Michael Porter is the well known Harvard Business School professor who developed a new standard framework for analyzing the forces at play in an industry that determine the likelihood of profits to be generated in a given industry.
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The well known "Porters 5" are factors that influence a firms ability to generate profits given the activities that they pursue and the industry in which they reside.
A quick review of Porters 5 forces:
1. Barriers to Entry - How difficult is it for anyone to enter the market of your business? Usually industries with high capital costs or high technological requirements have a high barrier of entry.
2. Threat Substitutes - Are there products that are easily substituted for the products/services that you offer. Substitutes to a car would be taking the train, plane, or walking and as such the auto-industry does not have a strong threat of substitutes.
3. Supplier Power - How much power do your suppliers have over the cost of goods that they are selling to you?
4. Buyer Control - How much power do your buyers have on setting the price from which they buy from you?
5. Industry Rivalry - How strong is the rivalry among firms in the industry. Although the auto-industry does not have many strong substitutes, rivalry among car firms is intense which as we have seen can drive down profits.
Pharmaceutical Industry -- The pharmaceutical industry requires immense capital, research & development, and a lot of luck to get products to market . There are no substitutes for a cancer treatment and the rivalry among competitors in the industry is relatively week, although generic competitors are starting to become a force. Pharmaceutical companies can for the most part set their own prices, and the suppliers of their goods are usually just the relatively inexpensive raw materials to produce. As a result, the pharmaceutical industry happens to have the highest return on assets among any industry due to the favorable industry forces.
Oil & Gas – Exxon Mobil generates the greatest profits among any company in the United States and looking at the oil & gas market it is easy to understand why. There is certainly no substitutes for oil (at least not yet), the barriers to entry are extremely high, unless you own an oil field, rivalry among competitors is limited to geographic locations of a gas station, and the companies have strong flexibility in setting the cost of oil.
Very few, if any industries would be able to claim the top spot on all 5 of Porters forces, but the relative strength of each force is worth evaluating when looking at favorable industries to enter. No matter what industry you are in, it is critical that you look at opportunities for differentiation. Creating value through differentiation in an industry that is favorable to Porters 5 is a strong recipe for success.