A firm’s profitability is heavily influenced by the overall strength of its industry. One approach for evaluating an industry structure is Porter’s Five Competitive Forces:

Force 1: Threat of New Entrants

The easier it is to enter an industry, the more competitive that industry becomes.  Increased competition tends to depress profit margins.

If the industry is already highly competitive, prices and profit margins may already be sufficiently low enough to discourage would be new entrants as their capital can be more attractively deployed elsewhere.

Barriers that can discourage new entrants are: large start-up capital requirements, strong brand identification with existing businesses, government restrictions, patented product technology of existing companies, and the threat of strong retaliation by existing companies.

Force 2: Bargaining Power of Suppliers

When suppliers to an industry have strong bargaining power, they can reduce the industry’s profits.

Conditions that increase supplier power include: relatively large supplier size, low buyer importance to supplier, high switching costs for buyers, supplier cartel, and shortage of supplier’s product.

Force 3: Bargaining Power of Buyers

Buyers of an industry’s product also influence the industry’s profit.

Conditions that increase buyer power are: high buyer importance to seller, high buyer knowledge of seller, and high buyer ability to influence end market users.

Force 4: Threat of Substitute Products

The existence of closely related products to that of the industry in question tangentially increases competition, lowering industry profitability.

When looking at substitute products, the analyst should consider how easy it would be for consumers to switch to a similar product.

Force 5: Intensity of Rivalry

An industry with an intense rivalry among firms will tend to have low profitability.

Symptoms of an intense rivalry include: high number of competitors, slow industry growth, low product differentiation, high product storage cost, and low relative strength among competitors.