Do Markets Differ much? TORIo Richard Schmalensee The American Economic Review, vol. 75, No 3 Jun, 1985), 341-351 Stable url: http://links.jstororg/sici?sici=0002-8282%028198506%2975%03a3%03c341%3admdm%3e2.0.c0%3b2-w The American Economic Review is currently published by American Economic Association. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://wwwjstor.org/journals/aea.html Each copy of any part of a jSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission jStOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor. org http://www」]stor.org Wed nov203:49:56200
Do Markets Differ Much? By RIChARD SChmALenSEe This essay reports the results of a cross- easily support full-blown structural estima section study of differences in accounting tion One can view the sort of search for profitability that sheds light on some basic stylized facts conducted here as either a re- controversies in industrial economics. Most placement for or an input to interindustry cross-section studies in this field structural estimation, depending have been concerned with testing hypotheses feeling about the long- run potential of that about structural coefficients in models meant research approach. This study also departs to apply to essentially all markets. As we from much of the cross-section literature by have learned more about the difficulties of being fundamentally concerned with the im- nstructing such general models and of per- portance of various effects, not just with forming tests on their structural parameters coefficient signs and t-statistics erly, structural cross-section analysis has In particular, this essay provides estimates out of fashion. In contrast to most of of the relative importance of firm, market, the cross-section literature, the analysis re- and market share differences in the de ported here is fundamentally descriptive; it termination of business unit ( divisional) does not attempt directly to estimate or profitability in U.S. manufacturing. Using test hypotheses about structural parameter 1975 data from the line of business pro- hope to show by example that one can gram of the U.s. Federal Trade Commission perform illuminating analysis of cross-sec- (FTC), I find support neither for the ex tion data without a host of controversial istence of firm effects nor for the importance maintained hypotheses. Cross-section data of market share effects. Moreover, while in an yield interesting stylized facts to guide dustry effects apparently exist and are im- both general theorizing and empirical anal portant, they appear to be negatively corre sis of specific industries, even if they cannot lated with seller concentration in these data Section I relates firm, market, and share ffects to current issues and controversies in industrial economics and thus supplies the Sloan School of Management, Massachusetts In stitute of Technology. motivation for our empirical analysis. The indebted to Stephen Postrel for excellent research assis remainder of the essay treats the data and ance to the FtCs Line of Bus taff, particularly statistical methods employed(Section II), the David Lean, William Long, and David Ravenscraft, for empirical results obtained (Section Im), and the main implications of those results (Sec chard Caves, Jerry Hausman, Paul Jos tion I luable advice. Seminar audiences at Stanford, Berke Chicago, Northwestern, and British Columbia pro I. Sources of Profitability Differences ided useful comments on earlier versions of this essa am grateful for financial support from the In the classical tradition, following Joe National Science Foundation, the U.S. Federal Trade Bain(1951, 1956), industrial economists grant to MIT). The representations and conclusior treated the industry or market as the unit of presented herein are my own and have not been adopted whole or in part by the FTC or its Bureau of onomics.The Manager of the Line of Business Pro- gram has certified that he has reviewed and approved ms(1980)has expressed a similar the disclosure avoidance procedures used by the staff of the Line of busines to ensure that the data ach taken by Michael gort and ra included in this paper do not identify individual com- Singamsetti (1976)is close in some espects to th Line of Business data. I alone can be held respon- taken here. They use firm-level data, howeve ible for this papers contents ain very different result 341
THEAMERICAN ECONOMIC REVIEW JUNE 1985 study. Differences among firms were as- thus predicts a positive correlation between sumed transitory or unimportant unless concentration and profitability in cross based on scale economies, which were gener- tion at the industry level even though, by ally found to be insubstantial. Equilibrium assumption, concentration does not facilitate ndustry profitability was generally assumed the exercise of market power to be primarily determined by the ability of At the firm or(for multiproduct firms) established firms to restrict rivalry among business unit level, the revisionist view themselves and the protection afforded them plies that market share should appear as the by barriers to entry. A central hypothesis in primary determinant of profitability in cross virtually all the classical work was that in- section regressions, while market concentra creases in seller concentration tend to raise tion should have no impact. David Ravens- industrywide profits by facilitating collusion. craft (1983)checked these predictions with Most classical studies thus included con- FTC Line of Business data. 5 He found the centration among the independent variables impact of share on business unit profitability in regression analysis of industry average to be positive and highly significant, while rates of return, and most published studies the coefficient of concentration in the same reported the coefficient of concentration to regression was negative and significant. be positive and significant Ravenscraft interpreted his results as provid An anticlassical. revisionist view of in Ing strong support for the revisionist argu- dustrial economics has emerged in the last ment that the significance of concentration decade. In the simplest model consistent with in traditional industry-level cross-section re- this view, all markets are(at least approxi gressions arises because concentration mately) competitive, and scale economies are related with share(and thus efficiency) absent(or negligible). The key assumption is differences, not because it facilitates collr that within at least some industries there are sion. Stephen Martin has recently obtained persistent efficiency differences among sell- similar results in a simultaneous equations ers. Because more efficient enterprises tend analysis of the FTC data. The strong relation both to grow at the expense of their rivals between market share and profitability found and to be more profitable, these differences by these and other authors is difficult tend to induce a positive intra-industry cor- interpret within the classical tradition, given relation between share and profitability even the apparent absence of important scale in the absence of scale economies. moreover. economies in most industries the more important are efficiency differences A third tradition, which I will call man- in any industry, the less equal are market aerial, has yet another set of implications shares (and thus the higher is market con- for business unit profitability. Business centration) and the higher are the profits of the leading firms (and thus the higher is ndustry average profitability). This model also Sam Peltzman (1977). Interesting formal models nsistent with this view have recently been 2Leonard Weiss( 1974)provides a survey of cross- by Boyan Jovanovic (1982), S. A. Lippman and R.P. section studies in the classical tradition; see also F, M. Rumelt(1982), and others. It is important to note that rer(1980,ch.9) something like the classical notion of entry or mobility Efficiency should not be interpreted barriers( richard C and Michael Porter, 1977)must cess terms here be invoked to explain why imitation does not the production of astrian climinate efficiency differences among firms characteristics it supplies to an existing lier studies of the eff reating something approaching a new market)canr of market share. Most obtained results n. It seem stent with those of Ravenscraft and ste propriate to think of nondramatic product innovations in efficiency terms for purposes of positive analysis of See Scherer(ch. 4) for an excellent survey of the rofitabili available evidence on economies of scale
VOL. 75 NO. 3 SCHMALENSEE: DO MARKETS DIFFER MUCH? schools and management consultants exist Conventional, classical industry-level vari- because it is widely believed that some firms ables may thus perform poorly at least in are better managed than others and that part because they are poor, incomplete mea one can learn important management skills sures of the(classical and other) market that are not industry specific. In a widely effects present in available data. Since many cclaimed best seller, Thomas Peters and of the usual classical industry-level variables Robert Waterman, Jr.(1982) stress the are endogeneous in the long run, and it mportance of firm-level efficiency differences difficult to formulate enough noncontrol- asure on differences in versial exclusion restrictions to identify organizational cultures. Dennis Mueller 1977, 1983)has recently reported economet- that problems of measurement and disequ ric results implying the existence of substan- librium can be successfully attacked by tial, long-lived differences measured firm structural modeling using available cre profitability. When profit rates in 1950 are section data taken into account, Mueller (1983)finds that concentration has a significant negative co- II. Methods and Data efficient in an equation explaining projected firm profit rates in 1972, and industry effects Instead of attempting structural analysis, in general are relatively unimportant. this study employs a simple analysis of vari- Both the revisionist and managerial alter- ance framework that allows us to focus di natives to the classical tradition are based on rectly on the existence and importance of plausible arguments and suggestive evidence. firm, market, and market share effects with But I do not think that it has been shown out having to deal simultaneously with that the classical attention to the industry specific hypotheses and measurement issues was in any sense a mistake: case studies related to their determinants. Specifically, I f real markets clearly reveal important deal in all that follows with the following differences. Why, then, do conventional mar- basic descriptive model ket-level variables perform poorly or per- versely when firm or share effects are in- (1) r,=u+a; +B+YS, +ei cluded in cross-section regressions One probable reason comes readily to where ri is the(accounting)rate of return of have very imperfect measures of the classic market share, the a's are firm effec,, is its dimensions of market structure and basic are industry effects, u and y are constants, onditions. Conditions of entry have proven and the e's are disturbances. The assump particularly difficult to measure in a satisfac- tions that market share enters linearly in( tory fashion. moreover, the link between the and that y is the same for all industries are eal, economic profitability dealt with in made mainly for comparability to the litera heoretical discussions and the accounting ture, though both also simplify computation returns used in empirical work is weakened and interpretation. The 1975 FTC Line of by inflation (Ge eoffrey Whittington, 1983), Business data set, which I use, contains in- depreciation policy(Thomas Stauffer, 1971; formation on large multidivisional firms Franklin Fisher and John McGowan, 1983), Such information is clearly required to sep- risk (myself, 1981), and both cyclical arate firm and industry effects in (1) (Leonard Weiss) and secular (Ralph Brad While none of the coefficients in (1)can be burd and Richard Caves, 1982)disequilibria. given a defensible structural interpretation analysis of that model as a whole can shed An additional individual lines of this, spurious industry effects added to bus trary. If firms fol
344 THE AMERICAN ECONOMIC REVIEW JUNE1985 light on the relative merits of at least the decomposed as follows extreme versions of the classical, revisionist and managerial positions. An extreme classi- (2 )02(r)=02(a)+o2(B)+r202(S) differ substantially with a =y=0 for al, o cist, for instance, would expect the B's a2()+2p(a,B)o(a)o(B) Estimates consistent with these expectations would of course not exclude the possibility +2yp(a, S)o(a)o(s) that industry effects simply reflect industry- wide differences between accounting and +2Yp(B,S)o(β)o(S) economic rates of return or industry-level disequilibria, with variations in monopoly where the p's are correlation coefficients and power of little or no importance. But a find- the as are standard deviations. Depending ing that the as and y did not differ signifi on which effects are revealed to exist by the cantly from zero would cast doubt on ex- analysis of (1),I estimate either (2)or a treme managerial or revisionist positions. special case thereof to provide information The implications of these last two posi- on the importance of the determinants of ons for the parameters of equation(1)are observed profitability. Estimates of (2)relate slightly less clear cut. An extreme revisionist directly to the predictions of the alternative would presumably expect a large y with all traditions discussed above. The particular the as and B's near zero if the r were (random effects) estimation techniques used observations on equilibrium rates of return. in this phase of the analysis are presented in But, since our data are in fact for a single Section Ill year and thus reflect the effects of cyclical In most of the statistical literature con- and other short-run industry-level disequi- cerned with variance decomposition, orthog libria, an extreme revisionist would not likely onality of effects is assumed, so that covari be surprised to find significant differences ance terms like the last three on the right of among the B's estimated here. Similarly, an (2) are set to zero. But that assumption is extreme managerial position might be that not plausible here. If an important attribute ariations in the a's should be much more of efficient firms is their ability to pick prof important in equilibrium than those in the itable industries in which to operate, for Bs or in the yS,, terms. But an extreme instance, we would expect this feature of the managerialist would also not likely be sur- data generation process on which I must rised to find differences in the Bs in a condition the estimates to produce a positiv single year's data. Moreover, firm-level p(a, B). Similarly, one expects efficient firm efficiency differences might affect business to have low costs and high shares, so that unit profitability through the revisionist p(a, S)should be positive. Finally, if one mechanism, so that firm-level and share knows that some particular Sii is above aver- effects might be hard to distinguish. (I in- age, one's conditional expectation must be vestigate this possibility below.) that concentration in market j is above aver Using firm and industry dummy variables, age. If one expects industry concentration to I first use ordinary least squares(fixed effects be positively related to industry profitability, estimation)and the usual F-statistics to test it then follows that one expects p(B, S)to be for the existence of market effects(noniden- positive. On the other hand, since e captures tical B's), firm effects(nonidentical as), and all profitability differences unrelated to firm, share effects (nonzero y )in(1)and the natu- industry, or market share diffe erences ral special cases thereof. To analyze the im- assumption that it is orthogonal to those portance of these effects, I treat the actual effects seems natural and reasonable ' s, B's, S's, and es in any particular sam- The strength of this descriptive approach ple as(unobservable)realizations of random is that my conclusions about the three rele- variables with some joint population distri- vant types of effects will not be conditioned bution. Under the usual assumption that e is distributed independently of the other vari- ables, the population variance of r can be See. for instance, S.R. Searle(1971, chs 9-11)