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Corporate-Level Strategy, Business-Level Strategy, and Firm Performance Author(s): Donald W. Beard and Gregory G. Dess

Corporate-Level Strategy, Business-Level Strategy, and Firm Performance Author(s): Donald W. Beard and Gregory G. Dess Source: The Academy of Management Journal, Vol. 24, No. 4 (Dec., 1981), pp. 663-688 Published by: Academy of Management

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i

Academyof ManagementJournal

1981,Vol. 24, No. 4, 663-688.

Corporate-LevelStrategy,

Business-LevelStrategy,

and

Firm

Performance

DONALDW. BEARD Universityof Washington

GREGORYG. DESS

University of SouthCarolina

Corporate-levelstrategy and business-levelstrategy are operationalizedin termsof interindustryand intra- industryvariation,respectively.Variablesrepresenting both levelsof strategyare used in a regressionmodel to explainvariationinfirmprofitperformance.Both kinds of variablearefound to be significantin explainingvar- iation infirm profitability.

Theoreticalliteraturein thebusinesspolicyareahasincreasinglyempha- sizeddistinctionsbetweentwo levelsof organizationalstrategy:(1) corpo- rate-level strategy, concernedwith questions about what businessesto competein, and (2) business-levelstrategy,concernedwith questionsof how to compete within a particularbusiness. Differing conceptual schemesandassociatedanalytictechniqueshavebeenproposedto aidtop managersin makingdecisionsabout the two differentkindsof strategy. Hofer and Schendel(1978) providea recentliteraturereviewand a ra- tionale for separatingand sequencingthese,two kinds of strategicdeci- sions. Althoughbusinesspolicy theoryhas been-evolvingin this direction,at least sinceAnsoff (1965), empiricalresearchto test propositionsderived

fromthistheoryhas beenlimited.It is the purposeof thispaperto present the resultsof such an empiricaltest. More specifically,the researchpre- sentedhereprovidesevidenceaboutthe relativeimportanceof corporate- levelstrategyandbusiness-levelstrategyin determiningfirmprofitperfor- mance. Conceptually,corporate-levelstrategyand business-levelstrategyare seenas corresponding,respectively,to interindustryandintraindustryvar-

iations in business firms' strategies. The researchdesign used

industryfirmsas the unitof analysis.In thisrespect,the researchis similar to the Profit Impact of MarketingStrategy(PIMS) projectat Harvard

single-

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University, except that single-industrycorporationsratherthan single- industrysubunitsof multi-industryfirmsarethe primaryunit of analysis. This designhas the advantagethat interindustryand intraindustrystrate- gic variationcan be clearlydistinguishedand operationalized.

CONCEPTS OF STRATEGY AND UNITS OF ANALYSIS

Organizationalstrategyis one of the broadestand most complexcon- ceptsused in studyingorganizations.Becausethe conceptof strategyhas been evolvingrapidlyin the businesspolicy literature,it shouldbe made clearat the outsetwhatconceptsof strategyhavebeenusedandwhatunits

of

to specifythe concernof this paper.Figure1 cross-classifiesthreehierar-

chicallevelsof strategywithfourhierarchicalunitsof analysis.Onthe left in Figure 1, the concepts of strategyare arrangedin hierarchicalorder from top to bottom, rangingfrom the most generalconcept, corporate- levelstrategy,to the leastgeneralconcept, functionalstrategy.Acrossthe top of Figure1, the units of analysisare arrangedin reversehierarchical order, rangingfrom the smallestunit, managementdecisionmakers,to the largestunit, the indirectlylinkedenvironment.The conceptsof direct andindirectlinkagesin an organization'senvironmentas usedin Figure1 are analogous to the concepts of direct and indirectrequirementsin a Leontief-typeinput-outputmodel. Leontief (1953), Cheneryand Clark (1959), and Miernyk(1965) providethoroughdiscussionsof the theory and applicationsof this model. Theresearchdiscussedbelowdealswithonlytwo conceptsof strategyin Figure1, corporate-levelstrategyandbusiness-levelstrategy.The focusof the researchis primarilyon the organizationas a whole,the secondunitof

analysishave been studied.Figure1 sets forth a frameworkthat helps

FIGURE1

Three Concepts of Strategy and Four Units of Analysis

Four Units of Analysis

Organizational Units

1.

2.

Environmental Units

3.

4.

Three

Management

The

The Directly

The Indirectly

Concepts of

Decision

Organization

Linked

Linked

Strategy

Makers

as a Whole

Environment

Environment

1. Corporate-Level

l

_

Strategy

l

l

2. Business-Level

Strategy

3. Functional-Level

Strategy

LI

--

-

-

-

-

-1I-

-

-

-

-

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analysisin Figure 1, and the organization'sdirectlylinked environment, the thirdunit of analysisin Figure1. Althoughspace limitationspreventmuchdiscussionof the distinctions madein Figure1, it is importantto elaboratebrieflyon the differencesbe- tween the characteristicsof strategicdecisionsor decisionmakerson one hand and the characteristicsof an organization'sstrategyon the other hand. It is believedthat organizationsoriginateandchangeon thebasisof creative,strategicdecisionsby individualsor groupsoccupyingkey orga- nizationalroles. Weick(1969),Child(1972),andMiles,Snow,Meyer,and Coleman (1978) develop this view more thoroughly. Strategicdecision making is seen as a crucialpart of the process by which organizations adaptto theirenvironments. It also is believedthatthosedecisionsthatactuallysucceedin creatingor changingorganizationsdo so via complexiterativeprocesses,whichpolicy theoristssubsumeunderthe conceptof strategyimplementation.Andrews (1971)providesa broadtheoreticaloverviewof the strategyimplementa- tion process.Empiricalworkdocumentingthe complexnatureof strategic decisionand implementationprocessesincludesCyertand March(1963), Bower(1970),Carter(1971),Pfeffer and Salancik(1974),and Mintzberg, Raisinghani,and Theoret(1976). For purposesof the presentstudy, a key assumptionhas been made aboutthe relationshipbetweenorganizationalstrategyandorganizational performance.It was assumedthat the effects of strategyon performance at a particularpoint in time, or duringa particularperiodof time,arebest studiedin termsof the organization'simplementedstrategyat or during the relevanttime. This meansthat the conceptof strategyhereis basedon organizationalcharacteristicsthat embody earlierstrategicdecisionand implementationprocesses.Actual outcomesof decisionand implementa- tion activitiesare, of course, determinedboth by complex,iterativepro- cessesamong decisionmakerswithinthe organizationand by interaction betweenthe organizationand its environment. Concernwill be only with the conceptsof strategyenclosedwithinthe dotted line of Figure 1-corporate-level strategyand business-levelstra- tegy. Corporatelevel strategyis conceived in terms of variationin the portfolio of industriesin whicha firm does business.Business-levelstra- tegyis conceivedin termsof variationin the firm'sstrategiccharacteristics relativeto the populationof firmswithin the industriesin whichit does business.Theverbaldefinitionsemployedcloselyfollow HoferandSchen- del's (1978) concepts of corporate-leveland business-levelstrategy.The operationalmeasuresof theseconceptsarediscussedin moredetaillaterin this paper. Corporate-levelstrategyis defined in termsof variationin the deploy- mentof a firm'sresourcesamongthe portfoliosof industrieswithinwhich all business firms compete. Hofer and Schendel propound this view:

"corporate-levelstrategyis concernedprimarilywith answeringthe ques- tion of what set of businessesshould we be in. Consequently,scope and

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resourcedeploymentsamong businessesare the primarycomponentsof corporatestrategy"(1978,p. 27). Thus, a firm'scorporate-levelstrategy

can be operationalizedin termsof the distributionof firm assets, sales, employment,capital-budget,or otherindexesof firmresourcesamongthe rangeof existingindustries. Most firmshave simplecorporate-levelstrategies,in theseterms.They competein onlyone industryamongthe hundredsthatarepossible.Other firms, however,such as the Fortune500 largestUnitedStatesindustrial firms, typicallyparticipatein severalindustries,and theirtop managers mustcontendwiththevariedandconflictingdemandsof theirindustrially specializedsubunits. Becauseresearchinterestin this paperis primarilyin the questionof how importantvariationin corporate-levelstrategyis relativeto business- level strategyin explainingfirm performance,the complex differences among industrieswill be representedquite abstractly.Differencesin the averageprofitabilityamongindustrieswillbe usedto representtheoverall differentialin profitmakingopportunityamongindustries. It is truethat decisionsaboutcorporate-levelstrategyin multi-industry firmsarebasedon a widevarietyof informationotherthanindustryprof- itabilityandthatthesedecisionsaffect manyvariablesotherthanthe dis- tributionof firmassetsamongindustries.Springerand Hofer (1980),for example, documentthe rich varietyof decisionsthat have attendedthe evolution of GeneralElectric'sstrategicplanningprocess,whichnow in- cludesdistinctresponsibilitiesandproceduresat the corporatelevelandat the businesslevel. Berry(1975)has identifiedGeneralElectricas the sec- ond most diversifiedfirmas of 1965amongtheFortune500largestindus- trials.

LiebersonandO'Connor(1972)haveusedvariationintheaverageprof-

itabilityof a subjectfirm'sprimaryindustryto assessthe impactof dif- ferencesin the firm'scompetitiveenvironmentupon firmperformance- an approachsimilarto that of the presentstudy. Otherresearchershave measuredvariationin a firm'scorporate-levelstrategyin differentways. For example,Gort(1962)usedthe numberof industriesin a firm'sport- folio to measurethe diversityof a firm's corporate-levelstrategy,and Rumelt(1974)useda measureof thetechnicalrelatednessof the industries in whichmulti-industryfirmscompeted.In anothervein, Pitts (1977)has shown that markedstructuraldifferencesexist at the corporatelevel be- tween firmsthat have diversifiedvia internalgrowthand thosethat have diversifiedby acquisition. Business-levelstrategyis definedin termsof variationin firmcharacter- isticsrelevantto competitivesuccessor failurewithina givenindustry.In this paper, a firm's competitivelyrelevant,business-levelcharacteristics are conceivedexclusivelyin relativeterms. That is, a firmwouldhave a separatebusiness-levelstrategyfor each industryin which it competed, and the relevantcharacteristicsof the firm'sbusiness-levelstrategywould

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be measuredrelativeto the rangeand normson eachcharacteristicin each of its industries. Hofer and Schendelagainprovidea succinctdefinitionalstatement:

At the businesslevel, strategyfocuseson how to competein a particularindustryor product-marketsegment.Thus,distinctivecompetencesandcompetitiveadvantageare usuallythe most importantcomponentsof strategyat this level (1978, pp. 27, 28).

In the selection of variablesto representbusiness-levelstrategy,focus wason variablesthat havebeen shownempiricallyto effect firmcompeti- tive performance.In this respect,less emphasiswas put on a firm'smixof marketsegmentsand productline items withina particularindustrythan that used by Hofer and Schendel(1978). Instead, emphasishas been on variablesthat demonstrablytend to confer competitiveadvantageor dis- advantage. As with corporate-levelstrategy,business-levelstrategycan be opera- tionalizedin termsof a richvarietyof measures.In two of thewidestrang- ing studies, Schoeffler, Buzzell, and Heany (1974) and Schendel and Patton (1978), firm size relativeto competitorsand firm resourcealloca- tions to capitalinvestment,advertising,and researchrelativeto competi- tors werestudiedas strategicdeterminantsof firm profitability.Takinga morefinanciallyorientedview, Hall andWeiss(1967)andFisherandHall (1969) found two risk factors, unpredictabilityof firm profitabilityand debtleverage,respectively,to explainconsiderablevariancein firmprofit- ability.

RELEVANTTHEORYAND RESEARCH

The main researchquestion addressedin this paper is degreeto which variationin a firm'scorporate-levelstrategyand in its business-levelstra- tegy explainsvariationin its profit performance.Althoughthis mayseem to be a simplequestion,rarelyhas theoryand researchcombinedboth the interindustryand intraindustryperspectivesin terms of definitions of corporate-levelstrategyand business-levelstrategyused here.

A greatdealof theoryand supportingresearchon the economicsof in-

dustrialorganizationleaves little doubt that interindustrydifferencesin structureand profitabilityarepersistentover time and are similaramong industrializednations. This also means, of course, that there are differ- encesin the averageprofitabilityof the firmscompetingin differentindus- tries.Scherer(1970),Weiss(1974),and Caves(1977)reviewthis literature. The industrialorganizationfield has focused largelyon industrialaggre- gatesof firms, however,ratherthan on the firms themselves.The indus-

trialorganizationframeworkthus sayslittleabout eitherthe rangeof vari- ation in firmperformanceacrossor withinindustriesor aboutotherrela- tivelylargedifferencesamongfirmsin generalor among firmscompeting withina singleindustry.Althoughbusinesspolicyand otherareasof busi- nessadministrationhave focusedon businessfirmsas the unitof analysis, until recentlythey have producedlittle systematicor comprehensivere- searchon variationin the environmentsin which individualfirmscom- pete.

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The literaturereviewedbelow is organizedin three sections. First, a brief reviewof pivotal works contributingto the evolution of separate, hierarchicalconceptsof strategywill be presented.These worksprovide more background on the concepts of corporate-levelstrategy and business-levelstrategyset forth above. The remainingtwo sectionscover the empiricalresearchfrom whichthe hypothesesof the presentresearch derive. These sections discuss evidence on relationshipsbetween firm profit performanceand both corporate-levelstrategyand business-level strategy,respectively.

Corporate-leveland Business-levelConceptsof Strategy

Ansoff wasamongthe firstto conceptualizedifferentlevelsof organiza- tional decisionmaking.Ansoff sawthreelevelsof decisionsfacingthe or-

ganization'sdecisionmakers:strategicdecisions- "the selectionof prod-

uct mixandmarkets

vironment,"administrativedecisions-"structuring a firm'sresourcesto maximizeperformancepotential," and operatingdecisions-"maximize the efficiencyof the firm'sresourceconversionprocess"(1965,pp. 5, 6). Ansoff's firsttwo types of strategyroughlyapproximatethe conceptsof corporate-leveland business-levelstrategy,respectively,that are used in the presentresearch. Authors in the HarvardBusinessSchool tradition(Levitt, 1960;An- drews, 1971;Uyterhoeven,Ackerman,& Rosenblum,1977;Christensen, Andrews,& Bower, 1978)have recognizedtwo similarlevelsof strategy. Andrews, for example, defined corporate strategy as "the pattern of major objectives,purposes,or goals and essentialpolicies and plansfor achievingthose goals statedin such a way as to define what businessthe company is in or is to be in and the kind of companyit is or is to be" (1971,p. 25). The decisionon whatbusinessthe companyis in or is to be in clearlyapproximatesthe conceptof corporate-levelstrategyusedhere. The decisionon what kind of companyit is or is to be is too vagueto be easily interpreted,but it could be seen as incorporatingthe concept of business-levelstrategy. Vancil and Lorange(1975) define threelevels of strategythat parallel thoseof thepresentstudy.Theyviewstrategicplanningin diversifiedcom- paniesas movingthroughthreecycles:settingcorporateobjectivesat the top, settingconsonantbusinessobjectivesand goals in the divisions,and establishingthe requiredaction programsat the functionallevel. Mileset al. (1978)identifythreebroadtypesof problemsfacingorgani- zations: the entrepreneurialproblem, the engineeringproblem, and the administrativeproblem. Solving the entrepreneurialproblem in their model is equivalentto decisionson corporate-levelstrategyin presently used terms,and the lattertwo types of problemsfit loosely withthe con- cept of business-levelstrategy.

an impedencematchbetweenthe firmandthe en-

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Hofer and Schendel(1978)prescribedifferentanalyticstrategictasksat the corporatelevel and the businesslevel. They see the principaltask of analysisat the corporatelevel as evaluatingthe relativeattractivenessof business(es)in the firm's portfolio and the principaltasks of analysisat the business-levelas assessingthe stage of the productlife cycleand the firm's competitive position-within each relevantbusiness. Hofer and Schendel's(1978)definitionsarethe most specific,andtheirsarefollowed closely in this paper.

Corporate-levelStrategyand FirmPerformance

Empiricalresearchon relationshipsbetween corporate-levelstrategy and firmperformanceis discussedin two partsbelow.The firstpartcon- cernseffectsof the quantityandtypeof diversityin a firm'sbusinessport- folio on its profitperformance.The secondpartconcernseffectsof varia- tion in industryon firmprofit performance. Althoughsome theoreticalreasonscanbe advancedthatthequantityof industrialdiversificationper se may affect businessfirms' profitability, empiricalresearchthus far indicatesthat little relationshipexistsbetween diversityand profitability.Rhoades(1973)suggestedthatdiversifiedfirms mightcreatebarriersto entryto variousindustriesin two ways:first, by using profits from one industryto subsidizepredatorypricingin another industryand, second, by obscuringattractivereturnsin one or more of

theirindustriesthroughconsolidatedfmancialreporting.Rhoades'(1973)

initialresearch,basedon 1963data for a sampleof 244manufacturingin-

dustries-four

some modest support for this view. However, Rhoades (1974) subse- quently developed three additionalmeasuresof industrydiversityusing improveddetail in data for 1967publishedby the U.S. CensusBureau. The data allowed measurementof firm diversilficationin termsof both (a) the numberof industriesin whichfirmscompetedand(b) the propor- tion of firms'salesoutsidetheirprimaryindustry.In the secondstudy,he found a modest negativerelationshipbetweendiversityand profitability. Rhoades (1974) attributedthe contradictoryresults of the two studies more to differencesin their levels of industrialaggregationthan to their differencesin diversificationmeasurement. SeveralstudiesusinglargeU.S. manufacturingfirmsas theunitof anal- ysis havefound no relationshipbetweendiversityandprofitability.Gort's (1962) work is one of the most comprehensivestudiesavailableon this subject. In a sampleof 100of the 200 largestmanufacturingfirmsin the United Statesin 1954,includingdata for the years1947through1954,he found virtuallyno correlationbetweenreturnon net worthandtwo mea- suresof firm diversification.

Gort(1962)did finda minimallysignificantpositivecorrelationbetween firm growth in assets between 1939 and 1954 and diversificationin the latteryear. Berry(1975)supportedthis resultin a sampleincludingnearly all of the 500 largest U.S. manufacturingfirms and includingdata for

digit StandardIndustrialClassifications(SIC)-showed

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1960and-1965.Berryfound low positiveassociationsbetweengrowthin corporateassets in this 5-yearperiodand severalmeasuresof growthin

corporatediversification.However,the regressionsas a whole explained little variancein corporategrowth.Using a sampleof approximately300 of the largestU.S. manufacturingfirms, Rumelt(1977)regressedBerry's measuresof firmdiversityin 1960andin 1965againstfirmprofitabilityin these yearsand found no significantrelationship.

A second kind of evidenceabout corporate-levelstrategyis especially

relevantto the presentresearchdesign.Thisis evidenceas to the effect of variationin the averageprofitabilityof industrieson the profitabilityof fi'rmscompetingwithin them. On the average,of course, the weighted averagefor all firmsin an industrygives the industry'sprofitability,and muchof this variationin industryprofitabilitycan be explainedby varia- tion in industrialmarket structure.However, individualfirms within a givenindustryclearlyvarymarkedlyin theirprofitability,and thusvaria- tion in profitabilityamongfirmscan be explainedonly partiallyby varia- tions in the industryor industriesin which they compete. The main re- searchinteresthereconcernsboth how muchof an individualfirm'sprof- itabilitycanbe explainedby its industrycomparedto otherindustriesand how much can be explainedby the firm's strategycomparedto other firms'strategieswithinits particularindustry. Rumelt(1977)found specializedfirmsto be the most profitable,rela- tively speaking,when his samplefirms' performancewas controlledfor the profitabilityof theirdifferingindustries.Firmswithtechnicallyrelated portfolios droppedto averagerelativeto theirindustries,and firmswith unrelatedportfoliosremainedthe leastprofitablein both relativeand ab- solute-terms.The latterresultsadd insighton Rumelt'searlierresultsas wellas provideevidenceof the positiveeffectsof industryprofitabilityon firm profitability. LiebersonandO'Connor(1972)studieda sampleof listedfirmsoverthe period 1946to 1965.Theyfoundthat variationin firms'primaryindustry explained 20 to 30 percent of the variation in their profitabilityand growth.LiebersonandO'Connor'sadditionalfindingthatvariationin the firms themselvesaccountedfor much of the remainingvariationin firm perfornmanceis also important.Because of Liebersonand O'Connor's (1972) unorthodoxmethodof partitioningvariance,the validityof their findingsis difficultto assess. BeardandDess(1979)obtainedresultssimilarto those of Liebersonand O'Connor. Both industryreturnon assetsand industryreturnon equity provedto be significantpredictorsof the correspondingmeasuresof firm profitability.In addition,intraindustryvariableswerefoundto be signifiL- cant.

Business-levelStrategyandFirmPerformance

The reviewof researchon relationshipsbetweenbusiness-levelstrategy and firm performanceis selective. Business-levelstrategicvariablesfor

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literaturereviewand for furtherresearchhavebeenchosenon the basisof

four criteria.The firstandmostimportantcriterionwasthatthe business- level strategyvariableshavean empiricaltraditionshowinga relationship with firmperformance.This is consistentwiththe definitionof business- level strategyabove, whichstressesdifferencesconferringcompetitivead- vantageor disadvantageamongthe competitorswithina givenindustry.A second criterionstemmedfrom practicalresourceconstraintson the re- search.Thiswasthat dataon the variablesmustbe availablein secondary sourcesfor both firmsand industriesand that comparablemeasurement of profit performanceand other variablesbe availablefor both units of analysis.A thirdcriterionwas that the variablesbe amenableto manage- mentcontrol.A flnal criterionwasthatthe variablesmustbe characteris- tics of the organizationas a wholethatcanbe observedobjectivelyacross organizationsin a givenindustry.Thisrestrictioneliminatedperceptualor judgmentalvariablessuchas the uncertaintyfelt by managementdecision makers. In applyingthese four criteria,three business-levelstrategyvariables have been identifiedas most significant:relativesize, debt leverage,and capitalintensiveness. Firmsizein eitherabsoluteor relativetermsis one of the mostvalidated correlatesof firmprofit performance.Forthisreasonit waschosenas the first business-levelstrategy variable. Researchgenerallyhas shown a positiveassociationbetweeneitherabsoluteor relativefirmsize and firm profitability.This relationshipis consistentwith a largebody of theory and researchthat demonstratesa wide variety of economies of scale. Scherer(1970)providesan extensivereviewof the literaturein the indus- trialeconomicstradition,as of the dateof publication.Morerecently,the Boston ConsultingGroup (1972) has documentedthe ubiquityof log- lineardeclinesin unit costs andpricesas cumulativeoutputexperiencein- creases. Relativefirm size withina specificindustryis the mainconcernof this paperandwillbe usedas a measureof firmbusiness-levelstrategy.Studies using marketshare as an independentvariablein explainingfirm proflt performanceincludeShepherd(1972),Gale(1972, 1974),Schoeffleret al. (1974), Buzzell,Gale, and Sultan(1975),Winn(1975),and Bass, Cattin, and Whittink(1978).All of thesestudiesincludedotherindependentvari- ablesas controlsin additionto the marketsharevariable,and all found a

significantpositivecorrelationbetweenfirmmarketshareandfirmprofit-

ability. Shepherd(1972)was one of the firstresearchersto specifyfirmmarket shareas an independentstructuralvariablein attemptingto explainfirm profltability.In a study of over 200 firmsamongthe Fortune500 largest

U.S. industrialflrms during the period 1960 through 1969, Shepherd found firm marketshare to explainas much or more variancein these flrms' profitabilitythan the moretraditionalmarketstructurevariables. Thelatterincludedleading-firmgroupshareof themarket,firmassetsize,

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firm advertisingto salesratio, firmgrowthrate, and industrybarriersto entry. Gale (1972) publisheda theoreticallymore complex study than Shep- herd's (1972)of the relationshipsamong firm profitability,firm market share,andseveralinteractionandcontrolvariables.Gale'sdatabasewasa sampleof over 100 firms from the Standardand Poors Compustat,An- nual IndustrialTapes(1979) for the five years 1963through 1967. Gale (1972)also found that firm marketshareexhibiteda positiveassociation with firmprofitability,but that this associationwas quitevariabledue to interactionbetweenmarketshareandotherindependentvariables,among whichindustryconcentrationwas the strongest. Gale's(1972)studyis especiallyrelevantto the researchreportedin this paperbecausehistheoreticaldiscussionandresearchon variabilityin mar- ket share'seffects on profitabilityareimportantin explainingthe present findingsabout this relationship.His theoreticaltreatmentand resultson the relationshipbetweenfirmdebtleverageand firmprofitabilityarealso germaneto the presentdiscussionof firmdebt-leverageas a business-level strategyvariable. Winn(1975)conducteda studyof firmprofitabilitysimilarin designto thetwojust discussedexceptthat firmsizewasmeasuredabsolutelyrather than relatively.Winn'ssampleincludednearly800 firmsin 79 industries fromthe StandardandPoors Compustat,AnnualIndustrialTapes(1979) for the years 1960and 1968.Winn'sfindingsof a strongpositiveassocia- tion betweenfirm size and profitabilitysupportsthe findingson market sharecited above. The studiesof Gale (1974), Schoeffleret al. (1974), and Buzzellet al. (1975)arebasedon datagatheredas partof the HarvardBusinessSchool's Profit Impactof MarketingStrategies(PIMS)project.The PIMSproject data base as of 1972includeddata from 57 largeNorth Americancom- panies,about620of theirsingle-industrysubunits.As Buzzellet al. (1975) indicate,an advantageof this data base for studyingmarketshareis that businessesor marketsaredefinedmorenarrowlythanthe U.S. SICsystem usuallyallows. The well knownresultof the PIMS researchon marketshareand firm profitabilityis a strongpositiveassociationamong the sampleof single- industrysubunits.However,the relativeimportanceof marketsharecom- paredto otherindependentvariableshas not been preciselyquantifiedin publishedform. Schoeffleret al. (1974)reportthata regressionmodelde- velopedfromthe PIMSdata base explained80 percentof the variancein returnon investmentamongthe 620 single-industrysubunits.Gale(1974) includesregressionresults,butthe coefficientsarenot standardized.It ap-

pearsfromthelatterresultsthatmarketshareandcapitalintensivenessac-

count for most of the variancein profitabilityand areabout equalin im- portanceamongover 35 independentvariablesreportedin Gale (1974). The PIMSprojectapproachof isolatingbusinessunitsof analysiscom- peting within only one product-marketstrongly influencedthe present

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study'sdesign. However,the presentdesignhas reliedon the SIC system in theUnitedStatesOffice of Managementand Budget(1972)to definein- dustriesor markets.The researchof Shepherd(1972), Gale (1972), and Winn(1975)reviewedabove shows that this method is serviceable.

A finalstudyusing firmperformanceas a dependentvariableand firm

relative size as an independent variable, Bass et al. (1978), suggests anotherimportantqualificationof the generalmarketshare-profitasso- ciation. Overall, Bass et al. (1978) confirmed this association among a sampleof 63 manufacturersof food, tobacco, and cosmetics. However, whenthe samplewasgroupedin 10moreinternallyhomogeneousindustry classifications,the marketsharevariablewas statisticallysignificantand positivein only about half of the groups. The secondbusiness-levelstrategyvariable,capitalintensiveness,also is wellvalidatedas a correlateof firmprofitability.In this case, the relation- ship is generallynegative.The theoreticalcontext and explanationof this phenomenonare not alwaysconsistent, however. Winn (1975)presented and testedthe hypothesisthat the relationshipbetweenfirmcapitalinten- sivenessand firmprofitabilityis positive, not negative. His reasoningin- cluded two major points. First, capital intensivenessimplies a relatively largemninimumefficient scale, a barrierto entry Second, consistentwith the first, firmsize and capitalintensivenessare associatedpositively,and the latterrelationshiphas a strongtheoreticaland empiricalrelationship with firmprofitability,as discussedabove. However,Winn(1975)found a negative regressioncoefficient for firm capitalintensiveness,as measuredby the assetsto salesratio, in relationto

profitability. Not only was this result statistically significant, but it ex-

plained 20 to 30 percentof the variancein firm profits. As mentioned above, this is preciselythe resultSchoeffleret al. (1974)and Gale (1974) obtainedin theiranalysesof the PIMS data base. Furthersupportingevi- denceis providedby Rumelt(1974), who found predominantlyvertically integratedfirmsto be amongthe most capitalintensiveand the leastprof- itable. Winn (1975) explainedhis finding of a negative association between firm capitalintensivenessand fLrmprofitabilityin terms of higherfixed operatingcosts that the formervariableimplies. He reasonedthat rela- tivelycapitalintensivefirmsweremoresubjectto operatinglossesin times of cyclicaldownturn.Schoeffleret al. (1974) reasoned, in addition, that capital intensivefirms tend to compete in markets with relativelystan- dardizedproductswherepricecuttingto obtain volume is frequent. HattenandSchendel(1977)providefurtherevidenceof a negativeasso- ciationbetweenfirmcapitalintensivenessand profitability.In a sampleof 13majorbrewers,covering20 yearsof data for most of them, they found a negativeassociationwhichremainedconsistentand significantamonga numberof subgroupswithintheirsample. The final business-levelstrategyvariableis debt leverage.Empirically, this variablehas had a fairly consistent negative association with firm

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profitability,as was the case with capitalintensiveness.However,in the case of firmdebt leverage,the theoreticalcontextis muchmorecomplex. Themaincomplexityis'thatmorethanone sourceof riskcanbe identified empiricallyand that these separateriskelementsappearto interact. Gale (1972)and Baker(1973)distinguishbetweenbusinessrisk and fi- nancialrisk. Businessrisk tends to be a function of variabilityresulting from ratherstableaspectsof industrystructureand technology.It thus is best studiedin termsof interindustryvariation.Interindustryvariationof this kind is viewedin this paperas relevantprimarilyto corporate-level strategy.Financialrisk, as measuredby financialleverage,is then corre- spondinglybest stidied in termsof intraindustryvariation.Thus, finan- cial leverageand attendantriskshouldbe measuredrelativeto the norms and rangewithina particularindustry.This is the approachtakenin the presentstudy. Most studiesof risk have focused on eitherbusinessrisk or financial risk. Only one study, to the authors'knowledge,has includedboth and consideredthemseparately.Studiesfocusingon the variabilityandunpre- dictabilityof profitsgenerallyhave found a positiverelationshipbetween this kind of businessrisk and ratesof return.TheseincludeConradand Plotkin(1968)and Fisherand Hall (1969).Winn(1975)pursueda similar design in studyingbusinessrisk. Rate of returnamong the almost 800 firmshe studiedwasnegativelyrelatedto the standarddeviationandposi- tivelyrelatedto the skewnessof this sample,just the oppositeof whathe hadhypothesized.The coefficientof determinationwas smallin this case,

in contrastto earlierstudies.

Studies focusing on financialrisk as measuredby the debt to equity ratiohavefound a negativeassociationbetweenthis kindof riskand firm profitability.Arditti (1967), Hall and Weiss (1967), and Gale (1972) fall

into this category. Baker (1973) obtained similarresults using a single equation,ordinaryleast squaresmodel. However,whenBakeruseda two equation, two stage least squaresmodel, the relationshipbetweendebt leverageand rateof returnbecamepositive, as classicaltheorysuggestsit should.Onecould feel moreconfidentin Baker'sresolutionof apparently contradictoryfindingsif it had beenreplicated.

HYPOTHESESAND METHOD

Theresearchaimsto providea balancedtestof the powerof variationin firmcorporate-levelstrategyandin firmbusiness-levelstrategyin explain- ing variationin firmprofitability.The correlationalresearchdesignused involves testing the statisticalsignificanceand explanatorypower of a linearregressionmodel. As mentionedin the introduction,the researchis limited to single-

industryfirms. Thus, first the model will be specifiedas it was actually tested,i.e., the single-industryversionof the modelshownin equation(1).

A briefdiscussionwill show how the modelcan be generalizedto include

1981

Beard and Dess

675

multi-industryfirms. Suchgeneralizationis mucheasierin theorythanin practice.Variationin corporate-levelstrategyhas beenmeasuredin terms of the averageprofitabilityof the industryin whicha firmdoes business. Variationin business-levelstrategyhas been measuredin terms of the firm'srelativepositionwithinits particularindustryon the threebusiness- level strategicvariablesdiscussedabove: sales size, capitalintensiveness, and debtleverage.

TheModel

Thehypothesestestedarespecifiedin termsof an additivelinearregres- sion model:

Yi = bo+ b1X1j - b2X2i-

b3X3i+ b4X4i+ U

(1)

where:

Yi= the before tax returnon total investmentor on equityof the ith firm,

Xli = the before task returnon total investmentor on equityof the in- dustryin whichthe ith firmcompetes,

X2j = the debtto equityratiocomputedas the ith firm'sratiorelativeto

the averageratioof the industryin whichthe ith firmcompetes,

X3j = the assetsto salesratiocomputedas the ith firm'sratiorelativeto

the averageratioof the industryin whichthe ith firmcompetes,

X4j = the salessizeof the ith firmrelativeto the averagefirm'ssalessize

in the industryin whichthe ith firmcompetes,

U = an errortermaccountingfor unspecifiedvariables,

i = 1 throughn, and

n = the numberof firmsin the sampleor population. Thesignsof the coefficientsin equation(1) indicatethe directionof there-

lationshipshypothesizedto exist betweenthe independentvariablesand the dependentvariables. To generalizethe above regressionmodel to include multi-industry firmsone would needto substituteweightedaverageson the independent variablesfor the single-industryvariablesshown in equation (1). The weightsrequiredto computeweightedaverageson the independentvaria-

bles could be specifiedas the proportions, Pj, firm's assets or other resourcesassignableto

whichit does business.Algebraicallythe weightscan be expressedas:

of a given multi-industry the various industriesin

Pj =Aj/A

(2)

where:

Pi

Aj

=the proportionof firmresourcesassignableto thejth industry,

= the absolutevalueof firmresourcesassignableto thejth industry,

676

Academy of Management Journal

December

A

j

= total firm resources=

=

j

2Aj,

1 throughm, and

the numberof industriesin whichinvestmentis possible.

m =

Giventhe weights, Pj, any business-levelstrategyvariablecan then be

expressedas follows:

Xk =

2PjXkj, or
j

Xk = PlXkl + P2Xk2 +

 

(3)

+ PmXkm

(4)

where:

Xk

= the kth business-levelstrategyvariable,

k

=

i throughq,

q

= the numberof business-levelstrategyvariables,

Pj

= the proportionsusedas industryweightsas definedin equation(2) above,

j

= 1 throughm, and

m

= the numberof industriesin whichinvestmentis possible.

The relativelylargeincreasein resourcesrequiredfor actualimplemen- tation of the moregeneralmodelin equations(3) and (4) comparedto the single-industrymodelin equation(1) wasjudgednot to be worthwhile. In practice,accurateestimatesof the proportionof firmassetsallocated amongthe industriesin whichdiversifiedfirmsdidbusinesswerefoundto be difficult to obtain by surveyprocedures.This sourceof measurement errorwasjudgedto be majoron the basisof a pilot survey.Therefore,the researchwas limitedto a sampleof listed firmsthat competedin only a singleindustry.The single-industryfirmsstudiedherearesimilarin many respectsto the single-industrysubunitsof largerfirmsincludedin the Har- vard Business School's PIMS project, as reportedin Schoeffler et al. (1974),Gale(1974)and Buzzellet al. (1975).

TheSample

The population sampledin the presentstudy was the single-industry manufacturingfirmsincludedin Standardand Poors (1979).All firmsin- cludedin the final samplewererequiredto havebeenin one andthe same

industryfor the years 1969through 1974.A firmwas consideredto

single-industryfirm if, and only if, duringthe 1969-1974period, a sub- stantialmajority,and in most casesall, of its salescould be clearlyclassi-

fied withinone threedigit SIC as definedby the U.S. Office of Manage- mentand Budget(1972). The processof identifyingthe single-industrycorporationsas specified abovewas painstaking.Standardand Poors (1979)givesonly the primary enterpriseindustrialclassificationof eachfirmin the Compustatfile. Thus

be a

1981

Beard and Dess

677

each firmdrawnat randomfrom this file was checkedmanuallyin Stan- dardand Poors (1969 through 1974)which gives each four digit SIC in whicha corporationdoes business.Onlyabout one in six of the Compu- stat firmswerefoundto be bona fide single-industryfirmsin termsof the fourdigitSICcodes. A finalsampleof 40 single-industryCompustatfirms was studied.

Data, Measurement, and Analysis

Firm-leveldata requiredto compute the appropriatecoefficients in equation (1) above were obtained from Standard and Poors (1979). Industry-leveldata requiredto compute the appropriatecoefficients in equation (1) were obtained from U.S. Internal Revenue Service (1974 through1979)and Troy (1973through1978).Thesesourcesof firm-level and industry-leveldata, respectively,providea consistentset of account- ing classificationsacross the reportingunits and across the six years studied. The years 1969through1974werechosen for analysisbecausethis was the most recent six year period for which the InternalRevenueService datawerepublishedand becausethis periodincludedan equalnumberof recessionyearsand relativelyfull employmentyears. In 1971, 1972, and 1974,U.S. unemploymentwasbetween5.5 and6.0 percent.In 1969,1970, and 1973unemploymentwas between3.5 and 5.0 percent. Operationalmeasurementof the variables specified in equation (1) above is straightforward.Two measuresof the dependentvariable,firm profitability,wereanalyzedin parallelfashion. The first, firm returnon equity (ROE), was measuredas the ratio of profits before income taxes andextraordinaryitemsto equity.Thesecond, firmreturnon total invest- ment(ROI),was measuredas the ratioof profitsbeforeincometaxesand extraordinaryitems plus interestto year-endtotal investment. Concerningmeasurementof the independentvariables,the appropriate industryprofitabilitymeasure(X1,the corporate-levelstrategyvariable), eitherreturnon equity (ROE)or returnon total investment(ROI), was computedfrom data in the U.S. InternalRevenueService(1974through 1979)exactly as the correspondingfirm profitabilitymeasurewas com- puted. The remainingthreeindependentvariables,all business-levelstra- tegy variables,were measuredin the same way regardlessof which firm profitabilitymeasurewas used as the dependentvariable.All threewere measuredas firm-characteristicsrelativeto industrynorms. The relative debtleveragemeasure(X2)usedwas the ratioof firmtotal debtto equity dividedby the correspondingaverageratiofor all firms(corporatetax re- turns)in the appropriateindustry.Similarly,the relativecapitalintensive- ness measure(X3)was the firmtotal assetsto total salesratio dividedby the averageratiofor all firmsin the appropriateindustry,andthe relative sales size measure(X4)was firm sales dividedby the averagesales of all firmsin the appropriateindustry.

678

Academy of Management Journai

December

The statistical analysis and hypothesis testing were done using a stepwise linear regression procedure. Independent variables were entered at each step in the order of their squared partial correlation with the dependent variable when all other independent variables were controlled. The mini- mum level of acceptable statistical significance for the regression equa- tions tested was p < .05. The model was tested for each of the six years in- cluded in the study as well as for the six year average, with respect to both of the dependent variables, return on equity and return on investment.

Reliability and Validity Issues

The pooling of firms in a sample, where these firms are in some impor- tant respects heterogeneous, has been accorded increasing critical atten- tion recently. Hatten and Schendel (1977) and Bass et al. (1978) are the most germane to our study. The basic point of both studies is that, if re- gression coefficients of subgroups of firms within a population or sample differ significantly from those of the population or sample as a whole, the reliability of the latter coefficients is subject to question. These studies make a useful methodological point and also serve to re- mind one of the complexities in the areas of organization-environment re- lationships and business policy. Nonetheless, it is believed that this meth- odological point leaves the reliability of representative samples such as the present one at a viable level. The above two critical studies additionally raise the important judgmental issue of what populations are most rele- vant in studying firm performance. This question clearly has many accept- able answers depending on the purposes and interests of the researchers. Two important trade-offs are seen between the external validity of a sample of firms and the kind of internal homogeneity that Hatten and Schendel (1977) and Bass et al. (1978) have persuasively raised as a reliabil- ity criterion. First, as such homogeneity is sought, the size of the popula- tion of firms that the sample represents, and thus the generality of the re- sults, diminishes. Second, the parsimony of the empirically supportable theory resulting is diminished, a cost of contingency or situational theories in general. Both articles discuss other, more statistically technical advan- tages and disadvantages of pursuing internal homogeneity in samples of firms. The present authors have opted to weigh the above kinds of exter- nal validity more heavily than the added reliability that internal homo- geneity admittedly provides. The present research design is believed to have a number of strengths. The sample is drawn from a large population of listed manufacturing firms. The single-industry firms are relatively homogeneous with respect to industrial diversity. Schoeffler et al.'s (1974) experience with single- industry subunits of large firms suggests that larger, diversified firms can usefully be represented as aggregates of units similar to the present ones. Thus the generality of current results is relatively wide.

1981

Beard and Dess

679

In using only single-industryfirms, in using industryprofitabilityto controlfor interindustryvariation,and in measuringfirmvariablesexclu- sivelyin relationto industrynorms,it is believedthatthe presentresearch has done much to distinguishclearly between interindustryand intra- industry(i.e., firm)sourcesof variation,a significantconfoundingprob- lem in most earlierstudiesof firmperformance.The sampleof 40 single- industryfirms represents38 separateindustriesas well. Becauseof this interindustryheterogeneity,the sample providesan adequaterange for variationat this level of analysis. Six yearsof data that are about equallysplit in termsof high and low pointson the businesscyclehavebeenused, andreasonablyconsistentre- sults for each yearseparatelyand in the aggregatehave been developed. The resultsalso are developedfor two differentperformancemeasures. Thereplicabilityof the designleavesits reliabilityandvalidityopento rel- ativelyeasy futuretesting.

RESULTS

Resultsof the stepwiseregressionanalysisare summarizedin Tables 1 and 2. The formergives resultswhen firm returnon equity(ROE)is the dependentvariable,and the lattergives parallelresultswhen firm return on total investment(ROI)is the dependentvariable. The resultsshown in Tables 1 and 2 indicatethat both corporate-level strategyandbusiness-levelstrategy,as definedandmeasuredhere,areim- portantin explainingvariationsin firm profitability.With respectto the measureof corporate-levelstrategy(X1,industryprofitability)the sign is positivein all equationsin Tables 1 and 2. In a largemajorityof equa- tions, XI is either first or second in explanatorypower as indicatedby eitherthe standardizedregressioncoefficientsor the stepwisechangein

multipleR2.

With respectto the three measuresof business-levelstrategy(relative size,debtleverage,and capitalintensiveness),one encountersboth confir- mationof some relationshipssymbolizedin equation(1) and some unex- pectedresults.The explanatorypowerof firmrelativedebtto equity,X2, is surprising.X2has a negativesign in virtuallyall equations,as hypothe- sizedin equation(1). It is also firstor secondin explanatorypowerin the largemajorityof equations.Thesignof firmrelativecapitalintensiveness, X3, is negativeas hypothesizedin equation(1). Overall,X3 rivalsX2 in ex- planatorypower, but it is not as consistentlyhigh in this respect.The al- most universallylow explanatorypower of firm relativesales size is a majorsurprise.Becausethe regressioncoefficientsfor X4 are so close to zero, theirsignis of no interest. Turningnow to the overallmagnitudeand statisticalsignificanceof the regressionresults,one can see in Table 1, wherereturnon equity(ROE)is the dependentvariable,thatthe multipleRs and associatedR2sexceedthe p < .05criteriaon one or morestepsin fourof the sevenequations.Results for two otherequations,includingthe equationfor the six yearaverages,

680

Academy of Management Journal

December

b4, b2, b3, b1, bo,

1972

b3, b4, b1, b2,

bo

1971

b4, b2,

b3,

b1, bo,

1970

b4, b2, b3, bl, bo,

1969

Firm Firm Firm

Firm Firm

Firm

Firm Firm Firm

Firm Firm Firm

Industry Constant

Industry Constant

Industry Constant

Industry

Constant

Relative

Relative

Relative

Relative

Relative

Relative

Relative

Relative

Relative

Relative

Relative

Relative

Return

Sales Debt on

to

Size

Capital

Return

Return

Return

Sales on Debt

Sales Debt on

Sales Debt on

Capital to

Size

to

Size

Capital

to

Size

Capital

Equity

Equity

Equity

Equity

Equity

Equity

Equity

Equity

Coefficients Regression

and

Equation

Variable

Intensiveness Intensiveness

Intensiveness Intensiveness

X1

X2

X4

X3

-

X4 X1 X2

X3

-

X4 X2

X3

X1

-

XI

X4 X2

X3

-

Xi

Stepwise

-.062 .838

-.000 -.092

.251 .112 .825 .272 -.000 -.139 .189 .000 -.153 .212

.001 -.130

-.061

1.550

-.033 1.391

.051 .537

.000 .060 .103 .158 .853 .202 .000 .076 .888 .000 .077 .112

.052 .519

.001 .100

.044 .428

.077 -.185 -.239 .254

-

-.115 .128 .158 -.212

-

.073 -.202 -.261 .527

-

.042 -.103 -.297 .405

-

.424 .418 .378 .292

-

.129 .072 .057 .068

-

-

.304 .283 .260 .190

.478 .386 .275 .239

-

.559

.564 .526

.451

-

.008 .003 .003 .004

-

-

.522 .414

.524 .514

.021 .009 .003 .008

-

Regression

Coefficients Regression

Analysis

Unstandardized

of

Coefficients Regression

in

Firm

Errors Standard

Final

TABLE

1

Equation

Step

Return

on

Regression

Coefficients

Standardized

Equity

R

R

Multiple Stepwise

(ROE),

of

Stepwise

and

Signifi

Multiple

1969-1974

Multiple ance

Statistical

.180 .175 .143 .085

-

.006 .031 .058 .085

-

.093 .080 .067 .036

-

.013 .012 .031 .036

-

.318 .313 .277 .203

-

-

.005 .036 .073 .203

.274 .273 .264 .172

-

.002 .093

-

.009 .172

R2 Correlation

Multiple Stepwise

Significance

Change Coefficients

R2

Multiple in

1981

Beard and Dess

b3, bI,, b2,

bo,

6-

Year

b3, b4, bl,

bo1974

b2,

b3, b2, b4, bl, bo,

1973

Firm Firm

Firm Firm

Firm

Firm Firm

Firm

Industry

Constant

Industry Constant

Average,

Industry Constant

Relative Relative

Return

on Debt

Relative

Relative

Return

Sales on Debt

Relative

Relative

Relative

Relative

Return

Debt Sales on

Capital to

Size

Equity

Equity

Capital to

Equity

Equity

1969-1974

Capital to

Size

Equity

Equity

Coefficients

Regression

and

Equation

Variable

Intensiveness

Intensiveness Intensiveness

X3 Xl X2

-

X4 XI

X3

X2

-

X3

X4 X1

X2

-

Xi

.000 -.072

.408

.096

.301

.000 .033

.046

.141

.212

-

-.344

.393 .367 .291

-

.106 .068

.069

-

.154 .135 .085

-

.019 .050 .085

-

-.007 1.260 .162 .000 -.069 .145

.001 -.308

.037 1.148

.068 .638 .149 .000 .060 .086

.006 .080

.052 .460

-.015 .171 .275 -.530

-

-

.057 -.116 -.184 .396

.590 .590 .565 .490

-

.004

.001

.001 .001

-

-

.348 .348 .320 .240

-

.000 .029 .079 .240

.421

.425 .406

-

.356

-

.128 .068 .036 .024

.180 .177 .165 .126

-

.003 .039

.012 .126

-

Coefficients Regression

Unstandardized

Coefficients Regression

in

TABLE

1

Errors Standard

Final

Equation

Step

(cont.)

Regression

Coefficients

Standardized

R

Multiple Stepwise

R

of

Stepwise

and

Multiple Multiple Significance Statistical

R2

Signf Correlation

Multiplk Stepwise

icance

Change Coefficients

R2

Multiple in

681

682

Academy of Management Journal

December

b4, b1, b3, b2,

bo,

b1, b3

1972

b4,

b2,

bo,

1971

b4, b3, b2, b1,

bo,

1970

bl, b2, b3,

b4,

bo,

1969

Firm

Firm Firm

Firm

Firm

Firm

Firm Firm Firm

Firm Firm Firm

Industry

Constant

Industry

Constant

Industry Industry

Constant

Constant

relative

relative

relative

relative

relative relative

relative relative

relative relative

relative

relative

return

sales on

size

debt

capital

to

equity

equity

return

sales

on

debt

capital

to

size

equity

equity

return

return

sales on debt

size

sales debt on

capital to

size

equity

equity

to

capital

equity

investment

Coefficients Regression

and

Equation

Variable Stepwise

intensiveness intensiveness intensiveness

intensiveness

XA

A4

2

X

X1

A

-

T4 X3

X2

XI

-

XI XT2

X4

X3

- Xi

Regression

.000 -.079

.527

-.081

.250 4.000

.671 -.097

-.099

.250

.571 .033

.000 .039

.067 .000

.084

.820 .053

.114

.023 -.302

.137 -.356

-

.097

.130 -.293

-.188

-

.497 .497 .478 .363

-

.037 .016 .008 .021

-

.247 .247 .228 .132

-

.001 .018 .096 .132

.366

.353 .273

.329

-

.270

.183 .088

.170

-

.134

.125 .075

.108

-

.009

.017 .075

.034

-

-.100 1.504

.000 -.064

.163

.048 .494

.000 .028

.059

.052 -.298 -.343 .449

-

.563 .561 .482 .322

-

.008 .003 .008 .043

-

.317 .232

.315 .104

-

.003 .129

.083 .104

-

.980 -.114

.000 -.064

.234

.000 .031

.054 .046

.068

.025 .289 -.320 -.360

-

.535 .534 .466 .422

-

.017 .011

.007 .007

-

.286 .285 .217 .178

-

.001 .068 .039 .178

-

Regression

co

Coefficients

Analysis

of

Unstandardized

Firm

ients Regression

Errors Standard

Return

TABLE

2

Equation

on

Total

Regression

Coefficients

Standardized

R

R

Step

Multiple wise

Investment

of

Stepwise

and

(ROI),

Multiple Multiple Significance Statistical

1969-1974

R2

Correlation

Multiple Stepwise

ncance

Change Coefficients

Rf

Multiple in

1981

Beard and Dess

b4, b3, bl, b2, bo,

b4, b3, bi, b2, bo,

6-Year

1974

b3, b2, b1, bo,

1973

Firm Firm Firm

Firm Firm Firm

Firm Firm

Industry Constant

Average,

Industry Constant

Industry Constant

relative relative relative relative relative

relative

relative

relative

return

sales

capital on to

debt

size

sales

return

on debt

capital

to

1969-1974

size

return debt capital to on

Coefficients

Regression

and

equity

equity

equity

equity

equity

equity

Equation

Variable

intensiveness

intensiveness intensiveness

X3 X1 X2

X4

-

X4 X3 X1 X2

-

X3 X2 XI

-

Xi

.000 .673 .195 .000 .577 .174 -.027 1.252

-.044 -.100

-.022 -.121

-.063 .103

.000 .583 .068 .000 .634 .084 .045 .625

.043 .037

.034 .040

.040 .072

.054 .177

-.156 -.420

-

.081

-.099 -.455

.139

-

-.093 .320

-.257

-

.461

.458 .398

.434

-

.072

.021

.035 .011

-

.213 .210 .189 .158

-

.003 .021 .030 .158

-

.459 .423

.466 .449

-

.035 .006

.066 .016

-

.211

.217 .202

-

.180

-

.006 .009 .022 .179

.377 .249

.366

-

.133 .122

.070

-

.142 .062

.134

-

.008 .062

.072

-

Coefficients Regression

Unstandardized

Coefficients Regression

in

TABLE

2

Errors Standard

Final

Equation

Step

(cont.)

Regression

Coefficients

Standardized

R

Multiple Stepwise

R

of

Stepwise

and

Multiple Multiple Significance Statistical

R2

Correlation

Multiple Stepwise

Significance

Change Coefficients

R2

Multiple in

683

684

Academy of Management Journal

December

approachthis level of significance,and the one remainingequation is clearlynot significant. The magnitudeand significanceof the resultsshownin Table2, where returnon totalinvestment(ROI)is the dependentvariable,aremoderately strongerthan those for ROE. In Table2, the multipleRs and associated R2sexceedthe p < .05 criteriaon one or more steps in five of the seven equations,includingthe equationfor the sixyearaverages.Of theremain- ing two equations,both approachsignificanceon one step, but the latter two also lag the otherfive equationsin the magnitudeand significanceof theirmultipleRs. The appropriateindustryprofitabilityvariable(X1)is strongerin explainingvariancein ROEthan it is in explainingvariancein ROI. The instabilityfromyearto yearin the top threeindependentvariables'

relativeexplanatorypoweris noteworthy.This is,

statisticalcriterionused to sequencevariablesfor stepwiseentryinto the regressionequations.A patternwithrespectto thegeneralbusinesscycleis

in part, a resultof the

unemployment,a major

also apparent,however. In yearsin whichU.S.

coincidentbusinesscycleindicator,was below 5 percent(1969, 1970,and 1973),the appropriateindustryprofitabilitymeasurehas the greatestex- planatorypower. In yearsin whichU.S. unemploymentexceeded5 per- cent (1971, 1972,and 1974),relativefirmdebt to equityand relativefirm capitalintensivenesshavethe greatestexplanatorypower.

DISCUSSIONAND CONCLUSIONS

On the question of the importanceof corporate-levelstrategy and business-levelstrategyin explainingfirmprofitability,the resultsindicate that both areimportant.In 10of the 14regressionequationsdescribedin Tables 1 and 2, the appropriateindustryreturnvariableand eitherfirm relativeleverageor firmrelativecapitalintensiveness(andmostoften both of thelattertwo) contributeappreciablyto statisticallysignificantmultiple correlationcoefficients. As to whichvariable,corporate-levelor business-level,is the moreim- portantin explainingfirmprofitability,one mustexercisecaution. If one looks at the two six year averageequations,the standardizedregression coefficientsin bothequationsshowconsistentrankingsof theindependent variables.Firmrelativedebtto equityis the mostimportant,andthisvari- able combinedwith firm relativecapitalintensivenessexceedsthe appro- priateindustryprofitabilityindexin explanatorypower. In Table 2, wherefirm ROI is the dependentvariable,the single-year equationsshowthatthe two majorbusiness-levelvariablescombinedgen- erallyexplainmorevariancein performancethan does the industryreturn variable.However,this is not so clearlythe case in Table 1, wherefirm ROEis the dependentvariable.In threeof the six yearsshownin Table1, the industryROE variableexceedsthe two major business-levelstrategy variablesin explanatorypower. All three such years are relativelylow

1981

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unemploymentyears,suggestingthatthe generalbusinesscycleaffectsthe relativeimportanceof the independentvariables. Theuniversalabsenceof anyrelationshipbetweenX4, firmrelativesales size, and eithermeasureof profitabilityis an unanticipatedresult.How- ever, this resultfits well with Gale's (1972)discussionof the relationship betweenfirm relativesize and firmprofitability,and it is consistentwith his findingof a strong,positiveinteractionbetweenfirmmarketshareand industryconcentration.When concentrationwas high in Gale's study, marketsharewasstronglycorrelatedwithprofit. Whenconcentrationwas low, marketsharewas not stronglycorrelatedwith profit. These results are consistentwith the theoreticalview that collectivemonopoly power amongmajorcompetitorsis a majorsourceof the profitsassociatedwith marketshare. The presentstudy'ssampleis certainto have smallerfirmson the aver- agethanthose basedupon theFortune500largestindustrialfirmssuchas Shepherd's(1972)study. Size data on the PIMSprojectparticipantssug- gestthat theirsingle-businesssubunitsarealso likelyto be amongthe top oligopolistsin the industriesin whichthey compete.Althoughthe present sampleis drawnfromthe CompustatAnnualIndustrialTapes,like Gale's (1972)andWinn's(1975)samples,the exclusionof multi-industryfirmsin the currentstudyno doubtwouldresultin the sample'scontainingsmaller firmsthan theirs,on the average. The greatmajorityof the sampleof single-industryfirmswereprofit- ableduringthe six yearsstudied.It thusappearsthatthesefirmsgenerally had reasonablysuccessfulstrategies.It appearslikely, however,that they would compete on a more selectivebasis than do leading oligopolists. Theythuswouldseemlikelyto specializein servingparticularmarketseg- ments, producingonly selectedproducts,or servingrestrictedgeographic areas. Hamermesh,Anderson,and Harris(1978)suggestthat firmswith smallmarketsharesmust follow these kindsof specializationin orderto succeed. If one could define the relevantcompetitiveenvironmentsfor these firmsmorepreciselythan the industrydata allow, theirrelativesize thenwouldbe likelyto appearmoreimportantto theirsuccess. On the question of how much of the variancein firm profit perfor- mancecan be explainedby the independentvariablestaken together,the resultsareencouragingbut not entirelypersuasive.In the 8 equations,out of the total of 14, in which statisticalsignificanceis high, more than a quarterof the variancein the dependentvariableis explained.The next threemost significantequations,whichexceedor approximatethep < .05 significancelevel, explainbetween15and20 percentof the variancein the dependentvariable.Becauseof the aggregatednatureof the three digit SICs used to provideindustrydata, one would expecthighercoefficients

of

employed. The multiplecoefficientsof determinationin Tables 1 and 2 are gen-

erallystrongerin yearsof relativelylow unemployment(1969, 1970,and

determination if

more precise industry classifications could be

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1973),although 1974, a high unemploymentyear, shows strongerresults than 1973. The effects of the generalbusinesscycle on the regressionre- sults can be rationalizedas follows. In years of risingemploymentand GNP, firms in any given industryare relativelyequal in their abilityto commandincreasesin financial,human,andmaterialresourcesneededto expandoutput.Undertheseconditions,the distributionof firmprofitabil- ity aroundthe industrymeanis narrowed,andthe meanprovidesa better approximationof each firm's profitability.In yearsof increasingunem- ployment and falling GNP, firms with relativelyhigh fixed costs asso- ciatedwith higherdebt and capitalintensivenesssuffer disproportionate drops in profitabilitycomparedto competitorswith lower fixed costs. Undertheseconditions,the distributionof firmprofitaroundtheindustry meanis wider,andthe meanprovidesa lesssatisfactoryapproximationof each firm'sprofitability. At any rate, it appearsthat businesscycle effects are not transmitted proportionatelyamongfirmsin a givenindustry.It also seemslikelythat controllablestrategicvariables,suchas capitalstructureand capitalinten- siveness,accountfor widevariancein thebusinesscycle'seffectson thein- dividualfirmsin a particularindustry. The presentstudy'sresultssupportseveraltentativeconclusions.First, variationin a firm'scorporate-levelstrategyand in its business-levelstra- tegy both help to explainvariationin firmprofitability.Second,the rela- tive importanceof variationin corporate-levelcomparedto business-level strategyin explainingfirmprofitabilityremainssomewhatambiguouson the basisof presentresults.Onthe faceof it, the relativedebtleverageand relativecapitalintensivenessdimensionsof business-levelstrategyappear stronger than industry return. However, the latter is measuredmore crudelythan the formertwo variables.Thus, a morediscriminatingmea- surementof industry-levelvariationmightpossiblytip the balanceof ex- planatorypowerin favor of corporate-levelstrategy. Third,relativefirmsizewithina givenindustrydoes not hold up hereas a powerfulpredictorof firmprofitability.Differingpopulationsof firms studiedseemlikelyto accountfor the differencebetweenthe researchre- sults and the resultsof severalstudies discussedabove. In competition among the few, the relativesize propositionlooks valid. In competition amongthe many, it does not. Fourth,the averagelevelof the multiplecorrelationcoefficientsandthe statisticalsignificanceof the regressionequationssuggestthatunderstudy arevariablesimportantto understandingandpredictingfirmprofitability. Nevertheless,theseresultssuggestthatroomremainsboth for bettermea- surementof our variablesand for specificationof additionalexplanatory variables. Finally,the variabilityof the resultsovertimearguesfor moreattention in futureresearchto sourcesof temporalvariation.The effect of some strategicvariableson a firm's profitabilityappearsto varywith business

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cycle conditionsor with other longitudinalchangesin the businessenvi- ronment.Firmdifferencesin business-levelstrategysuch as firm capital structureand capitalintensivenessappearto account for widelyvarying effects of environmentalchangeon individualcompetitorswithina given industry.

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