The design of international strategies is based upon the interplay between the comparative advantages of countries and the competitive advantages of firms. These two advantages determine the answer to the two principal questions in international strategy:
- Where should the value-added chain be broken across borders?
- In what functional activities should a firm concentrate its resources?
Answers to both of these questions are affected by comparative and competitive advantage. Comparative advantage, sometimes referred to as location-specific advantage, influences the decision of where to source and market. It is based on the lower cost of a factor (labor, for example) in one country relative to another, favoring industries that use this factor intensively. Competitive advantage, sometimes referred to as firm-specific advantage, influences the decision of what activities and technologies along the value-added chain a firm should concentrate its investment and managerial resources in, relative to other firms in its industry. It stems from some proprietary characteristic of the firm such as a brand name, which cannot be imitated by rivals without substantial cost and uncertainty.1 The value-added chain is the process by which technology is combined with material and labor inputs, and then processed inputs are assembled, marketed, and distributed. A single firm may consist of only one link in this process, or it may be extensively vertically integrated, such as steel firms that carry out operations that range from mining ore to fabricating final goods.
Competitive and comparative advantages are not completely independent of each other. Firms differ in location of sourcing of their production and can, therefore, acquire a competitive edge with superior exploitation of the comparative advantages among countries. Thus, differences between firms regarding the location of their sourcing can give rise to strategic advantages. It is therefore important to distinguish between strategies based on competitive advantage and those based on comparative advantage.
It is the interaction between comparative and competitive advantage in the international strategy of firms that is examined in this article. The concept of the value-added chain is developed in order to analyze the competitive position of the firm in a global industry. The first section develops the use of the value-added chain for structuring the strategic allocation decision. The second section turns to developing the concept of comparative advantage; an international production chain for countries is derived from differences in factor costs.
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).