The starting point for understanding core competences is understanding that businesses need to have something that customers uniquely value if they're to make good profits.

"Me too" businesses (with nothing unique to distinguish them from their competition) are doomed to compete on price: the only thing they can do to make themselves the customer's top choice is drop price. And as other "me too" businesses do the same, profit margins become thinner and thinner.

This is why there's such an emphasis on building and selling USPs in business.

If you're able to offer something uniquely good, customers will want to choose your products and will be willing to pay more for them.

The question, though, is where this uniqueness comes from, and how it can be sustained.

In their key 1990 paper "The Core Competence of the Corporation," C.K.Prahalad and Gary Hamel argue that "Core Competences" are some of the most important sources of uniqueness: these are the things that a company can do uniquely well, and that no-one else can copy quickly enough to affect competition.

Prahalad and Hamel used examples of slow-growing and now-forgotten mega corporations that failed to recognize and capitalize on their strengths. They compared them with star performers of the 1980s (such as NEC, Canon and Honda), which had a very clear idea of what they were good at, and which grew very fast.

Because these companies were focused on their core competences, and continually worked to build and reinforce them, their products were more advanced than those of their competitors, and customers were prepared to pay more for them. And as they switched effort away from areas where they were weak, and further focused on areas of strength, their products built up more and more of a market lead.

Now you'll probably find this an attractive idea, and it's often easy to think about a whole range of things that a company does that it can do well. However, Hamel and Prahalad give three tests to see whether they are true core competences:

  1. Relevance – The competence must give your customer something that strongly influences him or her to choose your product or service. If it does not, then it has no effect on your competitive position and is not a core competence.
  2. Difficulty of imitation – The core competence should be difficult to imitate. This allows you to provide products that are better than those of your competition. And because you're continually working to improve these skills, means that you can sustain its competitive position.
  3. Breadth of application – It should be something that opens up a good number of potential markets. If it only opens up a few small, niche markets, then success in these markets will not be enough to sustain significant growth.

For example, you might consider strong industry knowledge and expertise to be a core competence in serving your industry. However, if your competitors have equivalent expertise, then this is not a core competence. All it does is make it more difficult for new competitors to enter the market. More than this, it's unlikely to help you much in moving into new markets, which will have established experts already.