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101 Concepts for the Level I Exam

Essential Concept 47: Impact of Competitive Factors in Prices and Costs


The forecasting process must consider the competitive environment of a company/industry. Porter’s “five forces” framework is commonly used to analyze the impact of competition on future prices and costs.

Force Comment
Threat of substitutes If numerous substitutes exist and switching costs are low, companies have limited pricing power. If few substitutes exist and/or switching costs are high, companies have greater pricing power.
Internal rivalry Pricing power is limited in industries that are fragmented, have limited growth, high exit barriers, high fixed costs, and have more or less identical product offerings.
Supplier power Companies (and overall industries) whose suppliers have greater ability to increase prices and/or limit the quality and quantity of inputs face downward pressure on profitability.
Customer power Companies (and overall industries) whose customers have greater ability to demand lower prices and/or control the quality and quantity of end products face downward pressure on profitability.
Threat of new entrants Companies in industries in which the threat of new entrants is high because of above-market returns face downward pressure on profitability.

If the competitive forces are strong, the return on invested capital will be low.