The Contributions of Industrial Organization to Strategic Management TORIo Michael E. Porter The Academy of management Review, Vol 6, No 4(Oct. 1981), 609-620 Stable url: http://links.jstor.org/sici?sici=0363-7425%28198110%296%03a4%3c609%03atcoiot%3e2.0.c0%3b2-m The Academy of Management Review is currently published by Academy of Management. 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/aom.html Each copy of any part of a JSTOR transmission must contain the same copy tice 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.or Mon oct3107:43:33200
Academy of Management Review 198T, Vol 6. No, 4. 609-62 The Contributions of Industrial orga To Strategic Management, ization MICHAEL E PORTER Harvard Universit The traditional Bain/Mason paradigm of industrial organization(1O )offered rategic management a systematic model for assessing competition within an industry, yet the model was seldom used in the business policy(BP)field. 1O and BP differed in their frames of reference(public us. private), units of analysis (indi Ds. firm), views of the decision maker and stability of structure, and in other ignificant respects. Development of Io theory during the 1970s has narrowed the gap between the fwo fields, to the extent that 1O should now be of central concern to policy scholars The majority of economists studying industrial In addition to analytical techniques, industrial organization(or industrial economics)and strategic organization is bringing a new methodological tra management researchers have, over the years, dition to bear in research on strategic management, mostly viewed each other with suspicion-if they one that holds promise of contributing to the devel knew each other existed, With few exceptions opment of the policy field in a way quite distinct ndustrial organization had little effect on the busi from the purely conceptual. And the benefits are ness policy concept of strategy and business policy clearly flowing in both directions-exposure to busi- had little effect on industrial organization, despite ness policy concepts is having a decidedly positive the increasingly clear evidence that much promise influence on industrial organization researcl for cross-fertilization existed. Why these ships have recently, on microeconomic the passed in the night is an intriguing question. Some In this article I will examine some existing and of the reasons reflect subtle, deep-rooted suspicions potential contributions of industrial organization to and even the type of training that scholars in both strategic management, especially to the formulation fields traditionally received. But many of the rea- of competitive strategy in individual industries. sons reflect real underlying differences in the pur- will take a quasi-historical approach, in order to poses, frame of reference, unit of analysis, and examine why the traditional industrial organization esearch values that each field has traditionally paradigm, while offering a valuable tool made rela embraced tively few inroads into the policy field. Making the It is becoming recognized today that industrial reasons for this explicit will highlight some of the organization can offer much to the analysis of stra- conceptual underpinnings and assumptions of both tegic choices by firms within industries, and the fields and provide a framework for seeing why new contribution is growing rapidly as new research industrial organization research is having breaks down the differences to which I have alluded impact. The reasons will also provide an agenda for I wish to thank R E Caves, Malcolm Salter, and K R.Andrews where future progress must be made if the true for their comments on earlier versions of this article promise of industrial organization is to be realized Most of my attention will be addressed to egy for competing in an individual industry or at the August 1979 SO-called strategic business unit level, because this is s 198 by the Academy of management 0363-7425 where industrial organization can have the greatest
impact. When considering the contribution of environment. The high-performing(high return on industrial organization to strategy formulation at investment) firm in LCAG's framework was one the level of the diversified firm as a whole I will that had found or created a position in its industry clearly note the shift in frame of reference where such consistency was present. However, LCAG offered no help in assessing the "contents"of The Promise of the each of the boxes in Figure I in a particular situa Industrial Organization Paradigm tion. This was left to the practitioner The concept of strategy emerged from the need The traditional industrial organization paradigm to help the practitioner (particularly the general has long held tantalizing promise for strategy for- manager)transform the daily chaos of events and mulation. This is clear when one examines the decisions into an orderly way of sizing up the firm Learned, Christensen, Andrews, and Guth(LCAG) position in its environment. As a result, the early framework that has become the foundation of busi policy literature on strategy formulation subse ness policy [1969; Andrews, 1971 LCAG defined quent to LCAG was largely process oriented, trans- strategy as how a firm attempts to compete in its lating the basic LCAG paradigm and extensions of it environment, encompassing key choices about into a sequence of logical (and very general)analyti- goals, products, markets, marketing, manufactur- cal steps [e. g. Ansoff, 1965]. Recently, quite a bit of ing, and so on. The goals of the firm were broadly research has sought to identify broad categories of factors that might be considered ssing economic considerations, such as social obligations contents of each box in Figure 1 and has offered treatment of employees, and organizational climate generalized strategic alternatives and some of their Effective strategy formulation from a normative pros and cons [Cannon, 1968: Hofer Schendel standpoint, according the LCAG, entailed relating 1978: Uyterhoeven, Ackerman, Rosenblum, the four key elements shown in Figure 1 1977. Another recent thread of research has been The successful firm had to match its internal examining the social, political, and organizational competences and values to its external environ processes by which strategic choices are actually ment, and LCAg offered a series of general but made [ Bower, 1970: MacMillan, 1978 logically compelling consistency tests that could Empirical research on the substance of strateg. help a firm probe its strategy to see if it truly related formulation in individual industries (as distin these elements. These consistency tests stressed the guished from the administrative processes by which need for a firms policies in each functional area to be firms arrive at strategies)has been rather limite interrelated as well as the need for the entire group Intil recently. This is no doubt in part because the of functional policies to make sense, given the broad concerns of policy researchers have encom- passed the complex role of the general manager, of which strategy formulation is but a part. Much policy research attention has been given to the more strengths, weaknesses technical administrative dimensions of the general managers opportunities, threat: job, such as relating organizational arrangements to trategy resource allocation processes, strategic planning systems, and the like In the backdrop of the lCag paradigm and sub- sequent work, the traditional Bain/Mason industrial broader societal organization(1O)paradigm of the 1950s and 1960 expectations held obvious promise at one level. The essence of this paradigm is that a firms performance in the marketplace depends critically on the characteristics of the industry environment in which it competes The Four Key elements of This is expressed in the familiar structure-conduct- Effective Strategy Formulation performance framework shown in Figure 2 610
Industry Performance paradigm itself, introduced a potentially rich frame Structure (Strategy) work for examining competitive interaction [ Schell Game theory took its place in IO as a part of oligo- The Traditional Bain/Mason The early Mason approach of identifying many Industrial Organization Paradigm structural factors that were important inin fluenc ing conduct and performance soon gave way to the Industry structure determined the behavior or Bain-initiated focus on a few key aspects of struc conduct of firms, whose joint conduct then deter ture. Bain also pioneered an empirical tradition of mined the collective performance of the firms in the statistical studies relating aspects of industry struc- marketplace [Bain, 1968; Mason, 1953]. Performance ture to conduct and performance (usually profitabil- was defined broadly and in the economist's sense of ty). Literally hundreds of studies of this form social performance, encompassing dimensions such drawn from large samples of industries all over the as allocative efficiency (profitability), technical effi- world, have formed the backbone of io literature ciency (cost minimization), and innovativeness The Bain/Mason paradigm of IO(enriched with Conduct was the firm s choice of key decision vari oligopoly theory) is a useful contribution to strategy ables such as price, advertising, capacity, and qual- formulation in an industry, though it has been a y. Thus, in policy terms, conduct could be viewed little-used one. It off a systematic model fo as the economic dimensions of firm strategy assessing the nature of competition in an industry Finally, industry structure was defined as the rela one aspect of the four-part LCAG framework tively stable economic and technical dimensions of industry opportunity and threats. Identifying the an industry that provided the context in which structure"of the industry in IO terms casts the competition occurred [Bain, 1972. The primary spotlight on the crucial aspects of the firms indus elements of structure identified as important to per- try environment, and illuminates such critical con formance in the early IO research were barriers to cepts as barriers to entry and demand elasticity. The entry [Bain, 1956, the number and size distribution model also allows an analysis of the performance a of firms, product differentiation, and the overall firm could hope to achieve in its industry. It rein elasticity of demand [Bain, 1968 A final crucial forces the important point that not all industries are aspect of the Bain/Mason paradigm was the view equal in terms of their potential profitability. Thus that because structure determined conduct(strat the model can help firms predict a level of perfor egy), which in turn determined performance, we hat can reasonably be expected. Unlike the could ignore conduct and look directly at industry ad hoc approach to industry analysis embodied in structure in trying to explain performance. Con most policy literature, Bain/ Mason is potentially a duct merely reflected the environment systematic and relatively rigorous one backed br An important branch of IO research was so-calle empirical tests. Bain/Mason does not help the strate ligopoly theory, or the study of the outcome of gist with the other three key eler ts identified b competitive interactions in markets where one LCAG, but it clearly helps with one rm's actions affect its rivals (for a survey, see Scherer [1970 ) Oligopoly theory sought to specify The Limitations of he link between industry structure and firm-to- The Bain/ Mason Paradigm firm rivalry, providing a rich set of determinants of the difficulty firms face in coordinating their actions Faced with this clear promise, why didnt strategy in the ma ketplace (for the classic analysis, see teachers and practitioners stumble over each othe Fellner [1949 ) It filled a gaping hole for the analysis to embrace the new IO paradigm? A number of the of real markets that had been left by economists reasons relate less to the substance of the paradigm traditional exclusive focus on the polar cases of pure than to the scholarly traditions in the IO and BP d fields. Many policy scholars were not aware of born at nearly the same time as the Bain/Mason developments going on in IO, a different, self 611
contained discipline with its own jargon Some pol competence"are hallmarks of the policy field in icy scholars also seemed to be innately suspicious of defining the bases on which firm strategies should economists' work, possibly because of their expo- sure to microeconomics at the introductory level, firms differed a great deal in performance even where it is laced with assumptions and normative though they competed in the same industry premises that practitioners cannot live with. And Conversely, the IO theory of the 1950s and 1960s there was little cross-fertilization between people took the industry as the unit of analysis.Masons either one was an economist, or one was a business g interest in firm teacher or practitioner. but this was largely lost when Bains influence came However, these reasons may have been only to be felt That it was lost made sense from the eflections of more fundamental, substantive rea traditional IO frame of reference, since it is collec sons why well-informed policy practitioners should tive industry performance and not one firms per have been skeptical of IO. Some important ones are formance that determines the quality of resourc outlined below: allocation in the economy and hence social perf here were translation problems owing to different mance. Furthermore, IO theory implicitly assumed frames of reference. Policy practitioners were inte that all firms in an industry are identical in an eco ested in improving a firms performance from nomic sense, except for differences in their size; the vate viewpoint, which meant increasing return other differences are random noise. as a result on investment (ROD). IO researchers were moti there was little room for stable differences in the vated to improve performance from a social performance of firms in the same industry. There iewpoint-which could mean reducing roi to the fore, while IO is useful for determining the likely purely competitive level. IO was historically oriented average profitability of an industry, in its traditional lbic policy, and the literature form it clearly is not very useful for sorting out the was written from this frame of reference different performances of different companies As I have argued, the IO explanation of industry IO and bP have different views of the decision maker competition and performance could clearly be ap- IO, by and large, viewed the firm as a single plied to either purpose-Private or social. For ex decision-making unit making choices based on eco ample, public policymakers could use their knowl nomic objectives. Some IO literature recognized edge of the sources of entry barriers to lower them, that firms were really collections of individuals whereas business strategists could use theirs to [Cyert March, 1963 and there was some dis- raise barriers, within the rules of the game set cussion of objectives other than profit maximiza antitrust policy. However, this fundamental differ- tion, but these isolated efforts were hardly inte- ence in the frame of reference meant that IO theory grated into mainstream theory. Policy practitioners, had to be translated before it appeared compatible on the other hand, placed great stress on how the vith the private perspective and thereby recogniz- personality of the leader, political processes within ably useful to policy practitioners. This translation the firm, and a broad range of possible firm objec was not made in the literature tives have a major impact on a firms actual behavior Policy teachers and practitioners also had a dif in the market place (a good illustration is Bower ferent definition of their task. policy aimed [1970). Also, BP has always stressed the difficult understanding the multiple functions and multiple leaders have in correctly perceiving environmental bjectives of the general manager, only some of change, and the long-standing assumptions that which were purely economic IO theory focused often create strategic myopia, The human dimen much more narrowly on the economic bases of sion was central in Bp: no humans were visible in Io I0 views the firm as a free-standing entity. Io ha lO differs in its unit of analysis and related assumption implicitly viewed the firm as a free-standing entity Policy practitioners have been vitally interested competing in a single business, and the lO literature the problems of the individual company, and have on diversification is largely distinct from the litera viewed each firm as a unique entity with unique ture on competitive outcomes in oligopolistic erms such as"distin 612