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CHAPTER 9

INTRODUCTION TO INDUSTRY AND


COMPANY ANALYSIS
Presenter
Venue
Date
USES OF INDUSTRY ANALYSIS

Understanding a
company’s business and
business environment

Identifying active equity


investment opportunities

Portfolio performance
attribution
APPROACHES TO IDENTIFYING SIMILAR
COMPANIES
Business-
Cycle
Sensitivities
Products
and/or Statistical
Services Similarities
Supplied

Industry
Classification
CYCLICAL AND NONCYCLICAL
COMPANIES

Cyclical
Company
High
operating
leverage
Expensive,
nonessential
products
Profits
strongly
correlated
with
economic
activity
LIMITATIONS OF INDUSTRY AND COMPANY
DESCRIPTORS

Defensive
Industries
Cyclical Growth
Industries Industries

Growth
Companies
COMMERCIAL INDUSTRY
CLASSIFICATION SYSTEMS

Global Industry
Classification Standard
(GICS)

Russell Global Sectors


(RGS)

Industry Classification
Benchmark (ICB)
REPRESENTATIVE INDUSTRY SECTORS
Basic Materials and Processing

Consumer Discretionary

Energy

Financial Services

Industrial/Producer Durables

Technology

Telecommunications

Utilities
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)
CONSTRUCTING A PEER GROUP
Examine commercial classification
systems

Review company’s annual report

Review competitors’ annual reports

Review industry trade publications

Compare business activities


EXHIBIT 9-2 FRAMEWORK FOR INDUSTRY
ANALYSIS
A Framework for Industry Analysis
Governmental Influences
Demographic Influences Macroeconomic Influences
(regulatory, political, legal)
(stage of business cycle, longer term growth, and structural economic trends)

New Entrant Threats

Economic
Sector
Group of Complementary Industries
Industry
Supplier Bargaining Forces Customer Bargaining Forces
(affected by number of industries Internal Competitive Forces (affected by number of suppliers,
buying suppliers’ products, of (affected by economies of scale, cost advantages, other number of purchasers, their
supply substitutes, switching brand loyalty, customers’ switching costs, product size/power, switching costs to
costs of suppliers’ customers, government regulation, industry’s competitive structure, other suppliers, number of
industry, and customers’ ability corporate rivalries, cost conditions, entry and exit barriers) contracted suppliers, customers’
to enter industry.) 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

Technological Influences Social Influences


STRATEGIC ANALYSIS: PORTER’S “FIVE
FORCES” FRAMEWORK
Threat of New Entrants
First focus
for analysis

Bargaining Bargaining
Power of Intensity Power of
Suppliers of Rivalry Customers

Threat of Substitute
Products
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?
BARRIERS TO ENTRY

Potential for Sustainable


High Barriers
Greater Economic
to Entry
Pricing Power Profits
INDUSTRY CONCENTRATION
What percentage of
the market does
each of the largest
players have?
ABC
MNO Company
Company

XYZ
Company
INDUSTRY CAPACITY

Tight or Greater
Limited Pricing
Capacity Power

Demand
Exceeds
Supply
MARKET SHARE STABILITY

Unstable
Market
Share

Limited
Pricing
Power
Source: Based on Figure 2.4 in Hill and

INDUSTRY LIFE CYCLE

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


Source: Based on Figure 2.4 in Hill and Jones (2008).
LIMITATIONS OF INDUSTRY LIFE-CYCLE
ANALYSIS

Technological
Changes

Demographic Regulatory
Changes Changes

Social
Changes
PRICE COMPETITION

Price strongly
affects Competition
customer within the
purchase industry
decisions
MACROECONOMIC INFLUENCES ON INDUSTRY
GROWTH, PROFITABILITY, AND RISK

Availability of
Interest Rates
Credit

Economic
Inflation
Growth Industry
Growth,
Profitability,
and Risk
OTHER INFLUENCES ON INDUSTRY GROWTH,
PROFITABILITY, AND RISK
Examples of • Invention of the microchip
Technological
• Digital imaging
Influences
Examples of • Baby Boomer generation
Demographic
• Aging populations
Influences
Examples of • Tax policies and government spending
Governmental
• Regulation
Influences

Examples of Social • Changes in tobacco consumption


Influences • Women in the workforce
INDUSTRY ANALYSIS FOR BRANDED
PHARMACEUTICALS
Major Companies Pfizer, Novartis, Merck, GlaxoSmithKline
Barriers to Very High: Substantial financial and intellectual capital required to compete
Entry/Success 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 Concentrated: A small number of companies control the bulk of the global
Concentration market for branded drugs. Recent mergers have increased the level of
concentration.
Impact of Industry Not applicable: Pharmaceutical pricing is primarily determined by patent
Capacity 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 Positive: Populations of developed markets are aging, which slightly increases
Influences demand.
Government & Very High: All drugs must be approved for sale by national safety regulators.
Regulatory Patent regimes may differ among countries. Also, health care is heavily
Influences regulated in most countries.
Social Influences Not applicable.
Technological Medium/High: Biologic (large-molecule) drugs are pushing new therapeutic
Influences boundaries, and many large pharmaceutical companies have a relatively small
presence in biotech.
Growth vs. Defensive: Demand for most health care services does not fluctuate with the
Defensive vs. economic cycle, but demand is not strong enough to be considered “growth.”
Cyclical
INDUSTRY ANALYSIS FOR OIL SERVICES
Major Companies Schlumberger, Baker Hughes, Halliburton
Barriers to Medium: Technological expertise is required, but a high level of innovation
Entry/Success allows niche companies to enter the industry and compete in specific areas.
Level of Fragmented: Although only a small number of companies provide a full range of
Concentration 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.
Impact of Industry Medium/High: Demand can fluctuate quickly depending on commodity prices,
Capacity 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.
Demographic Not applicable.
Influences
Government & Medium: Regulatory frameworks can affect energy demand at the margin. Also,
Regulatory governments play an important role in allocating exploration opportunities to E&P
Influences companies, which can indirectly affect the amount of work flowing down to
service companies.
Social Influences Not applicable.
Technological Medium/High: Industry is reasonably innovative, and players must re-invest in
Influences R&D to remain competitive. Temporary competitive advantages are possible via
commercialization of new processes or exploitation of accumulated expertise.
Growth vs. Cyclical: Demand is highly variable and depends on oil prices, exploration
Defensive vs. budgets, and the economic cycle.
Cyclical
INDUSTRY ANALYSIS FOR
CONFECTIONS/CANDY

Major Companies Cadbury, Hershey, Mars/Wrigley, Nestle


Barriers to Very High: Low financial or technological hurdles, but new players would lack
Entry/Success the established brands that drive consumer purchase decisions.
Level of Very Concentrated: Top four companies have a large proportion of global
Concentration market share. Recent mergers have increased the level of concentration.
Impact of Industry Not applicable: Pricing is driven primarily by brand strength. Manufacturing
Capacity 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.
Demographic Not applicable.
Influences
Government & Low: Industry is not regulated, but childhood obesity concerns in developed
Regulatory markets are a low-level potential threat. Also, high-growth emerging markets
Influences may block entry of established players into their markets, possibly limiting
growth.
Social Influences Not applicable.
Technological Very Low: Innovation does not play a major role in the industry.
Influences
Growth vs. Defensive: Demand for candy and gum is extremely stable.
Defensive vs.
Cyclical
PORTER: COMPETITIVE STRATEGY
Source of Competitive Advantage
Cost Differentiation

Cost
Broad

Differentiation
Leadership
Scope
Narrow

Differentiation
Cost Focus Focus
COMPANY ANALYSIS
Provide a company profile

Explain relevant industry characteristics

Analyze demand

Analyze supply and input costs

Explain the pricing environment

Present and interpret relevant financial ratios


DECOMPOSITION OF ROE

Net
Asset Financial
Profit Leverage ROE
Turnover
Margin
SPREADSHEET MODELING

Optimistic

Expected

Pessimistic
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