VOL, 75 NO. 3 SCHMALENSEE: DO MARKETS DIFFER MUCH? 349 ut they are conditional on the assignment I. Conclusions and Implications of firms to markets. Similarly, for h*j, E(BhB,)=(nS)=0, and E(SinSk) The analysis of Section Ill indicates that the 1975 FTC line of Business data provide Let r, be the unweighted mean of the rates strong support for the following four em- of return of business units in industry j. pirical propositions Then if (4)is the true model, (8a) and some PROPOSITION 1: Firm effects do not exist (9)ESS(;-r)=(N-M)yo2(S) PROPOSITION 2: Industry effects exi are important, accounting for at least 7 x[1-P2(B, S)+(N-M)02(e). on assets cent of the variance of industry rates of The quantity on the left is the expected sum PROPOSITiON 3: Market share effects ex of squared residuals from a regression of ible fraction of the rii on M industry dummy variables variance of business unit rates of return regression appears as the "Industry Effects Only" model in Figure 1. Use of( 8)and a PROPOSITION 4: Industry and market bit more algebra yields share effects are negatively correlate (10)ESS)(N-1)=E[o() The apparent nonexistence of firm effects is somewhat surprising. This finding is per =Ho2(B)+y2(S)[1-(1-H)p2(B,s ctly consistent with substantial intra-in dustry profitability differences, which Table 1 shows to be present in these data. The +o2(e)+2HYp(B, s)o(B)o(S), absence of firm effects in(1) merely means that knowing a firms profitability in market here A tells nothing about its likely profitability in randomly selected market B. This is con H=(N-G)/(N-1) sistent with the conglomerate bust of the past decade and with a central prescriptive Equation(10) provides a decomposition of thrust of Peters and Waterman(ch. 10): wise ability corresponding to the d s unit profit firms do not diversify beyond their demon- composition strated spheres of competence. The nonex of the population variance given by (5) istence of firm effects suggests that Mueller's Setting expectations equal to sample val-( 1983)persistent firm-level profitability dif ues, solving (9) for yo(S)and substituting ferences are traceable to persistent differ- into(10), an equation is obtained involving ences at the business unit or industry level p(B, S), sample statistics, and estimates combined with relatively stable patterns of derived above. A search of the interval activity at the firm level. 6 eveals a unique root; the esti The finding that industry effects are im- mated value of p(B, S)is-0.089. This con- portant supports the classical focus on in- firms the negative correlation between in- dustry-level analysis as against the revisionist dustry and share effects. Equation (9)then tendancy to downplay industry differences. ields an estimate of 2. 182 for y202(S).As this is only about 3.2 percent of the esti- share effects is also confirmed. Table 1 re- FTC Line of Business data, Johny variables to analyze mated value of a(B), the unimportance of 16 Using firm and industry dumn (5)and(10), respectively, implied by these reflects policy rather than performance, it is not surpris- ing that firm effects show up there but not here