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The Letter From: Industry Fragmentation (I): A Function of Emergence or Structure?

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("The Letter From" is on hiatus through December. This is an "encore presentation" from April 4, 2005 - before edbizbuzz came on the scene. Consider it an opportunity to judge my predictive capacity, an introduction to academia's dean of business strategy, and an application of his analytic approach to the school improvement industry.)

The terms “fragmented” and “emerging” are often conflated in discussions of the school improvement industry. In Competitive Strategy (1980), Michael E. Porter explains that while new industries can be fragmented, fragmentation need not be a function of age. The distinction is important - many providers’ profitability and investment potential depends on an assumption of scale that implies industry maturation based on consolidation.

Usually fragmented industries are populated by a large number of small- and medium-sized companies, many of them privately held. There is no single precise quantitative definition of a fragmented industry... The essential notion that makes these industries a unique environment in which to compete is the absence of market leaders with the power to shape industry events.

Especially if the school improvement industry’s “old Europe” of textbook publishing is set aside, those segments changing the practice of teaching and learning consist of a large number of small privately held providers. “Industry shaping power” lies almost exclusively with the federal government. To illustrate, no SES firm’s or group of firms’ actions could have anything like the effect of a Department of Education decision under NCLB Section 9401 to permit districts to restrict tutoring services to the specific students and subjects that caused a school to fail AYP.

Porter provides nine explanations for fragmentation that are relevant to school improvement, including 1. “newness.” ”It takes only one of these characteristics to block the consolidation of an industry.”

2. “Low entry Barriers.” “Although a prerequisite to fragmentation, low entry barriers are usually not sufficient to explain it. ...(The are) nearly always accompanied by one or more ...other causes.” For the most part, product development is not a significant barrier. Consider how quickly Platform was funded, purchased curriculum and ramped up its SES tutoring operations. Ironically, in this emerging industry, the principal barrier to entry is reputation. The quality of products and services remains hard to judge objectively, so the perception relates to providers’ age, size, and marketing budgets, and even the “star quality” of its educational leadership.

3. “The absence of significant scale economies or learning curves in any major aspect of the business.” This is particularly true when the industry involves “inherently high labor content... high personal service content, or is intrinsically hard to routinize.”

4. “High transportation costs.” “They are effectively high in many service industries because the service is ‘produced’ at the customer’s premises.” The closer to the product or service is to the teaching-learning relationship, the more factors 3 and 4 are likely to apply - unless the service is entirely online. SES, CSR and professional development involve both factors to a high degree.

5. “Diseconomies of scale in some important aspect” of the business. These are especially likely when the service depends on “close local control”, “local image” and “local contacts.” Quality control systems and community relations don’t scale easily or well in school improvement services. In both cases, initial growth follows from informal systems of personal contacts. After the founders run through the “people they know” to fuel the growth of clients and staff, firms require formal systems to maintain consistency. Implementation exacts a high entry price and adds greatly to fixed overhead. Moreover, these systems undermine the flexibility that enabled the firm to take advantage of local opportunities in the first place.

6. Diverse market needs, 7. High product differentiation and 8. Local regulation, “driven by industries where buyers tastes are fragmented.” No one fights the standardization of products and services like educators. No other field of government contracts is so encrusted with federal, state and local regulation.

9. Exit barriers. When it is hard to leave an industry, marginal firms tend to stay. Moreover there may be players with goals that are not profit-oriented. Some businesses enjoy “a romantic appeal or excitement that attracts competitors who want to be in the industry despite low or even nonexistent profitability.” School improvement has an unusually high number of nonprofits providing close substitutes to for-profit offerings, socially motivated owners, part-timers, and sole practitioners.

The school improvement industry’s current fragmentation follows from several factors besides newness. Is the condition permanent or amenable to change?

Next week: assessing the potential for industry consolidation.

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