Markets and Competitive Advantage

Markets: where buyers and sellers meet

A market is any physical or virtual space where businesses (the sellers) interact with their customers (the buyers). The farmers market is a physical one. An app where people buy and sell used sneakers is a virtual one. Markets can be local, like the farmers market; regional, like the market for fresh milk across a few neighboring states; or global, like the market for smartphones.

Trade in a market is a voluntary exchange: nobody is forced to buy or to sell. Each sale generates revenue for the seller, the money it takes in, and creates value for the buyer, who walks away with a product they needed or wanted.

On price, though, the two sides pull in opposite directions. Sellers seek to charge higher prices to gain profit. Buyers try to pay lower prices to achieve savings.

How a market price settles

In a competitive market, many sellers offer similar products to many buyers. A seller who prices well above the rest loses buyers to the cheaper sellers. A seller who prices well below the rest gives up money that buyers would have paid. As sellers keep reaching for higher prices and buyers keep hunting for lower ones, prices tend to settle at a prevailing market price.

Picture four gas stations at one busy intersection whose owners never talk to each other. Their prices for regular gasoline still end up within a few cents of each other, because a station that charged 40 cents more per gallon would watch drivers pull in across the street.

Competitive advantage

Businesses that sell in the same market are rivals. Competitive advantage is a business's ability to outperform its rivals in that market. It leads to a larger market share, the business's portion of all the sales in that market, and potentially to larger profits.

Say two pizza shops on Main Street are rivals. Last year each sold about 500 pizzas a week. This year Tony's sells 600 a week and Bella's sells 400, so Tony's share of the pizzas sold on Main Street has grown from half to 60%. Tony's has a competitive advantage, at least for now. Whether it also earns more profit depends on what it did to win those sales and what that cost.

The competitiveness of a market determines the strategies a business will use to seek competitive advantage, so a strategy that wins in one market can fail in another.

How competitive is the market?

Markets vary in competitiveness based on how many rival businesses and product offerings there are, how differentiated the products are, and how easily rivals can offer identical or similar products at a lower price. A differentiated product has distinguishing features that set it apart from rivals' products.

Markets for many agricultural goods and other commodities, products that are basically the same whoever makes them, tend to be highly competitive. A grain buyer has no reason to pay more for one farm's wheat than for another farm's wheat of the same type and grade. So businesses in these markets seek competitive advantage by producing as efficiently as possible, which lets them charge the lowest price possible.

In competitive markets where rivals sell differentiated products, like running shoes or pizza, a business seeks competitive advantage by showing customers that its product is superior to its rivals'. It can do that with:

• Higher-quality products, like a kitchen knife made of steel that stays sharp longer.
• Unique product features, like a water bottle with a built-in filter.
• Better customer service, like a bike shop that tunes up every bike it sells, free, for a year.
• Lower prices, like a phone plan that costs less than rivals' plans for the same data.
• More effective marketing, like a sneaker brand whose ads reach exactly the runners it wants.

Barriers to entry and monopoly

Businesses in competitive markets may also seek competitive advantage by creating or strengthening barriers to entry, obstacles that make it difficult for new firms to compete. Barriers to entry may include:

• Intellectual property rights, such as patents. A company that patents a new insulin pump design can stop rivals from copying it.
• Regulations that limit rivals. A city that caps the number of taxi licenses keeps new taxi companies out.
• Limited access to resource suppliers. A cement maker that buys all the limestone from the region's only quarry leaves newcomers without a key ingredient.
• High startup costs. A new computer chip factory can cost billions of dollars, so few firms can afford to try.
• Low prices made possible by operating at a large scale. A warehouse chain that buys millions of items at a time can sell them at prices a new store cannot match.

A market with no competition at all, in which only one business operates and produces a unique good or service, is a monopoly. A business in that position does not have to compete for customers, and it may protect that advantage by maintaining its barriers to entry. Picture the only ferry company licensed to land at an island's harbor. Every visitor rides its boats, and it has every reason to defend the licensing rule that keeps rival ferries away.