Five Forces Related to Industry Profit
When companies grow their profits, managers must recognize which approaches led to success so they can continue that progress. Michael Porter, a professor at Harvard Business School, established the "five forces" to help managers evaluate their approaches. He writes, "This framework organizes many complex managerial economics issues into five categories or 'forces' that impact the sustainability of industry profits: (1) entry, (2) power of input suppliers, (3) power of buyers, (4) industry rivalry, and (5) substitutes and complements" (Porter, 2004, p. 5). These forces all impact the financial effectiveness of various industries.
Entry
Power of Input Suppliers
Power of Buyers
Industry Rivalry
Substitutes & Complements
Entry increases any opposition and minimizes boundaries within current companies in the industry. Because of this, if obstacles to entry exist, companies may have difficulty maintaining profitability. Companies may enter an industry in many different ways. For example, Toyota "sold vehicles in Japan since the 1930s but waited until the middle of the last century to enter the U.S. automobile market" (Baye, 2010, p.8).
The power of input suppliers is another force that impacts profit. When suppliers agree to satisfactory conditions for their efforts, their profits decrease. In turn, supplier power is significantly lower when investments decrease, when inputs remain consistent, or when companies find cheaper alternative inputs that produce comparable outputs. For example, some countries have restrictions on the prices of inputs, which in turn limits the amount of profit suppliers can make.
The power of buyers is comparable to the power of suppliers in that profits are lower when buyers must agree to satisfactory conditions for their product or service. Within customer markets, buyers are generally split; this leads to a low level of buyer awareness or the buyer's knowledge of a particular product, which stems from minimal alternatives to the particular product. However, companies that have greater sales capacity or less competition tend to have a high level of buyer power and buyer awareness.
Industry rivalry affects companies' ability to maintain profit in their industry. Industries that focus on one specific product usually do not have strong rivalries between companies. However, when products are numerous and diverse, rivalries increase and impact profitability "whether firms' strategies involve prices, quantities, capacity, or quality/service attributes" (Baye, 2010, p. 10).
Substitutes and complements also affect profits. The cost and value of all connected products and services impact the sustainability of profits in an industry. Porter (2004) points out that when alternative products or services exist, an industry's profit can decrease. Government guidelines can also limit the accessibility of products or services. For example, the United States and Canada have restrictions on importing and exporting prescription drugs.
