Industrial Evolution

Industries evolve through a complex process of perpetual transformation. Industrial transformation has many of the defining characteristics of evolution. It is a dynamic process of development affected by both random and systematic forces. Innovation is at the core of transformation process, it is the way firms’ metamorphoses in order to compete with rivals, and is correlating with profitability. Firms which are not innovative will not sustain the competition and are more likely to die.

A dead company will exit the industry. There are types of two exits for a company:

1. Permanent exits (business cessations), business failure.
2. Temporary exits (mergers and take overs), rebirth which may in fact is a cause of business success.

The process of Industrial Evolution
The treat of competition induces firms to develop themselves and force them to decide in innovation, advertising, brands and skills development. The effectiveness of those investments affects productivity, growth rates and the size of firms. Thus firms which had bad hand by nature can increase the survival through prudent decisions with regards to their innovation strategies or marketing expenditures.


The process involves a complex set of mechanisms which are governed by both systematic and random forces. Firms with persistently bad performances in cash flow, will be unable to service their debt and more likely to die. There are exogenous events, which are random with respect to firm’s potential, macroeconomic event (recession or oil price hikes), scientific discoveries and changes in political or regulatory environment.

A Normative Typology of Firm Survival
This stylized conceptual framework of industrial evolution is positive in nature. Industries evolve efficiently if the deaths of the firms are economically desirable. A ‘good’ firm (Superstars) is one which is either currently a highly productive firm or will be highly productive in future due its capacity to learn, innovate and grow. A ‘bad’ (Deficient) firm is one which has low productivity currently and will continue to do so in the future because it is resistant to change and has low innovative capability. Government should be concerned only about the death of ‘good’ firms. Efficient industrial evolution requires the survival of both current high productivity firms and potential high productivity firms. While Complacent firms are one which high productivity but are resistant to change and no longer innovative. Potential stars firm is one which low productivity and are highly innovative to try to improve.


There is strong evidence that current productivity is an important selection filter; the literature consistently finds a positive relationship between survival and proxy variables for current productivity such as age and size at birth. Selection through firm death is not totally random with respect to underlying productivity, but positively reinforces improvements to overall industry performance. However, empirically there is no consensus that innovative activity is an important selection filter. If death depends on productivity, current low productivity (or poor cash flow) innovators will die before their efforts are recognized by the market. Strong positive correlation between innovation and productivity is common but not universal. The relationship between innovation and survival is complex. Some firms may successfully innovate and become superstars, while others will be less successful and perhaps move into the deficient quadrant (from where exit is most likely). The primary public policy concern should be with the premature death of ’potential stars’, but the whole process of innovation is uncertain. Death can be due to factors external to the firm and unrelated to the firm’s intrinsic capabilities.

The presence of superstar firms is unambiguously good, but these firms do not create public policy concern since they are likely to survive into the future. The deficient firms which have low levels of innovative capability are not likely to create any significant public policy concern if they exit.

Complacent firms are those firms that currently have high productivity levels (presumably due to previous innovative activity), but are now resistant to change, may be able to live off their previous successes for some time, however their performance will deteriorate as new rivals enter the industry and slowly but surely undermine their profitability.

The death of potential stars is macroeconomic conditions. Aggregate demand, interest rates, unemployment are factors which strongly affect survival, especially for new firms. It is estimated that industries such as mining, construction, wholesale trade, transport and storage, cultural and recreational services are more sensitive to high interest rates or low aggregate economic growth than other industries. This evidence reinforcing the need for governments to maintain stable macroeconomic policy settings. In theory, efficient industry evolution occurs when firms with both low productivity and low innovative capability are the only firms which exit. Available evidence suggests that the low productivity firms which have the most potential to improve (new and innovative) are also most susceptible to death during the period of adverse macroeconomic conditions, accordingly, the death of such firms in this circumstance is likely to hinder efficient industrial evolution.