NPTEL Course

Course Title: Security Analysis and Portfolio Management

Instructor: Dr. Chandra Sekhar Mishra

Module-8
Session-16
Industry Analysis II
Outline

Industry life cycle

Analysis of industry competition (Porters Five Forces Model)
Select Financials of Select Industries

In the previous section, we discussed about importance of industry analysis, business cycle, sector
rotation in response to different stages of business cycle. This session deals with industry life cycle,
different mechanism of industry analysis among other things.
The Industry Life Cycle
At a given point of time, different industries perform differently. While one reason could be because of
the business cycle prevailing then another reason is the stage of the particular industry. Industries go
through different stages. In the initial stage, very high growth is observed and lot of investment takes
place. At this time the players have got fist mover advantage and protect and subsequently very high rate
of returns are earned by the players in the industry, which attracts new entities into the industry and
subsequently because of this the initial players loose the advantages or superiority over others. An
industry goes through four distinct phases as depicted by figure 16.1.
Figure 16.1: Industry Life Cycle

In the introduction or start up stage, one sees a rapid and increasing sales growth that becomes stable in
consolidation phase. In maturity stage, the sales growth declies and during decline stage sales growth
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becomes negative. The duration of different phases of industry life cycle varies from one industry to
another. For industries where technological obsolescence is high, the duration becomes shorter. One
should find the securities of firms that are able to capitalize on technological change.
An alternate way of analyzing the industry life cycle is to divide the same into five stages with unique
features in each stage as provided in table 16.1.
Table 16.1: Industry Life Cycle An Alternate Approach
Stages of Industry Life Cycle

Salient Features

Pioneering Development

Modest Sales
Low or negative profit margin
Major Development Costs

Rapid Accelerating Growth

High sales growth

Limited number of competitors
Very high profit margin

Mature Growth

Higher than normal sales growth

More number of competitors
High but declining profit margin

Stabilization and Market Maturity

Longest phase
Normal sales growth
Lower profit margin

Deceleration of Growth and

Decline

Declining sales growth

Low or negative profit margin
Very low rate of return on capital

Source: Reilly and Brown (2006)

Industry Structure and Performance:
Besides forecasting growth in sales and earnings in different stages of industry and identifying the
opportunities to invest, one should anlayse the competitive structure for the industry. Michale Porter has
provided five competitive forces that determine the competitive structure of the industry. Those are
explained as below.
1. Threat of New Entrants: While existing firms in a particular industry compete among themselves,
there are always possibilities of new firms entering the market. If the barriers to entry are high or
strong then the existing players can benefit. The barriers to entry can take different forms. Certain
industries require very high investment in technology and other resources thus limiting the
number of players. New players may have to abandon their existing facility and technology to
enter a new market. Existing players might have got good relationship with suppliers and
customers in the supply chain. This might be difficult for the new entrants to emulate. There are
also regulatory constraints that prohibit other players entering a market. For example, unless a
new telecom company has got the license for spectrum, cannot enter mobile service market in
India. There are other resources like mines for which licenses are required to be taken from the
Government before starting a business. Entry barriers exist for firms from other countries.
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Existing firms might have cost advantage because of experience and scale of activity which might
be difficult to achieve for new players.
Figure 16.2: Forces Driving Industry Competition (Michael E. Porter)

Source: Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter, Free Press, 1998

2. Rivalry among Existing Firms: If there are several players in the market, there will be very high
completion for price and profit margins are likely to be lower. If firms are of similar size, the
rivalry becomes more severe. Firms tend to price the products very low. Because of exit barriers
like existing agreements with input suppliers, firms might operate with below-average or negative
return. In a slow growth industry the rivalry becomes worse because expansion for a particular
firm will come at the cost of an existing player. This will lead to further price wars.
3. Threat of Substitute Products or Services: Substitute products pose threat in terms of keeping the
price lower in a particular industry. However the substitute has to be close in its functionality and
utility. In food industry, one can see lot of substitutes. In cooking appliances industry, induction
cookers are very close substitute for gas burners. Thus, there is likely to be limited rise in price of
gas burners.
4. Bargaining Power of Suppliers: If suppliers are limited in number, they can pose threat to the
industry in terms of high input costs. The firms will be always on their toes. It becomes further
difficult if the number of players is relative large compared to suppliers industry. Suppliers
include labor which can be organized and critical input for the firms. Availability of substitutes
for inputs make the suppliers weak.
5. Bargaining Power of Buyers: Buyers can impose restrictions for the firms by asking for lower
prices and superior quality. This is possible for buyers who are very large in size [like retail
chains]. The players in passenger car or commercial vehicles industry have considerable
influence on suppliers of automobile components. This can lead to lower profitability for auto
components industry.
As an investor, one has to analyse all the above factors to assess the intensity of competition in a
particular industry its impact on the long run profitability of the industy.
Select Financials of Select Industries: The financial performance of industries vary over time as well as
among industries at a particular point of time. The following table shows the financial performance in
terms of three parameters for three select industries.
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Table 16.2: Financials of Select Industries in India

Year

Asset Turnover Net profit Margin (%) Return on Assets (%) Total Assets / Equity RoE or RoNW (%)
Capital
Capital
Capital
Capital
Capital
FMCG IT
FMCG IT
FMCG IT
FMCG IT
FMCG IT
Goods
Goods
Goods
Goods
Goods
1.57 1.04 6.84
10.98 22.40 6.33
17.19 23.33 2.97
2.14 1.83 14.88 27.85 28.65
1999-00 0.93
2000-01

0.94

1.43

1.00

7.43

8.97

27.87

6.97

12.83 27.77

2.88

1.96

1.63 16.75

23.25 27.58

2001-02

0.90

1.50

1.03

5.90

9.51

27.39

5.34

14.22 28.26

3.21

2.03

1.94 12.77

29.57 24.50

2002-03

0.91

1.47

1.17

5.98

8.39

43.31

5.43

12.37 50.83

3.15

2.02

2.04 11.84

26.49 19.55

2003-04

0.98

1.57

1.32

9.05

9.71

57.61

8.87

15.27 76.10

3.23

2.20

2.41 18.57

35.80 43.13

2004-05

1.12

1.54

0.97

8.55

10.67 18.14

9.54

16.41 17.63

3.02

2.31

1.62 21.17

39.22 22.95

2005-06

1.08

1.45

0.91

9.75

11.16 18.06 10.53

16.17 16.38

2.75

2.18

1.65 23.42

37.17 22.47

2006-07

1.10

1.47

0.88 10.40

12.85 20.12 11.49

18.94 17.67

2.76

2.28

1.79 25.88

41.56 21.56

2007-08

1.05

1.39

0.91 11.35

12.95 52.43 11.96

17.96 47.56

2.53

2.45

2.02 24.78

46.84 25.98

2008-09

0.93

1.36

0.86

9.97

10.95 21.71

9.28

14.86 18.70

2.71

2.21

2.01 21.09

36.46 23.31

Average

0.99

1.48

1.01

8.52

10.61 30.90

8.57

15.62 32.42

2.92

2.18

1.89 19.12

34.42 25.97

Source: Prepared with data from CMIE-Prowess

Table 16.2 shows the return on equity which is a function of three other financial parameters as below:

Total Assets
Sales
Net Profit Net Income
x
x
=
Equity
Total Assets
Sales
Equity
= Profit Margin x Total Asset Turnover x Financial Leverage
RoE =

The financial data as given in Table 16.2 are shown in different charts so that one could compare the
performance among different industries.
Figure 16.3

Figure 16.4

Figure 16.5

Figure 16.6

Figure 16.6

There is widespread dispersion observed in the performance of different industries. Risk analysis and
measurement for different industries are necessary. Valuation ratios differ for different industries. It is
also essential to perform industry analysis on a global scale. Individual company analysis is also
important besides industry analysis.

References:
Bodie et al (2009), Investments, 8e, Tata McGraw Hill, New Delhi
Mayo, Herbert B. (2009), An Introduction to Investments, 1/e, Cengage Learing
Porter, Michael E.: Competitive Strategy: Techniques for Analyzing Industries and Competitors, 1998
Reilly and Brown (2006), Investment Analysis and Portfolio Management, 8e, Thomson (Cengage)
Learning, New Delhi
Prasanna Chandra (2008), Investment Analysis and Portfolio Management, 3e, Tata McGraw Hill, New
Delhi
Source of Data: Prowess Database, Center for Monitoring Indian Economy

Questions and Answers

Q.1: What are the different stages of industry cycle and the main features of such stages?
Ans.: The various stages of industry cycle are broadly divided into four: Start-up; Consolidation; Maturity
and Relative Decline. An alternate framework of industry life cycle and the salient features of each stage
is given below:
Stages of Industry Life Cycle

Salient Features

Pioneering Development

Modest Sales
Low or negative profit margin
Major Development Costs

Rapid Accelerating Growth

High sales growth

Limited number of competitors
Very high profit margin

Mature Growth

Higher than normal sales growth

More number of competitors
High but declining profit margin

Stabilization and Market Maturity

Longest phase
Normal sales growth
Lower profit margin

Deceleration of Growth and Decline

Declining sales growth

Low or negative profit margin
Very low rate of return on capital

Q.2: What is five-force analysis and its utility for industry analysis?
Ans.; As per Michael E. Porter, average profitability of an industry is influenced by the five forces (as
shown in the following figure). According to this framework, the intensity of competition determines the
potential for creating abnormal profits by the firms in an industry. Whether or not the potential profits are
kept by the industry is determined by the relative bargaining power of the firms in the industry and their
customers and suppliers.
Forces Driving Industry Competition (Michael E. Porter)

Q.3: State the different attributes of the five competitive forces identified by Michael E Porter.
Ans.:
I.

Rivalry among existing competitors:

a. Concentration and balance of competitors
b. Diversity of competitors
c. Product differentiation and switching costs for customers
d. Excess capacity and exit barriers
e. Cost conditions i.e. ratio of fixed to variable costs.

II.

Threat of new entrants:

a. Economies of scale
b. Absolute cost advantages
c. Capital requirements
d. Product differentiation
e. Access to distribution channels
f. Government and legal barriers
g. Retaliation by established producers

III.

Pressure from substitute products

a. Buyer propensity to substitute
b. Relative prices and performance of substitutes

IV.

Bargaining power of buyers

a. Size and concentration of buyers relative to producers
b. Undifferentiated products
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c. Buyers switching costs

d. Buyers information
e. Buyers ability to backward integrate
V.

Bargaining power of suppliers

a. Few large supplier dominates market
b. No substitute for input
c. Switching cost from one supplier to another high
d. Possibility of suppliers integrating forward- to get higher margin
e. Buying industry low barrier to entry

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