What is the principal source of profits – Part One

This seems to be the fundamental debate between researchers in industrial organisation economics (IOE) and the field of strategic management (SM). This debate can be traced all the way back to Ed Mason who in the 1930s argued that there was a rather deterministic association between market structure and profitability.

The logic of the argument rested on the promise that there are structural characteristics of the market (such as concentration) that placed constraints on which strategies a firm could pursue – which in turn led to differential performance among firms according to which industry the firm operated.

Within this field, companies within an industry were considered to be alike in all important strategic aspects – except for scale – and therefore the analysis focus was on the industry, not the company.

Although this was receiving strong approval by commentators, there was some disturbing research pointing in a different direction. One of them was done by Richard Rumelt in 1991. Rumelt found that effects connected to the business itself were the main contributor for profits, not the market the business was operating in.

From a practical standpoint, the identification of the factors which most sustainably contribute to your company’s performance would enable you as a manager to focus on the influential factors. For obvious reasons, economist would also be interested in predicting which firms will earn high rates of return.

In the forthcoming posts, I will go head to head with the market- and management arguments in order to seek what is driving profitability .