5 Things that effect profitability of a business

5 Things that effect profitability of a business

Profitability, a common factor in all the industries is also the most important one. Both startups and established chase profitability and worry about it. It is often said that each business has its unique way of being profitable. But the question is whether there is a collective wisdom about profitability that unites that binds all the industries as single entity?

Well yes..there are 5 elements that influence profitability of any industry.

Customer Leverage:- This has to do with how much power buyers have over a company. In some industries, buyers have a lot of negotiating power. This is especially true when there are few buyers who buy a lot and when the industry has high fixed costs. Buyers also have a lot of power when the goods in an industry are all the same and when there aren't any big costs for them to switch.

?Example- The suppliers to Walmart, Big Bazaar, DMart ,Ppwer companies supplying to the central and state governments, airlines. In all these cases the companies either have fixed costs, or limited customers or undifferentiated product. Usually in these cases company reduces the price to retain the customers, driving down the profitability.

?Increasing the switching costs for the buyer, cultivating buyer loyalty towards the brand, or distinguishing the products to increase the value offered can influence the price-based decision and counter this force.

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Supplier leverage:- ?Suppliers with strong bargaining power might boost their profits by raising prices, lowering quality, or shifting costs to other industry players. According to Porter such suppliers can hurt a business that cannot transfer these costs onto customers,

Example- Any airlines, neither has unlimited number of suppliers and nor a luxury to charge as much it wants from the customer. If we notice the suppliers to aviation industry, be it fuel, air craft engines etc are much more profitable than airlines themselves. When few, unique, and able to threaten industry integration, suppliers have considerable bargaining power.

?Companies can integrate backwards or outsource to solve the problem.

New Entrants :- The danger of new entrants is the most difficult of the five forces. This is especially true in today's world, where the barriers to enter in a business are low. When new players enter a market, to capture the market they lower their prices, putting pressure on current players to lower their prices too. This hurts the ability of older companies to make money. In some cases, new businesses can even force older ones to leave the market.

Example- Nokia lost market share to Apple in the mobile phone business. ??

To deal with this threat, companies can make it more expensive for customers to switch brands by building brand loyalty, or they can make it harder for new competitors to get into the market by limiting their access to distribution outlets. New competitors can also be scared away by aggressive marketing and lower prices, before they enter into the market.

Threat of substitute products:- The idea of "substitutes" refers to the problem that comes up on the market when there are other goods that are just as useful to buyers.

Examples- When buyers have choices that offer similar benefits, like choosing between a flight and a train to get from one city to another, choosing between electric or petrol vehicle, jacket or a sweater, Coffee or other hot beverages, it can make the business more competitive. If the pricing of the intended product is high, customers can easily switch to other products.

When buyers see a better mix between price and performance or when switching to a different product doesn't pose too many problems, the chance that they will do so goes up. Even though this may seem like a simple problem, it can be hard for businesses to solve because they may not always know about all the possible goods that consumers could buy instead.

Existing Competition:- Competition among firms ,which results in reduction of the profitability of an industry, is dependent upon the degree and basis of their competition.

High levels of competition often happen in markets that grow slowly or where there are a lot of rivals. It can also happen when companies have trouble understanding what the market is telling them. This is like the Prisoner's Dilemma model from Game Theory, where cooperation is rare and one firm's gain is another firm's loss.

But this competition can also be good if each rival goes after different parts of the market. This is called a positive-sum game.

The above article is based upon Porter’s Five Forces model. The best place to be in a certain industry is where there are high barriers to entry, where both suppliers and buyers have low bargaining power, where there are few or no substitutes, where there is no threat of new entrants, and where competition is low.

For start-ups this can be achieved by starting with a small group of customers and solve their problem which no one is solving or solving ineffectively. This results in some kind monopoly in that customer segment. Once that is achieved it results in a moat around that segment, and the business can be further built on that.

To discuss more about profitability please connect.

References-

www.researchgate.net

https://www.youtube.com/@harvardbusinessreview

#businesstalks #profitability

Mukta Chaudhary - Business Analyst

Business Analyst || Sales Business Analyst

1 年

Insightful,

Sanjay Bablani

Country Head For Blueberry Travels

1 年

Very Well Explained as powerful communication

Ramchandar Ragavendran

Senior Director at IDFC FIRST Bank

1 年

Well explained

Manish Prajapati

Technology Executive | Cloud | Site Reliability Engineering | IIM Ahmedabad

1 年

Good explanation Anshuman Dwivedi

Varun Tyagi

Associate Vice President Design Engineering and Management Professional for Underground & Elevated Metro Rail Projects , Indian Institute of Management- Ahmedabad Ex AECOM Ex AMBERG Engineering AG

1 年

These are close to Michael Porters Five Forces …….

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