Now that I have finally finished reading Michael E Porter’s The Competitive Advantage of Nations, I thought I’d write about its relevance in today’s globalized world. Like many business and economics books that I have been writing about recently, it wouldn’t be fair for me to review this book either, for the same reasons. I am not sure how much of it is Porter’s original book and how much unprofessional PR agency’s meddling. Large sections of it appear to be mischief and meddling by unprofessional PR agencies and their cronies.
At any rate, since Porter wrote this more than 30 years ago, it is worth examining the relevance of the idea of competitive advantage of nations and his theories in a world where much has changed in the intervening years. The world has become much more interconnected, through business investment, trade and economic ties. In many ways, the world that Porter foresaw of countries enjoying a competitive advantage through their companies’ overseas operations has reached its logical conclusion, with even supply chains being integrated across the world. The question, though, is that when we have achieved such a high and sophisticated degree of globalization and interconnectedness, does it not pose a challenge to nations’ competitive advantage? To my mind, there are two ways in which this can happen: i) through the homogenizing effects of globalization, as it spreads to more countries and markets and ii) through the increased concentration of market power which tends to blunt competition.
In this article, I would like to examine the relevance therefore of Porter’s competitive advantage of nations theory as well as new ways in which it might manifest itself in today’s globalized world. I would also like to consider the changed competitive scenario today among globally competing nations, and look at the theory in this context. This might suggest directions for the future.
Before looking at its relevance, however, it might be necessary to understand the core of Porter’s theory and I shall attempt to provide its essence in a nutshell. Michael Porter studies 10 nations in The Competitive Advantage of Nations and hones in on four of them for detailed analysis of national competitive advantage. He studies them through four dimensions of how he thinks nations achieve their competitive advantage, in what he calls the Diamond Theory. The four dimensions are factor conditions, demand conditions, firm strategy, structure and rivalry and lastly, related and integrated industries.
Porter believes that countries don’t have competitive advantages, their industries do. And it is companies that provide the competitive advantage. In Porter’s analysis, a nation builds its competitive advantage through its companies in the home market first. This necessarily means that the home market must provide the requisite factor conditions as well as the demand conditions, in the form of educated, skilled workforce, availability of resources, and a consumer market of adequate purchasing power, variety of needs, upward mobility, etc. In fact, he thinks that the more sophisticated and mature the home market consumers are, the more it spurs companies to innovate and increase their competitive advantage. As companies grow in the home market, they begin to look at external markets for growth and soon exports becomes an important aspect of competitive advantage, though he is careful to point out that exports alone are not sufficient for a country to gain competitive advantage. From exports, companies then might want to expand their overseas operations by basing their manufacturing, sales and marketing in those markets. This is where the third dimension of firm strategy, structure and rivalry comes into the picture. Finally, the fourth aspect of related industries and services becomes important as the industry grows and spawns new, related industries, thereby creating an entire ecosystem for future growth.
Strangely enough, Porter doesn’t mention his Five Forces Model of Competitive Advantage, which I have written about before, anywhere in this book, nor does he explain in the introduction why it makes way for the diamond theory in this context. I kept thinking about it as I was reading this book and it became apparent to me that since this book is about nations competing at an industry level, the five forces model might have been inadequate especially in dealing with things like factor conditions and demand conditions.
If I try and apply this theory in today’s globalized world and look at the two concerns that I mentioned earlier in the piece, I find that the theory of competitive advantage still maintains its relevance. More specifically, here are some of my conclusions:
- Since companies compete with each other and gain competitive advantage through Porter’s Five Forces Model, their overseas or global operations will follow a similar pattern
- Homogenisation, therefore not such a threat, as long as companies keep innovating
- Since industries compete at country and economy level to gain competitive advantage through diamond theory, there is every need to invest in R&D in order to maintain lead at home and internationally
- Blunting of competition through increased concentration of market power is a threat for the smaller and medium sized companies. As far as large MNCs are concerned, they would continue to compete at home and overseas the way they have always done and a nation’s competitive advantage rests mainly on them
It appears, therefore, that competitive advantage of nations is not challenged too much yet, by the forces of homogenization and reduced competition, though these are still legitimate concerns and they can slow down innovation engines considerably.
This is where the role of governments is so vital. They are not merely required to manage the process of globalization better for their people, they are required to formulate policies that encourage and enable investment, improvement of factor and demand conditions as well as regulate on antitrust and other important matters. Governments have a huge role to play in factor creation, that is in educating their people to the highest standards and ensuring the availability of a healthy, educated workforce as well as availability of land, capital and infrastructure. Demand conditions too can be improved by governments through well-formulated and progressive taxation policies.
Porter, rightly, is not in favour of too much government intervention or regulation as these tend to discourage business investment and growth. He is also not in favour of governments actively trying to encourage national champions, and is quite against protectionism as well, be it of the tariff or non-tariff kind. In fact, when we look at Porter’s theory on the stages of development of competitive advantage, it becomes even clearer where and what kind of role government can play.
Porter writes that a country goes through four stages of development of competitive advantage: factor-driven, investment-driven, innovation-driven and wealth-driven. Similar to Rostow’s theory of economic development, Porter believes that a nation achieves its greatest competitive advantage when it reaches the innovation-driven stage, as this is when all four dimensions of the diamond theory are fully employed. We can see that governments have the biggest role to play at the factor-driven and investment-driven stages. He also writes that a country tends to decline when it reaches the wealth-driven stage, as it is usually benefitting from wealth gained in the past. I suppose that at this stage, a country is not allocating its resources optimally, either to improve productivity, or to innovate and compete globally.
Porter writes that Britain is in a state of decline as far as competitiveness is concerned, as it reached the wealth-driven stage in the 1950s and 1960s. Similarly, he writes that America’s innovation engine has slowed considerably since the 1970s. His view seems to give short shrift to the efforts of Thatcher and Reagan at rejuvenating their economies in the 1980s. In fact, he makes no mention of it. And when it comes to Britain’s competitive advantage, he focuses on chemicals and pharma, as well as oil and gas, ignoring financial services where Britain grew significantly since the 1980s and London remains an important international financial centre. In both Britain and America, Porter thinks weakened factor creation is largely to blame, as well as tax policies that tax long term capital gains and treat them as the same as income. These, as well as compensation packages, encourage short-term time horizons, and I couldn’t agree more.
There are a few other curious omissions as well. In his chapter on the four nations whose competitive advantage he studies in detail, he chooses to focus on Germany and the printing press industry, America and patient-health monitoring devices, Italy in ceramic tiles and Japan in robotics. I would have thought that Germany in chemicals as well as automobiles and America in information technology would have made more sense. Something tells me that unprofessional PR agency idiots have probably been meddling here, since they are obsessed with printing, robotics, tiles and health monitors – where Hewlett Packard is highlighted as the pioneer in the health-monitoring industry!
While I said that I am not reviewing the book, I must mention that this Free Press edition from Simon & Schuster with a new (1998) introduction by the author, could do with some serious and good editing. It is too repetitive in parts, and unnecessarily long, especially on account of the numerous examples that Porter cites. Including examples like Japanese cosmetic and personal care companies like Kao and Shiseido that he mentions, and which I shared on social media saying that I had heard of Shiseido, but not of Kao! When I visited Kao’s website, their brands page features a whole lot of logos, but little else! Incidentally, it appears that Kao even has a page on WIPO’s website. I suspect these too are part of the mischief by PR agency idiot bosses in India who have been meddling in publishing and elsewhere for decades. The other problem with the book is that it reads like somewhere between a research study report (with detailed appendices) and a textbook on business strategy.
Returning to today and where these 10 countries stand in competitive advantage. I think only Germany and Japan have managed to stay most competitive globally, investing in their R&D as well as in factor creation. This is on the basis of all that I have read thus far and not specifically on any data set. There are statistics of how much countries spend on R&D from OECD and World Bank and these are certainly worth looking at. The World Economic Forum used to publish a report on Global Competitiveness, which seems to have changed its parameters in its last report from what I saw on their website. While the Japanese economy is recovering from the pandemic rather well, with even CPI in healthy territory, one doesn’t know if the economy can sustain the growth. Because Japan is reported to not have increased wages in decades, it might have helped its competitiveness, but it runs the risk of slowing domestic consumption and going back into a deflationary funk again.
The big elephant, or should I say dragon, in the room is China! As the world’s second largest economy with the largest market for most products and services, its large footprint in global trade, its large foreign reserves and its huge strides in developing cutting edge technology, there is no way that the global economy can ignore its impact. From infrastructure development, power plants, semiconductors, solar panels, EVs and battery technology, mobile payment systems, AI and 5G technology, China appears to have built a competitive advantage in many industries in a relatively short span of time.
Finally, we come to which sectors are likely to dominate the future, and how companies and countries will navigate the path to competitive advantage. The relevance of competitive advantage, as I see it, will be greatest in these industries as they will dominate the business landscape and our lives. These are information technology, AI, automation, clean and green technology including EVs and battery technology, pharma and healthcare, including digital healthcare as well as telecom and media. This is the battlefield where companies and countries will vie for competitive advantage in the decades ahead. Countries such as America have already made technology and trade the basis for their competitive war with China. I believe that my country, India, has made significant progress in a few of these industries such as information technology and pharma and needs to start building its competitive advantage in these and related areas. Unfortunately, as you can see in the World Bank chart, India spends a measly 0.7% of GDP on R&D, and that just won’t do. Hopefully, our Indian companies will innovate their way to growth and provide India its competitive advantage in the decades ahead.