A good start in strategy must be to choose a profitable industry to compete in. But does simply being in the right industry matter more than having the right kinds of skills and resources? This week focuses on the role of the environment in strategy making, with particular regard to industries. But the importance of industries in determining organisational performance has been challenged in recent years. This has led to a debate about whether strategy making should be externally orientated, starting with the environment, or internally orientated, starting with the organisations own skills and resources. Managers favouring an external approach look primarily outside the organisation, for example, building market share in their industries through mergers and acquisitions or aggressive marketing. Managers favouring an internal approach concentrate their attention inside the organisation, fostering the skills of their people or nurturing technologies, for example. Because managerial time is limited, there is a real trade-off to be made between external and internal approaches. The chief advocate of the external approach is Michael Porter, Professor at Harvard Business School and founder of the Monitor Consulting Group. An influential sceptic of this approach is Richard Rumelt, a student at Harvard Business School but now at the University of California Los Angeles. Porter, Rumelt and others have done a series of empirical studies examining the relative importance of industries in explaining organisations performance. Typically, these studies take a large sample of firms and compare the extent to which variance in profitability is due to firms or industries (controlling for other effects such as size). If firms within the same industry tend to bunch together in terms of profitability, it is the industry that is accounting for the greater proportion of profitability. In essence, an external approach to strategy is supported. If firms within the same industry vary widely in terms of profitability, it is the specific skills and resources of the firms that matter most. In essence, an internal approach is most appropriate. The two most important studies find that more of the variance in profitability is due to firms rather than industries firms account for 47 per cent in Rumelts study of manufacturing (see the figure). However, when Porter and McGahan included service industries as well as manufacturing, they found a larger industry effect (19 per cent).

This work implies that firm-specific factors generally influence profitability more than industry factors. Firms need to attend carefully to their own skills and resources. However, the greater industry effect found in Porter and McGahans study of both manufacturing and services suggests that the industrys importance varies strongly by industry. External influences can matter more in some industries than others. Sources: R.P. Rumelt, How much does industry matter? Strategic Management Journal, vol. 12, no. 2 (1991), pp. 16785; M.E. Porter and A.M. McGahan, How much does industry matter really?, Strategic Management Journal, vol. 18, Summer Special Issue (1997), pp. 1530; M.E. Porter and A.M. McGahan, The emergence and sustainability of abnormal profits, Strategic Organisation, vol. 1, no. 1 (2003), pp. 79108. Questions 1. Why might some industries have a larger influence on their members profitability than others? 2. What other factors might account for business unit profitability?

Per cent of variance in profitability due to