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Porter's diamond model and opportunity recognition: a cognitive perspective.

INTRODUCTION

Opportunity recognition has been accepted as a crucial element in entrepreneurship. Although past research has investigated opportunity recognition focusing on various factors in the external environment and the individual to date a numerous body of opportunity recognition research revealed that there is a need to examine opportunity recognition under different theoretical approaches drawn from other fields (Short, Ketchen, Shook and Ireland, 2010; Corbett and Mcmullen, 2010).

This research applies a multidisciplinary approach and examines the Porter's diamond theory of the competitive advantage of nations drawn from the strategy field and investigates how these four determinants influence entrepreneurs in recognizing opportunities. Although a numerous body of early research investigated opportunity recognition as a joint function of the external environment and individual to date limited attention is provided on the interplay between certain factors in the external environment and cognitive underpinnings in this process. Previous research pointed out the importance of cognitive characteristics in opportunity recognition research (Koen, Markman, Baron and Reilly, 2001, Julien and Vaghely, 2001, Corbett, 2005; Corbett, Mcmullen, 2010) and suggested further exploration of the cognitive underpinnings in the opportunity recognition process. In other words, extensive studies are required to understand "why" and "how" the mental mechanism is triggered in mobilizing external resources in recognition of opportunities. Further early studies have in common that although there were some entrepreneurial theory developments opportunity recognition research on entrepreneurship cognition still lacks a substantial theoretical foundation (Corbett and Mcmullen, 2010).

In this study by drawing a theoretical model from the strategy field we attempt to examine "how" industry competitiveness triggers entrepreneurial mindset and influences entrepreneurs acquire and transform information and identify opportunities. This paper attempts to advance the existing research by providing a multidisciplinary approach and studies the Porter's diamond model drawn from the strategy field and investigates the cognitive underpinnings in the opportunity recognition process. We suggest that the analysis of cognitive context that exists behind the Porter's diamond model and how it relates to potential entrepreneurs will help us underpin the opportunity recognition process.

We now present the literature review on opportunity recognition to provide the foundation of the conceptual connection of the study and next we investigate the relationship between the Porter's diamond model and the entrepreneurial mindset. Finally we discuss implications of the study and future research agenda.

OPPORTUNITY RECOGNITION

A numerous body of research increased investigated opportunity recognition and explained opportunity recognition through various approaches (Schumpeter, 1934; Kirzner, 1973; Drucker, 1985; Stevensen et al., 1998; McMullan and Long, 1990; Bhave 1994; Baron and Shane, 2008, Ozgen and Baron, 2007). A stream of research found that the external environment plays a crucial factor in creating opportunities as opportunity recognition is a process influenced by many contextual factors in the external environment (Gaglio and Taub, 1992; Singh, 1998), most importantly the availability of resources (Timmons, 1994) and assorted technologies (Zahra, 2008). Based on this reasoning, environmental contexts and technology, consumer economics, social values and governmental regulations (Stevensen and Gumpert, 1985) and changing trends in the present, i.e. social behavior patterns, market circumstances and technology (McMullan and Long, 1990), networks, demand and supply gaps, price differences, technology substitution and innovation (Thakur, 1999) , technological change (Shane, 2000); environmental dynamism (Wiklund and Shepherd, 2003); industry deregulation (Jennings and Seaman, 1990); industry characteristics and geographic dispersion (Davidsson, 1991) play a crucial role in opportunity recognition (Short, Ketchen, Shook and Ireland, 2010). .

In other words entrepreneurs identify opportunities by using different types of information about the environment (Busenitz and Barney, 1997). They make a habit of scanning their environments for information that may lead to entrepreneurial opportunities (Stewart, May and Kalia, 2008). Focusing on markets and changes in industry structure (Kuratko and Welsch, 2001); market inefficiencies (Denrell et all, 2003); and transaction cost and property rights (Foss and Foss, 2008) increase the probability of recognizing opportunities.

A stream of research focused on the role of an individual in the opportunity recognition process. An entrepreneurial opportunity is a market imperfection that can be exploited by bringing market to equilibrium (Kirzner, 1973). This implies that opportunities exist all around us yet only those who are "alert" to possibilities that the market presents have the ability to recognize them. (West and Myer, 1997). A body of research found opportunity recognition highly associated with the cognitive skills of certain individuals (Baron, 2006; Shane 2009) as entrepreneurs use cognitive insights and spend more time than non-entrepreneurs in searching information that lead new opportunities (Kaish and Gilad, 1991; Gaglio, 2004). In sum the understanding of the cognitive aspects of entrepreneurship (i.e. the way entrepreneurs perceive information and process knowledge) is required to articulate the techniques that help entrepreneurs recognize opportunities. Therefore from the theoretical perspective, to be able to explore opportunity recognition early studies draw attention to the entrepreneurs' cognitive skills (Koen, et al, 2001, Julien and Vaghely, 2001, Corbett, 2005). It was found that opportunity recognition is highly associated with the entrepreneurial alertness (Archvili, Carozo and Ray, 2003; Chiles et al, 2007); prior knowledge of a particular field (Shane, 2000); mental stimulation (Gaglio, 2004); behavioral, cognitive and action learning (Lumpkin and Lichstenstein, 2005); social capital and cognitive biases (De Carolis and Saparito, 2006). Applying the experiential learning theory Corbett (2005) found the importance of different learning modes in opportunity recognition. Corbett (2005) suggested that experiential learning facilitates the recognition of opportunities and argued that future research should focus on the cognitive insights and how individuals use and store information to exploit opportunities drawing other theories from other fields. Applying the social cognitive theory Gaglio (2004) studied a few selected cognitive mechanism and found that mental stimulation and counterfactual thinking play an important role in recognizing opportunities. Lumpkin and Lichstenstein (2005) also examined the link between the cognitive learning and opportunity recognition and found that tacit knowledge is crucial in recognizing market opportunities and suggested to further expand the cognitive insights into opportunity recognition research. Based on the inductive theory building and network theory (Dyer, Geregersen and Christensen, 2008) found that the cognitive mechanism that involves observing, experimenting, idea networking and "questioning" provide the mechanisms by which opportunities are recognized.

A growing body of research suggested that examining opportunity recognition as a joint function of individual and the environment (Singh, 2000; Shane and Ventakaraman, 2000; Baron, 2002; Ozgen and Baron, 2007) will help us better understand the opportunity recognition process. Previous research found the relation between the market changes and the entrepreneur (Eckerd and Shane, 2003); interaction between social systems and entrepreneur (Sarason, et al, 2006) and a combination of cognitive skills and information (Gregoire, Barr and Shepherd, 2010) will play a crucial role in opportunity recognition. De Carolis and Saparito (2006) applied social cognitive theory in understanding entrepreneurial behavior and confirmed that the interaction between the environments and cognitive factors play an important role in entrepreneurial behavior. De Carolis and Saparito (2006) focused on social networks and individual cognition and suggested that future research should extend the interplay between environments and individual cognition and look into various factors that might influence entrepreneurial behavior and new venture success.

In sum although various approaches were applied in the early opportunity recognition research most research is in common that information is central in the process and various sources of information and the interplay between entrepreneur and a range of factors in the environments need to be examined to better understand the process.

Previous studies also revealed that there is a need to study entrepreneurial behavior under different theoretical lenses or in a multidisciplinary approach. To date "how" industry competitiveness influences entrepreneurs synthesize and organize information and identify opportunities has not, as yet, been investigated. Extending previous research this study examines the Porter's diamond model (the competitive advantage of nations) drawn from the strategy field and studies how it influences the way entrepreneurs think and recognize opportunities.

THE PORTER'S DIAMOND THEORY OF THE COMPETITIVE ADVANTAGE OF NATIONS

The competitive advantage of a nation or a region is partly attributed to the competitive advantage in particular industries (Porter, 1990). The Porter's "diamond of advantages" model (1990) includes four determinants of industry competitiveness or national advantage i.e. factor (input) conditions, home demand conditions, related and supporting industries and industry strategy structure and competitiveness. The model suggests causes of productivity with which companies compete in different country and regional setting. Early research examined industry clusters originated from the Porter's diamond model in opportunity recognition and found that geographic concentration of industry clusters helps ease technology transfer and innovation (Tan, 2006). (Lehtinen, Poikela and Pongracz (2006) confirmed that the determinants of the Porter's diamond model create industry clusters and impact new business ventures. Although previous research investigated the impact of industry clusters on entrepreneurial ventures early studies did not specifically inspect the relation between each of the determinants (i.e. contexts) of the Porter's diamond model and the opportunity recognition. In fact early studies suggested that when examining the opportunity recognition process efforts need to be made to include the key contextual characteristics in the environment as moderators of opportunities (Short, Ketchen, Shook and Ireland, 2010). Therefore extending previous research we suggest that further investigating the role of each determinant of the Porter's diamond model on opportunity recognition and how it triggers entrepreneurial mindset will be of value. The analysis of cognitive context that exists behind the Porter's diamond model and how it relates to potential entrepreneurs will help us underpin the opportunity recognition process. We now turn to the determinants of the Porter's diamond model.

Factor Conditions

Factor conditions refer to home country production factors including human, material, knowledge and capital resources and infrastructure (Porter, 1990). Human resources include skilled workforce; material resources include availability of raw materials; knowledge resources include the education level, quality of research; capital resources refer to the availability of assets and social capital (network connections) and infrastructure include both physical and legal regulatory infrastructure and refer to the basic foundation, facilities or services, needed for the functioning of society, such as sewer, transportation, communications and school systems, water and power lines etc and government policies and programs.

Porter suggests that each country or region has certain factor conditions and develop competitive advantages for industries in which these factor conditions are considered optimal. We also think that the extent of factor conditions in a country or region drive opportunity recognition in certain industries triggering entrepreneurial mindset due to the speed of knowledge transfer and access to specific resources. In other words the entrepreneurial behavior is guided in choice of market or industry by the availability of resources in the environment.

For instance, let's take infrastructure. Although it is widely accepted that basic physical and legal infrastructure development, availability of financing (Kulawczuk, 1998) and spending on infrastructure improvements (Bruinsma, Nijkamp, & Rietwald, 1992; Van de Ven, 1993) are correlated with the level of entrepreneurial activities across different countries (Zacharakis, Reynolds & Bygrave, 1999) to date there is limited research on "how" the level of infrastructure influences opportunity recognition. We think that heavy regulations, bureaucratic rules on obtaining business license, or lack of funding in some regions or countries may limit access to some markets, financial services and credit, and thereby creates barriers in seizing opportunities. For instance, the overall institutional environment for the development of entrepreneurship was found as less than favorable in Bulgaria, Hungary, and Latvia and infrastructure difficulties (the regulatory infrastructure scored the highest in Hungary) play a significant role in that (Manolova, Eunni and Gyoshev , 2008). On the other hand access to a well developed infrastructure such as transportation, communications, water, legal system, etc. and a good communications network in any region or country could facilitate responding to potential demand, ease technology and the speed of information exchange, and knowledge transfer and assist recognition of entrepreneurial opportunities. Spending on infrastructure development leads to a change in the industry structure thus creating a new demand and supply curve for new ideas and resources, which in turn impacts the availability of opportunities.

Also let's take the human and social capital. The availability of human and social capital in any industry in a region or country influences the recognition of opportunities. For instance, India's master weavers in the handloom industry were researched and it was found that access to social and human capital of entrepreneurs influenced their ability to recognize opportunities in this industry (Bhagavatula, Elfring, Van Tilburg, Van de Bunt, 2010). Also the success of the many industry clusters (for instance, Silicon Valley (Saxenian, 1994); insurance industry cluster in Hartford, Connecticut; banking in New York and San Francisco; electronics industry in Penang, Malaysia; furniture and palm oil in Johor, Malaysia (Arif, 2008)) are credited to the social infrastructure in these regions. In other words the accessibility to social capital and networks create favorable conditions for the exchange of knowledge and creation of new knowledge which help in recognition of opportunities.

The social capital theory basically suggests that network ties provide potential or possibilities of access to resources and information that is critical to recognition of opportunities (Nahapiet and Ghoskal, 1998). Social networks facilitate information exchange, knowledge spillover. Social network contacts of a potential entrepreneur create access to knowledge to an individual exposing him to new venture ideas. Social networking provides potential entrepreneurs access to critical resources by enlarging the knowledge that leads them to pursue a set of ideas (Floyd and Woolridge, 1999). An entrepreneur's social network contacts can expand the "bounded rationality" of the individual by offering access to knowledge (Simon, 1976). Therefore entrepreneurs use information generated from their social capital and networks and enlarge their knowledge of opportunities.

Also based on the pattern recognition theory and prototype model, Baron (2006) suggested that knowledge and learning shape individuals' mental frameworks, which influence their perception of external world. Thus, it might be easier to notice and identify opportunities through information relevant to individuals' existing mental frame. In other words knowledge embedded in individual shapes the capacity to create new knowledge (Knudsen, Dalum and Villumsen, 2001). We think that in industries where the factor conditions are "optimal" entrepreneur's continuous access to particular resources and social capital networks generates certain knowledge framework and prepares entrepreneur's mindset. Thus, entrepreneurs based on their knowledge could have increased ability to "comprehend" and synthesize new information and be alert to exploit the opportunities in that industry.

Proposition # 1a: Home country factor conditions are positively related to opportunity recognition.

Proposition # 1b: The more entrepreneurs engage in the "optimal" home country factor conditions the more effective they will be in the discovery of opportunities for new ventures (i.e., the more alert they will be to such opportunities).

Demand conditions

Demand conditions refer to the home demand for products/services produced in a country. The Porter's model suggests if the local demand for a product or service is larger than foreign markets then local firms put more emphasize developing certain products/services than foreign firms and it creates competitive advantage for the home markets. For instance due to increasing local demand for the IT the entrepreneurial activities in Europe are moving away from traditional industries towards knowledge based industries (Acs, Desai and Hessels, 2008). The growing market demand in the IT industry leads entrepreneurs shift their focus towards the IT industry and come up with innovative ideas and new ventures in the IT industry. Extending previous literature we think that demanding home market triggers entrepreneurial mindset in recognition of opportunities. We note that customer demand is an important factor for opportunity recognition (Choi and Shephers, 2004) yet having information and knowledge related with a specific market and industry speeds up entrepreneurs noticing and predicting trends and analyzing the nature of demand and recognizing opportunities (Singh, 2000).

The German-Austrian school of thought emphasizes that opportunities are not exclusively accidental events but active search and experimentation of new ideas lead to new possibilities and opportunities (Schumpeter, 1942). Therefore informed entrepreneurs scan their environments for information (Kaish and Gilad, 1991; Fiet, Clouse & Norton, 2004; Fiet, Piskounov & Patel, 2005), and focus on specific markets, industry and the customers (in this case demanding buyers and their needs) (Bhave, 1994). Systematic search on markets where entrepreneurs are knowledgeable and informed (Patel and Fiet, 2009; Fiet, Norton and Clouse, 2007) enables entrepreneurs better understand the needs and demands of the customers and thereby facilitates recognition of opportunities. In the light of the available market information potential entrepreneur's mindset is fashioned and adapted to the existing market demand and thereby more likely to explore novel ideas related with that demand. Thus, focusing on existing market demand knowledgeable entrepreneurs can introduce new products, services, sources of input or advances that lead to increased entrepreneurial behavior. In sum, individuals with information on certain market demands or industries may recognize more entrepreneurial opportunities in these industries and markets than those who have no knowledge on these industries.

Proposition # 2a: Country demand conditions are positively related to opportunity recognition.

Proposition# 2b: The more entrepreneurs engage in the country demand conditions the more effective they will be in the discovery of opportunities for new ventures (i.e., the more alert they will be to such opportunities).

Related and Supporting Industries

Related and supporting industries refer to the availability of competitive supplying and supporting industries. When industries coordinate activities and form clusters of supporting industries within the value chain they achieve a competitive advantage (Porter, 1991). We also think that the strength and competitiveness of related and supporting industries in a region/country triggers entrepreneurial mindset in recognizing opportunities. When local supporting industries are competitive new entrants continue to grow in both related and supportive industries and form clusters. Due to the ease of information flow and transactions between buyers and sellers firms can better come up with cost effective and innovative products. Clusters of related and supporting industries play a significant role in technology transfer and innovation (Tan, 2006) and facilitate coordination, efficiency and effectiveness and flexibility (Porter, 1990), lower transportation and transaction costs in the production process (Doeringer and Terkla, 1995).

The strength of the related and supporting industries in a region/country enables horizontal and vertical connections within industries (Walzer, Shumway, Gruidl, 2005) and facilitates social interaction, interchange and information flow (Saxenian, 1994; Doeringer & Terkla,1995; Jacobs and De Man, 1996; Rosenfeld,1996). Social infrastructure within the value chain of related and supporting industries eases technology and knowledge transfer (Rosenfeld 1997). We also suggest that access to social infrastructure within these industries will encourage thinking open mindedly and generate novel ideas. Applying the inductive theory building and network theory it was found that recognizing an creating an opportunity and starting an innovative entrepreneurial venture is a function of cognitive mechanism that involves observing, experimenting, idea networking and "questioning" (Dyer, Geregersen and Christensen, 2008). Experiential learning influences recognition of opportunities (Denrell and Corbett, 2005). Therefore we think that possible continuous access to particular industrial, commercial and research partners, consultants, investors, suppliers, customers, etc within the related and supported industries in a region will link entrepreneur to information sources and also improves experience related with these industries. Access to unique information will invite experimentation, enhance potential entrepreneur's critical thinking, intuition and insights and help interpretation of evaluation of information which leads to recognition of opportunities.

Proposition # 3a: Related and supporting industries are positively related to opportunity recognition.

Proposition # 3b: The more entrepreneurs engage in the related and supporting industries the more effective they will be in the discovery of opportunities for new ventures (i.e., the more alert they will be to such opportunities).

Firm Strategy, Structure, and Rivalry

The organization structure and management systems of firms in various countries influence national competitiveness (Porter, 1990). Companies build their capabilities on the fields/ industries in which they are competitive. For instance, companies in Germany have usually very systematic, highly technical, process oriented and hierarchical organization structure and as a result they build up strengths in engineering related fields. Also rivalry increases home demand.

Based on the dynamic capabilities we suggest that the firm structure, strategy and rivalry triggers entrepreneurial mindset in recognition of opportunities. Dynamic capabilities are firm specific processes,(i.e. product development, strategy, structure) and allow organizations to continuously improve the performance within the firms market position (Molin, 2001). Dynamic capabilities (Teece, Pisano & Shuen, 1997) focus on the creation of firm specific capabilities arising from their organizational structure that link its capabilities to changing circumstances. In a changing environment, firms must continuously improve their capabilities to maintain competitive advantage. Organizations often respond to challenging conditions found in instable environments by adopting an entrepreneurial behavior (Khandwalla, 1987) through dynamic capabilities. Capabilities are difficult to imitate as they are a function of organization and technology and are built over time in a path dependent process (Dierickx and Cool, 1989; Reed and De Fillippi, 1990).

Dynamic capabilities induce entrepreneurial mindset in shifting away from outdated processes to effective ones and tend to create opportunities in a firm's markets (Zahra, 1991). Based on the dynamic capabilities perspective we suggest that the more entrepreneurs rely on firm specific capabilities, such as strategy and structure that a firm has developed and perfected over time, the more likely they discover opportunities for new ventures.

Proposition # 4a: Firm strategy, structure, and rivalry are positively related to opportunity recognition.

Proposition # 4b: The more entrepreneurs engage in the firm strategy, structure, and rivalry the more effective they will be in the discovery of opportunities for new ventures (i.e., the more alert they will be to such opportunities).

We now turn to a cognitive process and examine how the Porter's diamond model may trigger entrepreneurs' pattern recognition.

Pattern recognition

A growing body of research reveals that opportunity recognition is partially a cognitive process (Baron, 2007). The pattern recognition, a crucial cognitive process, was found related to recognizing opportunities (Baron, 2006). The pattern recognition is taking in raw data and classifying data based on the category of data patterns that have already been classified in the memory (Gobet, 1997; Hayes, 2000; Duda and Stork, 2001). The pattern recognition involves taking in outside information matching with the existing information in the memory and indentifying the data category the information belongs to (Gobet, 1997; Hayes, 2000). Various pattern recognition models (i.e. prototype model, examplar model) were introduced to help us understand the pattern recognition process (Duda and Stork, 2001; Baron and Ensley, 2006). The theory of Prototype Model suggests that memory matches outside patterns with prototypes stored in the memory (Hayes, 2000).

Prototype is the "idealized representation" of a combination of certain characteristics associated with an object in one certain category (Matlin, 2002; Baron, 2004b). Information obtained from "outside sources" or "seemingly random events" is compared with the existing prototypes stored in the memory and organized in the category of a certain prototype (Hayes, 2000). Cognitive psychology suggests that people understand the meaning of the outside stimuli based on one's prototype which acquired through knowledge (Baron, 2004b; Baron and Ensley, 2006). Therefore prototypes provide a cognitive frame of reference to individuals to help them recognize, or notice links between random events in the environment (Baron, 2004b, Matlin, 2002). The exemplar model refers the storage of specific examples (i.e. exemplars) of relevant concepts in the memory (Hahn and Chatler, 1997). The exemplar model suggests that new events are evaluated based on how closely they resemble to the specific examples a person has encountered (Baron, 2004b). Exemplars are constructed as individuals develop experience and expertise in a given field. In sum the pattern recognition theory suggests that entrepreneurs recognize opportunities and come up with novel ideas for new ventures as they employ either prototypes or exemplars or both prototypes and exemplars to detect for patterns (Baron, 2004b; Baron and Ensley, 2006).

We suggest that the more a potential entrepreneur engages in any of the determinants in the Porter's theory of diamond model the more his/her pattern recognition will be stimulated in opportunity recognition. For instance, a person having number of years of job experience in a related or supportive industry has an extensive familiarity with this industry. Due to his/her extensive knowledge with this industry the person develops a prototype for a certain "knowhow" or "idealized representation" for that industry. Therefore through repeated contacts in the industry when this person learns about new trends, demands, developments or changes the individual may notice a potential link or connection between the random event(s) and the prototype that he developed for the industry. The existing prototype that the individual has may help him notice the emergent pattern for the apparently independent and different developments or advances and may lead him/her connect the patterns of the new information with the existing one (prototype(s) stored in the memory) and develop new ideas. Also due to a number of years of expertise in a certain industry the individual may develop certain exemplars in the memory that will help him/her recognize multifaceted patterns in the environment. It was found that to identify an idea and recognize an opportunity in a specific industry it is crucial to be knowledgeable about the domain with a solid understanding of the knowledge base (Shepherd and DeTienne, 2001). Therefore perceiving and identifying emergent patterns in the environment may help individual recognize opportunities and come up with novel ideas for new ventures. Based on this reasoning we suggest the following proposition.

Proposition # 5: The more entrepreneurs engage in any of the determinants in the Porter's diamond model the more their pattern recognition will be stimulated in opportunity recognition.

DISCUSSION

Opportunity recognition is a multidimensional process in nature. As it was found in early research entrepreneur and information are central in the process. Information obtained from numerous sources in the environment is assimilated by the entrepreneur's cognitive mechanism. Therefore zooming in the cognitive process will help us to understand how entrepreneurs incorporate information in the external environment to recognize opportunities.

To date early work did valuable contributions in our understanding of the opportunity recognition process by highlighting various "elements" in the external environment such as networks, demand and supply gaps, price differences, technology substitution and innovation (Thakur, 1999), technology context (Zahra, 2008), technological change (Shane, 2000); environmental dynamism (Wiklund and Shepherd, 2003); customer demand (Choi and Shephers, 2004); industry deregulation (Jennings and Seaman, 1990); industry characteristics, geographic dispersion (Davidsson, 1991). Extending previous research we suggest that the Porter's diamond model (determinants of industry competitiveness) could also play a role in the opportunity recognition process and trigger entrepreneurial mindset (i.e., the cognitive processes).In other words information generated by these determinants prepares entrepreneur's mindset to be alert to opportunities. Therefore informed entrepreneurs more likely recognize opportunities related with the industries in which Porter's determinants are "optimal".

The ideas presented in this paper are a step towards future entrepreneurship research in opportunity recognition. We suggest further empirical investigation of the propositions presented in this paper. Yet we hope the propositions we raised in this paper have promising fruitful implications for the policy makers. Policymakers may want to promote entrepreneurship in industries where Porter's determinants are "optimal". Therefore subsidized loans or regulatory exemptions can be applied to such these industries.

In the future there is still need to investigate various other contexts to underpin the opportunity recognition process. Therefore future entrepreneurship researchers need to examine the interaction of entrepreneur with various other environmental contexts, industries or economies and apply different theories to advance opportunity recognition research further.

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Eren Ozgen, Troy University, Dothan Campus
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Date:Jul 1, 2011
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