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MBA 8480 - Industry Analysis

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MBA 8480 - Industry Analysis

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MBA 8480 - Industry Analysis

  1. 1. Industry Analysis* Professor Mike Pagano michael.pagano@villanova.edu * - These slides are adapted / excerpted from some of the CFA Institute’s material on this topic.1
  2. 2. Uses of Industry Analysis Understanding a company’s business and business environment Identifying active equity investment opportunities Portfolio performance attribution 2
  3. 3. Approaches to Identifying Similar Companies Industry Classification Products and/or Services Supplied Business-Cycle Sensitivities Statistical Similarities 3
  4. 4. Cyclical and Noncyclical Companies Profits strongly correlated with economic activity Expensive or non-essential products (discretionary or ‘luxury’) High operating leverage Cyclical Company 4
  5. 5. Limitations of Industry and Company Descriptors Growth Companies Cyclical Industries Defensive Industries Growth Industries 5
  6. 6. Commercial Industry Classification Systems Global Industry Classification Standard (GICS) Russell Global Sectors (RGS) Industry Classification Benchmark (ICB) 6
  7. 7. 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) 7
  8. 8. Representative Industry Sectors Basic Materials and Processing Consumer Discretionary Energy Financial Services Industrial/Producer Durables Technology Telecommunications Utilities 8
  9. 9. Constructing a Peer Group Examine commercial classification systems Review company’s annual report Review competitors’ annual reports Review industry trade publications Compare business activities 9
  10. 10. 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 10
  11. 11. 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 11
  12. 12. 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? 12
  13. 13. Barriers to Entry Sustainable Economic Profits Potential for Greater Pricing Power High Barriers to Entry 13
  14. 14. Industry Concentration ABC Company XYZ Company MNO Company What percentage of the market does each of the largest players have? 14
  15. 15. Industry Capacity Tight or Limited Capacity Demand Exceeds Supply Greater Pricing Power 15
  16. 16. Market Share Stability Unstable Market Share Limited Pricing Power 16
  17. 17. 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). 17
  18. 18. Limitations of Industry Life-Cycle Analysis Technological Changes Regulatory Changes Social Changes Demographic Changes 18
  19. 19. Price Competition Price strongly affects customer purchase decisions Competition within the industry 19
  20. 20. Macroeconomic Influences on Industry Growth, Profitability, and Risk Industry Growth, Profitability, and Risk Economic Growth Interest Rates Availability of Credit Inflation 20
  21. 21. 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 21
  22. 22. 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.” 22
  23. 23. Industry Analysis for Oil Services Major 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. 23
  24. 24. 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. 24
  25. 25. Porter: Competitive Strategy Cost Leadership Differentiation Cost Focus Differentiation Focus Scope NarrowBroad Source of Competitive Advantage Cost Differentiation 25
  26. 26. 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 26
  27. 27. Decomposition of ROE (DuPont ratios) Net Profit Margin Asset Turnover Financial Leverage ROE 27
  28. 28. Spreadsheet Modeling Expected Optimistic Pessimistic 28
  29. 29. 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 29

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