“Evaluate Porter’s concept of the ‘diamond’ as a tool for analysing the competitive advantage of nations, assessing its theoretical coherence and empirical support.”
The contribution by Porter (1990) on the competitive advantage of nations has led to an extensive discussion among academics and practitioners on the sources of international competitiveness (Grant, 1991; Gray, 1991). However, in order to understand why so much emphasis is place on the diamond framework in the management literature, this essay will discuss Porter’s concept of the Diamond and the factors that contribute to the development of national competitive advantage. This paper will begin with a theoretical approach followed by the reception of different authors and schools of thoughts who disagreed with his management thinking, and then goes on to consider empirical issues which have arisen subsequently, followed by a conclusion.
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Porter’s theory of national competitive advantage is based upon a study of the characteristics of the national environment which identifies four sets of variables which influences companies ability to establish and maintain competitive advantage within international markets. (chapter 3). These interacting determinants, factor conditions, demand conditions, related and supporting industries and firm strategy, structure and rivalry form are what Porter refers to as the “national diamond”. Below is a snapshot of Porter’s Diamond stage, showing the importance of the government in the development of national competitive advantage.
Within factor conditions, it comprises land, labour, capital and infrastructure. These are a mixture of the given factors, which are fundamental to competitive advantage. However, these factors are not inherited but are actually built within the nation, which typically varies from different economics and industries. Consequently, countries will be successful only in those industries where usually more than one factor condition will be in their favour. Saudi Arabia, for example, along with other neighbours from Middle East, has long dominated the oil industry due to the fact that it naturally posses lands which are enriched with oil reserves. Within the “diamond” framework, Porter places particular importance on the role of home demand by providing the impetus for “upgrading” competitive advantage. The demand conditions within the home base affect a sector’s capability to vie internationally through three mechanisms. First, an industry will have a competitive advantage in areas which are more important at home than elsewhere (Swedish companies lead in high voltage electricity distribution over long distances due to their familiarity in serving remote and energy-intensive steel and paper industries; p. 87). Second, the demanding buyers within the home base force companies to achieve high standards (Japanese workforce value space-saving, giving Japan a lead in compact products, nevertheless, America’s long distances areas have led to competitive advantage in very large truck engines; p. 89). And third, a nation’s industries will grow if buyers at home foresees the wants of buyers in other countries, in so doing, giving it a advantage in learning how to meet those requirements. ( Japanese and government and buyers forced companies to make energy-saving products prior to energy costs becoming more important). The third determinant is “related and support industries”. In this case, the tendency for the successful industries in every country is grouped into ‘clusters’, which represents an environment in where innovation, operating productivity and learning can flourish. One such cluster, for example, is centred upon Denmark, which has a cluster in health and home products, Sweden in papermaking, and Germany in chemicals, metal-working, transportation and printing;p. 149). The last determinant is firm strategy, structure and rivalry. According to Porter, rivalry is critically important in pressuring companies to innovate, cut costs, and to improve quality. He identifies rivalry as the most important driver of competitive advantage of a country’s industry. Another important component is “the role of chance” where events cannot be controlled by industries nor government. These could be in the shape of a price decrease, a new invention, a war or a significant change in foreign exchange markets. These factors can change the balance by increasing the demand for artillery in case of a war or by helping the steel or ammunition industry to boost profits. The final component is the role of government
Ever since Michael Porter came up with his work of competitive advantage along with the ‘diamond’, many authors and school of thought have criticized his theory as they find it vague , dangerous or incomplete in its explanation. This criticism resolves around a number of assumptions that underlie it. As described by Krugman (1994a), the main risk with respect to the belief that countries compete is the misunderstanding that countries, like companies, are somehow in competition with one another. More important, the abuse by special interest groups, the potential role of predatory trade policies and the budget constraint still apply. Furthermore, the welfare effects of trade intervention based on external economies are far more ambiguous than the effects of comparative advantage and internal economies of scale, and may lead to a distortion of specialisation patterns for a specific country (Krugman & Obstfeld 2003). Criticism of the ‘Diamond Theory’ comes from two perspectives: from within the management school (Rugman 1991; Dunning 1992, 1993; Cartwright 1993; Rugman & Verbeke 1993; Bellak & Weiss 1993; Rugman & D’Cruz 1993) and from the economic school (Waverman 1995; Jegers 1995; Davies & Ellis 2000; Boltho 1996).
Criticism from the management school – suggests that the home diamond focus of Porter does not take the attributes of the home country’s largest trading partner into account (Rugman 1990), is not applicable to most of the world’s smaller nations (Bellak & Weiss 1993; Cartwright 1993) and ignores the role of multinational organisations in influencing the competitive success of nations (Dunning 1992, 1993. At the same time, the economic school states that the diamond is so general that by trying to explain all aspects of trade and competition, it ends up explaining nothing (Waverman (1995). As well, Porter (2004) has shifted his focus to productivity at locations that will improve the competiveness of companies located in those specific locations. Thus, if through these location, firms can increase their productivity, it will be good for that country, due to the fact that higher productivity always leads to higher levels of welfare. However, this does not mean, that the country thus becomes internationally competitive, even if the companies located there are internationally competitive. This is because productivity is purely a domestic matter and has nothing to do with the international competitiveness of a country (Krugman 1998).
Critics argue that the importance of geographic proximity has been overstated in the model, that it may be more partial than suggested in the model (Penttinen, 1994).This may be partly because the geographical scale of production is not a constant but differs between industries and is often international (Jacobs, 1995). Nevertheless, O’Donnell (1998) has made a fundamental critique of the contention of Porter that companies mainly derive competitive advantage from characteristics of their ‘home base’. According to O’Donnell, certain societies and economies are so open and small that purely local innovation is limited and it is possible and easy to cross national boundaries easily, where locally-owned firms are not ‘constrained by the paucity of local innovation processes’ (Clancy, etal., 2001). Another claim is that an industry’s ‘competitiveness’ depends upon the strength of the diamond in its ‘home base. So, if for example, the question will be ‘what are the requirements for a successful environment?’ the answer will be ‘a strong diamond’. However, If a theory concerning a specific aspect is to be beneficial it must enlighten which circumstances are which. Competitive advantage of nations does not provide this kind of clarification, as well it does not even try to identify the required conditions for strength in each single corner of the diamond. As Reich (1990a) mentioned, this four corners, supplemented by government and chance, are so broad that they include everything which might contribute to success, thereby identifying almost nothing significant. In Congdon’s view (1990, p. 42) these weaknesses render the diamond ‘completely fatuous, corresponding logically to the statement that movement may be to the North, South, East or West’. However, Chandler in 1994 attempted to tackle this issue by developing “late development theory”, which states that developing countries can skip through all four stages described by Porter. This is because they can import or imitate the technology and business systems which already exists in other developed nations. China, for example, was able to increase their productivity by coping new products in their home country and therefore, achieving a cost advantage strategy. This was due mainly the low wages and favourable exchange rates policy. Therefore, China was able to increase its productivity without innovating, without any risk of technology development. Only USA ,which has high capital per worker and is already in the technological frontier must innovate to prosper, leading Porter to over generalises other countries.
Porter denied that competitiveness could be achieved on the basis of comparative advantage and insisted that firms must produce up-graded products in order to compete. That is to be a valid assertion for American companies. Chalmers Johnson argued that Japan was successfully guided by MITI ( Johnson, 1982) and others have seen the experience of Taiwan , Singapore and South Korea as providing further support for government intervention (Wade, 1990). A further point is made by Lin et al. (1997) which takes the view that the rapid progression of China, Japan and the Asian ‘dragons’ are all best explained as ‘comparative-advantage-based’ development. In China, for example, the absolute productivity of the toy industry and the machine tool industry are both very low compared to America. However, China has a comparative advantage in toys, which it exports them to US, while on the other hand, the US has a comparative advantage in machine tools, which its used to export to China. Therefore, Chinese toy manufacture is not competitive because it has higher absolute level of productivity but because toys are much cheaper in China when measured in terms of the amount of machine tools which can be produced with the same resources. America, consequently, is competitive in machine tools for the converse reason.
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However, different demand conditions in different countries, leading to diverse demand structures, can determine location economies of increasing returns. Location economies of increasing returns that keep an industry in a specific location, due to a specific set of demand conditions, will be difficult to be competed away by industries in another country (Krugman & Obstfeld 2003). In such instance, comparative advantage is not determined by differences in factor conditions, but by demand conditions.
Government and company policies and practices that bound a free market also come under criticism from Porter, mentioning that policies and ‘trade negotiations’ that are specific to a home market, can actually limit international feat. According to Krugman (1991b), countries do not compete internationally. They are not like firms, competing with rivals in the global market place. Daly (1993), in common with Eilon (1990), Gray (1991) and Waverman (1995), adopted the market share interpretation of competitiveness, and have used export shares as the dependent variable, following by Porter’s own practice. They found evidence to support the idea that export shares are affected by labour costs and exchange, and contradict Porter’s assertion that wages and exchange rates and are unimportant in the determination of competitiveness. China, for example, is able to benefit from its exchange rates policy. Therefore, companies exporting their goods have a competitive advantage towards over companies located abroad.
A further disapproval of Porter framework is concerned with his conviction that outward foreign direct investment (FDI) is a sign of competitive strength in a nation’s industry while inward investment indicates that ‘the process of competitive up-grading is not entirely healthy’ (CAN, p. 671). Lau (1994) stated in this work that capital flows towards the locations where it has a high productivity, in the case of foreign direct investment, could be regarded as a positive indicator of competitiveness. Rugman and D’Cruz (1993) noted that foreign-owned firms in Canada carry out the similar level of research and development within the country as domestic firms does, thereby creating competitive advantage locally. They also pointed the fact that in Canada, foreign subsidiaries export as much as they import. Nevertheless, Chia (1994) noted that most of the residents of Singapore are quite wealthy despite the fact of being almost entirely dependent upon foreign affiliates for both manufacturing output and exports. Liu and Song (1997) took up Dunning’s (1995) extension of the Porter model, which adds ‘multinational business activity’ as a determinant of competitive advantage. They have applied that model to China’s recent development and concluded that the country’s success has been attributed to inward FDI. As opposed to the pursuit of Porter’s recommended up-grading strategy, they also credited China’s success to the exploitation of its comparative advantage in labour-intensive sectors. Consequently, Japan was able to obtain many of the benefits that inward investment might have provided by importing knowledge-intensive products and non-equity transfers of technology and human skills. Nevertheless, smaller European countries, such is the case of Netherlands, Sweden and Switzerland, without their companies’ producing much of their output outside their home countries, could not have retained or improved their competitive position. By contrast, (Gilpin, 1975) argued that, by exporting its advanced technology through outward direct investments, the US has eroded its competitive dominance and reduced the capability of their companies to sustain their innovating advantage compared with the European or Japanese counterparts.
As well, according to Van den Bosch and Van Prooijen (1992), the impact of national culture on the sources of competitive advantage is given too little attention in Porter’s model. Hofstede showed that, for instance, achievement of visible and symbolic organisational rewards, acquisition of money, the importance of performance and growth, are characteristics are a important factor by which productivity is measured. Needless to say, the leadership qualities, the need for a vision and the communication efforts all play an important role. As stated by Nokata & Takeuchi, (1995), the transfer of tacit knowledge into explicit information will increase trust and cooperation and therefore, the productivity of the enterprise is likely to go one way, and that is up.
To conclude, Michael Porter’s competitive advantage along with its four determinants of diamond theory can be described as a general framework for analysing country sources of advantage that enhance the international competitive advantage. While this study is widely used nowadays by many successful companies and governments in order to create a competitive advantage strategy, however different authors and school of thought criticize his work. As a checklist thorough this essay, we can see that most of his criticism was related to the role of government, location and culture. Nevertheless, the differences between different developing countries are strong enough to advocate that specific features of the diamond, such as the demand conditions, might be more important in one stage of a country’s development than in other. Therefore, Porter’s work should be used as a tool for analysing competitive advantage of country sources. This is due to enhance the ability of managers to make informed decisions on how to configure the value chain, but not to rely entirely on his study.