“America is meant to be entrepreneurial. Why then are some American firms finding it difficult to enshrine flexibility in their organization?” Entrepreneurship is defined as “The initiating and organizing of the production of new goods, or the introduction of new techniques, and the risk taking associated with it.” (Sloman 1997). To be entrepreneurial, an advantage is needed, some say this is inherent others it is simply circumstantial. If we examine Porter’s theory of ‘The competitive advantage of Nations’ we see that other factors also contribute towards the success of a firm.
Competitive advantage is a firm specific advantage derived from investment that leads to innovation and upgrading that enables firms to become superior to their competition. Porter says that ‘firms gain and sustain competitive advantage in international competition through improvement, innovation and upgrading’. This must be a continual process, improving beyond the competition and doing so fast enough to stay ahead and retain the advantage. Porter’s theory of competitive advantage focuses on four different areas, which are vital to obtain competitive advantage. These are Factor conditions, Demand conditions, Related and supporting industries and Firm strategy, structure and rivalry. They are all inter-related in what is commonly known as Porters Diamond.
Firm strategy, structure And rivalry Factor conditions Demand conditions Related and supporting Industries This needs to be explained to deepen our understanding of competitive advantage. Factor conditions are the basic raw materials needed for economic activity, it is composed of factor endowments such as physical resources, human resources, knowledge resources and capital resources. Factor endowments have different characteristics; these can be sophisticated or basic. Everyone has basic factor endowments but it is the access to the sophisticated ones e.g. a highly educated workforce that can enable success.
Factor endowments can alter over time, sometimes a sophisticated resource can become basic and the competitive advantage is lost, this also works vise versa e.g. Japan had a massive workforce and through investment in this human capital they now have a sophisticated endowment that has led to a competitive advantage. The demand conditions in the diamond relate to the home demand composition. The majority of firms are quick to respond to signals from their domestic market. The implication of this is that if a firm is situated near sophisticated and demanding buyers there will be a quicker rate of innovation and upgrading than a competitor who doesn’t have such sophisticated buyers.
This also enables an advantage over international rivals if demand conditions in the domestic market anticipate those in foreign markets’ as they will be further along in the product lifecycle and also more experienced. It is widely thought that the entrepreneur organizes the factors of production, which are labour, land and capital. These three categories roughly correspond to the factor conditions within the diamond, meaning that entrepreneurship plays a vital part in obtaining and retaining a competitive advantage.
The US model of firm structure is dominant in financial literature and throughout Europe the US system has been highlighted as a benchmark. However, in recent years the success of the United States has not been so great. Since 1995 the success has been in one sector only, Information and communication technology (ICT). This sector only accounts for 6% of American manufacturing and it’s still at the beginning of its lifecycle, so the importance so far is limited. If we apply Porter’s diamond we may be able to offer some explanation as to why the US has fallen from its pedestal.
If we examine the US factor conditions we would see the main focus is on agriculture, the most competitive firms are dependent upon natural components (which are often limited resources) such as mineral and agricultural wealth. So we begin to see how US success is based upon what was bestowed on them rather than innovation and upgrading. US firms are strong in Food, beer, soap and detergent, computers and consumer electronics.
There are few industries where the technological lead is strong outside of new technology, the lack of upgrading through education has not helped matters. While the private sector has lacked investment, government spending on research and development has produced unintended consequences. The spending, which was mainly on military and defense research led to the ICT revolution, illustrating that luck does play a part in competitive advantage.
The demand conditions could be due to the fact that the US consumer is less sophisticated that they were twenty years previously. They have become less demanding and tend to prefer mass marketed goods and standardized products. This arrived due to the size of the domestic market but also means that the United States no longer holds the competitive advantage, as the needs of the US consumer do not reflect that of the rest of the world. Japanese consumers for example are always demanding new and better technology, which is why Japan is world leader in consumer electronics. US firms have kept focusing on meeting the home demand as it is more certain and easier to forecast than demand internationally.
Being part of a competitive domestic supplier industry is preferable to relying on even well qualified foreign supplies as proximity and cultural similarity often facilitates open information flow as well as reduces transaction costs. However, due to the friendly environment the US creates, many foreign firms have set up there and reap these benefits. Domestic rivalry is important as it adds pressure to improve and innovate, as the competing firms would have the same cost advantages they must seek more sustainable sources of competitiveness. Firms are also more likely to succeed internationally if they have faced tough competition in the domestic market.
The United States has experienced the thinning of clusters of competitive industries, especially in machinery. This uncompetitive supplier industry penalizes other US manufacturers while at the same time becoming less valuable partners, as far as stimulating innovation is concerned. The US rarely invests in building up relationships with suppliers, the relationships tend to be opportunistic and distant so they do not benefit form jointly sponsoring specialized research institutes or work together to increase the standard of their human resources.
The exaggerated success of the US, based upon the new technology bubble, brought the downfall of America. The nature of a bubble is for it to burst, this however was unexpected and brought about a major recession for the global leader. Competitive advantage then took a backseat in the flagging economy. The manufacturing sector is especially suffering at present, as there has been a noticeable diversion of the most highly educated to move away from industry and into professions such as law. The implications of this is there is a steadily diminishing number of senior managers with technical backgrounds the result of which is they have more difficulty understanding the benefits of technology and therefore lack the confidence to invest in it.
During the 1980s there was a trend to downsize and restructure among large firms to reap efficiency gains. However, this was not coupled with worker training to maximize human capital and the result was the companies were unable to turn around their fortune. It is not only the growing affluence which has a negative effect on motivation (the ‘American Dream’ was to be able to provide for themselves, now this is a given so people tend not to work as hard as if this was not taken for granted. Most Americans enjoy a high standard of living) but the US tendency to emphasize short termism, so managers concern themselves with maximizing quarterly results rather than investing, innovating and upgrading for long term benefits.
A flexible firm is one that has the ability to “respond to changing market conditions by changing the composition of its workforce” (Sloman 1997). Many countries are experiencing a move towards a flexible labour market; it has been welcomed by many families with small children to look after which allows the parents to work part time and flexible hours to fit in with their other requirements. This can be seen as an extension of what Japan was trying to achieve with the introduction of its ‘Just In Time’ system, which allows them to respond quickly to demand changes. Labour flexibility can be characterized into three types, functional flexibility where the employer can transfer employees between different tasks or projects (the advantage of this is multi-skilling which raises the level of training the workforce receive), numerical flexibility is where the firm employs labour on a part time or casual basis as well as outsourcing.
Here financial flexibility is tied to the other two factors, but by rewarding individual productivity rather than paying a flat rate, financial flexibility in wage costs can be achieved. The implications of this, is not only the widening pay gap between skilled and unskilled workers but also increasing pay gaps between workers in the same industry in different parts of the country. Reductions in the power of trade unions have helped flexibility take hold. The Japanese philosophy of a job for life is not one the western world promotes, as it doesn’t take into consideration the consistently altering market conditions. Once this has been considered a firm can begin to make efficiency gains.
While the United States is thought of as entrepreneurial, much of this reputation is based in the past rather than present. Decades of success has led to comfortable oligopolies e.g. in the automobile and steel industries, where the competition is restrained and as a result innovation is blunted. This disadvantages both firms and the country as a whole as no competitive advantage is being sought after and as they become settled they are less willing to try new ideas and they are left behind as the world innovates to please it’s demanding markets. The domestic consumers are left with inferior goods and a lower level of intellectual capital that doesn’t inspire them to become more flexible.
The huge conglomerates have hindered the situation. Competitive advantage has been undermined by the buying and selling of unrelated companies as the parent company feels little commitment to the newly acquired businesses and often under-invests in them to offset the cost of acquiring the company. What the United States needs is change. The wealth it has generated has created lethargy. It needs some of the entrepreneurial spirit that made it a global force in the nineteenth century. To do this it needs to restructure the way its consumers think to inspire dynamism and drive amongst firms. To make this possible it should examine the four factors of the diamond to see how they can regain their competitive advantage.