Decision Criteria Consolidation: A Theoretical Foundation of Pareto Principle to Porter's Competitive Forces

Abstract

Also known as the 80/20 rule, the Pareto Principle separates a class of significant few from the trivial many. With this classification, Pareto Principle has managerial and strategic implications in many disciplines. A recent mathematical model of the Pareto Principle identifies several important factors that cause such separation; the most important 2 are the probability of new entry (can be viewed as "entry barrier") and the recentness of usage. Because the probability of new entry determines the upper bound of the usage concentration, it is deemed to be the most important factor. Observing that Porter's [1] five competitive forces are all closely related to the barrier of entry, it is apparent that the theoretical model of Pareto Principle can be used as the theoretical foundation for Porter's Five Competitive Forces. We further argue that, similar to what has been described in microeconomics, the barrier of entry is the most important factor that determines the market structure-be it monopoly or pure competition. Thus, the decision criteria in strategic planning can be greatly simplified to its effect on the barrier of entry. Furthermore, we suggest that the recentness of usage (i.e., a product not recently in use may be forgotten by customers, thus reducing the probability of its future usage), though not emphasized in Porter's theory, should also be part of the strategy formation.