The competitive advantage of nations by Michael porter The central question in economics is why a nation becomes a home base

for successful international competitors in an industry? Hence why are firms in a particular nation able to create and sustain competitive advantage against the best competitors? The answers to these questions are of central concern to firms that must compete in the international markets. These answers have implication to all firms in a country. A nations standard of living in the long term depends on its ability to attain a high level of productivity in the industries in which its firms compete. This rests on the firms capacity to achieve improved quality or greater efficiency. Changes in the nature of competition internationally have weakened the traditional explanations of dominance of international trade. Some see national competitiveness as a macroeconomic phenomenon while others see it as function of cheap and abundant labor. Plenty of natural resources have also been expounded as one reason for competitiveness, while some have looked it as an influence of government policy. Management practices have also been put forward to explain competitiveness. These conflicting explanations merit the asking of the question what is competitiveness? Is a competitive nation: 1. one competitive in all industries 2. who has favorable exchange rate 3. ability of a nations industry to command high prices in markets 4. large positive balance of trade 5. rising share of world exports 6. one that creates jobs 7. low labor costs The principal economic goal of a nation is to produce a high and rising standard of living for its citizens. This ability depends on the productivity with which nations resources are employed. Productivity is the value of output produced by a unit of factor input. This depends on the quality and features of products and the efficiency with which they are produced. National productivity determines the competitiveness of a nation. Sustained productivity requires continuous up gradation of the economy. Thus nations firms must relentlessly improve productivity in existing industries by raising product quality, adding desirable features, improving production technology and boosting production efficiency. It must also develop the capabilities required to compete in more and more sophisticated industry segments, where productivity is generally higher. An upgrading economy is thus one which has the capability of competing successfully in new and sophisticated industries. The aim is to support high wages and command premium prices. International trade and foreign investment provide opportunities to do so. 1. a nation can specialize in those industries in which its firms are relatively more productive 2. no nation can be competitive in everything 3. International competition necessitates meeting of higher standards both in features and in productivity. 4. a rising share of exports in increasingly sophisticated industries can support productivity growth Hence the core question is why nations are able to compete in sophisticated industries and activities involving high productivity. To understand this, need is to concentrate on specific industries and industry segments. Concentration on macroeconomic aggregates does not

explain why and how meaningful and commercially valuable skills and technology are created. This can be understood only at the level of particular industries. Methodology: 1. Competing internationally means exports and/or locating activities abroad. This study is concerned with determinants of international success in relatively sophisticated industries and segments of industries involving complex technology or human skills. 2. To be successful, firms must possess competitive advantage. This competitive advantage must be sustained over time. This can be achieved through lower costs or differentiation of products which enable higher prices. 3. International advantage is often concentrated in narrowly defined industries or segments of a particular industry. 4. Increased trade has led to increased specialization and in narrow segments of industries. 5. In many industries and in many distinct segments of industries, true international competitive advantage is based only in few nations. Hence the influence of nations applies to industries and segments. Hence the unit of analysis has been taken as the industries or segments of industries. Classical explanations: Absolute Advantage Theory (Adam smith 1776) Nations could specialize in producing and exporting goods where they have a natural or acquired Absolute Advantage and import those goods they dont produce as well. Comparative Advantage Theory (David Ricardo 1816) Ricardo indicated that nations that are comparatively more efficient at production will make those goods even though they may not have an absolute advantage. Comparative Advantage explains and predicts trade of goods where absolute advantages may not exist. Comparative Advantage must be explained by: Comparative Production Cost depends on the commoditys production process. Production Factors such as labor, land, capital, and natural resources Heckscher-Ohlin Theorem ( 1933) 1. All nations have equivalent technology but differ in their endowments or factors of production. 2. Countries export goods that make intensive use of the countrys abundant factor. 3. Countries import goods that make intensive use of the countrys scarce factor. 4. Differences in comparative advantage are attributed to differences in the structure of the economy. 5. Implications: Trade should be greatest between countries with the greatest differences in economic structure. Trade should cause countries to specialize more. Trade policy should take the form of trade restrictions. Countries should export goods that make use of the abundant factors. The Leontief Paradox Stimulated a search for explanations. Demand bias for capital-investment goods. Existence of trade barriers. Importance of natural resources Prevalence of factor-intensity reversals International Product Life-Cycle (Vernon)

 Most new products initially conceived and produced in the US in 20th century US firms kept production close to the market Aid decisions; minimize risk of new product introductions Demand not based on price yet; low production cost not an issue Limited initial demand in other advanced countries Exports more attractive than production there initially With demand increase in advanced countries Production follows there. With demand expansion elsewhere Product becomes standardized production moves to low production cost areas Product now imported to US and to advanced countries Fundamentally: Free Trade expands the world pie for goods/services Suggests how home market can influence innovation Does not explain why innovation is continuous phenomenon Theory Limitations Simple world (two countries, two products) no transportation costs no price differences in resources resources immobile across countries constant returns to scale each country has a fixed stock of resources and no efficiency gains in resource use from trade full employment most of world trade occurs between nations with similar factor endowments and in goods which are produced with similar factor proportions significant trade is between MNCS and its subsidiaries Eclectic theory of international trade (dunning 1988) The propensity of an enterprise to engage in international production financed by foreign direct investmentis dependent on 1. the extent to which it controls assets which it competitors do not do so( ownership advantage)this can consist of ownership of brand, trademarks, trade secrets, intellectual property rights, technology, management know how, economies of scale of production. 2. Whether it is in its interest to sell or lease these assets or make use of them itself (internalization advantage)this depends on whether the transaction costs of an arms length relationship is higher than managing the activity within its boundaries. 3. How far it is profitable to exploit these ownership advantages in conjunction with locational advantages of foreign country or home market. There is a need for a new paradigm to explain 1. In industries where factor comparative advantage is not the only factor leading to competitive advantage. These technology intensive industries offer widespread

economies of scale, differentiated products, and varying buyer need across countries. 2. role of technology which allows bypassing of the advantage of scarce factors of production 3. trade between countries with comparable factor endowments 4. the impact of globalization which decouples the firm from factor endowments of a single nation 5. international flow of capital 6. While many factors are mobile, however trade persists. Thus it can be postulated that international success is determined by where and how factors of production are effectively deployed. The new postulations: 1. Economies of scale, which gives a firm a cost advantage that allows exports. This coupled with associated market imperfections enables nations to exploit these to maintain exports. 2. a large home market 3. technology gap and its exploitation 4. emergence of multinational corporations( does not explain why and how they attain the skills and know how in particular industries) A new theory of competitive advantage This theory would attempt to explain why do firms based in particular nations achieve international success in distinct segments and industries? The search is for decisive characteristics of a nation that allows its firms to create and sustain competitive advantage in particular fields. Findings: 1. leaders in particular industries tend to be concentrated in few nations and sustain it for decades 2. when firms form alliances, firms based in nations supporting true competitive advantage emerge as unambiguous leaders 3. competitive advantage is created and sustained through a highly localized process 4. differences in national economic structures ,values, culture, institutions and histories contribute profoundly to competitive success 5. with fewer impediments to trade, home nation takes the more important role of source of skills and technology that underpin the competitive advantage Assumptions: 1. firms can and do choose strategies that differ: explain why firms of a particular nation choose better strategies 2. successful international competitors often compete with global strategies in which trade and foreign investment are integrated 3. The home base is the nation where the essential competitive advantages of an enterprise are created and sustained. It is where a firms strategy is set and core technologies are created and maintained 4. The home base will be the location of many of the most productive jobs, core technologies, and most advanced skills. 5. the presence of a home base also stimulates the greatest positive influences on other linked domestic industries and leads to benefits of competition 6. While ownerships of firms is concentrated at the home base, nationality of share holders is secondary. as long as the local company remains the true home base

retaining effective strategic , creative and technical control, the nation reaps the benefits. 7. Competition is richer and reflects segmented markets, differentiated products, technology differences and economies of scale. Quality, features and new product innovation are central to advanced industries and segments. Hence competition is dynamic and evolving. This means that improvement and innovation in methods and technology are a central element to explain sustained competitive advantage. Real issue: 1. How can one explain the ability of firms to continuously innovate and change whereby they are able to increase the returns available through new products, processes? 2. how can the theory have utility value to the practicing manager Methodology: 1. conducted a four year study of ten important trading nations 2. study limited to ten nations because of time and resource constraints 3. these ten nations accounted for 50% of total world exports in1985 4. focus was on sophisticated industries and segments hold the key to rising productivity 5. nations chosen were ones that were already competing successfully in those industries 6. The study consisted of two parts: 7. Part 1: identify all of the industries in which nations firms are internationally successful. Data sources were statistical data, supplementary published sources, and field interviews. Includes service industries. 8. Defined international success by a nations industry as possessing competitive advantage relative to the best world wide competitors. The measures chosen were ; Presence of substantial and sustained exports to a wide array of nations And /or significant outbound investment based on skills and assets created in home country The nation was treated as a home base if it was either a locally owned, indigenous firm, or a firm that was managed autonomously though owned by a foreign company or investors. If a nations industry consisted largely of production subsidiaries of foreign companies, the nation was not deemed competitive in that field. 9. cluster maps were used to map successful industries in each economy 10. Part 2 consisted of examination of the history of competition in particular industries to understand the dynamic process of creation of competitive advantage. 11. For each nation sample of industries chosen was representative of most important groups of competitive industries in the economy. The industries of significance were which accounted for >20% of total exports of a country 12. All the industries selected were the ones in which the nation had a significant international market position. Aim was to represent the entire economy. 13. Avoided industries highly dependent on natural resources. Included those industries where technology was crucial. 14. Studied history of each industry to understand the basis for competitive advantage. Each case study considered the entire global industry. Industries chosen were the success cases for that country. The competitive advantage of firms in global industries:

Firms compete in international markets. An industry is a group of competitors producing products or services that compete directly with each other. A strategically distinct industry encompasses products where the sources of competitive advantage are similar. The factors underlying a competitive strategy are: 1. industry structure 2. positioning within an industry Industry attractiveness and competitive position can be shaped by a firm. The competitive forces in an industry determine industry profitability as they shape the prices that can be charged and the costs incurred to deliver the services or products. Industry structure is stable but can change over time. It is significant in international competition as: creates differing requirements for success in different industries industries important for high standard of living are the structurally attractive industries Structural change creates genuine opportunities for competitors from a nation to penetrate new industries. Important is how a nations environment points the way to its firms to perceive and respond to such structural changes. At the heart of positioning is competitive advantage. Positioning embodies the firms overall approach to competing. Two types of competitive advantagelower costs and differentiation. Lower costs is the ability to design, produce and market a comparable product more efficiently than competitors Differentiation is the ability to provide unique and superior value to the buyer in terms of product quality, special features or after sales service. Competitive scope is defined as the breadth of the firms target within the industry. Competitive scope leads to advantage based on economies of scope. The type of advantage and scope of advantage are combined into generic strategies:

Comp etitive scope

Cost leadership Cost focus

differentiation Focused differentiation

Competitive advantage Sources of competitive advantage: 1. how firms organize and carry out activities 2. strategy guides how these activities are performed 3. conceiving new ways to perform these activities confers competitive advantage 4. all activities are linked to form a value chain 5. managed linkages can be a source of competitive advantage 6. a value chain is embedded in an industries value system which includes all actors in its field of business.

7. the value chain exposes the sources of differentiation 8. Differentiation of the second order give greater scope for competitive advantage. 9. Firms create competitive advantage by perceiving or discovering new and better ways of doing things (innovation). This includes both improvements in technology and processes. Innovations shift competitive advantage. 10. The causes of innovations are new technologies, new or shifting buyer needs, emergence of new industry segment, shifting costs or inputs availability, changes in government regulations. 11. Early movers gain advantage by reaping economies of scale, reduction of costs through learning curve effects, establishing brand names, monopolizing resources required for production, and monopolizing locations. 12. Information plays an important role in the process of innovation. 13. Sustainability of competitive advantage depends on source of advantage, number of distinct sources and constant improvement and upgrading of sources of innovation. 14. Lower order sources of advantage are due to factor endowment differentials and cost differentials. Second order advantage sources are based on proprietary technological processes, product differentiation, brand reputation, customer relationships. They require a history of sustained and cumulative investments. 15. Sustaining advantage requires a firm to exploit structural changes. 16. Competing internationally requires the same principles. One can compete by being a global firm or a multidomestic firm. 17. a global strategy involves configuration- where and in how many nations will, activities be located coordinationhow will the activities be coordinated 18. Configuration involves choice of dispersion or concentration of activities. Locational advantages decide the choice of location. 19. Firms use a variety of strategies to gain competitive advantage. Nations succeed where country circumstances support the pursuit of proper strategy for a particular segment or industry. Creating competitive advantage demands improvement and innovation. This requires insight into new ways of competing, willingness to take risks and invest in implementing them. Local circumstances must provide an impetus to firms to pursue these strategies. Sustaining the competitive advantage requires upgrading of the sources of competitive advantage. Nations succeed where pressures are created to overcome inertia and promote ongoing improvements. Nations succeed when their home base advantages are valued in other countries and when their innovations and improvements foreshadow international demands. Determinants of national competitive advantage: A nation achieves international success in a particular industry based on four attributes: A: factor conditions- consist of factors of production B: demand conditions: the nature of home demand for a product C: related and supporting industries: D: firm strategy, structure and rivalry: The determinants, individually and as a system create the context in which a nations firms are born and compete. It also determines the availability of resources, skills necessary for competitive advantage. It also determines the information that shapes the perception and the

direction in which resources and skills are deployed, the goals of the persona in the acts, and the pressures on firms to invest and innovate. Firm structure, strategy and rivalry

Chance events

Factor conditions

Demand conditions

Related and supporting industries

Governme nt

Factor conditions: 1. Are inputs necessary to compete in any industry. A nations endowments of factors plays a major role in gaining competitive advantage. 2. Important are the rate at which they are created, upgraded and made more specialized to industries. 3. They includehuman resources, physical resources, knowledge resourcesthese reside in universities, research labs, trade associations etc, capital resources, and infrastructure. 4. a nations firms gain competitive advantage if they possess low cost or uniquely high quality factors of the particulars that are significant to competition in a particular industry. 5. Competitive advantage depends on how efficiently and effectively they are deployed. These factors are mobile and mere possession of these do not confirm advantage for a long time. 6. Advanced factors like research institutes, highly educated personnel etc, are more significant for competitive advantage. However these are built on the basic factors. Specialized factors are more important for competitive advantage. These require more focused investments. 7. Significant and sustained competitive advantage is seen when both specialized and generalized factors for a particular industry are present. The ability to continuously generate these factors and upgrade them. 8. Innovations are the key to offset certain disadvantages due to non possession of factors. Innovations are stimulated if a nations firm face trends in factor costs early. Home demand conditions: Three factors are important: composition, size and pattern of growth and mechanisms by which a nations domestic preferences are transmitted to foreign markets. Home demand composition is influenced by: Mix and character of home buyer needs Pressure from local customers to innovate Size , necessity and visibility of home demand

Range of segments Sophisticated and demanding buyers Anticipatory buyers needs- if domestic needs foreshadow international buyers needs defined by social and cultural factors Number of independent buyers Rate of growth of home demand Early home demand Early saturation of home demand Internationalization of domestic demand Presence of mobile buyers Related and supporting industries: Is the presence of internationally competitive supplier and related industries. This gives competitive advantage through: Efficient access to inputs Provide ongoing coordination Help in the process of innovation and upgrading based on exchange of research and development, information and ideas. Leads to new competitive industries Pulls demand for complimentary products Reinforce competitive advantage of other related industries Firm strategy, structure and rivalry: Management practices and modes of organization which are favored to suit the industries which a nation is competitive in. these include training , orientation of leaders, management styles, individual initiative, tools for decision making, ability to coordinate etc. Attitudes towards authority, competition, norms of interpersonal communication Language skills, inclination to learn Goals, ownership structures national prestige, sustained commitment Domestic rivalryin price, research and development, innovation, technology, emotional and personal New business formation Role of chance: Chance events create the discontinuities that allow shifts in competitive position. National attributes play an important role in taking advantage of the shifts created by chance events. Innovation, entrepreneurship and chance: Innovation and entrepreneurship are at the heart of national advantage. The determinants play a large role in locating where invention and entrepreneurship are most likely to occur in a particular industry. National factor conditions mechanisms affect the pool of knowledge and talent. Role of government: The role of government is to influence the four determinants positively so as to facilitate generation of competitive advantage in industries. The dynamics of national advantage:

Stimulate factor creation

Firm strategy, structure and rivalry Demand conditions National challenges Stimulate factor creation Influences priorities for factor creating investments

Factor condition s

Create and stimulate transferable factors

Related and supporting industries

Influences on factor creation

Sophisticat ed factor creation

Firm strategy, structure and rivalry Demand conditions National challenges Stimulate image creation, recognition World class related industries

Factor condition s

Complimentary pulls on products

Related and supporting industries

Influences on home demand conditions

Stimulate factor creation

Firm strategy, structure and rivalry Demand conditions National challenges Stimulate factor creation Deepening of support industries

Factor condition s

Create and stimulate transferable factors

Related and supporting industries

Influences on related and supporting industries

Stimulate new firm creation

Firm strategy, structure and rivalry Demand conditions Early product penetration feeds entry

Factor condition s

New entrants emerge

Related and supporting industries

Influences on domestic rivalry Role of geographic concentration Genesis and evolution of a competitive industry:

1. Formation of local industry is triggered by an initial advantage in factors of production or may emerge out of special factor creating mechanisms or emerge from related and supporting industries. 2. demand conditions also facilitate new entrants 3. The ability of this firm to grow into a competitive industry depends upon whether advantages in other determinants are already present or can be created. 4. to sustain advantage , these bases of advantage must broaden and cumulate 5. A set of competitive industry and its related industries form a cluster. These are the seeds for further generation of new industries. Bnv lakshmi