Please after reading The Competitive Advantage of Nations and the Harley Davidson article answer the following questions. Harley Davidson’s case is in your book, (pages 204-2014).  1

The Competitive Advantage of Nations

Michael E. Porter

Harvard Business Review

90211

HBR MARCH±APRIL 1990

The Competitive Advantage of Nations Michael E. Porter

National prosperity is created, not inherited. It does of the patterns of competitive success in ten leading trading nations, contradict the conventional wisdomnot grow out of a country's natural endowments, its

labor pool, its interest rates, or its currency's value, that guides the thinking of many companies and na- tional governments— and that is pervasive today inas classical economics insists.

Anation'scompetitivenessdependsonthecapacity the United States. (For more about the study, see the insert “ Patterns of National Competitive Success.” )of its industry to innovate and upgrade. Companies

gain advantage against the world's best competitors According to prevailing thinking, labor costs, inter- est rates, exchange rates, and economies of scale arebecause of pressure and challenge. They benefit from

having strong domestic rivals, aggressive home-based the most potent determinants of competitiveness. In companies, the words of the day are merger, alliance,suppliers, and demanding local customers.

In a world of increasingly global competition, na- strategic partnerships, collaboration, and suprana- tional globalization. Managers are pressing for moretions have become more, not less, important. As the

basis of competition has shifted more and more to government support for particular industries. Among governments, there is a growing tendency to experi-the creation and assimilation of knowledge, the role

of the nation has grown. Competitive advantage is ment with various policies intended to promote na- tional competitiveness— from efforts to managecreated and sustained through a highly localized pro-

cess. Differences in national values, culture, eco- exchange rates to new measures to manage trade to policies to relax antitrust— which usually end upnomic structures, institutions, and histories all

contribute to competitive success. There are striking only undermining it. (See the insert “ What Is Na- tional Competitiveness?” )differences in the patterns of competitiveness in

every country; no nation can or will be competitive These approaches, now much in favor in both companies and governments, are flawed. They funda-in every or even most industries. Ultimately, nations

succeed in particular industries because their home mentally misperceive the true sources of competi- tive advantage. Pursuing them, with all their short-environment is the most forward-looking, dynamic,

and challenging. term appeal, will virtually guarantee that the United States— or any other advanced nation— neverThese conclusions, the product of a four-year study achieves real and sustainable competitive advantage.

We need a new perspective and new tools— an ap- Harvard Business School professor Michael E. Porter is the author proach to competitiveness that grows directly out of of Competitive Strategy (Free Press, 1980) and Competitive Ad-

an analysis of internationally successful industries,vantage (Free Press, 1985) and will publish The Competitive Ad- without regard for traditional ideology or current in-vantage of Nations (Free Press) in May 1990. tellectual fashion. We need to know, very simply,Author's note: Michael J. Enright, who served as project coordina-

tor for this study, has contributed valuable suggestions. what works and why. Then we need to apply it.

Copyright q 1990 by the President and Fellows of Harvard College. All rights reserved.

Patterns of National Competitive Success To investigate why nations gain competitive advan- tries or industry groups for detailed study; we examined

tage in particular industries and the implications for many more in less detail. We went back as far as neces- company strategy and national economies, I conducted sary to understand how and why the industry began in a four-year study of ten important trading nations: Den- the nation, how it grew, when and why companies from mark, Germany, Italy, Japan, Korea, Singapore, Sweden, the nation developed international competitive advan- Switzerland, the United Kingdom, and the United tage, and the process by which competitive advantage States. I was assisted by a team of more than 30 research- had been either sustained or lost. The resulting case ers, most of whom were natives of and based in the histories fall short of the work of a good historian in nation they studied. The researchers all used the same their level of detail, but they do provide insight into methodology. the development of both the industry and the nation's

Three nations— the United States, Japan, and Ger- economy. many— are the world's leading industrial powers. The We chose a sample of industries for each nation that other nations represent a variety of population sizes, represented the most important groups of competitive government policies toward industry, social philoso- industries in the economy. The industries studied ac- phies, geographical sizes, and locations. Together, the counted for a large share of total exports in each nation: ten nations accounted for fully 50% of total world ex- more than 20% of total exports in Japan, Germany, and ports in 1985, the base year for statistical analysis. Switzerland, for example, and more than 40% in South

Most previous analyses of national competitiveness Korea. We studied some of the most famous and have focused on single nation or bilateral comparisons. important international success stories— German high- By studying nations with widely varying characteristics performance autos and chemicals, Japanese semi-con- and circumstances, this study sought to separate the ductors and VCRs, Swiss banking and pharmaceuticals, fundamental forces underlying national competitive ad- Italian footwear and textiles, U.S. commercial aircraft vantage from the idiosyncratic ones. and motion pictures— and some relatively obscure but

In each nation, the study consisted of two parts. The highly competitive industries— South Korean pianos, first identified all industries in which the nation's com- Italian ski boots, and British biscuits. We also added a panies were internationally successful, using available few industries because they appeared to be paradoxes: statistical data, supplementary published sources, and Japanese home demand for Western-character typewrit- field interviews. We defined a nation's industry as inter- ers is nearly nonexistent, for example, but Japan holds nationally successful if it possessed competitive advan- a strong export and foreign investment position in the tage relative to the best worldwide competitors. Many industry. We avoided industries that were highly depen- measures of competitive advantage, such as reported dent on natural resources: such industries do not form profitability, can be misleading. We chose as the best the backbone of advanced economies, and the capacity indicators the presence of substantial and sustained ex- to compete in them is more explicable using classical ports to a wide array of other nations and/or significant theory. We did, however, include a number of more outbound foreign investment based on skills and assets technologically intensive, natural-resource-related in- created in the home country. A nation was considered dustries such as newsprint and agricultural chemicals. the home base for a company if it was either a locally The sample of nations and industries offers a rich owned, indigenous enterprise or managed autono- empirical foundation for developing and testing the new mously although owned by a foreign company or invest- theory of how countries gain competitive advantage. ors. We then created a profile of all the industries in The accompanying article concentrates on the determi- which each nation was internationally successful at nants of competitive advantage in individual industries three points in time: 1971, 1978, and 1985. The pattern and also sketches out some of the study's overall impli- of competitive industries in each economy was far from cations for government policy and company strategy. A random: the task was to explain it and how it had fuller treatment in my book, The Competitive Advan- changed over time. Of particular interest were the con- tage of Nations, develops the theory and its implica- nections or relationships among the nation's competi- tions in greater depth and provides many additional tive industries. examples. It also contains detailed descriptions of the

In the second part of the study, we examined the nations we studied and the future prospects for their history of competition in particular industries to under- economies. stand how competitive advantage was created. On the — Michael E. Porter basis of national profiles, we selected over 100 indus-

74 HARVARD BUSINESS REVIEW March–April 1990

cumbered by blinding assumptions or conventionalHow Companies Succeed in wisdom.International Markets

This is why innovators are often outsiders from a different industry or a different country. Innovation may come from a new company, whose founder hasAround the world, companies that have achieved

international leadership employ strategies that differ a nontraditional background or was simply not ap- preciated in an older, established company. Or thefrom each other in every respect. But while every

successful company will employ its own particular capacity for innovation may come into an existing company through senior managers who are new tostrategy, the underlying mode of operation— the

character and trajectory of all successful compa- the particular industry and thus more able to per- ceive opportunities and more likely to pursue them.nies— is fundamentally the same.

Companies achieve competitive advantage Or innovation may occur as a company diversifies, bringing new resources, skills, or perspectives to an-through acts of innovation. They approach innova-

tion in its broadest sense, including both new other industry. Or innovations may come from another nation with different circumstances or dif-technologies and new ways of doing things. They

perceive a new basis for competing or find better ferent ways of competing. With few exceptions, innovation is the result ofmeans for competing in old ways. Innovation can be

manifested in a new product design, a new produc- unusual effort. The company that successfully im- plements a new or better way of competing pursuestion process, a new marketing approach, or a new

way of conducting training. Much innovation is its approach with dogged determination, often in the face of harsh criticism and tough obstacles. In fact,mundane and incremental, depending more on a cu-

mulation of small insights and advances than on a to succeed, innovation usually requires pressure, ne- cessity, and even adversity: the fear of loss oftensingle, major technological breakthrough. It often

involves ideas that are not even “ new” — ideas that proves more powerful than the hope of gain. Once a company achieves competitive advantagehave been around, but never vigorously pursued. It

always involves investments in skill and knowledge, through an innovation, it can sustain it only through relentless improvement. Almost any advantageas well as in physical assets and brand reputations.

Some innovations create competitive advantage by can be imitated. Korean companies have already matched the ability of their Japanese rivals to mass-perceiving an entirely new market opportunity or by

serving a market segment that others have ignored. produce standard color televisions and VCRs; Brazil- ian companies have assembled technology andWhen competitors are slow to respond, such innova-

tion yields competitive advantage. For instance, in designs comparable to Italian competitors in casual leather footwear.industries such as autos and home electronics, Japa-

nese companies gained their initial advantage by em- Competitors will eventually and inevitably over- take any company that stops improving and innovat-phasizing smaller, more compact, lower capacity

models that foreign competitors disdained as less ing. Sometimes early-mover advantages such as customer relationships, scale economies in existingprofitable, less important, and less attractive.

In international markets, innovations that yield technologies, or the loyalty of distribution channels are enough to permit a stagnant company to retaincompetitive advantage anticipate both domestic and

foreign needs. For example, as international concern its entrenched position for years or even decades. But sooner or later, more dynamic rivals will find a wayfor product safety has grown, Swedish companies

like Volvo, Atlas Copco, and AGA have succeeded to innovate around these advantages or create a bet- ter or cheaper way of doing things. Italian applianceby anticipating the market opportunity in this area.

On the other hand, innovations that respond to con- producers, which competed successfully on the basis of cost in selling midsize and compact appliancescerns or circumstances that are peculiar to the home

market can actually retard international competitive through large retail chains, rested too long on this initial advantage. By developing more differentiatedsuccess. The lure of the huge U.S. defense market, for

instance, has diverted the attention of U.S. materials products and creating strong brand franchises, Ger- man competitors have begun to gain ground.and machine-tool companies from attractive, global

commercial markets. Ultimately, the only way to sustain a competitive advantage is to upgrade it— to move to more sophisti-Information plays a large role in the process of

innovation and improvement— information that ei- cated types. This is precisely what Japanese auto- makers have done. They initially penetrated foreignther is not available to competitors or that they do

not seek. Sometimes it comes from simple invest- markets with small, inexpensive compact cars of ad- equate quality and competed on the basis of lowerment in research and development or market re-

search; more often, it comes from effort and from labor costs. Even while their labor-cost advantage persisted, however, the Japanese companies were up-openness and from looking in the right place unen-

HARVARD BUSINESS REVIEW March–April 1990 75

What Is National Competitiveness? National competitiveness has become one of the cen- held view that powerful unions undermine competitive

tral preoccupations of government and industry in every advantage, unions are strong in Germany and Sweden— nation. Yet for all the discussion, debate, and writing and both countries boast internationally preeminent on the topic, there is still no persuasive theory to explain companies. national competitiveness. What is more, there is not Clearly, none of these explanations is fully satisfac- even an accepted definition of the term “ competitive- tory; none is sufficient by itself to rationalize the com- ness” as applied to a nation. While the notion of a com- petitive position of industries within a national border. petitive company is clear, the notion of a competitive Each contains some truth; but a broader, more complex nation is not. set of forces seems to be at work.

Some see national competitiveness as a macroeco- The lack of a clear explanation signals an even more nomic phenomenon, driven by variables such as ex- fundamental question. What is a “ competitive” nation change rates, interest rates, and government deficits. in the first place? Is a “ competitive” nation one where But Japan, Italy, and South Korea have all enjoyed rap- every company or industry is competitive? No nation idly rising living standards despite budget deficits; Ger- meets this test. Even Japan has large sectors of its econ- many and Switzerland despite appreciating currencies; omy that fall far behind the world‘s best competitors. and Italy and Korea despite high interest rates. Is a “ competitive” nation one whose exchange rate

Others argue that competitiveness is a function of makes its goods price competitive in international mar- cheap and abundant labor. But Germany, Switzerland, kets? Both Germany and Japan have enjoyed remarkable and Sweden have all prospered even with high wages gains in their standards of living— and experienced sus- and labor shortages. Besides, shouldn't a nation seek tained periods of strong currency and rising prices. Is a higher wages for its workers as a goal of competitive- “ competitive” nation one with a large positive balance ness? of trade? Switzerland has roughly balanced trade; Italy

Another view connects competitiveness with bounti- has a chronic trade deficit— both nations enjoy strongly ful natural resources. But how, then, can one explain rising national income. Is a “ competitive” nation one the success of Germany, Japan, Switzerland, Italy, and with low labor costs? India and Mexico both have low South Korea— countries with limited natural resources? wages and low labor costs— but neither seems an attrac-

More recently, the argument has gained favor that tive industrial model. competitiveness is driven by government policy: tar- The only meaningful concept of competitiveness at geting, protection, import promotion, and subsidies the national level is productivity. The principal goal of have propelled Japanese and South Korean auto, steel, a nation is to produce a high and rising standard of living shipbuilding, and semiconductor industries into global for its citizens. The ability to do so depends on the preeminence. But a closer look reveals a spotty record. productivity with which a nation's labor and capital In Italy, government intervention has been ineffectual— are employed. Productivity is the value of the output but Italy has experienced a boom in world export share produced by a unit of labor or capital. Productivity de- second only to Japan. In Germany, direct government pends on both the quality and features of products intervention in exporting industries is rare. And even (which determine the prices that they can command) in Japan and South Korea, government's role in such and the efficiency with which they are produced. Pro- important industries as facsimile machines, copiers, ro- ductivity is the prime determinant of a nation's long- botics, and advanced materials has been modest; some run standard of living; it is the root cause of national of the most frequently cited examples, such as sewing per capita income. The productivity of human resources machines, steel, and shipbuilding, are now quite dated. determines employee wages; the productivity with

A final popular explanation for national competitive- which capital is employed determines the return it ness is differences in management practices, including earns for its holders. management-labor relations. The problem here, how- A nation's standard of living depends on the capacity ever, is that different industries require different ap- of its companies to achieve high levels of productivity— proaches to management. The successful management and to increase productivity over time. Sustained pro- practices governing small, private, and loosely orga- ductivity growth requires that an economy continually nized Italian family companies in footwear, textiles, upgrade itself. A nation's companies must relentlessly and jewelry, for example, would produce a management improve productivity in existing industries by raising disaster if applied to German chemical or auto compa- product quality, adding desirable features, improving nies, Swiss pharmaceutical makers, or American air- product technology, or boosting production efficiency. craft producers. Nor is it possible to generalize about They must develop the necessary capabilities to com- management-labor relations. Despite the commonly pete in more and more sophisticated industry segments,

76 HARVARD BUSINESS REVIEW March–April 1990

where productivity is generally high. They must finally performance cars, while Korean exports are all compacts develop the capability to compete in entirely new, so- and subcompacts. In many industries and segments of phisticated industries. industries, the competitors with true international

International trade and foreign investment can both competitive advantage are based in only a few nations. improve a nation's productivity as well as threaten it. Our search, then, is for the decisive characteristic of They support rising national productivity by allowing a nation that allows its companies to create and sustain a nation to specialize in those industries and segments competitive advantage in particular fields— the search of industries where its companies are more productive is for the competitive advantage of nations. We are par- and to import where its companies are less productive. ticularly concerned with the determinants of inter- No nation can be competitive in everything. The ideal national success in technology- and skill-intensive is to deploy the nation's limited pool of human and segments and industries, which underpin high and ris- other resources into the most productive uses. Even ing productivity. those nations with the highest standards of living have Classical theory explains the success of nations in many industries in which local companies are uncom- particular industries based on so-called factors of pro- petitive. duction such as land, labor, and natural resources. Na-

Yet international trade and foreign investment also tions gain factor-based comparative advantage in can threaten productivity growth. They expose a na- industries that make intensive use of the factors they tion's industries to the test of international standards possess in abundance. Classical theory, however, has of productivity. An industry will lose out if its produc- been overshadowed in advanced industries and econo- tivity is not sufficiently higher than foreign rivals‘ to mies by the globalization of competition and the power offset any advantages in local wage rates. If a nation of technology. loses the ability to compete in a range of high-productiv- A new theory must recognize that in modern interna- ity/high-wage industries, its standard of living is threat- tional competition, companies compete with global ened. strategies involving not only trade but also foreign in-

Defining national competitiveness as achieving a vestment. What a new theory must explain is why a trade surplus or balanced trade per se is inappropriate. nation provides a favorable home base for companies The expansion of exports because of low wages and a that compete internationally. The home base is the na- weak currency, at the same time that the nation imports tion in which the essential competitive advantages of sophisticated goods that its companies cannot produce the enterprise are created and sustained. It is where a competitively, may bring trade into balance or surplus company's strategy is set, where the core product and but lowers the nation‘s standard of living. Competitive- process technology is created and maintained, and ness also does not mean jobs. It's the type of jobs, not where the most productive jobs and most advanced just the ability to employ citizens at low wages, that is skills are located. The presence of the home base in a decisive for economic prosperity. nation has the greatest positive influence on other

Seeking to explain “ competitiveness” at the national linked domestic industries and leads to other benefits level, then, is to answer the wrong question. What we in the nation's economy. While the ownership of the must understand instead is the determinants of produc- company is often concentrated at the home base, the tivity and the rate of productivity growth. To find an- nationality of shareholders is secondary. swers, we must focus not on the economy as a whole A new theory must move beyond comparative advan- but on specific industries and industry segments. We tage to the competitive advantage of a nation. It must must understand how and why commercially viable reflect a rich conception of competition that includes skills and technology are created, which can only be segmented markets, differentiated products, technology fully understood at the level of particular industries. It differences, and economies of scale. A new theory must is the outcome of the thousands of struggles for compet- go beyond cost and explain why companies from some itive advantage against foreign rivals in particular seg- nations are better than others at creating advantages ments and industries, in which products and processes based on quality, features, and new product innovation. are created and improved, that underpins the process A new theory must begin from the premise that compe- of upgrading national productivity. tition is dynamic and evolving; it must answer the ques-

When one looks closely at any national economy, tions: Why do some companies based in some nations there are striking differences among a nation's indus- innovate more than others? Why do some nations pro- tries in competitive success. International advantage vide an environment that enables companies to improve is often concentrated in particular industry segments. and innovate faster than foreign rivals? German exports of cars are heavily skewed toward high- — Michael E. Porter

HARVARD BUSINESS REVIEW March–April 1990 77

grading. They invested aggressively to build large ruthlessly pursue improvements, seeking an ever- more sophisticated source of competitive advantage?modern plants to reap economies of scale. Then they

became innovators in process technology, pioneering Why are they able to overcome the substantial barri- ers to change and innovation that so often accom-just-in-time production and a host of other quality

and productivity practices. These process improve- pany success? The answer lies in four broad attributes of a nation,ments led to better product quality, better repair re-

cords, and better customer-satisfaction ratings than attributes that individually and as a system consti- tute the diamond of national advantage, the playingforeign competitors had. Most recently, Japanese au-

tomakers have advanced to the vanguard of product field that each nation establishes and operates for its industries. These attributes are.technology and are introducing new, premium brand

names to compete with the world's most prestigious 1. Factor Conditions. The nation's position in fac-passenger cars.

tors of production, such as skilled labor or infra-The example of the Japanese automakers also illus- structure, necessary to compete in a giventrates two additional prerequisites for sustaining industry.competitive advantage. First, a company must adopt

2. Demand Conditions. The nature of home-mar-a global approach to strategy. It must sell its product ket demand for the industry's product or service.worldwide, under its own brand name, through inter-

3. Related and Supporting Industries. The pres-national marketing channels that it controls. A truly ence or absence in the nation of supplier indus-global approach may even require the company to tries and other related industries that arelocate production or R&D facilities in other nations internationally competitive.to take advantage of lower wage rates, to gain or

4. Firm Strategy, Structure, and Rivalry. The con-improve market access, or to take advantage of for- ditions in the nation governing how companieseign technology. Second, creating more sustainable are created, organized, and managed, as well asadvantages often means that a company must make the nature of domestic rivalry.its existing advantage obsolete— even while it is still

an advantage. Japanese auto companies recognized These determinants create the national environ- this; either they would make their advantage obso- ment in which companies are born and learn how lete, or a competitor would do it for them. to compete. (See the diagram “ Determinants of Na-

As this example suggests, innovation and change tional Competitive Advantage.” ) Each point on the are inextricably tied together. But change is an unnat- ural act, particularly in successful companies; power- ful forces are at work to avoid and defeat it. Past approaches become institutionalized in standard op- Determinants of National erating procedures and management controls. Train- Competitive Advantageing emphasizes the one correct way to do anything; the construction of specialized, dedicated facilities solidifies past practice into expensive brick and mor- tar; the existing strategy takes on an aura of invinci- bility and becomes rooted in the company culture.

Successful companies tend to develop a bias for predictability and stability; they work on defending what they have. Change is tempered by the fear that there is much to lose. The organization at all levels filters out information that would suggest new approaches, modifications, or departures from the norm. The internal environment operates like an immune system to isolate or expel “ hostile” individ- uals who challenge current directions or established thinking. Innovation ceases; the company becomes stagnant; it is only a matter of time before aggressive competitors overtake it.

The Diamond of National Advantage

Firm Strategy, Structure,

and Rivalry

Factor Conditions

Demand Conditions

Related and Supporting Industries

Why are certain companies based in certain na- tions capable of consistent innovation? Why do they

78 HARVARD BUSINESS REVIEW March–April 1990