What makes an industry profitable?

Published on October 30, 2022   8 min

A selection of talks on Strategy

Hi, I'm Dave Ketchen. I serve as Harbert Eminent Scholar and Professor of Management at Auburn University in Auburn, Alabama, in the United States of America. I want to try to answer for you the question, what makes an industry profitable? We see that some industries have a lot of profit potential and companies enjoy a lot of success. Other industries seem to be quagmires, where not much profit is made. Why is that? Research has shown, a lot of this
grounded in the work of Dr. Michael Porter at Harvard University, that five forces tend to influence whether an industry is a grounds for success or a real struggle. We're going to take a look at these five forces: bargaining power of suppliers, bargaining power of customers, the threat of new entrants, the threat of substitute products, and then the competitive rivalry among a set of peers within an industry.
Let's take a quick look at the auto industry, e.g. when we think about the competitors in that industry, historically it's been companies like Ford and Chrysler and General Motors. In recent years, the potential entrants have become quite a factor, mainly with electric cars. Companies such as Tesla have managed to enter the industry and take away market share. As a competitor in this industry, you need to be aware of where might the next new entrant come from. Suppliers are companies that provide components of automobiles, such as the Lear Corporation, which produces auto interior systems. Sometimes industry competitors will choose to enter that industry, perhaps by purchasing one of their suppliers in order to ensure that they will get a good price. On the other side, we can think about buyers, people who actually buy automobiles. This is of course a very important force because this is where revenue comes from. One thing to point out is that not all buyers are equal. When you buy a vehicle, we have a little bit of negotiating power. But when a rental company buys thousands of cars, they are able to cut a much better deal with one of those competitors like Ford or Chrysler or General Motors. Lastly, we can think about substitute products, which in the case of the automobile industry, are things like bicycles, mass transit, air travel. Now in the United States, mass transit is not something that is popular among a lot of folks. That helps companies like Ford, Chrysler, and GM to sell more cars. In other countries, Japan, e.g. mass transit is very popular, and in that case, mass transit is a very effective substitute for automobiles.