Parth Verma I The Valuation School

CHAPTER 6

INDUSTRY ANALYSIS

Learning objectives

• 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

.6.1. ROLE OF INDUSTRY ANALYSIS IN FUNDAMENTAL ANALYSIS

• Economic analysis helps us predict if businesses will grow or decline in the future.

• Industry analysis looks at how different industries are affected by the current
economic conditions.

• Analysts study how companies in the market may react and impact the industry's
prospects. Key questions include

• This analysis guides us in making

informed decisions about a
company's potential growth or
challenges in the dynamic business
landscape.
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.6.2. CHALLENGES IN DEFINING THE INDUSTRY

The initial step in industry analysis is defining the company's operating industry.

Despite standard systems like NIC in India or GICS/NAICS in the US, industry
definitions may not fully capture the essence of the industry.

PVR LIMITED EXAMPLE : CAR MANUFACTURE EXAMPLE :

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.6.3. UNDERSTANDING INDUSTRY CYCLICALITY

Understanding Economic Cycles:

- Economic cycles impact businesses differently.

- Some industries are more affected than others.

.6.4. MARKET SIZING AND TREND ANALYSIS

UNDERSTANDING INDUSTRY GROWTH

KEY ANALYSIS FACTORS

- Assessing the potential vs. current market size is crucial in industry study.

- Current market size measurement is complex, especially with unorganized players or

private companies lacking public information.

- Past trend analysis helps understand industry evolution and secular trends. aiding in
growth predictions.

- Market sizing often requires assumptions due to limited information availability.

MARKET SIZING APPROACHES

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.6.5. SECULAR TRENDS

Secular trends are like big, long-lasting changes in how things are made or what people buy.

For example, digital cameras came changed how we take photos, making traditional film
cameras less popular.

DRIVING FACTORS

- Technological Advancement:

Significant changes in how things are made or used.

e.g advanced farming techniques using tractors impacting traditional methods.

- Change in Income Levels:

Economic growth leading to shifts in consumer spending. In India, with rising incomes,
e.g purchasing high-end smartphones instead of budget-friendly.

- Demographic Changes:

Alterations in the age or composition of a population influencing consumer choices. In

India, the youth-dominated demographic may lead to increased demand for trendy
fashion and tech gadgets.

- Culture, Tastes, and Preferences:

Evolving preferences and cultural influences shaping consumer behavior. For instance,
the growing popularity of plant-based diets reflects changing food preferences
influenced by global health trends.

- Changes in Regulation or Government Policy:

Modifications in rules impacting industries. In India, environmental regulations

promoting sustainable practices may lead to increased demand for eco-friendly
products and services.
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6.5.1 VALUE MIGRATION

Due to secular trends value migration happens

- Value migration occurs when something makes one entity way better for a long time.

- The entity that gets better sees more success and increased shareholder value, Others lose
out in this shift.

- This shift can happen between geographics, different businesses, or even among competitors
in the same industry.

example - maybe through diagram

• people always bought groceries from local stores.

• Then, online grocery service came, making shopping easier.
• More people started using it, making it successful.
• The local stores lost customers, but the online service gained, showing value migration.

1. Geographic Migration:

Shift of value between countries due to secular trends. For example, advancements in
renewable energy technologies boosted Scandinavian nations' value in the energy sector,
surpassing traditional oil-producing regions.

2. Cross-Industry Migration:

One industry gains, and another loses. Take the rise of e-commerce, causing a decline in
traditional brick-and-mortar retail and boosting online retail giants like Amazon.

3. Migration Across Value Chain:

Industries at different ends of the value chain gain or lose. Consider the rise of electric
vehicles impacting traditional automakers but elevating companies involved in battery
manufacturing.
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4. Migration Across Companies in the Same Industry:

Disruptions create new advantages or remove existing ones. Think about the surge in
streaming services affecting traditional cable TV companies, leading to a shift in value
towards companies like Netflix.

5. Investment Insights:

Recognizing value migration helps analysts identify investment opportunities early and
exit declining businesses. For instance, anticipating the growth of sustainable technologies
can guide investors towards renewable energy stocks.

( rarely, goods or services

find new use, start a new
6.5.2. BUSINESS LIFE CYCLE cycle )

2023 & beyond

• In response, Ola is
exploring new
avenues, such as
electric vehicles,
(Industry is new, concept expanding into
being proven.) adjacent markets,
and enhancing its
2010 - 2013 technology offerings,
• Ola was founded in signaling a
2010, introducing the reinvention and
concept of app-based potential revival in
ride-hailing to the its business
Indian market.

(Concept proven, many customers ( industry exists for long, most ( change in preference or new tech
adopt, industry sees steep growth) potential customers already using replaces, industry loses to alternatives)
the product)
2014 - 2017 2021-2022
2018-2020 • Facing challenges such as
• As the concept proved viable
• By the late 2020s, Ola had operational issues, changing
and more customers adopted become a well-established transportation trends, and
the service, Ola experienced player in the ride-hailing increased competition, Ola
rapid growth, expanding its industry, with a substantial experienced a phase of decline or
presence across various cities in user base and market share. stagnancy.
India.
 .6.6. UNDERSTANDING THE INDUSTRY LANDSCAPE

- Industry landscaping involves studying competitors, customers, suppliers, regulators,

and emerging technologies to grasp how they interact.

6.6.1 PORTER FORCES

• Horizontal Forces:

- Threat of Substitutes: Potential alternatives impacting industry viability.

- Threat of New Entrants: New competitors entering the market.
- Threat of Established Rivals: Intensity of competition among existing players.

• Vertical Forces:

- Bargaining Power of Suppliers: Influence of input providers.

- Bargaining Power of Buyers: Influence of customers.

INDUSTRY RIVALS

• Many competitors, undifferentiated products, aggressive pricing.

• High competition leads to frequent low revenues and profitability phases.
• Innovation and brand-building crucial for sustained success
• Price-sensitive subscribers easily shift to lower-priced offerings from competitors.
• example - food delivery industry - Zomato swiggy, etc

THREAT OF SUBSTITUTES

• High when substitutes offer equal or better experiences.

• Industry's ability to foresee changes and adapt defines success.
• As technology evolves existing products become irrelevant due to innovations., cheaper
and more efficient substitutes pose a higher threat to traditional businesses.
• The rise of e-learning platforms in India, such as Byju's and Unacademy, posed a
significant threat to traditional classroom education

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 BARGAINING POWER OF BUYERS

• High when many sellers offer similar products, giving buyer choices.
• Strengthens if products/services lack differentiation.
• Increases with the presence of close substitutes and low switching costs for
customers.
• Government buyers, due to their size and influence, can have significant
bargaining power.
• In the Indian online travel agency (OTA) sector, buyers wield substantial power.
With multiple OTAs like MakeMyTrip, Cleartrip, and Goibibo offering similar
services, customers can easily compare and switch platforms based on
discounts and incentives.

BARGAINING POWER OF SUPPLIERS

• Limited suppliers with many buyers.

• Strong supplier bargaining power in regulated industries
• Limited or no threat of substitutes.
• High switching costs for customers.
• Example: IRCTC is the monopoly in online ticket booking

BARRIERS TO ENTRY ( THREAT OF NEW ENTRANTS )

• High barriers create attractive industries for investors.

• Licensing, patents, capital requirements act as entry barriers.
• High entry barriers result in pricing power.
• Example: Hindustan Aeronautics Limited (HAL) faces formidable entry
barriers in the defense aviation industry

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6.6.2. PESTEL ( POLITICAL, ECONOMIC, SOCIO CULTURAL, TECH, LEGAL, ENVIRONMEN TAL

PESTLE analysis helps businesses make informed strategic decisions by evaluating

external factors crucial for success in different countries.
Evaluating the impact and criticality of each factor is crucial for businesses.

Political Factors:

Governance stability, lack of corruption, freedom of press, ease of doing business are
key considerations for investors.

Economic Factors:

GDP growth, inflation rates, balance of payments, exchange rate stability influence
investment attractiveness.

-Socio-Cultural Factors:

Demographics, education, health, social values impact consumer choices and business
opportunities.

Technological Factors:

Technology-driven societies attract investors; availability of tech-savvy population is

crucial.

Legal Factors:

Consistent legal frameworks, transparency, and enforcement of laws provide comfort

to businesses and investors.

Environmental Factors:

Policies on pollution control, waste disposal, and environmental protection impact

business operations.

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6.6.3 BOSTON CONSULTING GROUP ANALYSIS (BCG)

BCG Analysis, by Boston Consulting Group, assesses business segments on a portfolio

basis, considering market growth and cash generation.

Stars:

- High-growth segments with a significant market share, generating increasing cash

over time.

Cash Cows:

- Segments with low growth but steady cash generation, requiring minimal investment
to maintain market share. e.g HUL, ITC

Question Marks:

- Fast-growing segments with low market share, needing strategic investments to

increase share and potentially become cash cows.

Dogs:

- Segments with slow growth, intense competition, and low cash generation.

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6.6.4 INDUSTRY ANALYSIS : STRUCTURE, CONDUCT, PERFORMANCE (SCP) MODEL

The SCP (Structure, Conduct, Performance) model provides a comprehensive framework for
understanding industries.

Starting with an exploration of industry structure, it delves into competitive intensity,

player domination, and the balance between organised and unorganised entities.

Conduct analysis then scrutinises business behaviour, considering factors like cyclicality,
skill demands, and technological impact.

Finally, performance analysis assesses financial outcomes, with a focus on industries that
generate high returns, offering long-term wealth creation potential for shareholders and
owners.

. Structure Analysis

• Examines competitive intensity, market concentration, and relationships among players.

• Factors include the number of players, dominance, organised vs. unorganised presence,
and threat from substitutes.
• Considers possibilities for backward/forward integration.

. Conduct Analysis:

• Industry behaviour, influenced by structure, impacts pricing and innovation.

• Conduct varies based on cyclical nature, skill requirements, talent availability, and
technology impact.
• Takes into account seasonal or round-the-year business and global factors.

. Performance Analysis:

• Evaluates financial outcomes for investors/owners based on industry structure and

conduct.
• Focuses on key financial ratios, emphasising businesses with high return on capital/
equity.
• Identifies these businesses as long-term wealth creators for shareholders.
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.6.7. KEY INDUSTRY DRIVERS AND INDUSTRY KPIs

In industry analysis, key performance indicators (KPIs) tailored to each industry help us in
measuring the performance of industry or peers among industry, metrics suitable for one
may not apply to others.

Analysts rely on industry companies and their annual reports to identify key performance
indicators (KPIs).

OTHER FACTORS ON WHICH KPI CAN BE DECIDED

6.7.1. UNIT PRICING

Unit of pricing essentially refers to what a company considers as unit while pricing a
product.

6.7.2. KEY CONSTRAINING FACTOR

Industry constraints, which broadly fall into demand, supply, and regulatory categories.
Industry-specific challenges, such as limited market size or capacity constraints, directly
impact a company's performance. Analysts should focus on KPIs aligned with these
constraints

Airlines and Transportation:

• Unit Pricing:
Revenue derived from the quantity of passengers or cargo transported and the distance
covered.

• Constraints:
Capacity significantly influences service provision.

• KPIs:
1. Passenger/Cargo Kilometer
2. Price per Passenger/Cargo Kilometer
3. Capacity and Utilization Rate/Occupancy Rate
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Automobiles and Capital Goods: IT Services/BPO/KPO:

• Unit Pricing: • Unit Pricing:

Quantity of goods sold Number of headcount per project per month.

• Constraint: • Constraints:
sales constrained by capacity. Availability of skilled workforce.

• KPIs: • KPIs:
1. Volume and Volume Growth 1. Average No. of FTEs Billed
2. Average Realizations and Their Growth 2. Average Revenue per FTE
3. Capacity and Capacity Utilization Rate 3. Bench Strength and Attrition Rates

Commercial Banks and NBFCs: Media:

• Unit Pricing: • Unit Pricing:

Value of loans, with interest rates as the Print space, airtime, or online views/clicks.
price.
• Constraints:
• Constraints: Limited space for advertisements.
Dependence on deposits, regulatory capital,
and liquid assets. • KPIs:
1. Readership/Viewership
• KPIs: 2. Average Ad Realization per Unit
1. Net Interest Margin 3. Content Acquisition Cost
2. Capital Adequacy Ratios
3. NPA Ratio, Growth Rates in Deposits
and Loans Retail:

• Unit Pricing:
Consumer Goods: Various, depending on product types.

• Unit Pricing: • Constraints:

Quantity of goods sold. Growth tied to expanding store network.

• KPIs: • KPIs:
1. Volume and Its Growth 1. Number of Stores
2. Average Price and Its Growth. 2. Same Stores' Sales Growth
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. 6.8. REGULATORY ENVIRONMENT AND FRAMEWORK

Understanding industry regulations is crucial as even minor changes can significantly affect
businesses.

for e.g - the telecom companies after environmental changes

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. 6.9. TAXATION

6.9.1. DIRECT TAXES

Direct taxes are borne and paid by the same person.

Income tax in India, where individuals and businesses pay a percentage of their profits.

Adjustments:Tax laws may encourage or discourage certain practices. For instance, India
promotes research by allowing companies to claim 1.5 times the expenditure on scientific
research.
 • Corporate Income Taxes in India:

- Income Tax:30% (25% for turnover below Rs 400 crores).

- Minimum Alternate Tax (MAT):18.5% of book profits if income tax is lower than 18.5%
of book profit, the extra tax paid can be claimed in future by MAT credits.
- Surcharge: Additional tax on income tax/MAT, not shared with state governments.
- Cess:Additional levy for specific purposes like health and education.

6.9.2. INDIRECT TAXES

indirect taxes are paid by one person but collected from another.

Example:
GST is charged on the sale of goods or services, collected by the seller, but borne by the end
consumer.

1. Rates: GST rates vary from 0% to 28% for different goods and services.

2. Excise Duty:Tax on production; removed for most goods with the introduction of GST, but
still applied on liquor, petrol, and diesel.

3. Value Added Tax (VAT): State-level tax on the sale of products, applicable to liquor, petrol,
and diesel.

4. Customs Duty:Tax on imported products; rates vary based on the imported product.

6.9.3. OTHER TAXES

1. Road Tax: Lifetime tax paid upfront by purchasers of new automobiles, impacting
automobile sales and related industries.

2. Stamp Duty:Paid during the registration of documents, affecting real estate and
investment firms.

3. Security Transaction Tax (STT):Paid during the sale of securities, discouraging short-term
trading and impacting stock traders and broking firms.

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. 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

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