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.. The Compet i t i ve Advant age
of Nat i ons
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Michae) E. Porter
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\ ' ~ H arvard B usiness R eview
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MARCH:tAPRlL 1990
The Compet i t i ve Advant age of Nat i ons
Michael E.Porter
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National prospcrity i8crcated, not inherited. It does
not growout of acountry's natural endowments, its
labor pool, its interest rates, or its currency's value,
ascla8sical economics msists.
Anation'scompetitiveness depcndsonthc capacity
of 1tsindustry to innovate andupgrade_Compames
gainadvantagc against the world's best competitors
because ofpressure andchaHenge.TheyheneHt from
havingstrongdomestic tivals,aggressivehome-based
suppliers, anddemanding local customcrs.
In aworld of increasingly global competition, na-
tions havebecome more, not less, important. Asthe
basis of competition has shifted more and more to
the creation andassimilation of knowledge, the role
of the O3tionhas grown.Competitive advantage is
createdandsustained tbrough ahighlylocalizcdpro-
cess_ Differences in national values, culture, eco~
nomic structures, institutions, and histories aIl
contribute tocompetitive success.Tbere arestriking
differences in the pattems of competitiveness in
cvery country no nation canor will becompetitive
ineveryor evenmost industries.lntimately, nations
succeed inparticular industries because their home
enYronment isthe most forward-Iooking, dynamic,
andchallenging.
Theseconclusions, thc product ofafour-year study
HUNard BU.~inessSchooI professm Mchn.eI E. Porter s the /lUthar
af Competitive StIategy (Free Press. 1980) and Competitive Arl-
vantage(Free PrtlSs. 1985)und will publish lbe Competitive Arl.
vantageof Nations (Fre)Press} in May 1990.
Aut1lOr's note: Michae1. Enright, who served as pro;ect coordI1fl-
tar tm ths study, has contributed vallluble .<mggesrions.
of the patlems of competitive success inten leading
tradingnations, contradlct theconventional wisdom
that guides the thinking o many companics andna-
tional governments-and that is pervasivc today in
the United States.(Formoreabout the study, seethe
insert "Pattems o National Competitivc Success.")
According to prevailing thinking. labor costs, inter-
est rates, exchange rates, andeconomies of scaleare
the most potent detenninants of competitivencss. In
companies, thewordsof thedayaremerger, alliance,
strategic partnerships, collaboration, and suprana-
tional globalization. Managers arepressing for more
govemment support forparticular industries.Among
govcrnments, thcrc is agrowingtendency to experi-
ment with vanous pollcies intended to promote na.
tional competitiveness-from efforts to manage
cxchange rates to newmeasures to manage trade to
pollcies to relax antitrust-which usually end up
only undermining it. (Seethe insert "What Is Na-
rional Compctitiveness?"l
Thesc approaches, now much in favor in both
companics andgovernments, areflawed.Theyfunda-
mentally misperceive the truc sourees of competi-
tive advantage.Pursuing them, with aHtheir short-
termappeal, 'will virtually guarantee that theUnited
States-or any other advanced nation-never
achievesreal andsustainable competitive advantage.
Weneedanewperspecrive andnewtools-an ap-
proach to competitiveness that growsdirectly out of
3D analysis of intemationally successful indlL.<;tries,
without regardfDI traditional ideologyor current in-
tellectual fashion. We need to know, very simply,
what works andwhy.Then we need to applyit.
Copyright o 1990by the President and FeUowso HarvardColJege.All rights reserved.
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Patterns of National Competitive Success
To invl"$ugate why nations gnin compctitivc advan.
tagc in panicular induStries and the implications lar
comp.any stratcgy and O1ltional tt:onomies, I condueted
four-yar lttudy of ten imporunt trading natiaos: Den-
mark, Cerrosn)', Italy, lapao, Korca, Singaporc, Swedcn,
Switurland, the United Kingdoffi, and the United
States.1 wasassistcd by8tcamof morethan 30research-
Cl'B, mast 01 whnm were natives of and bascd in !he
nation they studicd. The resc.archcrs all used the samc
rncthodology.
Thrc:c nation&-thc United Sute:'!, 'apan, and (;tt.
many-llte thc world's lcading industrial poweOl. The
othCf nations represent a variety o population tiius,
govemment policics toward induSU)', social philoso-
phie.", ;eographical sizcs, and 100000tiona. Togcther, the
ten natinos acoounted orfully 50% of total world ot-
J 'Ons in 1985. thc MSCyear 1m slatistical 8nt1lysis.
MOStprevious .llnlllyseso nalional competitiveness
hltvefocused on single nation or bilateral comparisons.
Bystudying nations with widcly varying ch.a.raeteristics
and circumstanccs, thi5 lrtudy sought to separate tbe
fundamenul forces uoderlying nationa1 competitive Id.
vanugc fromthe idiosynetatic oncs.
Ineaeh nation, thc study consistcd of twOpart!!. The
first identHied all industries inwhich the na.tinn'scom-
panics wcre intcrn.ationally succcssful, using availahle
statistical data, supplc:mentary published sources, and
ficldintervicws. Wedcfincd anation's industry as inter-
nilltionllJ lysucccssful if itpossessed compelitiv~ advan-
lage relaliv~ lo tbe best wo[ldwid~ campeLiroIS. Many
mcasures of competitive advantagc, 5uch as rcportcd
profitability, can be misleading. We Ch05Cas thc best
indicatol'll the presente of subsuntial and 5ustained 0-
ports tO.l widt array of other nations and/or significant
outbound forcign invcstment based on llhlls and assets
cn:lIItcdin the homc COUntry.A n:ltion was considen:d
the home base far ocompany if it WlIScither o locally
owncd, indigcnou5 cntcrprisc or managcd autooo-
mousl)' although owncd byaforeign rompan)' or invest.
Ots. Wc thcn creatcd a profiJ e of all the industries in
which cach nation was intemationally 5uccessful at
three points in time: 1971, ]978, and 1985. Thepattern
of camtetitive industries ineach economy WIIS far &om
random: the tllsk was lo cxpIain it and how it hlld
changcd over time. Of particulu intcrest wcrc the con-
ncelians ar relationships among tbe nation's competi-
tive industries.
In the second part of the study, we cxnmincd the
history of competition inparticular industries tounder-
stand hnw competitive advanugc WllScrcated. On the
basis of nationaI profiles, we KI~cd over 100 indu.'l-
tries or industry groups lor detailcd studyJ weexamincd
many more in less dcuiJ . Wewent back as far4Sneces.
Uf)' to undcrsund how a.ndwhy the industry bcgan in
the nation, how it grew, whcn and why rompanic.~from
the nlltion dcvcIopcd intcrnational competitive advan-
tage, lInd the pr0ecs5 by which rompctitive advanuge
had bcen cither sustllined or Inst. The resulting case
histories faJ l shon o the work of a good historian in
thcir levc:l 01 detail, hut they do provide insight into
the dcvclopment of both the industry and the nation's
economy.
Wcchose asample of industries for cach nation that
represcntcd thc most important groups of competitivc
industries in the ecnnomy. The industries studied se-
counted for olargeShllrcof total exports incaeh nation:
more tblln 20%of total export!! in 'apan, Germllny, and
SwittcrLmd, for cx.arnple, and more than 40% inSouth
Rorea. We studicd some of the mast faffious and
imponant intcrnationsl SUCCC5S storics-Ccnnlln high-
pcrlonnancc autos and chcmicals, ,apanese serni-cnn-
ductors and VeRs, Swiss banking and pharmaccuticals,
Italian footwCllr and textiles, U.s. commcrcialairersft
and motion pietures-and sorne rclativcly obseure but
highly competitive ndwrtriC5-South Rarean pianos,
ltalian ski boots, and 8ritish hiscuits. We.11150 added a
kw industries bccause they Ilppcan:d tObeparlldoxes;
'apancse home demand far Weste:rn-charaetcr typcwrit-
en;isncarly nonexistent, for cxample, hut 'apan holds
8strong cxport IIndforcign investment position in the
indusU)'. Weavoidcd industries that wcrc highly depen-
dent on natural rc:sourccs: such industries do not forrn
thc backhonc of adv.anced cconomics, and the capllcity
to compete in them is more explicable using cillssical
thcory. We did, howcvcr, indude a nnmber of more
tcchnologically intcnsive, nlltural.rcsource-rclatcd in.
dustries such as newsprint llnd agricultural chc:micals.
The sample of nations and industries nfcn;a rieh
cmpiric:al foundation for devclopingand testing thenew
thcory of how rountnes gain rompctitive advantage.
The accompanying anide conccntratcs onthe dctenni.
nants of competitive advantagc inindividual industries
nndalso sketehcs out sorne of the study's overaIl impli-
cation! for gove:rnment poliey 8nd company strategy. A
fuJ ler treatment in my book, 71J ~Competitiv~ Advan-
tag~ 01 Nations, devclops the thcory and its impliCtl-
tion! in grcater depth snd provides many additional
examples. It aIso rontains dctailed descriptions of thc
na.tion! we studicd and the fnture prospccts for thcir
cconomics.
-Miehacl E. 'Poner
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HARVARD BUSINESS RIMEW Msrch-April 1990
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How Companies Succeed in
International Markets
Around the world, companies tbat have achieved
internationalleadership employ strategies that diffcr
froro each other in cvery respectoBut while evcry
successful company will employ its OWD particular
stratcgy, the underlying marle o operation-the
character and trajectory of a11succcssful compa-
nies--is fundamental1y the saroc.
Companies achicvc competitive advantage
through acts of innovatioo. They approach innova-
tion in its broadest serrse, including both new
technologies and new ways of doing things. They
perceive a new basis foy competing or fiud hetter
meaos for competing in oIdways. Innovaton can be
manifested in anewproduct design, anew produc*
tion process, anew marketing approach, or anew
way of conducting training. Much innovatan is
mundane andincremental, depenmng more 00acu~
mulation of small insights and advances than on a
single, major technological breakthrough. 1t oftcn
involvcs ideas that arenot evcn "new"~ideas tmt
have been around, but nevet vigotously pursued. It
always involves investments inskill andknowledge,
aswell asinphysical assets and brand reputations.
Sorneinnovations cteate competitiveadvantage by
petceiving anentirely newmarket opportunity orby
serving amarkct scgment that others have ignored.
Whencompctitors areslowtorespond, suchinnova-
tion yields compctitive advantage. For instance, in
industries such asautos andhome electronics, Tapa-
nesecompanies gainedtherr initial advantagc bycm-
phasizing smaller, more compact, lower capacity
models that forcign competitors disdained as less
profitable, lcss important, andless attraetive.
In intemational markcts, innovations that yield
competitive advaotage anticipate both domestic and
forcignneeds. For example, asintemational concern
for product safety has grown, Swcdish companies
like Volvo, Atlas Copco, and AGA have suceeeded
by aotieipating themarket opportunity in this area.
Onthe other hand, innovations that rcspond tocon-
cernsor crrcumstances that arepeculiar totbeborne
market canactually rctardinternational competitive
success. Thelureof thehugeU.S. defensemarket, for
instance, hasdiverted thc attention of U.S. materials
andmachine-tool companies romattractivc, global
commercial markets.
Information plays a large tole in thc process of
innovation and imptovement-informatioll that ei-
thet is not available to competitors or that tbey do
not seek. Sometimes it comes fromsimple invest-
ment in research and development or market re-
search more often, it comes romeffort and rom
openness and fromlooking inthe right place unen-
HARVARDBUSINESS REVIEW Marcn-Aprill990
cumbered by blinding assumptions or conventional
wisdom_
This iswhy innovators areoften outsidcrs froma
difierent industry or adifferent country. lnnovation
may comeromanewcompany, whose founder has
anontraditional background or was simply not ap-
preciated in an older, established company. Or the
capacity for innovation may come into ao existing
company through senior managers who arencw to
the particular industry and thus more able to per-
ceiveopportunities andmore likely topursue thero.
Or innovation may occur as acompany diversifics,
bringing newresources, skiIls, or perspectives to an-
other industry. Or innovations may come from
another nation with different circumstances or dif-
ferent ways of competing.
With fewexceptions, innovation is the tesuIt of
unusual effort. The company that successfully im-
plcments anewor better way of competing pursues
its approach with doggeddetermination, aftcn inthe
faeeof harsh criticism and tough obstacles. Infact,
tosucceerl, innovation usually requires prcssurc, oe-
cessity, and even adversity: the fear of loss oftcn
proves morc powerful than the hopeof gaio.
Once acompany achieves competitive advantage
through aninnovation, it cansustain it ooly through
relentless improvement. Almost any advantage
can be imitaterl. Korean companies have already
matched the ability of their Japaneserivals to mass-
producestandard color televisions andVCRsBrazil-
ian companies havc assembled technology and
designs comparable to Italian competitors in casual
leather footwear.
Competitors wiIl eventually and inevitably over-
takeanycompany that stopsimproving andinnovat-
ing. Sometimes early-mover advantages such as
customer relationships, scale economies inexisting
technologics, or the loyalty of distributioo channels
ate cnough to permit astagnant company to retain
its entrenched position foryearsorevendecades. But
sooner or later, more dynamic rivals will findaway
toinnovate around these advantages or create abet-
ter or cheaper way of doingthings. Italian appliance
producers, which competed successfully 00thebasis
of cost in selling midsize and compact appliances
through largeretail chains, restcd too long 00this
initial advantage. Bydeveloping more differentiated
products and creating strong brand franchises, Ger-
man competitors have begun to gaio gronnd.
Ultimately, theooly way to sustain acompetitive
advantageistoupgradeit~tomovetomore sophisti-
cated types. This is precisely what Tapancscauto-
makers have done. They initiaIly peoetrated foreigo
markets with small, inexpensivc compact carsof ad.
equatc quality and competed 00the basis of lower
labor costs. Even while their labor-cost advantage
pcrsisted, however, theJapanesecompanies wereup-
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What 15National Competitivene55?
National competitivcncss has bccome ane o the cen.
mI preoecupnions of govemment and industry incvcry
mltion. Yet fm11I1l tbe discusson, debJ Ite, snd writing
onmetapie, then: isStill nopcrsuasivc thcory toexplsin
nalinnal competitiveness. What 5mnre, there is 001
cven aa Bccqltcd ddlnition of the terro "compctirive-
nes!!" asapplied t08I1J Ition.While the notan of acomo
petitivc company is cleRt, thc notan of 8competitivc
oation is noto
Sorne see naton.1 compctitivcnC!l~ as a maeroeco-
nomic phenomenon, drivc::nby variables such as ex-
changc rates, interest r.;atcs,4tId government ddicits.
Rut llpan, luly, aad Soutb Rarea havc .11 e.n.foyedrapo
idly rising living 8tandards <k-lpitc hudgct dcficits Cer.
mllay and Switurland de!pitc apprttiating currencics
IIndItaly aad Korea dcspite high nterest rates.
Othcrs arguc tbat comprtitivcncss is 8 function of
cheap liad ahund:mt lahor. But Germany, Switurland,
and Swedcn have all prospered even with high WlIgcs
and labor shoJ UgCS. &sirles, shouldn't 8 nation seek
higbcr wages for its worlu::rs l1ISa goal of competitive-
n c s s !
Another view connect.c;compctitiveness with bounti.
fui naturnl ttSOurttS. But how, then, can one explain
the 5UCCl$Sof Ccnnl1lny, lapan, Switzerland, ltaly, lInd
South Korea-countries with J imited ruaturnl resourec:sr
More recently, tbe argument has gained favor that
c.ompetitiveness is driven by govemment poliey: tu-
geting, protection, import promotion, and ,ubsidies
have propclled J apanese aod South Rarean auto, stecl,
!lhipbuilding, and semiconduCtor industries iota global
prc:cminence. Hut a closer look revcals. spotty -record.
loItaly,govemment intervention hasbeen ineffectual-
but 118lyhas c::xperiencedaboomio world export share
sttond only tOJ aptlD. lo Germany. dim:t government
intervcntion io exponing industries is rnre. And even
in J apan and South Rorea, govcmment's role in such
important industries as faesimile machines, copiers, f'O.
botics, and advanecd matctials h,ssbecn modest 5OTT1e
of the mmt frequentJ y cited examples, sueh .s sew:ing
maehines, stccl, and shiphuilding. atenow quite dated.
A final popular cxp!l1Inarionfar nlltion,,1compctitivc-
ness is diffttttl.~ in management prnetiees, including
maoagement-Iabor rclations. The problem hete, how.
cver, is that diffen:nt industries rcquire:: diffcrent ap-
proaehes tOmanagemcnt. The sueecssful management
prnetiees goveming !mIall, private, and looscly Org!-
nized Itnlian family comp.llni~ in footwcar, textiles,
and jewelry, for CXlImple,would produce s managcment
disaster if applied to Cenosn chemical or auto rompa-
nies, Swiss phannaeeutical makers, or American airo
erah producers. Nor is it possible to genernIize about
managcment-Iabor rdations. Despite the eommonly
held view that powerful unions undermine competitive
advllntage, unions arestrong inCermany and Sweden-
llnd both rountnes boast intemationally pra:minent
companies.
Clearly, none of the..-lecxplamtions is fully satisfae.
tory none is sufficient by ltsclf to I'lltionalizc the com-
pctitive position of industries within anationa! border.
Eachconuins sorne truth but IIbreader, more complex
set of forces seem:'l to he .litwork.
11Iebek of IIclcar explamtion signals an even more::
fundamenu.1 qutstion. What is aHoompetitive" nation
in the first placer Is a"competitive" nlltion one where
every eompany or indu~try is competitive1 No nation
mectS this test. Even'apan has I.rge sector.'! o it.'lecon-
omy th.at fan far behind the world's he:lt competitors.
b a "competitive" nation one whose exehange rate
makes its goods pria: competitive inintemational mar-
km1 80th Gennany liadJ ap.onIuve enjoyed remarkable
gains in thcir SUlndardso living-and experieneed sus-
tained period.'1of strong curreney and rising priccs. 15a
"compc:titive
H
natian one with aIargc positive halanee
o trndd Switzerland has roughly balaneed trade Italy
has achmnie tntde ddicit-both nations enjay strongly
rising mtional income. Is ."rompctitive" nation one
with low labor OO5t.'llIndia and Mexico both have low
wages Bndlow labor costs-but ncithcr !leemsanaurae-
tive industrial model.
The only meaningful concept o competitiveness at
the nationallevel is produCljvily. The principal goal of
anation is toproduec ahigh and rising standard ofliving
or its citizens. The ability to do so depends on the
produetivity with which a nation'!! labor and capital
are::employed. Productivity is the vlllue of the output
produeed by aunit of labor or capital. Produetivity de-
pends on both the quality and features of produCts
(which dcte:noine the priees dut they ean command)
and the dficieney with which they are produced. Pro-
duetivity is the prime detcrmilUnt o a nation's long-
nm mandard of living: it is the root C8useof nariana}
per capita income. Theproduetivity of human re.'1ourees
dett:nnines employee wages thc produetivity with
whieh capital ia employed determines th\". retuen it
caens for its holders.
A nation's standard of living dcpend'l on the capacity
o its companics toachicve high levcls of pmduetivity-
.nd to increase produetivity over time. Sust4ined pro-
duCtivity gmwth rcquires tbat an economy continually
upgrade ftsell. A nation's companies must relentlessly
imprnve productivity in existing industries by raising
produet quality. adding desirable features, improving
product teehnology, or boosting produCtion effieieney.
They must devclop the nceessary ClI;pabilitiesto com-
pete inmore::and more sophistie.ated industry segments,
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HARVARD BUSINESS REVIEW March-April199Q
" . whc:reproductivity is genc:nlly high. Thcy must fin.ally
dcvdop thc capability to compete in cntirely ncw. so-
phisticated industrie:s.
Intemational tradc and forcign invcstrnttlt can both
improvc 8 nation'8 prnductivity as wcU as thn:aten it.
Thcy support rising national productivity hy allowing
8OJ Ition10speciJ l.lizein those industrie5 and segment.'!
of indu!ltries whcrc its companics are more productivc
and 10impon whcre its companics are Icss produetivc..
No nation can becompetitive in everything. The ideal
is to dcploy the nation's limitro pool o human and
other resources into the mast productivc uses. EvO!
thase nations with the highcst standards of living havc
man)' industries in which local companics are uncom-
petitive.
Ya intenultional uade and forcign investrncnt 11150
can thn:aten productivity growth. Thcy expose ra-
tion's industries to the te5t of intcmational standard
o pmductivity. An industry will lose out if its produc-
tivity is nm sufficicntly higbcr tluln forcign rivals' to
offset any advanugc.'1 in local wage rates. If a nation
loses the abilit)' tocompetein arnngeofhigh-produetiv-
ityfhigb.wage industries, its standard of living is threat-
encd.
Defining national compctitivcnCl'r.l as achicvi.ng a
tr.fIdesurplus or lulanced trade per se is inlllppmpriate.
TIte cxpansion of cxpo1'tSbecause of low wages and a
wcak curreney, littbe gametime that tbe nation imports
sophisticated good:- tbat it:- companics cannot produce
competitively, may bring tTlldeinto balance or surplu!I
but lowers tbe nation'!ll'ltandard of living.. Competitive.
ness ,dso does not mean jabs. )t's thc type of jobs, not
fust tbeability tOcmploy citizens llt lowwages, Wt is
decisivc for c:conomie pmspcrity.
Secking to cxplain ncompetitivcncs.'1" at the national
levcl, thcn, is to answcr tbe wrong question. What we
must undersUlnd instc:.adis tbe determinants mprodue.
tivity .nd tbc nnc of pmduetivity growth. To find .In-
SWCfS, wc mu.'!t focus nOi 00 tbc cconomy as II wbole
hut on speci/ie industries oDd industry segments. We
must underst.and bow IInd wb)' commcrcially viable
skills and teehnolngy are ereatcd,. which un only be
fully undcrstood at the levcl of particular industries. It
h theouteome of the thousand'l of suugglcs for compet-
itive advantage against orcign rivals in particular seg.
ments and industries, in whieh produets and pmccsses
are created and improvcd, that undcrpins the pmccss
of upgrading national produetivity.
When one looks dosely at any national cconomy,
there are striking differmce5 arnong 11nation's indus-
tries in competitive sua:ess. lntem:a.tional advantage
is mten conccntrated in particular industry llCgR1ents.
Cerman expons of c.arsare bcavily skcwed toward higb-
pc::rformancecar.;, whi1eK~n aponsareall cornpaets
and suhcomp,aets. In nUlny industries .lInd:,!cgmenl.'1o
industric.'1, tbe competitors with uue intemational
competitive advant.llgc Arebasw in only o ft.w omioos.
Our SClIreb,thcn, is for the dccisive charnetcnstle of
anatian that allows its compani~ to create and sustllin
campetitive advanugc in panicular fidds-the seareh
is fortbe C(Impetitive adv.antagc o nations. Wean::par-
ticularly coneemed with the dctenninants o inter.
nationAI liUcees!! in tecbnology- and skill-intensive
segments IIndindustries, which underpin high and riso
ing productivity.
CiassiC41 theory cxplains the !lueecss al nations in
partieular industries lused on so-called factor.; of pro-
duetion ~ch as land, bbor, and naturnl rcsourccS. Na-
tions gain factor-ha:'led compuative advantage in
industries th.at make intensive use of the faetol1l thcy
po!I!leSSin abundance. Classical thC(lry, howevcr, has
beco ovCl1lh4dowedin advanccd industries :!OdeCOno-
mi~ by theglohalization o competition and the power
al technology.
A ncw thoory must rccognize tMt in modem intema.
tional compctition, companies compete with global
strategies involving not only trade but abo forcign in.
vesnttent. What a ncw thcory must explain is wby a
nation providc.'1a favoTllblehorne base for companies
that compete intcmationally. The borne hase is the na-
tion in which the essential compctitive advantagcs of
the cntcrprisc are crc.ated and sustaincd. It is where 1I
company's sU1Itcgy is set, wb~ the core produet snd
pmcess tcchnology 15 cre.ued llnd maintained, and
where the mast produetive johs and most lldvanced
skills are located. The presente al tbe home base in a
ruatian has !he greatest positive influence on otber
Iinked domestie industries and leads to other bendits
in tbe nation's cconomy. While tbe owncrship of the
campan)' is ohen concenUated lit tbe horne hase, the
nationality al shareholdcrs is ltCCOndary.
A new thcory must move heyond cornl'arative lIdvan-
tagc tOtbe competitive advantage of a nation. lt must
rdIeet a rieh conception mcompetition !hat neludes
SegIDcntedmarkets, differentiated produet:'!, technology
differcnces, llndcconomies of sea1e. A new tbeory must
go bcyond COStand cxplain wh)' cornpanies from sorne
Mtions are bctter tblln otbers al cre.ating advantagcs
based en quality, ft::.lltures,Ilndnew produet innovation.
A new thcory must begin fmm thepremise thllt compe-
tition isdynamieand evolving; it must answer tbe ques-
rians: Why do some companies based in some nntions
innov.llte mon: tban othersr Why do sorne nations pro-
vide.llnenvironmcnt that cnables companics tOimprove
and innovate faster tban forcign riv21sr
-Michad E. Porter
HARVARD BUSINESS RVIEW Mlltth-Aprlll990 77
Determinants of National
Competitive Advantage
These detenninants crcate the national environ-
ment in which companies arebom and learn how
to compete. (Seethe diagram"Determinants of Na-
tionaI Competitive Advantage.") Eachpoint on the
""~"" Condilions
Reloredond
/
S~ling
In usfries
l. FactorConditions. Thenation's position infac-
tors of production, such as skilled labor or infra-
structure, necessary to compete in a given
industry.
2. Demand Conditions. Thc nature of horne-mar-
ket demand for the industry's product or service.
3. ReJated and Supporting Industries. The pres-
ence or abscnce io the natian of supplier indus-
tries and other related industries that are
intemationally competitive.
4. FirmStrategy. Structure. and Rivalry. TheCOD-
ditions in the nation goveming how companies
are crcated, organized,. and managed, as well as
the nature of domcstic rivalry.
FirmSlrofegy.
Slrudure,
/lo""Ri~I'YI~
I~~I
~
ruthlessly pursue improvements, seeking an ever-
moresophisticated soureeof competitive advantage?
Whyarethey abletoavercome thesubstantial barri-
ers t change and innovation that so often accom.
pany SllcceSS?
Theanswer hesinfOUTbroadattriblltcs ofanation,
attributes that individualIy andas asystem consti.
tute the diamond of nationaI advantage, theplaying
fieldthat eachnatian establishes audoperates forits
industries. These attributes are.
grading. They invested aggressively to build large
modemplants torcapeconomies of scalc. Thcn they
bccameinnovators inprocesstechnology, pioneering
just-in-time production and ahost of other quality
andproductivity practices. Thesc process improve-
ments ledtobetter product quality, bettcr repair re-
cords, andbetter customer.satisfaction ratings than
foreigncompetitors had. Mast recently, Japaneseau-
tomakers haveadvanced to thc vanguard of prodllct
technology andareintroducing new, premiumbrand
names tocompetewith thc world's most prestigious
passenger cars.
Theexampleof theJapaneseautomakers alsoillus-
trates two additional prerequisites for sustaining
competitive advantage. First, acompany must adopt
aglobal approach tstrategy. It must sell itsproduct
worldwide, under itsownbrandname, throughinter-
nationaI marketing channels that it contrals. Atruly
global approach may cvcn require the company to
locateproduction or R&Dfacilities inother nations
to take advantage of lowcr wage rates, to gain or
improve market access, or to take advantage of for-
eigntechnoIogy. Second, creating more sustainable
advantages oftenmeans that acompany must make
tsexisting advantageobsolete-even whileit isstill
an advantage. Japanese auto companies recognized
this; either they would make thcir advantage obso-
lete, or acompetitor would doit for them.
As this cxamplc suggests, innovation and change
areinextricablytied together. Butchangeis anunnat-
mal act, particularly insucccssful companies power-
ful forces are at work to avoid and defeat it. Past
approaches becomeinstitutionalized instandard op-
eratingprocedures andmanagcmcnt contraIs. Train-
ingemphasizes the ane correet way to doanything;
the construction of spccialized, dedieated facilities
solidifiespast practice into expcnsivebrick andmor-
tar; theexisting strategy takcs 00aoauraof invinci-
bility andbccomes rooted inthe company culture.
Successful companies tend to develop abias for
predictability andstability they work 00defeodiog
what they have. Changeistempercd bythc fear that
there ismuch to lose. Theorganization at allleveIs
filters out information that would suggest new
approaches, modifications, or dcpartures romthe
nonn. The intemal environment operates like an
immune systemtoisolateor expel "hostile" individ-
uals who challcngecurrent directions or established
thinking. Innovation ceases the company bccomcs
stagnant it isoo1yamatter of timebefareaggressivc
competitors overtake it.
TheDiamand al Natianal Advantage
Why are ccTtancompanies based in certain na-
tions capablc of consistent innovatioo? Whydothey
78 HARVARD BUSINESS REVIEW March-April1990
'.
damond~and thediamond asasystem-affects es-
sential ingrements for achievinginternabana1 COID-
petitivc Sllccess: the availability o resources and
skills necessary for competitive advantageinanin-
dustry the information that shapes the opportnni-
ties that companies perceive and the dircctions in
which they deploy their resources and skills the
goals oI thc owners, managers, and individuals in
companics; and mast important, tbe pressures on
companies to iovest and innovate. Scc thc insert
"HowtheDiamondWorks:TheItalianCeramic Tile
Industry.JI)
When anational envUonment permits 3nd sup-
parts the most rapid accllffiulation of specialized
assets and skills---sometimes simply bccause D
greater effort and commitment-companies gaio a
competitive advantage. When a oatiooal environ-
ment affarelsbetter ongoinginformaban andinsight
into product and process need<>,companies gain a
competitive advantage. Finally, when thc national
environment presswes companies to innovate and
invest, companiesbothgainacompetitive advantage
andupgradethose advantagcs over time.
Factor Conditions. According to standard eco-
oomie theory, factors of production-labor, land,
natural rcsources, capital, infrastructure-will deter-
mine the flowof trade. A nation will cxport those
goodsthat makemost useof thefactorswith which
it is relatively well endowed. This doctrine, whose
originsdatebacktoAdamSmithandDavidRicardo
andthat is embcdded in classical economics, is at
best incomplete andat worst incorrecto
Inthesophisticated industries that formtheback-
bone of any advanced econorny, anation does not
inherit but instead creates the most important fac-
torsofproduetion-such asskilledhumanresources
or ascientilic base. Moreover, the stock of factors
that anation enjoys at aparticular time islessim-
portant than the mte and efficiency with which it
creates, upgrades, anddcploystheminparticular in-
dustries.
Themost important factorsofproductionarethose
that involvesustained andheavyinvestment andare
specialized. BasiefaetoIS,such asapool of labor or
alocal raw-material source, donot constitute anad-
vantageinknowledge.intensive industries. Compa-
niescanaccessthemeasilythroughaglobal strategy
or eircumvent them through tcehnology. Cootrary
to conventional wisdom, simply having ageneral
work force that is high school or even college
educated rcpresents no competitive advantage in
modero intemational competition. Tosupport coro-
petitive advantage, afactor must behigh1yspecial-
izedto 3Dindustry's particular needs-a scientific
institute specializediooptics, apool ofventurecapi-
tal to fund software companies. These factors are
more scarce, more difficult far foreigncompetitors
HARVARD BUSINESS REVlEW Marcb-Aprill990
to imitate-and thcy requue sustained investment
to create.
Nations suceeedinindustries wherethey arepar-
ticularly goodat factor creation. Competitive advan-
tage resuIts from the presence of world-class
institutions that Rrst createspecializedfactoISand
thcn continually work to upgradethero. Denmark
has two hospitals that coocentrate in studying and
treating diabetes--and aworld-Ieadingexport posi-
tion ininsulin. HolIandhas premier research insti-
tutes inthecultivation, packaging, andshipping of
flowers, whereit is theworld's cxport lcader.
What isnot soobvious, however, isthat selective
disadvantages in the morebasic factors canproda
company to innovate andupgrade-a disadvantage
inastatic model of eompetition canbeeomeanad-
vantagc inadynamic ooe. Wben thcre Isanample
supply of cheap raw materials or abundant labor,
companics cansimply rest ontheseadvantages and
oftendcploytheminefficiently. Butwhencompanies
faceaselective disadvantage, like high land costs,
labor shortages, or the lack of local rawmaterials,
they must innovate andllpgradeto compete.
hnplicit in the oft-rcpeated Japanesc statement,
'Weareanislandnationwith nonatural resources,"
is the understanding that thesc deReieneies have
only servedto spur Japan'scompetitive innovation.
Just-in-timeproduction, orexample, cconomizedon
prohibitively expensivespace.Italianstecl producers
in the Bresciaarcafaeedasimilar set of disadvan-
tages: high capital costs, high energy costs, andno
local rawmaterials. LocatedinNorthem Lombardy,
these privately owned campanies faeedstaggering
logistics costs due to thcir distance romsouthern
portsandtheinefficienciesofthestate-owncdItalian
transportation system. The result: thcy pioneered
technologically advanced minimills that require
onlymodest capital investment, uselessenergy,ern-
play scrap metal as the feedstock, are efficient at
small scale, andpermit produeers to locatecloseto
sources of scrap and end-use customers. lo othcr
words,theyconvertedfactor disadvantagesintocomo
petitive advantage.
Disadvantages canbecomeadvantagesonIyunder
certain conditions. First, they must sendcompanies
proper signals abaut circumstances that wiUspread
toother oations, therebyequippingtherotoinnovate
inadvaneeof oreignrivals. Switzerland, thenation
that experiencedthefirst laborshortagcs after World
Warn, isacaseinpoint. Swisscompanies responded
tothe disadvantagebyupgradinglabor productivity
andseeking higher value, moresustainable market
segffients_Companies in most other parts of the
world, whcretherewerestill ampleworkers, focused
their attcntion 00 othcr issues, which resulted in
slower upgrading.
The secondcondition for transforming disadvan-
79

\
' .
Howthe DiamondWorks:
Theltalian Ceramiclile Industry
In 1987, (talun companies were world IClldersin thc
produetion and expon of ct:rlLIDicliles, a $10 biJ lion
industry. ltalian produccrs, concentrated in and.mnnd
the smaIl town of Sassuolo in the Emilia.Romagna re-
gion, accounted for .boUl 30% of world production and
almost 60% of worId apons. Tbc lulian trade surplus
that year in cuamic tilC!'lwas abont $1.4 bi1lion.
The development o the Italianct:ramic tileindustry's
competitivc advanuge iIIumratCll how thc diamond of
I\titional adv8ntage works. Sa1lsuolo'ssustllin.hlc com-
petitivc advanuge in ceramic liles grcw nOl from any
5UtiC or historical advantagt: bUI from dyn.amism and
change. Sophisticated and demandin; local buyers,
stmng and uDique distribution ehannels, and ntense
rivalry amo118local companics eteated consunt pres.
SIIn: lar nnovalioo. Knowlcdgc grcw quickly fmm con.
tinuous cxpcrimentation and cumulativc production
cxperienee. Private ownaship of the comp2nies and
loyalty tO the community 5ptwncd intense commit-
rncnt to invcst in the industry.
Tile producen; bendlted 8S wcll fmm a highly de-
vdoped Set o local machinery fluppliernand other su~
porting industries, producing materials, servioes, .nd
iofmstmcture. The presence of world-class, ltalian-
rc:lated industries also reinforced IUllian Sttcogth in
tiles. Finnlly, the geogrsphic conccntr"ation of the entirc
cluster supen:.harged the whole p~. Today foreign
companies cmnpete ag.tinst J lnentirc subculture. 111e
organie nature of this systc:mreprcsents the mOst sus-
tainable advantage of Sassuolo's ccramic tileeompanics.
Tbe Origim othe ltalian Industry
TIle production in Sss.'mologrew out of the canhen-
ware aod cnxkcry industry, whose hiS10rytraces back
tothe thineenth century. Immediately after World War
11,there wereonly ahandful of cccamie tile INInufaetur-
crs inand amund Ssssuolo, .1111 saving the 10000l market
c:xclusively.
Demand far ccramie tiles within Italy hq;an to grow
dram:nieally in the immedillte po5tWlIr yean;, as the
nxonstruction of ltaly ~ed aboomin building ma-
terials of all kinds. ltalian demand for ccramic tiJ es was
panicularly great due to the c1imate, local tastes, .nd
bui1din~techniques.
Bcausc Sassuolo was in a reLnivcly pmsperous ptrt
of J taly, there wcremany who could combine the modo
cst amount of capital and ncctSSllry organizational
skill!'l to S1art a tile com~ny. In ]955, there wcre 14
Sassunlo arca tile companicsl by 1962, there wcrc ]02-
Thc newtile com~nics bcndited fmm a10000l pool of
mcchanically uained workers. The regioo around Ssssu.
010was horne to J lc:rTlIri,M.scrati, Lamborghini, and
other tcchnically sophisticatcd companics. As thc tile
industry besan togrowandprosper, many coginccrs and
skillcd worlters gravitated to the 5uttesSfut companies.
Thc Emerging ltalian nle Cluster
Initially, ltaliao tile produccrs wcredependent on for-
ogo soun:cs al rawmaterials andproduetion tcchnology.
Inthe 19505, the principal raw m.aterials used to malte
rileswcre Molin (white}e1.y", $ince there werc red- but
no whitc-clay dt:pm;itSncar $assuolo, ltalian producers
hadtoimpon the e1aysfremthe United Kingdom. Tile.
making equipmcnt was 8150importcd in the 19505
and 19605: kilns from Ccrmany, America, and Francc
presses for formins tiles fmm Cermany. Sassuolo tile
maken; had toimpon evcn simple glazing m.llchnes.
Ovcr time, the Itatian tile produccrs lcarned how tO
modify imported equipment to lit local circumstance.'I:
redversus whitc e1ays, n.aturaI gasversus heavy oil. As
pt'OCCSstccbnicians frern rile companics leh to Stan
thcir own cquipment companics, alocal rn.achinery io.
dustry lrose in Sas..'Iuolo.By 1970, IUlIi.n companies
h.td emerged as world-cbs..'I producen; of kilm and
presscs the carlier situation had ex.actly reven;ed: they
wcrc cxporting thcir red-clay cquipment for forcigners
to use with white days.
The relarionship betwecn Italian tile and equipment
manufacturcrs was a mutually supporting one, made
cvcn mon:!lObyelose pmximity. Inthc rnid-1980s, there
wcrc sorne 200 Italian cquipment manufaeturcrs more
than 60% were located in the Sassuoln UCIl.111ecquip-
ment manufaeturas competed fien:ely for local busi.
ness, andtile msnufaeturcrs benefited fmmbetter prices
andmore lIdvanccd cquipmcnt than their foreign rivals.
As the emeJ ging tile cluster grcw and conccntrated
in the *suolo regioo, a pool of skilled worltcrs and
tcchnicians devclopcd, inc1uding enginccrs, production
spccialistS, nuintcnancc worlters, service teehnicians,
and design pel'!mnocl. The industry's gengraphie con.
centration ClIcouraged other supporting companies to
form, offering mold'l, paeuging INIterials, glazes, nnd
trnnsport1ltion (Ilerviccs.An amly of small, specialiud
consulting companies emerged to give advice to tile
producers on plant dcsign, logistics, and enmmadal,
adverti!ling. and fiscal manas.
With its membership concentrated in the $as!luolo
arca, Assopiastrelle, the cenmic tle ndustry associs-
tion, hegan offering serv1CC5in area!'lof common nter-
CS1: bulk purchasing.. foreign.market research, llnd
consulting onfiscal and legal matten;. The growing tile
cluster stimulated the formation of a new, l'lpCCializcd
flletor-crcating institution: in ]976, aconsortum of the
80
liARVARD BUSINESS REVlEW Mnrch-Aprill990
'.
University o Bologna, rq;ional agencies, IInd the ce-
runic indusuy assoc:iation founded the Centro Cera-
mico di Bologna, which c:onductcd prOttSs research and
product analysis.
Sophisticated Home Dem,nd
By me mid-J 960s, per-capita tile consumption inluly
was considerably highcr than in lhe TC5tuf the wortd.
Thc Italian marltet was.also the world's most sophisti-
cate<!. J ulian c:ustomers, who were gcncrally the first
to.adoptnew designs 3ndfCltu~, lIndItal iaoproduccrs,
who consuntly innov.ated to impmve manufactung
m~ods Bndcreate new designs, progressed in a mutu-
.lIy reinforcing pmccss.
The unique1y sophisticated charaeter ol domcstic de.
m.andl!Ilsoextended to retail OUtlet5. In the 196Cb,spe-
ciatizcd tileshowrooms hcgan openingin Itllly. By1985,
thm: wcrc roughly 7,600 specializcd showrooms han-
dling IIPJ lroximately 80% of dorncstic Slllcs, fu more
thaR in other nations. In 1976, the J tali.lln cornpany
Picmme intrnduccd tiles by famous designers to gaio
distrihutinn outlets aad tObuild hmnd IUmC.w'u'cness
.lmong consumcrs. This innovation drcw on anotht:r
related industry, desWJ , serviccs, in whiclJ J taIy wa!l
world J eader, with over $10 hillion in ocports.
Sassuolo Rivalry
TIte sheet numbcr o tile companics in thc Sassuolo
ara creatcd intense rivalry. News of product lIndpro-
CC5.'l innovationsllpread IlIpidly, and companics sr:cking
technological, design, and distribution 1eadcrship had
to impmve: conlltantly.
Proximity addeda pcr.on:alnote tothe intenseriv.l1ry.
AJ I of tbc produccrs were privatcly hdd, most wt:refllm-
ilr run. ThCDWncr.lllJ llived inthesarncarea,kncwcsch
othcr, aod were thc leading citizc:os of thc sarnc lOwnS.
PttSsuttS to Upgnde
J n the early J 9705, faced with ntense domestic ri-
valry, prcssure fmm m.-il customel1'l, .lod the shock of
the 1973 energy crisis, ltali.ln tile comIUnies struggled
to rmuce gas and l:abor ar.'Its. Thcse dlorts led to a
tcchoological brcakthrough, tbe: rapid singlc-firing pro-
ces!!, io which thc hardcnins; process, nuterial trans-
formation, and glazc:-fixing all occum:d in ooe pa~
through thc kilo. A proccss tbat too,", 225 cmployecs
using the double-firing methCMIneo:led ooly 90employ-
ces using singlc-firing mJ ler kilns. CyeJ e timc ciroppr:d
frnm 16to 20 hours tOonly SO lO55 minutt:S.
The ncw, smallcr, .nd lightcr cquipmcnt was .Iso
casicr lo export. By tbe early 19805,cxports fromltalian
cquiprnent rrulOuf.cturers exc:ccdcd dorncstic sales; in
1988, aports rcpresentcd almost 80% 01 total sales.
Working togethcr, tile manubcturcrs and cquipment
manufacturers nude tbe nen imponant brcakthrough
during thc mid- and la.tC 1970s; the devdopmcnt of
materials-handJ iog cquipmcnt trua transformcd tilc
manufacture roroabatch proccss to acontinuous pro-
cess. 111cinnovation rcduccd high labor cm;t....... wruch
luidbeen.a substanti.al sclcctive factor disadvllntage fac-
ing ltaliao tilc manuf.aetutc:rs.
111c cornmon pcn:c:ption is that J talian labor easts
were lowcr during this perind than tbasc in thc Unitcd
Sutes dod Ccrmany. In thosc two countries, bowcver,
diffcrcnt jobs had widcly diffcrent wagcs. InItaly, wages
for different skill catcgories wcre compres.'lcd, and work
rules constraincd manufacturcr.; from using overtime
or multiple shifts. Tbc rcstriction proved costly: once
conl, kiln!'l are cxpensivc to reheat nnd are bcst run
continuously. Bccause of this factor disadvantage, the
ltalian companic8 wcrc thc first to devdop continuous,
automatcd produC;tion.
Intcmationalization
By 1970, J ulian domestic dcmand bad matured. The
slsgnant J tali:m madct led companics to stcp up their
cfforts to pursue loreign madcts. The prescnce of re-
lated and supponing Italiao industries hclpcd in thc
expon drive. Individl.LA1 tile manufaeturers bcgan .lldvcr-
tising in ltalian and forcign homc-design and archi-
tectural magazines, publications with wide global
circullltion nmongarchitcets, dcsignen;, and consumcl1'l.
TItis hcightcnod awaren~'i rcinforced thcquality imngc
of ltali.n tiles. nlc makcrs wcre also able to apitalize
on ltaly's Ic.adingworld cxport positions in relsted in.
dunries Hitemarble, building stonc, sinb, washbasins,
fumiture, lamps, .lIndhome llpplianees.
Assopillstrcllc, the industry .SSocilltion, cstablished
tnufc-promotion officcs in thc Unitcd SUtes in 1980,
in Cermnny in 1984, .andin France in 1987. It organized
elaborate uadc ahows in cities ranging lrom Bolognll 10
Miami and nm!lOpbisticatcd advcnising. Bctwcen 1980
nnd 1987, thc associAtian spcnt roughly $8 million tO
promote Italma tilcs in thc Unitcd Ststes.
-Michael J . Enright snd Paolo Tcnti
MirlJad /. Enr1glrt. a doctora' Madent In lmsfru:,'t~t'.ronomfes
al tbelIarvmd BusIness School. PQformt'.d trtlmaflU.~rt'.$Mrch
attd sopervi.fory tlJSk.. fur Thc CompetitIve AdvlInuge of Na.
tions. PDOIo 'lentl was respoTl.Qble /or 1M. ltnlfnn pnrt of re.
setfrch ondml1ken fartbe book.lle Is tl con.rultant in strategy
ttnd {int1Tlu 1m Monitm eomp.my attd Ana1y:rfs F.A.-MilQn.
,
HARVARD BUSINESSREVlEW Marc:h-April 1990 81
tages into advantages is favorable circurnstances
elsewherein thediamond--a consideration that ap-
plies toalmost a11determinants. Toinnovate, com~
palies must haveaccesstopeoplewith appropriate
skiils andhavehome-demand conditions that send
theright signals. They must alsohaveactivedomes-
tic rivalswho createpressurc toinnovate_ Another
precondition iscompany goalsthat leadtosustained
commitment tothe industry. Without such acom-
rnitmcnt and thepresence of active rivalry, acorn-
pany may take an easy way around adisadvantage
rather than using it asaspur to innovation.
For example, U_S_consumer-electronics compa-
nies, facedwith high relative labor costs, chose to
lcavetheproduct andproduction processlargelyun-
changedandmave lahor.intensive activities to Tai-
wanandother Asianeountries. Instead of llpgrading
their sourcesofadvantagc, thcyscttlcd farlabor-cost
parity. Ontheather hand, Japane.<:;e rivals, confronted
with intense domestic competitian and a mature
hornemarket, chosetoeliminate labortbrough auta..
mation. Thisledtolower assemblycosts, toproducts
withfewercomponents andtoimprovedquality and
reliability. SoonJapanesecompanies were building
assemblyplants intheUnitcd $tatcs----theplaccu-s.
companies hadfled.
Demand Conditions. It might seem that the
globalization ofcompetition woulddiminish theim-
portance ofhomedemand_Inpractice, however, this
issimply not the case. Infact, the composition and
character of the home market usually has adispro-
portionate effect onhowcompanies perceive, inter-
pret, and respond to buyer needs. Nations gain
competitive advantageinindustries wherethehorne
demand gives their companies a clearer or earHer
picture of emerging buyer needs, and where de-
manding buyers pressure eompanies to innovate
faster and achieve more sophisticated competitive
advantagesthan their foreignrivals. The,sizeofhome
demandprovesfarlesssignificant than thecharacter
of hornedemando
Home~demandconditions help build competitive
advantage when a particular industry segment is
larger or more visible in the domestic market than
inforeigomarkets. Thelarger market segments ina
nation receivethe most attention &omthenation's
companies; companies accord smaller ar less desir-
ablesegments alower priority. A goodexample is
hydraulic cxcavators, wmch rcpresent the most
widely used typeof constru.ction equipment in the
Japaoesedomestic market-but which compriseafar
smaller proportion of the market in other advanced
nacioos. This segment isoueof thc fcwwhcrc there
arevigorousJapaneseintemational competitors and
whcre Caterpillar doesnot hold asubstancial share
of the worldmarket.
82
Moreimportant than thc rnixof segmentsper seis
thenature o domestic buyers_Anation'scompanies
gain competitive advantage if domestic buyers are
the world'smost sophisticated anddemanding buy-
ers for the product ar service. Sophisticatcd, de-
manding buyers provide awindow into advanced
customer needs; they pressure companies to meet
highstandards; they prodthemtoimprove, toinno-
vate, andto upgradeinto more advanced segments.
Aswith factor conditions, demand conditions pro-
videadvanta.gesby forcingcompanies to respondto
toughchallenges.
Especially stringent needs arise because of local
valu.es and circumstances. For example, Japanese
conswners, wholiveinsmal}.tight1ypackedhomes,
must contend with hot, humid surnrners and high.
cost electrical energy-a daunting combination of
crrcumstances. In response, Japanese companies
havepioneeredcompact, quiet air-conditioningunits
powercdbyencrgy-savingrotary compressors. Inin-
dustry atter industry, thetightly constrained require-
ments o theJapanesemarket haveforcedcompanies
toinnovate, yieldingproducts that arekei-haku-tan-
sho-light, thi~ short, small-and that areintema-
tionally accepted.
Local buyers can help anation's companies gain
advantage if their needs anticipate or even shape
those o other nations--- if their needsprovideongo-
ing "early~waming indicators" of global market
trends. Sometimes anticipatory needs emerge be-
cause anation's political values foreshadow nceds
that wiil grow elsewhere. Sweden's long-standing
concemior handicapped peoplehas spawned anin-
creasingly competitivc iodtL.try foctL.ed 00special
needs. Denmark's environrnentalism hasledtosuc-
cessforcompanies inwater-pollution control equip-
meot andwindmills.
Moregenerally, anation's companies can antici-
pateglobal trends if the nation's values arespread-
ing-that is, if the country is exporting its values
andtastes aswell asits products. The international
SllCceSSo U.$. compames in fast food and credit
cards, for example, reflects not only the American
desirefor convenience hut aIsothe spreado these
tastes tothe rest of the world. Natioos export their
values and tastes through media, through training
foreigners, through political influence, andthrough
theforeigoactivities oftheir citizens andcompanies.
Relared and Supporting Industries. The third
broad determinant of national advantage is the
presence inthe nation of related andsupporting in-
dustries that areinternationally competitive. Inter-
nationally competitive home-based suppliers create
advantages in downstream indtLtries in several
ways_First, they deliver the most cost.effcctive in-
puts inancfficient, early,rapid, andsometimes pref-
HARVARD BUSINESS REVlEW March-Apri11990

erential way. ItaHan gold and sil ver jewelry

companies lcad the world in that industry in part
because other Italian companies supply two-thirds
af thc world's jewelry-making and precious-metal
recyc1ingmachinery.
Far more significant than mere access to campo-
ncnts and macmnery, however, i8thc advantage that
home-based related and supporting industries pro-
vide in innovaton and upgrading-an advantage
based 00closeworking relationships. Suppliers and
end-users locatedncar eachother cantakeadvantage
of short lines of communicatioD, quick andconstant
flow af informatan, and aD ongoing exchange af
ideasandinnovatiollS. Campanies havetheopportu-
nity toinfluence their suppliers' technical effortsand
can serve as test sites for R&D work, accelerating
the paceof innovatioo.
Theillustration of "The Italian Footwear Cluster"
offersagraphic cxample of how agroupof close-by,
supporting industries crcatcs competitive advantage
in arange of intcrconnected industries that are a11
internationally competitive. Shoeproducers, fur in-
stanee, interaet regularly with leather manufacturcrs
on new styles and manufacturing tcchniques and
learn about newtextures andcolors of leather when
they arestill on the drawing board..Leather manu-
faeturers gainearlyinsights intofashiontrends, help-
ing them to plan new products. Thc interaction is
mutually advantageous and self-reinforcing, but it
does not happen automatically: it ishelped byprox-
imity, but occursonIyhecausecompanies andsuppli-
ers work at it.
Thc nation's companies benefit most when the
suppliers are, themselves, global competitors. It is
ultimately sel.defeating for acompany or country
to create "captive" suppliers who aretotally depen-
dent on the domestic industry and prevented rom
serving foreign eompetitors. Bythe same token, a
nation neednot becompetitivc inall supplier indus-
tries faritscompanies togaincompetitive advantage.
Companies eanreadilysowee fromabroadmaterials,
components, or technologies without amajor effect
oninnovation or performance of theindustry's prod-
uCS.The same is true of other generalized tech-
nologies---like eleetronics or software-where the
industry represents anarrow application area.
Home-based compctitiveness inrelated industries
provides similar benefits: information flowandtech-
nieal intcrchange speed the rate of innovation and
upgrading. A home-based related industry also in-
crea...e. the likelihood that companies will embrace
new skills, and it also provides asowee of entrants
who will bring anovel approach to competing. Thc
Swisssuccess inphannaceuticals emergedout ofpre-
vious intemational success in the dyc industry, for
exampIc; Japanesedominance in e1ectronic musical
HARVARD BUSINESS REVIEW March~Apri11990
keyboards grows out of success in acoustie instru-
mcnts combined with astrongposition inconsumer
electronics.
Firm StIategy, Structure, and Rivalry. National
circumstances and context create strong tcndencies
in how companies areercated, organized, and man-
aged, aswe11aswhat the natwe of domestic rivalry
will be.InltaIy, forcumple, successful international
competitors areoftensmall or medium-sized compa-
nies tbat areprivately owned and operated like ex-
tended families; inGermany, incontrast, companies
tend to be strictly hierarerncal in organization and
management practices, and top managers usually
have technical backgrounds.
No one managerial system is universally ap-
propriate-notwithstanding the cwrent fascination
with Japancse management. Competitiveness in a
specific industry results from convergence of the
management praetices andorganizational modes fa-
voredinthe country andthe sources of compctitive
advantageintheindustry.ln industries whereltalian
companies areworldleaders-such aslighting, furni.
ture, footwear, woolen fabrics, and packaging ma-
ehines-a company strategy that emphasizes foeus,
customized products, niehemarketing, rapidchange,
and breathtaking flexibility fits both the dynamics
of the industry andthe charneter of theltalian man-
agement system. The German management system,
in contrast, works well in technical or engineering-
oriented industries-opties, chemicals, complicated
maehinery-where complex products demand preci-
sion manufaeturing, aeareful development process,
after-saleservice, andthus ahighIy disciplined man-
agement structure. Gennan success ismuch rarer in
consumer goodsandserviceswhereimagemarketing
and rapid new-feature and model turnover are im-
portant to competition.
Countries also differ markedly in tbe goals that
companies and individuals seek to achieve. Com-
panygoalsreflect thecbaracteristies ofnational capi-
tal markets and the compensation praetices far
managers. For example, in Germany and Switzer-
land, wherebanks comprise asubstantial part of the
nation's shareholders, most shares areheld for long.
termappreciation and arerarely traded. Companies
dowell inmatute industries, where ongoing invest-
ment in R&D and new facilities is essential but re-
turns may be onIy moderate. The United States is
at the opposite extreme, with alarge pool of risk
capital but widespread trading of public companies
andastrong empbasis by invcstors onquarterly and
annual share-price appreciation. Managernent com-
pensation isheavily basedonannual bonuses tied to
individual resutts. America does well in relatively
new industries, like software and biotechnology, or
anes where equity funding of new companies feeds
83
" .
TheItalianFootwear Cluster
tnjedion-
I
. 6
nidding
Mochirtery

,
~
,
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,
M,,""
,
,~
,
'""h
,
,
,
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~
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-
,
,

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_01
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f -. ,. . f -. ,. .
@
Design
Scrvices
\
I.euttref ....orl,lng
~
Modllnery
active dorncstic rivalry, Iikc spccialty c1cctronics and
services. Strong prcs!'>urc.o; lcading to undcrinvcst.
ment, however, plague more matUTe industrics.
IndividU31motivation to work and cxpand skills
is also important to competitivc advantagc. Out-
standing talcnt is ascarcercsoUTCC in any narion.
A nation's success largely depends on the typcs of
cducation jts talcntcd pcople choose, where they
choosc to work, and thcir commitment and effort.
Thc goals anatioo's institutions and valucs sct far
individuals and comp.1nics, and thc prestigc it ato
taches to certain industries, guidc thc flow o capital
and human resourees--which, in turo, dircctIy a E .
fects the competitive performance of certain indus-
tries. Nations tend to becompetitive in activitics
that pcoplc admire or dcpcnd on-the activities froro
whic.h thc nation's hcrocs emerge_InSwitzerland, it
isbanking and pharmaccuticals. InIsrael, the highcst
callings havc bccn agriculturc and defense-related
fields. Soroctirocs it is hard to distinguish bctween
84
HARVARD BUSINESS REvmW Mareh-April 1990
Estimated Number of Japanese Rivols in
Selected Industries
SoVn;"e$: Fieldintervi"""",;Nippon /(ogro Shinfxm, Nippon lCogyo
Nenkan, 1987; YonoReM!Orch, Morket5horeJiton, 1987; reseorchers'
estimotes.
*Thenumbe!"of componies varied by product orea. lhe smollest
number, 10, produced bulldozers. fifteen companies produced shavel
truoo, trua aones, and osphah-paving equipment. lhere werll 20
companies inhydruulic excovolors, o pmduct oroo where lepan wos
porticulcrly strong.
tSixcomponies had annuol production exports inexcess of 10,000
tons.
tInlegrutedcompanies.
cause and effect. Attaining international success can
make an industry prestigious, reinforcing it8 advan-
tagc.
The presence o strong local rivals i8a final, and
powerful, stimulus to thc creation and persistence
of competitive advantage. This is true of small coun-
tries, likc Switzerland, where the rivalry among its
pharmaceutical companies, Hoffmann-La Rache,
Ciba-Geigy, and Sanrloz, contributes to a leading
worldwidepositioo. lt i8true in the Unitcd Statcs
in thc computer and software industries. Nowhere
i8 the role of heree rivahy more apparent than in
J apan, where there are 112companies competing in
machine tools, 34 in semiconductors, 25 in audio
equipment, 15in cameras-in faet, there are usually
double figures in the industries in wmch Tapanboasts
global dominance. fSeethe table "Estimated Number
of J apanese Rivals in Selected Industries.'" Among
aH thc points 00 the diamond, domestic rivalry is

Air Conditioners
Audio Equipmenl
Automobiles
Cameros
Cor Audio
Carban Fibers
ConslrlJ etion Equipmenl*
Copiers
Focsimile Machines
large-scole Compufers
lift Trucks
Machine Tools
Microwove Equipment
Motorcydes
Musicollnsfruments
Personal Compulers
Semicondoctors
Sewing Mochines
Shipbuilding1
Steelt
Synthetic Fibers
Television Seis
Truck ond Bus Tires
Trucks
Typewrifers
Videocossetle Recorders
13
25
9
15
12
7
15
lA
10
6
B
112
5
A
A
16
3A
20
33
5
B
15
5
11
lA
10
arguably the most important heCalL,>eof thc power.
fully stimulating efcct it has on aHthe others.
Conventional wisdom argues that domestic com.
petition is wasteful: it leads to duplication of effort
and prevents companies romachieving ecooomies
of scalc. The "right solution" is to embrace one or
two national champions, companies with the sca1e
and strength to tack1e foreign competitors, and to
guarantee them the necessary resourccs, with the
govemment's hlessing. In fact, however, most na.
tional cbampions are uncompetitive, although heav.
ily subsidized and protceted hy their government. In
many of the prominent industries in which there is
onIy one national rival, such as aerospace and tele-
oommunications, govemment has playcd alargerole
in distorting competition.
Static efficiency is much Iess important than
dynamic improvement, which domestic rivalry
uniquely spurs. Domestic rivalry, like any rivalry,
creatcs pressure on oompanies to innovate and im.
proveo Local rivals push each othel to lower costs,
improve quality and service, and create new products
and proeesses. But unlike rivalries with foreigo como
petitors, which tend to be analytical and distaot,
local rivalries often gobeyond pure economic or busi.
ness competition and become intensely personaL
Domestic rivals engagein active feuds; they compete
not ooly fOI market share bnt also for people, for
technical excellence, and perhaps most important,
for "bragging rigbts." Qne domestic rival's success
proves to others that advancement is possible and
often attracts ncw rivals to the industry. Companies
often attrihute the success of foreign rivals to "un.
fair" advantages. With domestic rivals, there are no
excuses.
Geographic concentration magnifies the powcr of
domestic riva1ry. This pattem is strikingly common
around the world: Italian jewelry companies are lo.
cated around two towns, Arezzo and Valenza Po;
cutlcry companies in Solingen, West Germany and
Seki, Tapan; pharmaceutical companies in Basel,
Switzerland; motorcycles and musical instrumeots
inHamamatsu, Tapan.The more localized the rivalry,
the more intense. And the more intense, the hetter.
Another benefit of domestic rivalry is the pressure
it creates for constant upgrading of the sources of
competitive advantage. The prescncc of dorncstic
competitors automatically canccls the typcs of ad.
vantage that come romsimply being in aparticular
nation-factor costs, access to 01 preference in the
horne rnarkct, or costs to foreigo competitors who
import into the market. Companies are forced to
move beyond thero, and as arcsult, gain more sus.
tainahle advantages. Morcovcr, oompeting domestic
rivals will keep each othcr honcst in ohtaining gov.
crnment support. Companies are less likely to get
HARVARDBUSINESSREVIEW March-Aprill990 85
.

hooked onthe narcotic Di govemment contracts DI

creepingindustry protectionism. Instead, theindus-
try will seek~and bencit rom-more constructive
forms D i government support, such asassistance in
opening forcignmarkets, aswell as investments in
focusededucational institutions or other specialized
factars.
Ironically, iti8alsovigorousdornestic competition
that ultimate1y pressures domestic companies to
lookatglobal markets andtoughens therotosucceed
in thero. Particlllarly when there areeconomies n
scale, local competitors forceeachother tolaok out-
wardtoforeignmarkets tocapturegreatcr efficiency
andhigher profitability. Andhaving been testcd by
ficreedomestic competition, thestronger companies
arewell equippedtoWnabroad.IfDigital Equipmcnt
canholdits ownagainst IBM,DataGeneral, Prime,
;lndHewlett-Packard, going up against Siemem or
MachinesBull doesnot seemsodaunting aprospecto
The Diamond os a System
Each of these four attributcs defines apoint on
thediamondof national advantage theeffect ofQue
point oftendepends00thestateof othcrs. Sophisti-
cated buyers will not translate inta advancedprod-
ucts, for example, unless the quality of human
resources permits eompanies to meet buyer needs.
Seleetivedisadvantages infactorsofproduction will
not motivate innovation unless rivalry is vigorous
and company goals support sustained invcstment.
At thebroade.~tlevel, weaknesses in anyane deter-
minant will constrain anindustry's potential forad-
vancement andupgrading.
Butthepoints ofthediamondarealsoself~reinforc-
ing: they eonstitute asystem. Twoelemcnts, domes-
tic rivalry and geogr.aphie concentration, have
espeeiallygreatpowerto transformthediamondinto
asystem-domestic rivalry becauseit promotes im-
provement in all the other detenninants and gro-
graphic concentration because it e1evates and
magnifies theinteraction of the four separateinflu-
ences.
The role of domestic rivalry illustrates how the
diamondoperatesasaseH-reinforcingsystem. Vigor-
ous domestic rivalry stimulates tbedevclopment of
unique pools of specialized factors, particularly i
the rivals arealllocated in onecity or region: the
University of California at Davis has beoome the
world's leading center of winc-making research,
working closely with the California wine industry.
Active local rivals also upgrade domestic demand
in anindlL~try.Infumiture and shoes, for example,
Italian consumers haveleamed t cxpcct more and
betterproducts becauseoftherapidpaceofnewprod-
uct development that is drivenbyintense domestic
rivalry aIDonghundreds of Italian eompanies. 00-
mestic rivalryalsopromotes theformation ofrelated
and supporting industries. Japan's world-lcading
groupof semiconductor produeers, for instance, has
spawned world-leading Japanese semiconductor-
equipment manufacturers.
Theeffects canwork inall directions: sometimes
world-class suppliers become new entrants in the
industry theyhavebeensupplying_Or highlysophis-
ticated buyers may themselves enter asupplier in-
dustry, particularly when they havc relcvant skills
andviewthe newindustry asstrategic. Inthe case
of theJapaneserobotics industry, for example, Mat-
sushita andKawasaki originaUydesignedrobots for
interna! usebeforebeginningtoseUrobotstoothers.
Today they are strong competitors in the roboties
industry. InSweden, Sandvik movedfromspecialty
steel into rock drills, andSKFmovedfromspecialty
stecl into ball bearings.
Another effect of the diamond's systemic nature
isthat nations arerarely hornetojust onecompeti-
tive industry rather, the diamond creates an en-
vironment that promotes cJusters of competitive
indlL~tries_Competitive industries arenot scattered
helter-skelter throughout theeconomy but areusu-
allylinkedtogether through vertical jbuyer-seller) or
horizontal (common customers, teehnology, chan.
neis!relationships. Nor areclusters usually scattered
physicallYi they tend to beconcentrated geographi-
eally. Onecompetitive industry helps to create an-
other in a mutually reinforcing process. Japan's
strength ineonswner clectronics, forexample, drove
its success in semiconductors toward the memory
chipsandintegrated circuitstheseproduets use. Japa-
nese strength in laptop computers, wmeh contrasts
to limited success in other segrncnts, rcflects thc
baseof strength inother compact, portableproducts
andlcadingexpertise inliquid-crystal displaygained
inthe ca1cu1atorandwatch industries.
Onceacluster forms, thewholegroupofindustries
becomesmutually supporting_Benefitsflowforward,
baekward, andhorizontally. Aggressiverivalryinone
indlL~tryspreads to others in the cluster, through
spin-offs, through the exerciseof bargaining power,
and through diversification by established compa-
nies. Entry fromother industries within thecluster
spursupgradingbystimulating diversity inR&Dap-
proaches and facilitating the introduction of new
strategies andskills. Tbroughtheconduits of suppli-
ers or customers who have contaet with multiple
competitors, information flows freely and innova-
tions diffuse rapid.1y.Interconnections within the
cluster, aften unantieipated, lead to perceptions of
newwaysof competing andnewopportunities. The
HARVARDBUSINESSREVIEW March-Aprill990
,

cluster becomes avehiclc faI maintaining diversity

andovercomiogtheinwardfOCllS, inertia, inHexibil-
ity, andaccommodation amongrivals that slows or
blocks competitivc upgradingandnewentry.
The Role 01Government
Inthecontinuing debateover thecompetitiveness
o nations, no tapie engenders more argument ar
creates less unrlcrstanding than the roleo thc gov-
ernrncnt. Many see government as an essential
helper or supporter o industry, employing ahast
D E policies to contribute directly tothecompetitive
performance astrategic DI target industries. Others
accept the "frcemarket" viewthat the operation o
the economy should be left to the workings o the
invisible hand.
Both views areincorrecto Either, followed to its
logical outcome, would lead to thc permanent ero-
SiDO of acountrls competitive capabilities. Onone
hand, advocates of goveroment helpforindustry fre-
qucntly propose policies that would actually hurt
companies in the long ron nnd oruy create the de-
mandformorehelping. Onthc other hnnd, advocates
of a diminished government presence ignore the
legitimate role that government plays in shaping
the context andinstitutional structure surrounding
companies andincreatinganenviroomcnt that stim-
ulates companies togaincompctitive advnntage.
Government's proper roleisasacatalyst andchal-
leoger; it istoencourage-or evenpush-companies
tomisetheir aspirations andmovetohigher levelsof
compctitive performance, eventhough tbis process
maybeinherently unpleasant anddifficult. Gavera-
ment cannot create competitive industries; only
companies candotbat. Government playsarolethat
isinherently partial, that succeeds onlywhen work-
ingintandemwith favorableunderIyingconmtions
iothemamond. Still, government's roleof transmit+
ting and amplifying the forces of the diamond is a
powerful one. Government policies that succeedare
those that create an environment in whieh eompa-
nies can gain competitivc advantage rather !han
thosc that involve government direetIy in the pro-
eess, cxccptinnations earIyinthedevelopment pro-
cesS.It is anindireet, rather than amrcct, role.
Japan's government, at its best, understands tbis
role better than anyone- including the point that
nations pass through stagesof competitive develop-
ment and tbat govemment's appmpriate role shifts
asthc economy progresses. Bystimulating early de-
mandfor advancedproducts, confronting industries
with theneedtopioncer frontier technology through
symbolic cooperative projects, establishing prizes
HARVARDBUSINESSREVIEW March-Aptill990
tbat rewardquality, andpursuing other policiestbat
magnifytheforcesof thediamond, theJapanesegov-
eroment aeeelerates thepaceof innovation. Butlike
government officials anywhere, at their worst Japa-
nesc bureaucrats can make the same mistakcs: at-
tempting to manage industry structure, protecting
themarket toolong, andyie1dingtopolltical pressure
toinsulateinefficient retailers, farmcrs, distributors,
andindustrial companies fromcompetition.
It isnot hardtounderstand why somaoy govern-
ments make thc same mistakes so often inpursuit
of national competitiveness: compctitive time for
companies and polltical time for govemments are
fundamentally at odds. It often takes more than a
dceadefor anindustry tocreate eompetitive advan-
tagethcproeessentails thelongupgradingof human
skills, investing inproducts andprocesses, building
clusters, andpcnetrating foreigomarkets. lothecase
of the Japaneseauto industry, for instance, compa-
niesmadetheir first faltcringstepstowardexporting
in the 1950s-yet did not aemeve strong interna-
tional posirioos until the 19708.
But in polltics, a decade is an eternity. Canse-
quent1y,mast governments favor policies that offer
casilyperceivedshort-term beneHts, suchassubsid-
ies, proteetion, andarrangedmergers-thc verypoli-
ciesthat retardinnovation. Mast of thcpohcies tbat
wouldmakeareal differenceeither aretooslowand
require too mueh patience far pollticians or, even
worse, carry withthemthestingof short-term pain.
Dercgulating aprotected industry, for example, will
Ieadto hankruptcies sooner and to strongcr, more
comperitive companies only latero
Policiesthat conveystatic, short-tenn cost advan-
tagcsbut that unconsciously undermine innovation
anddynamismrepresent themost common andmost
profounderror ingovernment industrial policy. Ina
desireto help, it is all too easy for governments to
adopt pollcies suchasjoint projectstoavoid"waste-
ful" R&Dthat undennine dynamism and competi-
tion. Yetevena10%cost savingthrough economies
of sca1eiseasilynullifiedthrough rapidproduct and
process improvement and thepursuit of volume in
global markets-something!hat suchpoliciesunder-
mine.
There aresornesimple, basic principIes tbat gov-
ernmerrtsshouldembracetoplaytheproper support-
ive role for national competitiveness: encourage
changc, promote domestic rivalry, stimulate innova-
tion. Sorneof thespecificpalicy approachestoguide
narions seeking to gain eompetitive advantage in-
eludethe following.
Focus on specialized factor creation. Govern-
ment has critical responsibilities for fundamentals
like the primary andsecondary education systems,
basic national infrastructure, and research in areas
87

o broad national concem such ashealth careoYet

these kinds of generalized efforts at factor creation
rarely produce competitive advantage. Rather, the
factorstbat translate into competitive advantage are
advanced, specialized, andtiedtospecificindustries
al industry groups. Mechanisms suchasspecialized
apprenticcship programs, research effortsin urnveI-
sities connected with anindustry, trarleassociation
activities, and, IDostimportant, the private invest-
ments o companies ultimately create the factOTs
that will yieldcompetitive advantage.
Avoid intervening in factor and currency m(JI-
keLS. Byintervcning intactor andcurrency markcts,
governments hope to create lower factor costs or
afavorableexchangerate tbat will help companies
compete more effectively in intemational markets.
Evidencefromaroundtheworldindicates that thesc
policies-sueh astheReaganadministration 'sdallar
devaluation-are often counterproductive. They
workagainsttheupgradingofindustry andthesearch
for more sustainablc competitive advantage.
The contrasting case of Japanis particularly in-
structive, although both Gennany and Switzcrland
havchadsimilar experiences. Over thepast 20years,
theJapanesehavebeenrockedbythesuddenNixon
curreney devaluation shock. two oi! shocks, and,
most recently, the yen shock-all of wmch forced
Japanesecompanies toupgradcther competitive ad-
vantages. Thepoint isnot that government should
pursue polieies that intentionally drive up factor
costs or thc exchange rate. Rather, when market
foreesereaterisingfactor costs or ahigher exebange
rate, government should resist the temptation to
push thero hack down..
Enforce strict produet. safety, and environmental
standards. Strict government regulations canpro-
mote competitivc advantagebystimulating andup-
grading dOIDcstiedemando Stringent standards for
product performance, product safety, and enviran-
mental impact pressurecompanies toimprovequal-
ity, upgrade technology, and provide featuIes that
respond to consumer and social demands. Easing
standards, however tempting, iseountetpmductive.
When toughrcgulations anticipate standards that
will spreadinternationally, they giveanation's com-
panies ahead start in developingproducts and ser-
vicestbat will bevaluableelsewhcre. Sweden'sstrict
standards for environmcntal protection have pro-
moted eompetitive advantage in rnany industries.
Atlas Copeo, for example, produces quiet compres-
sors that can be used in dense urhan arcas with
minimal disruption to residents. Striet standards,
however, must becombinedwitha rapidandstream-
lined regulatory process that does not absorb re.
sourees andcausede1ays.
ShaIply limit direet cooperation among industry
rivals. Themost pervasiveglobal policy fadinthe
88
competitiveness arenatoday isthecall for moreco-
operativeresearchandindustry consortia. Operating
onthe belief that independent research by rivals is
wasteful and duplicative, that eollaborative efforts
acmeveeconomies of scale, andthat individual com-
paniesarelikelyto underinvest inR&Dbeeausethey
cannot reapa11the beneHts, govemments haveem-
braeed the idea of more direct cooperation. In the
United States, antitrust laws havcbeen modifiedto
allowmore cooperative R&D; in Europe, megapro-
jcets sueh as ESPRIT, an infonnation-teehnology
projcet, bringtogether companies fromseveral coun-
tries. Lurking behind much of this thinking is the
fascinaton of Westerngovernments with-and fun-
damental misunderstanding of-the countlcss coop-
erative researeh projects sponsored by the Ministry
of International TradeandIndustry {MITII,projects
that appear tohavecontributed to]apan's competi~
tiverise.
But acloser look at Japanesecoopcrativeprojects
suggestsadifferent story. Japanesccompanies partic-
ipate in Mmprojects to maintain goodrclations
with Mm, to preserve their corporate images, and
tohedgetherisk that competitors will gainrorothe
pmjeet-largely defensiverensons. Companies rarely
contribute theiI best scientists andcngineers to co-
operativeprojects andusua11yspcndmuch more on
their own private research in the saroe field. Typi-
cally,thegovernment makes onIyaroodest financial
contribution tothe projeet.
Thereal value of Japanesecooperativeresearch is
tosignal theimportance of emergingtcehnical areas
andtostimulate proprietary eompany research. Co-
opcrativeprojectsprompt companies toexplorenew
fields and baost internal R&D spending because
eompanies know that their domestic rivals are io-
vestigating thero.
Under eertain limited eonditions, cooperative re-
seareh can prove beneficia!. Projects should be in
areas of basic product and process researeh, not in
subjects c1ose1yeonnected to acompany's proprie-
tary sourees o advantage. They should eonstitute
onlyamodcstportion ofacompany's overall research
program in any given field. Cooperative researeh
shouldbeonIyindirect, channeled through indcpen-
dent organizations to which most industry partici-
pants have aecess. Organizational struetures, like
university labs and eenters of exeellence, reduce
management problems andminimize thc risk tori-
valry. Final1y,the most useful cooperativc projects
ofteninvolvcfieldsthat touchanumber ofindustries
andthat require substantial R&Dinvestrncnts.
Promote goals mat lead to sustained invest-
ment. Covernment has avital rolein shaping the
goalsofinvestors, mana.gers,andemployees through
policies invarious areas. Themanner inwhich capi-
tal markets areregulated, for example, shapes the
HARVARDBUSINESSREVIEW March-Aprill990

incentives of invcstors and, in turo. the behavioI of

companies. Government should aim to encouragc
sustainedrnvesnnent inhumanskills, ininnovatian,
andinphysical assets. Perhaps the single most pow.
erful tool arraisingthetateof sustained investment
inindustry isataxincentive farlong-terro(fiveyears
OI more)capital gainsrestrictcd tonewrnvestment in
corporateequity. Long-termcapital gainsincentives
should also be applicd to pemioo funds and other
currently untaxedinvestors, whonowhavefewTea-
sonsnot toengageinrapidtrading.
DereguJate compelition. Regulation of competi-
tian through such policies as maintaining a state
monopoly, controlling entry into anindustry, al fix-
ing prices has twa strong negative consequences: it
stifles rivalry andinnovatian ascompanies become
preoccupied with dealing with regulators and pro-
tecting what they already bave and it makes tbe
industry aless dynamic andless desirablebuyet or
supplier. Deregulation and privatization on theI
own, bowever, will not succeed without vigorous
domestic rivalry-and tbat requires, as acorollary,
astrong andconsistent antitrust poliey.
Enfolce stmng domestic antitrust polides. A
strong antitrust policy-espeeially for borizontal
mergers, alliances, andcollusivebebavior- isfunda-
mental to innovation. Whileit isfasrnonabletoday
tocall formergersand allianeesintbenameofglobal-
izationandthecreationofnational champions, thcse
oftenundcrminc theereation of eompetitive advan-
tage. Real national eompetitiveness requires gov-
ernrncnts to disallow mergers, acquisitions, and
alliances tbat involveindustry leaders. Furtbennore,
thc samestandards formergers andallianccs sbould
apply to both domestie and foreign companies. Fi.
nally, government paliey sbouldfavorinternal entry,
botb domcstic and intemational, over acquisition.
Companies should, however, beallowed to acquire
small companies in related industries when the
movepromates thetransfer of skills tbat couldulti-
mately createcompetitive advantage.
Re;ect managed uade. Managedtradereprcsents
agrowing anddangcraus tcndency for dealing with
thefallout ofnational competitiveness. Orderly mar-
keting agrccrncnts, voluntary restraint agreements,
orother devicestbat setquantitative targetstodivide
up markets are dangerous, incffectivc, and often
enormously costly to consumers. Ratber tban pro-
moting innovation inanation's industries, managed
tradeguarantccs amarket for ineffieient companies.
Govemmcnt tradepolicy shouldpursueopenmar-
ket access in cvcry foreignnation. Tobeeffective,
tIade poliey should not beapassive instrument it
cannot respondonly tocomplaints or work only for
those industries tbat can muster enough political
clout; it shouldnot requirealonghistory ofinjury or
selVeonly distressed industries. Tradepoliey should
HARVARDBUSINESSREVIEW March-Aprill990
seektoopenmarkets wberever anationhascompeti-
tiveadvantageandshouldactivcly addressemerging
industries andineipient problems.
Wheregovernment findsatradebarrier inanother
nation, itshouldconcentrate itsremedies ondisman-
tling barriers, not onregulating imports or exports.
InthecaseofTapan,forexample, pressurc toacceler-
atethealreadyrapidgrowthofmanufactured imports
isamoreeffeetiveapproachtban ashift tomanaged
trade. Compensatory tariffs tbat punish companies
forunfair tradepractices arebetter tban market qua-
tas. Other increasingly important tools toopenmar-
kets are restrictions that prevent companies in
offending nations frominvesting in acquisitions or
production facilities in tbe host country-thereby
blocking tbe unfair country's eompanies romusing
their advantagetoestablish anewbeachhead tbat is
immune fromsanctions.
Any oftheseremedies, however, canbackfire. Itis
virtually impossibleloeratt remedies tounfair trade
practices tbat avoidbothreducing incentives for do-
mestic companies toinnovate andexport andhann-
ingdomestie buyers. Theaimofremedies shouldbe
adjustments tbat allowtheremedy todisappear.
TheCompony Agenda
Ultimately, only companies themselvcs can
acmeve and sustain competitive advantage. To do
so, they must aet on the fundamentals described
ahoye. Inparticular, tbey must recognizcthc central
roleofinnovation-and thcuncomfortable truth tbat
innovation grows out of pressurc and challenge. It
takes leadersmp to create a dynamic, cballenging
environment. And it takes leadersrnp to recognize
the all-too-easy escaperoutes that appcar to offer a
path lo eompetitve advantage, but are actually
short-cuts to failure. For examplc, it is tempting to
rely on cooperativeresearch anddevelopment proj.
ects tolower the cost andrisk of research. But they
can divert company attention and resources from
proprietary researcheffortsandwill all but eliminate
theprospects far real innovation.
Competitive advantageatisesfromleadcrship that
barnesses and amplifies the forces in the diamond
topromote nnovation andupgrading. Rere arejust
afcw of the kinds of company policies that will
support that effort:
Create pressures faI innavauon. A company
should seek out pressure and challenge, not avoid
them. Part of sttategy is to take advantage of the
home nation to ereate the impetus for innovation.
Todotbat, companies canseUtothemost sophisti-
catedanddemanding buyers andcbannels; seek out
thosebuyers with thcmost difficult needs; establish
"

norms that exceed the toughest regulatory hurdles

Uf product standanls; sourcefromthe most advanced
suppliers treat employees aspermanent inarder to
stimulate upgrading of skills andproductivity.
Seek out the most capable competitors as motiva-
tor$. To motivate organizational change, capable
competitors and respected rivals can beacommon
enerny. Thebest managers a1waysron alittle scared;
they respect andstudycompetitors. Tostay dynamc,
companies must make meeting challenge apart o
thc organizatan 's norms. For example, lobbying
against strict product standards signals theorganiza-
tion that company leadership hasdiminishcd aspira-
tioos. Companies that value stability, obedient
customers, dependent suppliers, and sleepy competi-
tor8areinviting inema and, ultimately, failure.
Establish early-warning systems. Early-waming
signals translate into early-mover advantages. Com-
panies cantakeactions that helpthemseethesignals
of change and aet on them, thereby getting ajump
on the competition. Por example, they can find and
servethosc huycrswith themost anticipatory needs
investigate all emergingnewbl1yersorchannels; find
places whosc rcgulations foreshadow emerging regu-
lations elsewhere bring sorne ol1tsiders mto the
management team; maintain ongoing relationships
with research centees andsourccs of talented people.
Improve thenational mamond. Companics have
avital stake in making their horne enviromnent a
bcttcr platform for intemational success. Part of a
company's responsibility is to play an active rolein
forming clusters and to work with its home.nation
buyers, suppliers, andchannels tohelpthero upgrade
and extend their own compctitive advantages. To
upgradehome demand, for examplc, lapanesc mum-
cal instrument manufacturers, led by Yamaha,
Kawai, and Suzuki, have established music schools.
Similarly, companies canstimulate andsupport local
suppliers of important specialized inputs-including
encouraging thero to compete globally. The health
andstrcngth of thenational clusterwillonly enhance
thecompany's ownrateof innovation andupgrading.
In nearly every successful cornpctitivc industry,
lcading companies also take cxplicit steps to create
specialized factors likc human resources, scientific
knowledge, or infrastructure. Inindustries likewool
c1oth, ceramic tiles, and lighting equipment, Italian
industry associations invest inmarket information,
process technology, and common infrastructwe.
Companies can aIso specd innovation by putting
their headquarters and other key operations where
there are concentrations of sophisticated buyers,
important suppliers, or specialized factor-creating
mechanisms, such as universities or laboratories.
Welcome domestic rivauy. Tocompete globally,
acompany needs capable domestic rivals andvigor~
90
ousdomestic rivalry. Especially intheUnited States
and Europe today, managers arewont to complain
about excessivecompetition andtoargueformergers
andacquisitions that will produce hoped-for econo-
mies ofscaleandcritica! mass. Thecomplaint isonly
natural-but the argument is plain wrong. Vigorous
domcstic rivalry creates sustainable competitive ad.
vantage. Moreover, it is better to growintemation-
ally tban to domnate the domestic market. If a
company wants an acquisition, a foreign one that
canspeedglobalization andsupplement home-based
advantages or offset home-based disadvantages is
usually far better than merging with leading domes-
tic competitors.
Globalize totap selective advantages in other na-
tions. Insearchof "global" strategies, many compa-
mes today abandon their home diamond. TobeSUfe,
adoptingaglobal perspective isimportant tocreating
competitive advantage. Hutrelying onforeignactivi-
ties that supplant domcstic capabilities is always a
second.best solution. Innovatingto offsetlocal factor
disadvantages isbetter than outsourcing; developing
domestic suppliers andbuycrs isbetter than relying
solely onforcignones. Unless the critical underpin-
nings of competitiveness arepresent at horne, com-
panies will not sustain competitive advantageinthe
long runoThe aimshould beto upgradc horne-base
capabilities so that foreign activities are selective
and supplemental onIy to over-all competitive ad.
vantagc.
The correct approach toglobalization isto tap se-
lectively into sources of advantage inother nations'
diamonds. For example, identifying sophisticated
buyers in other countries helps companies under-
stand different needs and create.."l prcssures that will
stimulate afaster rateof innovation. Nomatter how
favorable the horne diamond, moreover, important
research isgoingoninother natioflS. Totakeadvan-
tage o foreign research, companies must station
high-quality people in overseas bases and mount a
credible Ievel of scicntific effort. To get anytrnng
back rorn foreign research ventures, cornpanies
must also allow access to their own ideas-
recognizing that competitive advantage comes from
continuous improvement, not romprotecting too
day's secrets.
Use alliances only selectively. Alliances with
foreigncompanies havebecome another managerial
fadandcure-all: they represcnt atempting solution
totheproblemof acompany wanting theadvantages
offoreignenterprises orhedgingagainst risk, without
giving up independence. In reality, however, while
alliances canachieve selectivebenefits, they always
exact significant costs: they involve coordinating
two separate operations, reconciling goals with an
independent entity, creatinga compctitor, andgiving
HARVARD BUSINESS REVIEW March-April1990
\
>

up profits. Thcsc cost.ultimately make most 3lli.

ancc.'l short.term transitional devices, rather than
stablc, long-terro rclationships.
Most important, allianCC!'!asahroo.d.bascd stratcgy
will ooly Cn5urc acompany's rncdiocrity, nOl it5in-
tcrnationallcadcrship. No campany can rely on an-
other outsidc, ndependent company far skills and
assct."l tbat are ccnt:rn.l to i18competitive advantagc.
AlHanees are bcst used a.c;asclcctivc tool, cmployed
on atemporary basis ar involving nancore activitics.
Locate the home base to support competitive ad-
vantage. Among thc most important decisions fOl
multinational companics is the nation in whicb to
lacate the horne base fOl cach distinct business. A
company can have difierent horne basc:>for distinct
busincsses ar segments. Ultimately, compctitivc ad.
vantagc i5 crcatcd al horne: jtis where strategy is
sel, the core product and proecss tcchnology is cre.
atcd, and a critical mass of production takcs place.
The circumstanees in the home nation must support
innovarion; otherwisc the company has no choice
hut to movc t.o; home ba.'leto acountry that stimu-
lates innovation and tltat providcs the bcst environ.
ment lar global competitiveness. There are no hall.
measurcs: the management tearo must move aswell.
HARVARD RUSlNESS REVIW M.n.rc:b-Aprill990
TheRole01l.eodership
Too rnany companics and top managers misper-
ceive the nature of compctition and the task belore
them by locusing on improving financial perfor-
mance, soliciting govcmmcnt assistance, seeking
stability, and rcducing risk through allianees and
metgerS.
Today's competitive rcalities dcmand lcadership.
Lcaders belicvc in change they cnergize their organi.
zatioos to innovate continuously they recognize the
importancc al thcir home country asintegral to their
competitive success and work to upgrade it. Most
impOrtant, leaders recognize the need lar prc-'lsurc
and challcnge. Becausc they are willing to encourage
appropriate-and painful-govemrnent policies and
rcgulations, thcy often caro the titlc "statesrnen,"
a1though fewset: tbemselves tbat way. Thcy arepre-
pared to sacrificc the easy lifefar difficulty and, u!ti.
mately, su.'ltained compctitive advantage. That must
bethe goal, lar both nations and companics: not just
surviving. but achieving intcmational compctitive-
ness.
And not just oncc, hut continuously.
91