An industry is a
group of firms that market products which are close substitutes for each other,
(e.g. the car industry, the travel industry). The main purpose of industry analysis, in the context of
strategic choice is to determine the industry attractiveness, and to understand
the structure and dynamics of the industry with a view to find out the
continued relevance to strategic alternatives that are there before a firm.
It follows that, for
instance, if the industry is not, or no longer, sufficiently attractive (i.e.
it does not offer long-term growth opportunities), then the strategic
alternatives that lie within the industry should not be considered. It also
means that alternative may have to be sought outside the industry calling for
diversification moves.
Michael Porter’s
Diamond Model ( Porter 1980), also known as the Theory of National Competitive
Advantage of Industries, is a diamond-shaped framework that focuses on
explaining why certain industries within a particular nation are competitive
internationally, whereas others might not.
Porter’s
Diamond Model is a diamond-shaped framework that explains why specific
industries in a nation become internationally competitive while those in other
nations do not. The model was
first published in Michael Porter’s 1990 book The Competitive Advantage of
Nations. This framework looks at the firm strategy, structure/rivalry, factor conditions, demand conditions, related and
supporting industries.
Traditional economic theory suggests that factors such as land, labor, population size, and
natural resources are crucial factors in a nation gaining competitive
advantage. In 1776, Adam Smith, considered to be the father of economics, wrote
his seminal book “An Inquiry into the Nature and Causes of the Wealth of
Nations”. In his magnus opus, commonly known as “The Wealth of Nations”, Smith
described how nations embarked on the process of building wealth by touching
upon topics such as the division of labor, productivity, and free markets
Instead,
he proposed that four other characteristics could accurately predict whether a
nation produced organizations that were competitive on the international
stage. Porter’s Diamond framework consists of a system of four mutually
reinforcing factors: factor conditions, demand conditions, related/supporting
industries, and firm strategy, structure and rivalry . If these conditions
are favorable, domestic companies will continuously innovate and as a result,
they will remain competitive internationally. On the other hand, unfavorable
conditions will result in the inability of these companies to compete globally.
1. Firm Strategy, Structure and Rivalry
This
characteristic encompasses how companies are structured and managed. It also
includes company objectives and the presence of competitive rivalries, if
applicable. Rivalry is particularly important because it forces companies to
innovate, better preparing them for the international market.
A good example for this is the
Japanese automobile industry with intense rivalry between players such as
Nissan, Honda, Toyota, Suzuki, Mitsubishi and Subaru. Because of their own
fierce domestic competition, they have become able to more easily compete in
foreign markets as well. Germany has a luxury cars industry which is another
example as well. The car manufacturing industry in German has a regional
advantage because it satisfies the four key factors in Porter’s Diamond. With
firm strategy and rivalry, we see that there is strong rivalry amongst lots of
car manufacturers and so they compete intensely and keep developing more
innovative and quality products.
Another example, German carmakers
BMW, Mercedes-Benz, and Audi would not have become globally successful brands
without the intense competition they face inside their native Germany.
The
competitiveness of firms in any country is largely determined by how those
firms set strategy and structure themselves. Governments can impact this with
laws that establish corporate governance rules. In addition, firms within an
industry will be positively affected by a certain level of competition in that
country. This is sometimes counterintuitive to many governments who prefer to
protect their companies by limiting competition. This is dangerous, because in
the long-term it will lead to an industry’s demise. When companies face no
competition, they grow lazy and fail to innovate. And when companies fail to
innovate, they die. It’s that simple. That is why governments must focus on
ensuring that there is healthy competition between different firms. The US
government is a good example as it has enacted antitrust laws (the laws that
ensure competition) that exist in an open-market economy and that are
meticulously implemented. In 1998, when the US government felt that Microsoft
was cornering the operating system and browser markets, they threatened to
break the company up.
2. Factor conditions
The
first element of the diamond is the nation's possession of factors of
production. Consistent with the factor proportions theory (Heckscher-Ohlin),
every country has a relative abundance of certain factor endowments. In his
diamond model, Porter distinguishes between basic and advanced factors.
Basic
factors are those such as land, climate, natural resources or demographics,
while advanced factors relate to more sophisticated ones, including the
nation's stock of knowledge resources (e.g. scientific, technical or market
knowledge), the transportation and communication infrastructure or a
sophisticated and skilled labour force (Rugman/Collinson 2012, p. 303).
Factor
conditions are more basic in nature and refer to unskilled labor, natural
resources, and infrastructure. However, Porter argued that more advanced factor
conditions such as skilled and specialist knowledge and access to capital were
more important to competitive advantage.
In
the diamond model, the advanced factors are regarded as being most significant
for competitive advantage. These factors can be created through training,
research and innovation and thus are a product of investment by individuals,
companies or the government. The basic assumption is that a nation must
continually upgrade or adjust its factor conditions. The basic factors provide
the country with an initial advantage that can subsequently be reinforced by
investing in advanced factors. On the other hand, disadvantages in basic
factors mean that countries need to invest in advanced factors (Porter 1990).
Thus, upgrading a nation's advanced factors, such as the educational system or
infrastructure, is regarded as a means to improve a nation's competitive
advantages.
Some countries can be rich in natural resources, such
as Saudi Arabia which has ample oil reserves , and Qatar, which is rich in
natural gas. Other countries, such as Singapore, are rich in their human
resources. Being rich in human resources (or human capital) means that the
country has created factor conditions that foster the establishment of a
skilled labor force. This usually means that the nation has created excellent
infrastructure and a solid scientific knowledge base. These “created” factors
are much more important than “naturally” occurring factors as they ensure the
country’s competitive advantage over the long term. Venezuela, compared to
Singapore, is a good case in point. With a population of 32 million, Venezuela
has the largest proven oil reserves in the world 7 while
Singapore has barely any natural resources. Yet Singapore, with no natural
resources, has a $90,000 GDP per capita compared to $11,000 for Venezuela .
In the long term, human capital development is what counts. How does Singapore
do it? The country is keenly focused on developing, and continuously revising,
its human resource strategies in conjunction with other national strategic
economic policies .
Porter
argues that especially these ‘created’ factor conditions are important opposed
to ‘natural’ factor conditions that are already present. It is important that
these created factor conditions are continiously upgraded through the
development of skills and the creation of new knowledge. Competitive advantage
results from the presence of world-class institutions that first create
specialized factors and then continually work to upgrade them. Nations thus
succeed in industries where they are particularly good at factor creation
3. Demand conditions
Demand conditions refer to the level
of demand in the home market of an industry. Demand creates competition and in turn, competition creates innovation. Specific demand conditions may include market
size and market sophistication.
Demand conditions refer to the nature
and size of the domestic demand for an industry's products and services. Here,
the main characteristics are the strength and sophistication of domestic
customer demand. Porter (1990b, pp. 79-80) argues that companies are most
sensitive to the needs of their closest customers. Thus, home market demand is
of particular importance in shaping the attributes of the companies' products.
The more sophisticated and demanding their local customers, the more pressure
is created for innovation, efficiency and upgrading product quality. Therefore,
it is assumed that with increasing consumer sophistication in their home
markets and, consequently, with increasing pressure on local sellers, their competitive
advantage will escalate.
The
constant demand from local customers will push companies to grow, innovate, and
improve quality. This can also lead companies to venture beyond their borders
and compete internationally. Take the airline industry as an example. Spurred
by strong local demand (from both companies and the government), Boeing grew to
be one of the leading aerospace manufacturers in the world. Nations can gain a
clear competitive advantage in industries where demand from local customers puts
pressure on companies to always do better.
Nations thus gain competitive
advantage in industries where the local customers give companies a clearer or
earlier picture of emerging buyer needs, and where demanding customers pressure
companies to innovate faster and achieve more sustainable competitive
advantages than their foreign rivals.
4. Related and supporting industries
Most large companies are only as
successful as their supply chains. Indeed, most are dependent on alliances and
good relationships with suppliers to make cost savings that can be passed to consumers.
Nations with high concentrations of large, innovative companies who operate
close to each other facilitate the spread of innovation.
Especially suppliers are crucial to
enhancing innovation through more efficient and higherquality inputs, timely
feedback and short lines of communication. A nation’s companies benefit most
when these suppliers themselves are, in fact, global competitors. It can often
take years (or even decades) of hard work and investments to create strong
related and supporting industries that assist domestic companies to become
globally competitive.
For example, the cluster of tech
companies in Silicon Valley, California, facilitates innovation because of the proximity of innovative
and often supportive companies.
Another
example, within the computer industry, Apple benefited widely from the
existence of highly capable suppliers who not only manufactured parts, but also
supplied Apple with innovative products that spurred growth. The mouse that
Apple popularized in its Lisa system in 1983 was, in fact, first invented by
Xerox. While Xerox is about to disappear into Japan’s FujiFilm , Apple is
one of the most valuable companies in the world. Therefore, a supporting
ecosystem is critical to any industry’s success, for without it, other
companies in other countries will surely steal the show.
Criticisms of Porter’s Diamond Model
Given that Porter’s Model
assesses competition in the relatively broad context of
nations, it has been subject to criticism like:
·
Scope – when the model was
developed in 1990, it included just 10 developed countries. Thus, it does not
yet apply to second or third world nations.
·
Contradictory evidence – there is a wealth
of evidence to suggest that the competitiveness of a nation has many external
influences that Porter does not account for.
·
Industry selective – Porter’s
original analysis focused
on the banking sector, consultancy firms and manufacturers. Some academics have
questioned whether the model is
at all relevant to the many large and influential global service companies such
as McDonald’s.
However,
from the very appearance of this model to its wide application, the model has
faced a lot of criticism. Those critics are mostly directed towards the lack of
concrete causal relationships between the very model factors and the lack of
its forecasting value. Also, criticism objects the fact that it did not comprise
the digitalization, globalization and deregularization as important
contemporary competitiveness factors (Ritson 2018). Also, according to Porter
the analysis of competitive forces or advantages should be directed towards the
key factors of competition country. Porter’s diamond model offers a holistic
and flexible concept which enables all interest groups in a certain country to
examine the competitiveness in all its complexity, as well as the constructive
communication that serves the improvement of surroundings with and aim to
improve the industrial competitiveness.
5 Government
The
role of the government in Porter’s Diamond Model is described as both ‘a
catalyst and challenger‘. Porter doesn’t believe in a free market where the
government leaves everything in the economy up to ‘the invisible hand’.
However, Porter doesn’t see the government as an essential helper and supporter
of industries either. Governments cannot create competitive industries; only
companies can do that. Rather, governments should encourage and push companies
to raise their aspirations and move to even higher levels of competitiveness.
This can be done by stimulating early demand for advanced products (demand
factors); focusing on specialized factor creations such as infrastructure, the
education system and the health sector (factor conditions); promoting domestic
rivalry by enforcing anti-trust laws; and encouraging change. The government
can thus assist the development of the four aforementioned factors in the way
that should benefit the industries in a certain country. Each of these four
attributes defines a point on the diamond of national advantage; the effect of
one point often depends on the state of others. Sophisticated buyers will not
translate into advanced products, for example, unless the quality of human
resources permits companies to meet buyer needs. Selective disadvantages in
factors of production will not motivate innovation unless rivalry is vigorous
and company goals support sustained investment. At the broadest level,
weaknesses in any one determinant will constrain an industry’s potential for
advancement and upgrading.
6 Chance
Even though Porter originally didn’t
write anything about chance or luck in his papers, the role of chance is oftenincluded in the Diamond Model as the likelihood that external events such aswar and natural disasters can negatively affect or benefit a country or
industry. However, it also includes random events such as where and when
fundamental scientific breakthroughs occur. These events are beyond the control
of the government or individual companies. For instance, the heightened
border security, resulting from the September 11 terrorist attacks on the US
undermined import traffic volumes from Mexico, which has had a large impact on
Mexican exporters. The discontinuities created by
chance may lead to advantages for some and disadvantages for other companies. Some
firms may gain competitive positions, while others may lose. While these
factors cannot be changed, they should at least be monitored so you can make
decisions as necessary to adapt to changing market conditions.
Conclusion
But
the points of the diamond are also self-reinforcing: they constitute a system.
Two elements, domestic rivalry and geographic concentration, have especially
great power to transform the diamond into a system—domestic rivalry because it
promotes improvement in all the other determinants and geographic concentration
because it elevates and magnifies the interaction of the four separate
influences.
Porter’s Diamond Model is an economic model which argues that the global competitiveness of a
particular organization is dependent on
the country it operates in.
Porter’s Diamond Model is based on four key characteristics that
explain the requirements for a competitively strong nation.
Porter’s Diamond Model has attracted criticism for its lack of
scope and focuses on select, non-service related industries.
Those who read this, also read:
1. Michael Porter's 5 Forces analysis
2. Michael Porter's analysis of Competitors
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