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Learning Objectives
Define key categories of growth drivers and business risks.
Compare different business analysis frameworks
Define how economic, industry and company-level characteristics influence business strategies & outcomes
Interpret the results of qualitative assessments
Explain how these results may inform financial analysis
1. Business Analysis Framework
A business operates within an industry that fits into the broader economy. To analyze a business and the external environment in which it operates, we can utilize several established frameworks:
Broader Economic Analysis
PESTEL Analysis
PESTEL is an acronym that stands for Political, Economic, Social, Technological, Environmental, and Legal factors. This framework helps businesses identify and evaluate the macro-environmental factors that could impact their operations and strategic decisions:
Political Factors: Consider the influence of government policies, political stability, taxation regulations, and trade tariffs.
Economic Factors: Examine economic growth rates, interest rates, inflation, and unemployment levels, which can affect consumer purchasing power and spending.
Social Factors: Analyze demographic trends, cultural attitudes, and lifestyle changes that influence consumer behavior and market demand.
Technological Factors: Evaluate the impact of emerging technologies, research and development, automation, and technological advancements on the industry.
Environmental Factors: Consider ecological and environmental aspects, including sustainability practices, climate change, and environmental regulations.
Legal Factors: Understand the laws and regulations that govern the industry, including employment laws, consumer protection laws, and industry-specific regulations.
1.2. Industry Analysis
Porter's Five Forces
This model is designed to assess the competitive forces that shape an industry, providing insights into the competitive landscape:
Supplier's Bargaining Power: Analyze how many suppliers are available and their control over pricing and quality. A few powerful suppliers can significantly impact a business’s cost structure.
Customer's Bargaining Power: Evaluate the influence customers have on pricing and quality. High customer power can drive prices down and demand higher quality.
Barriers to Entry for Potential Entrants: Identify obstacles that new entrants face when trying to enter the market, such as high startup costs, brand loyalty, or regulatory requirements.
Threat of Substitutes: Assess the availability of alternative products or services that can fulfill the same need. A high threat of substitutes can pressure prices and profitability.
Industry Competition: Analyze the intensity of competition within the industry. High competition often leads to price wars and reduced profit margins.
Industry Lifecycle: Understand the phase of the industry lifecycle the business is in (launch, growth, maturity, or decline) which can influence strategic decisions.
1.3. Business Analysis
Competitive Positioning and Competitive Advantage
Competitive positioning refers to how a company differentiates itself within the market. This can be achieved through:
Best Product: Offering the lowest cost or most differentiated product in the market.
Total Customer Solution: Providing a comprehensive solution that meets the overall needs of customers, rather than just selling a product.
System Lock-in: Creating a scenario where customers find it difficult to switch to competitors due to high switching costs or integration of systems.
Ansoff Matrix (Product-Market Expansion Grid)
The Ansoff Matrix is a strategic tool used for identifying growth opportunities through four main strategies:
- Existing Market and Existing Product: Market Penetration - Focus on increasing sales of existing products in the current market.
- Existing Market and New Product: Product Development - Introduce new products to the existing market.
- New Market and Existing Product: Market Development - Expand into new markets with existing products.
- New Market and New Product: Diversification - Develop new products for new markets, which carries the highest risk.
SWOT Analysis
SWOT analysis helps businesses identify their internal strengths and weaknesses, as well as external opportunities and threats:
Strengths: Internal attributes that give the company an advantage.
Weaknesses: Internal factors that place the company at a disadvantage.
Opportunities: External factors that the company could exploit for growth.
Threats: External challenges that could hinder the company’s performance.
2. Translating Growth Drivers & Business Risks into Financial Analysis
Business growth drivers and risks exist at all three levels: economy, industry, and the individual business itself. To effectively conduct analysis, an analyst must start with a clear end goal or question to answer. This involves several steps:
Assess Growth Drivers and Business Risks:
Identify and evaluate the key factors that can drive growth or pose risks. This can include market trends, regulatory changes, technological advancements, and shifts in consumer preferences.
Translate Findings into Financial Model Assumptions and Drivers:
Convert the insights gained from the analysis into quantifiable financial metrics and assumptions that can be integrated into financial models. This includes projecting revenues, costs, and cash flows based on identified growth drivers and risks, thereby facilitating informed decision-making and strategic planning.