How Much Does Industry Matter, Really? 17 differences, including diversity in market share, ventions may influence all four types of effects differentiation, heterogeneity in fixed assets, dif- on profitability (i.e, year, industry, corpora ferences in organizational processes, differences parent, and segment-specific).5 Because we have in organizational effectiveness, heterogeneity in no a priori hypothesis about the nature and direc activity configurations, anomalies in accounting tion of these biases, and because the Compustat practices, and differences in managerial com- Business Segment Reports are the best source of petence. Our objective is to understand the rela- available data on profitability, we proceed with tive significance of industry, corporate-parent, and the analysis but interpret the results with caution segment-specific differences in explaining profit Our specification differs from Schmalensee's variation when industries are defined by the (1985)in several ways. Because Schmalensee had only one year of data, his analysis excluded both the year effect(Y,) and the segment-specific effect( k). The segment-specific effect can only METHODS be identified when multiple years of data are available on each segment because only multiple Our analysis relies on the following model, which years identify when a segments performance dif- draws on the models used by Schmalensee and fers systematically from the mean given the Rumelt. simultaneity of year, industry, and corporate parent effects. Instead, Schmalensee included k=μ+y+α1+阝k+中k+∈;k,(1) measures of market share that had been developed by David Ravenscraft for an earlier study on the In this equation, rik, is the accounting profit in FTC data(Ravenscraft, 1983) year t of corporate-parent ks business in industry Our model also differs from Rumelt's(1991). Profit is measured as the ratio of operating which is reproduced as Equation 2 income to identifiable assets in percent. The first nnd-side term is H, which is the average rk,=μ+Y+α1+Bk+δn+dk+∈kn(2) profit over the entire period for all business seg- ments. The second term is Y, which represents Rumelt's model includes an additional term to the difference between u and the average profit represent industry-year interactions, 8ir. By of all business segments in year t. The next three including both a, and Sir, he distinguishes stable terms represent industry, corporate-parent, and industry effects from transient'industry effects segment-specific effects. The term a; is the Transient industry effects occur when all mem increment to profit associated with participation bers of an industry have high low profits in industry i; B is the increment to profit con- in year t ferred by membership in a diversified corporate- Rumelt proceeds by assuming that the error in parent k: and i k is the increment to profit Equation 2 is drawn independently. In making associated with the specific situation of business this assumption, he suppresses the possibility that segment i, k given the other effects. We assume a shock to the year, corporate-parent or business that a corporate-parent effect arises only if a specific effect at time t-l influences the year, business segment is a member of a diversified corporate parent or business-specific effect at time firm. The final term, ei k n, is the residual. Any of t. Suppose, for example, that a specific segment he increments to profit may be positive or nega- has an unusually good year at time t-1. Rumelt's tive. The model is estimated using dummy vari- specification does not account for the possibility ables to represent industry, corporate-parent, and segment-specific effec Our study is limited by shortcomings in 'For example, consider accounting measures of profit. Because account- which is relatively resear ing conventions exclude intangible assets fror ounting for research that similarly affect all members of the balance sheet, measured assets may be too low for some segments. The use of operating Powell(1996)uses executives'perceptions instead of income excludes the effects of differences in that indt accounting profit to assess the influence of industry. He finds accounts for about 20 percent of performance financing. Measurement error and accounting con- variation among the 54 single-business firms in his survey