Building a Robust Industry Analysis Framework
Leveraging industry insights for investment decisions
I’m not going to say that I go around looking for good industries to invest in. I’m not that type of top-down investor. Nevertheless, doing a really deep dive on industry dynamics and competitors can often provide further insight into the specific company I’m researching.
That’s the reason why I’ll be sharing the different parts of my process in this article. Hopefully, by the end, you will have a good structure to fully understand a sector and its various implications for the company you are interested in.
So let’s begin with a good ol’ historical analysis.
Temporal Tapestry: Weaving Through Years of Industry Insights
Not to say that I was surprised by the number of insights you can gain from going the extra mile and studying the last 10 years of history in a specific sector; but certainly, understanding the forces that shaped the current ecosystem is a great point to start.
Below I share my plan to carry out this task in an orderly manner:
Create a timeline with key events in the industry: identify inventions, regulations, mergers and acquisitions, entries and exits of major players, crises, etc.
Technological evolution: consider how the adoption of new technologies has transformed business models, operations and competition.
Regulation and policy: study the government regulations and policies that have influenced the industry.
Competitive dynamics: analyze Porter's forces to understand competitive dynamics over time (more on this below).
Economic and macroeconomic factors: examine how economic events (such as recessions or booms) affected the industry.
Change in consumer behaviour: understanding how consumer needs and wants have evolved. Evaluates the impact of cultural, social and demographic trends on the industry.
Entry and exit of key players: analyze the entry of new competitors or the exit of historical players and how this reconfigured the competitive landscape. See the impact of disruptive or innovative companies that have changed the rules of the game.
Geographic analysis: If the industry operates in multiple geographies, consider how different regions or countries have influenced the evolution of the industry. Examines geopolitical events that could have affected the industry.
Although carrying out this type of analysis takes time, it can help me detect aspects of the company's operation that I had overlooked, or at the same time discover new opportunities or trends in which the company may have strengths or weaknesses.
What are the sources that can be used to conduct this in-depth research? Below I share the most common ones.
Annual reports and company presentations: leading companies in an industry often provide valuable information on sector developments, competition, risks and opportunities in their annual reports.
Market research databases: there are some specialized databases but generally these reports have an additional cost.
IBISWorld: Provides detailed industry reports including statistics, analysis and trends.
Statista: Extensive database of statistics covering many industries.
MarketResearch.com: Reports on a variety of sectors.
Industry organizations and associations: Many industries have associations or trade groups that publish reports, studies and statistics about the sector.
Specialized publications: Depending on the industry, there may be specific magazines or publications that cover news, trends and analysis of the sector.
Books and academic publications: You can search Google Scholar or academic databases such as JSTOR to find studies and articles related to the evolution of a particular industry.
Interviews with sector experts: clearly if you have access, interviewing experts, veterans or academics who specialize in the industry is one of the best sources of information.
YouTube videos: not surprisingly it is worth doing an in-depth search on YouTube since there are often documentaries or interviews that can provide valuable information.
Government agencies and regulatory bodies: depending on the industry, government agencies may have reports, statistics and other relevant data. Examples: the Federal Trade Commission (FTC) in the US or the European Commission in the EU.
Well, now that we have all this information we should have a fairly clear idea of ​​what are the forces that affect the industry, what are the opportunities and what are the threats that are going to affect companies in the sector.
At this point, I may start to wonder how profitable are those companies?How’s industry ROIC distribution? Michael Mauboussin provides some context in relation this.
The ROIC Spectrum: Evaluating Industry Profitability Landscapes
As you know, ROIC, or return on invested capital, measures how profitable business operations are based on the capital that has been invested in the company. Now, how does this metric pan out across a sector or industry?
Basically, you can have two types of scenarios: a concentrated cluster of returns or wide dispersion.
If I see that there are many companies with consistently good levels of ROIC over the years, it means there are good chances of choosing a company that results in a good investment. Of course, the opposite can happen: a concentration of companies with lousy returns and only a handful of exceptions.
Michael Mauboussin did a lot of research on this, an indeed, you have industries like Paper & Forest Product where most of the companies destroy shareholder value. On the other and you have industries like Communications Equipment where the opposite occurs.
Each graph below shows the distribution of companies for each level of CFROI (-) Discount Rate as a way to approximate how much value the company is generating for shareholders.
Catching the Breeze: Identifying Industries with Tailwinds
I like industries with tailwinds, this makes things easier when it comes to the management team executing and delivering results.
What are some industries that have tailwinds today? I can think of AI, defence, renewable energy, payment platforms, cybersecurity, etc.
Where to look for how the industry is trending? I look for a reports from associations or industry analysts where they show the historical growth rate and projections.
Another thing I do is search [Google Images] for the industry name plus "growth projections" or something like that. This is an easy way to find charts from industry reports. Of course you have to check the source but this is a good way of finding the information.
An industry growing at almost 9.7%, like cybersecurity is definitely above average.
Industries growing at 20%, such as the artificial intelligence chip production, are exceptional cases but can also be found from time to time.Â
A company that is growing faster than the industry is definitely a good prospect, especially because in the long term, growth rates should first converge with the industry and then with the economy as a whole.
What I try to assess here is: What needs are companies in that industry covering? Will these needs be maintained over time?
It is for this reason that I classify industries in terms of trends using these two dimensions: positive/negative and structural/temporal.
If the trend is positive and structural then I can rest assured that the company will continue to have tailwinds in the future.
Industry-Specific Strategies from Mauboussin’s Playbook
Michael Mauboussin places great emphasis on the analysis of Porter's Five Forces to really understand how an industry works. However, he also refers to structural analysis and points out what aspects should be emphasized during the analysis.
Below, I share the table where opportunities are mentioned according to the type of industry structure you are analyzing. This classification offers guidance on which aspects you should emphasize when performing the analysis. For example, the challenges in a mature industry are likely to be very different from those in an emerging industry.
Strategic Levers: Exploring the Bargaining Power within Industries
Yes, these are the classic Porter's Five Forces. You have probably learned about this tool in school or university, and I do not want to sound like a broken record.
Yet, I find it interesting to delve into these three here:
Bargaining power of suppliers: it will influence how the company manages price, quality and service with customers. If the company cannot adjust prices due to suppliers with high bargaining power, the industry is less attractive. Suppliers prosper if they have greater concentration, few substitute products, high switching costs, or if their product is vital to the buyer. Sellers of common products face more challenges than those of unique products.
Bargaining power of buyers: depends on factors such as the concentration of buyers, switching costs, available information, existence of substitute products and the relevance of the product to the buyer.
Entry barriers: lastly, this aspect has to do with the protections that exist in the industry to prevent the entry of new players. A very important concept in this case is that of moat or sustainable competitive advantage, which I will discuss in future articles.
Substitute products: products that cover the same needs can affect margins and operations of the company. Being clear about which are these product or services is a good way to anticipate potential threats.
Now, as you may remember, the last force is Industry Rivalry. Since analyzing competitors is such an important part of the investment process, I will cover it in the next section.
Unpacking Competitiveness Across Industries
Below, I share different aspects on which I base my analysis of a company's competition. This approach helps to comprehensively understand the competitive landscape and identify key factors that can influence investment decisions.
1) Industry Rivalry - How many competitors does the company have?
The fewer competitors, the better. Generally, more profitability is observed when there is less competition. This is good for investors and bad for consumers, of course.
At one extreme, we have a totally monopolistic situation, and at the other, an industry with perfect competition.
A good way to assess competitors is to look at the 10-Ks and note what comments the management team makes about the competition. Generally, if there are few players in the industry, they may name them one by one.
2) Industry Rivalry - What is the speed of change in the industry?
There are industries in which the speed of change is tremendous, such as tech, while in other industries the rate of change is much slower.
To highlight this aspect, it is advisable to understand the customers' needs and observe how current products or solutions are meeting these needs. If there is significant potential for innovation, it likely indicates that the industry is prone to disruption.
3) Industry Rivalry - In what dimensions do you compete?
Generally, these are some dimensions in which companies compete:
Capital: which company has the advantage? Are the largest companies in the sector the ones that have an advantage because they have more capital to invest and therefore can undertake larger investment projects?
Service: is customer service one of the essential factors that customers analyze when making a purchasing decision? How is the company I want to invest in positioned in this regard?
Quality: is product quality the main attribute that customers value when making a purchasing decision?
Price: if you compete solely on price and face recurring price wars, it becomes very difficult for the company to improve its margins. Any improvements will typically arise from cost reductions and enhanced efficiency, but these strategies have their limits; there’s only so many efficiencies you can gain.
The most effective way to assess the most important dimension in which a company is competing is by asking the customers directly. There's no substitute for engaging with customers to understand their priorities and needs.
4) Industry Rivalry - How fierce is the competition?
To analyze how challenging the competition is within an industry, I look at different aspects of the industry:
The size of the players that make it up. Industries with many companies of similar size competing for the same customers are likely to present much more challenging competitive environments than sectors where there are dominant players that set the standard for the playing field.
Industry growth rate. If I’m looking at a mature industry where growth is flat or stagnant, there is probably high competition as players have to gain market share from each other. On the other hand, in growing industries where the pie is getting larger, the level of competition or rivalry between players may be much lower.
CAC analysis. If the customer acquisition cost is increasing sharply during recent periods, it may be that the industry is becoming more and more competitive.
Operating costs per unit, per customer or per transaction. Check if they are increasing or not. Again, a sudden increase can mean a tightening of competition.
Finally, I conduct a general qualitative assessment. There are often articles in the specialized press that comment on the competitive situation of the industry and its profitability. A simple Google search using keywords such as "industry + profitability" can yield articles with relevant information on the topic.
5) Industry Rivalry - Competition from other countries?
There are industries where competition from other countries is non-existent, whether due to regulations, tariffs or it is simply an economic result due to the fact that transportation costs represent an important part of the final cost of the product.
For example, in commodities that come from a mine and where the extracted mineral has a very low cost per ton, the incidence of transportation costs will be decisive when evaluating which are the possible competitors for the products of that mine.
On the other hand, just as economic factors can protect the company, they may also make it more exposed. In the case of labor-intensive industries, foreign companies with lower labor costs can create a competitive problem for the company in its local market.
6) Industry Rivalry - What is the best company in the industry?
A good way to understand which characteristics of companies are most important in the industry is to analyze the best and worst companies in the sector and then compare them with each other.
Seeing the contrast between them helps to understand how they evolved and why they did it that way.
What are generally the best companies in the sector? Those that have better operating margins, higher returns on invested capital and a shorter cash conversion cycle.
Creating a table with the annual evolution of the margins of each company in the industry can help you see the differences and how they have evolved over time.
7) Industry Rivalry - Why have other industry players failed in the past?
Finally, analyzing companies that have gone bankrupt or have withdrawn from the industry as a result of failed strategies can also help to have a more complete picture of what the competition has been like in the past and what the results of those dynamics have been.
Investment Checklist
To provide a little bit more structure to the analysis, I share below a complete checklist I use to help me with a deeper understanding of the industry.
What is the historical growth rate of the industry? - It is essential to know past growth to establish trends and predict possible future scenarios. An industry with a strong growth history can present attractive investment opportunities.
Is there dispersion between the ROIC of companies in the sector? - If there is a lot of dispersion between the ROIC of each of the companies in the sector, then it means that the industry in general is not so good at generating good returns since there are companies that do it very well but we also have many companies that are not delivering good results.
Are there many companies in the industry with good ROIC levels over time? - If we see that there are many companies that have consistently good levels of ROIC over the years, it means that there are good chances of choosing a company that results in a good investment.
What are the needs that companies in that industry are covering? Are they going to be maintained over time? - Classify the industry in terms of trend using these two dimensions: Positive/negative Structural/temporal.
What key developments have happened in the industry over the last few years? - These events, whether inventions, mergers, crises or regulatory changes, can significantly influence the performance and direction of an industry. By identifying them, you get a clearer view of the path the industry has taken and how these events have affected its current state.
Is there a recognizable economic or seasonal cycle affecting the industry? - Some industries may have predictable patterns of ups and downs throughout the year or in response to economic cycles.
How vulnerable are companies in the industry to fluctuations in raw material prices? - For industries that depend on certain inputs, fluctuations can have a significant impact on profitability.
Is there a history of mergers and acquisitions in the industry? - A trend toward consolidation may indicate a mature industry, while a high level of acquisitions could signal expansion and growth.
How has technological evolution impacted the industry? - Technology is a driving force that can completely transform business models, operations and competition in an industry. Technological innovations can create new opportunities or threaten the viability of established business models.
What government regulations and policies have influenced the industry? - Regulations can facilitate or restrict the growth and operations of companies in an industry. Understanding these influences is essential to evaluate the barriers to entry, risks and opportunities associated with the industry.
How have competitive dynamics evolved over time? - Porter's forces provide a useful framework for understanding how competitive relationships in an industry have changed and how this might influence investment prospects.
What economic and macroeconomic events have affected the industry? - Recessions, booms and other economic events can have a profound impact on the health and direction of an industry.
How has consumer behaviour changed in relation to the industry? - Cultural, social and demographic trends can alter consumer demands and expectations. Understanding these changes is essential to anticipate future market demands and evaluate the position of companies in relation to these trends.
What impact have the entry and exit of key players had on the competitive dynamics of the industry? - Disruptive or innovative companies can completely reconfigure a market. Analyzing how the entry or exit of these companies has affected the industry can provide insights into barriers to entry, competitive threats, and investment opportunities.
What is the overall financial health of the industry's top companies? - Analyzing financial strength, such as debt levels and cash reserves, can give insight into the stability of the industry.
Is there a significant dependence on finite resources or environmental factors? - Industries that rely on depleting resources or face environmental criticism may present long-term risks.
How have different geographies influenced the evolution of the industry? - Industries that operate globally may be affected by geopolitical events and regional differences in demand, regulation and competition. It is vital to consider these influences when evaluating the competitive landscape and prospects for an industry.
What is the bargaining power of suppliers? - The bargaining power of suppliers determines how a company manages price, quality and service with its customers. If suppliers have high bargaining power, they can put pressure on companies, which can make the industry less attractive for investment. The concentration of suppliers, the lack of substitute products, high switching costs, and the importance of their product to the buyer can strengthen the power of suppliers.
How does the bargaining power of buyers affect companies in an industry? - This power depends on several factors, such as the concentration of buyers, switching costs, available information, the presence of substitute products, and the relevance of the product to the buyer. When buyers have significant bargaining power, they can pressure companies to reduce prices or improve quality, which can affect the profitability of companies in that industry.
What are the barriers to entry? - Entry barriers refer to the protections or difficulties that exist in an industry to prevent or hinder the entry of new competitors. These barriers may include high initial costs, patents, limited access to distribution channels, among others. An industry with high barriers to entry is generally more attractive to invest in because it protects established companies from potential competition.Â
What is customer loyalty like in the industry? - Customer loyalty can indicate the strength of the relationships between companies and their customers. High loyalty can mean recurring revenue and less susceptibility to market fluctuations.
What level of investment in research and development (R&D) is seen in the industry? - Industries with high investment in R&D may be more oriented towards innovation and have a greater probability of adapting to market changes.
How are companies generally financed within the industry? - Knowing the predominant capital structure can offer clues about the financial stability of the industry.
Is there a geographic concentration of companies in the industry? - A high concentration in a specific region can make the industry vulnerable to local factors, such as natural disasters or government policies.
What is access to raw materials like? - The availability and cost of raw materials can directly influence the profit margins of companies in certain industries.
What impact do changes in interest rates have on the industry? - Some industries are especially sensitive to changes in interest rates, which can influence their financing decisions and investment capacity.
Is there a significant dependence on specific distribution channels? - If an industry relies heavily on a specific type of distribution channel, any disturbance in that channel could affect its performance.
What is the cost structure like in the industry? - Understanding the cost structure can give insight into profit margins, operational efficiency, and flexibility to adapt to changes.
How many competitors does the company have? - The fewer competitors the better, generally more profitability is observed if there is less competition. This is good for investors and bad for consumers, of course.
What is the speed of change in the industry? - To highlight this aspect, it is advisable to understand what the client's needs are and see how current products or solutions are satisfying those needs.Â
In what dimensions does the company compete? - Understand well what things customers value when making a purchasing decision and see how the company in which you plan to invest is positioned.Â
How many companies of similar size are competing for the same customers? - Industries with many companies of similar size fighting for the same customer segment tend to be more competitive. These scenarios can result in price wars or increases in marketing expenses to gain market share.
Are there dominant players who determine a standard for playing conditions in the industry? Dominant players often set standards that others must follow. These leading companies can influence trends, prices, and more. Analyzing its presence gives you an idea of ​​the market structure.
Is the industry mature with flat or stagnant growth? - Mature industries tend to have fiercer competition, as companies seek to capture existing market share rather than explore new markets.
Has CAC (customer acquisition cost) been increasing in recent periods? A growing CAC suggests that it is costing more to attract each customer, which may be a sign of more intense competition or changes in customer behaviour.
Have operating costs been tracked per unit, per customer, or per transaction? - Controlling these costs is essential to understanding efficiency and financial health. If these costs are increasing, it may be a sign of operational problems or more intense competition.
What results does a Google search with the keywords "industry + profitability/profitability" return? - The results of this search can offer an overview of the financial state and health of the industry, giving an idea of ​​​​its profitability and long-term sustainability.
What are the substitute products? - Being clear about which products or services cover the same needs as your company's products is a good way to keep on your radar which ones may be a potential threat.
Competition from other countries? - There are industries where competition from other countries is non-existent either due to regulations, tariffs or it is simply an economic result due to the fact that transportation costs represent an important part of the final cost of the product.
What is the best company in the industry? - Those that have better operating margins, higher returns on invested capital and a shorter cash conversion cycle. Creating a table with the annual evolution of the margins of each company in the industry can help you see the differences and how they have evolved over time.
Why have other industry players failed in the past? - Analyzing companies that have gone bankrupt or have withdrawn from the industry as a result of failed strategies can also help to have a more complete picture of what the competition has been like in the past and what the results of those dynamics have been.
How do demographic trends affect the industry? - Changes in the population, such as aging or growth, can have significant impacts on the demand for certain products or services.
Conclusion
Before making an investment decision, it is necessary to resort to all the information available about the industry in which a company operates, since this can have implications for future business performance.
I hope that with this article you now have a more complete picture of all the dimensions that involve a complete analysis of the industry.Â
Sources
Mauboussin, M. J., & Callahan, D. (2013). Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation. Swiss credit. http://csinvesting.org/wp-content/uploads/2013/07/Measuring_the_Moat_July2013.pdf
Shearn, M. (2011). The Investment Checklist: The Art of In-Depth Research. [Hardcover edition]. Publication date: November 8.
Mauboussin, M. J., & Callahan, D. (2022, September 15). Market Share: Understanding Competitive Advantage Through Market Power. Consilient Observer: Counterpoint Global Insights.
Dorsey, P. (2008). The Little Book That Builds Wealth: The Knockout Formula for Finding Great Investments. Publication date: March 5.