This article, the first of a two-part series, shows how the value-added chain can be used to analyze sources of international strategic advantages. The author argues that it is essential that a distinction be drawn between competitive and comparative advantage. He illustrates the importance of this distinction by looking at structural shifts in the world economy and arguing that these shifts reflect changes in comparative advantage. The impact of these changes leads to only a few choices for the firm facing import competition and possessing no competitive advantage. The author stresses that if the global advantages acquired by international participation are not sustained, competition reverts to domestic competition among firms with different national names.
1. For a discussion of location- and firm-specific advantages in terms of foreign direct investment, see the seminal article by John Dunning, “Trade, Location of Economic Activity and the MNE: A Search for an Eclectic Theory,” in The International Allocation of Economic Activity, edited by B. Ohlin et al. (London: Holmes and Meier, 1979).
2. For a complete statement, see Michael Porter, Competitive Strategy (New York: Basic Books, 1981).
3. Although the concept of the value-added chain has been circulated among consultants and academics for several years, it has only recently been discussed in academic publications. See, for example, Bruce Kogut, “Normative Observations on the International Value-Added Chain and Strategic Groups,” Journal of International Business Studies, Fall 1984, pp. 151–167 and Michael Porter, Competitive Advantage (New York: The Free Press, 1985).
4. Although we cannot pursue this point further, it is important to note that the decision to divest because of a relative cost disadvantage may be deterred because of supply or price uncertainty arising from a scarcity of suppliers. For the impact of small numbers of suppliers on the decision to source externally, see Oliver Williamson, “Transaction-cost Economics: The Governance of Contractual Relations,” Journal of Law and Economics, October 1979, pp. 233–261.
5. I thank Stephen Schaubert for his description of how Bain & Company have applied the value-added chain to an analysis of the steel industry.
6. The microeconomic underpinnings of our approach is the treatment of goods as bundles of attributes that differ in terms of consumer demand. For this line of inquiry, see the seminal article by Kevin Lancaster, “A New Approach to Consumer Demand,” Journal of Political Economy 74 (1966): 132–57 and the interesting extension to product rivalry by Richard Schmalensee, “The Ready-to-Eat Breakfast Cereal Industry,” Bell Journal of Economics 9(1978): 305–27.
7. The costs of redeploying assets result in the existence, to use a term from the strategy literature, of different “strategic groups.” These different product-market strategies can be mapped back upon the value-added chain.
8. See H. Ebeling and L. Doorley, “A Strategic Approach to Acquisitions,” Journal of Business Strategy 3 (1983): 44–55.
9. Our discussion is consistent with a theory of foreign direct investment called the international product life cycle, which predicts that as products become more standardized, their production shifts to sourcing from overseas plants. See the collection of articles edited by Louis Wells, The Product Life Cycle (Boston: Harvard Business School Press, 1972).
10. See Alan Deardorff, “Weak Links in the Chain of Comparative Advantage,” Journal of International Economics 9 (1979): 97–209.
11. The term “profits” may cause some confusion. Profits are earned as a competitive payment to capital. Earnings in excess of the competitive return to capital are considered excess profits or economic rents.
12. Our ordering is drawn from data give by Chad Leechor, Harinder Kohli, and Sujin Hur in Structural Changes in World Industry: A Quantitative Analysis of Recent Developments (Washington, D.C.: World Bank, 1983).
13. Assuming competitive markets, the production of intermediate goods is defined as the value of the output minus the intermediate good inputs. Because labor and capital are paid their marginal products, and there are no excess profits, we can also order intermediate products along an isocost line.
14. This and the following data are drawn from Robert Ballance and Stuart Sinclair, Collapse and Survival: Industry Strategies in a Changing World (London: George Allen & Unwin, 1983) and Leechor et al. (1983).
15. See Gerald Helleiner, “Transnational Corporation and Trade Structure: The Role of Intra-firm Trade,” in On the Economics of Intro-industry Trade, edited by H. Giersch (Tubingen: J.C.B. Mohr, 1979).
16. See John Dunning, “Changes in the Level and Structure of International Production: The Last One Hundred Years,” in The Growth of International Business, edited by M. Casson (London: George Allen & Unwin, 1983).
17. The inadequacy of the Heckscher–Ohlin model, which rests upon comparative advantage, to explain intro-industry foreign direct investment and trade has led to a number of new theories which incorporate product differentiation and economies of scale as critical variables. For a representative work, see Paul Krugman, “Increasing Returns, Monopolistic Competition, and International Trade,” Journal of Political Economy 9 (1979): 469–79.
18. For a variety of reasons, firms may choose to enter into joint ventures, license, or franchise. Most studies show, however, that a firm tends to maintain full ownership over its strategic assets unless it can arrange enforceable claims on their use and derived profits.
19. See Kogut (1984).
Research for this article was funded by the Reginald H. Jones Center of The Wharton School. The author thanks Ned Bowman, Paul Browne, Jean Francois Hennart, Laurent Jacque, Franklin Root, Harbir Singh, and Louis Wells for their help.