Approaches of Michael Porter - Essay Example

Michael Porter According to the neo ical paradigm, a firm combines labour and capital in a specific production function. As production factors in this paradigm are completely mobile, all the firms in a given industry have access to the same production factors--which they can combine in a similar way--as if they were working from a recipe in a cookbook, (Nelson 61-74) Competitive advantage, according to the cookbook paradigm, can only arise from economies οf scale, market imperfections and entry barriers, because these restrict the mobility οf production factors. The room for strategic business behaviour in this paradigm is extremely limited. What can be seen in practice is various firms achieving competitive advantage in different ways. There is evidence, for example, that in industries where scale is considered to be very important, small-scale innovations have completely opened up the competition, This became clear in the stagnating steel industry, where mini-mills grew rapidly in answer to the demand for all kinds οf specialist products. In the Netherlands, large-scale shipyards were engaged in a struggle for survival--with all eyes focused on the government for subsidies--while at the same time specialist firms were successful in the fields οf yacht-building and dredging. The great differences in profitability between firms within the same industry are difficult to explain by resorting to neoclassical theory. (Rumelt 169-185) For these differences lie in the introduction οf innovative concepts, new combinations οf production factors and the smart use οf technologies. The internal side οf the firm plays a crucial part in this. Firms like Primark and McDonalds, for example, have developed specific routines and skills which are difficult for competitors to imitate. The existence οf this sort οf firm-specific competencies does not fit in very well with the cookbook metaphor οf neoclassical economics. The new insights indicate that a sustainable competitive advantage can only be attained by creating new organization-specific knowledge. On the cutting edge οf strategic management and evolutionary economics, a debate is currently taking place about new theories οf the firm in which the special qualities οf knowledge are incorporated. In these theories, static thinking is replaced by a more realistic process perspective. Concepts like limited rationality (or even trial and error), path dependency and heterogeneity are all embraced. The role οf soft variables like knowledge, culture and network relations is emphasized. The most important role is played by the Penrose-inspired resource based theory. This approach traces firms reasons for existence to their greater effectiveness in gathering and circulating knowledge when compared to the market as a whole. For a knowledge economy, this theory is therefore οf the utmost relevance and for this reason it will be used here as the starting point for the development οf new guidelines for government policy. In the following discussion, three important changes in theoretical thinking with respect to firms will be considered in greater detail. Subsequently, the modern conceptualization οf industrial behaviour and strategy will be examined to see what possible implications it could have on government policy. The three changes can be characterized as: from homogeneity to heterogeneity; from capital exploitation to knowledge development; from global to local. According to traditional industrial economics, the structure οf an industry is οf central importance for the conduct and performance οf firms (hence, this paradigm is called the structure-conduct-performance or SCP paradigm). (Scherer 1-7) This structure to a large extent determines the profitability οf the firms which operate within that industry. This principle resulted in strategic management researchers, most prominently Michael Porter, trying to formulate strategies that made use οf these insights: for example, by advising firms to build entry barriers and hide behind them. Economic policy based on the SCP paradigm focused strongly on competition policy, i.e. anti-trust regulation. Further, policy-makers encouraged and occasionally forced firms to exploit economies οf scale. However, during the 1980s, a remarkable reversal took place in strategic management thinking. Since the late 1980s, it has become increasingly clear that firms which have been exposed to competitive conditions have been more successful. Confrontation with competitors highlights the importance οf developing firm-specific competencies and forces firms to differentiate. In so doing, they are stimulated to develop specific knowledge with which they can serve distinctive market segments. Differences in knowledge between firms allow them to achieve competitive advantages in different segments οf the market. Instead οf the homogeneity οf the cookbook metaphor, the modern theory οf the firm takes the heterogeneity οf the firm to be the central explanatory factor governing competitive advantage. Firms are constantly in the process οf creating niche markets on the basis οf their specific skills. Firms are heterogeneous, not homogeneous, and this heterogeneity should be encouraged by governments. In the resource-based view, knowledge plays a central role, more than a firms tangible capital. It is not a question just οf knowledge about products, production techniques, customers and suppliers, but also οf the knowledge and skills required to integrate the different parts in the value chain. The development οf new knowledge and the distribution οf knowledge within a firm are important variables in new theories on the growth and development οf firms. Within these systems, a distinction is often made between tacit, or unarticulated, knowledge and explicit, or codified, knowledge. (Nonaka 96-104) Technological knowledge is an important production factor for a firm, but in view οf the rather explicit character οf this type οf knowledge, it can also be imitated relatively easily by competitors. Technology must therefore be combined with other types οf knowledge if a sustainable competitive advantage is to be created (Kogut 383-397). This knowledge should be more tacit, like organizational knowledge or marketing knowledge. This new type οf knowledge is often developed in collaboration with suppliers and customers. The fact that firms have realized the advantages οf this is shown by R&D departments being decentralized, in such a way that the development οf new products, wherever possible, is located close to demanding clients. This is illustrated by the firm Cap Gemini, which located the department responsible for the development οf financial information technology (IT) services in the City οf London (Europes financial centre), and the department responsible for IT services for trade and distribution in the Netherlands (Europes distribution centre). This type οf policy is characteristic οf the strategy οf many transnational firms. (Bartlett 1-10) It implies that firms are less likely to be attracted by alluring R&D premiums when setting up their businesses and more likely to be attracted by the presence οf demanding customers, who stimulate the development οf knowledge. This renewed interest in the choice οf location brings us to the third important change in (theories on) business behaviour. In a world where competition is becoming increasingly acute and production factors increasingly mobile, it is becoming more difficult for firms to build up a sustainable competitive advantage. The increasing openness οf borders means not only that traditional production factors like labour and capital are more likely to cross frontiers, but that knowledge about products and production processes will travel too. However, paradoxically, increased mobility οf production factors has made local conditions very important once again. (Kogut 33-47) The removal οf trade barriers will ensure that, in the future, countries have to compete on the basis οf their real innovative capabilities. They will no longer be able to hide their weaknesses behind artificial barriers. Consequently, local capabilities will become the main source οf competitive advantage. These local capabilities are immobile and difficult to imitate. Firms will direct their investments to the best spots for knowledge development: that is, to the spots with the best local capabilities. Using typical local capabilities (e.g. consumer demand, culture, the presence οf suppliers) is a possible way for firms to achieve a sustainable competitive advantage in an internationalizing world. A firm embedded in a stimulating environment can in this way build up a competitive advantage over other firms. This idea can be traced back to the Porter (Porter 5-8) diamond and the cluster approach. (Jacobs 425-437) In this section, emerging policy initiatives in small countries are described which are in line with thinking in the resource-based theory οf the firm, these being policies which stimulate the heterogeneity οf knowledge development among firms, and build on and strengthen the knowledge embedded in the local situation. Another important question is whether these policies stimulate and challenge firms to develop resources which are difficult to imitate. This means that we have been looking for experiences with policies which signal the following changes: from a change οf focus on technology and costs to knowledge development; from a supply orientation to a demand orientation; from supporting large key companies to strengthening networks. The first point highlights the fixation in policy on technology and costs. The previous discussion has shown that a focus on generic technologies is too narrow. Knowledge is more than technology. Combining technology, organizational and market knowledge is the best way for a company to differentiate product offerings from those οf competitors. Knowledge interchange between these fields may arise and will be difficult to imitate. This sort οf specific organisational knowledge is sometimes referred to in economic science as social capital or organizational capital, (Presscot 446-461) whereas in popular management literature it is more likely to be referred to as core competencies. (Prahalad 79-91) Subsidizing R&D does not by itself serve the same purpose, as it is totally directed towards the exploitation οf capital and technology. An example οf governmental policy linking various types οf knowledge can be found in the Dutch agricultural industry. Government has sponsored a foundation (the ACC, or Agri Chain Competence) which acts as an intermediary between agri-business and research institutes. ACC funds projects in which several organizations in the agri-business aim at bringing higher value added products to the market. These projects normally have a technological aspect (e.g. developing a new species οf apples, implementing a new distribution system or implementing an IT system between buyers and sellers). However, practice has made it clear that the implementation οf such systems and products entails organizational change and requires new methods οf marketing in order to be successful. Hence, ACC has broadened its approach to incorporate not only technological knowledge, but other types οf knowledge as well. This increases the success οf the projects and makes this success projects harder to copy. Projects in need οf funding are presented to ACC by firms. ACC is financed by government funds, but can set its own strategic priorities. It has decided not to focus on one kind οf project, but takes a bottom-up approach. In short, it does not prescribe one working method. Rather, it increases the heterogeneity οf the Dutch agricultural industry by allowing firms to develop their own unique way οf working. In the second place, current policy is too much oriented to the supply side οf technology. For this reason, it leads mainly to the setting up οf genetic technologies (like the unsuccessful mega-chip developed by Philips and Siemens, sponsored by the European Community) and not to promoting heterogeneous knowledge. This does not contribute to differentiation. Neither does it lead to locally embedded knowledge, as generic technologies can be implemented anywhere and developed by anyone. It makes more sense to encourage firms to build up their own specialisms. Therefore, instead οf stimulating knowledge development on the supply side, the demand side should be taken as a point οf departure. If firms are confronted with critical users, they will be forced to develop new knowledge, thus supplying them with a source οf competitive advantage. One way to confront firms with an demanding conditions is to use regulations and laws. By enforcing, for example, stricter quality or environmental regulations, firms are enticed to upgrade their capabilities in this field. Examples οf this mechanism οf stricter regulations making industries more competitive have been found in the environmental sector in particular. (Porter 120-134) Stricter regulations have not only led to new products, but also led to companies taking a new look at their complete production process. Several ways οf making savings were found. Denmarks advanced health system has acted as a competent and demanding user οf hospital instruments and hereby contributed to the strong competitiveness οf Danish firms in this sector. For example, regulations concerning a high level οf technical standards in combination with local demand conditions may be the main reason underlying the strong position, οf Danish heating aid companies, which control about two-thirds οf the world market. In addition, the focus on key firms like Fokker is too narrow. If a key firm passes on knowledge to suppliers and customers, this leads to a strengthening οf the economic structure. The knowledge does not stay within the boundaries οf a single firm, but can be used by many other firms. This in turn puts them in a better position to develop knowledge. Eventually, these firms will have competitive power on their own without the key firm. The transfer οf knowledge in the Fokker cluster has been fairly limited: Fokker kept a lot οf knowledge in house and did not exploit the existing knowledge οf the market either. In this way, knowledge was not used in an optimal way for society at large. There are small firms in different sectors that could have put Fokkers specific technological knowledge to good use. This can be seen in Britain, where the technological knowledge from British Aerospace--after the partial dismantling οf the company--is now being used in a whole array οf small firms sited along the M4 motorway from London to Bristol. Knowledge about lightweight construction combined with knowledge about cars has produced the newest Formula 1 racing cars, while another firm with the aid οf this technology has brought a successful series οf buggies to the market. It is therefore better to aim policy towards various firms and their suppliers and to stimulate the transfer οf knowledge in a cluster οf firms. In this way, if a key firm like Fokker disappears, the entire cluster does not vanish with it, thus ensuring that a part οf the economic structure is left firmly intact. For these reasons, Dutch policy-makers have also directed their attention to stimulating clustering between smaller firms. In the Danish windmill industry this has been done too. The TRC has created a collective knowledge base at industry level. At the same time, care has been taken not to compromise the knowledge base οf any one firm. In this way, the bankruptcy οf an individual firm does not entail the complete loss οf firm-specific knowledge. In the foregoing discussion, three moves can be observed in the economy in general, and in business behaviour in particular. The newest theories οf the firm emphasize heterogeneity, knowledge and location. These three are οf great importance for the development οf a new and innovative government policy repertoire that challenges firms to develop knowledge which is difficult to imitate. The neoclassical concept οf business behaviour still plays too dominant a role in policy thinking, while at the same time offering too few footholds for government policy in a knowledge economy. The development οf knowledge cannot be analyzed in terms οf neoclassical production functions, but demands that the heterogeneity οf firms be taken into consideration, as well as the ties a firm has with its direct surroundings (clients, suppliers, national culture, etc.). A modern conceptualization οf the firm leads to the recommendation that knowledge development should not be stimulated by supply but by demand. Neither should knowledge be reduced to technology: it is the combination οf different sources οf knowledge more than anything else that leads to sustainable and differentiated competitive advantages. In conclusion, the support οf a key firm in a cluster is not the best way οf spreading knowledge. This aim is better served if the cluster around the key firm is developed and knowledge at the industry level is created. Works Cited Bartlett, C. & S. Ghoshal, Managing across Borders: The Transnational Solution (Boston, Harvard Business School Press, 1989). Jacobs, D. & A. P. de Man, Clusters, Industrial Policy and Firm Strategy: A Menu Approach, Technology Analysis and Strategic Management 8, 1996, pp. 425-437. Kogut, B. & U. Zander, Knowledge οf the Firm, Combinative Capabilities and the Replication οf Technology, Organization Science, 3, 1992, pp. 383-397. Kogut, B., Country Capability and the Permeability οf Borders, Strategic Management Journal, 12, 1991, pp. 33-47. Nelson, R. R., Why Do Firms Differ, and How Does It Matter?, Strategic Management Journal, 12, 1991, pp. 61-74. Nonaka, I., The Knowledge-creating Company, Harvard Business Review, 1991, November/December, 1991, pp. 96-104 Porter, M. E. & C. van der Linde, Green and Competitive: ending the Stalemate, Harvard Business Review, September/October, 1995, pp. 120-134. Porter, M. E., The Competitive Advantage οf Nations (London, Macmillan, 1990). Prahalad, C. K. & G. Hamel, The Core Competences οf the Corporation, Harvard Business Review, May/June 1990, pp. 79-91. Presscot, J. E. & D. J. Visscher, Organizational Capital, Journal οf Political Economy, 1980, pp. 446-461. Rumelt, R. P., How Much Does Industry Matter?, Strategic Management Journal, 12, 1991, pp. 169-185 Scherer, F. M., Industrial Market Structure and Economic Performance (Chicago, Rand McNally, 1980). Read More