What is Industry Analysis and How to do it

23 Feb 2022  Read 2359 Views

The world of finance is a huge jungle. The ecosystem is dynamic and involves so many things and when it comes to investing, one of the most important steps that should be taken into consideration before we invest in any stock is, Stock Analysis. After all, you should always invest some time in analysing a stock before you invest money in it. In the process of stock analysis, in a broader sense, analysing the industry is a factor that is significant.  

So, today we bring to you a guide to understanding the industry to cater to your stock analysis process. Let’s just begin by understanding what Industry is.

Industry Analysis : Overview

In a nutshell, Industry is a combination of companies that are involved in similar kinds of business activities. Investors can compare companies within the same industry for investment purposes. 

In any given economy you can find industries under various categories such as manufacturing, construction, durable, non-durable, heavy, light, domestic, foreign etc. 

Let us take a look at different types of industries based on these categories. 

Industry

Heavy vs Light

Durable vs non-Durable

Manufacturing vs Construction

Automobile

Heavy

Durable

Manufacturing

Food Services

Light

Non-durable

Manufacturing

Clothing

Light

Durable

Manufacturing

Mining

Heavy

Durable

Construction

In the above example, we have the Automobile industry that is a combination of companies that are involved in automotive manufacturing, selling or manufacturing of automotive parts and such. Similarly, the food services industry comprise a group of companies that are involved in the food business.  

By the way, you might have noticed that the terms sector & industry are used interchangeably but they are different. In an economy, where industry implies a group of companies, sectors is a much broader term. In a sector, different industries operate together. 

So, that is what an industry is. Now let us take a look at what industry analysis is. As the name implies Industry analysis is the process of researching a particular industry to find a suitable company from that industry to invest in. 

Importance of Industry Analysis

It is very important to analyse an industry before you invest in any stock from it because that way you get to understand the macroeconomic factors that can affect your chosen stock. There are multiple reasons why Industry analysis is important as it lets you:

  • Identify the best investment opportunities

  • Understand how an industry works

  • Evaluate future prospects of the stock as well as the industry as a whole. 

Yes, since you know the WHY it's time to understand the HOW. How can you analyse an industry? Well, the answer lies in simples analysis tools such as SWOT, Porter’s five forces, PEST analysis, Blue Ocean strategy and more. Today, let's learn about two of them. 

A step-by-step guide to Industry Analysis

Porter's five forces to Industry analysis

There are various ways from which you can perform industry analysis and one of them is Porter’s five forces. Let’s understand it today. 

This method was introduced by Michael Porter in the book, Competitive Strategy: Techniques for Analyzing Industries and Competitors. The model was created to analyse the attractiveness and profitability of an industry. Also, it is used to identify the main source of competition in the industry. You see, when you know the forces affecting the industry it becomes easier to take an investment decision

It's clear from the name, there are 5 main forces that affect the competitive pressure in the industry as seen in the image below. 

 

Let us understand this model with an example. We will take into consideration the Aviation industry and talk about passenger airlines. 

In India, the major players in airlines are Indigo, Vistara, GoAir, Air India, Spicejet. For starters take a look at the market share of these airlines as of January 2022. 

Industry Rivalry  

This is the force at the very centre of the model. It provides a view on the number & strengths of the competitors in the industry. In regard to our example, if we consider Indigo, the competitors surrounding it are Vistara, Goair, Air India & Spicejet. 

In this kind of intense competition/rivalry, these airlines attract customers by lowering their prices. Like how all of us choose cheap flight tickets over expensive ones. In this competitive industry, a customer always has a choice to choose one over the other according to his needs & capacity. 

The main factors that influence industry performance in terms of rivalry are

-Number of competitors
-Quality differences
-Switching cost
-Customer loyalty

Threat of entry

This implies the ease with which new firms can enter the market. It's easy to enter some industries while very difficult to enter other industries. In our example of aviation, the barriers to entry are high. It's an asset-heavy space that requires huge investment, plenty of legal & regulatory requirements and more. In short, an entry into aviation is cumbersome. 
Where entry is difficult, any company which enjoys a little competitive advantage is benefited for a longer period of time.  

The main factors that influence industry performance in terms of Threat of entry are

-Time & Cost of entry
-Specialist Knowledge
-Economies of scale
-Cost advantages
-Technology protection

Bargaining power of Suppliers

The more the suppliers in the market the less is their bargaining power & the less the suppliers in the market the more is their bargaining power.
In simple words, If you want to buy an aeroplane and there is only one seller/supplier then the supplier will have the power to quote any price for the aeroplane to you. In a way, a single supplier becomes your ‘only’ provider. 

For eg. In the aviation industry, there are only two most significant manufacturers of aeroplanes namely, Airbus & Boeing. Thus, the bargaining power of suppliers in the aviation industry is very high which means they have the power to quote prices, quality, discounts according to their needs.

The main factors that influence industry performance in terms of the bargaining power of suppliers are

-Number & size of suppliers
-Ability to substitute
-Uniqueness of services

Bargaining power of Buyers

The complete opposite happens when the bargaining power lies with the customers. If there are plenty of suppliers and very less customers. The bargaining power goes into the hands of buyers/customers. 
Where customers will have an upper hand to quote prices, quality, discounts and more. 
The main factors that influence industry performance in terms of the bargaining power of buyers are

-Number of customers
-Differences between competitors
-Price Sensitivity
-Ability to substitute
-Cost of changing

Threat of Substitutes

We all know that the Airline business is very competitive. And the substitute for Airplanes is train, car, ship, bus. It might take a longer time to reach the destination from the substitutes we discussed but substitutes can also be cost-effective. This is known as the threat of substitutes. In the case where there is no option for substitutes and you have to take a flight. Then the threat becomes competitors who offer better rewards and prices for a better flying experience. 

I hope you understood this, this is how you analyse an industry with Porter’s five forces. Moving ahead we will see how to analyse an industry through SWOT. 

Swot Analysis

SWOT analysis is the process of identifying the Strengths, Weaknesses, Opportunities & Threats a company has over its competitors. 

For your better understanding, let's again take the aviation sector into consideration.

Strength of Airline Industry

Under this, you have to look for the unique factors in an industry which will help it stand out against other competitors. The biggest strength of the Airline industry is its safe and fastest mode of transportation.

Weakness of Airline Industry

Here you have to identify the weakness that can take the Airline industry downhill. The most common weaknesses are poor aviation infrastructure in most of the developing countries. Also, airlines face a very high rate of cancellations. 

Opportunities of Airline Industry

This section covers the growth factors in an industry. As far as airlines are concerned the opportunities in this space is, growth in tourism, how cheap airline fares are becoming and more. 

Threats of the Airline Industry

Well, the best example to explain this is, just to take a look at how Covid19 situation threatened the Airline industry. So, this section deals with the prospect danger an industry can face. 

We really hope that you understood the concepts that we tried to explain to you here. Stock analysis is a tricky process and analysing the industry is just the beginning. Recipe by Finology understands how time taking the process can be and they have simplified this process for you with their feature called, Recommendations where you will find hand-picked Stock & Mutual fund recommendations hand-picked after endless brainstorming only for you because you are special!

 

That's all for today. If you have any queries regarding the concept you learned today, feel free to comment and ask or you can also write us at support@finology.in. Until then, Happy Investing! 

About the Author: Ayushi Upadhyay | 234 Post(s)

A Keen Learner.
Passionate for Creative Writing & Finance!

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