The profit earned by a company is a function of both industry structure and strategy. The former is a powerful, sometimes overwhelming force, and is largely out of one's control. The latter is firmly within one's control. The appropriate profit-maximizing strategy a firm should take, however, can be found in an analysis of the structure of the industry in which one operates.
The forces of industry structure are:
* Barriers to Entry
* Threat of Substitutes
* Customer Bargaining Power
* Supplier Bargaining Power
* Competitor Rivalry
These five competitive forces determine how much profit the firms in an industry are able to earn. Why? They determine the prices that can be charged, the costs that must be paid, and the investment that is required to enter and remain in an industry. Sale prices, costs, and required investment are the elements of profit and return on investment.
The profit that is earned by the players in an industry, therefore, is not a matter of the type or function of the products or services but of the structure of the industry. The strength of each of the five forces varies from industry to industry and can change over time. The result is that, at any point in time, not all industries are alike from a profit-making standpoint. Some allow higher profits than others.
Industry analysis can be used to decide when to enter and exit an industry, or a particular segment of an industry. It can also be used to craft a strategy that will lead to maximized profits, given the realities of the industry's structure.
Barriers to Entry: Competition means lower profit. Industries that have low barriers to entry will attract new entrants, particularly during periods of robust demand. Any supply shortage that allows prices to be raised, and higher profit, will be swiftly eliminated.
Consider the residential lawn care industry. Any person who can purchase or borrow a pickup truck, lawn mower, edger, broom and trash bags can enter the residential lawn care business and charge any amount that will exceed their cost of gas, oil, trash bags, etc. The entrants drive prices down and make it difficult to charge enough to earn attractive returns.
Efforts could be made to raise the barriers to entry, such as getting laws enforced that prevent the hiring of illegal aliens, getting legislation passed that would require all providers to be bonded, outlawing the use of older equipment, etc. In most industries, however, it's an uphill battle.
Of course, one...