For reasons that remain unclear to me to this day, back in college when I was majoring in economics, one of the fields I became fascinated with was that of industrial structure.

Antitrust lawyers swim in the sea of industrial structure, whether or not they think of it that way, but “industrial structure” is simply the descriptor for the study of how companies populate the landscape of an industry.

Some industries are natural monopolies, such as regional utilities or, say, the Port of Los Angeles or the O’Hare Airport Authority. Other industries are atomistic, with no sizable players and no meaningful prospect of sizable players (classically, wheat farmers; more currently, artisanal anything). Many industries exhibit increasing returns to scale, which exert a strong gravitational pull towards monopoly or oligopoly (global aircraft manufacturers, pharmaceuticals, railroads and ocean shipping, petroleum, low-cost retailing, mining and extraction).

Other industries (or more precisely markets), particularly in today’s hyper-networked world, are “winner take all”, or virtually all. They’re markets which exhibit “network effects,” meaning the more participants there are the more valuable the marketplace is to everyone, and the less valuable rival marketplaces, less densely populated, are. EBay is the obvious example: Everyone wants to sell stuff there because that’s where the most buyers are, and likewise everyone wants to buy stuff there because that’s where the most sellers are.

But most industries have none of these innate features.

Which brings us to our next to last category of firm in the taxonomy: The Hollow Middle. This should be a shoo-in to win, place, or show in the competition for most controversial and potentially divisive among readers, of all our categories.

In the absence of powerful intrinsic structural pressures such as those outlined above, what type of structure do industries tend to migrate towards?

Conceptually, there are three structures that matter most in the real world.

The first is migration towards players in the no-frills or low-cost niche. These are industries where customers just want the lowest price and don’t find any supposed variation in quality plausible. Now, this is always and everywhere the case with true commodities—our classic bushel of wheat or today’s gallon of gas—but it’s also true with goods and services such as groceries at retail and virtually the entire family tree of computers, from servers to desktops to laptops and notebooks. (I grant you Apple has staked out an unusual position here, but they are an extraordinary firm performing feats more mortal firms should not attempt and cannot achieve.)

The second is basically the opposite of the first, namely migration towards the high end. Here everyone seems to coalesce around the view that a certain pretty high level of quality is the minimum required or you’re not even going to put the offering in your consideration set.

We can all stipulate that major surgery for a loved one or close friend is squarely in this category, but there are other slightly less obvious examples as well. One pair of markets that has moved in this direction—for which I give the geniuses at consumer packaged goods companies extraordinary credit—is the pair of markets for razors and for toothpaste.

It used to be that a single blade was state of the art, but today we’re approaching the half-dozen blades per razor milestone, with or without battery power, with or without lubricants and emolients, with available handles of luxurious materials, and as for toothpaste, the generic green cavity-preventing variety of yore is almost nowhere to be found, and in its stead we have probably hundreds of variations from all natural to tartar prevention, whitening, baking soda/peroxide, striped, kids’, sensitive teeth, and on and on.

A few decades ago, who knew that we needed these things? But need them we clearly do.

We can also cite Apple here in a less defensive way, for having singlehandedly positioned the market for MP3 players at the high end. Indeed, some of you probably did a double-take at the phrase “MP3 players”—I’m referring of course to iPods.

Now, in a way, each of the foregoing markets is simple, even simplistic, when it comes to analysis. At the no-frills end, competitors who can’t lower their costs far enough have little choice but to surrender. And at the high end, if you can’t deliver superb quality, with a reputation for same, you’ll never get out of the gate. Not much more to be said.

So at last to the Hollow Middle.

These are markets where customers’ preferences tend to settle into a polarized equilibrium. In other words, they want to go high-end some of the time and low-end some of the time. It depends.

But the critically important corollary to this is they hardly ever want to go middle-market. The middle seems unappealing, even at the extremes irrational.

Now, I submit—and back in the days when I was wandering the corridors of the economics department at my college it seemed to be amply confirmed—that the Hollow Middle industry structure has two particularly salient characteristics:

  • It’s extremely widespread throughout the economy; and
  • Once an industry arrives at this model, it tends to stay there. It’s what’s called “an equilibrium solution.”

The easiest way to understand what a Hollow Middle structure looks like, and for you to confirm through your own intuition and experience that it can be a very appealing and durable model, is to give you some examples.

  • Apparel: We want fitted suits, shirts, and dresses from name-brand designers or we want a generic polo shirt and jeans and a semi-disposable frock from the Gap, H&M, or Zara.
  • Beer, wine, and liquor: The craft brew or a Budweiser; a waiting-list-only Napa Screaming Predator Cab or the house Chardonnay; a 12-year-old single malt or the well vodka.
  • Cameras: The “free” one built into our smartphones or a Nikon or Canon digital SLR with half a dozen lenses each worth more than that smartphone.
  • Home entertainment: Our iPod/iPhone/iPad plugged into a pair of sub-$100 speakers or the concert hall-emulating home theater system.
  • Cars: An Audi, BMW, Mercedes, or Porsche for the experience; or the Accord or Camry, Civic or Corolla, to get us back and forth when we turn the key.
  • Hotels: A Four Seasons or Ritz-Carlton; or a Courtyard by Marriott. By now you get the idea but one more example, for a reason.
  • And lastly, financial services: Private banking from US Trust or a Morgan Stanley financial adviser and your own CPA; or the $200 minimum balance checking account from TD bank, H&R Block, and an e-Trade account.

I left financial services for last because isn’t that the closest approximate analog to legal services?

My own working hypothesis is that law firms are going to find themselves increasingly isolated if they don’t have a distinctive, credible, and meaningful value proposition.

Firms that do a little bit of everything—”full service”—but which also don’t stand for anything in particular are, in our ecological/biological analogy where we began all this, an endangered species.

Understand I would take no satisfaction in being proven right about this category of firms.

But the arguments from economics and, yes, industrial structure, show that history looks most unfavorably on this category. And once clients begin self-selecting their migration paths either up or down the value chain (or both at the same time, more realistically, because “it depends”), there will be less and less oxygen in the room.

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