You are on page 1of 12

The Cognitive Structuring of Industries

By J.L. Stimpert, Colorado College

Revised, with permission, by Michael Wasserman, Clarkson University (2009)

Objectives

Present a dynamic model of industry competition and evolution.

Illustrate how this dynamic model can be used to analyze the competitive space.

Introduction

In his book, The Soul of a New Machine, Kidder describes how an emerging market for
minicomputers facilitated the entry of new firms into the computer industry:

Scientists and engineers, it seems, were the first to express a desire for a relatively inexpensive
computer that they could operate for themselves. The result was a machine called a
minicomputer. In time, the demand for such a machine turned out to be enormous. Probably
IBM could not have controlled this new market the way it did the one for large computers. As it
happened, IBM ignored it, and so the field was left open for aspiring entrepreneurs... (1981:12).

By the end of the 1970s, history repeated itself when the computer industry was rocked by
Apple Computer's development and commercialization of the personal computer. Apple's
phenomenal success is particularly noteworthy because, like the minicomputer entrepreneurs of
the previous decade, Apple entered an industry occupied by major firms, including of course,
IBM. During the 1980s, history repeated itself again as many "clone" manufacturers also entered
this industry to satisfy the extraordinary demand for personal computers. Like previous new
entrants, many of these firms not only entered but profitably competed in an industry
dominated by formidable rivals.

The evolution of the computer industry is inconsistent with industrial organization (IO) theory
which claims that a variety of entry barriers erected by incumbent firms can effectively prevent
potential new rivals from entering an industry. Yet, contrary to this accepted wisdom, new
firms not only do enter industries but frequently enjoy remarkable success in competing against
powerful incumbent firms. In fact, the entry of new rivals is frequently associated with the
subsequent decline of incumbent firms.

In spite of the poor predictive power of IO models, researchers in strategic management and
other fields have largely accepted and incorporated much of the conventional IO thinking into
their own models. Porter (1980), for example, adapts IO's structure-conduct-performance
framework to develop his "Five Forces" model of competitive strategy that offers strategic
prescriptions for the management of individual firms. His objective is to describe how firms can
exploit various characteristics of industry structure to increase their profitability. By adopting
the highly stylized, static IO model, the strategic management field lacks models of industry
structure that reflect reality and recognize the dynamic nature of business activity.

While this is by no means the first criticism of traditional industrial organization theory for its
limited applicability, this paper goes further than previous critiques by offering an alternative
model to explain industry structure and competition. Instead of taking industry structure and
boundaries as givens, this perspective assumes that industry structure is cognitively
constructed -- that structure is, to a large extent, the product of the mental representations of
industry participants. Entrepreneurial activity restructures industries through the creative
thinking that develops or exploits changes in industry dimensions while the lethargy and
cognitive limitations of the managers of incumbent firms inhibit effective proactive responses.
This chapter will demonstrate how this managerial thinking, over time, allows new entrants to
move beyond established niches, shift the locus of competition in the industry away from the
incumbent firms, and undermine their dominant position. Thus, the title of this chapter is quite
appropriate, industries are cognitively structured and restructured by their participants.

The paper begins by arguing that the IO perspective is based on unrealistic assumptions. A new
model of industry structure is then described. The chapter concludes with a discussion of
various propositions that follow from this new model.

The Problems with the Industrial Organization Perspective

IO models are based on three implicit assumptions that are unrealistic, and these unrealistic
assumptions about the rate of change in industry environments, the ability of incumbent firms
to notice and anticipate the entry of new rivals, and the rationality of managers seriously
undermine the ability of the conventional model to explain industry structure and competition.
This section describes each of these assumptions in more detail.

How dynamic is they economy? The IO perspective assumes that the locus of competition
within an industry remains fixed on familiar patterns of interaction and rivalry for long periods
of time. More elaborate IO models assume that managers make their decisions anticipating the
reactions of rivals, but their models implicitly assume that the rivals will respond in familiar, or
at least predictable, ways. Most strategy researchers who have studied strategic groups (firms
within industries that pursue similar strategies) focus on the movement of firms among existing
strategic groups, not considering the possibility that the real "action" might be the efforts of new
firms to fill the holes that emerge in the competitive space as industry dimensions change.

How quickly do incumbent firms recognize new entrants? The conventional IO perspective also
assumes that the managers of incumbent firms see and respond quickly to potential rivals. This
assumption ignores the possibility that the managers of incumbent firms may fail to notice an
emerging rival. Though Porter's (1980) framework for industry analysis emerges from the
traditional IO model of industry structure, he does acknowledge that "blind spots" might exist.
These blind spots would be "areas where a competitor will either not see the significance of
events at all, will perceive them incorrectly, or will perceive them very slowly" (1980:59). Zajac
and Bazerman (1991) suggest that these blind spots are in fact a critical component of industry
structure. They argue that because of these blind spots, strategic decision makers often "do not
consider the contingent decisions of competitive others or make simplifying and often false
assumptions" (1991:42), both of which can easily lead to poor decisions. In conventional IO
models, defining the nature of the threat or the rival is not a problem. A considerable body of
evidence suggests, however, that defining the nature of a competitive threat is a problem for
managers of incumbent firms.

How rational are managers? Finally, traditional perspectives about industry structure not only
assume that the managers of incumbent firms notice potential rivals, but also that these
managers act rationally and suffer no limitations on their ability to act rationally. Many IO
models assume that managers can somehow "know" how the managers of rival firms will
respond to their initiatives; that the range of possible responses and the likelihood of different
responses can be objectively known and assessed. Again, a considerable body of research
evidence suggests that this, too, is an unrealistic assumption.

Summary. In fact, none of these three assumptions are realistic. Industry dimensions are
constantly evolving, rivals rarely act in predictable ways, and managers of incumbent firms
often have difficulty developing effective responses. Cooper and Schendel (1976) report that
new rivals are often associated with new consumer preferences or emerging technologies that
completely change the nature of competition in established industries and that incumbent firms
are usually caught so off-guard that they rarely regain leadership positions and often fade into
obscurity.

The traditional IO perspective assumes that incumbents and their rivals play the same game,
battle on the same turf, and abide by the same rules. From a strategic point of view, however,
new entrants would be much more likely to think and act in new and totally different ways.
Rather than invading an already crowded playing field, an entrant might seek to find or even
create a new, more promising game to play -- a game that has become possible due to changing
industry dimensions, including new consumer demands and technological developments. And,
because a new rival might choose to develop a totally new game rather than take on established
firms in an old game, the rules of the game will also be different. The managers of incumbent
firms may not even see this new game as a threat to their organizations, and the decision rules
they use may not suggest appropriate responses. In fact, their decision rules may suggest
responses with pathological consequences. For example, Cooper and Schendel (1976) find that
when confronted by new technologies, the managers of incumbent firms do not embrace the
new technologies but instead seek to improve their own technologies even as these old
technologies are quickly becoming obsolete.

The Building Blocks of a New Theory of Industry Structuring

This section offers a new theory suggesting that industries are "structuring" over time, the result
of an on-going process that is tied to the cognitive understandings of managers. This model
suggests that four factors -- 1) changing industry dimensions, 2) the enactment by the managers
of incumbent firms of shared industry environments, 3) managers' cognitive limitations, and 4)
the phenomena of threat rigidity and first mover advantages -- together conspire to provide
new entrants with opportunities to restructure industries, undermining the competitive
position of incumbent firms.

The changing dimensions of industries. An industry can be thought of as a space in which rivals
compete along various dimensions. Abell (1980) suggests that industries are defined by firms
that serve similar customers, meet similar customer needs, and employ similar technologies. As
illustrated at right, Abell's framework results in a three-dimensional "competitive space"
delineated by customers, products and/or services, and technologies. Traditional IO models
assume that changes in the dimensions of industries are relatively unimportant, that the size
and shape of the competitive space is relatively stable over time and that the locus of
competition remains fixed on traditional patterns of interaction among participating firms. Of
course, this is rarely the case. Consumer preferences and new product and process technologies
are constantly evolving so that changes in Abell's three industry dimensions are occurring all
the time. As a result, the competitive space is very fluid.
Industry norms or recipes. Firms in the same industry typically share a common language and
similar understandings about how to compete. These shared norms or "recipes" play an
important role in providing industry standards, in encouraging consumer acceptance of
products and services, and in facilitating incremental technological developments and
improvements. These shared industry norms result from formal educational programs,
professional networks, and fairly standard personnel selection policies, which promote and
reinforce conformity within industries. Executives of firms in the same industries are especially
likely to possess a "common body of knowledge" that they obtain from reading the same
publications, participating in trade associations, and moving across firms.

The problem that these shared recipes or understandings can foster is that the managers of
incumbent firms enact industry environments that clearly delineate what are and what are not
acceptable bases of competition and patterns of behavior. These institutional understandings
remain relatively stable over time and can easily fail to keep pace with changes in the
environment. As a result, the managers of incumbent firms might be vigilant in watching for
potential rivals, but they are likely to be watching for potential rivals that look and behave very
much as they do. Their current institutional understandings do not quip them for "seeing"
potential rivals that are different.

Cognitive limitations. Even if shared industry norms homogenize managers' understandings,
blinding them to atypical rivals, shouldn't managers of incumbent firms at least notice major
changes in industry dimensions, such as changes in consumer tastes and new technological
developments? After all, many firms employ sophisticated market research, forecasting,
planning, and R&D departments which should help their managers to be aware of important
new developments in their industry environments.

Even with all these resources, a number of factors may prevent managers from appreciating the
importance of changing industry dimensions. First, managers may simply fail to notice
changing industry dimensions. Mintzberg, Raisinghani, and Theoret note that most strategic
issues "do not present themselves to the decision maker in convenient ways; problems and
opportunities in particular must be identified in streams of ambiguous, largely verbal data"
(1976:253).

Furthermore, psychology researchers suggest that this problem is compounded because
individuals make sense only of what they perceive to be key or important events. Individuals
tend to recall the most salient attributes of a particular situation. Individuals also seek to
confirm their beliefs (Kiesler & Sproull, 1982) and will therefore pay greater attention to events
that support their views, views that were formed by past events. Kiesler and Sproull write that
"[m]anagers operate on mental representations of the world and those representations are likely
to be of historical environments rather than current ones" (1982:557). Furthermore, individuals
often cannot make objective or rational evaluations of the data they collect. This explains why a
new rival offering a new and different product or service, or employing a new and different
technology might easily be ignored or rationalized away. Expanding industry dimensions may
not be perceived as important, especially if incumbent firms continue to enjoy satisfactory levels
of performance.

Perhaps the most remarkable feature of organizational behavior is that complex organizations
develop and implement sophisticated strategies that are based on untested assumptions or
understandings of the environment that may no longer be appropriate. Moreover, many
researchers have concluded that these understandings are so strongly held that they can only be
altered by a crisis or calamity such as a loss of profitability or even bankruptcy.

Successful entry enhanced by incumbents' threat rigidity and new entrants' first-mover
advantages. Traditional perspectives on industry structure suggest that following the entry of a
new rival into an established industry, incumbent firms will move quickly to counter or nullify
the initiatives of a new rival. Yet, a number of factors mitigate against the retaliation predicted
by traditional models. First, as already suggested, managers of incumbent firms may simply fail
to "see" the entrant. Given the effects of industry recipes and managers' cognitive limitations, a
new entrant could easily proceed to carve out a niche and establish a presence without being
detected.

Second, even after a new entrant is detected, incumbent firms will have to determine whether
new rivals pose a serious threat, and if so, how they should respond, but instead of the IO
concern with the "credible deterrence" of incumbent firms, a more relevant issue may be
whether incumbent firms identify the "credible threats" posed by new entrants. New entrants
are likely to be working in a previously unoccupied area of the industry or competitive space.
The managers of incumbent firms could easily assume that the niches occupied by new entrants
are neither viable nor large enough to be of concern. This kind of myopic thinking, continuing
over a period of many years, may explain the decline of Western Union:

Western Union's troubles grew out of a parochial mind-set that dates back 113 years. Then a
high-tech giant sending messages by Morse code, the company turned down rights to the
telephone, telling Alexander Graham Bell that sending voice over wire would never replace
telegraph, particularly for business communication (Guyon, 1989:A1).

Schmalensee reaches a similar conclusion to explain the emergence of natural cereals:

After a rise in consumer interest in "health foods," all natural cereals together had a market
share of about 0.5 percent in early 1972. By early 1973 the naturals share had climbed to about
four percent, and in mid-1974 natural cereals accounted for about ten percent of the market.
Testimony and documentary evidence suggest that the shifts in consumer taste that led to this
sharp increase in demand were not well anticipated by most of the established firms. As a
result, a substantial new market segment was up for grabs (1978:318, emphasis added).
Additional research also suggests that when confronted by a threatening situation, managers
seek more information in order to better understand the threat, but the information overload
that follows this data gathering can create confusion. In this confusion, the true nature of the
threat is obscured and managers are more likely to shift their focus back to less strategic
concerns. The paradox of information gathering is that, instead of leading to a better
understanding, managers are likely to develop a "threat rigidity" so that they end up actively
ignoring new rivals (Staw, Sandelands, & Dutton, 1981).

Furthermore, because of lags in the processes of recognition, understanding, and action, new
rivals will still have an important advantage even if the managers of incumbent firms do
perceive the seriousness of the threat. Once the threat is recognized, the managers of incumbent
firms will still have to determine how and when to retaliate. Some responses could emerge
quickly. For example, incumbent firms could simply lower prices in order to improve the
value/cost ratio of their products. More elaborate responses to meet the threat such as
developing new products or services which are true substitutes for those offered by the entrant
may require considerably more time and large investments. Yet, if the incumbent firms are large
and "structurally overbounded," they may not be able to respond quickly.

Even fast responses may come too late. Research suggests that "first-movers" enjoy market
share, pricing, and other advantages not enjoyed by "subsequent-movers." Most studies
conclude that first-mover advantages can continue for many years, so that even if incumbent
firms respond quickly and are able to offer products that are close substitutes, a new entrant
might still enjoy many advantages that would persist over time.

The likely outcome: The strategic retreat and economic decline of incumbent firms. The
evidence from many industries suggests that the likely outcome of the combination of these
four factors is that new firms not only enter established industries, but that incumbent firms
retreat and often enter periods of decline. Often the retreat of incumbent firms is described as a
"rationalization" or a "downsizing," yet rarely does such a strategic retreat lead to a
strengthened position for the incumbent firm. New rivals are rarely content to remain in smaller
niches when opportunities exist for them to use their products and/or services and technologies
to move into larger parts of the competitive space. Even when an incumbent's strategic retreat
does provide a period of relief, the continuing advances of new rivals are likely to make the
incumbent's respite quite ephemeral. Drucker calls the advance of new rivals "entrepreneurial
judo:"

Entrepreneurial judo aims first at securing a beachhead, and one which the established leaders
either do not defend at all or defend only halfheartedly... Once that beachhead has been
secured, that is once the newcomers have an adequate market and an adequate revenue stream,
they then move on to the rest of the "beach" and finally to the whole "island" (Drucker,
1985:230).

When an incumbent firm makes a strategic retreat, its managers actually believe they are
moving to a more defensible market segment. The paradox of strategic retreat is that, in reality,
competition actually intensifies along two fronts: From more intense competition among
industry incumbents who have retreated to a smaller segment of the industry and now compete
more intensively for a smaller piece of the pie, and from the new rival or rivals that are seeking
to expand from their "beachhead" to take more of the "island."

The steel industry provides an excellent example of the dangers of strategic retreat. Nearly all of
the major integrated steel manufacturers have abandoned the market for steel rod and other
structural products. This segment of the market has traditionally offered only low margins and
the major integrated mills encountered intense competition not only from foreign steel
producers but also from a growing number of domestic minimills such as Nucor Steel. In
retreating to what their managers believed to be the more defensible and higher margin market
for sheet steel, the major integrated mills have enjoyed very few benefits. Not only is the excess
capacity of the major integrated producers now focused on a smaller segment of the total steel
market forcing downward pressure on sheet steel prices, but the minimills have not been
content to remain in the structural steel segment of the market. Nucor, for example, has already
begun construction of a new mill that will produce sheet steel, defying predictions that
minimills would never be able to produce high quality sheet steel (Ansberry & Milbank, 1992).

Patterns in the Evolution of Industries: Some Specific Propositions

This model of the cognitive structuring of industries suggests a number of propositions. These
propositions, if supported by further research, should improve the recommendations that can
be suggested to practicing managers. The propositions relate primarily to two major issues: the
attack of new rivals, and the non-response and strategic retreat of incumbent firms.

The attack of new rivals. The "attack" of new rivals is interesting in at least three respects. First,
the most dangerous new rivals are unlikely to attack the products or markets of incumbent
firms directly. Potential rivals would be foolish to attack incumbent firms' positions when
lucrative opportunities exist to create or meet new demands. New rivals are more likely to offer
new or different types of products or services or to provide these products or services using a
new or different technology. At least part of the successful entry into the United States market
by the Japanese automobile manufacturers is because their small cars filled a new market
demand for fuel efficient cars that had not been well occupied by any of the Big-Three U.S.
producers.

In fact, the Japanese invasion of the U.S. automobile market closely follows the cognitive model
presented in this paper. The Japanese manufacturers exploited changes in industry dimensions,
namely the demand for more fuel efficient cars and new production technologies. Because the
U.S. Big-Three producers possessed a quite different understanding of their environment, their
managers failed to appreciate the seriousness of the threat posed by the Japanese producers.
Brock Yates describes what he calls "the Detroit Mind" and he quotes a former U.S. automobile
executive:

[i]f they [U.S. automobile executives] weren't isolated in Bloomfield Hills, driving their
Cadillacs and Lincolns and Imperials, they'd understand why imported cars sell so well. Their
automobiles are built to their life-styles, and they have no comprehension of why people in Los
Angeles, San Francisco, Scarsdale, or Fairfield County, Connecticut, want Mercedes, BMW's,
and Hondas instead of Buicks and LeBarons" (1983:80-81).

The Japanese producers further exploited the "blindness" of the Big-Three producers by not
attacking directly. Instead, the Japanese producers carved out and then dominated the small car
market, selling in what the Big-Three producers regarded as an unattractive market segment
due to the low margins of small cars. In describing the Japanese strategy, Yutaka Natayama,
Nissan's representative in the United States was quoted as having said "[w]hat we should do is
get better and creep up slowly, so we'll be good -- and the customer will think we're good --
before Detroit even knows about us" (Shapiro, 1991:52-53).
This pattern -- of new entrants attacking "holes" in the competitive space -- is observed in the
experience of many industries. Apple Computer sought to tap the market for individual
computing that had been ignored by virtually all other computer makers. Nucor did not attack
the integrated steel manufacturers directly, in fact, Nucor began manufacturing structural steel
products primarily for its own internal consumption. This discussion suggests the following
proposition about the entry of new firms into established industries.

Proposition #1: Successful new rivals generally do not attack incumbent firms directly, but instead are
more likely to enter an industry at the "holes" that are created by changes in consumer preferences and
the adoption of new product and process technologies.

The second noteworthy aspect of the model is that incentives exist for new rivals to capitalize
on changes in more than one industry dimension. By moving into a "hole" in the competitive
space by not only filling an unmet customer need but by doing so in a novel way, a new entrant
may be able to disguise itself even better from incumbent firms. Such a new rival might look
sufficiently "different" to the managers of incumbent firms that they will have quite a difficult
time recognizing the new entrant as a serious threat.

Again, the Japanese automobile manufacturers provide an example. Not only did they offer a
new product -- the small, fuel efficient car, but they also exploited developments in
manufacturing technology. Similarly, Apple not only sought to tap an unserved market for
personal computing, but to do so, the company took advantage of important advances in
microprocessing technology. Wal-Mart stores not only provided customers with a unique
product mix, but the company also incorporated technological developments that allowed it to
operate with a very low cost structure. This suggests a second proposition about the entry of
new rivals:

Proposition #2: Successful new entrants generally offer new products or services that capitalize on
changes in more than one industry dimension. For example, a successful new entrant is likely to
introduce a new product that not only responds to a change in consumer preferences but also incorporates
a new technological development or a new production process.

Finally, new rivals are rarely content to occupy niche positions in their industries. While their
initial presence may be modest, new entrants will have many incentives to move beyond their
initial market segments. Consumers may develop a loyalty to the new entrant and this loyalty
can be exploited by offering a broader range of products or services. Similarly, the possibility of
enjoying economies of scale or scope from a broader application of the technology will also
encourage a new entrant to expand beyond an initial niche position.

Over the years, the Japanese automobile manufacturers gradually expanded their car lines,
introducing products that now fill the complete spectrum of the automobile market. In only a
very short period of time, Wal-Mart grew from a small regional company to surpass Sears as the
nation's largest retailer. And, as already described, Nucor did not remain content producing
structural steel products but is now seeking to apply its minimill technology to manufacture
flat-rolled steel, invading markets the large integrated steel makers once thought were off-limits
to minimills. This discussion suggests another proposition about new entrants:

Proposition #3: Successful new entrants seek to establish strong niches from which they then expand into
ever larger areas in the competitive space.
Asleep at the switch: The non-response of incumbent firms. The mental models of the managers
of incumbent firms may have pathological consequences. They are often locked in an
understanding of their competitive environments that does not allow them to recognize either
changing industry dimensions or the presence of new rivals. In fact, managers may often fail to
appreciate the challenges posed by new entrants until long after decline has already crippled
their firms. In his company's 1982 annual report, David Roderick, the CEO of U.S. Steel, wrote
that "[w]e have been shocked out of our complacency and smugness. We now realize that
American industry has no manifest destiny to be always first, always right, always best"
(Shapiro, 1991:3-4). Roderick was shocked only because he and the managers of other integrated
steel mills had been able to ignore for a very long time the existence of new competitors and
problems that were apparent and well documented by industry observers as early as the 1950s.

The result of this nescience is that incumbent firms are rarely able to match the developments of
new rivals. Even in cases when incumbent firms can match a new rival's initiatives, the new
rival may have already accrued significant first-mover advantages. This discussion suggests the
following proposition:

Proposition #4: Incumbent firms are rarely able to match new entrants' products, services, or
technological capabilities.

Strategic withdrawal and its dangers. When confronted by a new entrant, firms in an industry
might respond by vigorously challenging the new entrant's products or services or by
acquiring, developing, or even improving on the new entrant's technology. As the model
offered in this paper suggests, however, a number of cognitive factors make such a vigorous
response unlikely. Asleep at the switch, the managers of incumbent firms are more likely to let a
considerable period of time pass before noticing the threat of a new entrant, and then, they are
likely to let even more time pass before taking action. By this time, the new entrant may have
already secured a comfortable niche, may be enjoying a number of "first-mover" advantages,
and may already be on its way toward challenging incumbent firms' positions of dominance. As
a result, a counterattack by incumbent firms, if launched, will typically come too late to be
effective.

At this point, incumbent firms will consider a number of other responses. For example, the
managers of incumbent firms will often complain about unfair competition. This was certainly
the case among managers of the automotive and steel industries who asked for quotas on
imported automobiles and steel. Diversification into unrelated businesses is another strategy
industry executives have adopted in order to "escape" from markets that are becoming less
attractive.

At the same time, managers are reluctant to abandon longstanding markets and to write-off
what had been productive investments (Porter, 1980). A good deal of research evidence
suggests that managers caught in such a situation may seek to "fight it out" by retreating to
what they believe to be a more defensible niche. In fact, incumbent firms pursue improvements
in existing products or services even though these products or services may have already been
rendered obsolete by the products, services, or technologies introduced by a new entrant.
Whatever the initial response, the end result is that incumbents tend to be more reactive than
proactive. Incumbent managers are much more likely to retreat to what they believe will be
more defensible positions than to launch effective counter-attacks. This suggests the following
proposition:
Proposition #5: Incumbent firms confronted by new rivals are more likely to respond by withdrawing to
supposedly "safer" areas in the competitive space, by diversifying, or by improving current offerings of
products and services.

As already described, this retreat to a supposedly more defensible position is a paradox. Instead
of finding a safe harbor, incumbents are likely to find that competition has actually escalated.
Competition among incumbent firms is likely to intensify as they begin serving a smaller
segment of the industry. These incumbent firms will have excess capacity and they will be
fighting even more vigorously for shares of a smaller pie. Furthermore, competition from
successful new entrants is likely to intensify as they proceed to move beyond their initial niche
positions into additional areas in the competitive space. This suggests another proposition:

Proposition #6: Incumbent firms rarely enjoy any sort of long run benefit from a strategic withdrawal
from market segments invaded by new entrants.

Conclusions

Given the cognitive model of industry structure described in this chapter, how should
managers formulate strategy? Before suggesting answers to this question, consider how
Mintzberg describes the strategy formation process:

In general terms, strategy formation in most organizations can be thought of as revolving
around the interplay of three basic forces: (a) an environment that changes continuously but
irregularly, with frequent discontinuities and wide swings in its rate of change, (b) an
organizational operating system, or bureaucracy, that above all seeks to stabilize its actions,
despite the characteristics of the environment it serves, and (c) a leadership whose role is to
mediate between these two forces, to maintain the stability of the organization's operating
system while at the same time insuring its adaptation to environmental change (1978:941).

Accepting for now Mintzberg's characterization of the strategy formation process, the cognitive
model described in this chapter suggests that the leadership component often fails or is
defeated by the pace of environmental change or by the power of bureaucratic inertia. Certainly
a major responsibility of managers in any business organization is to exercise creative
leadership by providing the organization with a vision that can serve as a "dominant logic"
(Prahalad & Bettis, 1986) helping to define and redefine the mission and purpose of the business
and provide coherence and direction. To do so, however, requires both discipline as well as
imagination.

The managers of a firm must not only understand the relevant dimensions of their firm's
current competitive space, but they must also think about what the relevant dimensions of a
future competitive space will be. They must also think imaginatively about where their firm
should be in that future competitive space and the extent to which their firm will create new
"space" by developing consumer interest in new products or services or by developing new
technological capabilities. Furthermore, for their firm to enjoy a sustainable competitive
advantage in its position in that future competitive space, they must also be able to create
strategies and processes that are difficult for rivals to emulate. Managerial thinking, insight, and
creativity may be among the most valuable (and least imitable) organizational resources, and all
are certainly key sources of competitive advantage.

Another practical implication of this cognitive model of industry structure is that managers
should watch the unoccupied and newly emerging areas of their industries -- the "holes" in the
competitive space. Yet because of the cognitive limitations described earlier in this paper, this
advice may not be a particularly helpful recommendation. It is difficult to see that which you do
not know how to look for. One possible way to overcome cognitive inertia and limitations is for
the managers of incumbent firms to adopt the domain-seeking activities of companies like 3M
and Rubbermaid. Both of these companies have explicit goals that a certain percentage of
annual sales must come from products which did not exist in previous years (Mitchell, 1989).
Rubbermaid, in its 1988 annual report, described its emphasis on new products as one of its
fundamental strengths: "Our goal is to have 30 percent of sales each year come from products
which were not in the line five years earlier." Some companies may be going even further.
Recent articles about Sony note that the company schedules dates for the introduction of
extensions to a new product and the date a replacement for a new product will be introduced
even before that new product is introduced into the marketplace.

It is not altogether clear that current business practices, educational institutions, and the larger
society foster this level of energy and creativity. In fact, much evidence suggests that firms seek
the easy route, preferring to acquire cash generating businesses rather than develop and "grow"
new businesses. Business schools may graduate M.B.A.s who have ambition but no vision. And
contemporary culture bears witness to the fact that economic affluence does not guarantee
artistic or creative achievement.

Most models suggest that the environment is a "given." The implications of the cognitive model
of industry structure offered in this chapter may be profound and exciting. Such a perspective
suggests that product and service offerings, the processes by which these products and services
are delivered, prices, and even profitability levels are largely determined, not only by market
forces and the conduct of firms, but by managers' cognitive understandings and capabilities. If
this is true, the possibilities for economic expansion are truly enormous and limited only by
managerial creativity and effort. The challenge for businesses, educational institutions, and the
larger society, must be to unlock and stimulate managerial thinking.

Key Points Introduced

Changing industry dimensions and managers' cognitive limitations create "holes" in the
competitive space.

These holes invite invasion from entrepreneurial firms. This invasion by entrepreneurial firms is
the source of economic growth and wealth.

Industry structure is not a "given." Instead, entrepreneurs cognitively create industry structure.

References

Abell, D. F. 1980. Defining the Business: Starting Point of Strategic Planning. Englewood, NJ:
Prentice-Hall.

Ansberry, C. & Milbank, D. 1992. Small, mid-size steelmakers are ripe for a shakeout. Wall
Street Journal, March 4: B4.

Cooper, A. C., & Schendel, D. 1976. Strategic responses to technological threats. Business
Horizons, 19: 61-69.
Drucker, P. 1985. Innovation and Entrepreneurship. New York: Harper & Row.

Guyon, J. 1989. S.O.S.: Western Union, saved by a junk-bond deal, needs rescuing again. Wall
Street Journal, October 13: A1, A7.

Kidder, T. 1981. The Soul of a New Machine. New York: Avon Books.

Kiesler, S., & Sproull, L. 1982. Managerial response to changing environments: Perspectives on
problem sensing from social cognition. Administrative Science Quarterly, 27: 548-570.

Mintzberg, H. 1978. Patterns in strategy formation. Management Science, 24: 934-948.

Mintzberg, H., Raisinghani, D., & Theoret, A. 1976. The structure of "unstructured" decision
processes. Administrative Science Quarterly, 21: 246-275.

Mitchell, R. 1989. Masters of innovation: How 3M keeps its new products coming. Business
Week, April 10: 58-63.

Porter, M. E. 1980. Competitive Strategy. New York: The Free Press.

Prahalad, C. K., & Bettis, R. A. 1986. The dominant logic: A new linkage between diversity and
performance. Strategic Management Journal, 7: 485-502.

Schmalensee, R. 1978. Entry deterrence in the ready-to-eat breakfast cereal industry. Bell Journal
of Economics, 9: 305-327.

Shapiro, E. C. 1991. How Corporate Truths Become Competitive Traps. New York: Wiley.

Staw, B. M., Sandelands, L. E., & Dutton, J. E. 1981. Threat-rigidity effects in organizational
behavior: A multilevel analysis. Administrative Science Quarterly, 26: 501-524.

Yates, B. 1983. The Decline and Fall of the American Automobile Industry. New York: Empire
Books.

Zajac, E. J., & Bazerman, M. H. 1991. Blind spots in industry and competitor analysis:
Implications of interfirm (mis)perceptions for strategic decisions. Academy of Management
Review, 16: 37-56.