Seeking competitive advantage
I CAN begin no better than the book’s preface*, ‘Why do some social groups, economic institutions, and nations advance and prosper? This subject has fascinated and consumed the attention of companies and governments for as long as there have been social, economic and political units. In fields as diverse as anthropology, history, sociology, economics and political science, there have been persistent efforts to understand the forces that explain the questions presented by the progress of some entities and the decline of others.’ Porter was moving beyond the usual remit of business school professor – as an economist he was approaching a grand question in the tradition of Smith, Marx, Marshall and Keynes. Even while work-a-day investment bankers like myself can turn to Porter to guide the selection of sectors and entities to back, he aimed to be useful to a much wider band of practitioners and thinkers.
It was no armchair enterprise. MIT’s Nobel Prize winning economist Robert M. Solow is quoted on the dust jacket, ‘Michael Porter reaches his conclusions the old fashioned way: he earns them through solid research.’ Porter’s 1980 Competitive Strategy1 (uniquely reviewed twice by the Harvard Business Review) and 1985 Competitive Advantage2 had already established his reputation for developing theories built on painstaking empiricism. He had a global following as a teacher. Further, as if to prove that ‘there is nothing more practical than a good theory,’ his consultancy firm, The Monitor Company, was already mentor to businesses, governments and multilaterals with issues beyond the commonplace. So Porter might have distilled his prior knowledge and experiences to address the questions raised. Instead, he orchestrated a study of world-beating industries across ten nations (Britain, Denmark, Germany, Italy, Japan, Korea, Singapore, Sweden, Switzerland and the United States): dozens of researchers and institutions, some celebrities in their own right, were involved.
What was the fruit of all this cultivation? It takes some 800 pages to describe in full. Even Part IV: Implications, is 260 dense pages with chapters on company strategy, government policy and national agendas. It is remarkable that this microeconomic work has so much to say to governments and nations – it is common for macroeconomics to be considered relevant at that level leaving micro-economic policy the subject of special pleadings by firms or industries. The most enduring output from the book is undoubtedly the ‘diamond’ model with its emphasis on clusters rather than narrow industry sectors. It is now so pervasive that I am tempted not to outline it in this short review. However, in a recent discussion even cognoscenti had only hazy notions of the model and how it establishes, for example, Mumbai’s unmatched advantages as South Asia’s financial centre.
So, what follows is a sketch that inevitably loses the richness and depth of a full exposition. Porter hypothesises that four broad attributes of a nation interact (see Figure 1) to shape the environment in which local firms compete. The quality of this competition promotes or impedes the creation of global competitive advantage. The attributes are:
1. Factor conditions. The nation’s position in factors of production, such as skilled labour or infrastructure (or, traditionally, raw materials), necessary to compete in a given industry.
2. Demand conditions. The nature of home demand for the industry’s product or service.
3. Related and supporting industries. The presence or absence of supplier and related industries that are internationally competitive.
4. Firm strategy, structure and rivalry. The conditions governing how companies are created, organised, and managed and the qualities of domestic rivalry.
The Determinants of National Advantage3
‘The determinants,’ writes Porter, ‘individually and as a system, create the context in which a nation’s firms are born and compete: the availability of resources and skills necessary for competitive advantage in an industry; the information that shapes what opportunities are perceived and the directions in which resources and skills are deployed; the goals of the owners, managers and employees that are involved in or carry out competition; and most importantly, the pressures on firms to invest and innovate.
‘Firms gain [global] competitive advantage where their home base allows the most rapid accumulation of specialized assets and skills, sometimes due solely to greater commitment. Firms gain competitive advantage in industries when their home base affords better ongoing information and insight into product and process needs. Firms gain competitive advantage when the goals of owners, managers and employees support intense commitment and sustained investment. Ultimately, nations succeed in particular industries because their home environment is most dynamic and the most challenging, and stimulates and prods firms to upgrade and widen their advantages over time.
‘Nations are most likely to succeed in industries or industry segments where the national "diamond", a term which I will use to refer to the determinants as a system, is the most favourable. This is not to say that all a nation’s firms will achieve competitive advantage in an industry. In fact, the most [sic.] dynamic the national environment, the more likely it is that some firms will fail, because not all have equal skills and resources nor do they exploit the national environment equally well. Yet those companies that emerge from such an environment will prosper in international competition.
‘The "diamond" is a mutually reinforcing system. The effect of one determinant is contingent upon the state of others. Favourable demand conditions, for example, will not lead to competitive advantage unless the state of rivalry is sufficient to cause firms to respond to them...’4
Further, ‘Nations succeed not in isolated industries, however, but in clusters of industries connected through vertical and horizontal relationships. A nation’s economy contains a mix of clusters, whose makeup and sources of competitive advantage (or disadvantage) reflect the state of the economy’s development...’5
Mumbai, for example, has well developed clusters for the financial services. These include not only stock exchanges, stock brokers and underwriters but international and domestic commercial banks with nationwide, even worldwide, payment systems; commodity markets; South Asia’s best infrastructure for telecom, commuting, power supply, health services, education and leisure; information technology vendors including network and facility managers; regulators for the financial sector; courts and lawyers with decades of experience with financial transactions; financial journalists, with deepening knowledge and probity, able to inform and police; sophisticated users of financial services including merchants, speculators, international traders and manufacturers; accountants, including the global ‘Big 5’; hundreds of thousands of middle level workers competent to process financial transactions; ancillaries ranging from couriers through printers (able to proof financial documents) to dabbawallahs, office cleaners and security guards; and networks of relationships and trust facilitating quick information flow and efficient deal making.
These clusters, more than any navratnas, deserve to be treated as national treasure.
These ideas are also demonstrated in India’s software services sector. For a long time it depended only upon factor conditions – the relatively low pay for Indian software engineers available for body shopping. Pioneers like Faqir Kohli of Tata Consultancy Services have long contended that real progress required sophisticated demand (especially, automation of government), better telecom infrastructure, development of the entire IT cluster (including hardware) and so on. In the event, demand has been improved through linkage with the USA; Indian communications infrastructure has improved immensely in recent years; free imports (and exports) have integrated the Indian and global IT clusters. And, as a result, India has emerged as the world’s largest software exporter, second only to the USA. NASSCOM’s agenda, developed with McKinsey, is for continued development of the ‘diamond’.
That Porter’s ideas work in ‘Indian conditions’ (a phrase commonly used to make special pleadings that appeal to the swadeshi lobby) was demonstrated in 1994 by the Confederation of Indian Industry/Harvard Business School project on the Indian economy. Professors Porter, Ghemawat and Rangan persuaded a galaxy of Indian businessmen and policy makers on such propositions as:
* Industrial development required focus on clusters, not on industries.
* Regions are best developed through investment in physical and human infrastructure rather than subsidies.
* Industry dispersion policies tend to break up cluster formation. The professors showed that industry specialisation and concentration is necessary not just across countries, as reported in the 1990 book, but in regions within countries.
* Competition has to be promoted to build world-beaters; monopolies, whether private or public, disincentivise a drive for product and service excellence. Some industrialists use this argument to plead that international liberalisation should be postponed till domestic competition has built up. On the contrary, the Porter advice would be to use foreign competition to enliven domestic monopolists like Life Insurance Corporation of India.
* Import and export canalisation, preferred in the sixties and seventies to give India scale in world markets (as well as control to the mandarins), creates monopolies or monopsonies which are demonstrably inefficient and anti-innovation.
* Economic knowledge and information needs to be widely dispersed throughout India. This would not only enhance policy discussion, but also reduce the counterproductive ignorance and suspicion of business that even in the 21st century is much too common.
It is a measure of the CII-Porter project’s influence that only half a dozen years later most of these ideas have passed into the mainstream of Indian policy debate, where they are quoted without acknowledgement of source. Many practical men, to paraphrase Keynes, have become the unconscious slaves of this economist. Even though The Competitive Advantage of Nations studied countries in which ‘Indian conditions’ did not prevail, at least superficially.
It is commonly experienced that intellectual acceptance is insufficient to create change. If I am habituated to drinking in company, for example, the next social gathering I attend encourages me to imbibe even against medical advice. Similarly, firms and nations have histories, geographies, relationships, contracts, policies, vested interests and so on, inhibiting change. Porter moves the focus of attention from macro to micro economics, and goes beyond analysis to model building and specific recommendations for firms, governments and nations.
Yet, as Karl Marx is quoted on his grave, the point is to change reality, not merely understand it. Can that be done? Or are Porter and his ilk mere philosophers? As Zhou-en-lai is reputed to have said about the French revolution (nearly two centuries after), it may be too early to comment. However, the history of India and its firms over the last decade has been encouraging, though it cannot be said that Porter was the sole, or even the most influential, prophet for the period.
What have been some of the main features that promoted change in India in the early nineties? I would identify the following:
* An external payments crisis which allowed radical ideas to gain influence among the Indian elite, with support from multilateral financial institutions.
* The collapse of the Soviet Union which left Stalinists without intellectual, moral or material support.
* Increasing empirical and theoretical evidence (see for example, Amartya Sen’s Development as Freedom6) that a liberal economic and political regime delivers welfare efficiently. And widespread recognition that this does not mean laissez-faire which is unacceptable in a country which experiences extreme poverty.
* International agreements, importantly the General Agreement on Trade and Tariffs which led to the World Trade Organisation, requiring India to open its economy or be abjured by the overwhelming majority of possible foreign business partners.
* A highly experienced individual, possibly surprised to find himself prime minister and with little expectation of longevity, staked his political and personal capital on a programme of change.
This was quite an exceptional combination of circumstances. Which was perhaps necessary because a web of barriers opposes change in nations, even more than in corporations. Porter’s books make no mention of these difficulties. However, his 1994 seminar listed barriers to change under the heads of attitudes, information, incentives and complexity. The seminar suggested that small, quick, wins might snowball into major shifts. And so it has been, though we now seem stuck on a plateau of middle height. Change management is becoming a major focus in management schools. Strategists need regularly to revisit Kipling’s verse:
If you can dream – and not make dreams your master;
If you can think – and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two impostors just the same...
Yours is the Earth and everything that’s in it,
And – which is more – you’ll be a man, my son!
* The Competitive Advantage of Nations by Michael E. Porter, The Free Press, New York, 1990.
1. Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors, The Free Press, New York, 1980.
2. Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance, The Free Press, New York, 1985.
3. Porter (1990), p. 72.
4. Ibid., pp. 71-72.
5. Ibid., p. 73.
6. Amartya Sen, Development as Freedom, Oxford University Press, New Delhi, 1999.