Businesses throughout their lifetime are inundated with many forces. A contextual understanding of the environment will support the estimation of the future performance of a business. Thus, in analysing financial statements, one must consider the broader context in which a business operates. The Corporate Financial Accounting (CFA) module provided me with insight into the forces and their potential impact on profitability. This write-up reflects on my learning by examining competitive forces in business and factors affecting them.
COMPETITIVE FORCES IN BUSINESS
There are five known forces in the business environment relating to competitiveness. They are industry competition, supplier power, buyer power, product substitutes, and new entrants to the market.
- Industry competition
This refers to the rivalry between two or more businesses. This may lead to an increase in the cost of doing business. For instance, companies may feel pressure to hire and train competitive workers, as well as invest in research and development. Factors contributing to industry competition include
i. customer loyalty
ii. brand awareness
iii. quality differences and
iv. the sheer number of competitors and
v. competitors are equal in size and market share.
2. Bargaining power of suppliers
This is the ability of supplies to increase the price of inputs/raw materials, and consequently goods and services. Some suppliers are skilled in bargaining for higher prices as well as early payments. This negatively impacts on profitability and cash flows to buyers. Factors contributing to supplier power are
i. the number of suppliers in each business space
ii. size of supplies and
iii. the uniqueness of service.
3. Bargaining power of buyers
This refers to the strength of customers to drive down prices. These are buyers who are proficient at negotiating price concessions and payment terms. This could directly impact profitability from sales and operating cash flow.
4. Product substitutes/alternatives
The threat of substitution refers to the degree to which other products can be used in place of another product. The increase in the number of product substitutes/alternatives prevents sellers from raising prices. In effect, the availability of alternatives has a direct impact on profit margin.
5. Threat of new entrants
This refers to the ease with which new companies enter the market to compete with a company generating huge revenue. When this happens, competition grows and current players are forced to reduce prices to retain customers. Factors contributing to this threat are
i. economies of scale
ii. capacity of the new entrant
iii. technological advancement
iv. time of entry
v. cost of entry and
vi. specialised knowledge.
Other factors affecting business performance includes global economic forces, the quality and cost of labour, government regulations, and procedures. These factors can affect the range of activities in which a company can operate. However, an awareness of all the forces can be used to inform the business’s strategic plans.
There are five main forces that impact profitability in the business space. Businesses can control their environment if they understand and study this broader context. Once an understanding is established, they can monitor trends and plan strategically to mitigate against these forces. Consequently, this can increase their competitive advantage and maximise profitability.
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