Aspects of Competitive Advantages and Regional Clusters

Table of Contents

1 Introduction

2 Conventional Theories
2.1 Internationalization Theories
2.1.1 Mercantilism
2.1.2 Absolute Advantage
2.1.3 Comparative Advantage
2.1.4 Factor Endowments
2.1.5 Leontief ’ s Paradox
2.2 Porter’s Five Forces

3 Competitive Advantage of Nations
3.1 Factor Conditions
3.2 Demand Conditions
3.3 Firm Strategy, Structure and Rivalry
3.4 Related and Supplying Industries
3.5 Role of Government and Chance
3.6 Influence of Culture

4 Regional Cluster in Germany[Abbildung in dieser Leseprobe nicht enthalten]

5 Conclusion

II. Appendix

III. Bibliography

1 Introduction

Today, the competition in many industries has internationalized. Due to the increasing globalization some firms are struggling to survive. In contrast to that, other firms are growing because of globalization. The following statement of Porter describes this situation perfectly: "Now that companies can source capital, goods, information, and technology from around the world, often with the click of a mouse, much of the conventional wisdom about how companies and nations compete needs to be overhauled"¹. But why are some firms more successful than others are? Porter's answer to that question is that there exists a competitive advantage of nations. Often this competitive advantage is attributed to an even smaller area, for example a region. This work will explain the factors leading to a competitive advantage of a nation and why regional clusters are built. An example of a creation of a regional cluster in Germany will complete the work on competitive advantage.

The following chapter will show that globalization will dominate the world economy by explaining the conventional theories of international trade. But regional clusters will survive and prove the existence the theories of 'conventional wisdom' will be described. Porter's model of comparative advantage of nations in the third, and an example of creating a regional cluster in Germany will be presented in the fourth chapter. In the fifth chapter the author will draw a short conclusion.

2 Conventional Theories

A wide array of social scientists have tried to identify the factors that lead nations to trade with another nation and why some nations have a competitive advantage in producing certain goods compared to others. Not in all cases it is attractive to internationalize, even if the theories of internationalization suggest so. Still, the competition in other countries has to be measured before deciding to set up a business in that particular country. Porter’s five forces model helps to evaluate the chances of entering a new market.

2.1 Internationalization Theories

Due to the limit of space I will only mention the most important ones in historical order:

2.1.1 Mercantilism

Mercantilism was one of the first economic doctrines (1550 to 1800). It flourished especially in the 18TH century in England. It measured a nation’s wealth by the amount of gold and silver it held, and argued that England should try to increase its wealth by exporting more than it imported. It therefore called for subsidies to encourage exports and tariffs on imports. In some cases Japan might still today be an example of mercantilism.

2.1.2 Absolute Advantage

In 1776, Adam Smith² rejected the idea that a nation’s wealth should be measured by the amount of gold and silver it holds. He believed it should be measured by the goods available to its citizens, and that governments should try to lower the unit resource cost of the goods its citizens wanted, by encouraging specialization and international trade. This proposal suggests, that a nation should specialize in producing and exporting goods it can produce more efficiently - that is, at a lower resource cost - than any other nation, and use the trade surplus to import goods that other nations can produce more efficiently than it can. So the absolute advantage is founded in the wealth of a nation.

2.1.3 Comparative Advantage

In 1817, David Ricardo³ compared in a two country / two product model the opportunity costs rather than the absolute costs attached to specialization. This enabled him to expand the theory of absolute advantage to cover the case of a nation that could produce everything more efficiently than any other nation. He therefore believed that a nation is able to increase its wealth when the opportunity costs attached to increasing its exports volumes through specialization is greater than the costs attached to importing some goods it could itself produce more efficiently. In summary, the theory of comparative advantage shows that everyone wins if each nation produces what it does best and trades with other nations even if they are trading for things they could make themselves. The nations trade successfully even if there is no absolute advantage.

2.1.4 Factor Endowments

Eli Heckscher (in 1919) and Bertil Ohlin⁴ (in 1933) argued that a nation’s absolute advantage is rooted in its endowments of land, labor and capital. They based their theory on two facts: For the production of different goods different proportions of the basic factors of production are needed. For example, wheat production uses large amounts of land and small amounts of labor and capital, but steel production uses small amounts of land and large amounts of labor and capital. And different countries have different factor endowments. For example, Japan has abundant labor and capital resources but very little land, whereas Australia has abundant land but very little labor and capital. Ignoring land as a factor, they made two specific predictions: Firstly labor rich countries would export labor intensive goods and import capital intensive goods. Secondly capital rich countries would export capital intensive goods and import labor intensive goods. So the countries should concentrate on producing and exporting goods requiring the most abundant factor.

2.1.5 Leontief’s Paradox

In 1953, Wassily Leontief⁵ questioned the truth of the factor endowment theory. He found out that the United States was more capital rich than labor rich, but they exported goods that were more labor intensive than capital intensive, and imported goods that were more capital intensive than labor intensive. This was a definite objection to the Heckscher/ Ohlin theory.

2.2 Porter’s Five Forces

In 1980 Michael Porter developed a practical model of competition, based on economic principles. Porter's study of industry groups revealed five determinants of long-term industry profitability. The first is the character of the rivalry among competitors in an industry, which can range from vicious and warlike to gentlemanly and subdued. Obviously, the more intense the rivalry, the more difficult it is to compete in an industry. Second is the threat of new entrants. If there are substantial barriers to entry, the companies in the industry will do better than if the barriers are weak. Another factor is the threat of substitute products or services. If customers have numerous alternatives from which to choose, the industry's profitability decreases.

The last two forces are the bargaining power of suppliers and the bargaining power of buyers. If suppliers have the ability to force up the price of what the firm has to buy, or buyers can force the company to lower prices, provide extra services, or store inventory, profitability can be difficult or even impossible to sustain.⁶

As mentioned at the beginning, these were of course not the only theories concerning international trade and competitive advantage, but the most important ones. The following chapter deals with the competitiveness of nations. Again, Michael Porter developed a model in order to explain why some nations or even regions have a competitive advantage. Regarding the internationalization theories as a basis for international trade, Porter takes also the special qualities and abilities of a country into account.

3 Competitive Advantage of Nations

In 1990, Michael Porter published a challenging and illuminating answer to a simple question: Why do some nations succeed and others fail in international competition? Porter studied 100 industries in 10 nations and found out that nations gain a competitive advantage over other countries in certain areas and trade those goods and services. Sustaining this competitive advantage depends on the productivity advance - the ability to produce more with a given level of inputs. This, in turn, is based on innovation and upgrading of products, production processes, and/or the management.

He describes four determinants of a specific area that lead to a sustainable competitive advantage in global industries. These are Factor Conditions, Demand Conditions, Related and Supporting Industries, Firm Strategy, Structure and Rivalry. Graphically they form a diamond as shown below:

Abbildung in dieser Leseprobe nicht enthalten

3.1 Factor Conditions

As we saw before, according to standard economic theories, factors of production such as labor, land, natural resources, capital and infrastructure will determine the flow of trade. But Leontief proved already that these assumptions are incomplete. Also Porter believes that "the factors most important to competitive advantage in most industries, especially the industries most vital to productivity growth in advanced economies, are not inherited but are created within a nation, through processes that differ widely across nations and among industries."⁷ Such as for example, skilled human resources. General use factors, such as unskilled labor and raw materials, can be obtained by any company in the world because of the globalization and therefore do not generate a competitive advantage. The competitive advantage of general factors is actually nullified by the globalization. But created factors, such as skilled human resource or infrastructure involve large investment. They are more difficult to duplicate. This leads to a competitive advantage, because if other firms cannot easily duplicate these factors, they are more valuable.

Porter argues that a lack of resources often actually helps countries to become competitive. Such countries are forced to innovate in order to overcome their problem of scarce resources. The best example for this might be Japan with the development of the just-in-time production because of the limited factory and stocking space they have.

3.2 Demand Conditions

According to Porter a sophisticated domestic market is an important element to increasing productivity and therefore producing competitiveness. It even "shapes the rate and character of improvement and innovation by a nation's firm's."⁸ Firms that face a sophisticated domestic market are likely to sell superior products because the market demands high quality and a close proximity to such consumers enables the firm to better understand the needs and desires of the customers.

One example is the French wine industry. The French are sophisticated wine consumers. These consumers force and help French wineries to produce high quality wines.

3.3 Firm Strategy, Structure and Rivalry

The national circumstances have an effect on how companies "are created, organized, and managed, as well as what the nature of domestic rivalry"⁹ will be. Therefore the firm strategy varies not only from country to country but also from firm to firm. Porter found out that the best management styles vary among industries. No single managerial system is applicable everywhere.

For example, Germany tends to have hierarchical management structures composed of managers with strong technical backgrounds. That might be the reason why the Germans have a competitive advantage in the production of high-quality cars.

Concerning rivalry Porter argues that intense domestic competition forces companies to innovate in order to be better than the other rivals are. And that "domestic rivalry becomes superior to rivalry with foreign competitors when improvement and innovation, rather than static efficiency, are recognized as the essential ingredients for competitive advantage in an industry"¹⁰.

3.4 Related and Supplying Industries

Being surrounded by strong related and supporting industries at a local or regional level can improve the competitiveness of firms. There can exist a vertical support, which means that there are other internationally competitive suppliers. These can deliver components more cheaply and faster. But also a horizontal support is important for competition, because related companies can share activities and stimulate competition. Such an area is called a cluster. "Clusters are geographic concentrations of interconnected companies and institutions in a particular field"¹¹

Clusters of competitive industries are promoted by "the systematic nature of the ‘diamond'"¹².

The best example for an existing cluster is probably the Silicon Valley in the US. The next chapter deals with an example of an intentionally created cluster in Germany.

3.5 Role of Government and Chance

In Porter's diamond there are also influences of the government and of chance. "The government can influence each of the four determinants either positively or negatively".¹³ An example might be subsidies to improve factor conditions. Concerning chance it played especially in history a major role. For example the industrialization in Germany after the World War II.

3.6 Influence of Culture

What is culture? “Culture is the way in which a group of people solve problems”¹⁴. This is a very general definition of culture. Trompenaars¹⁵ differentiates different levels of culture. “At the highest level is the culture of a national or a regional society”. “The way in which attitudes are expressed within a specific organization is described as a corporate or organizational culture.” And sometimes there exists even a “professional culture” in particular business levels. All these levels of culture have different influences on each of the determinants of the diamond. The corporate and professional culture have a significant impact on the firm strategy, structure and related and supporting industries. Whereas the national culture has a strong influence on the factor and demand conditions. For example, if the corporate and professional culture is developed in a way that the whole company pulls together in order to increase productivity. Or if the national culture is a rather sophisticated culture than it has a positive effect on the education of the people living in this culture. And according to Porter the more sophisticated the employees (factor conditions) and the customers (demand conditions) are, it is more easy for a company to produce products that are higher in quality and meet the customer’s needs.

Due to the fact that the globalization nullifies general competitive advantages, the more important are the specific competitive advantages of regional clusters. Because of this importance I will illustrate the creation of a regional cluster in Germany in the following chapter.

4 Regional Cluster in Germany[Abbildung in dieser Leseprobe nicht enthalten]

In the book “Competitive Advantage of Nations” Porter showed several clusters, for example the footwear and leather industry in northern Italy. He describes their advantages as follows: “Clusters affect competition in three broad ways: first, by increasing the productivity of companies based in the area; second, by driving the direction and pace of innovation, which underpins future productivity growth; and third, by stimulating the formation of new businesses, which expands and strengthens the cluster itself.”¹⁶

In order to profit from those advantages the Volkswagen AG (VW) and the town of Wolfsburg, where VW is located in Germany, originated a project called AutoVision with the creation of the Wolfsburg AG¹⁷. The main goal is to create 10.000 new jobs in the following years by increasing the company foundations, the settlement of new companies, improving the supply of entertainment and leisure facilities and developing of an integral personnel service. Under the roof of the Wolfsburg AG there are four main departments: “InnovationsCampus”, “LieferantenAnsiedlung” (settlement of suppliers), ErlebnisWelt Wolfsburg (adventure world) and “PersonalServiceAgentur” (personnel service agency). (see appendix p.14)

The InnovationCampus supports foundation and development processes of young companies by consulting, coaching and supporting them. Renting offices in one building offers them to profit from the network. The foundation of companies (startups) has an effect on two determinants of the diamond: The rivalry, and the number of related and supporting industries increases. As mentioned before, this will force the companies to innovate more.

The LieferantenAnsiedlung wants to increase the settlement of automobile supplying industries, especially those of the automobile development and production. Not only VW but also the suppliers will profit from the cooperation and the networking. This, of course, has an effect on the determinant of supplying industries. The car components can be delivered to VW more cheaply and faster.

The ErlebnisWelt Wolfsburg’s aim is to improve the attraction of the town Wolfsburg. Various leisure and entertainment activities for the whole family, as well as tourist attractions will be offered. This does not only create jobs in the service sector, but also improves the life quality of the employees working in Wolfsburg. The ErlebnisWelt Wolfsburg positively affects two determinants of the diamond: the demand conditions and the factor conditions. The demand conditions are affected because there will be more sophisticated people living in Wolfsburg who are demanding more and more from the companies. And the factor conditions are affected because the motivation of the employees living and working in Wolfsburg will be increased.

The PersonalServiceAgentur is a complex service company, which tries to bring together the labor supply and demand on the market. Additionally it will offer an integral and individual service for employees. This also has an effect on both determinants mentioned above.

What should not be neglected is the influence of the state in this project. First of all, the town of Wolfsburg is with VW together the major shareholder of the Wolfsburg AG. Both support this project not only with financial aids, but also by providing an advanced industrial area with a promising future.

The creation of a regional cluster, like the Wolfsburg AG, is only possible if the people in that region have an open-minded culture, that fits the economic idea.

5 Conclusion

The explanation of international trade by the conventional theories is not wrong, but due to the globalization, incomplete, and not up to date. Porter tried to complement the theories by a challenging work on competitive advantage.

As I have shown, regional clusters provide an advantage which can outweigh threats of globalization: The town of Wolfsburg has recognized this notion too, and therefore tries to build up an artificially regional cluster by stimulating the determinants of Porter’s diamond. So Wolfsburg is one of the towns which recognized that supporting the most important branch of the region could stimulate the whole economy of this particular region. To pick out certain important branches, encourage and promote them is a new task for the country’s and region’s economic policy.

II. Appendix

Abbildung in dieser Leseprobe nicht enthalten

III. Bibliography

Kutschker, Michael: Internationales Management in Corsten, H. / Reiß, M. (1998): Betriebswirtschaftslehre, München, Wien.

Porter, Michael: Attitudes, Values Beliefs, and the Microeconomics of Prosperity in Culture Matters: How Values Shape Human Progress, Samuel Huntington, 2000.

Porter, Michael: Clusters and the New Economics of Competition, Harvard Business Review, November-December, 1998.

Porter, Michael: Competitive Strategy: Techniques for Analyzing Industries and Competitors, 1980.

Porter, Michael: The Competitive Advantage of Nations, New York: Free Press, 1990.

Ricardo, David: Principles of Political Economy and Taxation with an introduction by Donald Winch. New York 1974.

Schein, E. H.: Organisational Culture and Leadership, Jossey-Bass, San Francisco, 1985 in: Trompenaars, F., Riding the Waves of Culture: Understanding Cultural Diversity in Business, Nicholas Brealey Publishing Ltd, London, 1993.

Smith, Adam: The Wealth of Nations, ed. Edwin Cannan, New York: Modern Library, 1937.

[...]

¹ Porter in "Clusters and the New Economics of Competition", p. 77

² compare Smith: "The Wealth of Nations"

³ compare Ricardo: “Principles of Political Economy and Taxation”

⁴ compare Kutschker: “Internationales Management”

⁵ see footnote 3

⁶ compare Porter: "Competitive Strategy" (1980)

⁷ Porter: "Competitive Advantage of Nations" (1998), p. 74

⁸ also Porter: p. 86

⁹ also Porter: p. 107

¹⁰ Porter: "Competitive Advantage of Nations" (1998), p. 117f.

¹¹ Porter: "Clusters and the New Economics of Competition" (1998), p. 78

¹² see footnote 7, p. 148

¹³ see footnote 7, p. 127

¹⁴ Schein: Organizational Culture and Leadership (1985), p. 6

¹⁵ Trompenaars: Riding the waves of culture (1993), p. 7

¹⁶ see footnote 11, p. 80

¹⁷ compare http://www.wolfsburg-ag.com