Firm Strategy, Structure, and Rivalry

The fourth broad attribute of national competitive advantage in Porter's model is the strategy, structure, and rivalry of firms within a nation. Porter makes two important points here. His first is that nations are characterized by different "management ideologies," which either help them or do not help them to build national competitive advantage. For example, Porter notes the predominance of engineers on the top-management teams of German and Japanese firms. He attributes this to these firms' emphasis on improving manufacturing processes and product design. In contrast, Porter notes a predominance of people with finance backgrounds on the top-management teams of many US firms. He links this to the lack of attention by many US firms to improving manufacturing processes and product design, particularly during the 1970s and 80s. He also argues that the dominance of finance has led to a corresponding overemphasis on maximizing short-term financial returns. According to Porter, one consequence of these different management ideologies has been a relative loss of US competitiveness in those engineering-based industries where manufacturing processes and product design issues are all-important (e.g., the automobile industry).

Porter's second point is that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which makes them better international competitors. Domestic rivalry creates pressures to innovate, to improve quality, to reduce costs, and to invest in upgrading advanced factors. All of this helps to create world-class competitors. Porter cites the case of Japan:

Nowhere is the role of domestic rivalry more evident than in Japan, where it is all-out warfare in which many companies fail to achieve profitability. With goals that stress market share, Japanese companies engage in a continuing struggle to outdo each other. Shares fluctuate markedly. The process is prominently covered in the business press. Elaborate rankings measure which companies are most popular with university graduates. The rate of new product and process development is breathtaking.²¹

Strong domestic competition also stimulated the rise of Nokia of Finland to global preeminence in the market for cellular telephone equipment. For details, see the accompanying Management Focus.

Evaluating Porter's Theory

In sum, Porter's argument is that the degree to which a nation is likely to achieve international success in a certain industry is a function of the combined impact of factor endowments, domestic demand conditions, related and supporting industries, and domestic rivalry. He argues that the presence of all four components is usually required for this diamond to positively impact competitive performance (although there are some exceptions). Porter also contends that government can influence each of the four components of the diamond either positively or negatively. Factor endowments can be affected by subsidies, policies toward capital markets, policies toward education, and the like. Government can shape domestic demand through local product standards or with regulations that mandate or influence buyer needs. Government policy can influence supporting and related industries through regulation and influence firm rivalry through such devices as capital market regulation, tax policy, and antitrust laws.

If Porter is correct, we would expect his model to predict the pattern of international trade that we observe in the real world. Countries should be exporting products from those industries where all four components of the diamond are favorable, while importing in those areas where the components are not favorable. Is he correct? We do not yet know. Porter's theory is so new that it has not yet been subjected to independent empirical testing. Much about the theory rings true, but the same can be said for the new trade theory, the theory of comparative advantage, and the Heckscher-Ohlin theory. It may be that each of these theories explains something about the pattern of international trade. In many respects, these theories complement each other.