AI Strategy, Competitive Advantage, and Business Model Innovation
The Necessity of AI Strategy and the Exponential Gap
AI strategy is critical for companies today because it determines their capacity to navigate the exponential age and dictates whether they can achieve competitive growth.
The exponential gap refers to the significant difference between traditional companies that grow linearly and high-performing companies that achieve exponential growth, driven primarily by the adoption of AI. To close this gap and remain competitive, companies must undergo a digital transformation and strategically incorporate AI into the core of their operations.
Characteristics of Top-Performing AI Companies
Top-performing companies (such as Facebook, Apple, Amazon, Netflix, and Alibaba) share three key characteristics:
- They are digital and AI-powered.
- They build ecosystems.
These characteristics allow them to scale rapidly with Near-Zero Marginal Costs: replacing human-dependent processes with technology to scale rapidly with little incremental cost. For example, personalized recommendations from Spotify or ad auctions from Google occur entirely without human intervention.
How AI Transforms Business and Empowers People
AI provides two major benefits:
- Improves Business Processes: Through automation (e.g., Ant Group’s 3-1-0 loan approval) and data-driven decision-making (e.g., JD Digits’ AI pig farming).
- Empowers People: By enabling non-experts to contribute meaningfully in fields like art and medicine, and by freeing employees from routine tasks to focus on strategic, creative work.
For instance, in the field of Creative Arts, engineers with limited artistic ability used AI to create a portrait in the style of Rembrandt that was nearly as good as the artist’s real works.
By implementing AI, companies and individuals move from traditional, specialized, and linear processes to data-driven, cross-functional, and exponential systems, effectively closing the massive competitive gap that defines the current business era.
The Innovation vs. Imitation Strategy Framework
A firm should decide whether to pursue innovation or imitation based on two critical dimensions: industry maturity and the company’s position within that industry relative to its competitors. By assessing where the company falls along these dimensions, leaders can make informed decisions that save resources, reduce risk, and accelerate impact.
Dimension 1: Industry Maturity
The maturity of the industry is the first critical dimension in determining strategy.
- If the industry is nascent (young): The firm should innovate. Innovation tends to win because many valuable opportunities await discovery, and superior designs have not yet been found.
- Companies are advised to leapfrog existing models to establish market leadership.
- Example: When Tesla entered the early modern electric vehicle market, it successfully innovated by launching premium, long-range vehicles, leapfrogging competitors who were merely imitating conventional car templates.
- If the industry is mature: The strategy depends entirely on the firm’s competitive position.
Dimension 2: Competitive Position (in a Mature Industry)
In a mature industry, a firm’s position—how it performs on key criteria (e.g., cost, quality) compared to others—dictates whether innovation or imitation is optimal.
- At the Performance Frontier (Leader): The firm must innovate and push the boundary further, as there are no better models to copy.
- Behind the Frontier (Challenger): The firm should strategically imitate. It is best to imitate nearby, better-performing competitors that sit within the “imitation radius” to efficiently catch up.
The Unique Business Model of Hermès: Scarcity and Exclusivity
The business model of Hermès differs fundamentally from that of competitors like LVMH and Gucci (owned by Kering) primarily through three factors:
- Extreme reliance on scarcity.
- Focus on craftsmanship and exclusivity.
- A distinct approach to growth and marketing.
Strategy of Intentional Scarcity
Hermès maintains a centuries-old strategy that places scarcity at the forefront, which fuels high demand for its products. Hermès intentionally ensures that they are always making less than there is demand for. This strategy involves having fewer stores and fewer online sales than the market would otherwise demand.
For the most exclusive products, such as the Birkin or Kelly bags, the company employs a “devious business model” to enforce exclusivity. Even elite customers are required to:
- Cultivate a relationship with a sales associate.
- Make several purchases just to be considered for a Birkin or Kelly.
To obtain one of these bags, customers often must spend “five to ten times that” amount on other Hermès products just to become eligible to buy the desired item.
Vertical Integration and Timeless Craftsmanship
Hermès also differentiates itself by staying true to its own history and product DNA, operating as a vertically integrated company. Unlike many rivals, it is still family-run, focuses on its heritage and timeless craftsmanship (like fine leather and stitching), and avoids heavy advertising and celebrity endorsements. This commitment to lasting quality over passing trends is what makes its products classic and “timeless.”
Financial Resilience Through Exclusivity
Hermès’ strategy of extreme scarcity and exclusivity is directly responsible for its powerful growth, high status, and financial resilience. By intentionally keeping supply below demand, they were able to outperform the market during downturns, achieving high revenue growth even when competitors struggled, as loyal customers spent more per transaction to access coveted items. Furthermore, despite operating far fewer stores, Hermès generates superior revenue and profit margins, earning investor confidence reflected in its high price-to-earnings ratio.