An executive summary for
managers and executive
readers can be found at the
end of this article
Disparity in income
246 JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001, pp. 246-257, # MCB UNIVERSITY PRESS, 0885-8624
Macro-economic risk factors in
industrial markets: are eÂlite
firms less susceptible?
Richard A. Heiens
Assistant Professor of Marketing, School of Business Administration,
University of South Carolina Aiken, Aiken, South Carolina, USA
Mark Kroll
Professor of Management, College of Administration and Business,
Louisiana Tech University, Rusten, Louisiana, USA
Peter Wright
Professor of Management, Fogelman College of Business and
Economics, The University of Memphis, Memphis, Tennessee, USA
Keywords Macroeconomics, Risk, Arbitrage, Competitive advantage
Abstract As far back as 1947, Alfred Marshall proposed that the disparity in income
between those individuals with moderate ability and those with greater ability is larger
than the disparity in talent. Building on Marshall's thesis, argues that marginal
differences in firm capability may result not only in increased profitability, but also in
lower susceptibility to macro-economic risk factors for basic manufacturing firms in
industrial markets. The results seem to suggest that the firms with greater ability have in
fact managed to combine resources in such a way as to create inimitable advantages.
Specifically, through a commitment to product and process innovation and modern
manufacturing facilities, the most successful firms in the study have been able to acquire
key resources, and gain extensive control over the value creation process. The outcome is
high relative product quality, relative pricing power, and lower susceptibility to macro-
economic risk.
Introduction
As far back as 1947, Alfred Marshall proposed that the disparity in income
between those individuals with moderate ability and those with greater
ability is larger than the disparity in talent. Building on Marshall's thesis, we
argue that marginal differences in firm capability may result not only in
increased profitability, but also in lower susceptibility to macro-economic
risk factors for basic manufacturing firms in industrial markets.
The basis for this conjecture is as follows. Initial marginal differences in firm
capability may translate into marginally better products (Miles and Snow
1978; 1986). Over time, those firms with better quality outputs may build a
reputation for superior quality, and might even further enhance their quality
differential. Superior product quality may enable the firm not only to
increase its market share (achieving scale economies and lower costs), but
also to implement premium pricing policies (Buzzell and Gale, 1987). This
may lead to increased profitability.
In turn, higher profits may enable the firm to continue to invest in firm
activities which might further lower costs and enhance differentiation
All authors contributed equally to this article.
The research register for this journal is available at
http://www.mcbup.com/research_registers
The current issue and full text archive of this journal is available at
http://www.emerald-library.com/ft
 through progressively superior outputs. Because the most capable, or
``eÂlite'', firms can defend themselves better against general economic trends
by forcing the burden of macroeconomic or industry decline on to their
weaker rivals (Lubatkin and Rogers, 1989), they are likely to have not only
higher profits, but also lower risk (Kroll et al., 1999).

Risk
Risk has been conceptualized in various ways. Most often, however, scholars
tend to conceptualize risk either as the variance in accounting returns (Cool
et al., 1989; Jemison, 1987) or as market related systematic and firm specific
unsystematic risk, according to the Capital Asset Pricing Model (CAPM)
(Kroll et al., 1999; Lubatkin and Rogers, 1989).
Measuring risk Many researchers, however, criticize the technique of measuring risk via
CAPM (Fama and French, 1992; Jegadeesh, 1992). Specifically, because
stock risks might have more than two dimensions associated with them,
partitioning a firm's risk into systematic and unsystematic risk may be too
narrow a view (Mei, 1993). In light of this limitation, an alternative measure
of risk may be provided by the Arbitrage Pricing Theory (APT) (Ross, 1976).
According to the APT, required rates of return are a function of a firm's
sensitivity to several macro-economic factors. As further developed by Roll
and Ross (1980; 1984), APT attributes a firm's required rate of return to as
many as four economic forces:
(1) the size of the spread between long-term and short-term interest rates;
(2) the level of price inflation;
(3) the level of industrial production; and
(4) the yield spread between high risk and low risk bonds (i.e. the prevailing
risk premium being demanded by investors).

Hypotheses
Macro-environmental risk Several studies have suggested that the most capable firms in a given
factors industry have less susceptibility to macro-environmental risk factors. For
example, many of the most capable firms in a given industry tend to create
greater value through vertical integration. Because vertically integrated firms
may have control over buying and selling costs, as well as distribution,
production, and transaction costs, they might also experience lower levels of
risk (Lubatkin and Chatterjee, 1994; Chatterjee et al., 1992). In addition,
more profitable firms are likely to have the resources to make higher
commitments to both process and product R&D, which tends to build entry
barriers that might insulate such firms from competitive pressures and,
concurrently, lower their risk levels (Amit and Livnat, 1989; Miller and
Bromiley, 1990). Consequently, we offer the following hypotheses with
respect to the most capable or ``eÂlite'' firms in industrial markets:
H1: Elite firms' returns will be significantly less influenced by changes in the
size of the spread between long-term and short-term interest rates than
non-eÂlite firms.
H2: Elite firms' returns will be significantly less influenced by changes in the
level of price inflation than non-eÂlite firms.
H3: Elite firms' returns will be significantly less influenced by changes in the
level of industrial production than non-eÂlite firms.

JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001 247

 H4: Elite firms' returns will be significantly less influenced by changes in the
yield spread between high risk and low risk bonds than non-eÂlite firms.

Methodology
Sample
At present, the two best available data sets which contain large samples and
detailed business-level data are the Federal Trade Commission's Line of
Business database and the Strategic Planning Institute's PIMS database. In
the present study, we selected a cross-sectional sample of 365 manufacturing
businesses from the PIMS database for the 1970 through 1983 time period.
These businesses, with SIC codes from 3080 to 3864, include a broad cross-
section of firms operating in industrial markets. Specifically, these firms
include manufacturers in rubber and plastics, stone, glass and clay, primary
metals, fabricated metals, industrial machinery, electrical equipment,
transportation equipment, and instrumentation.
Heterogeneous businesses It has been suggested that pooled samples of very heterogeneous businesses
may seriously distort the observed relationships between variables owing to
the possibility of unique industry-specific forces (Bass et al., 1978). Because
the business units chosen all manufacture component parts, the present study
allows for an examination of multiple-year data for a large sample of
business units subject to similar industry forces.

Variables included in the study

The businesses participating in the PIMS study use a standardized reporting
system to describe their strategies and market environments. In order to
identify the most capable or ``eÂlite'' firms among the sample of
manufacturing businesses included in the study, several strategic variables
were selected from the PIMS database. Specifically, the ``Relative Quality''
variable was used to represent the quality performance relative to the
competition for each business unit in the sample.
In order to measure the commitment of each business unit to product and
process innovation, product R&D as a percentage of revenues and process
R&D as a percentage of revenues were included in the analysis. As an
additional measure of the business unit's commitment to innovation, the
percentage of sales derived from new products was also included.
Value creation process In order to measure the extensiveness of the business unit's control over the
value creation process, the percentage of the business unit's products value
added was included. The Strategic Planning Institute defines value added as
net sales minus total purchases (Buzzell and Gale, 1987).
The ``Plant and Equipment Newness'' variable was included in order to
assess the business unit's commitment to modern manufacturing facilities.
This variable is defined as the ratio of net book value of plant and equipment
to gross book value (Buzzell and Gale, 1987).
Finally, in order to assess the business unit's relative pricing power, we
included the ``Relative Price'' variable, which simply assesses the business
unit's product prices in relation to their leading competitors.

Identification of strategic clusters

In order to segment the SBUs in the sample into ``eÂlite'' and ``non-eÂlite''
groups, cluster analysis was employed. Specifically, all SBUs were evaluated
in terms of their strategic orientation with regard to the PIMS variables
described in the previous section. A non-hierarchical cluster analysis, utilizing

248 JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001


Macro-economic factors
Treasury bond yields
JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001
Anderberg's (1973) nearest centroid sorting method was employed. According
to MoÈller et al. (1985), the non-hierarchical technique tends to simultaneously
produce homogeneous clusters in terms of within-group differences, and
heterogeneous clusters in terms of between-group differences.
Because the variables included in the study were based on various scales, the
data were normalized by first calculating the sample SBUs' standard
deviations from the sample means for each variable. As per Romesburg
(1984), the resulting standard deviation values were then used in the cluster
analysis. The technique resulted in two distinct clusters of SBUs. One group
appeared to be made up of 62 ``eÂlite'' firms, or those firms scoring highest on
the strategic variables included in the analysis. The other cluster contained
the remaining 303 firms, or the less capable, ``non-eÂlite'' firms in the sample.
Sensitivities to macro-economic factors
As mentioned earlier, Roll and Ross (1980; 1984) identified four important
macro-economic factors which systematically influence securities markets:
unanticipated movements in the shape of the interest rate term structure,
unanticipated changes in inflation, unanticipated changes in the level of
industrial production, and unanticipated shifts in risk premiums.
In order to assess the two groups of SBUs' sensitivities to the four macro-
economic risk factors, we regressed four surrogate measures of the risk
factors against both ROI and Par ROI values for both the ``eÂlite'' and
``non-eÂlite'' sample groups. This resulted in two regression models for each
cluster. The data used to represent each factor in the regression models were
as follows:
(1) The GNP deflator, labeled as GNPD, was used to test the firm's ROI and
Par ROI sensitivity to changes in the rate of inflation. A statistically
significant, positive or negative coefficient in the regression model
would indicate earnings sensitivity to inflation, whereas a statistically
insignificant coefficient would indicate no such sensitivity.
(2) The index of industrial production, labeled here as IIP, was used to
represent changes in industrial activity. The resulting regression
coefficient represents the sample groups' sensitivities to unanticipated
changes in the level of industrial production.
(3) The variable labeled as YIELD is used to represent unanticipated
changes in the yield curve. This variable was estimated by subtracting
the quarterly rate on 90-day Treasury Bills from the rate on long-term
(ten-year) Treasury Bonds.
(4) Changes in the risk premium on private sector bonds, labeled here as
RISK, was estimated by subtracting the rate on long-term Treasury
Bonds from the average rate earned on Moody's AAA-rated corporate
bonds. Because government bonds are free of the risk of default, the
spread between the yields on the two instruments should provide a fairly
accurate estimate of the risk premium on private sector bonds.
Despite the contention of Roll and Ross (1984) that the four macro-economic
risk factors are clearly not perfectly correlated, Treasury bond yields are
nevertheless used to estimate both the yield curve and the risk premium.
Consequently, due to the possibility of collinearity in the data, the various
regression models were estimated using the AUTOREG procedure available
in SAS. In order to test for differences between the results of each set of
regression models specific to each of the four macro-economic risk factors,
249
 Chow tests were employed (Chow, 1960). Significant Chow Test results
would suggest that the models' betas represent truly unique relationships.

Results
Cluster analysis and strategic groups
Cluster analysis As discussed earlier, the cluster analysis conducted on the firms included in
the sample resulted in two distinct strategic groups. As gauged by differences
in the values of the strategic variables included in the study, these distinct
groups appear to pursue very distinct strategic agendas.
As suggested by the results presented in Table I, the firms labeled as ``eÂlite''
clearly invest more heavily than their ``non-eÂlite'' counterparts in R&D, new
product introduction, and plant and equipment. Additionally, the ``eÂlite'' firms
contribute more to the total value added of the finished product than their
``non-eÂlite'' counterparts. The net result of these efforts is that the ``eÂlite''
firms successfully pursue higher quality levels than the ``non-eÂlite'' firms and
are able to charge premium prices for their goods.

Performance differences between groups

As reported by Buzzell and Gale (1987), firms with superior product quality
tend to enjoy growing market shares and superior returns on investment.
Similarly, the present study verifies this finding. As presented in Table II,
``eÂlite'' firms tended to experience significantly better ROIs, Par ROIs, and
market share growth figures than ``non-eÂlite'' firms.

Cluster 1 Cluster 2
(N = 62) (N = 303)
Strategic variables eÂlite firms non-eÂlite firms Probability value
1. Product R&D 1.142 0.515 0.004
(1.061) (0.628)
2. Process R&D 0.306 0.134 0.026
(0.356) (0.204)
3. Proprietary products 0.044 0.0036 0.038
(0.075) (0.025)
4. New plant and equipment 7.500 5.000 0.011
(8.081) (3.877)
5. Relative price 3.650 1.749 0.001
(3.378) (2.108)
6. Value added 41.835 28.734 0.001
(12.713) (11.478)
7. Product quality 35.261 5.95 0.001
(13.483) (6.313)

Table I. Strategic variable profiles of the two clusters means, standard

deviations (in parentheses), and probability values

Cluster 1 (N = 62) Cluster 2 (N = 303)

Performance measures eÂlite firms non-eÂlite firms Probability value
1. ROI 19.756 13.500 0.001
(11.456) (7.468)
2. Par ROI 8.856 6.415 0.009
(4.039) (3.940)
3. Change in market share 26.337 11.883 0.002
(29.730) (18.364)

Table II. Performance profiles of the two clusters means, standard deviations (in
parentheses), and probability values

250 JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001

 Differences in sensitivities to macro-economic risk factors
Regression models As stated previously, two regression models were estimated for each cluster,
one using ROI as the dependent variable, and the other using Par ROI as the
dependent variable. The four resulting regression models are presented in
Tables III and IV.
For simplicity of presentation, the regression coefficients for the ``eÂlite'' and
``non-eÂlite'' firms have been paired. Based on the information presented in
Table III, the results seem to support our a priori expectations of greater
performance sensitivity to macro-economic changes on the part of the ``non-
eÂlite'' group. In fact, the ``non-eÂlite'' firms included in cluster 2 experience
significantly negative reactions to unanticipated increases in inflation,
unanticipated declines in industrial output, unexpected increases in long-
term rates, and unexpected rises in risk premiums. In contrast, the ``eÂlite''
firms in cluster 1 demonstrate no significant sensitivities to changes in the
four macro-economic risk factors.
Regression results The regression results in which Par ROI is used as the dependent variable are
presented in Table IV. Once again, the ``non-eÂlite'' firms tend to demonstrate
greater sensitivity to the four macro-economic risk factors. However, as is
apparent from the results presented in Table IV, ``eÂlite'' firms demonstrate
some susceptibility to changes in industrial output and, to a lesser extent,
changes in the level of inflation. The difference between these results and

Independent
variable Cluster Coefficienta Probability value Chow test
GNPD Elite firms ± 0.075 0.230 4.58b
Non-eÂlite firms ± 0.156 0.001
IIP Elite firms 0.025 0.247 5.94b
Non-eÂlite firms 0.053 0.001
YIELD Elite firms ± 0.267 0.371 5.76b
Non-eÂlite firms ± 0.799 0.060
RISK Elite firms ± 0.2777 0.414 5.81b
Non-eÂlite firms ± 5.050 0.022
Notes: aDurbin-Watson results all approach 2.0, suggesting that auto-correlation was
not a problem when using ROI as the dependent variable. bChow test significant at
0.05 level

Table III. Cluster sensitivities to macro-economic factors for return on

investment

Independent
variable Cluster Coefficienta Probability value Chow test
GNPD Elite firms ± 0.051 0.083 3.55b
Non-eÂlite firms ± 0.258 0.004
IIP Elite firms 0.27 0.034 2.15b
Non-eÂlite firms 0.097 0.001
YIELD Elite firms ± 0.475 0.441 4.81b
Non-eÂlite firms ± 1.208 0.001
RISK Elite firms ± 4.505 0.122 3.55b
Non-eÂlite firms ± 8.038 0.001
Notes: aDurbin-Watson results all approach 0.5, suggesting that auto-correlation in the
models, and necessitating use of the AUTOREG procedure. bChow test significant at
0.05 level

Table IV. Cluster sensitivities to macro-economic factors for par return on

investment

JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001 251


Differences in profitability
Sharing characteristics
252
those reported for ROI probably stems from the structure of the Par ROI
variable.
The Strategic Planning Institute developed the Par ROI figures in order to
control for a host of variables thought to cause differences in profitability
across industries. In effect, Par ROI is intended to normalize performance
data, permitting more accurate conclusions to be drawn when using pooled
data from across the entire PIMS database. In an effort to correct for
differences across industries, Par ROI includes adjustments made for
vertical integration, pricing, and percent of sales from new products.
Because these factors are included in our clustering procedure, the striking
contrast between the two groups is not as obvious when Par ROI is used as
the dependent measure. Nevertheless, as seen in Table IV, the ``non-eÂlite''
firms continue to emerge as the more economically sensitive and risky
businesses.
Managerial implications
The results seem to suggest that the 62 ``eÂlite'' firms in cluster 1 have
managed to combine resources in such a way as to create inimitable
advantages. Barney (1991) argues that resources may be used to create
sustainable competitive advantage, if those resources meet one of three
criteria:
(1) the firms' ability to acquire the resources is predicated upon ``unique
historical conditions;'' in effect the firm is positioned to exploit key
resources at an opportune time;
(2) the ability of a firm to exploit a resource so as to achieve competitive
advantage is not easily understood by those within or without the firm,
and therefore not easily copied; or
(3) the resource providing the competitive advantage is the product of a
complex social process within the firm.
The cluster analysis performed in the present study seems to indicate that
firms which have been able to gain competitive advantage and establish
themselves as eÂlite organizations share several characteristics. One
important characteristic of the eÂlite firms in our sample was a commitment
to innovation. Specifically, our eÂlite firms tended to spend more heavily
than the non-eÂlite firms on both product R&D and process R&D as a
percentage of revenues. In addition, eÂlite firms tended to derive a greater
proportion of revenue from the sale of unique proprietary products and
maintained higher relative product quality than competing firms. These
firms also procured and maintained modern manufacturing facilities.
Furthermore, the most successful firms in our study have been able to
acquire key resources, and gain extensive control over the value creation
process. As suggested by both conventional wisdom and empirical
findings, the outcome is higher market share and higher return on
investment.
Although not included in the current study, numerous conceptual and
empirical studies appear to suggest that pioneering or first-mover firms are
often especially successful in achieving long-term competitive advantages.
As a consequence, first-movers have frequently been shown to have higher
market shares than market followers (Lambkin, 1988; Parry and Bass, 1990;
Robinson, 1988). According to Lieberman and Montgomery (1988), first-
movers may gain competitive advantage through the preemption of various
resources, such as technology, location and personnel, and through the
JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001

Competitive advantage
Lower susceptibility
JOURNAL OF BUSINESS & INDUSTRIAL MARKETING, VOL. 16 NO. 4 2001
development of organizational capabilities that are crucial to the success of
their products or services.
Firms may strive to gain the competitive advantage often accruing to the
first-mover in several ways. For example, the first firm to:
(1) produce a new product;
(2) use a new process; or
(3) enter a new market
can claim the distinction and potential benefits of being a first-mover
(Lieberman and Montgomery, 1988).
First-mover firms may also include those organizations that are the first to
pursue opportunities deriving from the initiating of pricing changes or the
adoption of new distribution ideas (Smith et al., 1989; McDaniel and Kolari,
1987).
Whether predicated on managerial skill, order of entry, or perhaps merely
unique historical conditions, some degree of competitive advantage is
usually required in order to achieve superior market share and superior
returns. The unique contribution of our study, however, is to demonstrate
that competitive advantage also appears to insulate these firms from several
important macro-economic risk factors. Specifically, firms with superior
commitment to innovation, product quality, and the value creation process
may minimize their susceptibility to unanticipated movements in the shape
of the interest rate term structure, unanticipated changes in inflation,
unanticipated changes in the level of industrial production, and unanticipated
shifts in risk premiums.
In summary, eÂlite firms are better able to protect their market positions when
faced with economic downturns. One possible explanation is that customers
prefer to make their purchases from larger firms and are predisposed to more
frequently form loyalties towards the outputs of such firms (Donthu, 1994).
Consequently, extending Alfred Marshall's Theorem, it may be accurate to
say that the disparity in macro-economic risk susceptibility between those
manufacturing firms with moderate ability and those with greater ability may
be even larger than the disparity in income.
One important implication that lower susceptibility to risk has for managers
is that lower risk levels tend to lower the discount rate that the market applies
in valuing the firm's earnings stream. As a result, such firms can further
enhance their value and create additional wealth for their shareholders
through an expansion of possible investment options, as these firms lower
the internal rate of return which investments must generate in order to be
profitable (Kroll et al., 1999).
In addition, other stakeholders, particularly the firm's managers, are likely to
favor lower levels of macro-economic risk. Managers, in contrast with
investors, can only invest their human capital in one firm at a time. Because
high susceptibility to macro-economic risk factors increases the likelihood of
firm failure and consequently job loss, firms with low susceptibility to
macro-economic risk will be more appealing to talented senior executives
(Martin and McConnell, 1991).
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