Porters Diamond Model

Business is more global than it’s ever been. And with every passing year, competition between different organizations in different countries is likely to become ever more intense. FDI in various new sectors and relaxing import and export norms are opening a avenue of opportunities for various organization in different countries.

For consumers like you and me it means downward pressure on prices and competition increases so organizations look at running their business in much more efficient manner to cut down costs to the minimal and provide the same quality of products at an much lower price.

Porter’s diamond model suggests that there are inherent reasons why some nations, and industries within nations, are more competitive than others on a global scale. The argument is that the national home base of an organization provides organizations with specific factors, which will potentially create competitive advantages on a global scale.

The diamond model is an economical model developed by Michael Porter in his book The Competitive Advantage of Nations, where he published his theory of why particular industries become competitive in particular locations. Afterwards, this model has been expanded by other scholars.

The individual points on the diamond and the diamond as a whole affect four ingredients that lead to national comparative advantage. These ingredients are

  1. Availability of resources and skills
  2. Information that firms use to decide which opportunities to pursue with those resources and skills
  3. The goal of individuals in a companies
  4. The pressure on companies to innovate and invest

Traditionally, economic theory mentions the following factors for comparative advantage for regions or countries:

  1. Land
  2. Location
  3. Natural resources (minerals, energy)
  4. Labor, and
  5. Local population size.

Because these 5 factors can hardly be influenced, this fits in a rather passive (inherited) view regarding national economic opportunity. Porter says that sustained industrial growth has hardly ever been built on above mentioned basic inherited factors. Abundance of such factors may actually undermine competitive advantage! He introduces a concept called “clusters” or groups of interconnected firms, suppliers, related industries, and institutions, which arise in certain locations.

According to Porter, as a rule competitive advantage of nations is the outcome of 4 interlinked advanced factors and activities in and between companies in these clusters. These can be influenced in a pro-active way by government.

Why is this there a difference? Porter explains that there are four factors responsible for such diversity. He calls those factors the “diamond of national advantage”. The diamond includes:

  1. Factor conditions
  2. Demand conditions
  3. Related and supporting industries
  4. Firm strategy, structure and rivalry

The four determinants of Porter’s model are shortly described below:

1. Factor Conditions

Factor conditions include those factors that can be exploited by companies in a given nation. It show how far the factor of production in a country can be utilized successfully in a particular industry. Factor conditions can be seen as advantageous factors found within a country that are subsequently build upon by companies to more advanced factors of competition. Factors not normally seen as advantageous, such as workforce shortage, can also be seen as a factor potentially strengthening competitiveness, because this factor may heighten companies’ focus on automation and zero defects.

Some examples of factor conditions:

  • Highly skilled workforce
  • Linguistic abilities of workforce
  • Rich amount of raw materials
  • Workforce shortage

Porter argues that a lack of resources often actually helps countries to become competitive (call it selected factor disadvantage). Abundance generates waste and scarcity generates an innovative mindset. Such countries are forced to innovate to overcome their problem of scarce resources. How true is this?

  • Switzerland was the first country to experience labor shortages. They abandoned labor-intensive watches and concentrated on innovative/high-end watches.
  • Japan has high priced land and so its factory space is at a premium. This lead to just-in-time inventory techniques (Japanese firms cannot 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).
  • Sweden has a short building season and high construction costs. These two things combined created a need for pre-fabricated houses.

2. Demand Conditions

The demand for product must be present in the domestic market from the very beginning of production. Porter is of the view that it is not merely the size of the market that is important, but it is the intensity and sophistication of the demand that is significant for competitive advantage.

If the local market for a product is larger and more demanding at home than in foreign markets, local firms potentially put more emphasis on improvements than foreign companies. This will potentially increase the global competitiveness of local exporting companies. A more demanding home market can thus be seen as a driver of growth, innovation and quality improvements. For instance, Japanese consumers have historically been more demanding of electrical and electronic equipment than western consumers. This has partly founded the success of Japanese manufacturers within this sector.

If consumers are sophisticated, they will make demands for sophisticated products and that, in turn, will help the production of sophisticated products. Gradually, the country will achieve competitive advantage in such production.

3. Related and Supporting Industries

The firm operating along with its competitors as well as its complementary firms gathers benefit through a close working relationship in form of competition or backward and forward linkages. If competition is acute, every firm will like to produce better quality goods at a lower cost in order to survive in the market.

When local supporting industries and suppliers are competitive, home country companies will potentially get more cost efficient and receive more innovative parts and products. This will potentially lead to greater competitiveness for national firms. For instance, the Italian shoe industry benefits from a highly competent pool of related businesses and industries, which has strengthened the competitiveness of the Italian shoe industry world-wide.

4. Firm Strategy, Structure and Rivalry

The firm’s own strategy helps in augmenting export. There is no fixed rule regarding the adoption of a particular strategy. It depends upon a number of factors present in the home country or the importing country and it differs from time to time. Nevertheless, the strategic decisions of the firm have lasting effects on their future competitiveness. Again, equally important is the industry structure and rivalry among different companies.

The structure and management systems of firms in different countries can potentially affect competitiveness. German firms are oftentimes very hierarchical, which has resulted in advantages within industries such as engineering. In comparison, Danish firms are oftentimes more flat and organic, which leads to advantages within industries such as biochemistry and design.

Likewise, if rivalry in the domestic market is very fierce, companies may build up capabilities that can act as competitive advantages on a global scale. Home markets with less rivalry may therefore be counterproductive, and act as a barrier in the generating of global competitive advantages such as innovation and development

Criticisms about The Diamond Model

Although Porter theory is renowned, it has a number of critics.

  • Porter developed this paper based on case studies and these tend to only apply to developed economies.
  • 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.
  • The Porter model does not adequately address the role of MNCs. There seems to be ample evidence that the diamond is influenced by factors outside the home country

References

http://vectorstudy.com/management_theories/diamond_model.htm

http://www.businessmate.org

http://en.wikipedia.org

http://www.valuebasedmanagement.net/methods_porter_diamond_model.html

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