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Precis of How Much Does Industry Matter?

Richard P. Rumelt October 10, 2003

This is an abridged and slightly edited version of the paper: Richard P. Rumelt, How Much Does Industry Matter?, Strategic Management Journal, 12 (1991):167-185.

Because competition acts to direct resources towards uses oering the highest returns, persistently unequal returns mark the presence of either natural or contrived impediments to resource ows. The study of such impediments is a principal concern of industrial organization economics and the dominant unit of analysis in that eld has been the industry. The implicit assumption has been that the most important market imperfections arise out of the collective circumstances and behavior of rms. However, there is a contrary view: it holds that the most important impediments are not the common property of collections of rms, but arise instead from the unique endowments and actions of individual corporations or business- units. If this is true, then industry may not be the most useful unit of analysis. Consequently, there should be considerable interest in the relative sizes of inter-industry and intra-industry dispersions in long-term prot rates. In the business strategy eld these contrary views are represented by industry analysis, as rst espoused by Porter [1980], and by the resource- based view, as articulated by Wernerfelt [1984], Rumelt [1984], and Barney [1986].1 Proponents of industry analysis see business strategy as the art of picking good industries, whereas proponents of the resource-based view place much more importance on the development and eective utilization of rm-specic dicult-to-imitate resources. Given this debate, it is surprising that so little research was directly addressed to this issue until Schmalensees [1985] estimation of the variance components of prot rates in the FTC Line of Business (LB) data. Schmalensee decomposed the total variance of rates of return on assets in the 1975 LB data into industry, corporate, and market-share components. He reported that (1) corporate eects did not exist; (2) market-share eects accounted for a negligible fraction of the variance in business-unit rates of return; (3) industry eects accounted for 20 percent of the variance in business-unit returns; (4) industry eects accounted for at least 75 percent of the variance in industry returns.2 He concluded [p. 349] the nding that industry eects are important supports the classical focus on industry-level analysis as against the revisionist tendency to downplay industry dierences. Schmalensees study was innovative and technically sophisticated. Nevertheless, there are diculties with it traceable to the use of a single- year of data.
1 Industry analysis admits heterogeneity within industries in the form of strategic groups. For a survey of the resource-based perspective, see Conner [1991] or Grant [1991].

In this article I perform a new variance components analysis of the FTC LB data that corrects this weakness. I analyze the four years (1974-1977) of data available and include components for overall business cycle eects, stable and transient industry eects, as well as stable and transient business-unit eects.3 Like Schmalensee, I nd that corporate eects are negligible. However, I draw dramatically dierent conclusions about the importance of industry eects, the existence and importance of business-level eects, and the validity of industrylevel analysis. The most straightforward way to review my analysis is to start with what Schmalensees results left undecided. The rst major incertitude is that, although 20 percent of business-unit returns are explained by industry eects, we do not know how much of this 20 percent is due to stable industry eects rather than to transient phenomena. For example, in 1975 the return on assets of the passenger automobile industry was 6.9 percent and that of the corn wet milling industry was 35 percent. But this dierence was far from stable; in the following year the industries virtually reversed positions, autos return rising to 22.1 percent and corn wet millings return falling to 11.5 percent [Federal Trade Commission, 1975, 1976]. The presence of industry-specic uctuations like these adds to the variance in industry returns observed in any one year. Thus, Schmalensees snapshot estimate of the variance of industry eects is the variance among stable industry eects plus the variance of annual uctuations. But the classical focus is surely on the stable dierences among industries, rather than on random year-to-year variations in those dierences. My analysis of the FTC LB data shows that stable industry eects account for only 8 percent of the variance in business-unit returns. Furthermore, only about 40 percent of the dispersion in industry returns is due to stable industry eects. The second incertitude concerns the variance not explained by industry effects. Schmalensee noted [p. 350] it is important to recognize that 80 percent of the variance in business-unit protability is unrelated to industry or share effects. While industry dierences matter, they are clearly not all that matters. If this intra-industry variance is due to transient disequilibrium phenomena, then the classical focus on industry would still be a contender; although it explains only 8 percent of the variance, it would be the only stable pattern in the data. But, if a large portion of the intra- industry variance is due to stable dierences among business-units within industries, then the classical focus on industry may be misplaced. In this study, I nd that the majority of this residual variance is due to stable long-term dierences among business-units rather than to transient phenomena. Using Schmalensees sample, I nd that stable business-unit eects account for 46 percent of the variance. Indeed, the stable business- unit eects are six times more important than stable industry eects in explaining the dispersion of returns. Business-units dier from one another within industries a great deal more than industries dier from one another. The conceptual conclusions are straightforward. The classical focus on industry analysis is mistaken because these industries are too heterogeneous to support classical theory. It is also mistaken because the most important impediments to the equilibration of long-term rates of return are not associated with industry, but with the unique endowments, positions, and strategies of individual businesses.
3 Stable industry

eects are the (unobserved) time-invariant components of business-unit

The empirical warning is equally striking. Most of the observed dierences among industry returns have nothing to do with long-term industry eects; they are due to the random distribution of especially high and low- performing business-units across industries. As will be shown, an FTC industry return must be at least 15.21 percentage points above the mean to warrant a conclusion (95 percent condence) that the true stable industry eect is positive. Fewer than one in forty industry returns are high enough to pass this test.


All of the lines of research concerning industry and business protability are connected with claims about whether prot-rate dispersion reects collusion, sharebased market power, or dicult-to-imitate resources and are also connected with claims that more aggregate phenomena are spurious or counter-claims that less aggregate phenomena are noise. My intention here is to suppress concern with causal mechanisms and focus instead on the question of locus. Put dierently, my concern here is with the existence and relative importance of time, corporate, industry, and business-unit eects, however generated, on the total dispersion of reported rates of return. Gort and Singamsetti [1976] were apparently the rst to explicitly ask whether or not the prot rates of rms cluster around industry means. Assigning rms to 3-digit and 4-digit industries, they found to their surprise that the data failed to support the hypothesis that industries have dierent characteristic levels of protability. Furthermore, they noted that the proportion of the total variance explained by industry was low (approximately 11 percent, adjusted), did not increase as they moved from 3- digit to 4-digit industry denitions, and did not increase as the sample was restricted to more specialized rms. Schmalensees [1985] study was the rst published work aimed squarely at this issue and is the direct ancestor of the work presented here. Looking at the 1975 FTC LB data, Schmalensee used regression to conclude that corporate eects were non-existent and performed a variance components decomposition to measure the relative importances of market share and industry eects. He found that both were statistically signicant, but that industry eects were very much more substantial.



Data on the operations of large U.S. corporations are available from a variety of sources. However, there is only one source of disaggregate data on the prots of corporations by industrythe FTCs Line of Business Program. The FTC collected data on the domestic operations of large corporations in each of 261 4-digit FTC manufacturing industry categories. Information on a total of 588 dierent corporations was collected for the years 1974-1977; because of late additions, deletions, acquisitions, and mergers, the number of corporations reporting in any one year ranged from 432 to 471. The average corporation reported on about 8 business-units. Schmalensees sample was constructed by starting with Ravenscrafts [1983] data-set of 3186 stable and meaningful business-unitsthose which were not in miscellaneous categories and which were neither newly created nor terminated during the 1974-1976 period. He then dropped business-units in 16 FTC industries judged to be primarily residual classications, dropped business-units with sales less than 1 percent of 1975 FTC industry total sales, and excluded one outlier.

1976, and 1977 les. After this expansion, one business-unit was judged to have unreliable asset measures (in 1976-77), and was dropped. Eight other observations were eliminated because assets were reported as zero. Sample A then contained 6932 observations provided by 457 corporations on 1774 businessunits operating in a total of 242 4-digit FTC industries. Sample B was constructed by adding to Sample A the 1070 small businessunits which had failed Schmalensees size criterion. After adjoining the 1974, 1976 and 1977 data for these business-units, 34 were excluded due to (apparent) measurement problems: negative or zero assets, sales-to-assets ratios over 30, and extreme year-to-year variations in assets that were unconnected to changes in sales. Sample B then contained 10,866 observations provided by 463 corporations on 2810 business-units operating in a total of 242 4-digit FTC industries. The rate of return was taken to be the ratio of prot before interest and taxes to total assets, expressed as a percentage. In sample A the average return was 13.92 and the sample variance was 279.35. In sample B, the average and sample variance of return were 13.17 and 410.73 respectively. The FTC dened operating income as total revenues (including transfers from other units) less cost of goods sold, less selling, advertising, and general and administrative expenses. Both expenses and assets were further divided into traceable and untraceable components, the traceable component being directly attributable to the line of business and the untraceable component being allocated by the reporting rm among lines of business using reasonable procedures. In 1975, 15.8 percent of the total expenses and 13.6 percent of total assets of the average business- unit were allocated.


A Variance Components Model

To reduce the ambiguity in what follows I avoid the term rm. Instead, I use the term business-unit to denote that portion of a companys operations which are wholly contained within a single industry. I use the term corporation to denote a legal company which owns and operates one or more business-units. Thus, both industries and corporations are considered to be sets of businessunits. In this regard, note that Schmalensee [1985] used the term rm eects to denote what I call corporate eects. Thus, his rst proposition, rm eects do not exist [p. 349] refers to what are here termed corporate eects. Consequently, as he noted, nding insignicant corporate eects does not rule out the presence of substantial intra-industry eects. However, unless more than one year of data are analyzed, intra-industry eects pool with the error and cannot be detected. Taking the unit of analysis to be the business-unit, assume that each businessunit is observed over time and is classied according to its industry membership and its corporate ownership. Let rikt denote the rate of return reported in time period t by the business-unit owned by corporation k and active in industry i. A particular business-unit is labeled ik, highlighting the fact that it is simultaneously a member of an industry and a corporation. Working with this notation, I posit the following descriptive model: rikt = + i + k + t + it + ik +
ikt ,


where the i are industry eects (i = 1, . . . , ), the k are corporate eects (k = 1, . . . , ), the t are year eects (t = 1, . . ., ), the it are industry-year interaction eects ( distinct it combinations), and the ik are business-unit eects ( distinct ik combinations). The ikt are random disturbances (one for

industries as given and is essentially descriptive. In particular, it oers no causal or structural explanation for protability dierences across industries, years, corporations, or business- unitsit simply posits the existence of dierences in return associated with these categories. Were this a xed-eects model, the usual assumption would be that the ikt are random disturbances, drawn independently from a distribution with mean zero and unknown variance 2 . In this model I make the additional assumption that all of the other eects, like the error term, are realizations of random 2 2 2 processes with zero means and constant, but unknown, variances , , , 2 , 2 and . Note that this random eects assumption does not mean that the various eects are inconstant. Instead, for example, each business-unit eect ik is seen 2 as having been independently generated by a random process with variance , and, having once been set, remaining xed thereafter. The random-eects assumption says nothing about why eects dier from one anothereects may dier from one another in either xed-eects or random eects models. The real substance of the random-eects assumption is that the dierences among eects, whatever their source, are natural, not having been controlled or contrived by the research design, and are independent of other eects. That is, the eects in the data represent a random sample of the eects in the population. Independence implies that knowing the value of a particular ik , for example, is of no help in predicting the values of other business-unit eects or the values of any industry, corporate, or year eects. An important exception to this assumption, involving an association between industry and corporate eects, is discussed below. The i represent all persistent industry-specic impacts on observed rates of return. Dierences among the i reect diering competitive behavior, conditions of entry, rates of growth, demand-capacity conditions, diering levels of risk, diering asset utilization rates, diering accounting practices, and any other industry-specic impacts on the rate of return. The fundamentally descriptive model used here oers no hypotheses as to the nature of these industry dierencesthe i represent their total collective impact. Corporate eects k should arise from dierences in the quality of monitoring and control, dierences in resource sharing and other types of synergy, and dierences in accounting policy. Total corporate returns will, of course, also be aected by the industry memberships of their constituent businesses. However, the unit of analysis here is the business-unit, not the corporation. The ik represent persistent dierences among business-unit returns other than those due to industry and corporate membership. That is, they are due to the presence of business-specic skills, resources, reputations, learning, patents, and other intangible contributions to stable dierences among business-unit returns. Such dierences may also arise from persistent errors in the allocation of costs or assets among a corporations business-units. (Note, however, that corporate-wide or industry-wide biases in accounting will appear as corporate or industry eects.) Are the dierences among business-unit returns within industries simply disequilibrium phenomena? Until recently, rates of return were thought to converge fairly rapidly to normal levels. Consequently, the idea of business-unit eects had little currency. If they surfaced empirically, they were treated as an autocorrelation problem. However, researchers using more disaggregate data have discovered that abnormal prot rates do not rapidly fade away; Mueller [1977, 1985] and Jacobson [1988] have found them to be extraordinarily persistent. This consideration, and the fact that the FTC LB data covers only four years, leads to modeling the business-unit eects as xed. If this assumption is incor-

a more complex autoregressive model. As will be seen, no such autocorrelation was found in the data studied here. The t represent year-to-year uctuations in macroeconomic conditions that inuence all business-units equally. The it represent industry-specic yearto-year uctuations in return. Finally, there is an ikt associated with each observation. Although these eects have been named error, they may equally well be thought of as year-to-year variations that are specic to each businessunit. In an important exception to the independence assumption, Schmalensee [1985, p. 344] argued that corporations which are more skillful at operating businesses might also be more skillful at having identied and entered more profitable industries, thereby inducing a dependence between the values of and observed across business-units. Incorporating this presumption, and maintaining elsewhere the assumption of independence, the total variance r2 of returns may be decomposed into these variance-covariance components:
2 2 2 2 r2 = + + + 2 + + 2 + 2C ,


where C is the covariance between i and k , given that corporation k is active in industry i (i.e., E (ik ) = C if business-unit ik exists, and 0 otherwise).


Empirical Results

Table 1 displays the estimated variance-covariance components for the full model. The procedure used does not prohibit negative estimates. The normal practice is to replace small negative estimates with zero and take large negative estimates 2 as an indication of specication error. In sample A, = 2.82, and in sample B, 2C = 0.01, results surely indistinguishable from zero. 2 The results strongly suggest that = 0 and C = 0 in both samples. Accordingly, the model was re-estimated with these restrictions. The results are shown in Table 2. The restrictions produce only slight changes in the estimates of the remaining variance components.4 The standard errors of the estimates oer strong evidence that the estimates of the larger variance components are not overly noisy.5 With regard to the corporate eects, I conclude that there is no evidence of non-zero corporate eects in sample A, whereas the inclusion of the smaller business-units (sample B) provides some evidence of (small) corporate eects.

Discussion and Implications

The variance in business-unit protability in sample A (B) may be partitioned approximately as follows: 8 (4) percent industry eects, 1 (2) percent corporate eects, 46 (44) percent business-unit eects, 8 (5) percent industry-year eects, and 37 (45) percent residual error. The fundamental dierences between the two samples is that in sample B the non-industry variances are substantially larger, making industry relatively less important. Whereas the industry and industry-year components are comparable in both samples, in sample B business-unit variance component is 40 percent larger than in sample A and the residual error is 80 percent larger.
4 Because the sample variance s2 is computed about the sample average, rather than about r the true mean , the sum of the variance components is not the sample variance. However, it is very close in both cases and the dierence will be ignored in what follows. 5 These estimates were obtained by simulation: taking the variance components at their estimated values, a realization of each eect in the model was generated by a draw from the

(The corporate variance component is three times as large but its magnitude is small in both samples.) If the components are expressed as percentages, the opposite pattern emerges: the contribution of industry falls from 8.29 percent in sample A to 4.01 percent in sample B, whereas the percentage contribution of the business- unit component is virtually unchanged. Table 3 compares the variance partition for sample A with that reported by Schmalensee [1985]. Schmalensee estimated that 19.59 percent of the total variance was due to industry eects. In this study, I nd that somewhat less, 16.12 percent, is due to all industry eects (stable plus year-to-year uctuations). The dierence between the estimates arises mainly because 1975 was an abnormal yearrepeating Schmalensees one-year analysis in 1976 and 1977 yields smaller industry components. More importantly, I nd that only one-half of this variance is due to stable eects. Long-term industry eects account for only 8.28 percent of the observed variance among sample A business-unit returns. Turning to the intra-industry variance, Schmalensee reported that 80.41 percent of the variance was unexplained by industry; the comparable gure in this study is 83.08 percent. However, my partition of this intra- industry variance into stable and year-to-year components reveals that over one-half is due to stable business-unit eects. Indeed, the variance among stable business-unit eects is six times as large as the variance among stable industry eectsbusiness-units dier from one another within industries much more than industries dier from one another. Despite the fact that this is a descriptive study, some strong general results can be reported: 1. There are signicant business-unit eects in U.S. manufacturing activities that strongly outweigh industry and corporate membership as predictors of protability. The variance among business-unit eects is much larger than the variance among industry eects (six times larger in sample A and eleven times larger in sample B). 2. Corporate eects, although present in sample B, are not important in explaining the dispersion in observed rates of return among business-units. Business-Unit Eects The large observed variance component for business-unit eects overshadows the other variance components. Although this model cannot reveal the sources of this dispersion, some insight can be gained by examining Schmalensees results on the importance of market share. His study of sample A for 1975 measured a variance component due to share of 2.2. This amounts to 1.7 percent of the business-unit variance component estimated for sample A data in this study. Hence, it seems safe to conclude that only a very small part of the large businessunit eects can be associated with dierences in the relative sizes of businessunits. The large business-unit eects indicate that there is more intra-industry heterogeneity than has been commonly recognized. Whereas economists are quick to refer to inframarginal rents when this issue arises, the unspoken presumption is that these eects are small, or related to scale. The results are otherwise. The business-unit eects are large and owe only a small fraction of their strength to market share. Some portion of these eects may, of course, be due to measurement biases. But the most obvious sources of bias, dierences in industry accounting and dierences in corporate policy, should appear as industry or corporate eects. The presence of strong business-unit eects is consonant with the presump-

size, [p. 250] ideas in this area have evolved in the direction of recognizing increasingly disaggregate sources of resource immobility or specicity.6 According to this view, product-specic reputation, team-specic learning, a variety of rst- mover advantages, causal ambiguity that limits eective imitation, and other special conditions permit equilibria in which competitors earn dramatically dierent rates of return. Although this study cannot discriminate among the various theories regarding the sources of intra- industry heterogeneity, it necessarily gives broad support to this class of theory and should encourage further work in this vein. What Do Industry Returns Measure? If business-units within industries have large and persistent dierences in return, it becomes necessary to ask what the industry returns measures used in many industrial organization studies actually represent. That is, when industries exhibit diering levels of overall return, to what extent are such dierences due to systematic industry eects and to what extent are such dierences the veiled result of dierences in individual business-unit performance? The actual variance among average industry returns was 61.9 in sample A and 58.1 in sample B. Using the variance components model, this variance can be broken into its constituent parts. The results are shown in Table 4. This partition reveals that only about forty percent of the variance among industry returns is actually due to stable industry eects. In sample A an additional forty percent is due to business-unit eects which randomly combine to aect industry averages; in sample B the corresponding proportion is close to one-half. The remaining variance (one-fth in sample A, one-eighth in sample B) is due to various industryyear and business-unit-year uctuations. (This portion would be smaller had the averages been taken over more than four years.) Because only forty percent of the variance in industry returns is due to industry eects, industry returns are noisy estimates of the true industry eects. How large does an industry return have to be in order to justify a conclusion that the corresponding industry eect is positive? Additional analysis shows that industry returns are such noisy measures of industry eects that only about six of the 242 FTC industries studied could be judged (95 percent condence) to have positive industry eects. Corporate Eects Turning to the issue of corporate eects, corporations exhibit little or no (differential) ability to aect business-unit returns. It is not that corporate eects 2 do not existit appears that > 0 in sample Bbut rather that corporate eects are astonishingly small. Put dierently, if one business- unit within a corporation is very protable, there is little reason to expect that any of the corporations other business-units will be performing at other than the norms set by industry, year, and industry-year eects. Corporate returns will, of course, dier from one another for reasons other than corporate eects. Corporate returns will dier because of their diering patterns of participation in industries. More importantly, corporate returns will dier because their portfolios of business-units dier. But the results indicate that the dispersion among corporate returns can be fully explained by the dispersions of industry and business-unit eects; there is no evidence of synergy. Given the extent of the literature on corporate strategy, corporate culture, the number of consulting rms that specialize in corporate management, and the focus on senior corporate leaders in the business world, it is surprising to nd only vanishingly small corporate eects in these data. This result, rst

Implications To the extent that accounting returns measure the presence of economic rents, the results obtained here imply that by far the most important sources of rents in U.S. manufacturing businesses are due to resources or market positions that are specic to particular business-units rather than to corporate resources or to membership in an industry. Put simply, business-units within industries dier from one another a great deal more than industries dier from one another. Empirical results are rarely denitive and there are a number of issues left unresolved in this study. It may be, for example, that the FTC 4-digit industries are simply too broad to reveal the true strength of industry eects. Or, it 2 may be that the assumption of a constant is unjustied, some industries being much more heterogeneous than others. Nevertheless, most empirical work within the industrial organization paradigm has been conducted on data at this or higher levels of aggregation and persistent intra-industry heterogeneity has been generally assumed away rather than measured. Consequently, it seems worthwhile to sharply and clearly state the implications of this study: 1. The neoclassical model of industry as composed of rms that are homogeneous (but for scale) does not describe 4-digit industries: these data show real industries to be extremely heterogeneous. 2. The simple revisionist model in which business-units dier in size due to dierences in manufacturing eciency is incorrectonly a small portion of the large observed variance among business-unit eects can be associated with dierences in relative size. 3. Theoretical or statistical explanations of business-unit performance that use industry as the unit of analysis can, at best, explain only about eight percent of the observed dispersion among business-unit prot rates. 4. Theoretical or statistical explanations of business-unit performance that use the corporation as the unit of analysis can, at best, explain only about two percent of the observed dispersion among business-unit prot rates. 5. Theoretical or statistical work seeking to explain an important portion of the observed dispersion in business-unit prot rates must use the businessunit (or even less aggregate entities) as the unit of analysis and must focus on sources of heterogeneity within industries other than relative size.

Barney, Jay B., Strategic Factor Markets: Expectations, Luck, and Business Strategy, Management Science, October 1986, 32, pp. 1231-1241. Caves, R. E. and M. E. Porter, From Entry Barriers to Mobility Barriers: Conjectural Decisions and Contrived Deterrence to New Competition, Quarterly Journal of Economics, May 1977, 91, 241-61. Conner, Kathleen R., A Historical Comparison of Resource-Based Theory and Five Schools of Thought Within Industrial Organization Economics: Do We Have a New Theory of the Firm? Journal of Management, 1991, 17, pp. 121-54. Federal Trade Commission, Statistical Report: Annual Line of Business Reports, 1975, 1976. Published in 1981 and 1982. Gort, Michael and Rao Singamsetti, Concentration and Prot Rates: New Evidence on an Old Issue, Occasional Papers of the National Bureau of Economic Research: Explorations in Economic Research, Winter 1976, 3, 1-20. Grant, Robert M. The Resource-Based Theory of Competitive Advantage.

Mueller, Dennis C., The Persistence of Prots above the Norm, Economica, November 1977, 44, 369-80. Mueller, Dennis C., Prots in the Long Run, Cambridge University Press, 1985. Porter, Michael E. Competitive Strategies: Techniques for Analyzing Industries and Competitors. New York: Free Press, 1980. Ravenscraft, David J., Structure-Prot Relationships at the Line of Business and Industry Level, Review of economics and Statistics, February 1983, 65, 22-31. Rumelt, R. P., Toward a Strategic Theory of the Firm, in Lamb, Robert B., ed. Competitive Strategic Management, Englewood Clis, N.J.: Prentice-Hall, 1984, 557-570. Rumelt, R. P., Theory, Strategy, and Entrepreneurship, in David Teece (ed.) The Competitive Challenge: Strategies for Industrial Innovation and Renewal, Cambridge, Mass.: Ballinger, 1987, 137-158. Schmalensee, Richard, Do Markets Dier Much? American Economic Review, June 1985, 75, 341-51. Searle, S. R., Linear Models, New York: Wiley & Sons, 1971. Wernerfelt, Birger, A Resource-Based View of the Firm, Strategic Management Journal, April-June 1984, 5, 171-80.

Table 1 Variance-Covariance Components Estimates: Full Model

Component Year Industry-Year Industry Corporation Business-unit 2C Error

Sample A -2.82 24.74 20.49 0.19 131.69 2.13 102.51

Sample B 0.20 21.89 16.62 6.75 181.49 -0.01 184.06

Table 2 Variance Components Estimates: Restricted Model (Year Eects and C Removed)

Sample A Std. Error 2.04 4.72 3.84 6.91 2.18

Sample B Std. Error 2.31 4.26 3.31 7.04 3.04

Component Industry-Year Industry Corporation Business-unit Error Total

Est. 21.92 23.26 2.25 129.63 102.51 279.56

Percent 7.84 8.32 0.80 46.37 36.87 100.00

Est. 22.09 16.55 6.74 181.50 184.06 410.95

Percent 5.38 4.03 1.64 44.17 44.79 100.00

Table 3 Comparison with Schmalensees Results (Percentage of Total Variance by Source)

Source Corporate Industry Industry-Year All Industry Share Share-Industry Covariance Business-Unit Business-Unit-Year All Intra-Industry Total
(x) Component not estimated.

This Study Sample A 0.80 8.28 7.84 16.12 (x) (x) 46.38 36.70 83.08 100.00

Schmalensee [1985] (x) (x) (x) 19.46 0.63 -0.62 (x) (x) 80.54 100.00

Table 4 Estimated Components of Sample Variance Among Industry Average Returns

Source Industry Industry*Year Business-Unit Error Total Actual Sample Variance

Sample A Component Percent 23.3 39.3 5.5 9.3 25.3 42.7 5.2 8.7 59.27 100.0 61.9

Sample B Component Percent 16.6 29.8 5.6 10.0 26.6 47.7 7.0 12.5 55.8 100.0 58.1