How and why do profits vary in different industries?
Level:
A-Level, IB
Last updated 12 Dec 2024
Share :
Share on Facebook
Share on Twitter
Share by Email
Profits vary across industries due to a combination of structural, operational, and market-specific
factors. These factors influence a firm's ability to generate and sustain profits over time. Here’s an
overview of the key drivers:
1. Market Structure
Perfect Competition:
Firms earn normal profits in the long run due to high competition and no significant barriers to
entry.
Example industries: Agriculture, basic commodities.
Monopolistic Competition:
Firms can earn short-term supernormal profits due to differentiation but typically settle at normal
profits in the long run as new entrants erode market share.
Example industries: Retail, restaurants.
Oligopoly:
High barriers to entry and market control by a few firms allow sustained supernormal profits,
particularly if firms collude or innovate.
Example industries: Airlines, telecom, automotive.
Monopoly:
Monopolists can maintain supernormal profits long-term due to exclusive control and very high
barriers to entry.
Example industries: Utilities, pharmaceuticals with patented drugs.
2. Barriers to Entry
Industries with high barriers to entry (e.g., capital intensity, regulatory requirements) typically see
higher profits due to limited competition.
Industries with low barriers often face profit erosion as new entrants compete for market share.
3. Nature of Demand
Price Elastic Demand: Industries with price-sensitive consumers often see thinner profit margins
due to competitive pricing.
Price Inelastic Demand: Industries providing essential or highly valued goods/services enjoy higher
profit margins (e.g., healthcare, luxury goods).
4. Cost Structure
High Fixed Costs: Industries like airlines or utilities can achieve higher profitability with economies
of scale but are vulnerable to demand shocks.
Low Fixed Costs: Industries like software-as-a-service (SaaS) have high initial profitability after
covering development costs.
5. Level of Competition
Fragmented Industries: High competition leads to reduced profit margins (e.g., small-scale retail).
Consolidated Industries: Firms in consolidated industries (few competitors) often command higher
profits (e.g., oil and gas).
6. Role of Innovation
Industries with a strong focus on R&D (e.g., technology, pharmaceuticals) can achieve
supernormal profits through product differentiation, innovation, and intellectual property
protection.
7. Regulatory Environment
Strict regulations can limit profitability (e.g., healthcare pricing caps).
Deregulated markets can spur higher profits but may lead to greater volatility.
8. Global Trends
Industries tied to global trends or geopolitical factors (e.g., energy, technology) often experience
profit fluctuations based on demand, supply chains, and policy changes.
In conclusion, profits vary widely across industries due to differences in market structure,
competition, cost dynamics, and external factors like regulation and innovation. Firms with a
unique value proposition and strong barriers to entry tend to sustain higher profitability.
Procedures
The financial manager sets procedures regarding how the finance team will process and distribute
financial data, like invoices, payments and reports, with security and accuracy. These written
procedures also outline who is responsible for making financial decisions at the company — and
who signs off on those decisions.
Companies don’t need to start from scratch; there are policy and procedure templates available
for a variety of organization types, such as this one for nonprofits.
Functions of Financial Management
More practically, a financial manager’s activities in the above areas revolve around planning and
forecasting and controlling expenditures.
The FP&A function includes issuing P&L statements, analyzing which product lines or services have
the highest profit margin or contribute the most to net profitability, maintaining the budget and
forecasting the company’s future financial performance and scenario planning.
Managing cash flow is also key. The financial manager must make sure there’s enough cash on
hand for day-to-day operations, like paying workers and purchasing raw materials for production.
This involves overseeing cash as it flows both in and out of the business, a practice called cash
management.
Along with cash management, financial management includes revenue recognition, or reporting
the company’s revenue according to standard accounting principles. Balancing accounts receivable
turnover ratios is a key part of strategic cash conservation and management. This may sound
simple, but it isn’t always: At some companies, customers might pay months after receiving your
service. At what point do you consider that money “yours” — and report the good news to
investors?
5 Tips to Improve Your Accounts Receivable Turnover Ratio
Invoice regularly and accurately. If invoices don’t go out on time, money will not come in on time.
Always state payment terms. You can’t enforce policies that you haven’t communicated to clients.
If you make changes, call them out.
Offer multiple ways to pay. New B2B options are coming online. Have you considered a payment
gateway?
Set follow-up reminders. Don’t wait until customers are in arrears to start collection procedures.
Be proactive, but not annoying, with reminders.
Consider offering discounts for cash and prepayments. Cash(less) is king in retail, and you can
reduce AR costs by encouraging customers to pay ahead rather than on your normal customer
credit terms.
