Mainstream: Diamond of Competitive Advantage (Porter)

Michael Porter’s study The Competitive Advantage of Nations (1990) is considered the basis and the “handbook” of the mainstream model of competitiveness. However, as stated in the first chapter, no one can argue that the competitive advantage theory is already a consolidated paradigm; there are still major differences in how competitiveness is defined and measured.

This section will describe Porter’s model and relevant contributions by other authors to his theory. Developments of the theory divide the analysis into macro- and micro-levels (the SMC adds meta- and meso-levels as well). These levels are implicit definitions of competitiveness at different units of analysis (nation, sector/ industry, firm, and product). The hypothesis is: there is not a single comprehensive definition of competitiveness, but a variety of different definitions can be employed in any given model, according to the researcher’s interest.

Premises of the Model

Porter offers the following premises as the backbone of his theory. (Porter 1980 and 1990 p.19-21)

- Firms can and do choose strategies that differ from condition to condition.

Every company has different objectives and sets its strategies from different starting points. Extending the analogy to countries, strategies for development applied to Asian countries work differently from those applied to Latin American countries.

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- Successful international competitors often compete using global strategies.

Strategies that consider factor-based advantages (including the theory of comparative advantage) do not necessarily gain competitive advantage in the international market.

Competitive advantage includes the following determinants: segmented markets (to specialized customers), differentiation of products and technology, economies of scale, and the recognition that international trade and foreign investments are integrated and non-exclusive to the firms.

- Competition is dynamic and evolving.

Competitiveness is a continuous process that must incorporate both internal developments (innovations, new products, new processes, etc.) and external developments (innovations, etc. from competitors).

Improvement and innovation in methods and technology are thus central elements.

Investment in innovation should go in three directions: research, physical capital, and human resources.

These premises carry the main criticism of the comparative advantage theory: national prosperity is created, not inherited. This model is dynamic and more comprehensive, including factor conditions and other variables simultaneously. (Cho and Moon 2000, p.

55-56)

Porter’s research uses ten nations (eight developed countries and two newly industrialized economies)⁴⁶. It concentrates on relatively sophisticated industries and industry segments and explicitly avoids sectors based on natural resources (Porter 1990, p. 28).

How does the model work? Porter’s Diamond Model

The capacity to innovate and upgrade processes or products is one of the bases of competitiveness according to Porter. Some companies are more successful than others in improving and overcoming barriers to achieve competitive advantage. Porter uses a

46 Developing countries were not included in the first stage of Porter’s research.

diamond-shaped model to illustrate international success⁴⁷. The “diamond” of national advantage consists of four determinants that are inter-related and two exogenous variables that Porter named chance (random effects) and government. Graph II.1 shows the interactions between determinants and the “external effects” of government and chance.

Graph II.1 Porter’s Diamond of Competitiveness

Source: Author´s elaboration based on Micheal Porter and CLACDS-INCAE

The Determinants

- Factor conditions

Competitive industries constantly upgrade their factors of production (land, labor, and capital), which derive from the comparative advantage theory, and create or acquire factors (innovation and technology) related to their product. A nation need not possess all the productive factors of the comparative advantage theory to be successful. Some

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47 The selection of the industries was based on a concept of international success defined “as possessing competitive advantage relative to the worldwide competitors...” measured by “(1) the presence of substantial and sustained exports to a wide array of other nations and/or (2) significant outbound foreign investment based on skills and assets created in the home country”(Porter, 1990: 25).

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countries can develop, innovate, and create specialized factors to replace the lack of factor endowments in a specific industry (for example, land in Japan).

- Strategy, structure, and rivalry

International competitiveness results from the presence of capable, committed, and fierce rivalry among local firms. The firm’s local environment determines the creation, organization, and management of the industry or firm, which determine its ability to become a world-class competitor. No single strategy or structure can be applied to all countries because national environments are different.

- Related and supporting industries

Groups of supporting and related businesses competing, cooperating, and collectively upgrading their industries result in competitive advantage. Supportive industries can provide inputs faster and more cheaply than if they were produced within the industry.

Also, improvements in some segments of the industry upgrade the industry as a whole.

This mechanism of transfer and exchange is clearly presented for competitive advantage theory in a cluster model.

- Demand conditions

In addition to local rivalry between firms, strong local demand conditions depend on the sophistication of the local customer base. In this context, consumer expectations in terms of quality standards are also important. Thus, if local demand coincides with changes in the behavior of consumers in the rest of the world, industries will be able to apply this knowledge to innovate, upgrade, or create new products or services that should be competitive worldwide.

The four determinants influence one another and, as a system, create the national environment where the firms compete. Therefore, firms gain competitive advantage when: the national environment supports the accumulation of specialized factors, allows a quick flow of consumer demand information, strengthens the links between suppliers and related industries, and pressures companies to invest and innovate.

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The External Factors

a) The role of chance refers to events out of the domain of firms and/or countries which influence their competitive advantage in a non-certain way. Chance can create advantages for particular groups of countries but also nullify them by altering the predominant conditions with no predictable results (e.g., oil price shocks, financial shocks, wars, natural phenomena).

b) The government, according to Porter, plays a fundamental role in the configuration of the whole system of competitive advantage. Although governmental decisions affect the four determinants, their decisions are not affected by the system.

According to Porter’s diamond, the government’s role is to facilitate, support, promote, and challenge firms to become more competitive through specific policy approaches, including: the focus on specialized factor creation; the avoidance of intervention in factor and currency markets; the strict enforcement of quality, safety, and environmental standards; the sharp limitation of direct cooperation between industry rivals; the promotion of goals that lead to sustained investment;

the deregulation of competition; the strong enforcement of domestic antitrust policies; and the rejection of managed trade.

Porter states that chance and governments influence the whole system but are not influenced by it, and for that reason are classified as external. As will be shown later, a criticism of Porter’s view is that he does not include the government as the fifth determinant, as it can also be affected by the system⁴⁸.

The objective of the model is to determine the environment of competitiveness⁴⁹. The more developed the determinants and their interactions are, the more favorable the environment of competitiveness is. Porter identifies two sources of value for products, cost and product differentiation advantages. The choice between these two strategies is crucial to the firm’s ability to achieve competitive advantage.

48 See Rugman and Cho’s criticisms in Sections II.4.2 and II.4.3

49 Porter and his followers use this approach to define competitiveness at the national unit and macro-level of analysis, as described in the first chapter.

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