Industrial organization

Industrial organization is a field that builds on the theory of the firm by examining the structure of firms and markets. Industrial organization adds real-world complications to the perfectly competitive model, complications such as transaction costs, limited information, and barriers to entry of new firms that may be associated with imperfect competition. The structure- conduct-performance (SCP) paradigm states that market structure would determine firm conduct which would determine performance. Market structure can be measured by the number of competitors in an industry, the heterogeneity of product and the cost of entry and exit. Conduct refers to a number of specific actions taken by a firm, which include price taking, product differentiation, tacit collusion, and exploitation of market power. The performance of the firm can be measured with productive efficiency, allocative efficiency and profitability. Drawing on the SCP model, Porter's (1980) view on industrial organization stipulates that performance heterogeneity between firms can be explained by a firm’s ability to occupy a unigue market position in an industry. Porter's five forces framework is a method for analyzing competition of a business and stipulates that five forces determine the competitive intensity and, therefore, the attractiveness (or lack thereof) of an industry in terms of its profitability. An 'unattractive' industry is one in which the effect of these five forces reduces overall profitability. The most unattractive industry would be one approaching ‘pure competition', in which available profits for all firms are driven to normal profit levels. The five forces are: (i) threat of new entrants; (ii) threat of substitutes; (iii) bargaining power of customers; (iv) bargaining power of suppliers; and (v) competitive rivalry. Porter also introduced three (four) generic strategies: cost- leadership, differentiation, and focus. A firm may be attempting to offer a lower cost in that scope (cost focus) or differentiate itself in that scope (differentiation focus).

References

Bain, J. S. (1959) Industrial organization: A treatise. New York: John Wiley.

Porter, M. E. (1980) Competitive strategy. New York: Free Press.

Porter, M. E. (1981) ‘The contributions of industrial organization to strategic management'. Academy of Management Review, 6(4): 609-620.

Porter, M. E. (1985) Competitive advantage. New York: Free Press.

Institutional theory

With an open system perspective, institutional theory (IT) states that firms are strongly influenced by their external environments. Influenced by economic factors, such as industry regulations, rival behavior, and socially constructed norms and beliefs, firms organize their boundary-spanning activities to mimic other firms. That is, firms pursue activities that increase their legitimacy and cause them to appear in agreement with the prevailing rules, requirements, and norms in their business environments (Dimaggio and Powell 1983), as these rules establish bases for production, exchange, and distribution. With this logic, IT can answer how and why firms enact specific strategic decisions. In particular, this school of thought states that firms aim for legitimacy and social approval, rather than effectiveness or efficiency. Legitimacy helps ensure that the initiative receives a certain level of acceptance; without it, the initiative is unlikely to persist. Such legitimacy can be enhanced by strategic decisions, initiatives that may improve the focal firm’s reputation or congruence with prevailing norms. When social behavior becomes accepted, it turns into an institution, and institutions give industry members a clearly laid route to success and lead to a bandwagon effect (Venkatraman, Koh, and Low. 1994). Bandwagon pressures also imply a lack of clarity in the firm's cost-benefit calculations. Alternatively, this pressure might induce firms to hire managers with similar industry backgrounds and experiences, who are familiar with industry practices. Beyond bandwagon pressures, firms may engage in status-driven imitations of their peers. This view of strategic decision-making implies a process of mimetic isomorphism: firms follow established rules and norms and copy, consciously or not, their successful peers. The resulting legitimacy and reputation can open doors to other initiatives that help the firm gain access to additional critical resources.

References

DiMaggio, P. J. and Powell, W. W. (1983) 'The iron cage revisited - Institutional isomorphism and collective rationality in organizational fields'. American Sociological Review, 48:147-160.

Scott, W. R. (2003) Organizations: Rational, natural and open systems. Upper Saddle River, NJ: Prentice Hall.

Venkatraman, N„ Koh, J„ and Loh, L. (1994) ‘The adoption of corporate governance mechanisms: A test of competing diffusion models'. Management Science, 40: 496-507.

 
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