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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 make up 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 gonna focus a little less on individual firms
and the differences between firms and we're gonna 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?
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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, was that it?
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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, you know, there are a couple of different perspectives
from economics that shed some light on this idea of, you know, 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 is a view, the Ricardian view,
that comes more from the resource based tradition.
This focuses much more on firm differences and barriers to imitation.
So, again, today we are gonna 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, you know, 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.
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Those arise 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 anyway 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 Farma.
These are industries where the average profitability, measured here in this chart
by just looking at return on assets, it's a simple simple measure of profits, but
in those industry segments, profitability potential is quite high.
And then you can see down at the bottom, we've got, you know,
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.
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So the question is, why is that?
Why do firms differ?
It can't possible 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 there's got to 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 that was pioneered by Professor Michael Porter at Harvard back
in the 80s.
And the idea is essentially very simple, it's that there are five
key competitive forces that serve to minimize or
dampen the prospects for profitability in a particular industry.
So these are the Five Forces that we're gonna 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.
Michael LenoxSenior Associate Dean and Chief Strategy Officer
Jared HarrisSamuel L. Slover Research Chair in Business Administration
