porters

7 January 2014, Background: on the Competitive Advantage of Nations (What About Cluj?)

basics

Michael Porter’s book The Competitive Advantage of Nations is considered by many to be one of the most ambitious books of our times. The book re-examines the nation-state, suggesting that its basic role today is an economic one, and that, even in a global economy, it has a key role to play by ensuring the success of the companies operating within its borders who are the actual wealth producers of the population.

One would ask why is this relevant for the issue of Cluj as 2015’s European Youth Capital. We think it does, and we want to demonstrate it in this blog post.

In 1990 Michael Porter of the Harvard Business School published the results of an intensive research effort that attempted to determine why some nations succeed and others fail in international competition. Porter and his team looked at 100 industries in 10 nations. Like the work of the new trade theorists, Porter’s work was driven by a belief that existing theories of international trade told only part of the story. For Porter, the essential task was to explain why a nation achieves international success in particular industry. Why does Japan do so well in the automobile industry? Why does Switzerland excel in the production and export of precision instruments and pharmaceuticals? Why do Germany and the United States do so well in the chemical industry? These questions cannot be answered easily by the Heckscher-Ohlin theory, and the theory of comparative advantage offer only a partial explanation. The theory of comparative advantage would say that Switzerland excels in the production and export of precision instruments because it uses its resources very productively in these industries. Although this may be correct, this does not explain why Switzerland is more productive in this industry than Great Britain, Germany, or Spain. Porter tries to solve this puzzle.

We believe, the model is also applicable to cities, not just countries or nations.

Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage. These attributes are:

  • Factor endowments – a nation’s position in factors of production such as skilled labour or the infrastructure necessary to compete in a certain industry
  • Demand conditions – the nature of home demand for the industry’s product or service
  • Relating and supporting industries – the presence or absence of supplier industries and related industries that are internationally competitive
  • Firm strategy, structure, and rivalry – the conditions governing how companies are created, organized, and managed and the nature of domestic rivalry.

Porter speaks of these four attributes as constituting the diamond. He argues that firms are most likely to succeed in industries or industry segments where the diamond is most favourable. He also argues that the diamond is a mutually reinforcing system. The effect of one attribute is contingent on the state of others. For example, Porter argues that favourable demand conditions will not result in competitive advantage unless the state of rivalry is sufficient to cause firms to respond to them.

In a lot of cases the attributes are also characteristics for Cluj. For example cooperation within the Cluj IT cluster can be built either on rivalry or cooperation. We are not used to cooperating, and this still defines how development is done in Cluj, although signs of joining forces and rather competing with other cities or regions starts to emerge as a concept.

Porter maintains that two additional variables can influence the national diamond in important ways: chance and government. Chance events, such as major innovations, can reshape industry structure and provide the opportunity for one nation’s firms to supplant another’s. Government, by its choice of policies, can detract from or improve national advantage. For example, regulation can alter home demand conditions, antitrust policies can influence the intensity of rivalry within an industry, and government investments in education can change factor endowments.

 

Factor endowments

 

Factor endowments lie at the center of the Heckscher-Ohlin theory. While Porter does not propose anything radically new, he does analyse the characteristics of factors of production. He recognizes hierarchies among factors, distinguishing between basic factors (e.g., natural resources, climate, location, and demographics) and advanced factors (e.g., communication infrastructure, sophisticated and skilled labour, research facilities, and technological know-how). He argues that advanced factors are the most significant for competitive advantage. Unlike the naturally endowed basic factors, advanced factors are a product of investment by individuals, companies, and governments. Thus, government investments in basic and higher education, by improving the general skill and knowledge level of the population and by stimulating advanced research at higher education institutions, can upgrade a nation’s advanced factors.

 

Demand conditions

 

Porter emphasizes the role home demand plays in upgrading competitive advantage. Firms are typically most sensitive to the needs of their closest customers. Thus, the characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. Porter argues that a nation’s firms gain competitive advantage if their domestic consumers are sophisticated and demanding. Such consumers pressure local firms to meet high standards of product quality and to produce innovative products. Porter notes that Japan’s sophisticated and knowledgeable buyers of cameras helped stimulate the Japanese camera industry to improve product quality and to produce innovative models. A similar example can be found in the wireless telephone equipment industry, where sophisticated and demanding local costumers in Scandinavia helped push Nokia of Finland and Ericsson of Sweden to invest in cellular phone technology long before demand for cellular phones took off in other developed nations.

In our case: can we foresee what is the need of the future and how could Cluj-Napoca become a key innovator on that thing of the future? Do we have our capacity to identify this and to meat the challenge of innovation?

 

Related and supporting industries

 

The third broad attribute of national advantage in an industry is the presence of suppliers or related industries that are internationally competitive. The benefits of investments in advanced factors of production by related and supporting industries can spill over into an industry, thereby helping it achieve a strong competitive position internationally. Swedish strength in fabricated steel products (e.g., ball bearings and cutting tools) has drawn on strengths in Sweden’s speciality steel industry. Technological leadership in the U.S. semiconductor industry provided the basis for U.S. success in personal computers and several other technically advanced electronic products. Similarly, Switzerland’s success in pharmaceuticals is closely related to its previous international success in the technologically related dye industry.

 

Firm strategy, structure, and rivalry

 

The fourth broad attribute of national competitive advantage in Porter’s model is the strategy, structure, and rivalry of firms within a nation. Porter makes two important points here. First, different nations are characterized by different management ideologies, which either help them or do not help them to build national competitive advantage. For example, Porter noted the predominance of engineers in top management at German and Japanese firms. He attributed this to these firms’ emphasis on improving manufacturing processes and product design. In contrast, Porter noted a predominance of people with finance backgrounds leading U.S. firms. He linked this to U.S. firms’ lack of attention to improving manufacturing processes and product design. He argued that the dominance of finance led to an overemphasis on maximizing short-term financial returns. According to Porter, one consequence of these different management ideologies was a relative loss of U.S. competitiveness in those engineering-based industries where manufacturing processes and product design issues are all-important (e.g., the automobile industry).

Porter’s second point is that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which makes them better international competitors. Domestic rivalry creates pressures to innovate, to improve quality, to reduce costs, and to invent the upgrading advanced factors. All this helps to create world-class competitors. Porter cites the case of Japan:

Nowhere is the role of domestic rivalry more evident than in Japan, where it is all-out warfare in which many companies fail to achieve profitability. With goals that stress market share, Japanese companies engage in a continuing struggle to outdo each other. Shares fluctuate markedly. The process is prominently covered in the business press. Elaborate ranking measure which companies are most popular with which university graduates. The rate of new product and process development is breathtaking.

A similar point about the stimulating effects of strong domestic competition can be made with regard to the rise of Nokia of Finland to global pre-eminence in the market for cellular telephone equipment. For details, see the Management Focus.

In the case of Cluj-Napoca (and the youth capital, either if it wants it or not, it will face this issue) doesn’t have a coherent identity. We don’t know if we are defined by rivalry or cooperation, we don’t have a single community, but communities within the city (analysis on the cultural sector and the EUROSTAT report also contained several line of data on this matter).

What we propose with the European Youth Capital year of 2015 is to start a process, a period of cooperation. We believe Cluj has to go through a period of inside peace and cooperation. At the end of this period Cluj can become strong enough to enable publicly rivalries which can lead to further progress. The Youth@Cluj-Napoca 2015 Initiative wants to be a first enable of this spirit of cooperation. The general development strategy of the city will define key industries, what is our competitive advantage. Or what should be.