Diamond Theory and Related and Supporting Industries - Essay Example

TOPIC: Does Porter fail to explain how the factor and demand conditions that mould a nation’s corporate strategies, business structures, and industrial clusters are established? What other theories and evidence might assist such an explanation? i. Introduction. Suggest answer to the question and outline how to validate your suggested answer by clarifying the analytical structure DIAMOND THEORY According to J. Porter, A Harvard University Professor, The four factors of his diamond theory are: a. Factor Conditions. Factory costs like labour, overhead, land, natural resources, capital and infrastructure that are created. Special factors included skilled labour, capital and infrastructure. Non key factors like unskilled labour and raw materials are easy to obtain do not generate competitive advantage because they are easy to hire and fire. But heavy sustained investments lead to competitive advantage thru expansion or improved service facilities. Porter argues that a lack of resources often actually helps countries to become competitive. Abundance generates waste while scarcity generates an innovative mindset. Such countries innovate to overcome their problem of scarce resources. Examples: a) Switzerland was the first country to experience labour shortages. They abandoned labour-intensive watches and concentrated on innovative/high-end watches. b) Japan has high priced land and so its factory space is at a premium. This lead to just-in-time inventory techniques (Japanese firms can’t have a lot of stock taking up space, so to cope with the potential of not have goods around when they need it, they innovated traditional inventory techniques). c) Sweden has a short building season and high construction costs. These two things combined created a need for pre-fabricated houses. b. Demand Conditions - Porter argues that a sophisticated domestic market is an important element to producing competitiveness. Firms that face a sophisticated domestic market are likely to sell superior products because the customers demand higher quality and after sales services and a close proximity to such markets consumers enables the firm to better understand the needs and desires of the customers. If the nation’s discriminating values spread to other countries, then the local firms will have to be competitive in the global market to survive. Example: French wine industry. The French are sophisticated wine consumers. These consumers force and help French wineries to produce high quality wines. c. Related and Supporting Industries. Porter also argues that a set of strong related and supporting industries is important to the competitiveness of firms such as suppliers and related industries. This usually occurs at a regional level as opposed to a national level. Examples are Silicon valley in the U.S., Detroit (for the auto industry) and Italy (leather-shoes-other leather goods industry). The phenomenon of competitors locating in the same area is known as clustering or agglomeration. Some advantages to locating close to your rivals are: 1)potential technology knowledge spillovers, 2)an association of a region on the part of consumers with a product and high quality and therefore some market power, or 3) an association of a region on the part of applicable labour force. Some disadvantages of locating close to your competitors are: 1) potential poaching of your employees by rival companies 2) obvious increase in competition possibly decreasing mark-ups. Cut throat competition ( lowering of prices )occurs to increase the market share. d. Firm Strategy, Structure and Rivalry. 1. Strategy: (a) Capital Markets. Domestic markets affect company strategy. Strategy could be use of advertising and promotions, excellent after sales services, expansion to competitors territories, etc. Example: The United States has a short run domestic capital competitive market like the computer industry. Switzerland has competition in the long run capital market like the pharmaceutical industry. (b) Career Choices. Individuals choose careers choices based on the job demand upon graduation. Students study business administration courses to put up or join the strategic business environment. 2. Structure . Porter argues that the best management styles vary among industries. Some countries may be oriented toward a particular style of management. The Japanese style of running the Car manufacturing business is very different from the United States car counterparts. The Japanese car has penetrated and swallowed a big share of the United States car business. Those countries will tend to be more competitive in industries for which that style of management is suited. Example: Germany tends to have hierarchical management structures composed of managers with strong technical backgrounds, whereas, Italy has smaller, family-run businesses. 3. Rivalry. Porter argues that intense competition spurs innovation. Example: Competition is particularly fierce in Japan, where many companies compete vigorously in most industries. International competition is not as intense and motivating. With international competition, there are enough differences between companies and their environments to provide handy excuses to managers who were outperformed by their competitors. RELATED EXAMPLES: Example 1. Abundance of resources makes waste & scarcity generates innovative ways maximize resources. Example: BC Forest Based industries, Lumber has seen rising competition from Chile (trees grow twice as fast?) and the Southeastern United States. Newsprint has seen rise of "Urban Forest"--recycled newspaper. Nevertheless, forest-products are a huge export for BC, and give us a clear example of the benefits of factor abundance. Porter proposed that technological advantage (greater output per unit of input), not relative factor abundance, was the key to obtaining competitive advantage. This could be chieved thru INNOVATION (unusual effort). "Innovation usually requires pressure, necessity, and even adversity: the fear of loss often proves more powerful than the hope of gain." COMMENT: Scarce resources cost higher than abundant resources. Example 2: Fresh- cut flowers from Holland. ($1b in exports despite cold, grey climate.) Innovations in glass-house growing, energy conservation (took advantage of abundant natural gas) COMMENT: Innovation is clearly shown here. We must adjust to survive. Example 3:Domestic rivalry is the single most important contributor to international competitiveness. " The more localized the rivalry, the more intense. And the more intense, the better." Examples: Japanese electronics industries and Automobiles. COMMENT: Competition, like Darwin says, is the survival of the fittest. To continue with the market share, companies must create quality products and give quality service. Counterexamples: Boeing, Reverse causation may be at play: For instance, when the decline of U.S. TV industry began (late 1960s), there were 25 domestic manufacturers, now one. Perhaps competitive advantage leads to lots of domestic producers, not vice versa! Further, it may be that Japan is able to support 9 motor vehicle manufacturers because its competitive advantage gives it ample success in export markets. Lacking that, the Japanese market would be too small and many of those companies would have to go out of business. The existence of rivalry may have indirect benefits by stimulating specific factor supply, input makers, complementary industries, and user industries. COMMENT: A saturated market will choke a new entrant competitor. Example 4: Picky buyers are a blessing in disguise. Example: Japanese air conditioners (small, quiet,effective). Counterexample: Israeli Kosher wine, Japanese preference for extensive plastic packaging and small serving units. COMMENT: Choosy customers will force companies to improve quality products and services in order to maintain their market share. Example 5: Competitiveness in related industries is mutually reinforcing. Two types of "relation": components and complements. examples: computers (semiconductors, software). leather shoes (leather tanneries, leather jackets) Why? information exchange, specialized investment, transportation costs. Examples: Italian Footwear/leather interaction ,Glass-house suppliers in Holland are competitive internationally. Counterexamples: U.S. speakers despite lack of competitiveness in other stereo components, same w/ CPUs even though weak in DRAM. COMMENT: Competition will bring out the strongest and best of the competing companies. Example 6: IRELAND’S BUSINESS CLIMATE: PORTER’S FAILURE The key elements of direct investment incentives and tax concessions to stimulate industrial activity, the focus on foreign direct investment (FDI) and the transition to free trade are all part of the Ireland’s First National Plan. In the early 1970s most effort was concentrated on attracting the high tech sectors which included the electronics and chemicals industries. It was assumed that Ireland would have a comparative advantage in competing for Foreign Direct Investment because of her relatively well educated workforce aided by a 10% corporation tax rate for the profit of manufacturing industry until 2010. In the 1970s and 1980s it appeared this strategy was paying off as the country witnessed a substantial growth in Irish based pharmaceutical, electronics and machinery sectors. The Telesis Report in the 1960s shows that the low level of skilled factors was identified, but since then indigenous companies have continued to concentrate on low skill, low value added activities with only modest improvement in marketing and technological sophistication. This dependence on basic-generalised factors has not necessitated reinvestment on the part of indigenous firms to upgrade these factors, nor has it necessitated their lobbying pressure on the Government to provide them with more advanced-specialised factors to use. The large successful Irish companies have grown due to their defender-like strategies (Miles) i.e. they stick to what they know best, do not innovate and do not reinvest. In short if they prove successful at one activity they remain with it. One must remember that a key rationale behind FDI was its positive spillover effects to the domestic economy through impacting on the activities of domestic firms - it would appear this has not occurred. This paper concludes that Porters model is unhelpful to explain the pattern of Irelands trade. The competitive environment created by the four determinants does not fit with the statistical NCA. The statistics indicates Irelands National Competitive Advantage lies in the high-tech industries,[ however, the factor conditions, demand conditions, related and supporting industries and the structure and strategy of firms do not create a competitive environment that fits these industries - Government policies have artificially created this statistical NCA. The Government industrial policy of attracting FDI has been responsible for the creation of high-tech industries in Ireland and their dominance of the trade statistics is in large part due to the attractive corporation tax rate which create the incentive for Profit Switching Transfer Pricing. Demand factor: Porter’s theory that local demand must be sophisticated and buyers will be choosy of products is argued to fall down in Irelands case on three key points. First, the home market segment in Ireland is too small to reap significant economies of scale benefits and there is little incentive to invest aggressively. Therefore, it is unlikely that a large percentage of Irish firms develop products with only the Irish market in mind. Demand conditions in the UK market are as, or more important, given the close proximity of the UK market and the historical links between the two countries. This is evidenced by the close trade linkages between the economies. This heavy dependence on the UK market has fallen dramatically over the last 35 years but it is still Irelands largest customer. Second, are Irish buyers truly sophisticated ? In Ireland it is considered poor performance on the part of the buyer rather than the seller should he complain about a defective product, a complaint being more a reflection of his poor character than the poor product quality. Porters model can also be criticised on a number of other points. First, it is an ex-post model and therefore has no predictive powers, also the number of variables involved weakens any predictions, in particular the inclusion of chance into the equation; second, Porter uses examples of success to back up his theories but his interpretation of the reasons behind the success is subjective in many cases and could be explained by other factors; third because of the number of variables and the inclusion of chance, the model has the ability to explain away evidence which does not agree with its findings and finally he also provides himself with a get-out clause when at the end of discussing each determinant he states it will not be effective unless the others reinforce it. COMMENT: Porter’s model is a general rule. In every general rule, there is always an exception or two. In every exception, there is always an exception to the exception or two. We cannot predict 100% the future outcome of events but we can increase the probability of its outcome thru statistical and research analysis. OTHER CRITICISMS: E. Criticisms Some of Porter’s critics say that: a)Porter developed this paper based on case studies and these tend to only apply to developed economies. b) Porter argues that only outward-FDI is valuable in creating competitive advantage, and inbound-FDI does not increase domestic competition significantly because the domestic firms lack the capability to defend their own markets and face a process of market-share erosion and decline. However, there seems to be little empirical evidence to support that claim. c) The Porter model does not adequately address the role of Multinational Corporations. There seems to be ample evidence that the diamond is influenced by factors outside the home country. REFERENCE: OHagan, J.W. (1995) Economy of Ireland, Policy and Performance of a small European Economy, Gill & Macmillan, Dublin REFERENCE: http://pacific.commerce.ubc.ca/keith/Lectures/diamond.html REFERENCE:  http://pacific.commerce.ubc.ca/ruckman/competitiveadvofnations.htm REFERENCE: Capacity Losses, Reconstruction and Unfinished Modernization: The Chemical Industry in the Soviet Zone of Occupation (SBZ)/GDR 1945-1965,Rainer Karlsch Center for German and European Studies, University of California at Berkeley March 1997 REFERENCE: Interregionaland Internatioanl Trade (1933) Ohlin, Nobel peace price winner for economics REFERENCE: Encylopedia Britannica National competitiveness shows how a nation’s gross product fares against other products of the same class or of different classes. Some criteria for improving the nation’s product competitiveness is through quality, lower pricing, after sales service, advertising and promotions. According to Porter, Factor endowment theories of Heckscher and Ohlin are too simplistic to determine a nation-states competitive advantage. Comparative advantage can no longer be seen as divine inheritance. In recognition of his ideas as described in his path-breaking book, Interregional and International Trade (1933), Ohlin was a recipient of the Nobel Prize for Economics in 1977. According to Heckscher and Ohlin, countries, through inheritance by having abundant natural resources, will a comparative advantage using those resources. Typical employees have plenty of machinery and equipment to assist him. In these places, wage hikes are high. REFERENCE: Interregionaland Internatioanl Trade (1933) Ohlin, Nobel peace price winner for economics (Encylopedia Britannica) iii. National competitiveness is not a theory but a check list that is a tautology. I.e. If you do certain economic activities well, you will do well economically. Or German chemical companies succeed because of Germany’s R&D base. But where did this base come from? Do they just appear in the diamond or do we have a theory of how differing factor and demand conditions arise? Yes, my set of economic activities will do well when implemented. I will sell goods at a reasonable price at strategically located places. I will make quality products so I will get a bigger share of the market as compared with my present competitors. I will create a big demand for my products by mass producing high quality items using high quality materials and highly skilled workers. I will offer after sales services and money and six months money back guarantee. In the article :Capacity Losses, Reconstruction and Unfinished Modernization: The Chemical Industry in the Soviet Zone of Occupation (SBZ)/GDR 1945-1965, The German chemical plants of Soviet Zone of Occupation has been rehabilitated by the German Government. It was intentionally destroyed in World War 2. Soviet Union’s head, Khruschev, proclaimed an economic race to bring back German chemical industries. The concentrated on chemical production of synthetic fibers and plastics. This Program failed. Germany’s joining the European Union could not help it find a partner to bail out its chemical industry business. Cooperation with the United States was also politically not possible at that time. REFERENCE: Rainer Karlsch Center for German and European Studies, University of California at Berkeley March 1997 iv. Is there a lack of the historical dimension, supplied in part by Late Development Theory? How might this add to missing dimensions in Porter? When industries develop late, then the market is already dominated or even saturated by the competitors that have developed or started mass production early. They already have a strong foothold and the customers have tested and proved the quality of service and products. This could help explain why porter was not 100 percent correct in his diamond theory. v. Why does Porter downplay the role of the state, given the historical importance of the developmental state in industrialisation and improving national competitiveness? Porter treats the government and chance as having minor importance to the four diamond areas. Government affects indirectly the business as influencer. The four diamonds affect directly the business enterprise. There are some things that governments do that they shouldnt, and other things that they do not do but should. Porter says, "Government’s proper role is as a catalyst and challenger; it is to encourage - or even push - companies to raise their aspirations and move to higher levels of competitive performance …" Governments can influence all four of Porter’s determinants through a variety of actions such as : a) Subsidies to firms, either directly (money) or indirectly (through infrastructure). b) Tax codes applicable to corporation, business or property ownership. c) Educational policies that affect the skill level of workers. d) They should focus on specialized factor creation. e) They should enforce tough standards. (This prescription may seem counterintuitive. REFERENCE: http://pacific.commerce.ubc.ca/ruckman/competitiveadvofnations.htm vi. Are factor and demand conditions purely national in their creation? Note Canada or Hong Kong, plus the role of the international economy and global webs (see Reich). How do we account for ideas about globalisation? No, factor and demand conditions are affected by the factor and demand requirements of international clients and competitors. Government regulations in other countries also strongly affect the factor and demand conditions of a business enterprise. vii. Conclusion Porter strongly states that business advantage is created thru innovation of the factor conditions that creating a competitive demand conditions. In the Ireland example above, government is the MAJOR factor in the success of Ireland’s economy. Ireland is an example of an exception to the Diamond theory of Porter. Porter’s diamond is only a general rule, In every general rule, there is always an exception or two. In every exception, there may also be exceptions to the exception. Chaos is a normal situation in everyday business. Chaos must be studied so that strategic steps will be implemented to lessen if not eradicate the impact of chaos. REFERENCES: OHagan, J.W. (1995) Economy of Ireland, Policy and Performance of a small European Economy, Gill & Macmillan, Dublin http://pacific.commerce.ubc.ca/keith/Lectures/diamond.html http://pacific.commerce.ubc.ca/ruckman/competitiveadvofnations.htm Capacity Losses, Reconstruction and Unfinished Modernization: The Chemical Industry in the Soviet Zone of Occupation (SBZ)/GDR 1945-1965,Rainer Karlsch Center for German and European Studies, University of California at Berkeley March 1997 Interregional and Internatioanl Trade (1933) Ohlin, Nobel peace price winner for economics Encylopedia Britannica Read More