LEARNING OBJECTIVES:
After studying this chapter, you should know about:
Role of industry analysis in fundamental analysis
Challenges in defining an industry
Industry cyclicality, market sizing and trend analysis
Secular trends, value migration and business life cycle
Various industry analysis framework such as Porter’s Five Force Model, PESTLE
analysis, BCG analysis and SCP analysis
Key Industry specific drives and industry KPIs
Regulatory Framework including taxation
6.1Role of industry analysis in fundamental analysis
Economic analysis helps us understand whether business, in general, is likely to grow in the
foreseeable future or decline. Industry analysis helps in understanding how each industry
would be impacted under the current economic conditions.
In Industry analysis, analysts also try to understand how the various players in the market
(industry) are likely to react and how that may affect the prospect of the industry.
The various questions that have to be addressed in industry analysis include the following:
(i) What is the industry in which the company operates?
(ii) How much does it get impacted on account of cyclical trends in the economy?
(iii) What is the potential industry size?
(iv) How has the industry been performing in the past and what were the drivers behind
the performance?
(v) What is the level of competition in the industry? How does it affect the pricing
power of the various players?
(vi) What are the various secular trends that affect the industry, and are they causing
any value migration?
(vii) Are there any regulatory headwinds or tail winds affecting the industry?
6.2Defining the industry
The very first step in an industry analysis is to define the industry in which the company
operates. Industry definition is not always an easy task. While there are several standard
industry classification systems, such as National Industry Classification (NIC) system in India or
North American Industry Classification System (NAICS) in US, they may not necessarily capture
the substance of the industry
For instance, NIC has a single classification for manufacture of passenger cars. Thus, every car
manufacturer including entry level compact car manufacturers and high-end luxury car
manufacturers fall under the same industry classification. However, since the dynamics of the
luxury car manufacturer is very different from entry level passenger car segment, analysts may
view them as different industries. The challenge especially increases when a company
competes in many industries to earn its income.
Let us take the example of PVR Limited. On one hand, PVR Cinemas competes with satellite
channels and Over the Top (OTT) platforms, such as Netflix and Hotstar, to attract audience. On
the other hand, the cinema industry also competes with live theatres, live performances, and
sporting leagues.
Thus, if an analyst applies a narrow industry definition and classifies the company as part of
cinema exhibitors, it creates a risk of overlooking other competitors. But if one were to give
broader definition, then challenge is to identify whether to classify the company as part of
entertainment media industry or should it be classified as part of Out of Home (OOH)
entertainment industry. This may force the analyst to classify it as part of a much broader
media and entertainment industry. But that would create another challenge as each segment
within this broader group have their own idiosyncrasies and not strictly comparable.
Camera manufacturing is another example that shows the challenges in defining an industry.
Couple of decades ago, cameras were a standalone product. However, with the emergence of
mobile phones with built-in cameras, a lot of entry level digital cameras started losing their
sales to these phones. Today, with emergence of high technology mobile phones, even mid-tier
cameras are facing competition from mobile phones. If cameras are defined as a standalone
industry, then an analyst may end up ignoring this huge competition from mobile phones.
An analyst should carefully consider the various factors that drive the business and should
classify it as part of the industry group which have such common driving factors. Thus, if an
analyst believes that PVR Limited’s business is driven by people’s propensity to spend time
outside their home, it may be appropriate to classify it as part of out of home entertainment
industry. On the other hand, if the business is largely driven by people’s propensity to consume
movie content, then it may be appropriate to classify it as part of entertainment media.
6.3Understanding industry cyclicality
Economic cycles affect all businesses. However, they affect some businesses more than others.
Based on the cyclical nature, industries can be classified into three categories:
Defensive industries: These are industries that create products and services that have low
income elasticity i.e., a fall or rise in income does not affect the demand significantly.
Therefore, these industries experience minimal impact on account of economic cycles. Rather,
their business prospects are affected only by secular trends. Food, agricultural inputs, and
healthcare are some of the industries that have exhibited these traits in the past.
Semi-cyclical industries: These industries experience growth in sales during the expansionary
phase and decline during recessionary phase. However, these industries do have some base
level demand which help the industry to have reasonably healthy sales in recessionary
conditions also. Consumer durables industry has exhibited these traits.
Deep cyclical industries: These industries witness extreme cyclicality in their revenues as they
are largely driven by economic cycle and/or commodity cycles. Capital goods industry exhibits
such behavior. During recessionary conditions, their sales drop significantly as most companies
put their capacity expansion plans on hold. However, these industries experience massive
growth at the first signs of economic recovery as pent up demand result in higher orders.
6.4Market sizing and trend analysis
Industries that are underpenetrated have high growth potential as there is more headroom for
growth. However, as industries mature, the new growth avenues decline and the overall
growth rates, thus, come down. Therefore, while studying industry, it is important to analyze
the potential size of the market and current size of the market.
However, measuring the current market size is difficult especially if there are many unorganized
players or private companies whose information is not available in public domain. Further,
quantifying the potential size of the market also involves making lot of assumptions, which can
go wrong.
Therefore, studying the past trends can supplement our analysis and help us understand how
the industry has been growing and what are the factors that are affecting growth. Such studies
also help us understand the underlying secular trends.
Market sizing can be done through either top-down approach or bottom-up approach. In a topdown approach, we measure the size of the market or industry starting from macro-economic
factors and arrive up to the industry level. In bottom-up approach, we quantify the market by
looking at individual companies and aggregating their data to arrive at the industry size.
For example, if we were to quantify the total industry size for a particular therapy, we can use
the top-down approach as follows: (i) identify how many patients underwent the therapy (ii)
ascertain average expenditure per patient (iii) take the product of (i) and (ii) to arrive at the
revenue.
From a bottom-up perspective, we can look at revenue of all the hospitals that provide this
therapy and identify how much (or what proportion) of their revenue was earned from this
particular therapy. We can then aggregate it to arrive at industry size.
As mentioned above, market sizing may involve making certain assumptions, as all the required
information may not be available.
6.5Secular trends, value migration and business life cycle
As discussed earlier, secular trends are long term trends that cause displacement in production
or consumption of goods and services. There are various factors that drive secular trends:
(i) Technological advancement: New technology can cause disruption in many ways. It
can bring in new methodology in production of goods. It can provide alternative to
an existing product or can create new consumption pattern. The following are some
of the examples of secular trends caused by technology:
a. Horizontal drilling technology enabled exploration of shale gas. This resulted in
significant decline in long term average price of hydrocarbons.
b. Digital cameras made film rolls obsolete; mobile cameras made entry level digital
cameras obsolete.
c. Improvement in battery technology is enabling increased use of electric vehicles
compared to fossil fuel driven vehicles.
(ii) Change in income levels: As an economy grows, the disposable income of population
is likely to increase. This can cause change in category of goods and services being
consumed. People start consuming premium products compared to cheaper
alternatives.
(iii) Demographic changes: The composition of a country’s population in terms of age,
gender and ethnicity may undergo change over a period. This may cause changes in
the consumption pattern within the country. For example, ageing population in
Japan has resulted in decrease in per capita consumption of beer.
(iv) Change in culture, and tastes and preferences: Cultural changes are a constant. Most
often, they are gradual. However, sometimes changes can also be sudden driven by
revolution, insurgencies, or a societal response to a pandemic. These changes can
cause a change in consumption pattern of goods and services. For example,
increasing influence of western culture in Asian societies created higher demand for
western clothing.
(v) Changes in regulation or government policy: Change in regulations, or government
actions may also create secular trends in industry. For instance, implementation of
GST created certain efficiencies in the logistic industry. It in turn reduced the
demand for purchase of new commercial vehicles.
In addition to the above, many other factors may also serve as a catalyst for a secular trend.
When a new secular trend emerges, it causes value migration between industries or between
players. And often it also creates an inflection point in the business cycle of one or more
affected industries.
6.5.1 Value Migration
In simple terms, value migration happens when a phenomenon creates long term advantage for
one or more entities at the cost of other entities. Thus, the entity that gains witnesses an
increase in its shareholder value, while the other entity loses.
Such a shift can happen across geographies, across industries, across the value chain and to a
lesser extent between competitors within the industry.
Geographic migration: Geographic migration of value happens when a secular trend helps a
country or geography as compared to other. For instance, horizontal drilling and shale gas
discovery shifted value to US based oil exploration at the cost of other oil producing countries
as US had large amount of shale gas reserve and were able to extract them at a lower cost
compared to other oil producing nation. Similarly, globalization helped low cost manufacturer
such as China to rapidly grow its economy as compared to many other high cost destinations.
Cross industry migration: Cross industry migration happens when one industry gains at the cost
of another. For example, advent of digital cameras resulted in massive decline of film rolls
industry and saw big companies like Kodak having to shut down.
Migration across value chain: Some phenomenon can result in industries at the down end of
value chain gain at the cost of those at the upper end or vice versa. For example, high
competition intensity in the Indian telecommunication space resulted in significant fall in price
of mobile services, which in turn led to significant decline in shareholder value for telecom
companies. However, this resulted in increased consumption of digital products and thus more
traction for digital content providers.
Migration across companies in the same industry: Certain disruption may create new
competitive advantage for one company or may remove a competitive advantage enjoyed by
an existing player. This may result is value migrating from one company to another. For
example, before advent of 2G technology, Research in Motion (Blackberry) enjoyed significant
competitive advantage among corporate mobile users. Its mobile devices were the most
efficient in accessing emails and other internet services. However, with the advent of 2G
Technology many new smartphone manufacturers emerged. They were able to provide similar
service. This eventually led to decline in shareholder value for Blackberry while its competitors
such as Apple saw the value increasing.
Understanding and pre-empting value migration can help analysts identify suitable investment
opportunities ahead of time and to exit from the loosing businesses.
6.5.2 Business life cycle
Business life cycle refers to the various stages through which a business transitions through its
journey from its emergence till its eventual decline.
Every industry typically goes through the following phases:
a) Pioneering stage: The industry is just taking shape. It is not widely adopted. The concept
is still being proven or just been proven.
b) Growth stage: The concept is found viable and many customers start adopting the new
product. As more and more customers adopt the product, the industry witness steep
growth.
c) Matured stage: The industry has existed for long and most customers who can use the
product are already using it. Number of new (potential) customers are relatively less.
d) Declining stage: Change in customer preference or a new technology replaces the
industry’s product with a new product. At this juncture, the industry starts losing out to
the alternatives.
e) Reinvention and revival: Although it is very rare, it is possible that the goods or services
produced by the industry finds a new use in a different application and starts a new
cycle all over again.
In the Indian context, call taxis can be looked at one example of an industry that has gone
through all the phases over a period.
Call taxis in India started taking shape during the end of 20th century and early parts of 21st
century. Aided by increased penetration of telephones and growing consumer income, call
taxi services witnessed tremendous growth over the next decade. However, with the advent
of app-based taxi aggregators, the industry declined significantly in size.
Every industry goes through the cycle and in turn causes significant displacement in the
economy. The labor force working in one industry will have to reskill themselves and move
to a new industry or find themselves out of workforce. Similarly, capacity will need to be
redirected to a different use.
Although secular trends can be traced to business lifecycles, there are other disruptors that
can affect the secular trend. For example, horizontal drilling technology enabled exploration
of shale gas which brought a long-term decline in crude oil prices without causing any
displacement of the goods being consumed.
Analyzing and understanding secular trends help the analyst understand the long-term
trajectory of the business.
However, in order to understand the medium term and short-term trends, analyst will have
to focus on cyclical trends.
6.6Understanding the industry landscape
Industry landscaping involves studying all the players in the industry and their interaction with
each other. This includes understanding competitors, customers, suppliers, regulators, and
emerging technologies. It also involves studying the differentiating factors between various
competitors and customer’s preference.
Such a study will help the analyst understand how the industry may react to external market
events. For example, in industries with low competition intensity, companies are likely to be
able to transfer any increase in input cost to their customers. Thus, their profit margin is likely
to remain intact. On the other hand, if the competition intensity is high, it may create pricing
pressure which will likely reduce the profits.
Industry landscaping needs to be very comprehensive. While analysts can use their own
frameworks, there are certain established frameworks that can help understand the industry
landscape. These include the following:
(i) Michael Porter’s Five Force Model
(ii) PESTLE analysis
(iii) BCG Matrix
(iv) SCP analysis
6.6.1 Michael Porter’s Five Force Model for Industry Analysis
Analyzing any industry requires looking at it from various angles and finally reaching to a
conclusion about its attractiveness as an investment proposition. Market participants use
different methods to make this analysis. Among the many methods used for doing such an
analysis is the popular Porter’s 5 Forces model developed by Dr. Michael Porter in 1979.
As the name suggests, this model analyses any industry on the basis of five broad parameters or
forces. These 5 forces are divided into 2 vertical and 3 horizontal ones, as listed below:
Horizontal Forces:
1. Threat of Substitutes
2. Threat of New Entrants
3. Threat of Established Rivals
Vertical Forces:
1. Bargaining Power of Suppliers
2. Bargaining Power of Customers
The below picture captures the essence of Porter’s Five Forces Model:
Some industries have structure wherein these forces make it very difficult for the businesses to
earn significant profits for the owners. For example, either or all or a combination of some of
these forces in industries like aviation, telecom, retail, textile, sugar, power, etc. end up keeping
profits low for companies in these sectors. Such sectors are termed as unattractive ones by the
model from owners’ perspective. On the other hand, industries like Education, FMCG,
Healthcare and IT enjoy huge margins over long periods of time as the forces are not so strong
there. Such sectors are termed as attractive by the model for shareholders.
Two of Warren Buffet’s quotes in the context of industry structure are pertinent here:
When a management with a reputation for brilliance tackles a business with a reputation
for bad economics, it is the reputation of the business that remains intact.
2. Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is
likely to be more productive than energy devoted to patching leaks.
Mr. Buffet, through these two quotes, is clearly indicating that if economics of business is bad, a
great management may not be able to bring anything substantial and an investor would be
better off shifting his investments to different industry.
Now, let us look at each of these five forces of Dr. Porter’s model in detail:
6.6.1.1 Industry Rivalry
An industry where rivalry is high, like the aviation and telecom space, the end result will be
lower pricing power and lower incomes for the industry participants. Innovation in products
and customer service and engagement initiatives become essential in such an industry. A strong
competitor with deep pockets can easily adopt the tactics such as continuously dumping
products/services at prices lower than the cost to drive others out of the industry. Not
everyone can sustain losses for long period. Intensity of rivalry can be understood from
following simple industry characteristics. It would be high if:
1. Many companies exist in the business segment
2. Similar products/services being offered by participants with little or no differentiation
3. Every industry participant tries to attract customers with similar strategies – lower prices or
longer credits
4. Switching cost for customers from one product/service to another is low or nil
If industry rivalry is strong, businesses in the industry will go through frequent phases of low
revenues and profitability. The telecom industry in India is a case to point where a number of
players in each telecom circle try to garner market share by offering competitive plans. The high
pre-paid component in the revenue of all telecom players means that the price sensitive
subscribers would easily migrate to lower priced offerings of competitors. It is relevant to quote
Mr. Charlie Munger, partner at Berkshire Hathaway here “If only basis of competition in an
industry is pricing, it is a self-defeating business.”
So, how can a company, in a competition intensive industry still deliver good returns to its
shareholders? Answer lies in aggressive innovation internally as well as externally. Better and
efficient operations resulting in lesser working capital requirement, faster turnaround times,
lesser cost of capital are some of the things which the company has to do internally. On the
external side, launching differentiating products, creating and nurturing strong brands,
positioning its products/ services uniquely are what the company can do to break-out of the
clutter. For example, Micromax, a cellular device company in India, managed to garner a 10%
market share in just three years of launch by focusing on special features at competitive prices.
6.6.1.2 Threat of Substitutes
Industries go through significant changes from time to time. Telegram does not exist anymore
as Short Messaging Service (SMS) emerged as cheaper and easier alternative with significant
accessibility. Cement pipes industry lost its relevance to steel and plastic pipes. Typewriters got
substituted by computers totally. IPods, mobiles etc. have rendered radio and two-in-ones a
thing of the past. The most famous example is of the how digital photography completely
destroyed the film-based model followed by Kodak. While first digital camera was invented by
Kodak engineers, to protect their existing business, the company did not move to that. As
innovations happen, existing products become irrelevant. This is called threat of substitutes.
The ability of an industry and company to foresee changes and to adapt to them early, will
define their success. Unfortunately, Kodak did not see the threat, and subsequently filed for
bankruptcy.
Some industries are not able to face the threat of substitutes and fail, while others reinvent
themselves to stay relevant. Also, some industries do not have threat of substitutes at all. For
example, power, healthcare, education etc. There could be different modes of servicing
customers at different times but these products/services will never be out of business.
Threat of substitutes can be understood from following two simple industry characteristics. It
would be high if:
1. Substitutes offer equal or better experience to customers – quality, price, ease etc.
2. Switching cost for customers from one product/service to another is low or nil
Sometimes, substitutes may take long time to replace the existing businesses. For example,
solar products, while are cheaper at operating level, need capex to begin with and that
becomes deterrent for customers. So is the case with LED lights. As technology evolves and new
products become cheaper, more and more customers shift to them posing higher threat to the
existence of traditional businesses.
6.6.1.3 Bargaining Power of Buyers
Buyers can exert a lot of pressure and dictate prices, if there are a large number of sellers with
similar products/services. On the contrary, they may not be such a big influencer in case there
are few sellers for a product/service. In nutshell, it is the function of number of buyers and
sellers and differentiation in their products/services, which may determine buyers’ bargaining
power in an industry. The size and profile of the buyer, for example, the government as a buyer
of the product or service, can influence the bargaining power they have.
Buyers’ bargaining power can be understood from following simple industry characteristics. It
would be high if:
1. Competitive intensity in the industry is strong (continuous pricing pressure would exist on
industry participants).
2. Products/Services are standardized with little or no differentiation.
3. Close substitutes of the products/services exist and switching cost for customers is low or
nil.
6.6.1.4 Bargaining Power of Suppliers
A consumer will rarely bargain over the fees charged by hospitals or schools? But, the same
consumer will bargain with the vegetable or fruits vender all the time. In the first case, the
bargaining power of suppliers is absolute and in the second case, bargaining power of suppliers
is nil (until he/she is the only vendor and close substitute is pretty far).
The sugar industry, especially in the Indian context, is totally dependent upon the price which is
decided by the government after considering the views of the sugarcane farmers. So the input
cost of the raw material depends upon the price which the suppliers demand. In this case,
suppliers have a strong bargaining power. Similarly, supplies of the essential commodity, crude
oil is virtually controlled by a few Organization of the Petroleum Exporting Countries (OPEC)
through adjustment of the outputs to maintain the price levels, they desire. In a sense, we may
say OPEC has pricing power on oil.
Suppliers’ bargaining power can be understood from following simple industry characteristics. It
would be high if:
1. The number of suppliers are limited and buyers are many
2. Suppliers supply some critical inputs to buyers
3. Competitive intensity in the industry is low with differentiation in products and services.
4. Products/services do not have threat of substitutes
5. Switching cost for the customers is high
6.6.1.5 Barriers to entry (Threat of new entrants)
An industry which does not face the threat of new competitors coming in would be an
attractive industry for investors/owners. There could be several barriers to entry for new
entrants in a business – licensing, required competence/skills (IT products), capital (oil and gas),
distribution reach (banking and finance), brand loyalty of customers with the existing
participants (toothpaste, coffee markets) etc. etc. This is what Warren Buffet calls as ‘the moat’;
he says “In business, I look for economic castles protected by unbreachable ‘moats’.” This
essentially means he looks for businesses with high entry barriers. Such businesses will have
pricing power viz. can sell the products at a premium without fear of losing customers.
Entry barriers in an industry can be understood from following simple industry characteristics.
They would be high if:
1. There are lots of licensing required in the business
2. Patents and copyrights prevent new entrants
3. Huge investments in specialized assets pose a challenge
4. Strong Brands, strong distribution network, specialized execution capabilities, customers
loyalty with existing products/services exist in the business
Based on the above discussion, attractive Industry from shareholders’ perspective is one that
has one or more the following salient features that create a profitable atmosphere for the
business:
1. Low competition
2. High barriers to entry
3. Weak suppliers’ bargaining power
4. Weak buyers’ bargaining power
5. Few substitutes
If an industry is having these features, it would have strong pricing power and high profit
margins and attract investors. For example, Education is an industry in India where there is
ample demand (and continuously increasing) and very little bargaining power of the students
(buyers of the service). The industry is by and large protected from recession. Starting an
educational institute requires multiple permissions (high entry barriers) and quality institutions
are a few (low competition). Teaching staff is hired at salaries decided by the management of
the institute (weak suppliers’ bargaining power). Competing courses though may be available,
but do not generate enough confidence amongst students (few substitutes). Thus, education
industry can be said to be an example of an attractive industry
6.6.2 Political, Economic, Socio-cultural, Technological, Legal and Environmental (PESTLE)
Analysis
PESTLE Analysis stands for Political, Economic, Socio-cultural, Technological, Legal and
Environmental Analysis. Some models also extend this to include Ethics and Demographics, thus
modifying the acronym to STEEPLED. This analysis is done more from the perspective of a
business which is looking to setup unit offshore and analyzing several countries to choose from.
This model primarily analyses the external environmental factors that will act as influencers for
a business.
To do business in any country, a business must know each of the above factors very well and
how changes in any/either of these would impact business. Let us see each one of these
individually in brief here.
Political Factors: Countries can have a variety of political structures. Communist countries
would have social objectives above anything else while capitalist ones would not necessarily
have all responsibilities of a welfare state. Further, capitalists also exhibit differences amongst
themselves in terms of their approach to the social welfare schemes. Stability in legislation and
policy, minimal corruption, bureaucracy, communal tensions and violence coupled with
maximum freedom of press, ease of doing business and quick turnaround time are some of the
factors which investors would look at in a country. Healthy public finances and a consistent
fiscal policy furthering investment in infrastructure are some other important parameters for
investors.
Economic Factors: The economic parameters of a country such as GDP growth and its
contributors, inflation and interest rates, composition of imports and exports, balance of
payment and exchange rate stability, stable monetary and fiscal situation, well developed
financial markets, taxation and others, will define its attractiveness as an investment
destination. Whether a country depends upon exports or internal consumption, whether this
internal consumption is driven by imports or domestic manufacturing, whether the country has
high inflation and hence a falling currency etc. are some of the first questions which an investor
will think before investing in any country. Country’s dependence on other countries in terms of
important natural resources such as oil, monitory policies of the Central Banker, Balance of
payment positions and forex reserves etc. are very important for an investor to get a comfort
level about a country’s economic situation. India has seen the worst and the best phases of
economies in the last three decades.
Socio-Cultural Factors: The social and cultural aspects of the population of the country, such as
the demographic profile in terms of age, education and skills, health, social values, lifestyle
factors, all affect the choices that people make in what they buy and consume. Cultures affect
businesses in multiple ways. With young population in India, India offers different opportunities
and challenges in comparison to say Japan with aging population. With the change in culture,
there is a change in the economic activity as well. For example, given nuclear families and
working spouses in metro cities in India, there has been an increase in demand for day cares
facilities, packaged foods and hotel chains/restaurants. Competitive pressures at the young
generation are also resulting in life style diseases such as diabetes, sugar, hyper tension etc.
This offers opportunity set for several new businesses in the country.
Technological Factors: No dimension of life can ever be imagined today without technological
support. Technology is playing crucial role in taking businesses and society to the next level.
Development of a scientific temper amongst students leads to an ever technologically evolving
society. Countries pushing R&D activities are bound to be at the forefront of technology.
Availability of technology savvy population and institutions driving technology based initiatives
and infrastructure help a country attract investors.
Legal Factors: Legal architecture of the country and ability of legal system to support and
protect businesses is what businesses look for in a country. Consistency of legal aspects and no
arbitrary changes give comfort to the businesses and investors both. In India, recently the
Vodafone retrospective tax case and also the cancellation of telecom licenses and mining
licenses etc. have been examples of discomfort to the investing community. Transparency in
the legal environment and enforcement of laws are things which investors would favour.
Environmental Factors: Developing nations are generally bound to emit environment harming
gases in the atmosphere. A country’s awareness of environmental issues and the policies
relating to pollution control, waste disposal, mining and protection of natural flora and fauna,
rehabilitation of displaced local residents, are all thorny issues, which if not clearly spelt out
unambiguously can lead to operational and legal issues in the future and ultimately loss of time,
money and resource for a business. Investors look for clear polices of government on these
issues.
As the government pushes for India to become a manufacturing hub, environmental issues are
creeping up and these are acting as one of the deterrent for investors ready to enter India.
Not all the factors referred to above affect all companies equally. Evaluating the impact of each
factor and its criticality for the business is an important step to follow.
6.6.3 Boston Consulting Group (BCG) Analysis
While models such as Porter’s and PESTLE are used to analyze the industries and economies,
the BCG Analysis, developed by the Boston Consulting Group, looks at different segments of a
business unit at portfolio basis through the lenses of market growth and cash generation. BCG
created a matrix based on sensitivity of growth and cash generation as defined below in
pictorial manner (picture courtesy – QuickMBA.com):
As per the matrix, business segments can be classified as:
Stars: These are segments in a business where market is growing rapidly and company is having
a large market share. This segment generates increasing cash for the business with the passage
of time. Cera Sanitaryware could be a good example of “star” with large market share,
continuous growth and significant cash generation.
Cash Cows: These are segments which require low cash infusion for investment to maintain
market shares because of low growth prospects but at the same time steadily generate cash for
the company from the established market share. Navneet Publications, which is into the
business of books and notebooks, could be a good example of “cash cow”. The industry grows
at a predictable and steady rate each year. With strong brand name, well penetrated
distribution channel, ready market, and strong balance sheet, all that the company needs to do
is change the content every time some syllabus changes and reap the benefits in the form of
steady cash flows. Colgate is another example of the cash cow.
Question Marks Business segments in a fast growing market, but having low market share. The
right strategies and investments can help the market share of the business grow, but they also
run the risk of consuming cash in the process of increasing market share and in the end turning
out to be not enough cash generating. Tata Nano can be considered as an example of a
question mark, which did not succeed; whereas, Bajaj Pulsar may be considered as an example
of a question mark product which succeeded.
Dogs: Business segments, which have slow growth rates and intensive competitive dynamics
which lead to low generation of cash are categorized as Dogs.
BCG matrix provides interesting sense of the businesses/segments in terms of their
attractiveness for the investors.
6.6.4 Structure Conduct Performance (SCP) Analysis:
Another method of analysing industries is to look at the industry structure (monopoly,
oligopoly), its conduct (commoditized or specialized, seasonal or round the year, cyclical or noncyclical etc.) and finally its performance (RoE, RoIC, WACC, etc.). Structure, Conduct,
Performance (SCP) analysis approaches the industry evaluation exactly with this categorization.
SCP analysis may be seen as extension of Porter’s model where probably first two points
structure and conduct were captured. Under SCP model, one also goes into the financial
dimension of industry from analysis perspective. Basic elements of SCP analysis are captured
below in brief:
Structure analysis: Industry structure refers to the competitive intensity in the industry
(number of players), concentration of business in industry, relationship among the various
players, market size, its growth rate, etc. In this section, analysts study:
How many players exist in the industry
Is there domination of few players in the industry
How is business scattered between organized and unorganized players
Are there any threats from substitute products
How are equations between suppliers and buyers
Is there backward/forward integration already in existence or a possibility in future
Thus, very broadly coverage of analysts in this section overlaps with what we study as part of
Porter’s 5 Forces model and the SWOT Analysis model.
Conduct analysis: The structure of the industry, as described above, will define the conduct of
the businesses on aspects such as pricing and product innovation. Each industry will have its
peculiar behaviour. Umbrellas and raincoats would be seasonal businesses and FMCG and
Pharma would be round-the-year ones. High interest rates may deter people from purchasing
real estate and 4 wheelers, but 2-wheelers may not be impacted that much. Mining business
may be commoditized but FMCG and white goods may be sold purely based on power of
brands.
So, while looking for an industry’s conduct, analysts have to study several factors such as:
Is business cyclical in nature
If business is cyclical, what are the factors affecting the business – commodity prices,
interest rates, currency prices or some other global factors
Is it a highly specialized business which requires skilled labour or it is a low skill based
industry
For skilled based business, is there enough talent available
How customers choose the products/services
How will technological changes affect this business
Is business heavily dependent on government policies
Performance analysis: Based on structure and conduct of the industry, industry would generate
financials for the investors/owners. Businesses with High return on capital/equity are the ones
which create wealth for shareholders/owners in the long run. While analyzing performance of
an industry, analysts will look at several numerical ratios, which are dealt with in great detail in
the unit on quantitative analysis.
6.7Key Industry Drivers and Industry KPIs
When studying an industry to identify trends or while preparing an industry landscape, it is
always important to focus on the key performance indicator (KPIs) for the industries.
The key performance indicator varies industry to industry and a metric that is suitable to
analyse one industry may not be suitable for other industries. For example, a metric such as
revenue per employee is likely to be very useful in analysing a service provider such as a BPO —
as the industry is labour driven and their billing is generally based on the head count assigned
on a contract. However, the same metric is far less valuable for manufacturing industries, which
are capital intensive.
Most often, analysts are guided by the companies in the industry in terms of identifying the
KPIs. Reading annual report and the management discussions of a company can certainly help
analysts understand what the industry players consider as KPIs for the relevant firms.
In addition, an analyst can be guided by two other factors: (i) unit of pricing and (ii) key
constraining factors.
6.7.1 Unit of pricing
Unit of pricing essentially refers to what a company considers as unit while pricing a product. It
is far simpler in the case of manufacturing industries as the unit of pricing is the number of
goods sold. However, it can be very challenging in the case of service sector. For instance, in the
case of a café like Star Bucks, it may appear that the unit of pricing is the quantity of beverage
how much they expect to earn from one patron rather than based on quantity of beverage sold.
6.7.2 Key constraining factors
Another important factor to consider while deciding on the KPIs is the key constraining factors
for the industry. At times, these constraints may vary within an industry. Further, these
constraints may also gradually change over a period of time as the industry evolves.
Broadly speaking, the constraints can be broken into three categories:
(i) Demand side constraints
(ii) Supply side constraints
(iii) Regulatory constraints
Since a company’s performance is dependent on how it handles these constraints, analysts
should look at KPIs that reflect these constraints. For example, if an industry has limited market
size (driven by limitations in number of target customers) then industry penetration rate will be
a key factor to look at. On the other hand, if an industry is constrained by capacity constraints,
then capacity utilisation rate will be an important metric to track. If regulatory constraints exist,
then it might be prudent to track metrics followed by regulators.
6.7.3 KPIs for select industries
Airlines and other transportation and logistics: In this sector, the pricing is driven by quantity
of passengers / cargo carried and the distance it is carried. In terms of constraints, their ability
to provide service significantly depend on the amount of capacity they hold. Accordingly, some
of the important KPIs for the industry include: (i) passenger/cargo kilo meter (km) (ii) price per
passenger/cargo km (iii) capacity and utilisation rate / occupancy rate.
Passenger/cargo km is a bundled metric that is arrived by multiplying the number of passengers
(or quantity of cargo) with the amount of distance travelled.
Automobiles and capital goods: In this sector, the unit of pricing is typically the quantity of
goods sold and one of the key internal constraining factors for sales is their capacity.
Accordingly, the critical metric for the industry include (i) volume and volume growth (ii)
average realisations and their growth (iii) capacity and capacity utilisation rate.
Commercial bank and NBFC: For the banks, the unit of pricing is the value of loan and the price
is denoted as interest rates. Lending money and recovering the same back with a healthy
interest rate that is well above its cost of funds is an important KPI. In terms of constraints,
their ability to lend depends on the amount of deposits and the amount of the regulatory
capital they hold and the mandated liquid assets they need to hold. On the external front, the
business is affected by the overall flow of liquidity in the market.
Accordingly, the following are some of the key metrics for the industry: (i) net interest margin,
(ii) capital adequacy ratios, (iii) NPA ratio, (iv) growth rates in deposits and loans, (v) cash
reserve ratio and statutory liquidity reserve ratio, (vi) CASA ratio.
Since the cost of funding for banks depend heavily on central bank policy rates, it is also
extremely important to track that.
Consumer goods: In the case of consumer goods including consumer staples and consumer
discretionary, the unit of pricing is generally the quantity of goods sold. Accordingly, the key
metrics tracked for this industry include (i) volume and its growth and (ii) average price and its
growth. In consumer durables, capacity can become constraint especially during the period of
high growth. Hence, it may be appropriate to track capacity and utilisation rate as well.
IT services/ BPO/ KPO: In this sector, the pricing is typically based on the number of headcount
who are assigned per project per month (often referred as full time equivalent or FTE per
month). Since it is a labour driven industry, one of their key constraints is the availability of
work force. Although labour force for the sector is available in abundance in India, during
period of high growth it can become a constraint. Further, since the sector is largely export
oriented, their realisations are heavily impacted by the foreign currency fluctuation. Further,
some of the companies in the industry are heavily reliant on a handful of customers, which, one
hand gives a steady stream of revenue while on the other creates high customer concentration
ratio.
Thus, some of the important metrics to track in this sector include (i) average no. of FTEs billed
(ii) average revenue per FTE (ii) bench strength (spare capacity) and attrition rates (iv) constant
currency growth rates (iv) customer concentration ratio and number of “million dollar”
customers (i.e., customers who are billed more than a million USD per annum).
Media: The media industry includes: (i) print medium, (ii) Television and radio, and (iii) online
medium. Revenue for the media industry comes from two sources: (i) payments by users and
(ii) advertisement revenue. Having said that, majority of their revenue is earned through
advertisement. In print media, the unit of pricing is based on the amount of real estate space
occupied in the paper while in television and radio, the unit of pricing is the amount of airtime
of the advertisement. Since there is real limitation in terms of the amount of airtime or real
estate space that can be allocated to advertisement, their ability to grow largely depends on
attracting larger audience so that they can charge higher price from the advertisers. This, in
turn, depends on their ability to acquire good quality content at reasonable price.
in online media, the unit of pricing is directly based on the number of views / clicks per
advertisement.
Thus, the following are some of the important metrics to track (i) Readership / viewership
(TRPs) / number of site visitors (ii) Average ad realisation per unit (iii) content acquisition cost.
Retail: Organised retailers sell variety of products. Each of these individual products will have
different units of pricing. Further, since the business is “trading” in nature, they can quickly shift
the products they retail based on market demands. Therefore, the unit of pricing is far less
relevant. However, in terms of constraints, their business growth heavily depends on expanding
their store network in localities where they can generate healthy sales.
Factoring these aspects, some of the key metrics tracked in the industry include (i) No. of stores
and (ii) Same stores’ sales growth.
Telecommunication / Internet service providers: In India, till a few years ago,
telecommunication providers charged customers based on the number of calls, messages and
data that were used. Over the past few years, this model has eventually changed, and more and
more subscribers are getting charged a fixed monthly rental. However, regardless of the billing
model, from an analytical perspective, a subscriber is considered as the unit of pricing and
companies try to increase their subscriber base while trying to upsell their services to existing
subscribers. In terms of constraints, the biggest constraint for the industry is the limited market
size as the number of subscribers is limited by the population in the geography they serve. At
individual service provider level, they also must ensure that they win over competition to
acquire and retain a customer.
Analysts, therefore, prefer to track the following metrics: (i) Average revenue per user (ARPU)
(ii) subscriber churn rate (iii) cost of subscriber acquisition (iv) market share.
6.8Regulatory environment/framework
Industry analysis cannot be complete without adequate knowledge of the rules of the game.
Even small changes in regulatory framework can have big impact on the businesses.
For example, the whole discussion in India on FDI in multi brand retail has been revolving
around how much should retailers invest in developing the back end infrastructure, what could
be construed as back end infrastructure, could they buy out some firms existing set up, how
much minimum they should purchase from Indian vendors, etc. Changes in the environment
policies have resulted in closure of various mines and have affected the businesses drastically.
Cancellation of Telecom licenses has affected the business in that industry. The latest
amendments made to the Companies Act have changed the entire landscape for doing business
in India.
Therefore, analysts should pay enough attention to the regulatory aspects of businesses.
6.9Taxation
Taxes are tools that a government uses to earn income which can be used to meet its expenses.
However, governments also use taxes as a tool to encourage or discourage certain businesses.
For example, the state government of Kerala introduced a fat tax in 2017. They levied 14.5%
additional tax on junk foods. This was done with the intention to discourage the junk food
industry.
Similarly, at a national level, India has several slabs of Goods and Service Tax (GST). Many
essential products have no GST or have lower GST rate while luxury products have much higher
GST rate.
Broadly, taxes charged by government can be classified into two categories (i) Direct taxes (ii)
Indirect taxes.
6.9.1 Direct Taxes
Direct taxes refer to taxes where the incidence of the tax and liability for the tax are on the
same person. In other words, the person who has to bear the tax is also the one who is obliged
to pay the tax to the government.
The most common form of direct tax is the income tax. Every individual and business has to pay
a particular rate of tax on the profits they earn. Tax laws prescribe how and when income and
expenses should be recognized. Although most often these are driven by nature of income and
expense, in many cases these are also driven by considerations on the business practice that
government wants to encourage or discourage.
For instance, in India, in order to promote research and development, companies are allowed
to claim expense that is 1.5 times of actual expenditure incurred on certain scientific research
activity. On the other hand, in order to discourage delay in payment of interest owed to
scheduled commercial banks, companies are allowed to deduct it as expense only if they
actually pay it.
These adjustments often result in difference between the profits shown for external reporting
purpose and for tax purpose.
Since government use direct tax also as a tool for promoting or discouraging certain activities,
tracking the developments is very critical to understand their impact on the industry’s growth.
Corporate income taxes, in India, have four components: (i) Income tax, (ii) MAT, (iii) Surcharge
and (iv) Cess
Most goods and services are charged GST at 18%. However, the GST rates vary from 0% to 28%
for different categories of goods and services.
Excise duty: Excise duty is tax on production. With the introduction of GST, excise duty has
been removed for most of the goods. However, excise duty is still applied on liquor, petrol and
diesel as these products do not come under GST.
Value Added Tax (VAT): Value added tax is levied on sale of products. These are charged by the
state governments. Similar to excise duty, these taxes are currently applicable only for liquor,
petrol and diesel.
Customs duty: Customs duty is a tax that is levied on imported products. The rate of customs
duty vary based on the product that is imported.
6.9.3 Other taxes
Road tax: Road tax is paid by the purchasers of new automobiles. These are lifetime taxes paid
upfront. This tax increases the acquisition cost of automobiles and thus impacts automobile
sales, and in turn, other downstream industries such as auto-ancillaries, and general insurance
firms offering vehicle insurance, etc.
Stamp duty: Stamp duty is payable whenever any document needs to be registered. These are
largely required at the time of purchase or sale of asset. Since this is an upfront cost, it
increases the cost of acquisition of asset (for the buyer) or realisable value of assets (for the
seller). Change in stamp duty affects the real estate industry and investment management firms
including stock broking firms and asset management companies.
Security transaction tax (STT): Security transaction tax is paid at the time of sale of securities.
Since it reduces the realisable value of security sales, it discourages short-term trading. Thus,
this affects stock traders and in turn stock broking firms.
6.10 Sources of information for industry analysis
There are several sources of information on industry. Some of them are stated below:
Industry reports from various sources – industry journals and media reports
Annual Reports of companies in the Industry – ‘Management Discussion and Analysis’
section
Associations/Trade Bodies publications
Relevant ministry website/publications
Sample Questions
1. The tyre industry in a country comprised of three organised players and several
unorganised players. A sample survey revealed that around 20% of total sales came from
unorganised sector. The three major companies reported revenue of Rs 6,000 crore, Rs
8,000 crore and Rs 10,000 crore, respectively, for the year 2019. Which of the following is
closest to the fair estimate of overall size of tyre market in that country for the year 2019?
a. Rs 48,000 crore
b. Rs 24,000 crore
c. Rs 30,000 crore
d. Rs 36,000 crore
2. An industry where rivalry is high, the end result will be _____ pricing power and ______
incomes for the industry participants.
a. Lower; higher
b. Lower; lower
c. Higher; higher
d. Higher; lower
3. Who can exert a lot of pressure and dictate prices, if there are a large number of sellers
with similar products/services?
a. Sellers
b. Consumers
c. Producers
d. None of the above
4. Which of the following is considered as an economic factor in PESTLE analysis?
a. Forex reserves
b. Monitory policies of the RBI
c. Country’s dependence on other countries in terms of important natural resources
d. All of the above
5. What does Industry structure in Structure Conduct Performance (SCP) analysis refer to?
a. Industry Growth rate
b. Relationship among the various players in the industry
c. Market size
d. All of the above
