October 2010
The most widely used theory of the competitiveness of nations is provided by Porter – but it has its limitations. By Alan Marsden, distance learning MBA Tutor, Warwick University Business School.
The UK has fallen back another place in the world league table of competitiveness to 22nd out of the 58 nations measured, according to this year's International Institute of Management Development (IMD) ‘World competitiveness year book’.
It's a far cry from the position of competitive supremacy that Britain held in the mid-19th century, when it dominated the world economy. The reason for this dominance derived from a remarkable set of innovations during the late 18th and early 19th century that helped produce the world’s first industrial society via a process known as the industrial revolution. The outcome of this revolution was to catapult Britain to the forefront of producing and trading nations and the creation of a new middle class that enjoyed income and wealth on a scale only experienced before by the landed aristocracy.
The IMD table also showed that the USA, long established as the world’s most productive nation, had fallen to third place behind Singapore and Hong Kong. To what extent this is a temporary situation brought on by the economic crisis remains to be seen but it shows how the relative competitiveness of nations can vary over time. These measures of competitiveness are more than matters of academic interest. They indicate the standard of living enjoyed by residents of each of the countries in the report.
Measuring competitiveness is complex and involves a comparison of nations on the basis of 327 criteria. These are grouped into four factors: economic performance, government efficiency, business efficiency and infrastructure. (Details of the methodology are available on the IMD website.)
The explanation of how and why nations improve or lose their competitive position is even more complex. Several types of explanation have been offered about why one country is more productive than another. Economists have tended to adopt a macro level approach and to argue that nations vary in their competitiveness because of differences in factor endowments of land, labour capital and enterprise. Meanwhile economic historians explain relative competitiveness by reference to the interaction of a range of demographic, economic, social and political processes.
Role of organisations and industryMichael Porter, the Harvard economist, considered these explanations in his early research on national competitiveness in the late 1980s and concluded that they were inadequate. His own approach was derived from work on industry structure and individual organisations’ competitiveness. It led him to argue that, since it is organisations, not nations, that compete in international markets, it is the competitiveness of the organisation and the industry in which it is located that we must understand in order to explain the role that the nation plays in the competitive process.
In Porter’s view, industry is the arena in which competitive advantage is won or lost, so the structure of the industry is very important. The competitive forces operating in the industry structure determine industry profitability because they shape the prices organisations can charge and the costs they have to bear. This is true, according to Porter, whether the organisation is competing domestically or internationally.
Porter came to see that the crucial focus for understanding international competitiveness was not the nation state as a whole but the organisations and industries that lay within each state. In other words, the key unit of analysis should be the industry and the individual organisation because it is the organisation that competes in the global market place.
Porter's DiamondFollowing a study of 100 organisations in 10 countries, Porter identified four determinants of a country that can affect the global competitiveness of companies located there: factor endowments; demand conditions; related and supporting industries; and the strategy, structure and rivalry of the companies in a country.
He also identified two external variables - government policy and chance - that impact on the determinants and thus on competitiveness more generally.
Porter created a model linking these four determinants that takes the shape of a diamond (see figure 1 below) and argued that firms are most likely to succeed in industries or industry segments in which the four determinants are favourable. He also argues that the determinants in the diamond form a mutually reinforcing system in which the effect of one determinant is dependent on the state of the others.
Porter used the term ’determinants’ in his original work but subsequent authors have used ‘sources’ ‘elements’ and ‘characteristics’ to mean the same thing.
Porter used the term ’determinants’ in his original work but subsequent authors have used ‘sources’ ‘elements’ and ‘characteristics’ to mean the same thing.
Factor endowmentsThere are two kinds of factor endowments - the basic factors of production such as land, labour, capital and materials; and advanced factors such as technological know how, managerial skills and physical infrastructure. Many of the advanced factors are not natural but acquired through the efforts of people living in a particular country. For example the Kenyan cut flower industry achieved success in the late 1990s through a combination of acquired and natural advantages.
Demand conditionsDemand conditions are relevant in creating pressure for innovation and quality. Domestic demand pressures are especially relevant in forcing companies within a country to improve their competitiveness. Porter claims that the more sophisticated and demanding domestic customers are, the more competitive domestic organisations are likely to be. For example, Japanese consumers live in small, tightly compact homes and endure hot humid summers. This created a domestic demand for quiet, energy efficient, compact air conditioning systems. In response, a number of competing Japanese companies came up with innovations which subsequently led them to become world leaders in this field.
Related and supporting industriesThese give companies an additional boost to their international competitiveness. When suppliers are located near the producer, these firms can provide lower cost inputs that are not available to the producer’s distant competitors. Being geographically close to suppliers also aids the sharing of information between supplier and producer. In the development of the Italian tile industry, suppliers of tile making equipment located in close proximity to tile manufacturers became aware of the needs of tile manufacturers for special equipment and adapted, specialised roller technologies first used in the glass industry. This reduced energy costs and thus promoted the efficiency and competitiveness of Italian tile manufacturers in international markets.
Porter also believed that the geographical concentration of leading organisations in an industry, which he referred to as ‘clusters’, was an important contributory factor in a nation’s international competitiveness. The proximity of organisations to each other, he argues, drives competition. Examples include pharmaceutical companies in Basel, Switzerland, motor cycles and musical instruments in Hamamatsu, Japan and financial services firms in Singapore. Porter argues that this clustering results in an accumulation and concentration of knowledge which, combined with fierce competition, results in innovative activities and hence greater productivity.
Strategy, structure and rivalryOrganisational strategy, structure and rivalry are also very important in the promotion of international competitiveness. Porter argues that strong domestic rivalry in a country promotes fitness to compete rather like athletes training for the Olympics. Only by competing with the best at home can one hope to compete successfully at the global level. The strategy and structure of organisations is also influenced by the management style and culture of the country in which they are located and Porter noted that no single management style guaranteed success.
In Italy, for example, successful firms are typically small and medium sized, operated in fragmented industries, managed like extended families and employ a focus strategy geared towards meeting the needs of small market niches. By contrast in Germany, successful organisations tend to be hierarchical; emphasise technical/engineering content; and involve precision manufacturing and a highly disciplined management structure.
The four determinants of national advantage covered above shape the competitive environment of industries but chance and government policies also play a role.
Chance events such as wars, natural disasters, oil shocks and major technological breakthroughs can bring about a shift in the overall competitive position of nation states.
Government policies can influence all four of the major sources of advantage through activities such as regulation or deregulation of capital markets, changes in taxation and changes in education policies.
Like all theoretical models, Porter’s diamond has its limitations. The framework was formulated on the basis of research conducted 30 years ago before the impact of the internet and the process of globalisation dramatically influenced the operation of international business. Students will find the main criticisms of the model in the CIMA Learning System.
Despite the limitations however, the model is employed widely by all who seek to explain international competitiveness and will continue to be used until we have a better model to replace it.
E2 Further reading
A Norton and J Hughes, ‘The Official CIMA Learning System - enterprise management’, CIMA Publishing 2009
Michael E Porter, ‘The competitive advantage of nations’, Free Press, Macmillan 1990
‘UK’s competitiveness slips no 22 in world’, From Times Online, 21 May, 2010
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