Understanding the competitiveness of an industry
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Written byCFI Team
What is Industry Analysis?
Industry analysis is a market assessment tool used by businesses and analysts to understand the competitive dynamics of an industry. It helps them get a sense of what is happening in an industry, e.g., demand-supply statistics, degree of competition within the industry, state of competition of the industry with other emerging industries, future prospects of the industry taking into account technological changes, credit system within the industry, and the influence of external factors on the industry.
Industry analysis, for an entrepreneur or a company, is a method that helps to understand a company’s position relative to other participants in the industry. It helps them to identify both the opportunities and threats coming their way and gives them a strong idea of the present and future scenario of the industry. The key to surviving in this ever-changing business environment is to understand the differences between yourself and your competitors in the industry and use it to your full advantage.
Learn more in CFI’s Corporate & Business Strategy Course.
Types of industry analysis
There are three commonly used and important methods of performing industry analysis. The three methods are:
#1 Competitive Forces Model (Porter’s 5 Forces)
One of the most famous models ever developed for industry analysis, famously known as Porter’s 5 Forces, was introduced by Michael Porter in his 1980 book “Competitive Strategy: Techniques for Analyzing Industries and Competitors.”
According to Porter, analysis of the five forces gives an accurate impression of the industry and makes analysis easier. In our Corporate & Business Strategy course, we cover these five forces and an additional force — power of complementary good/service providers.
The above image comes from a section of CFI’s Corporate & Business Strategy Course.
1. Intensity of industry rivalry
The number of participants in the industry and their respective market shares are a direct representation of the competitiveness of the industry. These are directly affected by all the factors mentioned above. Lack of differentiation in products tends to add to the intensity of competition. High exit costs such as high fixed assets, government restrictions, labor unions, etc. also make the competitors fight the battle a little harder.
2. Threat of potential entrants
This indicates the ease with which new firms can enter the market of a particular industry. If it is easy to enter an industry, companies face the constant risk of new competitors. If the entry is difficult, whichever company enjoys little competitive advantage reaps the benefits for a longer period. Also, under difficult entry circ*mstances, companies face a constant set of competitors.
3. Bargaining power of suppliers
This refers to the bargaining power of suppliers. If the industry relies on a small number of suppliers, they enjoy a considerable amount of bargaining power. This can particularly affect small businesses because it directly influences the quality and the price of the final product.
4. Bargaining power of buyers
The complete opposite happens when the bargaining power lies with the customers. If consumers/buyers enjoy market power, they are in a position to negotiate lower prices, better quality, or additional services and discounts. This is the case in an industry with more competitors but with a single buyer constituting a large share of the industry’s sales.
5. Threat of substitute goods/services
The industry is always competing with another industry producing a similar substitute product. Hence, all firms in an industry have potential competitors from other industries. This takes a toll on their profitability because they are unable to charge exorbitant prices. Substitutes can take two forms – products with the same function/quality but lesser price, or products of the same price but of better quality or providing more utility.
#2 Broad Factors Analysis (PEST Analysis)
Broad Factors Analysis, also commonly called the PEST Analysis stands for Political, Economic, Social and Technological. PEST analysis is a useful framework for analyzing the external environment.
The above image comes from a section of CFI’s Corporate & Business Strategy Course.
To use PEST as a form of industry analysis, an analyst will analyze each of the 4 components of the model. These components include:
1. Political
Political factors that impact an industry include specific policies and regulations related to things like taxes, environmental regulation, tariffs, trade policies, labor laws, ease of doing business, and overall political stability.
2. Economic
The economic forces that have an impact include inflation, exchange rates (FX), interest rates, GDP growth rates, conditions in the capital markets (ability to access capital), etc.
3. Social
The social impact on an industry refers to trends among people and includes things such as population growth, demographics (age, gender, etc.), and trends in behavior such as health, fashion, and social movements.
4. Technological
The technological aspect of PEST analysis incorporates factors such as advancements and developments that change the way a business operates and the ways in which people live their lives (e.g., the advent of the internet).
#3 SWOT Analysis
SWOT Analysis stands for Strengths, Weaknesses, Opportunities, and Threats. It can be a great way of summarizing various industry forces and determining their implications for the business in question.
The above image comes from a section of CFI’s Corporate & Business Strategy Course. Check it out to learn more about performing SWOT analysis.
1. Internal
Internal factors that already exist and have contributed to the current position and may continue to exist.
2. External
External factors are usually contingent events. Assess their importance based on the likelihood of them happening and their potential impact on the company. Also, consider whether management has the intention and ability to take advantage of the opportunity/avoid the threat.
Importance of Industry Analysis
Industry analysis, as a form of market assessment, is crucial because it helps a business understand market conditions. It helps them forecast demand and supply and, consequently, financial returns from the business. It indicates the competitiveness of the industry and costs associated with entering and exiting the industry. It is very important when planning a small business. Analysis helps to identify which stage an industry is currently in; whether it is still growing and there is scope to reap benefits or has reached its saturation point.
With a very detailed study of the industry, entrepreneurs can get a stronghold on the operations of the industry and may discover untapped opportunities. It is also important to understand that industry analysis is somewhat subjective and does not always guarantee success. It may happen that incorrect interpretation of data leads entrepreneurs to a wrong path or into making wrong decisions. Hence, it becomes important to collect data carefully.
Additional Resources
Thank you for reading the CFI guide to industry analysis. To continue advancing your skills as a financial analyst, these additional CFI resources will be of value:
