Meaning of Competitive Advantage Theory
Porter’s competitive advantage is an international trade theory that explains why a nation achieves success in the international market (trade, business, and competition) and why others do not.
This theory is also known as Porter’s international trade theory, Porter’s diamond model, and national competitive advantage.
In 1990, Prof. Michael Porter of Harvard Business School did extensive research on 100 industries in 10 countries with his team.
Their main aim was to find out what makes a firm achieve a national competitive advantage and a nation succeed in international competition in a particular industry.
Porter’s through his extensive research identified four attributes that help a firm to get a competitive advantage in its nation, which he named Porter’s Diamond, namely…
- Demand Conditions
- Factor Endowments
- Related and Supporting Industries
- Firm Strategy, Structure, and Rivalry
According to Porter, the development of internationally competitive products depends on their domestic factors which are above mentioned four attributes or characteristics of Porter’s Diamond.
Porter’s research was based on the questions like, Why does Japan do so well in the automobile industry, and Switzerland in the luxury watches and pharmaceuticals?
Or, why do Germany and the United States do well in chemical industries? These questions could not be easily answered even by the Heckscher-Ohlin Theory and Comparative Advantage Theory.
With his four attributes or determinants, Porter tried to solve this puzzle of national competitive advantage. As per this theory, four attributes always shape the environment in which local firms compete.
These four attributes promote or impede the creation of a competitive advantage for the nation.
Porter’s Diamond (Attributes of National Competitive Diamond)
Porter’s theory states that these four attributes create a diamond. Firms are most likely to be successful in the industries where the diamond is most favorable.
He adds that one attribute could reinforce or strengthen the state of the other. A country can achieve a competitive advantage in the industry where the combined effect of all four attributes is favorable.
He also stresses that a government can play a role in facilitating or obstructing the creation of such a favorable environment.
The four Poter’s Diamonds are:
Demand Conditions
Porter emphasized that the nature of a product’s home country’s demand is a critical requirement for a country’s competitive advantage to be strengthened.
When consumers in a country’s home market are knowledgeable and sophisticated, they put pressure on businesses to provide high-quality, useful, and innovative items, increasing the chances that their products will be exported to foreign countries.
Firms from the US, Japan, and Europe have entered most of the countries, as their demand conditions have pressed them to build better products that become saleable in the rest of the world.
Factor Endowments
Porter analyzed a nation’s position in factors of production such as skilled labor, or infrastructure necessary to compete in a given international industry. A country with better factor endowments can do better in the given industry.
Porter has analyzed the features and level of composition of production factors.
He has also distinguished between basic factors like natural resources, climate, location, educational level, health, demographics, etc., and advanced factors like technologies, communication, infrastructures, skilled labor, R&D facilities, etc.
Related and Supporting Industries
The presence or absence of related and supporting industries also determines the level of competitive advantage of a firm in a given nation.
For example, the availability and efficiency of internationally linked banks in Nepal determine the competitive advantage of Nepali manpower agency firms.
Similarly, the availability and efficiency of tire manufacturers in the country impact the competitive advantage of the automobile industry.
Switzerland was prosperous in pharmaceuticals because of its long experience in chemical industries.
At the same time, Germany was stronger in textile manufacturing due to their capacity to produce high-quality sewing machines and other accessories.
Read More: Comparative Advantage Theory
Firm Strategy, Structure, and Rivalry
A firm’s strategy (in financial, marketing, and technical areas) and structure are the conditions that govern how the firm is created, organized, and managed.
Another condition or factor is the nature of rivalry among the firms in the nation. These all determine their competitive advantage in the country.
A firm having a predominance of technocrats in the top management places more preference on technological strategies and less on assessing market realities and positioning strategies; then such a firm loses the competitive advantage.
Similarly, if there is a big rivalry among the firms, they may go for two programs: in the worst case, they may go for an intense price war for survival.
In the best case, they may opt for innovating new products and technologies to improve quality and reduce costs. In this instance, the latter case is the better one.
Criticisms of Competitive Advantage Theory
A critical review of Porter’s theory of national competitive advantage can be explained below.
- Porter assumed that competitive advantage in a nation or the emergence of high-quality and affordable products is due to national demand. He has ignored the international demand that may greatly influence to offer of quality products at affordable prices.
- Competition is not always good for firms to compete – as it creates an environment of affordable products but most firms are also in a state of collapse due to high competition.
- Due to a shortage of natural resources/factor endowments – it may not always remain an essential attribute of a nation’s competitive advantage.
- The role of government in the industry is a challenge for a government
Read Next: IPLC Theory
Sujan Chaudhary holds a BBA degree. He loves to share his business knowledge with the rest of the world.