The Competitive Advantage Of Nations

This chapter looks at the general theoretical reasons why certain firms are successful—a question that must be addressed before assessing why different national contexts allow for such success. As Porter emphasises, the basic unit for analyzing the former question is the industry, which he defines as “a group of competitors producing products or services that compete directly with each other” (33). A firm’s competitive strategy in relation to its specific industry determines its success. In turn, two main factors shape strategy: industry structure and positioning within an industry. For firms to succeed, they must understand their industry’s competitive structure and how it is changing—and adapt their competitive strategy to it.

Five main variables influence industry structure. Their strength determines which industries are most profitable in the long run. These variables are (1) the threat of new entrants, (2) the threat of substitute products or services, (3) the bargaining power of suppliers, (4) the bargaining power of buyers, and (5) the rivalry among existing competitors. If the potential for many new entrants is high due to low costs of entry, like in the restaurant industry, this puts downward pressure on prices and therefore profits as more competitors seek a market share. Likewise, a small number of powerful buyers or sellers can reduce profits by commanding higher prices for their products. Competitive rivalries can also negatively affect markets for the firms involved but positively affect customers when competitors lower prices.

In contrast, limited threat from potential substitutes, as for trans-Atlantic flights, allows for higher prices and profits. Finally, strong existing competition between industry firms drives down profits. This, as Porter highlights, is due to greater costs required for advertising and investment in research and development when competition is high. Further, as he writes, “Standard of living will depend importantly on the capacity of a nation’s firms to successfully penetrate structurally attractive industries” (36). These are industries whose alignment of the five factors allows for the highest long-term profits.

To be successful, firms must also position themselves within their industry structures and attempt to achieve one of two forms of competitive advantage. In broad terms, these two types are lower cost and differentiation. A firm achieves a competitive advantage in cost if it can design, produce, and market a similar product more efficiently than its rivals. It can thereby sell the comparable product at a lower price or gain higher returns selling at the same price. For example, American hotel chains have made inroads into foreign markets by offering similar rooms and service to local hotels at lower prices. In contrast, differentiation “is the ability to provide unique and superior value to the buyer in terms of product quality, special features, or after-sale service” (37). For example, German car manufacturers like BMW or Mercedes-Benz can charge higher prices for a better product and thus gain higher returns than rivals with similar costs.

Relative to these two broad choices, a firm must also decide on its “competitive scope” (38). This can be either narrow, focusing on a small industry segment and range of products, or broad, like Japanese electronics manufacturer Sony, pursuing wide industry coverage and product lines. As with lower cost versus differentiation, neither strategy is necessarily superior. For example, broad coverage can bring with it the advantage of economies of scale in research and brand reputation. However, it can risk spreading resources too thinly over the design or promotion of individual products. What matters is that firms make a choice. As Porter emphasises, “the worst strategic error is to be stuck in the middle” (40). This is because firms can rarely pursue all strategies well at the same time.

Firms gain competitive advantage over others when they can adapt and improve their strategy relative to changes in the forces affecting industry structure. This involves both anticipating and initiating industry change to allow for the creation of new or better products or innovative ways of producing and selling existing ones. These changes in an industry’s competitive structure usually result from five broad factors: (1) new technologies that improve the production or sale of a product (in which not just possession of a technology but the ability and willingness to use it effectively is crucial); (2) new or shifting buyer needs that mean customers prioritize new features or aspects of products (for example, concern for the environmental impact of a product, where firms that anticipated this concern and modified their marketing and product appropriately gained an edge); (3) emergence of a new or underserved industry segment, allowing firms that perceive it to gain advantage; (4) shifting input costs or availability that necessitate changes in production processes; and (5) changes in government regulations that require updated methods of production and sale. A firm’s ability to perceive these changes and respond to them by adapting its strategy—faster or better than its rivals—determines whether it will gain competitive advantage.