Every manager knows about ‘competitive advantage’: the ability to sustain profits above the industry average by developing distinctive capacity that competitors lack and are hard to replicate.

There are two types of competitive advantage: cost advantage and differentiation advantage.

People make firms work and determine efficiency, and productivity. They also create innovative ways to differentiate products and services. People are key to achieving competitive advantage.

People develop products, intellectual property, and proprietary know-how. They attract customers and build the customer base, which reflects the firm’s reputation and brand. People are instrumental in producing profits.

This blog explores the idea that firms seek competitive advantage and achieve it through investing in people.

Why competitive advantage matters

Entrepreneurs start firms with an idea and assemble resources to produce, market, sell, and deliver goods and services.

Goods and services have a market price that customers think fair, considering the benefits of ownership. The market price is usually higher than the cost of production or service delivery, but they are not directly linked.

The ‘top line’ of a profit-and-loss account or sales value represents the aggregate of all goods and services sold.

Direct costs incurred in producing and delivering goods and services (including labour costs) represent the cost of goods sold.

The difference between the top line and direct costs represents gross profit, which funds materials and administrative expenses, and includes net profit, the primary measure of success in trading firms. Administrative expenses, or ‘overheads,’ include sales, marketing, and administration costs.

Firms trade to make profits, but not all firms can achieve above-average profits in their industry. Competitive advantage exists when a firm can sustain above-average profits compared to competitors. This advantage arises from both physical and human resources, with staff development being easier and more cost-effective to change than investment in tools and processes.

Five determinants of advantage are productivity, effectiveness, innovation, quality, and service.

Employer-employee relationships

For competitive advantage through people, a strong positive relationship between employer and employee is essential. This relationship includes both explicit and implicit elements. Explicit elements include managerial documents (such as the employment contract) and communications.

Achieving competitive advantage requires either cost advantage or differentiation advantage, where customers prefer to buy from the firm over others. Since firms are composed of processes and people, both aspects matter.

What drives employees to excel and contribute more than average? The psychological contract explains this phenomenon. It describes the relationship between employees and employers and suggests that a strong psychological contract leads to added value and competitive advantage. Conversely, a damaged psychological contract can result in reduced discretionary behaviour and poor outcomes for the firm.

What Makes a Good Firm

To achieve competitive advantage, a good firm should prioritise employee well-being, development, and engagement. Examples include offering job security, training, work-life balance, and supportive culture. These initiatives not only improve employee satisfaction but also boost productivity and profitability.

So, what makes a successful firm? It’s one in which there is enough margin to fund activities such as staff development and to allow employees time to assist one another. But is it the margin that releases the funds or the activities that motivate and engage staff such that increased increased margin follows?

The cycle must start somewhere. The manager must believe in the benefits and take the first step.

Researchers at the University of Bath linked performance to 18 HR practices. They settled on 11 key practices that form an integrated model linking ability, motivation, opportunity, and performance. The Bath model shows the influence of these practices.

The model shows that training and development feed the ‘A, M, O’ processes, leading to commitment, motivation, job satisfaction, and high performance.

Achieving competitive advantage through people

Achieving competitive advantage through people realises one or both of two types: cost advantage and differentiation advantage. Cost advantage means making and delivering products and services for less than competitors. Differentiation advantage means customers prefer the firm’s products.

Managers find competitive advantage valuable because it leads to greater profits.

However, competitive advantage requires investment in people. The determinants of competitive advantage depend on the firm’s staff’s ability, motivation, and opportunity. This creates a chicken-and-egg situation, but managers must trust that investment in HR practices will lead to the desired outcomes and take the first step.