Industry Is Not Destiny
Market share and industry structure don't dictate corporate profitability
By: Greg Obenshain
Michael Mauboussin is the most interesting and comprehensive thinker on corporate fundamentals and the big ideas in investing today. He has written regularly for decades on the question of “moats”—whether certain companies have durable competitive advantages—publishing major pieces in 2002, 2016 and October of this year.
We have long-running beef with the idea of competitive advantage. We’ve argued that there’s no real evidence to support Michael Porter’s Five Forces theory and that, empirically, market share does not predict profitability.
We’d go as far as to argue that industry analysis generally is much less valuable than fundamental investors or strategy consultants might hope.
Mauboussin’s new study, Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation, grapples with this issue. Mauboussin’s study includes a chart that is difficult to unsee once you’ve seen it (h/t Edward Conard’s Macro Roundup for highlighting this).
Figure 1: Adjusted ROICs by Industry for U.S. Companies, 1963 – 2023
Source: Mauboussin & Callahan
Note: Adjusted ROIC uses invested capital adjusted for internally generated intangible assets.
This chart shows that profitability varies more within industry (the vertical bars) than across industries (the dots). Over the long run, the fate of a company is not primarily determined by its industry—a finding consistent with Chicago school research from the 1980s that dealt a death blow to structure-conduct-performance theory in antitrust law.
Mauboussin notes that while industry analysis matters when it comes to deciding where to compete, ultimately the right unit of analysis is not the industry level but the company level, specifically: “each of a company’s strategic business units that operate in a distinct industry.” Mauboussin goes on to cite research from Henderson, Raynor and Ahmed that suggests that companies that exhibit superior long-term results follow a strategy of differentiation and operate with two rules: compete on differentiators rather than price and prioritize growing revenues over reducing costs.
This does not mean that industry is unimportant. An industry can make it more difficult to have a return on invested capital above the cost of capital, especially in the shorter run. Mauboussin especially focuses on market share instability driven by new entrants and rivalry among existing firms as an inhibitor to sustainable profitability. According to Mauboussin, “market share stability is favorable for sustainable value creation and instability makes it harder for any individual company to consistently create value.”
But industry is less important than company when it comes to profitability. Even within the worst industries at a given time, there are companies that still do well, as Mauboussin illustrates in the chart below.
Figure 2: Return on Capital minus Cost of Capital for U.S. Industries, 2023
Source: Mauboussin & Callahan
Industries with higher overall profitability have more companies that are profitable, but even within industries with low profitability, there are still companies that have returns well above the cost of capital and some companies that have profitability substantially above.
Industry is not destiny. Great companies can emerge from mediocre industries.