What is Industrial Organization?

Industrial organization is a field of economics dealing with the strategic behavior of firms, regulatory policy, antitrust policy and market competition. Industrial organization applies the economic theory of price to industries. Economists and other academics who study industrial organization seek to increase understanding of the methods by which industries operate, improve industries' contributions to economic welfare, and improve government policy in relation to these industries. The "industrial" in industrial organization refers to any large-scale business activity, such as tourism or agriculture — not just manufacturing. Industrial organization is also sometimes referred to as "industrial economy."

Understanding Industrial Organization

The study of industrial organization builds on the theory of the firm, a set of economic theories that describe, explain and attempt to predict the nature of a firm in terms of its existence, behavior, structure and its relationship to the market. In a 1989, economists Bengt Holmstrom and Jean Tirole posed two simple questions for a theory of the firm. The first question was why do firms exist, meaning what is the need that they fill in society or an economic system. The second question succeeds the first and relates to determining the scale and scope of their operations. Answers to these two questions form the basis of Industrial organization economics. Above all, industrial organization focuses on how markets and industries compete with one another by factoring in real-world complications, such as government intervention in the marketplace, transaction costs, barriers to entry and more.

Some believe that since microeconomics focuses on markets and how they operate, industrial organization is a subset of it. Rather, industrial organization is defined by its emphasis on market interactions, such as price competition, product placing, advertising, research and development and more. More pertinently, the study of oligopolies (where a handful of big players dominate a market) gives industrial organization its reason for being (whereas microeconomics focuses on perfect competition or extreme monopolies).

According to a Massachusetts Institute of Technology (MIT) white paper, it is easier to give an example of industrial organization than it is to define it, though the white paper's authors still managed to come up with this description: the "economics of imperfect competition." The imperfect competition referenced in this description gives rise to several questions relating to the success or failure of a product or an organization. By analyzing the factors that contributed to success or failure, industrial organization attempts to answer these questions.

Key Takeaways

  • Industrial organization is an analysis of factors, operational or otherwise, that contribute to a firm's overall strategy and product placement.
  • It involves a study of different areas, from market power to product differentiation to industrial policy, that affect a firm's operations.

Industrial Organization Areas of Study

Below is a sample listing of topics that the study of industrial organization can focus on:

  • Market power
  • Product differentiation
  • Price discrimination
  • Durable goods and experience goods
  • Secondary markets and their relationship with primary markets
  • Collusion
  • Signaling
  • Mergers and acquisitions
  • Antitrust and competition
  • Industrial policy

Industrial Organization and Policy

Several organizations exist to promote research and collaboration on the study of industrial organization. One such organization is the Industrial Organization Society (IOS), founded in 1972 by Stanley Boyle and Willard Mueller to promote research on antitrust policy, regulatory policy, and competition and market power in real-world markets. The Review of Industrial Organization is the official journal of the IOS. The IOS has sponsored an annual International Industrial Organization Conference since 2003.

Example of Industrial Organization

As mentioned earlier, industrial organization is concerned with analyzing industries and determining answers related to their development.

For example, consider the smartphone industry. Apple Inc. (AAPL) was the first company to manufacture smartphones in an attractive design and load it with features for the average consumer. But the product's price - $499 for 4GB and $599 for 8GB - was prohibitively expensive. To ensure mainstream adoption without denting its profit margins, the Cupertino company tied up with network providers to defray the cost of a smartphone over a period of time.

Apple's sales were on an upward curve until Google and Samsung came along. They exploited the demand for smartphones by offering cheaper versions, packed with similar features, into the market. The competition turned out to be good for the overall industry and, over time, the device's market expanded beyond the United States. It encompasses major markets in developed and developing countries. The number of smartphone manufacturers has also exploded.

This fairly simple account of the smartphone industry's growth gives rise to several questions.

Here are some:

  • Why were Apple's phones expensive?
  • What innovation did Samsung and Google undertake in the manufacturing process to make phones cheaper?
  • How and why did network providers agree to the partnership with smartphone manufacturers?
  • How did Apple attempt to defend its turf and why did it fail?
  • What regulation contributed to the smartphone industry's success?

Industrial organization studies such questions and attempts to answer them.