If the market was purely competitive and driven solely by the forces of supply and demand, every industry would reach equilibrium when the quantity demanded and supplies were equal. In the process of reaching this equilibrium, the profits of all producers would tend towards zero. In reality, however, some markets are more attractive than others, and there are some where the producers can achieve a high level of profitability. Back in 1979, Michael Porter of the Harvard business school developed a framework for analyzing the factors that made some markets more attractive than others. This model is based on five forces.
Bargaining Power of Suppliers
It is often said that the secret of business is buying low and selling high. However, you may be unable to buy low if the bargaining power of your suppliers is strong. Different industries will require different inputs, such as labor, parts, or raw materials. If some of those inputs are scarce, are only available from a few suppliers, or are so specialized that switching suppliers is difficult, the supplier's bargaining power will be high.
Bargaining Power of Buyers
Sometimes, selling high is not an option. Several factors can give strong bargaining power to the buyer, driving prices down. For example, there are products for which there are many sellers but only one buyer (e.g, large defense contracts), and thus the buyer has significant leverage. On the opposite side of the spectrum, when there are few suppliers for a product with many potential buyers, the seller may sell at a significant margin. This is the case, for example, for brand-name must-have consumer electronics.
Threat of New Entrants
If you are selling a very profitable product but there are no barriers for entry in your industry, you will soon be swamped by competitors and your profits will go down. Barriers can come in the form of regulations, patents, capital costs, or specialized knowledge. For some of the more profitable products, several of these barriers will come in play simultaneously. For instance, a prestigious brand of MP3 players may sell at a high premium because it is protected by patents, because significant capital and technological know-how is required to produce a similar product, and because even if the product was successfully imitated brand loyalty alone would suffice for preventing copycats from making inroads into the market.
Threat of Substitutes
Even if your product cannot be easily copied, customers may find substitute products. If you sell paper bags and attempt to raise the price, for example, customers could probably switch to plastic bags. Likewise, even if you owned the only burger place in town, your customers would probably switch to pizza if you attempt to raise prices. If your product is undifferentiated, substitutes will be easily found, but if you offer a unique value proposition or you sell a hard-to-replace product or service your position will be much stronger.
Rivalry Among Competitors
For some industries, competition is abundant and fierce. For others, competitors are few and complacent. For some industries, particularly those where there is little product differentiation and no barriers to entry, competition will degenerate into a race to the bottom toward the lowest price. In others, it may lead into industry growth, as competitors introduce products with more features, better service and a stronger brand image. in some cases competition may even become mutually beneficial, as in the case of shopping areas where the presence of (competing) shops will attract customers.
