5 - External Economies: Organization of Interfirm Relations

Summary

[E]xecutives must extend their thinking beyond what goes on inside their own organizations and within their own industries. Strategy must also address what goes outside.

(Porter 1998, 86–7)

Introduction

External economies contribute to the competitive advantage of a firm. The sources of external economies may be at the industrial level, national level or international level. At the industry level the previous existence of other industrial firms and their experience will provide newcomers with external economies; these firms may be suppliers or engaged in distribution or other downstream activities. The large size of the market is the most important source of external economies because it not only allows for the specialization and division of labour at the industry level, but is also necessary for the materialization of internal economies. External economies may also arise from agglomeration: collective efficiency through clustering, industrial districts and production sharing and, further, from learning and experience at the industry level. At the national level, the existence of developed infrastructure, efficient institutions and availability of back-up services is beneficial to a firm through their dampening influence on production and distribution costs. Thus government policies which aim at provision of these facilities contribute to external economies indirectly. Further, a favourable national reputation (e.g. the Japanese reputation in electronics) allows a firm to engage in mass production and thus increase returns. Ethier (1982) argues that the source of external economies can also be international: in the age of globalization economies resulting from agglomeration, production sharing among various countries, etc.