equity 6: Industry and Competitive Analysis

What is the purpose of industry and competitive analysis?

To study the drivers of an industry’s size, profitability, and market share, and evaluate a company’s competitive position within its industry.

Why do firms in the same industry tend to have similar risks and opportunities?

• share similar business models

• compete in the same product and factor markets

• similar supply, demand, and risk factors.

What does Porter’s industry structure suggest about profitability?

• Industry structure creates long-run differences in profitability across industries

• company-specific factors create variation within the industry.

What did McGahan and Porter (1997) find about profitability drivers?

• Industry effects are the most important factor in sustaining economic profits,

• company-specific effects are larger for low performers than high performers.

What does it mean that competition “pulls” profitability toward an industry base rate?

Over time, competitive forces drive firm returns toward a long-run industry average profitability level.

What are the main uses of industry and competitive analysis for forecasting?

• helps estimate industry base profitability,

• identify structural changes

• assess firm strengths and weaknesses relative to peers.

How does industry analysis improve earnings forecasts?

• belping analysts understand competitive forces (buyers, suppliers, substitutes, rivals),

• improving prediction accuracy

• avoiding overly firm-centric views.

Industry Analysis Process steps

1. Define the industry.

• Clarify boundaries and participants.

2. Collect industry data.

• Study size, growth, and profitability trends.

3. Analyze structure.

• Use frameworks such as Porter’s Five Forces.

4. Assess external factors.

• Include economic, political, and regulatory influences.

5. Evaluate competition.

• Compare firms and determine relative positioning.

what are porter’s 5 forces?

1. Competitive Rivalry

2. Threat of New Entrants

3. Bargaining Power of Buyers (Customers)

4. Bargaining Power of Suppliers

5. Threat of Substitutes

What are key challenges in defining an industry?

• Including substitutes,

• classifying multi-industry firms,

• geographical differences

• evolving business models.

Why are third-party industry classification systems used?

To standardize industry grouping because defining industries manually is complex and inconsistent.

What are examples of legacy industry classification systems and their limitations?

• SIC, NACE, and ISIC

• They are country-specific, infrequently updated, and based on production (“supply”) rather than products (“demand”).

what are the classification systems and their hierarchical structures

• GICS: sector, industry groups, industries, subindustries

• ICB: industries, supersectors, sectors, subsectors

• TRBC: economic sectors, business sectors, industry groups, industries, activities

How is a company classified in hierarchical systems?

It is assigned to a single lowest-level group, which determines all higher-level classifications.

limitations that make classifications difficult?

1. Groupings of companies with business model variations or that sell substitute products

2. The classification of multi-product companies

3. Geographical considerations

4. Changes in groupings over time that affect prior-period comparability of industry statistics

how are businesses classified

1. single line into that business

2. multi line - into the one with > 60% revenue

3. if none - then reduce to 50%

4. if none - then use judgement

three alternative methods for grouping companies

1. Geography

• Group by country or region.

• Based on incorporation, listing, or headquarters.

• Not usually based on revenue location.

2. Business Cycle Sensitivity

• Defensive vs cyclical grouping.

• Defensive: stable demand (e.g. utilities, healthcare).

• Cyclical: sensitive to economic growth (e.g. industrials).

3. Statistical Clustering

• Groups based on data similarity.

• Includes ratios, growth, returns, volatility, ESG metrics.

• These groups change frequently.

• They are less stable than industry classifications.

what sectors are typically defensive

• Health care

• Utilities

• Telecommunications

• Consumer staples

what sectors are typically cyclical

• Basic materials

• Consumer discretionary

• Energy

• Financials

• Industrials

• Technology

How is industry size typically measured?

By total annual sales from a product or customer perspective.

• Only relevant segment sales are included

3 estimation methosd for indsutry size

• Government statistics

• Third-party research firms

• Company disclosures and investor presentations

How is industry growth rate calculated?

• Using year-over-year growth rates

• or compounded annual growth rate (CAGR).

What defines a “growth industry”?

An industry not yet fully saturated, often driven by new technology or emerging demand.

key questions for growth industry

• Will growth continue?

• What is maximum market penetration?

What defines a “mature industry”?

An industry with fully penetrated markets and growth near economic growth or declining.

What risks are important in mature industries?

• Disruption

• Rising competition

• Industry decline

What factors affect industry cyclicality?

• Discretionary demand

• pricing power

• interest rates

• whether products are durable or consumable.

What is the best measure of industry profitability?

Distribution of ROIC (e.g., 25th, 50th, 75th percentiles).

Why is ROIC preferred over profit margins?

It is after-tax, accounts for invested capital, and is independent of capital structure.

Why is full ROIC data often unavailable?

because many firms are private or data is incomplete.

How is industry profitability estimated in practice?

• Use listed companies as a proxy

• Estimate private firm profitability

• Use government or consultancy data

What is more important than the level of industry profitability?

The trend (whether profitability is rising or falling).

market share formula

Market share = company revenue ÷ total industry sales.

What is the Herfindahl-Hirschman Index (HHI) and formula?

A measure of industry concentration calculated as the sum of squared market shares.

HHI = s₁² + s₂² + ... + sₙ²

External Influences on Industry (PESTLE)

1. Political

• Government policy, regulation, trade, taxation.

2. Economical

• GDP, inflation, interest rates, exchange rates.

3. Social

• Culture, demographics, lifestyle trends.

4. Technological

• Innovation and disruption.

5. Legal

• Law and regulation changes.

6. Environmental

• Climate change and sustainability pressures.

what are the three different strategies for competitive strategy and

1. how it works

2. what does it defend against

3. best industry conditions

4. main risks

Strategy	Cost Leadership	Differentiation	Focus
How it works	Lowest cost producer via scale, strict cost control, low prices	Unique products via branding, quality, innovation, service	Targets niche market with tailored offering
Defends Against	New entrants, customer bargaining power, rivalry	New entrants, substitutes, customer & supplier power	New entrants, substitutes, customer power in niche
Best Industry Conditions	Price-sensitive customers, little product differentiation, stable industry	Customers value uniqueness, innovation-heavy industries	Niche markets underserved by larger firms
Main Risks	Cost inflation, tech disruption, loss of cost advantage	Imitation, premium prices too high, customers stop valuing uniqueness	Large firms enter niche, niche demand changes, customers become less loyal