Strategic groups and heterogeneous technologies: an application to the US banking industry

Using the US banking industry data during 1991-2000, this paper carries out a cluster analysis to segment banks into distinct strategic groups in terms of their product mix and allocation of inputs. We then investigate the production technology and cost structures for banks in each strategic group. A system of cost function and derived share equations is used to estimate the technology for each group. The distributions of returns to scale and technical change for each strategic group are also examined. Our results support the presence of seven distinct strategic groups and heterogeneous technologies in the US banking industry. We also find variations in returns to scale and technical change across strategic groups and over time. By allowing technologies to differ across strategic groups, our results show the presence of increasing, constant, and decreasing returns to scale in different strategic groups. In contrast, if one follows the conventional cost function approach which assumes a single homogeneous technology, one would conclude erroneously that the US banking industry is characterized by decreasing returns to scale. Based on these findings we conclude that the results based on a single homogeneous technology are likely to misrepresent the US banking industry.