Introduction

Competition is a dynamic process involving innovation and adaptation, survival, and failure; its outcome is a variety of products and prices that evolve in complex ways over time and are produced by a changing collection of firms. The particular patterns of evolution exhibited by different industries depend on both exogenous factors and the degree of competition present at any particular time. There are, of course, numerous ways to evaluate the strength of market competition, but for fairly obvious reasons, most attention has focused on profitability. From the point of view of the corporate strategist, profits are both an index of current success and a source of funds to finance the kinds of strategic investment that help to ensure the continuance of that success. From the point of view of public policy, profits provide a rough indication of the divergence of prices from marginal cost and thus of the difference between current market performance and the competitive ideal. And finally, from the point of view of those interested in analyzing market dynamics, profits are an important piece of the puzzle of explaining the evolution of competition. Profits at any time reflect the current degree of competition in a market, and because high profits attract entry, current profits also cause changes in the degree of competition, thus affecting its intensity in the near future.

Using profitability as an indicator of market performance is not, however, completely straightforward, and there are at least three different notions of profitability that command attention.