When Growth Weakens Competitive Advantages

When businesses grow and develop, they often look to expand production, enter new markets, and increase their customer base. This, in turn, will lead to increased revenue. However, growing a business at too quick a pace without the necessary strategic discipline can create new problems rather than simply adding more value. For example, issues with market planning, supplier capacity, the need for capital, and maintaining product or service quality.

This leads to an important strategic question: when does the growth of a company strengthen the business, and when does it begin to weaken the competitive advantage that made the business successful in the first place? Increased revenue and greater market share do not automatically translate into a stronger competitive position. Growth can create strategic costs of its own if the company’s resources, capabilities and desired customer experience are unable to keep pace with the increased scale of the business.

The purpose of this research is to develop a framework to determine whether growth supports a company’s competitive advantage and when it starts to erode it. To that end, the relationship between the basis of a company’s competitive advantage, the degree to which that advantage can be scaled up, the extent of dilution, and the degree of discipline in growth will be examined. The result will be a way to assess whether a company should grow, and how and at what rate it can grow without undermining its source of advantage.

Many companies strive for growth. By increasing sales, production or markets, it is possible to increase revenue and achieve higher levels of profitability. A business can also benefit from economies of scale. Here, fixed costs are covered by a higher volume of sales. This allows for greater efficiency in terms of production and operations. In addition, a larger customer base and stronger market position can result in a greater competitive edge. In many cases, growth will lead to additional funds that can be used for re-investment, innovation and further growth.

However, growth is not without limit. Not only do sales and production have to increase, but so too will requirements for capital, supplies, systems, and people to manage. To the extent that growth is greater than that which the business can support, then growth can pose serious challenges. It creates problems of an operational, financial, and quality nature. And these will tend to erode that which has enabled the business to compete in the first place.

In summary, growth for its own sake is not sufficient; it is important to assess whether the business can sustain and develop in line with its growth, without compromising its existing strengths.

While growth can bring great financial and strategic benefits, it also creates tremendous pressure on the resources and capabilities that a business originally developed to deliver its value proposition to customers. This is because, as a business grows, demand for its production capacity, skilled employees, capital, management, and suppliers will typically grow at the same time. Thus, while this demand can create additional value for a business, it also can create a lot of pressure on it, too.

Of even greater concern, however, is that certain competitive advantages are significantly more difficult to scale because they depend on factors such as craftsmanship, scarcity and tightly controlled quality. A company such as Hermès, whose competitive position depends heavily on these characteristics, must therefore manage growth carefully. As production increases, the company also requires additional skilled artisans, production capacity and suitable raw materials, placing greater pressure on the capabilities that support its competitive advantage. In such circumstances, growth and value do not necessarily move in the same direction: additional volume may create financial value, but expanding too quickly can begin to weaken the characteristics that made the business distinctive in the first place.

In many industries, there are many ways that growth creates problems for the basis of a company’s competitive advantage. For Cathay Pacific, for example, growth in routes, in capacity, in volume of passengers, leads to demands on aircraft, on staff, on airports, on systems to deal with customers. If these are unable to grow as fast as the growth in demand for the business, then the premium experience for customers will start to break down.

Technology companies face a different version of the same problem. Digital products and services can often be distributed across a large customer base, allowing growth to create significant additional value. However, as a technological ecosystem expands across more products, services and user needs, the system can also become increasingly complex. Apple’s ecosystem provides an example: as the number of connected products and services expands, maintaining integration, simplicity and a consistent user experience across the ecosystem can become more challenging. Growth in this case is therefore less constrained by physical scarcity and more by the company’s ability to manage increasing complexity without weakening the coherence of the overall system.

These examples give more substance to the general strategic principle that growth creates pressure on the resources, the capabilities and the characteristics of a company that have created its competitive advantage in the first place. The question of whether or not there is sufficient demand for further growth is not the strategic question. The more important question is whether or not the core of advantages that have created value in the first place can also be brought to further growth.

A Conceptual Relationship

The central logic of the Growth–Advantage Framework can be expressed through a simple conceptual relationship:

This relationship does not represent a quantitative financial formula. Instead, it illustrates the directional logic of the framework. As the scalability of a company’s competitive advantage increases, the business is generally better positioned to support further growth. As dilution risk increases, however, the ability to expand without weakening that advantage decreases. Sustainable growth therefore depends not simply on the existence of demand, but on the balance between how easily the underlying advantage can scale and how much strategic value expansion may place at risk.

Growth should not be evaluated only by the amount of additional revenue, customers or market share it can generate. A more important question is whether the source of a company’s competitive advantage can expand at the same pace. If demand grows faster than the capabilities supporting that advantage, expansion may begin to create pressure on quality, customer experience, exclusivity or operational control. The Growth–Advantage Framework therefore evaluates growth through four stages: identifying what creates the company’s advantage, testing whether that advantage can scale, diagnosing what may be diluted during expansion, and determining the appropriate level of growth discipline.

The Model

Accelerate Growth applies when the source of competitive advantage can be made to grow quite easily and in addition even greater scale is created with only slight risk of it decreasing in value.

Scale Selectively is relevant if the advantage is in fact scalable but there is also the potential for significant dilution from expanding into other products, markets and activities. Growth can be focused to maximum advantage in those areas in which the advantage is being preserved.

Increase Scalability – If the source of advantage for your company is difficult to scale but growth does not create significant dilution of advantage, invest in scalability before growth is accelerated. This means investing in the right people, technology, physical and human infrastructure, supply capacity, and systems etc. to enable growth.

Protect the Advantage – The advantage cannot be scaled and therefore growth can only occur in a manner that allows the advantage to be protected from dilution in the short term. Growth may occur but it must occur at a pace that is commensurate with the company’s ability to protect its advantage.

Thus, the new framework is not meant to decide whether or not growth in a business is good. Instead, it is intended to help determine if a business can grow while remaining true to the source(s) of the advantage(s) that brought customers to it in the first place. Growth can occur at a very aggressive pace or at a more measured (and perhaps even, in some cases, more deliberate) pace.

By applying the Growth–Advantage Framework to different businesses with different sources of competitive advantage, a strategic framework will be of value. The framework will produce different strategies depending on the scalability of the advantage and the risks of expansion. The following are examples of three different businesses and their corresponding strategies.

Hermès — Protect the Advantage

Hermès provides an example of relatively low advantage scalability combined with high dilution risk. Its competitive position depends heavily on craftsmanship, product quality, controlled supply and exclusivity. Although global demand can increase rapidly, the capabilities supporting these characteristics cannot necessarily expand at the same pace. Increasing production requires additional skilled artisans, production capacity and suitable materials, while excessive availability could also place pressure on scarcity and exclusivity. The Growth–Advantage Framework therefore places Hermès closest to Protect the Advantage. This does not mean rejecting growth; rather, production capacity should expand only at a pace that allows craftsmanship, quality and supply capabilities to develop without significant dilution. In this situation, strategic discipline can create greater long-term value than maximising short-term production volume.

Apple — Scale While Protecting Integration

Apple represents a different position within the framework. Many elements of its ecosystem, particularly software and digital services, can be distributed across a very large user base. However, the competitive advantage of the ecosystem depends not simply on scale, but on maintaining integration, simplicity and consistency across an expanding range of products and services. As the ecosystem grows, increasing complexity may therefore become an important source of dilution risk.

The Growth–Advantage Framework places Apple closer to Scale Selectively. The scalability of software and digital services allows substantial expansion, but growth should remain disciplined where additional products, services or platform complexity could weaken integration and simplicity. In this case, the objective is not to restrict scale itself, but to ensure that expansion continues to reinforce rather than fragment the wider ecosystem.

Cathay Pacific — Build Capacity Alongside Growth

Cathay Pacific demonstrates how growth can be constrained by physical and service capacity. Expanding passenger numbers, routes or flight frequency can create additional revenue opportunities, but the airline’s premium experience also depends on aircraft availability, trained employees, airport operations, lounges and consistent service delivery. These capabilities cannot necessarily expand immediately alongside demand.

The Growth–Advantage Framework therefore suggests that Cathay Pacific should Increase Scalability by developing the operational and service capacity required to support further expansion. Growth creates greater value when aircraft, employees, infrastructure and service capabilities develop alongside passenger demand. In this case, the objective is not simply to maximise passenger volume, but to ensure that the capabilities supporting the premium customer experience can scale with it.

Notice, however, that businesses that deliberately restrict their growth in order to protect their existing strategic position will, in time, suffer several serious disadvantages as competitors gain ground based on growing market opportunities, greater economies of scale, and increasingly sophisticated customer needs.

A further important point is that industries differ greatly with regard to scalability. For example, companies with strong network effects (e.g. Facebook) or very scalable digital businesses (e.g. Amazon Web Services) can in fact gain advantage through fast growth. It is therefore potentially far more damaging for such companies to hold back on growth to protect the current set up (i.e. through dilution) than it would be for companies that are highly dependent on scarce resources (e.g. Hermès’ rarity), on craftsmanship (e.g. Hermès’ skilled craftsmen), or on very personal services (e.g. high-end fashion designers).

Scalability can also change over time. While initially, a business has low advantage scalability due to factors such as diluted value added per unit, through investments such as technology, employee training, infrastructure, and relationships with suppliers and partners, as well as through the introduction of new operating systems, the scalability can increase.

Finally, this framework is primarily of use as a strategic tool for diagnosing a situation, not for providing a quantitative basis for a decision. Issues such as dilution risk, customer experience, and control of a business’s operations cannot be reduced to a single financial measure. Therefore, this framework is best used as the basis for making a strategic decision, after due consideration has been given to relevant financial, operational, and market data.

The framework also depends heavily on correctly identifying the true source of competitive advantage. A large customer base, high profitability or significant market share may be outcomes of competitive advantage rather than the underlying capabilities that created it. If a business incorrectly identifies the source of its advantage, its assessment of scalability and dilution risk may also become misleading. The first stage of the framework should therefore be treated as a critical strategic diagnosis rather than a simple classification exercise.

The Growth–Advantage Framework can be used before a business makes a major expansion decision, for example entering a new market, increasing production, opening additional locations, expanding its product portfolio or serving a substantially larger customer base.

The process begins with five questions:

1. 01

   Step 1 — Identify the true source of competitive advantage.

   Determine why customers choose the business over its alternatives and identify the capabilities that make this possible. A large customer base, high revenue or significant market share may be outcomes of competitive advantage, but they are not necessarily the underlying capabilities that created it. The objective is therefore to identify what the business must continue to protect as it grows.

2. 02

   Step 2 — Determine whether that advantage can scale.

   Evaluate whether the resources (physical and intellectual), the people, the technology, the supply, and the organizational structure required to deliver the advantage can scale up to the required extent and to the necessary pace.

3. 03

   Step 3 — Identify potential dilution.

   Assess the extent to which greater scale could weaken the characteristics supporting the company’s competitive advantage. This should include potential pressure on (1) quality, (2) customer experience, (3) brand positioning, (4) exclusivity and (5) operational control. The purpose is to identify what the company risks losing as it expands, rather than evaluating growth only through the additional revenue it may generate.

4. 04

   Step 4 — Compare the value of growth with the cost of dilution.

   Similarly, when weighing additional revenue from increased scale against the challenges of scaling, do the economic benefits of growth exceed the cost of diluting your competitive advantage?

5. 05

   Step 5 — Select the appropriate growth discipline.

   Based on advantage scalability and dilution risk, a company can choose to Accelerate Growth, Scale Selectively, Increase Scalability, or Protect the Advantage. The appropriate response depends on whether the source of competitive advantage can expand alongside demand and how much strategic dilution additional growth may create.

Value is created by businesses through growth, i.e. through an increase in revenue, creation of economies of scale, expansion of market and increased resources for future investment. Increased size, however, does not automatically translate into increased strategic strength.

As set out in the Growth–Advantage Framework, the quality of growth for a business depends upon the relationship between its expansion and its competitive advantage(s). Thus, as long as the capabilities behind an advantage can scale up with demand and only suffer slight dilution, growth will bring about increased value. However, as soon as the underlying capabilities are unable to keep pace with a company’s expansion, demand for quality and, above all, the customer’s experience will begin to suffer, as will brand differentiation, customer’s exclusivity and the company’s operational control.

Growth does not have to be fast to create value for a business. In fact, there are different levels of growth discipline that are needed for companies with different advantages, and some will benefit from accelerating their growth, while others will need to increase scalability, expand selectively or even try to protect the source of their advantage.

This implies that rather than focusing solely on whether or not a business should engage in growth, the key strategic issue for a company is the extent to which its competitive advantage is able to scale with its growth in order to ensure that, as the business becomes larger, it does not become strategically weaker.