Transcript industry analysis

Industry Analysis
– Firm performance is closely tied to industry performance – a firm’s
profitability is circumscribed by industry profitability and the firm’s
relative position within the industry
– Knowing the industry adds to your understanding of the firm
– According to Porter’s framework, industry profitability is determined
by
• Degree of actual and potential competition
Potential profits in an industry is a function of the price that customers are
willing to pay for a product. This price is in part determined by the degree of
competition among the firms in the industry.
• Bargaining power of buyers and suppliers
The actual profits depend on the firms’ bargaining power with suppliers (i.e., the
price they pay for their inputs) and buyers (i.e., the price they get for their
output.)
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• Degree of actual and potential competition
– Rivalry among existing firms
• Industry growth rate
– Determines how intensely firms have to compete with each other for market share. For
example, firms in mature industries will have to compete more for market share,
compared to firms in high growth industries.
– High growth industries also tend to attract potential competitors.
• Concentration and balance of competitors
– The number of firms in an industry as well as the relative size of the firms determine the
level of competition in an industry. For example, one large firm can set the price in an
industry. Alternatively, a group of similarly sized firms can cooperate and set prices at a
high level, or, they may engage in price wars.
• Degree of differentiation and switching costs
– Are the products differentiated enough such that customers could have strong
preferences about which product to buy?
• Scale/learning economies and the ratio of fixed to variable costs
– Economies of scale and learning typically encourage fierce competition among firms
already in the industry.
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• Excess capacity and exit barriers
– Firms in industries with excess capacity are more likely to cut prices.
– Similarly, high exit barriers (e.g., specialized equipment, high sunk costs) could cause
firms to utilize excess capacity (and lower prices) rather than leave. These also serve as
deterrents to potential competitors.
– Threat of new entrants
• Economies of scale
– Large investments in capacity will tend to discourage potential entrants into the industry.
• First mover advantage
– First mover advantage refers to the competitive advantage (e.g., costs, learning, set
industry standards) gained by the first firm/s to enter an industry.
• Access to channels of distribution and relationships
– Potential competitors are discouraged from entering an industry if it is difficult to have
an avenue to sell their products. For example, an auto manufacturer will have to set up a
dealer network.
• Legal barriers
– Includes licenses, patents, copyrights.
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– Threat of substitute products
• Customers are likely to be more sensitive to price if there are close
substitutes (e.g., air versus train travel)
• Bargaining power of buyers and suppliers
– Bargaining power of buyers
• Price sensitivity. Buyers will be more sensitive to price if
– the item comprises a big proportion of total cost/expenses
– sellers produce undifferentiated products
– the item has little or no effect on the quality of the buyer’s product or service
• Relative bargaining power
– Size and concentration of buyers relative to suppliers. Buyers will have bargaining power
if they are few in number and make large purchases. For example, HMOs purchase
healthcare from doctors and hospitals at a much lower cost.
– Buyer’s information. Buyers will be able to bargain more if they know the suppliers prices
and costs.
– Bargaining power of suppliers
• Arguments would be similar to bargaining power of buyers, with the roles reversed.
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Industry classifications
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Global Industry Classification Standard (GICS)
Thomson Reuters Business Classification
Standard Industrial Classification (SIC)
North American Industry Classification System (NAICS)
Others
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Opportunities based on industry life cycle
– Emerging industries are characterized by
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Technological uncertainty
Strategic uncertainty
High but steeply falling costs
Large numbers of newly formed companies
First-time buyers
Altered entry barriers
 A firm may be able to establish product standards or
define the business model
 Early commitments to suppliers and customers can
produce loyalty and favored treatment
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Opportunities based on industry life cycle
– Mature industries are characterized by
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As product and market penetration increases, competition
focuses more on market share
Customers are knowledgeable, competition focused on cost
and service
Reduced growth in personnel and productive capacity
Fewer opportunities for new product and process
development opportunities
Increased international competition
Reduced profits
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Focus on operational efficiency
Cross selling
Acquisition opportunities
International market opportunities
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Alternatives to Porter’s view
– Value net and mixed business relationships
• Complementor – if customers value a firm’s product
more when they have the other firm’s product than
when they have the firm’s product alone
• Competitor - if customers value a firm’s product less
when they have the other firm’s product than when
they have the firm’s product alone
– Innovation based industry analysis
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• Sources:
– English, Applied Equity Analysis
– Palepu and Healy, Business Analysis and Valuation Using Financial
Statements, 4th ed.
– Grant, Contemporary Strategy Analysis, 7th ed.
– Valentine, Best Practices for Equity Research Analysts
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