Comparative Advantage & Porter’s Diamond of National Advantage (1990)
When analysing competitive strategy, it is also important to remember that this does not occur in a vacuum but is influenced by global environmental pressures. Early strategic theory referred to an interplay between the competitive advantages possessed by the firm and the comparative advantages possessed by a particular country or region. in order to understand this dilemma, it is important to consider the traditional economist’s view that international trade was firmly based on the principle of comparative costs (i.e. cost differences) between nations. Any gains from trade were also based on specialisation. Adam Smith’s theory of international trade first published in 1776, was based on the simple idea that an overall welfare gain was made if countries produced the goods in which they had an absolute cost advantage and traded them with other countries for goods in which those countries had absolute cost advantages. In 1817, David Ricardo developed this into a theory of comparative advantage. Comparative advantage can be expressed as international differences in the opportunity costs of goods i.e. the number of other goods sacrificed to make one more unit of that good in one country as compared to another country.
The economics of comparative costs and comparative advantage, used to underpin the development of all international trade, was mainly in non-branded commodity goods. Countries incur different costs in producing similar goods because they are differently endowed with the three traditional factors of production: land, labour and capital. The exchange between countries should, therefore, lead to welfare gains for all barring protectionist policies that threaten to reduce overall welfare gains.
In his book The Competitive Advantage of Nations, Michael Porter (1990) raised the question of why certain companies based in certain nations were capable of consistent innovation. His response took the form of the Diamond of National Advantage based on four attributes. These four attributes are the determinants of the national environment in which companies are born and subsequently learn how to compete. Each point on the diamond - and the diamond as a system - affects the essential ingredients for achieving international competitive success. We will analyse each of the four attributes in detail before considering the relevance of the theory of comparative advantage and the diamond of national advantage to the modern ICT ecosystem.
Factor conditions: According to standard economic theory, factor conditions consist of the factors of production and include land, labour and capital (i.e. natural resources and infrastructure) which determine the flow of trade. The idea is that a nation will export those goods that make the most use of the factors with which it is relatively endowed. This classical economics doctrine, dating back to Adam Smith (1776) and David Ricardo (1817) is, however, no longer correct. In any advanced economy, it is the factors of production created by sophisticated high-value industries that are more important than any inherited factors (Porter 1990).
Demand conditions: Nations gain a competitive advantage in industries where the home demand gives their companies a clearer or earlier picture of emerging buyer needs and where demanding buyers’ pressure companies to innovate faster and achieve more sophisticated competitive advantage than their foreign rivals. A nation’s companies gain competitive advantages if domestic consumers are the world’s most sophisticated and demanding buyers for the product or service. Sophisticated, demanding buyers provide a window into advanced customer needs; they pressure companies to meet high standards (Porter 1990).
Related and Supporting Industries: The third broad determinant of national advantage is the presence in the nation of related and supporting industries that are internationally competitive. However, what is far more significant than mere access to components and machinery is the advantage that home-base related and supporting industries provide in terms of innovation and upgrading due to close working relationships. Suppliers and end users located near each other can take advantage of short lines of communication, quick and constant flows of information and an ongoing exchange of ideas and innovations (Porter 1990; 1998).
Firm Strategy, Structure and Rivalry: The presence of strong local rivals is a final and powerful stimulus to the creation and persistence of competitive advantage. Among all the points on the diamond, domestic rivalry is probably the most important because of the stimulating effect it has on all the others. Domestic rivalry, like any rivalry, creates pressure on companies to innovate and improve. Local rivals push each other to lower costs, improve quality and service and create new products and processes. Geographic concentration also magnifies the power of domestic rivalry as specialist clusters form (Porter 1980, 1985).
Not only are the points of the diamond self-reinforcing and constitute a system, but another effect of the diamond’s systemic nature is that nations are rarely home to just one competitive industry but an environment is created that promotes clusters of competitive industries. These clusters also tend to be concentrated geographically, and one competitive industry will also help to create another in a mutually reinforcing process. Once a cluster forms, the whole group of industries becomes mutually supportive, and benefits flow forward, backward and horizontally (Porter 1998).
The theories of both comparative advantage and Porter’s Diamond of National Advantage (Porter 1990), when applied to the ICT sector, reveal some very important flaws and weaknesses. The first weakness relates to the actual factors of production. Not only are two of these factors mobile (labour and capital) but new factors of production should also be added. These should include data and information. In the information age, the new source of competitive advantage is the ability of firms to capture large amounts of structured and unstructured data and undertake sophisticated Big Data analytics (Simon 2013). This is the core competency and source of competitive advantage of the data-rich, Internet-based firms such as Google, Facebook, Amazon, Apple, Microsoft, Alibaba, etc. The ability of these firms to move up Sharda et al’s., (2014) Analytics Value Chain’ - see Fig. 2.1 - and Debons et al’s., (1998) Knowledge Pyramid (see Fig. 2.2) and to achieve high levels of innovation through predictive and prescriptive analytics has resulted in the achievement of extraordinary financial returns and the disruption of traditional industries (Downes and Nunes 2013).
This industry disruption has occurred (Hitt et al. 2003) because the incumbent firms in the ‘old economy’ industries have become overly reliant on the traditional factors of production and have not developed
Fig. 2.1 The analytics value chain (Adapted from Sharda et al., 2014)
Fig. 2.2 The knowledge pyramid (Adapted from Debons et al., 1998)
or acquired the new advanced factors of production (data, information and analytics capabilities).
However, when the classical economists developed the theory of comparative advantage, it was not possible to capture and store data nor could data be traded in the same way as a product. It was not quantifiable, and therefore, not considered as a relevant factor of production. However, due to Moore’s Law (Moore 1965) and the falling cost of computing power and data and modern hardware and software, it is not only possible to audit and quantify data but to process it in real time (Sharda et al. 2014).
Data can also be classified as a ‘good’ that can be traded (which is another reason that economists didn’t include it as a factor of production). The dematerialisation of media products such as music, films, books, and newspapers into digital formats and their online delivery via downloads and streaming are examples of this new trend.
Porter (1990) criticised classical comparative advantage theory and the natural endowments of land, labour and capital saying that these were not enough to ensure that firms within an industry would have a sustainable competitive advantage. He then stated that only the advanced factors of production were relevant to the achievement of competitive advantage. Although Porter (1990) included technological resources, knowledge resources, communication systems and infrastructure in his list of advanced factors of production, his critique of comparative advantage was undertaken in 1990 before the arrival of the Internet. Therefore, Porter’s (1990) criticisms do not go far enough in terms of the role of data and information in the innovation process and the relevance of the advanced factors of production to ICT.
Not only are the factors of production limited and constrained but Porter’s demand conditions are also flawed when analysing firms in the ICT sector. For example, consumers of online services are not simply demanding in terms of pressuring firms to deliver more; they are directly involved in designing, developing and producing new online content themselves. The millennials today are ‘Prosumers’ who produce as well as consume content. User generated content has been a key feature of Web 2.0. During the Web 1.0 era consumers were passive recipients of promotional messages and content, but today they are the new creators (Kotler 1986).
The third attribute of the diamond model, Porter’s (1990) related and supporting industries, is also flawed. Since Porter’s theory was developed before the full impact of globalisation had occurred, it ignored the move towards international supply chains. All the technology hardware companies have used international supply partners to produce products and components at significantly lower costs. Apple’s hardware products are made by Foxconn (Hon Hai, Taiwan) in China. The new international division of labour (NIDL) is a trend that began in the personal computer sector as early as the 1980s. Porter, therefore, ignored the role of the multinational technology companies as a key source of technology transfer and learning to firms in the newly industrialised countries (NICs).
The ability to outsource manufacturing on a global scale was also only possible due to the development of the Internet as a co-ordinating mechanism. This is a further flaw in Porter’s diamond model i.e. the fact that it has a national and parochial focus. Since the Internet is a world-wide, global platform, it means that its consumers and related and supporting industries are also distributed globally thereby rendering the concept of national advantage obsolete. The only aspect of Porter’s work where there are still some national benefits and geographic concentration are in the technology clusters that drive innovation. The leading geographic technology cluster is still Silicon Valley, but other clusters have emerged on a global scale in both Europe and Asia and not just North America.
Finally, Porter was still correct in saying that inter-firm rivalry was one of the greatest drivers of innovation and that this would need to be done on a continuous basis. The importance and impact of ‘local’ national rivalry may have been true during the personal computer era of the 1980s and the early days of the Internet (Web 1.0) in the 1990s. However, as new app-based aggregator firms such as Uber and Airbnb have emerged, these asset-light platform-based firms have launched their products globally by entering and attacking multiple markets simultaneously with little regard for staged approaches based on the leveraging of strengths developed in their home markets nurtured by ‘local’ rivals. This is known as a winner-takes-all-strategy.