An important aspect of business strategy is the ability to understand the dynamics and the structure of an industry or market segment. And specifically how that makeup of an industry can impact the future profitability potential of firms who operate in that industry. So today, to zero in on that, we're going to focus a little less on individual firms and the differences between firms. And we're going to focus more on how to better understand the dynamics and structure of market segments and industries. So let's begin with an example. If we think of an example, like say the US airline industry, it illustrates some of what we want to talk about here. It's a fascinating case study because historically US airlines were highly regulated. But then in the late 1970s, that was an industry that was deregulated and all of a sudden, that freed up things so that a lot of these market dynamics could play out. So the question is, what's happened over the last 30 years in this industry? We've had literally hundreds of carriers enter the industry, we've had literally hundreds of carriers exit the industry. Many of the firms have been in and out of bankruptcy and generally speaking, a lot of the airlines have really struggled. So the question is, why has competition been so difficult in the airline industry? I mean, one might think, well maybe it goes back to this fundamental idea from strategy that if everybody can do it, it's difficult to create and capture value from it. So the question is, well, is that it? But when you think about it, it's not obvious that that would describe the airline industry. I think airlines are, these are businesses which are characterized by huge capital budgets, it's a highly technical business to be in. I don't think it's necessarily the case that just anybody can run an airline. So remember theoretically, in a perfectly competitive market, no firm realizes economic profits or what economists would describe as rents. So you may recall that there are a couple of different perspectives from economics that shed some light on this idea of where do profits come from in a particular industry, market segment or in a particular firm. So on one hand, we have this idea from industrial organization economics about monopoly profits or monopoly rents. And this is an idea that focuses largely on barriers to entry. And it really focuses on the structure of the industry and how that can impact the prospects of firms operating in that industry. On the other hand, there's a view the Ricardian in view that comes more from the resource based tradition. This focuses much more on firm differences and barriers to imitation. So again, today, we're going to focus a little bit more on the monopoly profits idea and how an industry structure and the set of dynamics in an industry can drive the possibility for monopolistic profits. So let's dig into that a bit more, remember that the industrial organization perspective kind of takes it as a given that the industry structure matters a lot. In fact, from this perspective, this is the most important thing. And it's very difficult given the sort of barriers to competition, it's very difficult to move the supply curve outward and lower prices. And so essentially that difficulty gives rise to the possibility of monopolistic profits, those arising largely from barriers to competition. And as a result of all of this, it turns out that some industries are simply on average more profitable than others. And we can see this almost any way you look at it. I mean, here's a set of data from a few years ago, that just looks at industry average profitability and you can see that some types of industries are very profitable. I mean aerospace and medical devices and pharmaceuticals. These are industries where the average profitability measured here in this chart by just looking at return on assets. It's a simple measure of profits, but those in those industry segments, profitability potential is quite high. And then you can see down at the bottom, we've got industries like real estate and airlines, like we were talking about a moment ago. And these are industries where the average profitability in the industry is quite low. So the question is, why is that, why do firms different can't possibly just be a difference in demand for these products and services? Last time we checked, I think there's lots of demand for airline tickets, right? So it's gotta be something else going on. What I want to introduce is a set of ideas, a framework, a tool that I'll refer to as the five forces. This was something was pioneered by Professor Michael Porter at Harvard back in the 1980s. And the idea is essentially very simple, is that there are five key competitive forces that served to minimize or dampen the prospects for profitability in a particular industry. So these are the five forces that we're going to talk about in more detail. And it's important because being able to understand the dynamics and structure of an industry is a really important skill for a business strategist.
