Why competitive advantage is about more than just performance

Imagine two almost identical companies: They operate in the same industry, produce similar products, have comparable revenue levels and employ a very similar workforce. Yet, Company A made $40 million in profits last year, while Company B made $45 million. At first glance, Company B has a competitive advantage as it generates more profits. But is that really the case?

In my new investigation published in the Strategic Management Journal, my co-author David Kryscynski and I provide a pioneering empirical approach and data to reconsider how to assess competitive advantage in businesses. While traditionally, a company’s worth is measured by shareholder returns, we consider it should be measured by profits and the value that other non-shareholder stakeholders capture.

Let’s say, for instance, the fair, market-based salary for employees at both Company A and B is $20 million. If Company B paid its employees exactly that but Company A paid $30 million, we need to adjust our understanding of a company’s true overall value creation.

Because Company A paid $10 million more than the market-based salary to its employees, the overall value it created equals $50 million ($40 million in profits plus $10 million in extra value shared with its employees). So, Company A has a competitive advantage despite its lower accounting profits.

At the end of the day, the value that a company generates can be distributed in many ways – it’s a matter of deciding who gets what and some may choose to distribute more to stakeholders than others. However, they should not be considered “less competitive” for doing so.

For the past few decades, much work in strategy research has been focused on understanding why some firms perform better than others. To do this, researchers have typically examined companies’ accounting profits – the usual revenue-minus-cost equation – which aligns with the belief that a firm aims to maximize shareholder returns.

But in recent years, there has been more discussion around the definition of “competitive advantage” and what a company’s true goal should be. Now, there’s increasing attention paid to the role of non-shareholder stakeholders – which includes employees, society at large and the environment, among others, and how much they’re getting out of it, too.

A key premise in this new perspective is that firms vary largely in how much value they share with these stakeholders – some firms share much more than the minimum needed to keep them contributing.

However, this theory has remained just that. Our research provides empirical evidence that some companies share much more with non-shareholder stakeholders than others, suggesting that relying on accounting profits may lead to an imprecise understanding of competitive advantage. In other words, overall value – the sum of all rents – is what really constitutes competitive advantage.

After analyzing over 14,000 Belgian firms and looking specifically at the firm’s workforce as a key stakeholder, we found significant variation in the value employees capture across firms. We proxied workforce rents as the difference between actual employee payments and estimates of market-appropriate salaries. We found that the standard deviation in workforce rents was about 86% of the average net accounting profits, suggesting that these rents often make up significant economic profits firms create.

Our findings also inform previous research on competitive advantage: reliably measuring competitive advantage and value creation requires consideration of value captured by shareholders and non-shareholder stakeholders. Simply put, just because a firm has lower accounting profits doesn’t necessarily mean it has a weaker competitive advantage – perhaps it just decided to share more with other stakeholders.

While more and more companies turn towards purpose-driven philosophies, our research provides a concrete way to measure performance in a world that continues to use traditional metrics like net accounting profits and shareholder returns. We do this, as mentioned earlier, by looking into stakeholder rents.

This approach is beneficial for CEOs because it gives them a way to show that, even if their profits are on par with those of their competitors, they share more value with other stakeholders (like employees) and therefore, have a competitive advantage over their peers.

It’s about re-evaluating our understanding of a company’s performance. That’s not to say shareholders and financial investors are not important. On the contrary, we need them and they must make returns to continue contributing capital. But it’s also important to consider other stakeholders’ returns. This will help firms understand the true economic value they create to make more informed strategic decisions.

It becomes much more than a qualitative statement. Rather, it’s about the value that a company creates at a holistic level and how it decides to distribute that wealth. Our research aims to support an evidence-based approach to integrating sustainable and ethical practices into corporate decision-making, allowing for more accurate measurement and understanding of overall value creation.