Porter’s concept of the ‘diamond’

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Table of Contents

Introduction
Critique
Conclusion
References

Introduction

Michael Porter in his book The Competitive Advantage of Nations (1990) enumerates that countries do not inherited by companies operating within a country rather is created. The central question that is posed in the book is “Why do some social groups, economic institutions, and nations advance and prosper?” (Porter, 1990, p.xi).

Though the book has been hailed as one “one of the most important books” written by Porter and in the area of national competitiveness (Grant, 1991), it is subject to many debate. Many believe that though the model may have theoretical implication, it lacks empirical support as Porter in his study tested the model only on 10 countries and that too a small group was explored (Stone & Ranchhod, 2006).

Further, some studies have also tried to test the validity of the theory and some have found it lacks empirical support (Yetton et al., 1992) while others found empirical findings support the theory’s assertions (Sledge, 2005). Some scholars also believe that the theory has some theoretical limitations in terms of its methodology (Bellak & Weiss, 1993; O’Shaughnessy, 1997) and neglect of cultural aspect (O’Shaughnessy, 1996).

The inconsistency in the empirical and theoretical support for the theory calls for further understanding of the model and its empirical applicability. This paper aims to understand the theoretical aspects of the ‘diamond’ model by Porter, and then see if the theory holds empirically.

Therefore, the main aim of the paper is to evaluate the Porter’s ‘diamond’ model as a tool for assessing the competitive advantage of nations, and then judge its theoretical consistency and empirical support. The paper will first discuss the ‘diamond’ model, then provide a critical review of the model based on theoretical strengths and shortcomings and see its empirical applicability.

The ‘Diamond’ Model

Porter’s main idea behind the theory is that competitive advantage in industries is the driving force of international competition rather than comparative advantage of natural resources of a nation. Therefore Porter emphasizes that:

Creating competitive advantage in sophisticated industries demands improvement and innovation—finding better ways to compete and exploiting them globally, and relentlessly upgrading the firm’s products and processes. Nations succeed in industries if their national circumstances provide an environment that supports this sort of behaviour. (Porter, 1990, p.67)

Porter presents four determinants that interact within the ‘diamond’ are the forces behind the industries that provide greater innovation and performance. These four determinants are factor conditions, demand conditions, related and supporting industries, and firm strategy structure and rivalry (Porter, 1990).

Factor conditions are production factors required in the industry i.e. skilled labour, infrastructure, etc. Demand condition is the demand in the home market for the product or services. Further, presence of supplier industry or nation is also a determining factor for competitive advantage.

The forth factor determines the internal condition of the nation wherein the firm operates and the nature of domestic competition. According to Porter these determinants must exist in close physical proximity of each other as competitive advantage, according to Porter is created and sustained through process localisation (Porter, 1990). Therefore, industries that have these clusters of four factors are geographically concentrated increasing the possibility of greater competitive advantage.

Porter’s model also has a close relation to a dynamic process with four stages viz. factor-driven, investment-driven, innovation-driven, and wealth-driven. The first three stages entail “successive upgrading of a nation’s competitive advantages and will normally is associated with progressively rising economic prosperity” and the fourth stage “is one of drift and ultimately decline” (Porter, 1990, p.546).

Porter plays down the influence of government making it dependent on specific stages i.e. in factor and investment driven stages (Porter, 1990, p.671). Further, as firms become the main source of creation of innovation, nations move towards an innovation-driven stage (Porter, 1990, p.672). Therefore, Porter emphasizes that at the initial stage government must step up investment that is optimally utilized by the private firms through innovation.

The core concept underlying Porter’s theory is the importance of innovation at the cost of sustained performance. Therefore the theory is more concerned with what can make the innovation sustainable.

According to the idea presented by Porter, eminent pressure creates innovation and therefore is instrumental in driving performance. Therefore, it becomes imminent that firms in porter’s theory perform only under pressure: “to succeed, innovation usually requires pressure, necessity, and even adversity: the fear of loss often proves more powerful than the hope of gain” (Porter, 1990, p.76).

For instance, domestic rivalry can put enough pressure on the performance of the firm for improving performance and inculcating innovation. Therefore, the model relies on pressure created by the determinant factors on the system. The other force that helps in gaining competitive advantage is proximity that further intensifies that pressure put on a firm.

Porter states the importance of proximity to the model as it “increases the concentration of information, and thus the likelihood of its being noticed and acted upon” (Porter, 1990, p.157). According porter’s theory pressure and proximity assumes the role of explaining the key to optimizing innovation. Anything that helps in driving innovation like enhanced technology, highly skilled labour, etc. becomes the driving force in the theory. In porter’s theory innovation occupies a central position for gaining sustained competitive advantage.

Critique

Theoretical Coherence

Proponents of theory believe that the ‘diamond’ model by Porter provides a new way to look at competitive advantage gained by firms through international trade (Grant, 1991). The main success of the theory is found in its ability to explaining international success is its theoretical cogency (Grant, 1991). The main contribution of Porter’s theory lies in the connection made between international trade theory and competitive advantage. Further, the model helps in incorporating a dynamic process due to the stress put by Porter on innovation.

However, even Grant could not overlook the “predictive power” of the theory (p.542). The debate on the success of ‘diamond’ model is marred through various researchers who have found methodological shortcomings to porter’s theory. O’Shaughnessy points out that the theory does not point out the “necessary conditions for success” (1997, p.74). He points out that at the end of the World War II Japan did not have any of the determinant factors portrayed by Porter in place.

He argues that even if the 100 industries studied by Porter agreed on the four factors, even then these cannot be established as “necessary” conditions. According to O’Shaughnessy necessary conditions can be established if Porter theory could prove that the unavailability of the four factors was the reason for the failure of the industry in a rival nation. Therefore, ‘diamond’ model has been labelled as an “orientating model” that helps in understanding only the success factors.

Another problem in the building of the theory by Porter is its cognizance with the past history of nations. Porter’s understanding and development process of the theory does not underline a study of the history of the 100 industries thus studied by Porter. O’Shaughnessy points out that “History helps define what a nation now is” (1997, p.75). Germany’s competitive success lies in the countries limitary affiliation in the past.

Japan’s success to a great extent is due to the “aggressive growth” policy of Japanese firms that made them push for entering new global markets when the product was in the early stage of the product life cycle as compared to the British philosophy of “maintenance” and “prevention of decline” (O’Shaughnessy, 1997, p.76).

Theoretically Porter’s model talks of governments fail to place competitive advantage of the nation at the core of their policy making. Though this is a novel idea it is not possible in reality as governments face political pressure. Thus, the theory fails to address actionable imperatives.

Another shortcoming of Porter’s theory is its omission of cultural dimension (O’Shaughnessy, 1996). It has been judged to provide simplistic explanations of the theory. Porter has considered national culture as a static artefact, which remains as it is for generations. It should be noted that cultures are dynamic. For instance, Germans are commended for being a hardworking society.

However, the erstwhile East Germany has plethora of examples that demonstrate lack of initiative in the workforce. Thus, culture is not a static concept. Even then, Porter has dwelled in national stereotypes in developing his model. Therefore critics believe that there cannot be any specific formula for competitive advantage as Porter’s theory make believes. And the discussion of competitive advantage of a nation without a discussion on its history and culture is redundant.

Porter’s theory does not look into the development process and competitive advantage of developing countries. An economy with 50 percent unemployment rate is unlikely to be interested in optimum automation and university education will have little importance in countries where most of the population is illiterate.

Thus, Porter’s model has been exemplified mostly with examples from the developed western countries. As in case of Germany, its competitive advantage has been diminished considerably with inclusion of millions of uneducated easterners (O’Shaughnessy, 1996).

According to other critics Porter has specified a wrong problem and an erroneous trigger of competitive advantage of nation may lead to wrong government policies (Krugman, 1994). The critic points out that government make investments from macroeconomic perspective to provide competitive advantage to the nation and it is not possible for them to look at the micro-level issues (Krugman, 1994).

For instance, the British industry has not actually made a transition from craft-based production to American style mass production and neither has attained the customization benefits of lean production (O’Shaughnessy, 1996). Therefore points out that “the foolishness of blaming economic and social policies, cultural factors, or even short-termism in the City of London for the prime causes of national economic decline.” (Krugman, 1994, p.39)

He further points out that “the primary cause of poor domestic productivity is internal to industry itself” like productivity issues in the firm (1994, p.40). Therefore, competitive advantage can be that of a firm, but cannot be modeled for nations, as there are other diverse factors involved in its assessment.

Other critiques of theoretical coherence of Porter’s theory lie in its close clusters that are dependent on the traditional concept of industries (Bellak & Weiss, 1993).

It is believed that without specific case studies “objective” measure for the theory cannot be found, and therefore case study of a number of countries and industries together is not the right tool to be used for analysis as their comparison becomes almost impossible (Bellak & Weiss, 1993). The only one cluster that can be identified in Porter’s book is the Danish “insulin-cluster” but this too lack empirical support (Bellak & Weiss, 1993).

Further, Porter’s theory does not consider modern trade theory and just presents a criticism of traditional trade theory. But the modern trade theory does incorporate services and factor movement. Porter does not take into account the neo-factor and neo-technology approach to trade.

Had Porter considered the trade theories developed after 1960s he could have seen that the ideas his theory incorporated were established concepts in modern trade theories (Bellak & Weiss, 1993). Other theoretical flaws in the theory are Porter’s omission of International business as a dimension in his model and his misinterpretation of two-way FDI flow (Bellak & Weiss, 1993).

Therefore, there is a number of theoretical incoherence in the ‘diamond’ model developed by Porter. The next section will show what empirical research shows of the success of the model in interpreting competitive advantage.

Empirical Applicability

There have been many studies that tried to test the empirical validity of Porter’s ‘diamond’ model. The model applied on Canada, New Zealand, and Australia concludes that Porter’s theory does not demonstrate national competitiveness (Yetton et al., 1992); rather it is one that demonstrates industry or firm competitiveness with a nation, though the emphasis on ‘nation’ mellow down significantly. Further, the theory does not provide any empirical proof in the original study of Porter nor in subsequent studies.

The reason for this they believe is the overemphasis of the study design on validation. The third finding of their study is that it overlooks the dynamic process of development of a firm. Rather it is believed that the theory aimed at “refocusing American or European firms on the essentials of global manufacturing in or near large markets, given that many of the ingredients of the diamond are already in place for them” (Yetton et al., 1992, p.118).

A study on the applicability of Porter’s model on small open economies like Austria shows that the main issue with the theory is the insufficient treatment by Porter of foreign investment, service industries, and technology (Bellak & Weiss, 1993). Further, it states that Porter’s study fails to identify the broad clusters of industries that are important for national competitiveness.

Other studies on UK, USA, and BRIC nations (Stone & Ranchhod, 2006) and that on global automobile industry (Sledge, 2005) supports the theory of Porter’s ‘diamond’ through empirical validation. Both these studies have shown support for Porter’s theory. The former study also developed a quantitative framework for studying the empirical validity of the theory by Porter.

However, the second study was limited in its assessment of the theory in automotive industry and therefore cannot be conclusively said to have established Porter’s claim of national competitiveness. It may have provided competitive advantage for industries within nations but not that of the nation.

Conclusion

The main issues related to the theory of Porter there is in its development of the idea of competitiveness as based on productivity and market share. Though throughout the book, Porter moves to and fro between the two.

Further, Porter’s idea of national competitiveness based of market share is erroneous as market share demonstrates the performance of an industry in a country but it does not necessarily imply the success of the whole nation. The other problem that arose through the model is the definition of competitive advantage that is often confused with comparative advantage.

The first explained the how industries compete with each other, and the later deal with which industry should be located in which location. This therefore created a gap between the theoretical explanation and the empirical studies. Porter’s ‘diamond’ model provides a new way of looking at the competitive advantage of nations. But it has serious theoretical shortcomings and therefore fails empirical validation.

References

Bellak, C.J. & Weiss, A., 1993. A Note on the Austrian” Diamond”. MIR: Management International Review, 33, pp.109-18.

Grant, R.M., 1991. Porter’s ‘Competitive Advantage of Nations’: An Assessment. Strategic Management Journal, 12(7), pp.535-48.

Krugman, P., 1994. A Dangerous Obsession. Foreign Affairs, 73(2), pp.28-44.

O’Shaughnessy, N.J., 1996. Michael Porter’s Competitive Advantage revisited. Management Decision, 34(6), p.12–20.

O’Shaughnessy, N., 1997. The idea of competitive advantage and the ideas of Michael Porter. Strategic Change, 6, pp.73-83.

Porter, M.E., 1990. The competitive advantage of nations. New York: Free Press.

Sledge, S., 2005. Does Porter’s Diamond Hold In The Global Automotive Industry? Advances in Competitiveness Research, 13(1), pp.22-32.

Stone, H.B.J. & Ranchhod, A., 2006. Competitive advantage of a nation in the global arena: a quantitative advancement to Porter’s diamond applied to the UK, USA and BRIC nations. Strategic Change, 15, p.283–294.

Yetton, P., Craig, J., Davis, J. & Hilmer, F., 1992. Are Diamonds a Country’s Best Friend? A Critique of Porter’s Theory of National Competition as Applied to Canada, New Zealand and Australia. Australian Journal of Management, 17(1), pp.89-119.

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