How can you use Porter's Five Forces to identify financial risks?

Porter's Five Forces is a framework primarily used to analyze a company's competitive environment, but it can also be insightful for identifying financial risks. One thing I have found helpful is using this framework to assess the market dynamics that can impact a company's revenue and costs. For example, the threat of new entrants and the bargaining power of suppliers can signal potential increases in costs or price wars, impacting profitability. Similarly, the bargaining power of customers and the threat of substitute products can indicate risks to revenue streams. By understanding these forces, a company can anticipate and mitigate financial risks associated with market competition and supply chain dynamics.

Think of Porter's Five Forces as your financial crystal ball, revealing the gremlins and monsters lurking in your industry. See cutthroat competition squeezing profits? That's the rivalry beast! Suppliers holding you hostage on prices? Supplier power's got you in its grip! New startups popping up like popcorn? The entry force is knocking! Customers flexing their muscles? Buyer power's flexing back! And lurking in the shadows, the substitute monster, ready to gobble up your market share. By facing these forces head-on, you can dodge the financial haymakers and keep your bank account smiling. Remember, knowledge is power, even when it involves mythical beasties and popcorn-spawning startups.

As a business, Competitive Rivalry very simply, increases the cost of business. For example, for a bank, competitive rivalry can: - increase the cost of deposits, driving up interest expenses - loss of income from Clients switching their business to another bank These impacts are both from a revenue generating and expense management point of view on the P&L. The key to ensuring that money is optimized is to 1. Differentiate your offering even in a homogenous market. What is the business doing differently? 2. What are elastic / in elastic options for the company to utilize to recover costs? E.g. reducing price may drive higher volume and overall deliver a greater return. 3. Know your competition and what you are competing on!

Using Porter's Five Forces to identify financial risk is like assessing a lemonade stand. Suppliers' pricing power, customer influence, new competition, alternative beverages, and intense rivalry impact the stand's financial health. It's like checking if lemon and sugar costs, customer loyalty, new competitors, changing preferences, and market competition pose risks, similar to examining a simple lemonade business for potential challenges.

Healthy competition in business is one thing, but too much competitive intensity within the competition drives down prices and can damage profits due to the cost of competing.

Lets understand this with an exmaple: The smartphone industry is characterized by intense competitive rivalry among major players like Apple, Samsung, and Xiaomi. These companies continually innovate to gain market share, leading to frequent product launches, aggressive marketing campaigns, and price wars. For instance, when Apple releases a new iPhone model, competitors may respond by offering discounts or launching their own flagship devices with similar or improved features.

Porter's Five Forces aids in pinpointing financial risks: 1. Threat of New Entrants: Analyze new competitors that could impact market share and profitability. 2. Bargaining Power of Suppliers: Assess supplier influence on costs, potential disruptions, and financial stability. 3. Bargaining Power of Buyers: Examine customer negotiation power, impacting pricing, revenue, and profitability. 4. Threat of Substitutes: Identify alternatives that may affect market share and revenue streams. 5. Intensity of Competitive Rivalry: Evaluate industry competition's impact on pricing and profit margins. Integrating these forces enhances financial risk awareness and strategic decision-making.

Existing firms imposes several entry barriers such as hefty capital requirements & cutthroat competition for the new entrants in order to save their market share & growth.

Porter's 5 Forces may identify potential threats and risks but competitive survival will depend on appropriate strategic responses

Lets understand this with example: In the smartphone industry, the threat of new entrants is relatively high. For instance, a new startup with innovative technology and sufficient funding may enter the market and disrupt established players like Apple, Samsung, or Huawei. This could be a company developing a new type of smartphone with advanced features or a lower price point, attracting customers away from existing brands.

Examining and including the bargaining power of suppliers into any financial plans or strategic decisions is important since it directly impacts margins and can significantly change COGS in the long term

Using Porter's Five Forces Model, if the bargaining power of suppliers is found to be strong, the financial model should be adjusted for a decline in gross margins or material costs, as well as an increase in the days of inventory ratio.

Lets understand it with an example: Smartphone manufacturers rely on various suppliers for components such as processors, displays, and batteries. If suppliers have significant bargaining power, they can dictate prices or impose stricter terms on manufacturers. For instance, if a key supplier of smartphone processors increases prices or faces production disruptions, it could impact the profitability of smartphone companies that rely on their components.

Using Porter's Five Forces Model, if the bargaining power of customers is found to be strong, the financial model should be adjusted for a decline in unit pricing or greater discounts, as well as an increase in the days of sales outstanding.

Lets understand it with an example: Smartphone buyers have considerable bargaining power due to the abundance of options available in the market. They can compare features, prices, and customer reviews before making a purchase decision. For instance, if a smartphone company increases prices without offering significant improvements in features or quality, buyers may switch to competitors offering better value for money.

Using Porter's Five Forces Model, if the threat of substitutes is found to be strong, the financial model should be adjusted for a lower revenue growth rate, and a higher cost of capital (highlighting greater return on capital required by investors because of higher business risk).

Lets understand it with an example: Substitutes in the smartphone industry include other devices with similar functionalities, such as tablets, laptops, or wearable technology like smartwatches. If these substitutes offer comparable features or fulfill similar needs, they can pose a threat to smartphone sales. For instance, consumers may opt for a tablet with a larger screen size instead of purchasing a new smartphone for media consumption and browsing.

By utilizing Porter's Five Forces framework and considering additional considerations, organizations can gain a holistic view of financial risks within their industry. This approach empowers businesses to make informed decisions and proactively mitigate potential challenges. By identifying industry-specific and broader financial risks, organizations can position themselves to overcome obstacles and achieve success. Businesses can confidently and uniquely navigate their industry's competitive landscape through strategic analysis and thoughtful consideration.

Threat of Inconsistent Government Policies: In climes where the government authorities are very inconsistent with the application of financial policies, the level of financial risk is very high. For instance policies in respect of foreign exchange repatriation by multinationals who provide goods or services in their host countries. A case in point is money due to foreign airlines trapped for many months in Nigeria as a result of the CBN monetary policies which resulted in shortage of dollars. The same thing has happened across several strata in respect of manufacturing and agro allied businesses. Some companies have left the country while others are selling off to leave as well.

Entering the pharmaceutical business in Mongolia took time due to high barriers to entry and intense competition. As a newcomer to this sector, Porter's Five Forces framework gave me a valuable tool to navigate this unfamiliar territory and mitigate financial risks. By applying this analysis, we gained insights into industry dynamics, allowing us to develop strategies to navigate challenges effectively. This framework identified risks and opportunities, enabling informed decisions to minimise financial risks and enhance our competitive position.