How Much Does Industry Matter, Really? TORIo Anita m. Mc Gahan: Michael E. Porter Strategic Management Journal, Vol 18, Summer 1997 Special Issue: Organizational and Competitive Interactions (Jul, 1997).15-30 Stable url: http://links.jstor.org/sici?sici=0143-2095%028199707902918%3c15%03ahmdimr%3e2.0.co%03b2-f trategic Management Journal is currently published by John Wiley Sons 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/jwiley.html Each copy of any part of a STOR 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 nov204:25:33200
Strategic Management Journal, Vol. 18(Summer Special Issue), 15-30(1997) HOW MUCH DOES INDUSTRY MATTER. REALLY? ANITA M. McGAHAN* and MICHAEL E. PORtER etts. School of Business Administration, Harvard University, Boston, Massa importance of year, industry, corporate-parent, and business- ategories. Our results indi fects account for 2 percent, 19 percent, 4 percent, and 32 percent, respectively, of the variance in profitabili substantially across broad economic sectors. Industry effects account for a smaller portion of profit variance in manufacturing but a larger portion in lodging/entertainment, services, wholesale/retail trade, and transportation, Across all sectors we find a negati between corporate-parent and industry effects. A detailed analysis suggests that industry. rporate-parent, and business-specific effects are related in complex ways, @1997 by John Wiley sons, Ltd Debate in strategy has long focused on the performance has received scant empirical study sources of performance differences among firms. reflecting both the unavailability of data and chal In the research growing out of the industrial- lenging statistical difficulties. Rumelt(1991)is organization tradition, industry structure is a cen- perhaps the most influential study. Rumelt's tral determinant of firm performance, and firm research followed methods introduced by Schma differences are considered against an industry lensee (1985)for disaggregating business-unit background. More recently, a line of thought profits into components associated with industry sometimes called the resource-based view argues effects, corporate-parent effects, and market-share that firm performance is most influenced by effects. Neither Rumelt(1991) nor Schmalensee unique organizational processes. Under this view, (1985) made claims about the economic or industry structure is less important than idiosyn- organizational processes underlying their results cratic historical factors giving rise to firm differ- both papers were descriptive rather than norma- ences tive. Nevertheless some have interpreted Rumelt's Despite the importance of these questions, the finding of low stable industry effects to support relative influence of firm and industry effects on the resource-based view In this paper, we revisit the influence of indus ry, business-specific, and corporate-parent influ Key words: profit components, firm performance, ences on profitability using comprehensive data ndustry effects and enhanced statistical methods We examine Conespondenne to: ian itH M, Md ane radsatd iech oileldfr the relative effects of these influences on prof Boston MA 02163, U.S.A itability the econe whole as Porter(1980) and Oster (1990)are in the industrial-organi. in broad economic sectors. Finally, we begin to (1991), Dierickx and Cool (1989a, 1989b), and Barney (1986,1989) For example, see Levinthal (1995: 20). CCC0143-2095/97/S10015-16$1750
16 A.M. McGahan and M. E. porter explore how the effects interact. Industry pr Our analysis differs from prior work in to have werful direct and indirect infl ays. First, we use recently compiled data from on profitabilit the Compustat Business Segment Reports for 1981 through 1994. This dataset covers activity in all sectors of the American economy(except ANTECEDENTS the financial sector ) whereas the prior studies cover only manufacturing. The breadth of cover- Schmalensee (1985)examined the accounting age provides not only a representative sample on profits of American manufacturing firms that were the economy but also allows examination of profit covered in the Federal Trade Commissions Line influences across sectors. The average time series of Business Report for a single year, 1975. He on each economic unit in our dataset is 5.7 years found that industry effects accounted for about which compares favorably with the 4-year series 20 percent of variation in business-unit profits on each business unit in Rumelt's data. Because (and nearly 100% of total variance explained), our dataset covers a 14-year period, our results and that corporate-parent effects(or 'firm effects, reflect several phases of the business cycle in his terminology) had no impact on variation. Second, we show how the results are affected Schmalensee's only measure of heterogeneity by a more robust statistical approach to inter among participants in the same industry was mar- temporal persistence. Rumelts specification ket share. He reported that share positively affec- allows for transient industry effects, but does not ted business-unit profits, but only by a negli- similarly allow for transient year, corporate-par ible amount ent, or business-unit effects. Our specification Rumelt (1991) extended Schmalensee's allows for transience in all effects, and we report approach by including data from the FTC Reports the effect of the difference in method on manufacturing firms for all available years Third, our unit of analysis differs. The Compu 1974 through 1977. With data on more than one stat Reports contain information on firm profit by year, Rumelt generalized Schmalensee's measure SIC code (i.e, by business segment), not by of intraindustry heterogeneity to all business-unit business unit. Schmalensee and Rumelt examined effects rather than just market-share effects. He the business-unit returns given in the FtC data. eported that business-unit effects explain 44-46 We believe that the average business segment percent of variation(about 73%of the explained covers the activity of several business units. All variation), stable and transient industry effects else equal, the diversity of business-unit activity account for a total of 9-16 percent of variation, attributed to a single 4-digit SIC code may arti and corporate-parent effects explain 1-2 percent ficially reduce the measured influence of industr of variation. It is these results-the relatively low relative to Schmalensee and Rumelt. Moreover, proportion attributed to industry effects compared our need to rely on the SIC system for industry with business-unit effects-that have been inter- classification further diminishes the measured esti preted to support the resource-based perspective. 4 mates of industry influence because SIC industries err primarily in being overly broad. In our dis " Rumelt's report of low corporate-parent influence is not cussion, we suggest that the influence of industry consistent with a resource-based view of diversification, and might be even stronger if data of finer grail has stimulated additional research. In a study of diversified were available rt, Andrisani, and Phillips(1996) challenge RUr S, Ro Like Rumelt, our specification includes a num- on corporate-parent effects. The authors find that corporate- ber of potential sources of variation in accounting Rumelt(1991). The Roquebert et al. study is not directly industry factors, corporate-parent effects, and seg et al, exclude single-business firms from their analysis. This ment-specific effects. This last category, segment- our Compustat Business Segment data, singlesithied firms. In Specific effects, encompasses all business-segment ructed from the perf account for half of all assets. When we exclude single rporate-pare itially. Low estimates of industry tendency may compound IS ebert et al. approach may dist corporate-pare ises from the exclusion of ent influence because of negative all single ness nirms
How Much Does Industry Matter, Really? 17 differences, including diversity in market share, ventions may influence all four types of effects differentiation, heterogeneity in fixed assets, dif- on profitability (i.e, year, industry, corpora ferences in organizational processes, differences parent, and segment-specific).5 Because we have in organizational effectiveness, heterogeneity in no a priori hypothesis about the nature and direc activity configurations, anomalies in accounting tion of these biases, and because the Compustat practices, and differences in managerial com- Business Segment Reports are the best source of petence. Our objective is to understand the rela- available data on profitability, we proceed with tive significance of industry, corporate-parent, and the analysis but interpret the results with caution segment-specific differences in explaining profit Our specification differs from Schmalensee's variation when industries are defined by the (1985)in several ways. Because Schmalensee had only one year of data, his analysis excluded both the year effect(Y,) and the segment-specific effect( k). The segment-specific effect can only METHODS be identified when multiple years of data are available on each segment because only multiple Our analysis relies on the following model, which years identify when a segments performance dif- draws on the models used by Schmalensee and fers systematically from the mean given the Rumelt. simultaneity of year, industry, and corporate parent effects. Instead, Schmalensee included k=μ+y+α1+阝k+中k+∈;k,(1) measures of market share that had been developed by David Ravenscraft for an earlier study on the In this equation, rik, is the accounting profit in FTC data(Ravenscraft, 1983) year t of corporate-parent ks business in industry Our model also differs from Rumelt's(1991). Profit is measured as the ratio of operating which is reproduced as Equation 2 income to identifiable assets in percent. The first nnd-side term is H, which is the average rk,=μ+Y+α1+Bk+δn+dk+∈kn(2) profit over the entire period for all business seg- ments. The second term is Y, which represents Rumelt's model includes an additional term to the difference between u and the average profit represent industry-year interactions, 8ir. By of all business segments in year t. The next three including both a, and Sir, he distinguishes stable terms represent industry, corporate-parent, and industry effects from transient'industry effects segment-specific effects. The term a; is the Transient industry effects occur when all mem increment to profit associated with participation bers of an industry have high low profits in industry i; B is the increment to profit con- in year t ferred by membership in a diversified corporate- Rumelt proceeds by assuming that the error in parent k: and i k is the increment to profit Equation 2 is drawn independently. In making associated with the specific situation of business this assumption, he suppresses the possibility that segment i, k given the other effects. We assume a shock to the year, corporate-parent or business that a corporate-parent effect arises only if a specific effect at time t-l influences the year, business segment is a member of a diversified corporate parent or business-specific effect at time firm. The final term, ei k n, is the residual. Any of t. Suppose, for example, that a specific segment he increments to profit may be positive or nega- has an unusually good year at time t-1. Rumelt's tive. The model is estimated using dummy vari- specification does not account for the possibility ables to represent industry, corporate-parent, and segment-specific effec Our study is limited by shortcomings in 'For example, consider accounting measures of profit. Because account- which is relatively resear ing conventions exclude intangible assets fror ounting for research that similarly affect all members of the balance sheet, measured assets may be too low for some segments. The use of operating Powell(1996)uses executives'perceptions instead of income excludes the effects of differences in that indt accounting profit to assess the influence of industry. He finds accounts for about 20 percent of performance financing. Measurement error and accounting con- variation among the 54 single-business firms in his survey
18 A M. McGahan and M. E. Porter of a spillover effect on the segment in year t. parent, or segment-specific. The error, ik, /, for By including industry-year interaction dummies, which we assume independence, is the portion of however, his model does capture spillovers that the transient shock that is not influenced by the ffect all the members of an industry. Now sup- shock in the prior year. This specification accom- pose that the business cycle generates unusually modates both new shocks and spillovers from the high year effects in successive years. Rumelt's prior year, although it cannot capture differences industry-year interaction term may partly capture in the rate at which shocks resound across years the influence of the business cycle, which would (Rumelt's model can capture differences in the be attributed to persistence in the year effect in rate of persistence in industry shocks ) We a complete model. Rumelt justified his approach acknowledge this deficiency, but argue tha y reporting no autocorrelation in residuals from changes in the rate of persistence are important his estimation. Nonetheless, this justification does in the second order whereas the simple presence not address the possibility that industry-year of persistence in year, corporate-parent and seg interaction effects may proxy for persistence in ment-specific shocks is important in the first year, corporate-parent, and business-specific order. As a result of this difference in spec effects in his specification. This possibility is ficati salient given that Rumelt's data cover the period only with the stable effects in Rumelt's work immediately subsequent to the 1973 oil shock It is important to note that a;, Bk, and i k and to the removal of wage and price controls describe how a business under the Nixon administration all years by its industry, corporate parent, and Although we appreciate the benefits of model- segment-specific situation. The rate of persistence, ing transient industry effects, we exclude them p, reflects the influence of a shock in any single because the model would be overspecified if we year on the performance in just the subsequent equally represented transient year effects, transi- year. To isolate the portions of effects that are ent corporate-parent effects, and transient busi- stable, we subtract from (1) the rate of persist ness-specific effects. This point is important to ence, p, multiplied by the lagged value of rik the differences in our econometric model com pared with Rumelt's In Rumelt's view, an asym- rik,=pr k -1+(1-p)u+Y-pYi-I treatment of industry effects is justifie when the data cover a relatively short period +(1-px1+(1-p)4+(1-p)dk because corporate-parent and business-specific ();k effects will not change much (i.e, when shocks are small so that the persistence of shocks The left-hand side of this equation is the same between years is not important ) However, transi- as in (1): it is the profit to business segment i, k ence may arise at any level, and it is at least at time t in percent. The first term on the right plausible that industry effects will change slower hand side is the rate of persistence multiplied by than business-specific or corporate-parent effects. the profit to the same business segment at time Indeed, in another paper (McGahan and Porter, t-1. In calculating lagged variables, we lose data 1997)based on the same data set but somewhat for the first year for which we have information different methods, we show that shocks to busi- on each segment. The other terms on the right ness-specific and corporate-parent effects may be hand side include the year, industry, corporate larger than industry shocks parent, and segment-specific effects To deal with the possibility that a shock in We analyze this model in two ways, following year t-I might influence profits in year I, we Schmalensee and Rumelt. First, we conduct a allow for serial correlation on the errors in components-of-variance(COV) estimation under uation I according to the following process: the assumption that random processes generate each of the effects in Equation 1. Consider, for ∈;k=p∈,k-1+①.k (3) This assumption is completely separate from our prior dis- The parameter p captures the intertemporal per- the technical assumptions by which we estimate the model cussion of stable and transient effects. Here, we are describe sistence of effects regardless of source: in Equation 4 given that the model includes only stable effects, macroeconomic fluctuations, industry, corporate- year effects, and the error. At this point, we are interested