Purpose and Steps in Industry and Competitive Analysis

Recall that industry and competitive analysis is the second step in the company and industry analysis framework:

Decoding Industry Dynamics and Profitability

Industries are ecosystems of interrelated businesses, often sharing fundamental operational characteristics. Companies within an industry usually possess parallel business models and face analogous market challenges. They not only vie for market share in product sectors but also in sourcing raw materials, talent, and other essential factors. This shared competitive environment exposes them to common demand trends, supply chain complexities, and overarching risks.

Porter’s Five Forces model is a fundamental framework for grasping industry dynamics. It asserts that variations in profitability among industries stem from structural elements like the power of suppliers, the risk of new competitors entering the market, competitive intensity, the influence of buyers, and the potential for substitute products or services. While the broader industry context establishes a basic profitability course, factors specific to individual companies, such as innovative strategies, operational intricacies, company size, and management effectiveness, can lead to deviations from the industry average.

The Balancing Act: Industry Versus Company-specific Effects

The tug-of-war between industry and company-specific factors in shaping profitability has been the subject of extensive research. A seminal study by McGahan and Porter in 1997 highlighted this dynamic interplay. Their findings suggest that while the overarching industry environment is crucial in determining the sustainability of economic profits, the company-specific factors often wield a more potent influence, especially for companies that don’t rank at the top of their industry. Essentially, while industry dynamics can act as a cap on profitability, they don’t necessarily guarantee a minimum profitability threshold.

Competition as the Great Equalizer

In any industry, competition serves as a constant force, striving to push companies toward an industry’s average profitability. The more intense the competition, the stronger this push. For analysts, understanding this dynamic is crucial. It allows them to gauge the industry’s median profitability rate, anticipate possible structural shifts in the market, and determine where a specific company stands in relation to this established baseline. However, it’s paramount to recognize the fluid nature of these dynamics. While the majority of businesses may hover around the industry average, outliers like disruptors or laggards can significantly deviate due to their strategies and market execution.

Importance of Analyzing an Industry

1. Improve Forecasts

A comprehensive understanding of an industry necessitates a deep dive into the various competitive forces at play. This includes not only direct industry competitors but also potential threats from alternative products, the influence and bargaining power of suppliers, and the ever-evolving demands and preferences of consumers. By adopting a bird’s-eye view of the industry, analysts can demystify these dynamics. This typically involves meticulously documenting past competitive strategies, their implementation, subsequent market reactions, and the long-term outcomes of these strategic decisions.

An interesting revelation by Guan, Wong, and Zhang in 2014 showcased the nuanced layers of industry analysis. Their study found that analysts who broadened their horizons to include both companies and their suppliers in their evaluations showcased a markedly improved accuracy in predicting earnings.

2. Identify Investment Opportunities

Going beyond the obvious, conducting a thorough industry analysis can unveil hidden investment opportunities. Sometimes, an analyst may stumble upon a hidden gem – a company that industry giants previously overshadowed but, under closer scrutiny, demonstrates substantial strengths compared to its competitors. Additionally, for investors interested in the broader industry outlook rather than any particular company, the appeal might lie in the industry’s overall growth prospects. These investors, seeking diversification, could opt for a ‘basket approach,’ spreading their investments across a range of companies in the industry. They can adjust their stakes based on factors like company size, market liquidity, or perceived future potential.

Industry and Competitive Analysis Steps

Industry and competitive analysis are vital tools for businesses and investors, offering a deeper understanding of a company’s position within its industry and the competitive landscape. This analysis is generally approached in a structured manner, breaking down into specific steps to ensure a holistic understanding. Here are the key steps involved:

• Define Industry: Utilize third-party classification systems. Exercise judgment considering similar products, substitutes, multidivisional entities, and geographic locations.
• Industry Survey: Measure the industry’s size, growth rate, character, profitability, and market share trends.
• Industry Structure: Conduct Porter’s Five Forces analysis. Identify the most crucial elements and determine what needs continuous monitoring.
• External Influences (PESTLE Analysis): Examine the Political, Economic, Social, Technological, Legal, and Environmental (PESTLE) influences on the industry.
• Competitive Analysis: Evaluate the company’s competitive strategy within the industry context. Determine the competitive edge.