The concept of comparative advantage was first formulated by economist David Ricardo as an explanation of the benefits of international trade for countries. His theory concluded that a country could increase its income by specializing in certain products and services and selling these on the international market. Businesses also may have a comparative advantage over their competitors resulting from certain assets, skills or geographical and historical factors. For example, an industry may be in an area where the workforce is specialized in certain skills, or an agricultural business may be situated in an area of rich soil and favorable climate. The benefits of comparative advantage also may apply to people and provide a reason why they should specialize in certain skills rather than others.
Ricardo’s theory of comparative advantage points out that, if a country is relatively efficient at producing certain products then it should specialize in these, even if it does not have an absolute advantage in their production. In other words, even though other countries might produce these goods more efficiently, a country should still specialize in certain goods if the opportunity cost of producing them is lower in that country. The opportunity cost is the cost of the next best use that could be made of the resources devoted to production of the goods. Opting to specialize in goods that it produces comparatively efficiently could help a country to sell more and increase its income.
The benefits of comparative advantage are that, if the country specializes in those goods in which it is relatively most efficient, then the total national output and, therefore, the national income may be increased. The country can produce more of those goods than it needs and export them to other countries while using export proceeds to purchase imported goods and services that it does not produce. In economists' terms, the country is pushing its production possibility frontier outward and, therefore, increasing its national output. The benefits of comparative advantage may, therefore, result in greater national income.
In the case of a trading company, the benefits of comparative advantage may explain how a company can increase its profits by concentrating on producing those goods and services for which it has a comparative advantage over its competitors. This may mean concentrating on core products and core competencies. The company may be more efficient than its competitors in producing certain items owing to the possession of certain advanced tangible assets or valuable intangible assets. For example, the company may possess certain patents or know-how enabling it to make its processes or products more efficient. Valuable intangible assets could include having experienced management or a skilled workforce in place.