Comparative and Competitive Advantage and the ValueAdded Chain

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Comparative and Competitive Advantage and the
Value-Added Chain
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The Porter Diamond
Firm Strategy Structure, and Rivalry
Factor Conditions
Demand Conditions
Related and Supporting Industries
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Value-Added Chain

• Process by which technology is combined with
  material and labor inputs, and then processed
  inputs are assembled, marketed, and distributed.

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Comparative vs. Competitive Advantage

• Influences the decision of where to source and
  market
• Based on the lower cost of a factor (such as
  labor, materials,capital charges, etc.) in one
  country vs. another, favoring industries that use
  this factor intensively

• Influences the decision of what activities and
  technologies to invest in
• Stems from proprietary characteristics of a firm
  such as brand name, core competencies, and
  favors firms in which such resources are
  inimitable

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Why do nations trade?

• Absolute Advantage (Adam Smith, 1776)
• Countries should specialize in the production of
  those goods they produce at lowest cost compared
  to other countries, and import whatever else they
  need from the rest of the worldKey implications
• International trade is a positive sum game in
  which all participants benefit
• Government restrictions on trade reduce
  welfare.But what if one country is the lowest
  cost producer of everything?
• Comparative Advantage (David Ricardo, 1817)
• A nation might still import a good where it could
  be the lowest-cost producer, if it is more
  productive in producing other goodsKey
  implication
• Countries benefit from free trade!

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Example of Comparative Advantage
In France, assume all the resources available
(land) can produce 60 lbs. of beef OR
150 bottles of wine To make each lb. of beef
costs 2.5 bottles of foregone wine in France In
the US, assume all the resources available
(land) can produce 50 lbs. of beef OR
25 bottles of wine To make each lb. of beef
costs 0.5 bottles of foregone wine in the
US Initial No Trade Production and
Consumption Beef (lbs) Wine
(bottles) US 40 5 France 20 100
Total 60 105 Production /Consumption with
Trade (at price of say, 1 lb. beef1 bottle of
wine) Beef Wine Domestic Import Domestic
Import US 40 0 0 10 France 16 10 10
0 0 56 10 100 10 Total 66 110
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Where does Comparative Advantage
come from?

• Hecksher-Ohlin theory (1933)
• Nations differ in endowed resources (factors of
  production). A country will export products
  which use its abundant resources most
  intensively.
• Counter Much of world trade takes place between
  advanced industrial societies with similar factor
  endowments
• Assumptions behind Comparative Advantage
  Hecksher-Ohlin theory
• constant returns to scale (comparative
  advantage), decreasing returns to scale
  (Hecksher-Ohlin)
• perfect competition, undifferentiated products
• factors immobile across borders, and static over
  time,
• factors easily and costlessly movable within
  borders across sectors,
• no technological innovation,
• full employment.

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Strategic Trade Theories

• Response to assumptions in comparative advantage
  and H-O models.
• Policy Issue Should the US government
• restrict activities of foreign firms in the
  domestic market?
• promote the activities of domestic firms in
  global markets?
• Strategic Trade Policy involves government
  intervention targeted at selected industries, in
  terms of RD subsidies, import restraints or
  export subsidies

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International Strategic Challenges

• Identify industry/competitive characteristics
• Identify strategic priorities for value-adding
  activities
• Global Efficiency?
• Multinational Flexibility?
• Learning and Innovation?
• Identify existing/required capabilities
• Decide where (location) and how (internally or
  externally, through alliances) to build
  capabilities

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Matching Strategy with Organization

• Key to a successful international strategy is
  that the firm creates operating flexibility to
  profit from uncertainty regarding exchange rates,
  government policy, and competitors moves
• To do this a firm must have managerial skills and
  organizational resources to respond to market and
  political fluctuations

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Operating Flexibility Arbitrage

• Production Shifting
• Respond to exchange rates
• Loss of economies of scale vs.excess capacity
• Firm must be able to capitalize of differences in
  variable costs across countries
• Tax Minimization and Financial Markets
• Transfer pricing
• adjusting intra-company mark-ups
• Multiple channels for income remittance
• Governments create arbitrage incentives
• Information Arbitrage
• Scanning world markets to match sellers buyers
• Intrafirm transfer of new product and process
  developments

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International Organizational Challenges

• Match organization to strategy by working on
• Structure (Anatomy)
• Systems/Process (Physiology)
• Information
• Integration
• Innovation
• Incentives
• Culture (Psychology)
• Develop people at HQ and subsidiaries with
  the right mindsets to achieve strategic
  goals

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Implications for Company Strategy

• Setting corporate goals
• Building an innovative organization
• Selecting industries and segments
• Upgrading the home base
• Designing a global strategy
• Locating and relocating the home base

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Setting Corporate GoalsLong-term competitive
positionNOTCurrent return on investment
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Building an Innovative Organization

• Internal prerequisites
• Aggressive investment
• Leaders that create pressure to innovate
• External prerequisites
• Demanding customers
• Respected competition
• Strict product safety and environmental standards

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Selecting Industries and Segments

• Consider home base characteristics
• Diversify only within strong clusters

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Upgrading the Home Base

• Invest aggressively
• Develop a critical mass of suppliers
• Strengthen local industry associations

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Designing Global Strategy

• Need for clear home base
• Roles of global strategy
• Source low cost inputs
• Gain access to foreign markets
• Selectively tap into specialized advantages of
  other countries
• Separate home bases for particular product lines
• Celebrate national identity

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Lessons of the New Global Paradigm for Companies

• Competitiveness grows out of the capacity for
  innovation and upgrading
• Companies must seek pressure and challenges, not
  avoid them
• Many of a companys competitive advantages reside
  in its local environment
• The home base is where the critical information
  and skills for innovation reside
• Companies must continually invest to upgrade
  their home base
• Companies must leverage home base advantages with
  a global strategy