By Josh Shilts, CPA, ASA, ABV/CFF/CGMA, CFE
March 23, 2022
NACVA’s QuickRead
What Forces Drive the Competition in the Industry?
The author of this article shares his thoughts on the book, Competitive Strategy: Techniques for Analyzing Industries and Competitors. This was a book he had read sections of during his university days, but this time around, read it with a new vantage point considering his education and experiences since then; particularly in the business valuation field. He notes that Porter reminds the reader of an important question: “What forces drive the competition in the industry?” and observes in the litigation reports this question is often not addressed. This is a potential problem and he provides the reader steps to answer this question.
The trend I see in the appraisal market is for professionals to support their conclusions with financials and spreadsheets; rarely is the question raised above addressed in these reports. It becomes even more apparent when an appraiser is asked to elaborate on this in a litigated setting using testimony as their means of communicating the results of the appraisal. This is troubling solely because without an answer to this question, I see no clear path to an explanation of future cash flow, capital commitment, growth rate, and risks associated with the industry and subject company. Yes, I will occasionally see a paragraph or testimony with verbatim commentary pulled from an industry publication, but it is rare to see the appraiser articulate the answer to the above question coupled in the company analysis and valuation approaches utilized. Why is that?
A lack of hands-on training provided is probably one source of the issue along with appraiser’s own inability or lack of recognition of this question in their analysis. We agree it is important. Then, the question becomes how?
Step 1: Understand that competitors are not the only drivers of competition within an industry. Customer behaviors, technology, and political events can all have an impact on consumers. Understanding how management assesses and analyzes these events along with benchmarking their strategy with other industry competitors can provide insight in the industry analysis as well as support conclusions regarding earnings growth, historical dividend paying capacity, and company specific risk.
Step 2: Industry analysis should include an analysis of competitors, but also assessment of consumers. Understanding what drives consumers will assist the appraiser in understanding what drives revenue. And revenue is the focus of most industry players. Linking economic and industry analysis to a focus on the end user and discussing this with management to assess their plans or concerns is another step to build confidence in the appraiser’s conclusion.
Step 3: Benchmark. The end user of the appraisal report is most likely using it to make an economic decision regarding the subject company. Detailing quantitatively and qualitatively what are the differences in the form of competitive advantages and disadvantages, lets the user assess the value of the subject vs. other market choices. For example, using graphs to show why the subject company is better able to implement technology (i.e., capital resources, consumer demographics) and expressing how this assists the subject company in terms of competition, is a clear indication to the reader of competitive advantage; particularly as it relates to the goal of revenue.
The core of appraisal work focuses on financial information. To increase the confidence of the appraisal, the use of a Competitive Strategy Assessment following the steps above will enhance the applicability of the appraiser’s report while instilling confidence and education in the user when making their economic decision.
[1] Porter, Michael. 1980. The Free Press.
The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.
Information contained in this article is provided for informational purposes only. It should not be misconstrued as legal or accounting advice or intended as a thorough, in-depth analysis of specific issues or a substitute for a formal opinion. It presents matters of general interest relating to business valuation, forensic accounting, and litigation support topics for educational purposes only. Shilts CPA, PLLC disclaims all liability concerning actions taken or not taken based on any or all of the contents of this article.
We would be pleased to perform the requisite research and provide a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation service.