Model answer E2: competitiveness of nations

October 2010

To help you revise, Velocity publishes regular model answers to practice questions. Before attempting this question, please read the article E2: enterprise management, competitive advantage of nations from this edition. By Alan Marsden, distance learning MBA Tutor, Warwick University Business School.

T Company manufactures ceramic tiles for floors, kitchens and bathrooms. Until recently, its international competitive advantage depended partially on favourable government policies in IY- the country where its manufacturing plants are located. The national debt caused by excessive government borrowing and spending in the years leading up to 2010 however, has caused IY’s government to reign back on its spending and so the energy subsidy and help with R&D that the tile industry used to enjoy have been removed. T Company will now have to rely on other sources of competitive advantage.

Required:

(a) With reference to Michael Porter’s diamond model, describe the key determinants of international competitive advantage that T Company may need to depend on to sustain its competitive position in international markets.

                                                                                                                        (15 marks)

(b) Like other models that seek to explain the basis of international competitiveness, Porter’s model has its limitations. Explain briefly the main limitations of the model.

                                                                                                                        (10 marks)

Total                                                                                                                (25 Marks)

Answer

Part (a)

In his study of national competitive advantage, Michael Porter identified four sources or determinants that can affect the global competitiveness of companies located in particular countries like IY.

These four sources are: factor endowments; demand conditions; related and supporting industries; and the strategy, structure and rivalry of the companies located in a country.

Porter created a model linking these four sources in a diamond (see figure 1 below) and argued that firms are most likely to succeed in industries or industry segments in which the four sources are favourable. He also argues that the sources in the diamond form a mutually reinforcing system in which the effect of one determinant or source is dependent on the state of the others.

The four sources that T Company may need to depend on can be characterised as follows.

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 of production are acquired by firms over a period of time. For example, in the tile industry, process innovations in the kiln firing process and the development of sophisticated marketing campaigns to attract overseas buyers have been important ingredients in the success of some tile manufacturers.

Demand conditionsDemand conditions are relevant, argues Porter, in creating pressure for innovation and quality. Domestic demand pressures in countries like IY may have been especially relevant in forcing companies like T to improve their competitiveness. Porter claims that the more sophisticated and demanding domestic customers are, the more competitive the domestic firms are likely to be. Powerful and knowledgeable retailers with large showrooms can add to the pressure to innovate.

Related and supporting industriesThese provide companies within 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 that is still relevant even in our digital age and is mutually beneficial to both.

In the tile industry, some countries have benefitted from the development of specialised equipment. Suppliers of tile making equipment that were located close to concentrations of tile manufacturers adapted roller technology from the glass industry which helped reduce energy costs and thus promoted the efficiency and competitiveness of the whole of the country’s tile industry.

Firm strategy, structure and rivalryPorter argues that strong domestic rivalry in a country like IY 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 firms 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, manufacturing firms are typically small and medium sized; operated in fragmented industries; managed like extended families; and employ a 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.

In conclusion, Porter’s argument is that the degree to which a nation like IY is able to achieve international success in the ceramic tile industry is a function of the combined impact of the four sources noted above. Porter also contends that government can influence each of the four components in the diamond either positively or negatively by pursuing appropriate policies and that chance factors - like oil price shocks, earthquakes, floods or the sudden discovery of a major energy saving process - can also play a role. As part of the tile industry in IY country it follows that T Company may benefit from the positive interaction of the four sources of national competitive advantage noted above or suffer from their absence.

(b)

Porter’s diamond model has come under some criticism given that when he formulated the model some thirty years ago the conditions of international business were so different from today. The internet didn't exist as we know it today. The outsourcing of manufacturing to low cost centres by the Triad group of the USA, Japan and Europe to emerging south east Asian low cost locations was still in an early stage of development; as was the giant leap forward by the BRIC economies of Brazil, Russia, India and China to the status of major world producing economies.

With hindsight, the central role of the state in the development and competitiveness of newly industrialising countries (NICs) is underplayed in Porter’s model. The government in many NICs targeted particular industry sectors including ship building, automobiles, semiconductors and personal computers; and actively promoted the development of competitive advantage through export promotion policies.

In the construction of the diamond model, Porter did not anticipate the role of the multinational companies as a key source of technology transfer and learning to latecomer firms in the NICs. Also, the model does not have much if anything to say about the role of public private partnerships as a source of competitive advantage in such countries.

The inability of the diamond to explain the growth and development of some very successful industries such as Indian software also points to weaknesses in the model. As a developing country India lacked most of the local endowments thought necessary for the development of a high technology industry such as software engineering.

Local demand for software was initially non existent. Related and supporting industries such as computers and telecommunications were undeveloped. And the national communications infrastructure was almost totally lacking.

One resource India did have, arising from its colonial past, was the widespread use of the English language which just happens to be the main language of software programming. The role of chance in Porter’s model played what seems to be a disproportionate role here.

The demand for customised software solutions did not come from India itself in the first instance as Porter’s model seems to suggest, but from European and American countries. The acquired factor endowment of software engineering did not come initially from India but from the USA where the Indian engineers received their training.

It was thus the existence of cheap programmers that gave the Indian software industry its initial competitive advantage - a stage that it has now moved beyond with the assistance of the Indian government in the development of the country’s ICT infrastructure.

Considering the Indian software industry, it would appear that local influences (other than the presence of a large number of people with a command of English and a readiness to travel abroad for their technical education) had little influence on the country’s development as a leading light in the software industry. Rather the important influences seem to have been overseas demand and overseas expertise. This is not what Porter’s diamond model would have led us to predict.