COMPETITIVE ADVANTAGE STRATEGY
Learn everything you need to know about sustainable competitive advantage. Written by an ex-McKinsey consultant, this guide on competitive advantage includes the 8 sources of competitive advantage, frameworks, best practices, examples, and a free PowerPoint template at the bottom.
Throughout Stratechi.com, we explain that the way to growth is to drive customer value better than competitors in a financially superior way. If you get the customer value element of your business model right, you will most likely turn on the growth engine. Yet, savvy competitors can often replicate a company, and over time can catch up and potentially surpass a leading company. The way to thwart competitive pressure is to develop sustainable competitive advantages, which is like building a big competitive moat around your business model.
By definition, sustainable competitive advantages are difficult for competitors to replicate. There are eight main sources of competitive advantage.
The sources of sustainable competitive advantage are:
• Brand Loyalty driven by the strength of the brand (Disney), design (Apple), products (Gillette), and loyalty programs (Target REDcard).
• Location in the form of prime physical locations for the given customer segments (Starbucks) or the sheer number of locations (7 Eleven).
• Scale over competitors that helps drive down costs and pricing, given leverage with purchasing (Walmart), volume production (Samsung), marketing (Coca-Cola), fixed costs (Costco), and partners (AT&T).
• Intellectual Property in the form of proprietary formulas (drug companies), processes (Toyota), and patents (Priceline).
• Innovation based on constant uniqueness and novel use of technology (Google) and design (Dyson).
• Proprietary Information, which can be in the form of knowledge (Glaxo Smith drug research), process (Tesla battery manufacturing) customer (Amazon purchase history), and many other types.
• Network Effects where the value of the product or service increases with the number of users or products. Typical of social (Facebook), technology (Salesforce.com) and market-based (Ebay) business models.
• Locked-up Supply happens when there are few to no other alternatives in the supply of product or service (DeBeers Diamonds).
While most companies focus on developing 1-3 sources of competitive advantage, some companies develop all eight sources of competitive advantage. Over the past 50+ years, Nike has developed all of the sources of competitive advantage in becoming the $35 billion leader in the athletic apparel, footwear, and equipment market.
In 1964, Nike was born through a partnership between Bill Bowerman, the head track coach at Oregon, and Phil Knight one of Bill’s middle-distance runners at Oregon, who finished his MBA at Stanford in 1962. In the beginning, the company went by the name Blue Ribbon Sports, and Phil imported Tiger brand shoes from Japan, initially selling them out of the trunk of his green Plymouth Valiant. With steady growth in the ‘60s, in 1971 Phil created the Nike brand and iconic Swoosh. The first Nike shoe, the “Moon” shoe was a hit with runners at the 1972 U.S. Olympic Trials, with an innovative waffle pattern sole invented by Bill Bowerman who used waffle irons to create the initial prototypes. Leveraging the patented waffle pattern, by 1980 Nike raked up $270 million in sales and represented 50% of the U.S. athletic shoe. The rest you can say is history, yet Nike’s history isn’t as rosy as our memories might make it out to be.
NIKE HAS HAD ROUGH PATCHES
While today, Nike has become a global brand juggernaut driving a record $34 billion in 2017 sales and $4.2 billion in net income, as you can see below there were a few blips of declining and stagnant sales in Nike's history. Though, after every blip, growth resumed, often at a torrid pace.
In 1986 Nike raked up their first $1 billion sales year, only to be followed by an 18% decline in 1987 sales driven by the extraordinary growth of Reebok and L.A. Gear riding the aerobic and fashion trend of the ‘80s. Reebok grew from a mere $1.5 million in sales in 1981 to $1.8 billion by 1989. Nike survived the aerobic fad and followed up the 1987 slump by more than tripling revenues over the next four years. In 1998, sales declined 8% and hit a lull until 2000. In an article, the NY Times attributed Nike’s slump to a maturing industry and a shift to alternative footwear such as “rugged boots and lug-soled shoes”. Yet again, Nike revved up the growth engine and in 2008 recorded $18.6 billion in sales, double what they did a mere six years early. And, while the great recession initially stagnated sales, from 2010 to 2017 Nike increased sales a whopping $15 billion to $34.3 billion.
In the meantime, so many once prominent athletic shoe brands, such as Reebok, Converse, Vans, L.A. Gear, Pony, Airwalk, and Avia have faded from their spotlight into nothingness or shadows of their former selves. Even Phil Knight in his 1986 letter to shareholders admitted, “(the athletic shoe market) is very easy to enter. Anybody with a glue pot and a pair of scissors can get into shoemaking, which was my mentor Bill Bowerman’s approach.”
So, the question is why over the past 50+ years, in the face of unrelenting competition and newcomers, Nike consistently won the long-term battle for the athletic shoe and apparel customers?
THE ANSWER: SUSTAINABLE COMPETITIVE ADVANTAGE
Over the past 50 years, Nike has continually developed all eight sources of competitive advantages, enabling it to deepen its hold on the market and weather competitive storms. Let's take a look at how Nike has and continues to invest in all of eight of the sources of sustainable competitive advantage.
1. CONTINUOUS INNOVATION
Nike’s innovation DNA began with Bill Bowerman's persistent drive to make shoes lighter and faster for his elite athletes all the way back in the 50’s. Stated in Nike’s first annual report in 1981,
“Our goal is to continually produce new and better shoes which will aid performance and reduce or eliminate injury. Today, Nike shoes have a reputation as being among the most technically innovative shoes on the market; a reputation that has been earned through an ongoing commitment to product research, development and evaluation.”
To achieve this goal that same year they opened up the Nike Sports Research Laboratory in Exeter, New Hampshire. From the 1981 annual report,
“Backed by more than 100 employees working in research and development, the Exeter facility was instrumental in the development of a complete individualized line of running shoes, designed for different foot types, body weights, running speeds, training schedules and sexes.
Today, our product development activities involve research and testing in biomechanics, exercise physiology, and wear testing…Through the use of high speed photographic analyses of the body in motion, the study of athletes on force plates and treadmills, plus continual testing of new shoes and materials, the researchers at Exeter can accurately identify the basic characteristic patterns of various foot types during activity. This data is then passed on to the company’s product development personnel, to be used in the development of prototype shoes. Input is also received from select research committees and advisory boards of athletes, coaches, trainers, equipment managers, podiatrists, and orthopedists during the conception and review of new designs.”
Today, the Nike Sports Research Lab is in a 16,000 square foot facility in Beaverton. Nike's research teams have been instrumental in the long lineage of innovations Nike has brought to the market from the waffle shoe, to Nike Air, to more recently Nike Free, Flyknit, and Fuelband. Innovation permeates almost every aspect of Nike. It is in their mission statement, “Nike’s Mission is to bring inspiration and innovation to every athlete in the world. If you have a body, you are an athlete.” It is in their culture, marketing and design. In 2013, Fast Company magazine ranked Nike as the most innovative company.
Continuous innovation has always been a cornerstone of Phil Knight's competitive game plan. As Phil stated in Nike's 1986 annual shareholder letter, the year before Reebok would overtake Nike in revenues:
“The industry is extremely competitive. The customer is placing great emphasis on “what’s new?” which puts extreme pressure on all facets of innovation – technological, styling and marketing.
But for all its negatives, especially the competitive factors, if a company can be innovative, the market responds positively… The sum-up on the industry is that it is one in which the rewards and risks are huge.
The thing I like about Nike, whose position I would not trade for any other in the industry, is that,…in virtually any long run scenario, it is a significant player…The final question is ‘Can we compete’…
Compete, I promise you, we can do.”
2. INTELLECTUAL PROPERTY
In 2017, the U.S. Patent Office issued Nike 1,213 patents, 21 times the number for Under Armour and even almost double the number for Facebook. Most people don’t equate Nike with intellectual property (IP), but, since their first patent in 1984, they have been steadily ramping up their efforts.
While patents represent Nike’s visible intellectual property, the vast majority of their intellectual property hidden from the public eye, which is the institutional knowledge and expertise within their research, product development, sourcing, marketing, digital, logistics and every other team within Nike. Any strong intellectual property strategy has the cultural foundation of empowerment to tap into the intelligence and creativity of the team.
3. A STRONG BRAND
A strong brand consistently delivers on its customer promise. Nike has always delivered on their customer promise of “bringing inspiration and innovation” to athletes around the world. While other athletic brands have come and gone, Nike has persevered and prospered. Over 100 publications and brand rankings have ranked Nike a top 50 brand.
While Nike is known for being the global pacesetter in marketing and advertising, branding always starts with great product. With Nike, many of the world’s best athletes and teams use their product. Though, Nike takes it a step further and collaborates with many of their signed athletes on product design and innovation.
This deep athlete partnership concept goes all the way back to Nike's beginning when they signed their first athlete, Steve Prefontaine, who held the American records in seven distances from 2000m to 10,000m at the time of his tragic death in a car accident at the age of 24. Phil Knight has often said Steve is the “soul of Nike,” because he was instrumental in pushing and collaborating with Phil and Bowerman on shoe design and innovation to make athletes faster and safer.
Nike took the first athlete partnership with Steve Prefontaine and utilized it as a blueprint to incubate and amplify new products into huge brands, like Nike’s multi-billion dollar Jordan and Tiger brands, along with many others.
Nike has always understood the power of billions of impressions of the world’s best athletes wearing Nike. If Nike shoes are good enough for Olympic, professional, and collegiate athletes they are most likely good enough for the billions of average athletes and the millions of kids dreaming of reaching the top.
4. LOCKED-UP SUPPLY
Typically with locked-up supply, companies come to mind like DeBeers, which had a virtual monopoly owning ~90% of the diamond market from the early 1900s all the way until 1980. In Nike’s case, they focus on locking-up the supply of the next up and coming global athletes with endorsement deals.
Even before Tiger left Stanford (a little-acknowledged fact is he never graduated), he had a $40+ million Nike contract ready to sign at any moment he decided to go pro. LeBron James signed a $90 million Nike deal at the age of 18, Michelle Wei signed at the age of 16. Nike has 6 of the top 9 paid athletes according to Forbes, and the only three females on the list.
While Nike pioneered locking up great athletes, there is now a war with Adidas, Under Armour and others to sign top athletes and tomorrow's prodigies. Over the past few decades, the business of sports has exploded, along with the sporting goods and athletic apparel markets. The battlefield has shifted a bit to identifying and locking up tomorrow's athletic prodigies. Nike has invested in their own network of scouts and partners who assess the global supply pipeline of up and coming athletes across almost every sport, which they are quick to sign as the prodigies mature to the professional ranks.
A great example of the Nike scouting and recruiting machine is their SPARQ combine program. They invest millions to annually grade the physical attributes and skills of the top 14,000 junior high and high school football prospects in the U.S. through an NFL-like combine. If an athlete performs well in the SPARQ combine, they could be invited to Nike Football Training Camp and then even the television show “The Opening” which takes place at Nike Headquarters. They have similar programs for almost every competitive sport.
Nike sells over 1 million shoes per day, along with countless other millions of units in apparel, socks, equipment, and accessories. The scale of Nike’s manufacturing operations is impressive with over 700 factories, in over 40 countries, employing over 1 million people.
To leverage the economies of scale, Nike utilizes contract manufacturers, continually finding new sources and factories that will drive higher quality and consistency at lower costs. Their economies of scale have allowed them to grow their gross margin from 28% in 1981 to 45% in 2017 and drive continuously increasing leverage on product development, selling, administrative and marketing costs.
On the flip side, Nike also uses its scale with its retail partners. In the early 2000s, there was an ugly dispute between Nike and Footlocker, as Footlocker wanted to become the “Walmart” of shoes with constant promotions and BOGOs (Buy one and Get one half off). Nike has always been a proponent of keeping retail pricing intact and non-promotional, and so the war began. The story goes that the CEO of Footlocker canceled a few hundred million in orders in protest to Nike’s rigid pricing guidelines and their high wholesale pricing. Nike responded by massively reducing the number of shoes they would ship to Footlocker, restricted some of the most popular styles from Footlocker, and increased distribution to competitive retailers. While Footlocker hurt, Nike prospered, and within about a year they reconciled their differences. Today, you see Nike leveraging its power and scale walking into almost every retailer that carriers Nike. Go to Footlocker, Dicks, Macy’s and look at Nike's prominence, typically in the front of the store with massive displays, fixtures, and inspiring imagery.
Location as a source of competitive differentiation is one of the oldest levers. In the 1700s and 1800s, establishing the first general store, with the right location, in a new town would often frighten off other competitors from coming in. Even today, location is a highly sought after competitive differentiator, especially for retailers, restaurants, and many service businesses.
In 1990, Nike took a gamble opening it's first flagship NikeTown store in downtown Portland. The flagship concept, part retail, part theater, and all brand, needed the best locations in the biggest cities. Nike made sure to capitalize on location as a competitive advantage, locking up premier retail real estate on Michigan Avenue in Chicago, Union Square in San Francisco, and about every other prime location in the top 50 cities in the world. Nike now has over 750 stores, with an average of over $8 million in sales per store.
7. PROPRIETARY INFORMATION
The digital enablement of almost everything has driven a massive proliferation of information. Companies that learn how to turn this proprietary information into knowledge, insight, and action help differentiate themselves.
Over the past decade, Nike has accelerated its ability to create and harness proprietary information, with big data strategies at the heart of many of their recent innovations, patents, and products. In 2010, Nike launched their Digital Sport Division which helped launch Nike+ which pairs sensors in Nike shoes with mobile apps, and FuelBand, which tracks your rate of activity and health statistics. The Nike+ RunClub community now numbers 140+ million, creating one of the world’s largest datasets on health and activity. Nike has double down on apps with their SNKRS app for sneaker junkies and the Nike shopping app. They’ve utilized proprietary data to design and stock a new concept store in Los Angeles.
Nike is a leader in digital advertising, social and ecommerce with 30+ million Facebook fans and over $2 billion in online sales. A few years ago, Nike shifted the majority of their advertising spend into digital and social to drive demand and the purchase of Nike product through the massive long-tail ecosystem of the web. Now, with NikeiD, anyone can go online and design shoes with personalized colors, graphics, and monograms, which is all the rage with teens. The ability for Nike, leveraging the massive amounts of big data generated from its digital and ecommerce strategy, to come up with new insights, products and sticky and engaging apps and services is almost endless and a competitive advantage practically impossible to surpass.
Over the next few years, we’ll be seeing a full out battle of innovations from Nike and others in creating and harnessing data sets of the body to help us understand and make better decisions about our health, activity, nutrition, sleep, and behavior.
8. NETWORK EFFECT
One of the most potent sustainable competitive differentiators is a network effect, where value grows as more users or nodes join a network. The more people join and post on Facebook, the more value users get out of Facebook. The more sellers on Amazon.com, the more buyers are attracted to it, which in turn drives more sellers to become part of the market. One of the reasons why social business models are so valuable, sticky and fast growing is because they often tap into the power of network effects.
With Nike, network effect is arguably Nike's weakest source of competitive advantage. They'll figure it out over time. They keep on coming out with new social features on the Nike+ RunClub app. With NikeiD, you can share your designs with friends. They'll continue to experiment with different models, apps, and features to tap into the power of network effects.
NIKE & SUSTAINABLE COMPETITIVE ADVANTAGE
While the shoe market is not hard to enter, it is difficult to succeed in. While many shoe companies have come and gone, Nike has continued its steady ascent to $34 billion in sales in large part because of its focus on developing and harvesting the eight sources of sustainable competitive advantage.
If you were fortunate it enough to buy $10,000 of Nike stock in 1984, it would be worth a cool $10+ million today.
DEVELOPING SUSTAINABLE COMPETITIVE ADVANTAGE
Developing sustainable competitive advantage is a long-term strategy. The more you can create a compelling vision and plant the seeds on the crucial sources of competitive advantage for your business and industry, the better off your company will be in 5-10 years.
If you want to begin thinking through a competitive advantage strategy, utilize the free PowerPoint download below to evaluate which sources of sustainable competitive advantage you currently have, prioritize those important to your industry or that you think you can drive, and then brainstorm various ways to improve the different sources of sustainable competitive advantage.