This article examines the nature of short-run dynamics in judging the profitability in the marketplace. The authors state that the dynamics of profits in the inter-industry averages, even between companies in the same industry, can be extremely variable.
That is, although it is assumed that there is some homogeneity that can permit comparison between company profits within and industry that can then be used to create an inter-industry average, this homogeneity does not, in fact, exist.
It is apparent that this flawed assumption has its roots in the “shared asset theory of profit determination” posited by Porter (1979) as a method of determining performance in an industry (Cubbin & Geroski, 1987, p. 427). The authors state that the flaw comes from assuming that the “intra-industry variations in profits are small and uncorrelated with market structure” (Cubbin & Geroski, 1987, p. 427), which, if this assumption is untrue, the industry-level analysis of the dynamics between companies is no longer of interest and is no longer of any value.
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In addition, Porter’s model seems to have failed to take into account the differences that exist between the industry leaders and the industry “followers” in terms of profitability and how that profit is made.
The literature review for Cubbin and Geroski (1987) suggests that analysis of different industries show that market power gains are unevenly distributed between these leaders (the large firms) and followers (the small firms) in these industries and that the markets share that this power reflects is important in determining the relative profitability between companies (pp. 427-428).
The authors indicate, however, that there are several assessment methods in terms of determining any individual organization’s profitability both on firm-specific and industry-wide factors. These factors include:
Coefficients on variables, such as market share and industry concentration.
An analysis of variance (ANOVA) framework that deconstructs performance variables into effects created by industry, firm, and market share.
A dynamic model, which the authors suggest that a co-variance might exist between “profit paths” across intra-industry firms (Cubbin & Geroski, 1987, p. 428).
The authors state their intent at this juncture; indicating that they intend to examine the importance of industry effect on industry profitability in the United Kingdom (Cubbin & Geroski, 1987). It is also at this point in the paper where the authors describe the form that the paper will take, explaining how the information will be organized and analyzed.
The model that the authors examined for the purpose of this paper is that of an individual firm (i) in a single industry (I). The current profit rate for i is then compared to the equilibrium profit rate for me, over the long term.
According to the authors, it is unlikely that the comparison of the profit rates for and I will be equal to one another over the period of analysis for one of two reasons:
- that there is no equilibrium in the individual firm’s profit over the long term, or
- that the equilibrium profit rate for the individual firm differs from that of the industry as a whole. In addition, the ease or difficulty with which a firm can enter the market and other factors that affect doing business in that industry may have an effect on the rate of equilibrium profit.
The authors maintain that the profit rate for the individual is determined by the equilibrium profit rate for the industry and “the dynamic forces that generate adjustment towards them within and between industries (Cubbin & Geroski, 1987, p. 429).
Cubbin and Geroski (1987) go on to explain that one issue in this model is that tracking the factors that go into the dynamic may be impossible to measure, in part due to the difficulty in observing them.
In addition, the actual entry of a firm into industry may or may not have an effect overall and may or may not lead to the existing firms in that industry--particularly, presumably, the leaders of that industry--to make strategic preemptive pricing moves that may affect the performance of the market before the new firm even has time to enter and disturb the equilibrium (Cubbin & Geroski, 1987).
The authors propose a solution to control these variables. They first define “entry” into an industry as being when
- new firms enter the industry,
- expansion of incumbent firms and
- as incumbent competitors attempt to block new firms by uniting their production and pricing efforts (Cubbin & Geroski, 1987).
This definition was left broad to “include all systematic dynamic forces interacting with profits” (Cubbin & Geroski, 1987). Entry might then have a strong impact if there are strong dynamic forces; however, weak dynamic forces result in the average industry profitability being affected over a long period (Cubbin & Geroski, 1987).
If a firm holds a strategic place in the industry and earns profits higher than those earned by others in the industry, then a response to this position might result in other firms in the industry might encourage “mobility” in the industry itself, with other new firms entering or incumbents restructuring to diversify (Cubbin & Geroski, 1987), which results in any of these actions having an effect on the individual firm.
The basic model that the authors suggest using to analyze industry profits is arrived at after a series of equations that are eventually modified to take compare the vulnerability to the effects of entry on the part of the individual firm against the industry at large (Cubbin & Geroski, 1987), based on the movement created by the firm and industry specifics.
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