SCP Model

What is it?

The Structure-Conduct-Performance model is used to trace the causes of industry performance. It is based on a model of Cause and Effect: Industry financial Performance is caused by the competitive Conduct of players in the industry; this Conduct is is turn caused by the industry Structure.

Analysis shows that 70% of an industry’s profitability can be explained by the structural features of the industry

SCP Model
We can use the SCP Model to diagnose industry performance challenges

 

When is it useful?

SCP Model has just explanatory power in an industry that is not changing. It is most powerful when used DYNAMICALLY to predict how an industry’s profitability will change in response to an external shock.

For example, when electricity was deregulated in the UK, we can predict a nosedive in profitability. Deregulation impacts industry Structure  by reducing barriers to entry and increasing number of competitors increased as the monolithic state-run Central Electricity Electricity Board was privatised into small Regional Electricity Companies (RECs). With economies of scale important, this change in structure drove aggressive pricing Conduct to capture share in each others regions. This drove down profit Performance. However, over time the natural economics re-emerged, M&A activity drove many RECs to merge again, leading to a more concentrated industry Structure, less aggressive competitive Conduct and better profit Performance. 

External Shocks often play out like this – a dramatic change in the industry leads to a landgrab, a bloodbath, a consolidation stage then a return to profitable stability.

This model can be used to justify consolidation in the industry. If Structure drives Performance, one way to improve performance is to create a more attractive industry Structure.

This analysis is similar to the Porters 5 forces analysis.

The usefulness of this model is diminished when industry boundaries are blurred and primary threats are coming from outside the industry.

An Example?

How do you do the analysis?

Highlight in Structure

  • Industry concentration (Herfindal index) – from monopoly to perfect competition
  • Market share pattern – is there a dominant leader?
  • What is the Minimum Efficient Scale?
  • Is it vertically integrated? Why?
  • Ownership of major companies (if they are listed/family/state-owned)

Highlight in Conduct

  • Where do they compete? Prices? Service? Advertising investment? War for Talent? Product innovation?
  • Is the conduct stable, or is it erratic, linked to the industry cycle?
  • Do player try to differentiate, or follow “me-too”  strategy?
  • Do competitors try to grow the pie (“good competitors”), or fight to enlarge their share (“bad competitors”)?

Highlight in Performance

  • Long term Total Shareholder Returns (TSR)?
  • Return on Capital Employed? (ROCE)
  • Economic Profit
  • 80/20 rule – if you calculate this for the largest companies, your estimate for the industry will be accurate. If you can’t get the data for some private companies or divisions, then identify the best comparable company and assume the same profitability
  • Quantify, and average over several years to remove the industry cycle effect