The intensity of competition in an industry determines the degree to which investment inflows drive returns to the free market level, hence the ability of firms in the industry to sustain above average returns. Intensity of competition is not a matter of luck. The underlying economic and technological characteristics of the industry determine the strength of the five basic competitive forces—threat of new entrants, bargaining power of buyers, rivalry between existing competitors, threat of substitute products and bargaining power of suppliers. These forces range from intense in industries like tires, paper and steel, where no firm earns spectacular returns, to mild in industries such as oil field equipment and services, cosmetics and toiletries, where high returns are common.

The goal of competitive strategy for a company is to find a position in its industry where these competitive forces will do it the most good or the least harm. A company may take a defensive posture, positioning itself so that its capabilities provide the best defense against the existing array of competitive forces. Alternatively, it can take an offensive approach by developing strategies designed to influence the balance of existing forces or to exploit a change in the competitive balance before rivals recognize it.

The first step in structural analysis is an assessment of the competitive environment in which the company operates—the basic competitive forces and the strength of each in shaping industry structure. The second is an assessment of the company’s own strategy—of how well it has positioned itself to prosper in this environment. Taken together, these steps are the key to forecasting a company’s earning power.