3H Strategy & International Business
Session 30: The Competitive Advantage of Nations - the Model
The following notes are largely a summary of Porter’s model taken from his book - The
Competitive Advantage of Nations. As such they can be read as a background to the class
discussion.
The Approach
The principal economic goal of the nation is to produce a high and rising standard of living for its
citizens.
A nation’s standard of living is determined by its productivity - the value of the output produced by
a unit of labour or capital based on:
 the quality & features of the product which affects prices
 the efficiency of production
Traditional theories on national competitiveness seek to answer the wrong question.
The critical question not:
Why do some nations succeed and others fail in international competition?
but:
Why are firms based in a particular nation able to create and sustain competitive advantage against
the world’s best competitors in a particular industry or segment?
Central to this creation and sustaining of advantage is, argues Porter, innovation.
Innovation - Creating Advantage
“Firms create competitive advantage by perceiving or discovering new and better ways to compete
in an industry and bringing them to market, which is ultimately an act of innovation”:
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improvements in technology
better methods / ways of doing things
product or process changes
Sources of Innovation:
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New technologies e.g. Japanese firms & medical imaging
New or shifting buyer needs e.g. American fast food & consumer demands for convenience &
consistency
Emergence of new industry segment e.g. small Japanese lift trucks for general purposes
Shifting input costs or availability e.g. transport costs and global production
Changes in government regulation e.g. early U.S. financial deregulation & American firms’
experience
Innovation - Sustaining Advantage
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Companies need to perceive opportunities for innovation and exploit them quickly.
Early moves often allow for innovations to be translated into other advantages and advantage
to be sustained over time e.g. economies of scale, learning effects, establishing a brand name.
A hierarchy of advantages - some more sustainable than others e.g. process technology v.
labour costs
More sources better than one for continued success e.g. Japanese copiers - flexible
manufacturing, dealer networks & reliability
Continued improvement & upgrading - move up the hierarchy e.g. Korean shipbuilders
expanded scale & increased technology whilst still possessing low labour costs
The Bases of the Model
Why do the firms in a particular nation achieve international success in a particular
industry?
Porter argues that firms gain competitive advantage when:
 their home base allows and supports the most rapid accumulation of specialised assets and
skills;
 their home base affords better ongoing information and insight into product and process needs;
 the goals of owners, managers, and employees support intense commitment and sustained
investment;
 their home environment is the most dynamic and challenging, stimulating firms to upgrade &
widen their advantages overtime.
These are the conditions which provide the pressures on firms to invest and innovate.
The Competitive Diamond
Figure 3.5 The determinants of national advantage (Porter’s diamond)
Firm strategy,
structure and
rivalry
Demand
conditions
Factor
conditions
Related and
supporting
industries
Porter’s model outlines four broad attributes of a nation that shape the environment in which
local firms compete that promote or impede the creation of competitive advantage:
 factor conditions
 demand conditions
 related & or supporting industries
 firm strategy, structure and rivalry
Two additional factors can also affect the model:
 chance
 government
All the factors act individually and as a mutually reinforcing system.
1. Factor conditions
The nation’s position in factors of production, such as skilled labour or infrastructure, necessary
to compete in a given industry will affect the resources available to create competitive advantage.
Goes beyond traditional factors of production. Factors most important to competitive advantage
are created within not inherited by the nation through processes that differ widely across nations
and industries. Stock less important than rate at which created, upgraded and made more
specialised. Selective disadvantages can, through influencing strategy and innovation, lead to
sustained success.
Grouped into broad categories:
 Human Resources quantities, skills and costs of personnel.
 Physical resources abundance, quality, accessibility and cost of land, water, mineral or timber
deposits, hydro electric sources, fishing grounds, climate, location (relative to markets and
suppliers, time zone) and geographic size.
 Knowledge resources scientific, technical and market knowledge, residing in universities,
research institutions, statistical agencies, business & scientific literature, market research
reports, trade associations etc.
 Capital resources amount and cost of capital available to finance industry, depending on
savings rates and capital market structures. Globalisation making conditions more similar but
differences likely to persist.
 Infrastructure type, quality and cost available that affects competition, includes transport
systems, communications, mail & parcel delivery, payments/funds transfer systems, health care
etc. Also housing, cultural institutions affecting quality and attractiveness of life.
The mix will vary widely and different factors important for different industries. Advantage
depends on how efficiently and effectively that they are deployed and where, not just access.
Human factors can be mobile between nations.
These categories also form a hierarchy of factors:
 Basic factors (natural resources, climate, location, unskilled/semi skilled labour, debt capital)
tend to be inherited, or require modest investment, often the advantage supplied is
unsustainable by diminished necessity, wider availability or easy access by global firms
sourcing internationally.
 Advanced factors (modern communications infrastructure, highly educated personnel, research
institutes) now most significant for higher order competitive advantage such as differentiated
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products & propriety process technology. Require larger sustained investments and more
difficult to produce globally.
Generalised factors (highways, debt capital, university-educated employees) can be deployed
in wide range of industries.
Specialised factors (specific skilled personnel specific knowledge bases or infrastructure),
usually includes most advanced factors, but not always e.g. computer programmers can go into
wide range of industries. More useful for sustained bases of competitive advantage because
less available globally or to outsiders.
Advanced & specialised factors tend to create the most significant and sustainable
competitive advantages.
The standard for factors is constantly rising; factor creation requires continual investments in
factor-creating mechanisms like education institutions and research institutes. In addition
private as well as public investment needed.
2. Demand conditions.
The nature of home demand for the industry’s product or service. Influence is dynamic - shaping
the rate and character of improvement by a nation’s firms. Quality more important than quantity.
Three broad attributes are significant:
Nature of buyer needs
Mix and character affects how firms perceive, interpret and respond to buyer needs. Advantage
created through pressure to innovate. Easier to understand needs of customers close to home than
in foreign markets.
Three characteristics important to achieving competitive advantage:
 Segment structure of demand gaining advantage in global segments that are significant at home
but less significant to other countries. Shapes attention and priorities of home firms. E.g.
Airbus Industries identified need for wide-body short-haul in Europe which Boeing had
ignored because USA distances longer and volume lower.
 Sophisticated and demanding buyers because provide window into advanced buyer needs e.g.
Japanese demands for sophisticated audio equipment because seen as status item. Distribution
channels as well as end customers can also play a role.
 Anticipatory buyer needs where needs of home-based buyers anticipate those of other nations.
E.g. American fast food or credit cards.
Size and pattern of growth of home demand
 Size of home demand can be significant in certain kinds of industries with high R & D costs or
substantial economies of scale or high levels of uncertainty because the home market can be
comforting in the making of investment decisions. But the segments must be repeated abroad.
Sometimes smaller countries represent large markets for particular products e.g. Finnish
icebreakers;
 Number of independent buyers, if high, can encourage environment for innovation;
 Rate of growth of home demand can be as important as size because it encourages investment;
 Early home demand can anticipate buyer needs in other markets helping firms to become move
sooner and get established in industry;
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Early saturation forces firms to continue improving and upgrading processes and products.
Reinforced when there is still buoyant growth in foreign markets.
Internationalisation of domestic demand
If domestic demand internationalises then it can pull a nation’s products and services abroad
through:
 Mobile or multinational local buyers mean that domestic buyers are also the foreign buyers.
Can highlight opportunity of establishing an overseas presence;
 Influences on foreign needs as domestic needs get transmitted into foreign buyers e.g. training
foreign doctors in US encourages demands for US medical equipment abroad.
3. Related or supporting industries.
The presence or absence in the nation of supplier industries and related industries that are
internationally competitive is important.
Competitive advantage in supplier industries confers potential advantages on a nation’s firms in
other industries because they produce inputs that are widely used and are important to innovation
or internationalisation. For example, Swedish strength in fabricated steel products like ball
bearings and cutting tools has drawn on strength in speciality steels. Mechanisms:
 Early, often preferential access to cost-effective inputs;
 Ongoing coordination through value chain linkages;
 Process of innovation or upgrading helped by close working relationships.
The presence of competitive related industries in a nation is no less common or significant.
Related industries are those in which firms can co-ordinate or share activities in the value chain or
those involving complementary products. For example, Swiss success in pharmaceuticals was
closely connected with previous international success in the dye industry. Ditto Japanese fax
machines and photocopiers, which employ many similar technologies. Mechanisms:
 Opportunities for information flow and technical interchange;
 Share activities, even forming formal alliances;
 Success in one industry can pull through demand in complementary industries.
4. Firm strategy, structure and rivalry.
The conditions in the nation governing how companies are created, organised, and managed, and
the nature of domestic rivalry are all important.
The way in which firms are managed and choose to compete - their strategy and structure - is
affected by national circumstances (c.f. Sue Miller’s lectures). No nation exhibits uniformity across
all firms but tendencies are observable. E.g. Italy - small/medium firms which are privately owned
and run like extended families; Germany - top managers have technical backgrounds, hierarchical
structures & practices.
Key is that nations will tend to succeed where the management practices and structures favoured
by national environment suit the sources of their industries’ competitive advantage. E.g Italy in
fragmented industries like lighting, furniture, footwear etc.
Willingness to compete globally can be affected by management attitudes - willingness to travel,
language skills etc.
Nations succeed where goals and motivations of firms, managers and employees are aligned with
sources of competitive advantage.
 Company goals - influenced by ownership structure, motivation of owners and holders of debt.
Publicly owned corporations will reflect attitudes of nation’s capital markets. E.g. German
commitment capitalism where banks are both debt and equity holders or Anglo - American
market capitalism, where managers respond to share price and threat of take-over.
 Individual goals - will reflect reward systems and social values to work, also attitudes to
wealth. Relationship between manager and employee also critical. Attitudes to skill
development and risk taking also feature.
 Influence of national prestige/priorities - e.g. USA response to Sputnik critical in aerospace.
Japan and prestige in steel and consumer electronics after WW2. Can also work in reverse e.g.
Britain’s decline in manufacturing reflecting its low status.
 Sustained commitment - often critical in preserving and enhancing competitive advantage.
Association between vigorous domestic rivalry and the creation and persistence of competitive
advantage in an industry was one of the strongest empirical findings of Porter’s study. Nation’s
tend to lead where there are a number of strong local rivals e.g. Sweden: Saab-Scania and Volvo;
Germany: BASF, Hoechst, Bayer etc., Switzerland: Hoffman-LaRoche, Ciba-Geigy, Sandoz etc..
Contrasts with traditional views on economies of scale and “national champions”.
Domestic rivalry creates visible pressure to innovate, pushing each other to lower costs, improved
quality and service. Often more than economic, emotional & personal as well. Also pressures
companies to sell abroad in order to grow, particularly if economies of scale are important.
Pressure also forces firms to upgrade sources of competitive advantage because lower level sources
are available to all firms in the industry in that nation. Geographic concentration amplifies these
effects.
In addition to the four factors outlined above, Porter identifies two further influences upon the
model which act by affecting the conditions experienced by the “points” of the diamond - chance
and government actions.
Chance events
Developments outside the control of firms (and governments) such as pure inventions,
breakthroughs in basic technologies, wars, external political developments and major shifts in
foreign market demand can all play a role in creating competitive advantage. These developments
create discontinuities that unfreeze or reshape industry structure and provide opportunities to gain
advantages over others.
Government
 Can improve or detract from national advantage.
 How policies affect the determinants: antitrust policies and domestic rivalry; regulation and
market conditions; investments in education changing factor conditions; government purchases
stimulating related/supporting industries.
 Factors in turn can influence government actions.
The Model as a system
The determinants, individually and as a mutually reinforcing system, create the context in which
a nation’s firms are born and compete e.g. favourable demand conditions will not lead to
competitive advantage unless rivalry sufficient to cause firms to respond. Competitive advantage
based on one or two factors is possible but usually unsustainable in the long run because of
competitive reaction. Advantages through the diamond are necessary for achieving and
sustaining competitive advantage in knowledge-based industries, the backbone of advanced
economies.
Competitive advantage can grow out of selective factor disadvantages. The only way to
overcome a disadvantage in basic factors is to innovate to achieve higher order factor advantages
e.g. lack of labour, natural resources or steady rise in nation’s exchange rate. One example of this
are the steel mini mills in the Bresciani region of Italy, which were faced with high logistical,
capital and energy costs and no local raw materials. By using modern mini-mills that use less
energy, have lower capital costs, employ scarp as feedstock, companies within the region are able
to compete successfully with larger steel companies in Europe. This has also led to success for the
suppliers of mini-mills as well as operators. However, factor disadvantages will only become
source of advantage if the other determinants of the diamond are supportive.
Industry clusters (Example - Italian Footwear Industry)
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The systemic nature of the diamond promotes clustering of a nation’s competitive industries.
Successful industries are usually linked through vertical (buyer/supplier) or horizontal
(common customers, technology, channels etc.) relationships.
A mutually reinforcing process, which can magnify and accelerate process of factor creation,
through competitive rivalry, as well as supporting the flow of information and technology to
meet joint needs.