In his 1990 book, The Competitive Advantage of Nations, Michael Porter presents conclusions from a four-year study of ten countries. He represents the determinants of national advantage as a diamond. The corners of the diamond represent four broad attributes of a nation that shape the environment in which local firms compete and which promote or impede the creation of competitive advantage:

1. Factor conditions. The nation’s position in factors of production, such as skilled labor or infrastructure, necessary to compete in a given industry.
2. Demand conditions. The nature of home demand for the industry’s product or service
3. Related and supporting industries. The presence or absence in the nation of supplier industries and related industries that are internationally competitive.
4. Firm strategy, structure, and rivalry. The conditions in the nation governing how companies are created, organized, and managed, and the nature of domestic rivalry.

The determinants, individually and as a system, create the context in which the nation’s firms are born and compete; the availability of resources and skills necessary for competitive advantage in an industry; the information that shapes what opportunities are perceived and the directions in which the resources and skills are deployed; the goals of the owners, managers, and employees that are involved in or carry out competition; and most importantly, the pressures on firms to invest and innovate

Porter groups the factors into broad categories:

He argues that the rate at which these factors are created, upgraded, and made more specialized to particular industries is more important than the abundance of factors at any given time. He makes the point that a selective disadvantage in factors, through influencing strategy and innovation, often contributes to sustained competitive success.

Porter differentiates between basic factors and advanced factors. Basic factors include natural resources, climate, location, unskilled and semiskilled labor, and debt capital. Advanced factors include modern digital data communications infrastructure, highly educated personnel such as graduate engineers and computer scientists, and university institutions in sophisticated disciplines. The importance of basic factors has been undermined by either their diminished necessity, their widening availability, or ready access to them by global firms. They remain important in extractive or agriculturally based industries. Advanced factors are now the most significant ones for competitive advantages. They are necessary to achieve higher-order competitive advantages such as differentiated products and proprietary production technology.

Home demand for an industry’s product or service can create economies of scale and can shape the rate and character of improvement and innovation at the nation’s firms. Three broad attributes of home demand are significant: the composition or nature of home demand (or nature of buyer needs), the size and pattern of growth of home demand, and the mechanisms by which the nation’s domestic preferences are transmitted to foreign markets.

The composition of home demand shapes how firms perceive, interpret, and respond to buyer needs. Nations gain competitive advantage in industries or industry segments where the home demand gives local firms a clearer or earlier picture of buyer needs than foreign rivals have. Nations also gain advantage if home buyers pressure local firms to innovate faster and achieve more sophisticated competitive advantages compared to foreign rivals. There are three characteristics of the composition of home demand particularly significant to achieving national competitive advantage:

1. Segment Structure of demand. A nation’s firms are likely to gain competitive advantage in global segments that represent a large or highly visible share of home demand but account for a less significant share in other nations. The relatively large segments in a nation receive the greatest and earliest attention by the nation’s firms. Small nations can be competitive in segments that represent an important share of local demand but a small share of demand elsewhere, even if the absolute size of the segment is greater in other nations.
2. Sophisticated and Demanding Buyers. A nation’s firms gain competitive advantage if domestic buyers are, or are among, the world’s most sophisticated and demanding buyers for the product or service. Such buyers provide a window into the most advanced buyer’s needs. They pressure local firms to meet high standards in terms of product quality, features, and service.
3. Anticipatory Buyer Needs. A nation’s firms gain advantages if the needs of home buyers anticipate those of other nations. This provides an early warning indicator of buyer needs that will become widespread. Anticipatory demand often result from having the world’s most sophisticated buyers, because sophisticated buyers are often early adopters of new products and service varieties that will come to be demanded elsewhere.

The size and pattern of growth of home demand can reinforce national advantage in an industry. Large home markets can lead to a competitive advantage in industries where there are economies of scale or learning by encouraging a nation’s firms to invest aggressively in large-scale facilities, technology development, and productivity improvements. The presence of a number of independent buyers in a nation, each with its own ideas about product needs, expands the pool of market information and motivates progress. Rapid domestic growth leads a nation’s firms to adopt new technologies faster with less fear that they will make existing investments redundant, and to build large, efficient facilities with the confidence that they will be utilized. Early home demand helps local firms to move sooner than foreign rivals to become established in an industry. Early saturation of markets forces firms to continue innovating and upgrading. It forces consolidation of the industry. And it often results in firms attempting to penetrate foreign markets.

Home demand can internationalize and pull a nation’s products and services abroad. If the nation’s buyers for a product or service are mobile or are multinational companies, and advantage is created for the nation’s firms because the domestic buyers are also foreign buyers. Domestic demand conditions can pull through foreign sales when domestic needs and desires get transmitted to or inculcated in foreign buyers. An example is when foreigners come to a nation for training. Another example is the demonstration effect. Foreign scientists seek to emulate the practices of the nations’ scientists that are perceived to be the world’s leaders. Domestic buyers needs are also transmitted abroad through movies and television programs. Emigration creates a base of foreign demand and a demonstration effect.

Related and Supporting Industries

Competitive advantage in some supplier industries confers potential advantages on a nation’s firms in many other industries, because they product inputs that are widely used and important to innovation and to internationalization. Internationally competitive supplier industries provide efficient, early, rapid, and sometimes preferential access to the most cost-effective inputs. Home based suppliers provide an advantage in terms of ongoing coordination. Suppliers help firms perceive new methods and opportunities to apply new technology. Firms gain quick access to information, to new ideas, and to supplier innovation. They have the opportunity to influence suppliers’ technical efforts as well as serve as test sites for development work.

The presence in a nation of competitive industries that are related often leads to new competitive industries. Related industries are those in which firms can coordinate or share activities in the value chain when competing, or those that involve products that are complementary, (such as computers and applications software). Sharing of activities can occur in technology development, manufacturing, distribution, marketing, or service. The presence of related industries provide opportunities for information flow and technical interchange. Domestic companies in related industries often share activities and sometimes forge formal alliances. International success in one industry can also pull through demand for complementary products or services.

The goals, strategies, and ways of organizing and managing firms in industries vary widely among nations. National advantage results from a good match between these choices and the sources of competitive advantage in a particular industry. Important national differences in management practices and approaches occur in such areas as the training, background, and orientation of leaders, group versus hierarchical style, the strength of individual initiative, the tools for decision making, the nature of the relationships with customers, the ability to coordinate across functions, the attitudes toward international activities, and the relationship between labor and management. These differences create advantages and disadvantages in competing in different types of industries. Specific aspects highlighted by Porter include:

The pattern of rivalry at home also has a profound role to play in the process of innovation and the ultimate prospects for international success. Nations with leading world positions often have a number of strong local rivals. In global competition, successful firms compete vigorously at home and pressure each other to improve and innovate. Additional scale is obtained by selling worldwide. The scale of the entire national industry is as important as that of individual firms.

Domestic rivalry creates pressure on firms to improve and innovate. Local rivals push each other to lower costs, to improve quality and service, and to create new products and processes. Vigorous local competition often pressures domestic firms to sell abroad in order to grow. Intense domestic rivalry depends on new business formation to crate new competitors. New companies serve new segments and try new approaches that older rivals fail to recognize or to which they are inflexible to respond. These new companies may be established by spin-offs from established firms, founded by employees of suppliers and customers, or the result of ideas gleaned during academic training or university result.

Porter identifies chance events as being important because they create discontinuities that allow shifts in competitive position. They can nullify the advantages of previously established competitors and create the potential that a new nation’s firms can supplant them. Examples of chance events are:

Government’s role in national competitive advantage is in influencing the four determinants. Factor conditions are affected through subsidies, policies toward the capital markets, policies toward education, and the like. Government’s role in shaping local demand conditions includes establishing local product standards or regulations that mandate or influence buyer needs. Government is often a major buyer of many products in a nation, among them defense goods, telecommunications equipment, aircraft for the national airline, and so on. Government can shape the circumstances of related and supporting industries through control of advertising media, regulation of supporting services. Government policy can influence firm strategy, structure, and rivalry through capital markets regulations, tax policy, and antitrust laws.

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Revised: 29 Mar 2001 22:24:59 -0500 .