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Competitive Advantage

A. Tony Prasetiantono
Faculty of Economics Gadjah Mada University

Absolute, Comparative, and Competitive Advantage
Absolute Advantage: Adam Smith (1776) Comparative Advantage: David Ricardo (1840).  Productivity is enhanced if each country specializes in those goods for which it has lowest opportunity cost.  The result of such a system is a more efficient global use of resources, greater output and consumption, and lower prices.

Comparative Advantage

What determines the goods for which a country has a comparative advantage? Eli Heckscher and Bertil Ohlin pointed to the correspondence between a country’s factor endowments—that is, how much land, labor and capital it has—and the factor intensity of the goods it produces.

Development and the Theory of International Trade

Products that require much land and relatively little labor (such as wheat) should be produced by those countries with high ratios of land to labor; while those goods that have higher labor requirements (such as inexpensive clothing) should be produced by countries with high ratios of labor to land and labor to capital. Capital intensive goods, such as jet aircraft, should be produced in those countries that have accumulated significant amounts of capital goods.

Terms of Trade

A country’s terms of trade (TOT) are measured by comparing an index of the prices of its export goods to an index of the prices of its import goods. This ratio, Px/Pm, known as the net barter terms of trade.

The Prebisch-Singer Thesis

Raul Prebisch (Argentina) suggested in 1950s that the prices of primary exports of the poor countries were deteriorating as the result of trade, while prices of the manufactured products of the industrialized countries were either constant or increasing. Developing countries were suffering from worsening living standards and also becoming stuck in a pattern of producing and exporting primary goods, which would keep them poor. Similar findings were reported by Hans Singer.

The Infant Industry Argument

Alexander Hamilton used the infant industry argument that new industries cannot compete internationally in their early stages. It could therefore be acceptable to protect the industry temporarily until it matured. However, protection brings inefficiencies, which are usually politically expedient.

Import Substitution

Import Substitution: government promotion of industrial development by restricting imports is referred to as a strategy.

What Determines Exchange Rates?

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Purchasing power parity (PPP) “Big Mac index” (The Economist magazine) Inflation rate Balance of payments International reserve Psychology


Export orientation (or export promotion) advocates suggest that a dollar earned from exports is more valuable than a dollar saved through importing.

Competitive Advantage Defined (1)

When a firm earns a higher rate of economic profit than the average rate of economic profit of other firms competing within the same market, the firm has a competitive advantage in that market. Competitive advantage requires a firm to create value to outperform competitors.

Competitive Advantage Defined (2)

Whether a firm has competitive advantage or disadvantage depends on whether the firm is more or less successful than rivals at creating and delivering economic value. A firm that can create and deliver more economic value than its competitors can simultaneously earn higher profits and offer higher net benefits to consumers than its competitors can.

Competitive Advantage, Consumer Surplus and Value Creation

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Market: Supply and Demand Curves Maximum willingness to pay for the product Equilibrium Consumer Surplus Case: Mercedes-Benz Vs. Japanese Lexus, Infiniti, and Acura Value Created = Consumer Surplus + Producer’s Profit

Value Creation and Michael Porter’s Value Chain
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Porter distinguishes between 5 primary activities and 4 support activities. Five primary activities are (1) inbound logistics, (2) production operations, (3) outbound logistics, (4) marketing and sales, and (5) service. Four support activities are: (1) firm infrastructure, e.g. finance, accounting, legal; (2) human resources management; (3) technology development; (4) procurement.

Cost Advantage (1)

A firm with a cost advantage creates more value than its competitors by offering products that have a lower cost. The firm can achieve benefit by exploiting economies of scale to lower average costs relative to rivals. The firm automates processes that are better performed, hires fewer skilled workers, purchases less expensive components. Yamaha’s cost advantage over Steinway & Sons, is a good example of this.

Cost Advantage at Cemex (1)

Mexico’s Cemex is the 3rd largest cement manufacturer in the world behind France’s Lafarge and Switzerland’s Holcim. Cemex now operates worldwide, claiming market leadership in Mexico, Egypt, Spain, the Philippines, and a number of Latin American markets. In 2000, it posted annual revenues of US$5.6 billion.

Cost Advantage at Cemex (2)

By exploiting economies of scale, increasing automation, and exploiting information technology, Cemex has maintained the low costs and flexibility necessary to markedly outperform its rivals in these markets. However, Cemex is not without problems. It is saddled with debt, mainly from its many acquisitions. (In Indonesia: they have 25% shares in Semen Gresik Group).

Cost Advantage (2)

A firm may offer a product that is qualitatively different from its rivals. Many people continue to use the U.S. Postal Service rather than private delivery services, such as Federal Express, because the cost savings are worth the lower quality for some services.