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Chapter 2: Literature Review

2.0 Introduction To answer the proposed research questions about competitiveness, this chapter will

discuss the several theoretical models and literature written about the competitiveness

of nations and their comparison. Next to this there is a discussion about the integration

of information technology and the Creative class in these models.

2.1.1 The competitiveness of Nations

There are several trade theories explaining the trade between countries. Examples

mentioned by Daniels (2004) are:

� Mercantilism theory,

� Neo mercantilism theory,

� Absolute advantage theory,

� comparative advantage theory,

� County size theory,

� Factor proportions theory,

� Product Life cycle (PLC) theory,

� Country similarity theory,

� Dependence theory,

� Strategic trade policy theory

� Porters Diamond theory.

Each of these theories has a different emphasis as shown in figure 1. Most of these

theories are country trade theories. Regardless of the advantages a country might gain

by trading, international trade ordinarily will not begin unless companies within that

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country have competitive advantages that enable them to be viable traders. Porter’s

diamond explains why specialized competitive advantages differ between among

countries.

Figure 1: Trade theories

Source: Daniels (2004)

The static factors mentioned in comparative advantage are hard to influence1. These

factors are: Land, Location, Natural resources (minerals. Energy), Labor, Local

population size. Specialized factors involve heavy, sustained investment2. This leads

to a competitive advantage, because if other firms cannot easily duplicate these factors,

they are valuable. Specialized factors of production such as skilled labor, capital and

infrastructure are created.

Porter (1990) argues that a lack of resources often actually helps countries to become

competitive (selected factor disadvantage). Abundance generates waste and scarcity

generates an innovative mindset. Such countries are forced to innovate to overcome

their problem of scarce resources.

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2 http://pacifi c.commerce.ubc.ca/ruckman/

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“Non-key" factors or general use factors, such as unskilled labor and raw materials,

can be obtained by any company and, hence, do not generate sustained competitive

advantage.

The Diamond Model of Porter introduces the concept of clusters or groups of

interconnected firms, suppliers, related industries and institutions in particular regions.

As a rule competitive advantage of nations has been the outcome of four interlinked

advanced factors and activities between companies in these clusters. And these can be

influenced in a pro-active way by the government. Clustering promotes the

networking of all participants in the value chain.

The phenomenon of upstream and/or downstream industries locating in the same area

is known as clustering or agglomeration. This has the following advantages: potential

technology knowledge spillovers, an association of a region on the part of consumers

with a product and high quality and therefore some market power, or an association of

a region on the part of applicable labor force. Disadvantages: potential poaching of

your employees by rival companies and obvious increase in competition, possibly

decreasing mark-ups1.

Daniels (2004) explains this using the Porter Diamond. Figure 2 illustrates the Porter

Diamond and shows four conditions which are important for competitive superiority:

demand conditions, factor conditions; related and supporting industries; and firm

strategy, structure and rivalry. How these factors are combined affects the

development and continued existence of competitive advantages.

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Figure 2: The Diamond Model

2.1.2 Background of Porters diamond

Figure 3 describes how innovative capacity helps to create a productive competitive

environment, which then helps to create prosperity (See Figure 4: Prosperity

illustrated by growth rate of GDP and GDP per capita (PPP)). Nations therefore

compete to offer the most productive environment for businesses as shown in figure 7.

Figure 3: The effect of innovative capacity on competitiveness and prosperity

Source: Porter (2001b)

Firm strategy, structure and rivalry • Strategy and structure

• Goals

• Personal goals

• Competition among domestic

companies

Demand conditions • Domestic demand

structure

• The size of demand and the form of

growth

• Internationalization

of demand

Factor conditions • Human Resources

• Knowledge resources

• Capital

• Physical resources

• Infrastructure

Related and supporting industries • Suppliers and Buyers

• Related Industries

Government

Chance

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How the Innovative capacity is measured is shown in figure 5, and it also highlights

the performance of Taiwan and the Netherlands. Another illustration of the innovative

capacity is the amount of patents a country produces (see

Figure 6: An illustration of innovative capacity by international patenting output). For

a prosperous economy there needs to be a stable political and legal context. The

competitiveness depends on improving the microeconomic foundations of

competitiveness, which are the elements that are mentioned in the Porter’s Diamond.

Figure 4: Prosperity illustrated by growth rate of GDP and GDP per capita (PPP)

Source: Porter (2001a & 2001b)

Clusters increase the productivity and efficiency because of easier access to

specialized inputs, easier coordination between firms, rapid diffusion of best practices,

visible performance comparisons. Clusters stimulate and enable innovation because of

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better perception of innovation opportunities, assistance in knowledge creation and

ease of experimentation. And Clusters stimulate commercialization opportunities for

new companies and new lines of business are more apparent. Furthermore the

competition is fundamentally enhanced by externalities and linkages across firms,

industries and associated institutions.

Figure 5: The Innovative Capacity Index of Taiwan and the Netherlands.

Source: Porter (2001a & 2001b)

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Figure 6: An illustration of innovative capacity by international patenting output

Source: Porter (2001a & 2001b)

Figure 7: An illustration of the relation between microeconomic competitiveness and GDP per capita.

Source: Porter (2001a & 2001b)

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However Cluster policy is different from industrial policy. Whereas industrial policy

targets desirable industries or sectors, cluster based policy states that all clusters can

contribute to prosperity, Industrial policy tends to focus on domestic companies,

where cluster policy focuses on any company that can enhance productivity. Industrial

policy intervenes in competition by protection, industry promotion and subsidies,

where Cluster based policy relaxes impediments and constraints to productivity and

emphasizes cross –industry linkages and complementarities. Industrial Policy

centralizes decisions at the national level which is different from cluster based policy

which encourages initiative at the state and local level. In short industrial policy tends

to distort competition and cluster based policy tries to enhance competition. The

advantages and disadvantages of industrial policy are also described by Gregory

Noble (2000) and The Industrial Performance Center of the MIT (Fuller, 2003),

though in general the industrial policy of Taiwan is described as positive for Taiwan.

As described in the previous paragraph collaboration is important for cluster building.

There are formal and informal organizations that facilitate the creation and flow of

information, technology and skills and support selected forms of collaboration. They

work through creating relationships that enhance the level of trust, facilitate the

organization of collective action and foster the establishment of common standards.

So they also provide a mechanism to develop a common agenda for a cluster or

economy. In general there are institutions in the private sector, public sector or mixed.

They contain: chambers of commerce, professional associations, religious networks,

school and university networks, advisory councils, competitiveness councils and

technology associations or alliances and government associations. Cluster specific

institutions are industry associations, specialized professional associations and

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societies, alumni groups of core cluster companies, incubators. At the end of the

Analysis chapter there is an interview with one of these institutions.

2.2 National Competitive Advantage in Services

2.2.1 Service Industry

Industrial design can be described as a service. And Porter (1990) places it in the

technology development supporting functions of the Value chain as is illustrated in

figure 8.

He also describes the de-integration of services, meaning firms are increasingly hiring

specialized service suppliers to perform services they used to perform themselves.

This has growing advantages over in-house service suppliers. This is supporting firms

that focus on delivering specialized design services. Services used to be labor

intensive, but nowadays the capital intensity of service firms is growing. Porter (1990)

mentions “The most important reason for the transformation of a service firms value

chain is information technology (IT). Service firms use computers or computerized

techniques to perform old (and new) functions, control operations better, and make

employees more productive”.

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Figure 8: The Value Chain

Source: Porter (1990)

Services are more and more going global. Porter (1990) mentions that the

internationalization of services is driven by a number of forces:

• Similarity of service needs

• More mobile and informed buyers of services

• Rising economies of scale and geographic scope

• Greater mobility of service personnel

• Greater ability to interact with remote buyers, “through telephone, online data

communication, rapid parcel delivery, and a variety of other means, it is

increasingly possible to communicate and engage in the needed interchange

with buyers of services even though they are located in foreign countries

(Porter, 1990)”

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• Continued wide disparities among nations in the cost, quality, and range of

services available from local firms.

There are three distinctly different links between manufacturing and service

industries that are important to national competitive advantage in these industries:

• Buyer/ supplier relationship. This has two implications: without local

manufacturing the demand for services will be limited and the structure of

the industry can strongly influence the type, amount and sophistication.

• Services tied to the sale of manufactured goods

• Manufactured goods tied to the sale of services.

2.2.2 Factor conditions

Factor condition (The input) can be important in international competition in the

service industry. Especially in a couple of cases:

1 In services where the buyer is attracted to a nation.

2 Services that are primarily delivered by domestic facilities or personnel

3 In services delivered through a network of foreign offices.

Porter (1990) mentioned: “While less skilled labor is usually unimportant, a nation’s

stock of specialized, skilled professional and technical personnel is frequently vital

international service competition”. “The growing complexity and specialization of

many industries mean that advanced factor creation mechanisms are becoming vital to

service competition”. ”Labor shortages or expensive labor is to spur automation and

upgrading of service industries, just as it is in manufacturing. Many services

industries are being revolutionized by new technology, much of it related to

information systems. This technology reduces the labor content of services and makes

service delivery personnel more productive”.

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2.2.3 Demand conditions

Porter (1990) says: “Demand conditions are perhaps the single most powerful

determinant of national competitive advantage in services today”. If a country has

consumers that demand more and specialized services then those service provider

might develop and competitive advantage that they can also export to other countries.

Stringent regulations might create a similar effect when companies learn how to cope

with them.

2.2.4 Related and supporting industries

Porter (1990) talks about: “The presence of national competitive advantage in related

or supporting industries spawns other service industries just as it does in

manufacturing industries. A particular important group of supporting industries to

many services is that involving information technology”. “National advantage in

complementary manufactured goods or other services pulls through demand in some

service industries. The presence of internationally competitive industries in a nation

has a triple-barreled benefit for national advantage in related service industries: it

provides sophisticated buyers at home, creates a base of demand abroad, and pulls

through linked services”. Since design services are a supporting function in the value

chain it can also help to improve the whole value chain.

2.2.5 Firm strategy, structure, and rivalry

Porter (1990) continuous: “Unimpeded, vigorous domestic rivalry creates a fertile

environment in which to grow world class service firms”. “Competition in most

service industries involves attention to detail, constant introduction of new service

variations, and the need of high levels of responsiveness to buyers. A group of

domestic rivals provides an essential ingredient to success in this sort of industry

environment”.

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“Service industries tend to grow out of small, entrepreneurial start-ups rather than

large-scale entries”. “The services sector, with its preponderance of smaller

companies and fragmented industry structures, is particular prone to government

intrusion. Regulations that protect small businesses or otherwise influence small

business activity are common. If these regulations retard the introduction of

technology, delay or block the creation of new services, retard the consolidation of

localized service industries into national ones, inhibit foreign competition, or mute

domestic rivalry, they will all but eliminate the possibility that the nation will achieve

international competitive advantage in the service industries affected.”

Points regarding Strategy1: Domestic capital markets affect the strategy of firms.

Some countries’ capital markets have a long-run outlook, while others have a short-

run outlook. Industries vary in how long the long-run is. Individuals’ Career Choices:

Individuals base their career decisions on opportunities and prestige. A country will

be competitive in an industry whose key personnel hold positions that are considered

prestigious.

Points regarding Structure2: the best management styles vary among industries. Some

countries may be oriented toward a particular style of management. Those countries

will tend to be more competitive in industries for which that style is suited.

Points regarding Rivalry3: Intense competition spurs innovation. International

competition is not as intense and motivating: there are enough differences between

companies and their environments to provide handy excuses to managers who were

outperformed by their competitors

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2.2.6 Government

Porter (1990 p.265) explains: “A heavy direct government role in a service industry is

usually a reliable indication that a nation will have a modest international presence.

Those nations with the greatest government involvement in providing services, such

as Italy, Germany, and Sweden, are amongst the weakest nations in terms of

international service position”. Developing a policy or innovation policy is therefore

something that should be handled with care to achieve the right purpose.

According Porter (1990): The government plays a role as a catalyst and challenger in

Porter’s diamond model; “to encourage - or push - companies to raise their aspirations

and move to higher levels of competitive performance …". Governments can

influence all four of Porter’s determinants through:

a. Subsidies to firms, directly (money) or indirectly (through infrastructure).

b. Tax codes applicable to corporation, business or property ownership.

c. Educational policies that affect the skill level of workers.

d. Focus on specialized factor creation.

e. Enforce tough standards. (Establish high technical and product standards

including environmental regulations.)

Through these actions, it becomes clear which industries they are choosing to help

innovate.

2.2.7 Chance

The role of chance in the model is the way random events can either benefit or harm a

firm’s competitive position. These can be: major technological breakthroughs or

inventions, acts of war and destruction, or dramatic shifts in exchange rates.

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2.2.8 The Diamond as a System

The points on the diamond constitute a system and are self-reinforcing.

Domestic rivalry for final goods stimulates industry that provides specialized

intermediate goods. Competition leads to more sophisticated consumers who come to

expect upgrading and innovation. The diamond promotes clustering.

How does the agglomeration become self-reinforcing?

1. When a large industry is present, it will increase the supply of specific

factors (i.e.: workers with industry-specific training) since they will tend to

get higher returns and less risk of losing employment.

2. At the same time, upstream firms will invest in the area. They wish to save

on transport costs, tariffs, inter-firm communication costs, inventories, etc.

3. The same is true for downstream firms.

4. Finally, producers in related industries will also invest. This will trigger

subsequent rounds of investment.

2.2.9 Clustering and service industries

Clusters are concentrations of companies that reached a critical mass and that produce

together all elements of the value chain. Porter (1990) says: “Service industries are an

integral part of clusters. Competitive service industries help spawn or upgrade

supplier and buyer industries. Competitive manufacturing industries also stimulate

international success in linked services. Italy’s design services firms, which design

cars, footwear, apparel, and many other products for foreign clients, grew out of

Italy’s strong manufacturing industries in these fields”. “In services such as

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manufacturing, clusters tend to be associated with specialized schools or

concentrations of strong university programs in a field”.

2.2.10 Services and national economic development

Services are just as valuable as manufacturing to the national economic development.

Also in services characterized by type 3 competition (see 2.2.2 Factor conditions) in

which many of the jobs are overseas. Porter (1990 p. 267) explains: “International

success in services also leads to an inflow of foreign profits on a base of modest

foreign direct investment compared to manufacturing”.

2.2.11 limitations of the Porter Diamond

Daniels (2004) writes: the existence of four favorable conditions does not guarantee

that an industry will develop. And Noble (2000) writes about other limitations: that

companies have the increased ability to attain market information, production factors

and supplies form abroad. At the same time they face more competition from foreign

production and foreign companies. So if any of the four conditions is missing

domestically, it does not mean it inhibits companies from being globally competitive.

The Porter’s diamond theory is also based on case studies.

2.3 The influence of Information Technology

As mentioned before the capital intensity of services is growing because of

information technology (IT) and it is helping to make them more productive. Figure 9

shows how all elements of the value chain in a firm can be enhanced by using

information and communication technology (ICT).

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Figure 9: Leveraging Technology in the Value Chain

Source: Laudon (2006 p.88) In recent years these components have proven to increase efficiency in companies. In

this research this enhancement of the infrastructure is especially mentioned. Porter’s

model does not mention it explicitly but is open for it as is shown in the following

citation.

Porter (1990 p.244): There is an imperative to de-integrate and to use outside service

providers. Service industry used to be labor intensive, but is now changing to more

capital intensive. “The most important reason for the transformation of service firm

value chains is information technology”. “… this in turn has accelerated the

internationalization of service competition”.

Other mentions it explicitly as virtual clusters or as e-clusters. As Hansen (2004)

mentions “Internet technologies, like infrastructure applications, platforms, broadband,

enable business processes, research institutes and government to be networked. The

Concept of cluster building gets a new dimension because innovative TIMES

(telecommunication, information technology, multimedia, entertainment, security)

Suppliers Firm Distributors Customers

Firm Value

Chain

Technology: Computer aided design systems

Procurement: Computerized ordering systems

Inbound

Logistics

Automated warehouse

systems

Operations

Computer controlled

machining

systems

Sales and

Marketing

Computerized ordering

systems

Service

Equipment maintenance

systems

Outbound

Logistics

Automated shipment

scheduling

systems

Human resources: Workforce planning systems

Administration and management: Electronic scheduling and messaging systems

Suppliers’ suppliers

Support activities

Primary

activities

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technologies provide new technology possibilities to support the process of cluster

building, Independent of time and location the actors of a cluster are able to take part

in processes of information, communication and transaction with internal or external

partners of a cluster. Whether the cluster is able to meet competition depends on its

capacity to digitize the internal cluster processes and the processes between different

clusters“.

The cluster might thus expand beyond its geographical location. Porter (1990, p.158)

describes a paradox concerning the regional clustering and the process and underlines

implicitly the e-clustering approach: “while classical factors of production are more

and more accessible because of globalization, competitive advantage in advanced

industries is increasingly determined by differential knowledge, skills, and rates of

innovation which are embodied in skilled people and organizational routines. The

process of creating skills and the important influences on the rate of improvement and

innovation are intensely local. Paradoxically, then, more open global competition

makes the home base more, not less, important”

Hansen (2004) mentions the following positive effects of e-clustering:

� E-clustering accelerate the distribution of knowledge

� The transaction costs are reduced by e-clusters

� E-clusters provide for an infrastructure

� The processes of e-clusters produce economies of scale

� The e-cluster causes external economies

� The e-cluster produces economies of specialization

� An e-cluster stimulates competition and cooperation

� The internationalization of the economic and cluster specific relations is enforced

by e-clusters

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Since the Industrial Design services industry is a knowledge based service, e-

clustering or virtual clustering will have big effect on the cluster forming.

2.4. The creative class A different theory about the attractiveness of regions is proposed by Richard Florida.

Florida (2002) has identified a new class of workers which he called the creative class.

He suggests that this highly mobile class is stimulated to work in certain areas if they

are attractive enough to this class. He measures the creative potential of areas with the

creativity index, constituted of the following factors:

• Creative class share of the workforce (Talent), which can be measured by:

o Share of Creative core

o Share of Creative professionals

o Share of Bohemians

• High Tech index:, which can be measured by for example:

o Milken institute’s Techpole index

• Innovation, which can be measured by:

o Patents and copyrights per capita

o High tech patents per capita

• Diversity, which can be measured by;

o Gay Index: as a reasonable proxy for an area’s openness to different

kinds of people and ideas (Tolerance)

o Ethnical diversity

o Lifestyle amenities: for authentic experience. Not instant office

complexes and retail stores with acres of parking lots

According Florida economic growth and development is dependent on the three T’s of

Technology, Talent and Tolerance.

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Porter (1998) mentions in his article about clusters and the new economics of

competition that enduring competitive advantage in a global economy more and more

dependent on local things like: knowledge, relationships and motivation. Florida’s

theory can fit with this; with a large share of creative class in an area they will have

more relation to each other and motivation to compete and compare with each other

and that means there will be knowledge spill over. These all can be advantageous for

cluster forming.