When you check the
research, the greatest determination of an organization's success is the
industry in which it operates. Profitable markets spawn profitable
businesses.
Several studies come
at this conclusion, from different directions. Perhaps most
notably, McKinsey has published some great analysis of what they call the
"industry effect," showing the economic profits along power curves
for different types of firms. That industry drives performance is no
doubt true: the data is clear and it’s compelling.
Chart: McKinsey & Company, "The industry effect" Extracted from web-site article on Insights.
Source reference Strategy Beyond the Hockey Stick, book written by Chris Bradley, Martin Hirt, Sven Smit
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But, the data can
also be deceiving. Because when we read things like this we’re typically
looking for advice, to see how how the info applies to our own situations.
“What does this mean to me?” we want to know. In this case, McKinsey's finding probably doesn't mean too much. Not only is the “industry effect" apt to be mostly
irrelevant, it can also be dangerously misleading.
Such research
answers the question “What’s most closely correlated with success?” or even
“What explains success?” It does not answer the question “What business
should I as an individual pursue or what business should we as a company diversify
into?”
It’d be a big
mistake to conclude from McKinsey’s research that the firm should pursue
opportunities based primarily—or even mostly—on the attractiveness of the
target industry. Obviously, we can’t ignore the entire issue of internal
compatibility. As the consultants will tell you, market analysis is easy,
change management is hard. In fact, when you balance the basic
considerations of strategic expansion— internal compatibility and external
opportunity—internal compatibility factors invariably weigh heavier.
Why? Because
we’re never starting from ground zero. Businesses have dedicated assets in
place, strengths and weaknesses, and experience with key industries or
operating agendas. For a given entity in any given game, we’re building
on existing experience. In reality, the question is not what best
explains success in the abstract or for companies in general. The
question is “Along which path are we able to out-execute our competitors?”
(Note this doesn’t mean we have to execute particularly well. It only
means we have to be able to out-perform the average competitor.)
A way to see the
glaring fallacy is to consider how this would hold for individual career
decisions. Career data would certainly show that, say, surgeons and
investment bankers command higher than average compensation. But, of
course, we couldn’t conclude from this data that if you personally wanted to
make more money you should pursue a job as a neurosurgeon. On average,
surgeons and bankers may make more, but, you’re not concerned with the average
person, you’re concerned with you. Specifically, you’re concerned with
the expected value—the payoff—you would get in a career shift. And odds
are that for a given person the expected compensation impact of a switch to
neurosurgery would be negative. Why? Again, we’re not starting at
ground zero. As individuals we’ve studied topics, developed strengths and
interests, and we’ve accumulated experience and contacts in specific industries and
functions. If you’ve taught middle school for 25 years, your expected
earnings for staying in education will undoubtedly exceed that of a switch to
med-school—even if the data shows that doctors earn more than teachers.
In short, in contemplating career moves, you’ll weigh internal factors
much more heavily than you will external factors.
Thus, we arrive at a
paradox: while the external market is the most important explanation
(post-facto) of economic profitability, it’s probably the least important factor in the
strategy decision. Put another way, such
results are remarkable at the macrolevel—for the theorist —and irrelevant at
the microlevel—for the practitioner.
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