Strategy is all about identifying and creating areas of competitive advantage. Project management is all about executing those strategies.
This post examines two economics concepts – Absolute Advantage and Comparative Advantage – which provide structure for analyzing and achieving competitive advantage.
What Is Absolute Advantage?
Absolute Advantage is a concept invented by Adam Smith in his book “The Wealth of Nations” in the context of international trade back in 1776. At the time, labor was the primary, or often only, input.
The original concept stated that a country can have distinct advantages over on another in terms of its inherent efficiencies in producing certain products.
The graph at right depicts two nations, one in Blue and the other in Green.
Based upon the lines, the Blue country has the capability to put all its resources into producing 20 units of wheat, all into producing 25 units of corn, or dividing its resources to produce some combination of wheat and corn along the Blue line.
Likewise, the Green country has the capability to put all of its resources into producing 15 units of wheat, all into producing 10 units of corn, or dividing its resources to produce some combination along the Green line.
For example, in the scenario above, with no trade, each the two countries might split their respective resources evenly between wheat and corn. The Green country would produce 7 of wheat and 5 of corn. The Blue country would produce 10 of wheat and 12 of corn.
The graph clearly shows that the Blue country can produce more of both Wheat and Corn than the Blue country. It has an Absolute Advantage in each.
The formal definition of Absolute Advantage is:
“The ability of one producer to produce a good or service in greater quantity for the same cost, or the same quantity for a lower cost, than its competitors.”
Clearly the Green country has an Absolute Advantage over the Blue country, as it satisfies that definition for both Wheat and Corn.
If you want to dig deeper into the financial aspects, see the coverage of Absolute Advantage from the Corporate Finance Institute,
Let’s turn from Absolute Advantage to Comparative Advantage.
What is Comparative Advantage?
Comparative Advantage looks beyond just the idea that the Green country can produce more of each product. It considers that the Green country has an Opportunity Cost for producing one product over the other. This reveals a Comparative Advantage that each country has – based on that Opportunity Cost.
A formal definition for Comparative Advantage is:
“The ability of one producer to produce a good or service at a lower Opportunity Cost than its competitors.”
Opportunity Cost is what is missing from Absolute Advantage. Opportunity Cost is the potential benefit that is lost when choosing one alternative over another.
In Comparative Advantage, we can look at the Opportunity Cost to the Green and Blue countries for not producing wheat or corn.
For example, for the Green country, the Opportunity Cost of producing corn instead of wheat is:
- 15 Units of Wheat / 10 Units of Corn = 1.50
The Opportunity Cost of the Blue country producing corn over wheat is:
- 25 Units of Wheat / 20 Units of Corn = 1.25
Since the Green country has a higher Opportunity Cost of producing corn instead of wheat, it should avoid that cost and produce wheat. The Blue country should use its resources to produce corn, where it has an Opportunity Cost advantage.
Pros and Cons of Absolute and Comparative Advantage Theory
The above explains the concepts. Now let’s look at the reality.
Given what works in theory, in what ways do we need to be cautious in the use of Absolute and Comparative Advantage?
- Absolute Advantage theory assumes that there is only trade between two countries, and of only two products. In reality, there will be multilateral trade of multiple products and services.
- Both Absolute and Comparative Advantage theory assume that there is free trade among countries. In reality, protectionist measures and other forces can restrict the freedom of trade.
- It may be advantageous for countries to maintain a minimal level of production of a product or service – for security or to manage risk – even if the theory says they should not.
- A country more likely will not have an Absolute Advantage across all products. Revisiting the example above, the Blue country may have an Absolute Advantage on wheat, while the Green country may have an Absolute Advantage on corn.
- As the theories are based on production only, they do not account for the demand for consuming each of the products.
These differences and issues need to be considered, but the basic theory behind Absolute and Comparative Advantage is still sound and worth taking into consideration. For further coverage, see Absolute vs Comparative Advantage on Investopedia.
Applying Absolute and Comparative Advantage in Strategy
Absolute and Comparative Advantage apply not only to nations, but to industries and organizations.
Michael Porter devised the Diamond Model to provide an approach to understanding the competitiveness of industries among nations. Absolute and Comparative Advantage undoubtedly provided some foundational concepts for that.
Here are some strategy oriented questions driven by Absolute and Comparative Advantage.
- Should the company be the network organizer, or a joiner/partner? – Companies need to be in particularly strong strategic position to create, manage, and own the network. If not, they should consider the potential network effect advantages of joining the network as a participant.
- Where should the business locate a factory for a particular product? – Absolute Advantage needs to be considered for each part of the business. One way to do that is to look at the value chain and evaluate the company’s positioning at each link. There may be an Absolute or Comparative Advantage on some links, while other links may require further consideration on how to approach.
- What should the company in source versus outsource? – It may be desirable to simply outsource to stronger competitors on links in the Value Chain where the company does not have an Absolute or Comparative Advantage.
- What are the Opportunity Costs of one direction versus another? – Consider more than financial costs. As illustrated with Comparative Advantage, consider whether it is advisable to seek the low Opportunity Cost solution.
Absolute and Comparative Advantage have roots in economics and can provide insights that are useful in evaluating strategic options.
Applying Absolute and Comparative Advantage in Project Management
The principles of Absolute and Comparative Advantage apply not only to nations, industries, and organizations, but also to projects!
The following are some common project situations where you can leverage these principles.
- Choosing projects – Which projects play to the strengths of the company, as determined by Absolute or Comparative Advantages? Is there a theme of emphasis on these advantages across most projects?
- Outsourcing decisions – On individual projects, which items should be outsourced? What tasks should the immediate team do itself? What talent strengths exist within the organization?
- Hiring and delegating – In thinking about strengths, think about Comparative Advantages. You or a team member may be strong at something, but due to the Opportunity Cost might be better off focusing on higher value efforts.
- Tasking team members – What relative strengths do team members have? Teams often have someone that can do everything quite well, but you are better to distribute work around the team and allow that person to focus on the tasks of the greatest value added.
- Building individual competencies – What talents, strengths, and capabilities do you want to build within the greater project execution community in your organization? Think of the kinds of decision and tradeoffs that you will need to make in the medium and long term, and the kind of options you would like to have.
I recommend these PM templates (paid link):
A broader, higher level concept like Absolute Advantage and Comparative Advantage can usually be applied effectively in smaller situations like projects and programs.
Go to Absolute Advantage at the Intelligent Economist for and economics-centric view.
For presentations and strategic planning, check out the strategic frameworks below. To apply Absolute and Comparative Advantage principles within the contacts of building a project framework, use the templates below.
I recommend these strategy resources (paid link):