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Competitive forces within the business environment and its impact on profitability

Ete Grant Written by hotpen · 1 min read >

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.

  1. 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.  

CONCLUSION

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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