competitive advantages

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In today’s modern economy, there is usually any number of providers for a given product, whether good or service. Generally speaking, especially for commodity goods, the more successful providers are the ones who have a comparative advantage in producing those goods and bringing them to market.

From an economics viewpoint, someone has a comparative advantage in producing a good (as compared to others) if he can do so more cheaply (or to be more precise, at a lower opportunity cost) – that is to say, for a given amount of resources, he can have higher units of production of that good.

For example, farmers Michael and Omar own identical plots of land next to each other. Michael can raise either 4 sheep or 8 cows, whereas Omar can raise either 8 sheep or 4 cows. For every sheep that Michael raises, he could raise 2 cows, whereas Omar can only raise ½ a cow; hence, Michael has a comparative advantage in raising cows. The opposite is true for Omar (who has a comparative advantage in raising sheep).

If both farmers were to split their resources between raising cows and sheep equally, they would be able to raise a total of 6 sheep and 6 cows (2 sheep, 4 cows from Michael and 4 sheep, 2 cows from Omar). However, if they were to instead fully concentrate on the animals they had comparative advantages in raising, they would raise a total of 8 sheep and 8 cows – a better result than they could have achieved otherwise.

This is true even if you compared either farmer with someone who can out-produce them, like Raj, who can raise either 10 sheep or 10 cows on his plot of land. It will still be in Raj’s best interest to raise sheep when compared to Michael, because that’s where his comparative advantage is.

Being able to produce something for less, therefore, would seem to make for an excellent competitive advantage. And indeed, it does. China, for instance, was for many years the ‘factory of the world’ precisely because it had a comparative advantage in labour for manufacturing purposes. In the same way, India also held a comparative advantage in IT outsourcing.

However, not all competitive advantages stem from comparative advantages. Comparative advantages work as competitive advantages where price is a primary differentiator between the various suppliers of a particular product. After all, a competitive advantage is the ‘X’ or the ‘wow’ factor that makes a supplier stand out against the rest of its competitors – and therefore, if price is a major component of the purchasing decision, being able to produce something cheaper (and thus sell it cheaper than others but still make a normal profit) is a competitive advantage.

Well and good, if you’re talking about commodity (or easily-commoditised) products. But in the current global marketplace, more focus is placed on the other components of the marketing mix (product, place, promotion), or what is known as differential advantage. Increasingly, for instance, consumers are evaluating brand propositions and reputations.

To see this in practice, one need only compare Apple and Microsoft. On the one hand, Apple has a reputation for stylish and chic designs, high-quality products and an increasingly large portfolio of interconnected consumer products. Microsoft, on the other hand, is well-known for its rock-solid enterprise products and support, making it the company of choice for the workplace.

On a larger scale, companies may drop the priority of cost considerations in favour of gaining a first-to-market advantage. When deciding to set up new factories or relocate existing ones, manufacturers will also consider ease of transportation, access to raw materials, even the financial and political stability of the nations/regions they’re considering.

Further down the value chain, possessing a comparative advantage in the supply of cheap labour is sufficient to make a country attractive to manufacturers, in much the same way that a comparative advantage in commodities is a competitive advantage. However, competing at the higher levels by way of using comparative advantage requires the use of differential advantage as well. It is no longer enough to be the most cost-effective; you must also demonstrate factors that make you stand out from others, whether it be low-to-no trade barriers, a liberalised economy or pro-business government policies.

Which, as it turns out, is precisely what is needed to fully capitalise on comparative advantages on a national scale anyway. Specialisation (concentrating on those subset of goods a nation has comparative advantages in producing) works only if there is a sufficiently large market demand to absorb those goods, and to subsequently purchase those goods not being produced (bilateral trade). As a country moves up the value train, in order to retain its comparative advantages, it must continue to seek improved efficiencies (which implies a mobile and highly-trained workforce) and invest in R&D on technologies that will reduce marginal production costs while increasing production volumes.

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