The Porter Approach. Olav Jull Sørensen

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1 ISSN The Porter Approach by Olav Jull Sørensen No.: Centre for International Studies Fibigerstraede 2, 9220 Aalborg, Denmark Tel.: Fax:

2 Competitive Advantage of Firms and Nations The Porter Approach by Olav Jull Sørensen Aalborg University, Denmark Centre for International Studies January 1994

3 March 1994 Competitive Advantage of Firms and Nations by Olav Jull Sørensen The aim of this paper is to give an overview of Michael E. Porter's contribution to the studies of industries with focus on his work within international industries. The paper is one of three parts, the other two parts dealing with the contributions made by John F. Dunning and David B. Yoffie. All three have come up with conceptual frameworks aiming at understanding the pattern of trade and investment on a global scale. The ultimate aim of the three parts is to make a comparison between the three contributions. 3. Competitive Advantage of Firms and Nations 3.1. Introduction Recently, The Economist (Dec. 25, 1993) nominated Michael E. Porter as one of a number of gurus with the following marks on a scale from one (lowest) to five (highest) : Influence: Originality: Intellectual Coherence Devotion of Followers Concentrating on the scientific qualities (originality and intellectual coherence), Porter beats Tom Peters (2,2) and is beaten by Kenichi Ohmae (4,3) and especially by Peter Drucker (5,3) and Milton Friedman (5,5). See annex 1. Porter - in all his writings - has his feet firmly planted within Industrial Economics or rather within the concept of "industry", i.e. he strongly believes in the structures of industry and the forces of competition. From this meso-level, he branches out to the micro or firm level and the macro or national and international level in his search for factors, forces, dimensions, etc which influence and shape competition. With his feet firmly planted in the concept of industry, he is equally firmly committed to the concept of "strategy" with a firm's strategy based on the creation of competitive advantage In the sense of devising alternative strategies for companies, he is action oriented although his research is not normative, but more oriented towards developing typologies. To deal with and be fair to the comprehensive writings of Porter is not easy. As his ultimate aim is to devise company strategies and as the ways in which firms create and sustain competitive advantages provide the necessary foundation for the role of the home nation, his understanding of the concept of a

4 firm is critical. Consequently, the starting point will be the firm level followed by the industry, the nation, and the inter-nation levels The Concept of a Firm Porter has never aimed at contributing to The Theory of the Firm and hence he has no explicitly stated model of a firm. By and large, he has a strategic understanding of the firm. He views the firm as one or a set of strategies. The following profile of Porter's concept of a firm is based on pieces from different writings of his. The Obiectives of the Firm Porter does not discuss explicitly the objectives of the firm, but he assumes the goal to be the maximization of long-term return on investments (1980, p. 3).The objective is only underpinning his thinking as Porter's models are not of the Micro-Economic type where the exact profit is calculated. The goals of the firm are discussed widely in Porter's conceptual framework for the response profile of competitors (1980, pp. A number of dimensions are discussed but no clearcut conclusion is made. Figure 1

5 3 In a way, Porter is not, neither does he need to be, very concerned with specifying the goals of the firm. His main concern is how does a company create and sustain competitive advantage, i.e. basically an issue of company survival rather than fulfilling specific goals. Often Porter is satisfied with working definition. In case of the firm, it seems safe to state that his working understanding of the goal of a firm is one of "profit orientation". The Organization of the firm. Organizationally, the firm is viewed as nine generic activities (1990, p. 40) comprising the value chain (figure 1). The activities form an interdependent system or a network of activities (1990, p. 41) connected by linkages, i.e. the performance of one activity influences the performance of others. Due to the connections and linkages, the activities have to be coordinated in content (e.g. quality), over time, and over space. (Management task 1). Competitive advantage is gained by carrying out the activities: at lower costs better, i.e. creating more value for the customer by superior coordination of the activities Thus, management task 2 is to manipulate the nine generic activities in order to create a competitive advantage. Innovation is a key concept in the creation of competitive advantages. The term is broadly defined (1990, p. 45) to include both product and process innovations and innovation in relation to all nine generic activities. Porter does not spell out how to organize a firm to become so pervasively innovative. However, by means of the concept of "cluster", he stipulates the innovative qualities, not of individual firms, but of industrial systems (see section 3.6.). The Management and Strategy of the Firm. Not much is said about management. Except for pointing out the need for sustained commitment on part of management as an important factor in the creation of competitive advantage (1990, p ), management is seen primarily as identical to strategic planning. "The essence of formulating competitive strategy is relating a company to its environment." (1980, p.3.). A competitive strategy is seen as a broad formula for how a business is going to compete (1980, p. xvi) and a formula for finding a profitable position in the industry.

6 4 The preoccupation with strategy is clearly demonstrated in the various typologies for strategies. In the book Competitive Strategy (1980), Porter defines four generic strategies along two dimensions: 1. Production costs (price) and product quality (differentiation) and 2. Broad or narrow scope, i.e. range of products, buyers, geographical areas, etc. (figure 2).Unless a firm adopts one of the four strategies, it gets stuck in the middle and will run into difficulties. Figure 2 Generic strategies COMPETITIVE ADVANTAGE Lower Cost Differentiation Broad Target Cost Leadership Differentiation I Competitive Scope Narrow Targt Cost Focus Focused Differentiation Later in the book (chapter 7), 12 strategic dimensions are presented (1980, p. 127).The dimensions can be put together in various ways to form a unique strategy. A closer look at the dimensions reveals that the majority of them belongs to what is called the 4 Ps in the marketing textbooks. Thus, Porter's concept of strategy is primarily a marketing strategy (figure 3).

7 5 Figure 3: Strategic Dimensions and their Marketing Eguivalent Price Produet Promotion Place 1. Specialization 2. Brand identific 3. Push us pull 4. Channel Selection 5. Produet quality 6. Technolog Leadership 7. Vertical integret. 8. Cost position 9. Service 10. Price policy 11. Relationship with parent comp. 12. Relationship with Gost. x x x+ x x x x x x x+ + means that the strategic dimension covers more than what is normally included in the marketing version of the P. For a treatment of international strategies, see section In summary, Porter's concept of the firm is not spelled out and discussed in any details. He views the firm as comprising nine generic activities which the firm manipulates (change, innovations) in order to create and sustain a competitive advantage. He has a strategic perspective of the firm with the competitive advantages forming the core of the strategy The Concept of Industry The concept of an industry is defined as "a group of firms producing products that are close substitutes for each other." (1980, p.5). This is a working definition. In practice, a great deal of controversy over the appropriate definition can be found, but Porter does not find it fruitful to take part in the debate. The intensiveness of competition is determined by five basic competitive forces (1980, p. 3) making up the structure of the industry (figure 4).I. e. the profit potential of the industry is determined by the five forces, and

8 the strategy of the firms is determined by the five forces 6 Figure 4 The Five Competitive Forces that Determine Industry Competition THREAT OF NEW ENTRANTS BARGAINING POWER OF SUPPLIERS RIVALRY AMONG EXISTING COMPETITORS BARGAINING POWER OF BUYERS THREAT OF SUBSTITUTE PRODUCTS OR SERVICES For each of the five forces, a number of dimensions - as a kind of check list - are listed and discussed (see annex 2}. The sum total of all the dimensions is what defines the overall competitive situation and the intensiveness of competition. No simple formula for how to sum up the situation is, however, provided to assist the user of the model. To use the five forces model, a specific level in the chain of production is selected, i.e. a specific value chain is looked at. By adding more value chains, Porter introduces the concept of value system. In conventional industry analysis, for example following the S-C-P-model, a specific level is the analytical unit. However, when forward and backward integration is common in an industry, it is necessary to include more value chains and perhaps even include the whole value system in the analysis. Following the overall determination of the competitiveness of an industry, Porter has developed a tool to analyze the rivalry among the firms of the industry. By means of the concept strategic group, the firms within the industry are sub-divided into groups pursuing the same strategy. The basis for grouping the firms is the 12 strategic dimensions. companies with the same set of strategic dimensions form a group of their own. To make the analysis easy, emphasis is put on the two key strate- gic dimensions in the industry which provides the opportunity to visualize the groups in so-called strategic group maps (see annex

9 7 The size of the circle indicate the market share and the distance etween the groups indicate how much the strategies resemble each other. If the strategies can clearly be identified, the strategic mapping exercise is a valuable way of getting an overview of an industry. It should be noted that Porter turns a basically conductual concept, namely strategy, into a structural concept. This indicates that he views a strategy as having some permanency The Relationship between Generic strategies and the Five Forces. 1 As stated, Porter is primarily concerned with strategic thinking within a industry, but the question is: How does he view the relation between the structure of the industry (the five forces) and the strategies - the conduct - of the firms? A first answer to the question can be given by confronting the generic stratgies with the five forces. How should the five forces look like, if a firm follows the cost leadership strategy. An answer is given in annex 4. Looking more losely at Porter's reasoning, it is obvious that he puts a lot of emphasis on the five forces as the determinants of the strategies: "Structural analysis is the fundamental underpinning for formulating competitive strategy." (1980, p. 5). The reasoning can be spelled out as follows: Five forces constitute the structure of industry Defines intensity of competition and the profit potential Generic strategy Performance However, Porter is not a pure "strategy follows structure - believer": While industry structure constrains the range of strategic options available, I have yet to encounter an industry in which only one strategy can be successful." (1990, p. 39. Thus, Porter's starting point is the S-C-F-model which he has extended primarily by focusing on the concept of strategy but also by introducing the concepts of strategic group and generic activities.

10 Adding the International Dimension Having outlined the basic concepts and conceptual frameworks for the analysis of industries, the next issue is to add the international dimension to the analysis. The basic question is: Can the same basic concepts and frameworks be used or is it necessary to develop some new ones. The presentation of Porter's thinking will follow the same structure as when the basic concepts and frameworks were presented. According to Porter (1980, p. 276), there are many differences in competing internationally versus nationally, e.g. factor cost differences; role of government; differences in management style, etc. "However, the structural factors and market forces operating in global industries are the same as those in domestic industries." (1980, p. 276) The Firm and its Global Strateqy On goals, Porter has nothing new to add. In the book Competitive Advantage of Nations, the concept of goal is not clearly specified. As the book spans over many nations, it is realized that the goals vary from one country to another and that the goals are an integral part of the diamond. (1990, p. 110). The starting point is the nine generic activities. What happens to the activities in the course of internationalization? Are they re-located? Are they coordinated differently? Obviously, sales become export when a firm enter foreign markets, but is this all to it? To deal with the new situation, Porter has developed the Confiquration-coordination Matrix (figure 5). In principle, a matrix is drawn for each of the nine generic activities showing the extent to which it is concentrated and the extent to which the activity is coordinated.

11 9 Figure 5 Types of International strategy High High Foreign Investment with Extensive Coordination Among Subsidiaries Simple Global Strategy Coordination of Activities Low Country-Centered Strategy by Multinationals or Domestic Firms operating in Only One Country Geographically Dispersed Export-Based Strategy with Decentralized Marketing Geographically Concentrated Configuration of Activities The pure exporter has concentrated all his activities in one country except the marketing activity. The marketing activity may be tightly or loosely coordinated, i.e. the marketing programme may be adapted to each country or the exporter may use the same basic marketing programme in all countries. Similarly, a firm with numerous plants in different countries has most of the nine activities dispersed. If each plant is specialized, the activities may be tightly coordinated on a global scale. The other extreme situation is that each plant is autonomous and cater primarily for the local market in which the plant is located. Using the matrix, Porter defines four international strategies: The Pure Global Export Strategy, i.e. the global exporter using standardized marketing programmes The Export-Based Strategy, i.e. the international ex-

12 10 porter adapting the marketing programme to each and every country The Pure Global FDI Strategy, ieee the multi-plant firm with tight coordination among the plants The Country Centered FDI Strategy, i.e. the multi-plant firm with each firm operating in only one country. According to Porter, a firm can gain a competitive advantage by relocating the portfolio of activities and by changing the mode of coordination. It is indicated that much has already been gained by re-locating and especially by exploiting economies of scale and the economies of learning, leaving a better coordination as the primary source of competitive advantages in the future (1986, p. 35). With flexible production systems becoming more popular as well as the increase in the catering for specific demands, competitive advantage may, in the future, have to be derived from tightly coordinated dispersed activities -a real challenge to an organization. The strategies following the rational of the configurationcoordination matrix are not in line with the four generic strategies presented earlier. In other works (1980, p. 294 and 1986, pp ), Porter has made an attempt to build upon the four generic strategies (figure 6). Figure 6 Strategic Alternatives in a Global Industry Geographic Scope Global Strategy Country-Centered Strategy Segment Scope Many Segments Global Cost Leadership or Differentiation Protected Markets Few segments Global Segmentation National Responsiveness

13 11 A distinction is made between a geographic scope and the scope of segments. The firm may pursue a global strategy or a country centered strategy and each of the two strategies may cater for many or few segments in the market. A global strategy is defined as one fol:lowing which a firm sells its product in many nations and employs an integrated world wide approach to doing so (1990, ]? 54).A firm may opt for a global strategy which serves many segments worldwide by pursuing global cost leadership or differentiation. Or it may opt for a global segmentation strategy catering for the special needs worldwide for a specific group of customers. In some instances, although the industry is global, economic and political impediments prevent the firm from using a global strategy. Then, the firm has the options to serve many segments in a few protected markets or serve a few but large segments with unusual needs and requirements in a few markets and hence prevent other global players to enter the market The Concept of a Global Industry At international industry level, the same five structural forces are at work and the same strategic group mapping will be carried out as in the domestic industry. However, moving from the domestic to the international level complicates the demarcation of the industry. Porter makes a distinction between the multi-domestic industry and the global industry (1980, p. 53). A global industry is defined a an industry in which a firm's competitive position in one country significantly affects its position in other nations, i.e. the domestic industries are linked. A multi-domestic industry is defined as an industry in which competition in one country is essentially different from competition in another. In a global industry, it is necessary to use the five forces model at the global level and add particularities in individual countries and regions to the analysis. In a multi-domestic industry, an international analysis of the industry means conducting a set of individual country analyses.

14 The Concept of Competitive Advantage of Nations Just as Porter's starting point was the S-C-P-model when he developed his model of industry analysis, so was the theory of comparative advantages his starting point when he developed his ideas of the role of the nation in the creation and sustaining of competitive advantages. Based on the comparative advantage concept, he developed the concept of a global platform (1986, p. 27) and defined it as follows: "A country is a desirable global platform in an industry if it provides an environment yielding firms domiciled in that country an advantage in competing globally in a particular industry." A global platform comprises the factor endowment and demand endowment, i.e. Porter added the demand side to the traditional supply side dominated theory of comparative advantage. The two endowments gave the firms a competitive advantage and hence formed the platform for the firms which in turn, through their strategies, could be used to go international. In 1990, Porter developed his thinking further. To explain why firms from a specific nations create and sustain a competitive advantage in a specific industry, Porter developed a conceptual framework comprising four attributes of a nation that shapes the environment in which local firms compete that promote or impede the creation of competitive advantage (see figure 7). The four attributes are(1990, p. 71): "Factor conditions. The nation's position in factors of production, such as skilled labor or infrastructure, necessary to compete in a given industry. Demand conditions. The nature of home demand for the industry's product or service. Related and supporting industries. The presence or absence in the nation of supplier industries and related industries that are internationally competitive. Firm strategy, structure, and rivalry. The conditions in the nation governing how companies are created, organized, and managed, and the nature of domestic rivalry.

15 The determinants, individually and as a system, create the context in which a nation's firms are born and compete.." The DIAMOND, as Porter has baptized his conceptual framework, constitutes a mutually reinforcing system and, depending on the industry, competitive advantages can be created and sustained based on two, three or four of the components. In addition: "The basic unit of analysis for understanding national advantage is the industry. Nations succeed not in isolated industries, however, but in clusters of industries connected through vertical and horizontal relationships." (1990, p. 73). Using his conventional style, Porter proceeds by enumerating numerous dimensions describing and qualifying each of the components in the diamond. Finally, two additional components are added, namely "chance" and "government". Chance comprises events outside the control of the firms such as a new invention, a. war etc. The government is an actor who, through policies, can improve or detract from the national advantage. To sum up: The diamond model has its roots in 1. the S-C-P-model which was developed into the five forces model and 2.

16 14 the theory of comparative advantages which was developed into a factor and demand endowment: model. The firm is the basic actor (the creator and exploiter of competitive advantage) ; the industry (and its strategic groups) are the basic analytical unit, and the cluster is the setting in which it is determined whether a competitive advantage will be created or not. The diamond model is an interaction model with the four components mutually reinforcing each other positively or negatively. The cluster goes beyond a single industry and comprises closely connected industries both vertically, horizontally, and diagonally. Competitive advantage is created when a nation's successful industries are connected and one competitive industry helps to create another in a mutually reinforcing process (1990, p. l49). "National competitive advantage...resides as much at the level of the cluster as it does in individual industries. This carries important implications for Government policy and company strategy." (1990, p. 152). A cluster is characterized by geographical and cultural proximity; an innovative and entrepreneurial atmosphere; competition, and dialogue. The home base - the cluster - forms the platform upon which a firm can go international (step 1}. To become global, the firm must play around with the generic activities in the configuration-coordination matrix (step 2}, making sure that the organization looks for or create the similarities (the global dimension} rather than the differences (the country dimension} (1986, p. 33}. The government has an exogenous position in relation to the diamond. It is not an integrated part of the diamond because it constitutes no source of its own for sustainable competitive advantage: "Successful policies work in those industries where underlying determinants of national advantage are present and where government reinforces them." (1990, p. 128). Overall it can be concluded that Porter has created many valuable concepts and put them together in conceptual frameworks (based on interaction among the concepts) and various typologies, primarily in four cell matrixes. Normally, each of the concepts are described using a number of dimensions. The conceptual frameworks are not theories in the sense of specifying the exact relationship between concepts. Porter has contributed to the creation of new views on industry analysis. His world view is primarily one of "structure leading strategy" with industry structure being objectively defined.

17 In addition, his models are, at times, a confusing mix of actors (visible hands) and forces, factors, functions, and chance, i.e. more invisible hands. 15 References Works by Michael E. Porter: Changing Pattern of International Competition (1986). California Manaqement Review, vol. XXVIII, no.2 (Winter). Competition in Global Industries (1986). Boston, Mass.: Harvard Business School Press. Competitive Advantage. Creating and Sustaining Superior Performance. New York: The Free Press. The Competitive Advantaqe of Nations (1990). London : The MacMillan Press. Competitive Strategy. Techniques for Analyzing Industries and competitors (1980). New York: The Free Press. Others: Miller A. and G.G. Dess (1993): Assessing Porter's (1980) Model in Terms of its Generalizability, Accuracy and Simplicity. Journal of Manaqement Studies. Vol. 30, no.4 (July) kode: Porter.tre(IIA)

18 kode: Porter.tre(IIA)

19 17 Annex 3 Strategic Group Map for the Wordwide Ship Building Industry Product specialization Full product line Narrow/ specialized product line Low High Cost position

20 18 Annex 4 Generic x) Competitive Strategies and the 5 forces of competition. Generic Strategy Competitive Structure 1. Intensive rivalry 2. Powerful buyers 3. Powerful suppliers 4. Entry barriers Cost Leadership (production orientation) same offer at lower price Price down only to next most efficient competitor can cope with cost increases (relatively) Scale economies Differentiation (marketing orientation) Brand loyalty (less price sensitivity) No better alternatives No better alternative due to high margins Customer loyalty and unigveness 5. Substitutes The last to be affected customer loyalty x) simplified and generalized description of the strategic options