Definition of the Industrial Organization (I/O) Model
The industrial organization (I/O) model is a model constructed to help us better understand the Industrial organization.
Industrial organization is a field in economics. It studies the structure of firms and the markets where firms compete against one another. Understanding these concepts is vital for firms in setting the right strategic direction.
Note that there are four basic market types: (1) perfect competition, (2) monopolistic competition, (3) oligopoly, and (4) monopoly. The other three advanced types are (1) duopoly, (2) oligopsony, and (3) monopsony.
The industrial organization (I/O) model stems from the literature on monopolistic competition.
Simple Explanation of the I/O Model
During strategy formulation, firms consider two primary factors: the external and internal environment. The external environment consists of the general environment and the industry environment.
In the I/O model, the industry environment has a dominant influence on strategies. It is most likely to determine the firms’ strategic conduct, and actions to deploy. These actions then result in competitive advantage.
The internal environment is only a minor factor in determining strategies. Resources and capabilities do not have a big impact on the firms’ strategic direction.
The First Implication of the I/O Model
To achieve strategic competitiveness, firms need to identify the industry that provides the best opportunities.
This is because the I/O model implies that the industry in which a firm operates has a much higher impact on its performance than internal resources, capabilities, and core competencies.
Managing strategically from the I/O model perspective would entail firms competing in attractive industries, avoiding weak or faltering industries. Firms should gain a full understanding of key external factor relationships within that attractive industry.
Characteristics of the industry would dictate the firms’ performance. Higher performance then leads to higher above-average (superior) returns.
These characteristics include (but are not limited to) barrier to entry, economies of scale, product differentiation, price discrimination, industry life cycle, measures of concentration, market power, and market frictions.
The Second Implication of the I/O Model
To increase their performance, firms can prepare internal resources and capabilities needed to implement necessary strategies.
The companies that can utilize their resources, capabilities, and core competencies might succeed in earning above-average returns. Those that do not are likely to fail.
Thus, firms must either find ways to imitate each other or try to develop strategically unique and valuable resources. Firms with imitation may perform poorly, especially in long term. Those that can obtain strategic resources and capabilities might, on the other hand, develop a foundation for superior products and services at a lower price.
The Four Assumptions of Industrial Organization (I/O) Model
The industrial organization (I/O) model assumes the following:
- The external environment imposes pressures and constraints that determine the firms’ strategy.
- Most firms control similar resources and pursue similar strategy that utilizes these resources. Thus, firms under an industry are more or less equal.
- Resources are mobile across firms, so any resource differences might only be short-lived.
- Organizations’ decision-makers are rational and committed to acting in the firms’ best interests.
These are the limitations of this model.
Process to Earn Superior Returns (based on I/O Model)
To earn above-average returns, the I/O model suggests these five steps that firms should complete.
They are,
- Study the external environment. This includes the general environment and industry environment.
- Locate the industry or industry segment with high above-average returns potential.
- Formulate strategy based on the industry or industry segment identified.
- Prepare resources (assets and capabilities) needed to implement the strategy.
- Deploy these resources (as the firms’ strengths) for actual implementation of the strategy.
Industrial Organization (I/O) Model versus Resource-Based View (RBV)
The industrial organization (I/O) model favors the external environment.
It explains that the industry or industry segment in which a firm chooses to compete has a stronger influence on the firm’s performance than do the choices that it makes inside the organization.
The resource-based view (RBV) favors the internal environment.
It assumes that each organization is a collection of unique resources that provides the basis for its strategy. According to this model, differences in firm performances across time are due primarily to their unique resources rather than the industry structural characteristics. Firms that have unique resources can develop core competencies to gain a competitive advantage.
The Right Model: I/O or RBV?
In general, both the industrial organization (I/O) model and the resource-based view (RBV) affect the profitability of a firm.
A firms’ profitability can be explained by the industry environment in which it chooses to compete. It can also be attributed to the firms’ internal resources, capabilities, and core competencies.
In conjunction, the external and the internal environment drive the performance of a firm. Both of these environments influence the firms’ ability to achieve strategic competitiveness and earn above-average returns.
It is not just a question of whether the external or internal environment is more important in gaining and maintaining competitive advantage. A firm should explore its internal resources (RBV model) and keep them in synergy with the external environment (I/O model).
Effective integration and understanding of both environments are the keys to securing strategic competitiveness.
Resources
Further Reading
- Industrial Organization (investopedia.com)
- Alternative Models of Developing Strategic Competitiveness (openlearningworld.com)
Related Concepts
References
- Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2016). Strategic Management: Concepts: Competitiveness and Globalization (12th ed.). Cengage Learning.
- Hitt, M. A., Ireland, D. R., & Hoskisson, R. E. (2019). Strategic Management: Concepts and Cases: Competitiveness and Globalization (MindTap Course List) (13th ed.). Cengage Learning.