Understanding industry structure
One of the primary ways of looking at industry structure is considering the concentrate and rivalry in the industry. The extent of competition typically varies depending on how concentrated an industry is – the proportion of sales made by the largest firms in the industry. Some common industry structures include monopolies, duopolies, and oligopolies, as well as perfect competition.
Industries dominated by one firm can be considered monopolies. If there is only one company, that firm may be able to obtain elevated profits by virtue of the fact that it is the only firm that customers can turn to. Indeed, monopolies may be regulated (for example utilities) because due to the absence of other firms, a monopoly may be in such a powerful position that it is bad for the economy and society.
Duopolies and oligopolies
Industries with two firms are duopolies, and several firms are oligopolies. Duopolies and oligopolies tend to have some greater levels of competition than in a monopoly context, however, still greater opportunities for elevated profits than in perfect competition.
Perfect competition refers to situations where there are lots of homogenous firms producing a standard product. Competition between the firms is high because they are undifferentiated. As such, perfect competition in economic theory, firms don’t make any elevated profit (i.e., beyond the cost of capital).
The impact of suppliers on industry structure
Suppliers play an important role in industry structure, and the nature of supply relationships with suppliers can influence industry profitability. In setting where the suppliers are power – for example, them being a monopoly with only one firm able to supply the good – a larger proportion of the overall value created can be captured by the supplier.
The impact of buyers on industry structure
Similarly, the nature of an industry’s relationships with customers can influence whether the industry is profitable. If customers are powerful – potentially because their industry is concentrated with only a limited number of potential customers – then the customers are likely to be powerful, able to push down prices.
The role of barriers to entry in maintaining industry structure
Industry entry barriers can protect industries from further competition. If entry barriers are high, it makes it difficult for new firms from being able to enter the market. As such, it can isolate the industry. In the absence of entry barriers, while it is possible that an industry may be an attractive industry in a particular time period, such elevated profits are likely to attract other firms to the industry. Indeed, the lower the entry barriers, the greater likelihood that the industry will move towards perfect competition.
Recognizing the impact of substitute industries
A final element closely connected to industry structure is substitute industries. Substitute industries are industries that produce a comparable product from the perspective of the customer, however one that uses different inputs, and thus a different industry. Such substitute products tangentially compete with an industry – potentially influencing the profitability of an industry.
Final thoughts: The Porter's Five Forces Framework for assessing industry structure
Porter’s Five Forces framework is a systematic approach for analyzing industry structure. The framework assesses whether there is likely to be high industry profitability based upon the supplier power, buyer power, threat of new entrants, substitute industries, and inter-industry rivalry.