COURSE CONTENT

Methodology for industry analysis

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INDUSTRY ANALYSIS

Sources:
• CFA Institute curriculum
• Extracts from broker research and financial press
• Industry and sector classification data
• Author’s documentation

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COURSE CONTENT

1. Framework for industry analysis

2. Porter’s 5 forces

3. Industry concentration and capacity

4. Market share stability

5. Industry life cycle model

6. Other methods used for analysis

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 A Framework for Industry Analysis
Demographic Influences
(stage of business cycle, longer term growth, and structural economic trends)
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
Source: CFA Curriculum
Governmental Influences
Macroeconomic Influences
(regulatory, political, legal)
New Entrant Threats
Economic
Sector
Group of Complementary Industries
Industry
Customer Bargaining Forces
Internal Competitive Forces (affected by number of suppliers,
(affected by economies of scale, cost advantages, other number of purchasers, their
brand loyalty, customers’ switching costs, product size/power, switching costs to
government regulation, industry’s competitive structure, other suppliers, number of
corporate rivalries, cost conditions, entry and exit barriers) contracted suppliers, customers’
Life Cycle Analysis ability to produce the product
(embryonic, growth, shake-out, mature, declining) themselves)
Business Cycle Sensitivity
(cyclical: leading, lagging, coincident; defensive, growth)
Analysis by Position on the Experience Curve
Product / Service Substitution Threats
Social Influences
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FRAMEWORK FOR INDUSTRY ANALYSIS

• The framework is designed to help analysts to consider the range of forces

that may affect the evolution of an industry.
• The framework depicts how an industry is affected by the forces driving
industry competition (threat of new entrants, substitution threats, customer
and supplier bargaining forces), the competitive forces in the industry, life-
cycle issues, business-cycle considerations, and the position of the industry
on the experience curve.
• At macro level macroeconomic, demographic, governmental, social, and
technological influences are affecting the industry.

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COURSE CONTENT

1. Framework for industry analysis

2. Porter’s 5 forces
3. Industry concentration and capacity

4. Market share stability

5. Industry life cycle model

6. Other methods used for analysis

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PORTER FIVE FORCES

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PORTER FIVE FORCES

• Analysis of the competitive environment with an emphasis on the

implications of the environment for corporate strategy is known as strategic
analysis. Michael Porter’s “five forces” framework is the classic starting
point for strategic analysis.
• Porter focused on five determinants of the intensity of competition in an
industry:
- The threat of substitute products.
- The bargaining power of customers.
- The bargaining power of supplier.
- The threat of new entrants to the industry.
- The intensity of rivalry.

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PORTER FIVE FORCES – THREAT OF
SUBSTITUTE PRODUCTS

• The threat of substitute products, which can negatively affect demand if

customers choose other ways of satisfying their needs.
• Examples:
- Consumers may trade down from premium beers to discount brands
during recessions.
- Low-priced brands may be close substitutes for premium brands, which,
when consumer budgets are constrained, reduces the ability of premium
brands to maintain or increase prices.
- Healthy food can become a substitute for healthcare in the long-run (e.g.,
a reduce consumption of sugar will induce reduced diabetes treatments).
- Hotels and short-term rentals of home and apartments.

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THREAT OF SUBSTITUTE PRODUCTS

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PORTER FIVE FORCES – BARGAINING POWER
OF CUSTOMERS

• The bargaining power of customers, which can affect the intensity of

competition by exerting influence on suppliers regarding prices (and possibly
other factors, such as product quality).
• Example:
- Auto parts companies generally sell to a small number of auto
manufacturers, which allows those customers - the auto manufacturers - to
be tough negotiators when it comes to setting prices.

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PORTER FIVE FORCES – BARGAINING POWER
OF SUPPLIERS

• The bargaining power of suppliers, which may be able to raise prices or

restrict the supply of key inputs to a company.
• Examples:
- Workers at a heavily unionized company may have greater bargaining
power as suppliers of labor than workers at a comparable nonunionized
company.
- Suppliers of scarce or limited parts or elements or resources often possess
significant pricing power.
- In the airline industry, companies rely on limited number of input, i.e.,
airplane providers and fuel, two criteria which are not controllable by airline
companies.

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PORTER FIVE FORCES – THREAT OF NEW
ENTRANTS

• The threat of new entrants to the industry, which depends on barriers to entry,
or how difficult it would be for new competitors to enter the industry.

• Example:
- Industries that are easy to enter will generally be more competitive than
industries with high barriers to entry.

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PORTER FIVE FORCES – INTENSITY OF
RIVALRY

• The intensity of rivalry among incumbent companies (i.e., the current

companies in the industry), which is a function of the industry’s competitive
structure.
• Example: Industries that are fragmented among many small competitors:
- Have high fixed costs.
- Provide undifferentiated (commodity-like) products.
- Have high exit barriers usually experience more intense rivalry than
industries without these characteristics.

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COURSE CONTENT

1. Framework for industry analysis

2. Porter’s 5 forces

3. Industry concentration and capacity

4. Market share stability

5. Industry life cycle model

6. Other methods used for analysis

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INDUSTRY CONCENTRATION

• Industries that are concentrated among a relatively small number of players

often experience relatively less price competition.
• An analysis of industry concentration should start with market share:
- What percentage of the market does each of the largest players have?
- How large are those shares relative to each other / relative to the market?
• Fragmented industries tend to be highly price competitive:
- The large number of companies makes coordination difficult because there
are too many competitors for each industry member to monitor effectively.
- Each player has such a small piece of the market that even a small gain in
market share can make a meaningful difference.
- The large number of players encourages industry members to think of
themselves individualistically rather than as members of a larger group,
which can lead to fierce competitive behavior.

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INDUSTRY CONCENTRATION – EXAMPLES

Concentrated industry Fragmented industry

Soft drinks
Private banking
- Coca-Cola, PepsiCo
- Credit Suisse, Northern trust
Strong Biotech
Asset management
pricing - Amgen, Genzyme
- Blackrock, Fidelity
power Futures exchanges
Propane distribution
- Chicago Mercantile Exchange,
- AmeriGas, FerrellGas
Intercontinental Exchange

Commercial aircraft Retail

- Boeing, Airbus - Walmart, Carrefour
Weak
Printers Consumer packaged goods
pricing
- HP, Lexmark - Protect & Gamble, Unilever
power
Equity exchanges Life insurance
- NYSE, Deutsche Börse, SIX - Axa, MetLife, Prudential

Source: CFA Curriculum

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INDUSTRY CAPACITY

• The effect on pricing of industry capacity (i.e., the maximum amount of a

good or service that can be supplied in a given time period) is usually clear:
- Tight, or limited capacity gives participants more pricing power as
demand for the product or service exceeds supply
- Overcapacity leads to price cutting and a very competitive environment as
excess supply chases demand.
• Analysts should think about not only current capacity conditions but also future
changes in capacity levels:
- How quickly can companies in the industry adjust to fluctuations in
demand?
- How flexible is the industry in bringing supply and demand into balance?
- What will be the effect of that process on industry pricing power or on
industry margins?

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COURSE CONTENT

1. Framework for industry analysis

2. Porter’s 5 forces

3. Industry concentration and capacity

4. Market share stability

5. Industry life cycle model

6. Other methods used for analysis

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MARKET SHARE STABILITY

• Examining the stability of industry market shares over time is similar to

thinking about barriers to entry and the frequency with which new players
enter an industry.
• Barriers to entry and the frequency of new product introductions, together
with such factors as product differentiation, all affect market shares.
- Stable market shares typically indicate less competitive industries.
- Unstable market shares often indicate highly competitive industries that
have limited pricing power.

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MARKET SHARE STABILITY – EXAMPLE

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MARKET SHARE STABILITY – EXAMPLE

Author’s note: merger between Zimmer and Biomet in 2014

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COURSE CONTENT

1. Framework for industry analysis

2. Porter’s 5 forces

3. Industry concentration and capacity

4. Market share stability

5. Industry life cycle model

6. Other methods used for analysis

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 Source: Based on Figure 2.4 in Hill and

INDUSTRY LIFE CYCLE MODEL

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

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EMBRYONIC

Embryonic: an embryonic industry is one that is just beginning to develop.

• Characteristics of the embryonic stage include slow growth and high prices
because customers tend to be unfamiliar with the industry’s product and
volumes are not yet sufficient to achieve meaningful economies of scale.
• Increasing product awareness and developing distribution channels are
key strategic initiatives of companies during this stage.
• Substantial investment is generally required, and the risk of failure is high.

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GROWTH

Growth: a growth industry tends to be characterized by rapidly increasing

demand, improving profitability, falling prices, and relatively low competition
among companies in the industry.
• Demand is fueled by new customers entering the market, and prices fall as
economies of scale are achieved and as distribution channels develop.
• The threat of new competitors entering the industry is usually highest during
the growth stage, when barriers to entry are relatively low.
• Competition tends to be relatively limited because rapidly expanding
demand provides companies with an opportunity to grow without needing to
capture market share from competitors.
• Industry profitability improves as volumes rise and economies of scale are
attained.

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SHAKEOUT

Shakeout: the shakeout stage is usually characterized by slowing growth,

intense competition, and declining profitability.
• During the shakeout stage, demand approaches market saturation levels
because few new customers are left to enter the market.
• Competition is intense as growth becomes increasingly dependent on market
share gains.
• Excess industry capacity begins to develop as the rate at which companies
continue to invest exceeds the overall growth of industry demand.
• In an effort to boost volumes to fill excess capacity, companies often cut
prices, so industry profitability begins to decline.
• Companies increasingly focus on reducing their cost structure (restructuring)
and building brand loyalty.
• Marginal companies may fail or merge with others.

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MATURE

Mature: characteristics of a mature industry include little or no growth, industry

consolidation, and relatively high barriers to entry.
• Industry growth tends to be limited to replacement demand and population
expansion because the market at this stage is completely saturated.
• Mature industries often consolidate and become oligopolies.
• The surviving companies tend to have brand loyalty and relatively efficient
cost structures, both of which are significant barriers to entry.
• During periods of stable demand, companies in mature industries tend to
recognize their interdependence and try to avoid price wars. Periodic price
wars do occur, however, most notably during periods of declining demand
(such as during economic downturns).
• Companies with superior products or services are likely to gain market
share and experience above-industry-average growth and profitability.

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DECLINE

Decline: during the decline stage, industry growth turns negative, excess
capacity develops, and competition increases.
• Industry demand at this stage may decline for a variety of reasons, including
technological substitution.
• As demand falls, excess capacity in the industry forms and companies respond
by cutting prices, which often leads to price wars.
• At this point, the weaker companies often exit the industry, merge, or
redeploy capital into different products and services.

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INDUSTRY LIFE-CYCLE MODEL – EXAMPLE

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INDUSTRY LIFE-CYCLE MODEL – EXAMPLE

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INDUSTRY LIFE-CYCLE MODEL – EXAMPLE

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COURSE CONTENT

1. Framework for industry analysis

2. Porter’s 5 forces

3. Industry concentration and capacity

4. Market share stability

5. Industry life cycle model

6. Other methods used for analysis

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OTHER RELEVANT METHODS FOR INDUSTRY
ANALYSIS - SWOT

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OTHER RELEVANT METHODS FOR INDUSTRY
ANALYSIS

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OTHER RELEVANT METHODS FOR INDUSTRY
ANALYSIS

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OTHER RELEVANT METHODS FOR INDUSTRY
ANALYSIS – BROAD FACTOR ANALYSIS

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OTHER RELEVANT METHODS FOR INDUSTRY
ANALYSIS – PESTLE

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