mba 8480 - industry analysis

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Industry Analysis*

Professor Mike [email protected]

* - These slides are adapted / excerpted from some of the CFA Institute’s material on this topic.

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Uses of Industry Analysis

Understanding a company’s business and business

environment

Identifying active equity investment opportunities

Portfolio performance attribution

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Approaches to Identifying Similar Companies

Industry Classification

Products and/or

Services Supplied

Business-Cycle

Sensitivities

Statistical Similarities

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Cyclical and Noncyclical Companies

Profits strongly correlated with economic activity

Expensive or non-essential products (discretionary or ‘luxury’)

High operating leverage

CyclicalCompany

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Limitations of Industry and Company Descriptors

Growth Companies

Cyclical Industrie

s

Defensive Industrie

s Growth Industrie

s

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Commercial Industry Classification Systems

Global Industry Classification Standard (GICS)

Russell Global Sectors (RGS)

Industry Classification Benchmark (ICB)

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Governmental Industry Classification Systems

International Standard Industrial Classification of All Economic Activities (ISIC)

Statistical Classification of Economic Activities in the European Community (NACE)

Australian and New Zealand Standard Industrial Classification (ANZSIC)

North American Industry Classification System (NAICS)

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Representative Industry SectorsBasic Materials and Processing

Consumer Discretionary

Energy

Financial Services

Industrial/Producer Durables

Technology

Telecommunications

Utilities

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Constructing a Peer Group

Examine commercial classification systems

Review company’s annual report

Review competitors’ annual reports

Review industry trade publications

Compare business activities

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Framework for Industry Analysis

A Framework for Industry Analysis

Economic Sector

Customer Bargaining Forces (affected by number of suppliers,

number of purchasers, their size/power, switching costs to

other suppliers, number of contracted suppliers, customers’

ability to produce the product themselves)

Supplier Bargaining Forces (affected by number of industries

buying suppliers’ products, of supply substitutes, switching costs of suppliers’ customers,

industry, and customers’ ability to enter industry.)

Technological Influences Social Influences

Macroeconomic Influences (stage of business cycle, longer term growth, and structural economic trends)

Demographic Influences Governmental Influences (regulatory, political, legal)

Product / Service Substitution Threats

New Entrant Threats

Group of Complementary Industries Industry

Internal Competitive Forces (affected by economies of scale, cost advantages, other

brand loyalty, customers’ switching costs, product government regulation, industry’s competitive structure,

corporate rivalries, cost conditions, entry and exit barriers) Life Cycle Analysis

(embryonic, growth, shake-out, mature, declining) Business Cycle Sensitivity

(cyclical: leading, lagging, coincident; defensive, growth) Analysis by Position on the Experience Curve

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Strategic Analysis: Porter’s “Five Forces”

Intensity of Rivalry

Bargaining Power of

Customers

Threat of New Entrants

Threat of Substitute Products

Bargaining Power of Suppliers

First focus for analysis

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Evaluating the Threat of New Entrants and the Level of Competition

What are the barriers to entry?

How concentrated is the industry?

What are capacity levels?

How stable are market shares?

Where is the industry in its life cycle?

How important is price to the customer’s purchase decision?

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Barriers to Entry

Sustainable Economic

Profits

Potential for Greater Pricing

Power

High Barriers to Entry

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Industry Concentration

ABC CompanyXYZ CompanyMNO Company

What percentage of the market does each of the largest players have?

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Industry Capacity

Tight or Limited Capacity

Demand Exceeds Supply

Greater Pricing Power

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Market Share Stability

Unstable Market Share

Limited Pricing Power

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Industry Life CycleSource: Based on Figure 2.4 in Hill and

Source: Based on Figure 2.4 in Hill and Jones (2008).Source: Based on Figure 2.4 in Hill and Jones (2008).

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Limitations of Industry Life-Cycle Analysis

Technological Changes

Regulatory Changes

Social Changes

Demographic Changes

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Price Competition

Price strongly affects

customer purchase decisions

Competition within the industry

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Macroeconomic Influences on Industry Growth, Profitability, and Risk

Industry Growth,

Profitability, and Risk

Economic Growth

Interest Rates Availability of Credit

Inflation

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Other Influences on Growth, Profitability, and Risk

• Invention of the microchip• Digital imaging

Examples of Technological

Influences

• Baby Boomer generation• Aging populations

Examples of Demographic

Influences

• Tax policies and government spending• Regulation

Examples of Governmental

Influences

• Changes in tobacco consumption• Women in the workforce

Examples of Social Influences

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Industry Analysis for Branded PharmaceuticalsMajor Companies Pfizer, Novartis, Merck, GlaxoSmithKline Barriers to Entry/Success

Very High: Substantial financial and intellectual capital required to compete effectively. A potential new entrant would need to create a sizable R&D operation, a global distribution network, and large-scale manufacturing capacity.

Level of Concentration

Concentrated: A small number of companies control the bulk of the global market for branded drugs. Recent mergers have increased the level of concentration.

Impact of Industry Capacity

Not applicable: Pharmaceutical pricing is primarily determined by patent protection and regulatory issues, including government approval of drugs and manufacturing facilities. Manufacturing capacity is of little importance.

Industry Stability Stable: The branded pharmaceutical market is dominated by major companies and consolidation via mega-mergers. Market shares shift quickly, however, as new drugs are approved and gain acceptance or lose patent protection.

Life Cycle Mature: Overall demand does not change greatly from year to year. Price Competition Low/Medium: In the United States, price is a minimal factor because of the

consumer- and provider-driven, deregulated health care system. Price is a larger part of the decision process in single-payer systems, where efficacy hurdles are higher.

Demographic Influences

Positive: Populations of developed markets are aging, which slightly increases demand.

Government & Regulatory Influences

Very High: All drugs must be approved for sale by national safety regulators. Patent regimes may differ among countries. Also, health care is heavily regulated in most countries.

Social Influences Not applicable. Technological Influences

Medium/High: Biologic (large-molecule) drugs are pushing new therapeutic boundaries, and many large pharmaceutical companies have a relatively small presence in biotech.

Growth vs. Defensive vs. Cyclical

Defensive: Demand for most health care services does not fluctuate with the economic cycle, but demand is not strong enough to be considered “growth.”

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Industry Analysis for Oil ServicesMajor Companies Schlumberger, Baker Hughes, Halliburton Barriers to Entry/Success

Medium: Technological expertise is required, but a high level of innovation allows niche companies to enter the industry and compete in specific areas.


Fragmented: Although only a small number of companies provide a full range of services, many smaller players compete effectively in specific areas. Service arms of national oil companies may control significant market share in their own countries, and some product lines are concentrated in the mature U.S. market.


Medium/High: Demand can fluctuate quickly depending on commodity prices, and industry players often find themselves with too few (or too many) employees on the payroll.

Industry Stability Unstable: Market shares may shift frequently depending on technology offerings and demand levels.

Life Cycle Mature: Demand does fluctuate with energy prices, but normalized revenue growth is only mid-single digits.

Price Competition High: Price is a major factor in purchasers’ decisions. Some companies have modest pricing power because of a wide range of services or best-in-class technology, but primary customers (major oil companies) can usually substitute with in-house services if prices are too high. Also, innovation tends to diffuse quickly throughout the industry.


Not applicable.


Medium: Regulatory frameworks can affect energy demand at the margin. Also, governments play an important role in allocating exploration opportunities to E&P companies, which can indirectly affect the amount of work flowing down to service companies.


Medium/High: Industry is reasonably innovative, and players must re-invest in R&D to remain competitive. Temporary competitive advantages are possible via commercialization of new processes or exploitation of accumulated expertise.


Cyclical: Demand is highly variable and depends on oil prices, exploration budgets, and the economic cycle.

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Industry Analysis for Confections/Candy

Major Companies Cadbury, Hershey, Mars/Wrigley, Nestle Barriers to Entry/Success

Very High: Low financial or technological hurdles, but new players would lack the established brands that drive consumer purchase decisions.


Very Concentrated: Top four companies have a large proportion of global market share. Recent mergers have increased the level of concentration.


Not applicable: Pricing is driven primarily by brand strength. Manufacturing capacity has little effect.

Industry Stability Very Stable: Market shares change glacially. Life Cycle Very Mature: Growth is driven by population trends and pricing. Price Competition Low: A lack of private-label competition keeps pricing stable among

established players, and brand/familiarity plays a much larger role in consumer purchase decisions than price.


Not applicable.


Low: Industry is not regulated, but childhood obesity concerns in developed markets are a low-level potential threat. Also, high-growth emerging markets may block entry of established players into their markets, possibly limiting growth.


Very Low: Innovation does not play a major role in the industry.


Defensive: Demand for candy and gum is extremely stable.

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Porter: Competitive Strategy

Cost Leadership Differentiation

Cost Focus Differentiation Focus

Scop

eN

arro

w

B

road

Source of Competitive Advantage Cost Differentiation

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Company AnalysisProvide a company profile

Explain relevant industry characteristics

Analyze demand

Analyze supply and input costs

Explain the pricing environment

Present and interpret relevant financial ratios

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Decomposition of ROE (DuPont ratios)

Net Profit Margin

Asset Turnover

Financial Leverage ROE

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Spreadsheet Modeling

Expected

Optimistic

Pessimistic

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Summary• Uses of industry analysis• Industry classification systems• Establishing a peer group• Strategic analysis: Porter’s five forces• Industry and product life cycles• Demographic, governmental, social, and technological

influences• Company analysis• Cost and differentiation strategies• Spreadsheet modeling

mba 8480 - industry analysis

Economy & Finance