BUS303: Strategic Information Technology

At first glance, the industry forces view makes a lot of sense, and there is indeed some tendency for industries with powerful pressure from these five forces to be less profitable than others where the forces are weaker. The implication is somewhat fatalistic: If industry conditions dominate your likely performance, then once you have chosen your industry, your destiny is fixed. However, research has found that industry conditions explain only a small fraction of profitability differences between firms. It turns out that factors to do with the business itself are far more important drivers of performance.

Management does matter: You can be successful in intensely competitive industries or unsuccessful in attractive industries. Moreover, the passive industry forces view takes no account of a firm's ability to create the industry conditions that it wants. In essence, the world is the way it is today because Microsoft, Wal-Mart, Ryanair, and many other firms have made it like this, not because market growth and industry conditions have been handed down from on high.

The competitive forces view places great importance on the concept of barriers that prevent industry participants (the competitors themselves plus customers, suppliers, and others) from entering, switching, exiting, and making other strategic moves. This implies that these barriers are absolute obstacles: If you can clear them, you are "in"; if not, you are "out". But business life is not like that. Many industries include small firms operating quite nicely with only a little of the necessary resources, while larger firms operate from a more substantial resource base. In fact, barriers to entry do not seem like barriers at all; they are more like hills. If you are a little way up these hills, you can participate to some degree, and the further up you are, the more strongly you can compete.

So why are strategy tools so weak at answering the basic question of what is driving performance through time? It turns out that most strategy research is based on analyzing possible explanations for profitability measures, such as return on sales or return on assets. Recently, more sophisticated and appropriate measures have been used, such as returns based on economic profit (profit minus the cost of capital required to deliver that profit). Typically, data are collected for large samples of firms and plausible explanations for performance differences among the sample are tested using statistical regression methods.

Such studies generate an estimate of how much of the variation in the profitability of different firms is explained by the suggested causes. These may be external factors such as competitive intensity, or internal factors such as technology or staff training. Unfortunately, today's profitability ratios are a very poor guide to future earnings and of little interest to investors. Would you, for example, prefer to have $1,000 invested in a firm making 20% margins but with declining revenue or in another firm making 15% but doubling in size every year?