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CHAPTER 9 INTRODUCTION TO INDUSTRY AND COMPANY
ANALYSIS
PresenterVenueDate
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
Industry Classification
Products and/or
Services Supplied
Business-Cycle
Sensitivities
Statistical Similarities
CYCLICAL AND NONCYCLICAL COMPANIES
Profits strongly correlated with economic activity
Expensive, nonessential products
High operating leverage
CyclicalCompany
LIMITATIONS OF INDUSTRY AND COMPANY DESCRIPTORS
Growth Companies
Cyclical Industries
Defensive Industries
Growth Industries
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 GROUPExamine commercial classification systems
Review competitors’ annual reports
Compare business activities
EXHIBIT 9-2 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
STRATEGIC ANALYSIS: PORTER’S “FIVE FORCES” FRAMEWORK
Intensity of Rivalry
Bargaining Power of
Customers
Threat of New Entrants
Threat of Substitute Products
Bargaining Power of Suppliers
First focus for analysis
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
Sustainable Economic
Profits
Potential for Greater Pricing
Power
High Barriers to Entry
INDUSTRY CONCENTRATION
ABC Company
XYZ Company
MNO Company
What percentage of the market does each of the largest players have?
INDUSTRY CAPACITY
Tight or Limited Capacity Greater Pricing Power
MARKET SHARE STABILITY
Unstable Market Share
Limited Pricing Power
INDUSTRY LIFE CYCLE
Source: 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).
LIMITATIONS OF INDUSTRY LIFE-CYCLE ANALYSIS
Technological Changes
Regulatory Changes
Social Changes
Demographic Changes
PRICE COMPETITION
Price strongly affects
customer purchase decisions
Competition within the industry
MACROECONOMIC INFLUENCES ON INDUSTRY GROWTH, PROFITABILITY, AND RISK
Industry Growth, Profitability, and
Risk
Economic Growth
Interest Rates
Availability of Credit
Inflation
OTHER INFLUENCES ON INDUSTRY 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
INDUSTRY ANALYSIS FOR BRANDED PHARMACEUTICALS
Major 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.”
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.
Level of Concentration
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.
Impact of Industry Capacity
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.
Demographic Influences
Not applicable.
Government & Regulatory Influences
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.
Social Influences Not applicable. Technological Influences
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.
Growth vs. Defensive vs. Cyclical
Cyclical: Demand is highly variable and depends on oil prices, exploration budgets, and the economic cycle.
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.
Level of Concentration
Very Concentrated: Top four companies have a large proportion of global market share. Recent mergers have increased the level of concentration.
Impact of Industry Capacity
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.
Demographic Influences
Not applicable.
Government & Regulatory Influences
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.
Social Influences Not applicable. Technological Influences
Very Low: Innovation does not play a major role in the industry.
Growth vs. Defensive vs. Cyclical
Defensive: Demand for candy and gum is extremely stable.
PORTER: COMPETITIVE STRATEGY
Cost Leadership
Differentiation
Cost Focus Differentiation Focus
Sc
op
eN
arr
ow
Bro
ad
Source of Competitive Advantage Cost Differentiation
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
DECOMPOSITION OF ROE
Net Profit Margi
n
Asset Turno
ver
Financial
Leverage
ROE
SPREADSHEET MODELING
Expected
Optimistic
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
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