Chapter 02 - Theoretical Foundations
CHAPTER TWO: Theoretical Foundations
CHAPTER OVERVIEW
As more firms enter the international marketplace, the competitive environment is more complex than ever. How can firms determine their level of competitiveness in a marketplace of expanded and increasingly intense rivalry? This chapter seeks to answer that question in a multi-faceted manner. First, the concepts of country-specific and firm-specific advantages are presented from the theories of international trade and the multinational firm. Firms must be aware of which advantages they can utilize in operationalizing their competitive advantages. The extent to which these advantages are transferable to other markets and not bound only to the markets in which a firm already operates will determine how successful that firm may be in new foreign markets. Then the Porter's Five Forces model is adapted as a systematic framework for analyzing the competitive environment in any market of the world. Finally, market-based and resource-based marketing strategies are compared. By skillful application of both perspectives, an organization may be well on its way to a profitable multinational presence.
QUICK REFERENCE CHAPTER OUTLINE
A. Introduction
B. Country-Specific Advantages (CSAs)
1. Comparative Advantage & Absolute Advantage
2. International Product Cycle
3. National Competitive Advantages
4. The New Trade Theory
5. CSAs and Country-of-Origin Effects
C. Firm-Specific Advantages (FSAs)
1. Knowledge-based FSAs
2. Marketing-Related FSAs
3. Transferability of FSAs
4. FSAs and Internalization
5. FSAs and Transaction Costs
6. FSAs in the Value Chain
7. FSAs, CSAs, and Regionalization
D. Extending Porter’s “Five Forces” Model
1. Rivalry
2. New Entrants
3. Substitutes
4. Buyer Power
5. Supplier Power
E. Rivalry between Global Competitors
1. Competitive Strength
2. Competitive Repertoire
3. Global Rivalry
F. Strategy And The Three Hats
G. Summary
FOCAL QUESTIONS ADDRESSED AND TEACHING SUGGESTIONS
Is there any logical and systematic way for a firm to analyze the competitive environment in foreign markets?
Porter's Five Forces model was developed to analyze the competitive environments of various markets. It identifies five sources of competitive pressure on firms in any particular industry, and these include rivalry, new entrants, substitutes, buyer power, and supplier power. The text has expanded the model to be more appropriate for global competition in many markets.
In doing so, the rivalry dimension considers the influences of strategic groups, domestic competitors, and foreign competitors. Strategic groups are comprised of firms in the same industry who share similar resources and markets (i.e., McDonald's, KFC, Pizza Hut; or Sony, Yamaha, Panasonic). The importance of identifying these groups is that members of these groupings tend to execute very similar strategies and tactics. Therefore, predicting likely strategic directions and responses is accomplished with a little more ease and confidence.
Domestic and foreign competitors may have some similarities, but they also possess significant and important differences as players in a given market. Domestic competitors may be hard to challenge due to local regulation and protectionist measures that protect these firms against foreign competitors. Depending upon their history and standing in the local market, they may have established strong brand loyalty. Additionally, being local gives these firms the inherent advantage of being in touch with and knowledgeable about the local culture and customers. They can respond more quickly and confidently to market changes. Foreign competition may be comprised of small- to medium-sized firms seeking to enter a host market. However, a significant portion of foreign competitors are global firms whose resources are daunting and their experience in international marketing is hard to overcome. Some foreign competitors may also have an advantage if they are members of a regional trading area while other foreign firms are left on the outside. It is much easier to be a competitive foreign firm when enjoying the advantages of trade bloc membership or favored status.
The second force in Porter's model is new entrants. These may be new industry entrants or established industry organizations who are new to any given foreign market. New entrants can be first movers or "me too" followers.
Advantages to first movers are: a. higher brand recognition, b. more positive brand image, c. more customer loyalty, d. better access to distribution channels, and e. longer market experience. However, drawbacks exist which include a. necessary training of channel members, b. customers may need educating, c. advertising is more generic, focusing on primary rather than secondary demand, and d. tastes and standards are unknown, perhaps not even formed
Substitutes pose significant competition for a firm's products. In multidomestic markets where preferences and behaviors are tied to the individual culture, globalized products may encounter a wide variety of diverse substitutes. A new American film introduced in Europe may have to compete with other forms of entertainment such as football (soccer) matches, local clubs and pubs, live theater, festivals, local films, and so forth.
Buyer power and supplier power are countervailing forces in a market. Where buyers have the power, they force sellers to be more flexible, accommodating, and price conscious. When suppliers have the power, their prices are not as constrained and they are more likely to get away with a standardized approach than a tailored one. As for foreign entrants, supplier power may inhibit the ability to establish local distribution channels (i.e. Japanese keiretsus), and buyer power may force the foreign marketer to compromise and adapt more than it would like or could afford.
What is the Principle of Comparative Advantage and how does it contribute to an understanding of international trade and production?
For students with sufficient international economics, trade, management, or marketing background, this question may be unnecessary to address or used briefly as review and set-up for other chapter concepts. For students without the benefit of such background, this is an essential cornerstone in a complete understanding of the theoretical underpinnings of international trade, production, and marketing.
Comparative advantage refers to the edge particular countries have over others in production and trade of certain products. Such an edge or advantage may be a function of the availability of natural resources needed for production, higher productivity or other labor advantages, technological innovation, country-of-origin bias - a long-held reputation in the product area which has been converted to a "mystique" (i.e., French wine, Swiss watches, etc.), proximity to intended markets, favorable trade conditions and policies in intended markets, and so on.
Possessing critical country-specific advantages makes it logical to produce products which capitalize on those advantages, both for domestic consumption and for sale to other markets which cannot produce these goods themselves, cannot produce them at a comparable level of quality or quantity, and/or cannot produce them at a relatively favorable cost or price level. Countries who once held such comparative advantages in certain industries may find that over time, for a variety of reasons, these country-specific advantages have eroded and are now possessed to a higher degree by other countries. It is at this point that the country of original manufacture will significantly decrease its own production, perhaps even cease it, and purchase such goods from the new manufacturing countries. Such an evolution in the country origins of production is referred to as the International Product Cycle.
Homework: Ask students to research and reflect on what commodities or products the United States used to produce and trade vigorously but for which a com-parative advantage apparently no longer exists, or at least the nature of that advantage has changed (the steel and/or industries may offer some interesting insights). What products in the U.S. have succumbed to the International Product Cycle and are now imported from other countries? Alternately, this assignment may be given for other countries as well. Different countries may be assigned to different students and their findings may be presented or discussed during a subsequent class meeting.
How do Porter's Diamond of National Advantage and the New Trade Theory extend the Principle of Comparative Advantage? How do they compare with one another?
Original thinking about comparative advantage tended to focus most on access to natural resources and labor advantages. Additionally, it more or less conceded that as countries developed technologically and economically, they would gladly buy into the "hollowing out" of certain manufacturing industries to "trade up" to more sophisticated, technology-based, and high margin industries.
Porter's Diamond of National Advantage counters those premises in several ways. First it presents four interrelated factors which he proposes make up the essence of comparative advantage for any given country. These are:
1) Factor conditions - related to production factors, skilled labor, infrastructure, etc.;
2) Demand conditions - nature of domestic demand for focal products/services;
3) Related and supporting industries - availability of supplier and support industries which are internationally competitive;
4) Firm strategy, structure, rivalry - how a country governs the creation
and management of firms and the nature of domestic competition and rivalry. In identifying and acknowledging the importance of these factors, Porter has extended the domain of comparative advantage beyond that of natural resources and labor advantages alone.
Also, for many reasons, both good and bad, countries tend to be reluctant to give up on industries that in the past have been domestic mainstays. Porter's Theory and Diamond illustrate that it is possible for countries to develop layers of advantage and create new conditions favorable to focal industries at home so that these industries may remain vital, central, and internationally competitive for an indefinite period of time.
The New Trade Theory concurs with the Porter position that comparative advantages may be "man-made and locational". The basic idea is that locational advantage attracts supporting industries, appropriately skilled labor, capital investment, responsive government treatment, etc. The New Trade Theory is used to explain the purposeful development of high-tech geographic areas (i.e., Silicon Valley) and "national industries". The New Trade Theory also points out that original theories of comparative advantage were developed to explain production and trade of relatively homogeneous commodities, whereas the bulk of trade today is made up of differentiated, often specialized products, thus changing many of the essential dynamics of the competitive environment.
Homework: Assign different countries to students. Ask them to determine if the country has any "national industries" or industry-specific geographic areas, how they came about and how the country acts to support them. Alternately, assign different industries. Ask them to identify any countries which claim them as national industries or which have developed special geographic areas devoted to those industries. Students may share their findings in class.
Speaker: Have a representative from your state's Department of Commerce, International Trade Administration speak to the class about a number of these issues as they relate to state trade. Perhaps he or she may identify comparative advantages of the state from the past, present, and foreseeable future, discuss the nature and impact of any national industries that companies in the state are involved in, geographic areas devoted to an industry in the state, or how relevant the New Theory of Trade appears to be for the state and/or country.
Do firms have any inherent advantages that aren't tied to their home country or production location? Can these be used effectively in foreign markets?
Yes, all thriving companies must possess unique skills and advantages over other competitors. If they do not, customers will have no reason to choose their products and services. Those areas in which a company provides customer benefits better than competitors create competitive advantage. Firm-specific advantages are those advantages that are unique to the firm and have no bearing on the organization's geographic location or national affiliation. Firm-specific advantages may also be described as those advantages held or developed by individual companies and which outweigh the cost of operating in one or more foreign markets.
Some examples of firm-specific advantages include but are not limited to: patents, trademarks, brands, specific skills and know-how, managerial talent, control of distribution channels, very low operating costs translating into more competitive prices, spectacular ad campaigns, or a highly effective sales force.
Given that competitors will seek to neutralize these advantages, the firm must continually develop new ways to maintain its competitive edge.
Some firm-specific advantages enjoy transferability to markets abroad, while some do not. What is a desired customer benefit in one market may be seen as neutral or even undesirable in another. For example, skimpy, revealing bathing suits may be the rage in the US, but strictly forbidden in religiously conservative Middle Eastern markets or irrelevant in areas where nudist beaches are common. When firm-specific advantages center around intangible skill development or specific personnel, this is also hard to transfer as the skills are only developed with experience, and limited numbers of skilled personnel cannot be everywhere.
Effective marketing research can identify which firm-specific advantages an organization may be able to employ in foreign markets and which they may not. This assessment is critical in making correct market entry and marketing strategy decisions.
What are internalization and externalization? How do they influence the entry modes of companies which supply international markets?
Internalization is related to firm-specific advantages as opposed to country-specific advantages. In the current dynamic market, most firms cannot "rest on their laurels" as few firm-specific advantages outlast vigorous attempts by competition to neutralize or remove them. Therefore, many firm-specific advantages are constantly evolving and changing. Internalization Theory deals with the way in which firms attempt to capitalize on firm-specific advantages by choosing foreign entry methods which allow them to retain control of the advantages and avoid "leakage" of important competitive information. Internalizing firms will likely choose some form of exporting or foreign direct investment, depending on an analysis of the firm's relative levels of resources, its strengths and weaknesses, and the particulars of the target markets.
However, another way for a company to reap a payoff from its firm-specific advantages by "selling them" into foreign markets. This would constitute and externalization strategy. Licensing and, to some extent, strategic alliances are modes which provide the firm with an immediate and sometimes ongoing payoff by selling the right to use its firm-specific advantages to a local buyer in the foreign market. The most familiar form of licensing is franchising in which brands and business processes are externalized to franchisees. Process technologies, product "recipes", patents, and so forth may also be externalized.