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.
|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.
|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.
|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.
|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.