How Accurate Are Your Industry Growth Forecasts?

Industry Growth Forecasts are used more than any other area of Industry Analysis, and for obvious reasons. They’re used to determine the strategy and direction of the business over the medium to long term, to guide risk mitigation strategies, and can ultimately impact the growth rates and business projections of the company employing them. Given the implications, it would seem prudent that the validity and reliability of such forecasts are well vetted, but this isn’t always the case.

For Marketers & Strategists who understand the power of Industry Analysis in the overall Market Data & Information mix, there are a number of concerns; Geographic/ Global coverage (fit to their Market presence), level of Major Player / company detail, etc. However, during the ‘risk versus reward’ stage of the buying process, a trade off occurs. Companies are willing to sacrifice quality coverage of a single market for sweeping coverage of many markets. In a big picture context, this could be a huge mistake.

Every Market Research company; whether using off-shore Sub-Continent outsourced researchers, or in-house analysts can collect data. Putting together a report on Industry Operating Conditions, Barriers to Entry, Life Cycle, Major Players/ Companies in the Industry, the Products and Markets then guess-timating the Forecast for that Industry is par for the course. Some of the better Market Research Companies will even use Regression Analysis and other statistical models to better validate their predictions. So what’s the difference, and why does it matter?

The single most important factor is Granularity.

Granularity

Lets take the example of a Credit Risk manager at a Bank. Banks need to assess the portfolio exposure of their loan origination strategies. Too many loans to one industry can leave them over exposed to a situation where un-expected price shocks occur, such as interest rate change. With capital tied up, they then cant lend to other, safer Industries. A  clothing retailer comes to the bank for a business loan. The underwriters and portfolio analysts do some regression analysis on the company and then look at the Industry Growth forecast, and work out their current level of Risk and exposure, and reserve capital on hand based on the outlook.

If that Bank has an ‘aggregated’ Industry report, then the decision they’re making will be flawed. Here’s why: an aggregated industry report dilutes the real outlook of the Clothing Sector within overall Retail. When you take an average of all Sectors within an Industry and produce a forecast, well it’s clear you can expect an average Forecast. This is why granularity is critical. Having a clear assessment of the specific sector within an industry will enable Risk Managers to get a handle on the Clothing Retail sector, as opposed to getting the watered-down aggregate forecast for the whole of the Retail Sector.

How Does this Apply to Other Firms?

The result for the bank will be a more accurate and balanced portfolio when using granular industry Growth Forecasts. The result for other businesses will be more accurate business plans and profit projections. Say you’re a software provider that can provide pay roll services. You want to decide whether to invest efforts & capital in the Retail or Healthcare over the next 5 years. The ‘aggregate’ reports tell you Healthcare will be better than Retail. However if you had Granular reports, written to the appropriate Standard Industry Classifications (ie the level at which Industries operate, and are audited at by Government & Regulatory bodies), you may find that the largest sector of Retail will be more profitable over the next 5 years than the largest Healthcare sector. You’ve just made a decision to steer your business in a direction that will be far less profitable than it could otherwise have been.

What to Look For When Evaluating Industry Analysis & Market Research:

Quite simply, the fewer the sectors covered in any single Market/ Economy, the easier it is to identify whether Growth Forecasts will be inaccurate. These other factors that can also be of assistance.

1-      Look for Providers that detail forward-looking Key External Drivers

2-      Look for Providers that have a very large Supply Chain Collection in each Market

3-      Look for Providers that offer Granularity at the Industry Sector rather than product level (eg SIC codes)

4-      Look for providers who update reports frequently throughout the year

Key External Drivers

KED’s are the factors outside a Firms’/ Managers control. These are the Factors Michael Porter claims account for 20% in variation of a company’s profits, and having a handle on these factors will allow you to build ahead of time Risk Mitigation to adverse Market Conditions. When Regression Analysis on company growth and profitability is put against granular KED’s, you’ll get a much more accurate forward looking view of where a Sector is headed and how profitable it will be.

Supply Chain

It stands to reason that the sample size from which you draw your research and analysis will be important. A smaller, more aggregated group of Industries clusters will never yield the accuracy and reliability you can achieve from wider Market Coverage. Industries share similar supply chains, and no Company or Industry operates in isolation. The broader the market coverage the more accurate your Growth Forecast will be. Key External Drivers will affect multiple Industries within a Supply Chain, so you may want to know the impact changes in KED’s will have on your Markets and their interconnectivity. Even if you don’t operate outside a handful of Industries, those Industries all have Supply Chains of which could offer your further growth opportunities- or threaten your profitability- if you don’t have a handle on the bigger picture of your markets and clients.

SIC Codes

Standard Industry Classification codes are a fantastic way to categorise sub-sectors of Industries, and underpin the axiom that the sum of the parts are greater than the whole. If a Forecast for each sub-sector within the aggregated Retail sector is done aligned with an appropriate SIC code, then Forecasts can tell decision makers what the specific sector will yield, and much more accurately give an indication of the aggregated Retail sector outlook. Decision Makers can then tailor product and service mix and marketing to where it will reap the most reward for the business. The impact of this is greater overall profitability, and stronger competitive advantage. The other reason to look at SIC codes is that Government & Regulatory bodies need to get a handle on these Industries and the company within them to in order to levy them appropriately. Having audited results and government statistics added into Industry Analysis at the SIC level will add further reliability to the overall Forecast.

Updates

If Forecasts drive your strategy, which for most larger forms and specialist SME’s they do, then you may want Industry Analysis that’s updated frequently, even if you only look at your business plans once a year. Key External Drivers and macroeconomic factors can change quickly and cause shocks to Industries and their supply chains. What you plan now may not be as valid in 6 or 12 months. A good solution/ tool will re-assess the forward looking KED’s, Technological Changes, and Supply Chain factors, and re-write their content so that your Marketing and Business Development people ‘on the front lines’ have the most accurate and up to date issues and trend information. Going to Market using out dated information can make you look inept, and raises the level of perceived risk for clients you wish to do business with. Keeping up to date on trends and issues will ensure your clients maintain strong belief in your capability, and trust you as an expert not only on their business but the environment they operate within.

Conclusion

Firms and Decision Makers who use Industry Analysis do so to gain competitive advantage. Larger Firms who operate across multiple markets need to be wary of the ‘shotgun’ approach to Industry Analysis. Having average coverage across multiple markets will only cost you the competitive advantage you’re seeking if smaller, more lithe firms in your key markets are looking at Industry Analysis in a more targeted, granular manner, and are therefore making better strategic decisions. Take the time to consider the opportunity – and profitability- costs of having a one-size-fits-all tool.  If you have aggregated information driving your strategies and you aren’t as successful as you would like to be, at least one reason why that is should be obvious.

Summary

  • Forecasts drive your strategy, and therefore you should always ensure you have the most up to date and accurate forecast available.
  • The more Granular the Industry Sector coverage, the more likely the Industry Forecast will be accurate, and therefore the sounder your business decisions will be
  • When identifying which vendor to look to, or which forecast to trust to support your business decisions you should look for a vendor whose reports include”

–          Key External Drivers

–          Broad Supply Chain Collection

–          Standard Industry Classification codes within Industries

–          Regular Updates

  • Don’t apply a ‘shotgun’ approach to Industry Analysis for the sake of multiple market coverage; you may be trading off Key Market competitive advantage to more agile competitors who will look at one market from a Granular, end-to-end perspective.

Mike works for leading Industry Analysis publisher IBISWorld www.ibisworld.co.uk

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The Importance of Industry Analysis With Financial Analysis

Why Use Industry Analysis When I Use Financial Analysis?

Financial ratios are one excellent way to analyze your financial position. However, they mean nothing in isolation, as the performance of a company is a function of the performance of the industry. Anyone who has subscribed to Standard & Poor’s Credit Ratings prior to the GFC can attest to this.

To bring this down to a very basic example, let’s say you calculate your debt ratio at 50%. What this means is that 50% of your firm is financed with debt and 50% with equity. Is this good or bad? This is where comparative data comes in. With comparative data, then you can have some basis for comparison and can determine whether your debt ratio is appropriate for your firm. Presumably, you have previous years of balance sheet data for your business. It’s also helpful to calculate the financial ratios for several years so you can track the Trends in your ratios.

Just as important as this Trend Analysis is Industry Analysis. It’s critical, particularly in today’s economic climate, to know how your industry is performing compared to your company. For example, if your industry’s ratios are much different than your firms, you want to examine these factors and take action accordingly. Are you performing better than the Industry? Is the Industry outperforming your firm? Why? You need to do both Trend and Industry analysis for every financial ratio you calculate to get the complete picture for your firm. There are two key reasons why you need to do this:

1-      Take advantage of ‘tailwinds’ that will provide current and future competitive advantage.

2-      Mitigate Risk relating to trends and Drivers outside a Manager/ Investors control.

As another example of the importance of Industry Analysis, let’s take a stock. Regardless of the quality of the stock, it is highly unlikely to outperform if the industry is performing poorly. This is due to the simple reason that most prices are driven by large financial institutions that buy and sell the majority of the volume of stocks. Institutions generally give a very heavy weighting to the current, and expected performance of a specific industry. After market risk, this is widely regarded as the most influential factor in the performance of a stock. As no company operates in isolation, and performance of a company is a function of the performance of the Industry, analyzing the current and expected performance of the Industry (Top Down approach) is crucial.

In fact Industry analysis is also a function of Market Risk; taking into account interest rates, foreign exchange rates, and commodity prices as Key External Drivers that affect an Industry under review- and their impact upon sensitivity in supply chains. These supply chain sensitivities are what Portfolio and Risk Managers look for and can be called ‘Risk Pockets /Buckets’. Why are they important? : How would a decline of 10% in key driver like household spending, or collapse in a key supply chain sector like construction affect the overall exposure or leverage of your portfolio? In simple business terms, what impact would this have on revenue and performance?

Generally, there are two reasons why Industry Analysis is important from an investment perspective:

1-      The performance of a company is a function of the performance of the industry. (eg if the price of oil goes up for an industry that is reliant on oil then all the companies in the industry will be affected, as will many supply chain industries and their companies)

2-      Market Herd Mentality:  If an industry suddenly becomes popular, or if a sudden change in the news is perceived to be good or bad for an industry, the price of the stock will be affected by the average investor’s perceptions, and most investors will follow industry trends.

Also of importance to note; a specific industry cycle is not necessarily the same as the business cycle. In many cases a specific industry may outperform or even drive in the opposite direction to the general economic cycle (counter-cyclical industries). Even within Industries, revenue volatility is a key factor to analyse as revenues can jump and crash, even though that Industry may experience overall growth of 0.1%

Painting a Clearer Picture of Financial Analysis:

There are downsides to using financial statements, too though.  As a colleague of mine- Stuart Hoffman- pointed out to me, two examples can highlight those downsides:

“Consider the case of the owner of the Cleveland Indians, Dick Jacobs.  In anti-trust testimony before Congress, Major League Baseball claimed the Indians’ revenue for 1998 at $125.74 million and 1997 at $113.75 million.  When Jacobs took 30% of the Indians public in 1998, he had to provide a prospectus.  The prospectus stated 1998 Revenue at $144.55 million and 1997 Revenue at $140.03 million.  Jacobs explained, “Under generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss and I can get every national accounting firm to agree with me.

The second example is Enron.”

What these examples really point to is that what goes into the model will determine what comes out of it. Data is key.

A novel way of demonstrating the importance of industry information is to compile a list of industries that have been adversely affected by technology.   Financial statements don’t address how technology might affect a company. This is because Financial Analysis is backward looking.

Financial Analysis ultimately only relates how successful a company is- or has been- until today. It is Industry Analysis that will be able to relate the performance of the company to the Industry and the Industry to the economy. Taking into account the impacts of Technology, Key External Drivers, and Supply Chain factors, coupled with the current/ historical performance benchmarks will determine the likely performance of the Industry, and therefore a significant determinant of how a company or stock will perform in the future.

Conclusion:

Industry Analysis adds a buffer to models and assumptions that pure quantitative financial models can’t account for.

Looking at the Key Success Factors that result in the success of the Major Players in an Industry will is also a strong indication of what will see a company or stock perform well in the future.

Ultimately, Industry Analysis assists decision makers with broader perspective, and a forward looking approach providing greater insight and oversight than reliance upon Financial Analysis alone.

Summary:

  • No company operates in isolation; the performance of a company is a function of the performance of the industry
  • Industry Analysis identifies Performance Benchmarks
  • Industry Analysis identifies Market & Operating Risk
  • Financial Analysis has significant limitations
  • Financial Analysis does not account for the impact of Technology on Industries and companies.
  • Financial Analysis is backward Looking
  • Industry Analysis enables you to understand what will make a company (or stock) successful in the future.
  • Industry Analysis if a forward looking predictor of performance
  • Industry Analysis provides a layer of judgement to Financial Analysis which gives greater predictive insight

Mike works for leading Industry Analysis publisher IBISWorld www.ibisworld.co.uk

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Why Industry Analysis Matters

What is Industry Analysis?

No company operates in isolation. According to Harvard Business School’s Michael Porter, the industry a company operates in accounts for 19 percent of its profitability (with aggregate Industry factors accounting for 33% in the variance of a company’s overall profit).

Every industry is a part of a supply chain which operates within the overall economy. Therefore to understand how your business, your investments or your clients are performing, it’s critical to understand how the company under review is performing against the industry, and how that industry is performing against the trend of the economy.

Industry analysis is a structured framework for reviewing the profitability of your industry’s previous, current and forecasted performance, to help you position your business in the most competitively advantageous way.

Industry analysis explains why one industry is very profitable and what the basis of that profitability is (against the concept of ‘perfect competition’). Managers and Investors alike need to understand these Industry Factors for two critical reasons:

1- Take advantage of ‘tailwinds’ that will provide current and future competitive advantage.

2- Mitigate Risk relating to trends and Drivers outside a Manager/ Investors control.

Why Use Industry Analysis?

Quite simply, from a business perspective owners and managers of Firms or Companies find themselves in three general positions:

  1. You are thinking about starting a business in a particular industry, so you ask “Is this a sensible market for us to enter? Is this market a source of superior profits?”
  2. You already have a business in an industry and you are committed to it, so you ask “How can we make sure that we perform better than our competitors?”
  3. You have a business but you are considering selling it, either because it is struggling or because it is very successful and you will be paid very well for it. In the divestment situation, you ask “How are the future prospects of the industry likely to be affected and how does that affect my decision to sell?”

Industry Analysis identifies the Supply and Demand factors of the market you operate in to determine the answers to your questions, and provides you with the performance metrics you need to make business decisions. The compelling reason to engage in Industry Analysis is to capitalize upon favorable Market opportunities, and avoid -or map contingencies for – those that are unfavorable.

What Factors Does Industry Analysis Account For?

Industry Analysis in the broadest application will look at the Company in relation to the Industry, and the Industry in relation to the Economy.

Generally, Managers & Business Owners can conduct an industry analysis in one of two ways: Quantitative or Qualitative. Quantitative analysis uses mathematical forecasting techniques to analyze specific pieces of an industry’s information. Qualitative analysis involves business owners reviewing industry information and making personal judgments or inferences from the information. Business owners with particular experience or expertise in an industry often use qualitative analysis as they are already familiar with that particular industry.

However, in relation to what we discussed earlier- no company operates in isolation. Managers and Investors with a sense for Risk Mitigation will always put what they understand to the test against Drivers outside their control, the complete supply chain affecting the Industry and the future forecasted performance of the Industry. Factors Owners & Managers should include in their Industry Analysis:

– Industry Performance Benchmarks (revenue, employment growth, profit margins, revenue volatility)

– Industry Cost Structure Benchmarks (depreciation costs, purchases, rent, utilities)

– Industry Operating Benchmarks (wage costs, profit per employee, import & export levels, key input costs)

– Supply Chain Analysis (growth, costs, demand drivers and volatility data)

– Operating Risk Analysis & Forecast (structural risk, growth risk and sensitivity risk)

– Product & Market Segmentation Analysis

– Lifecycle Review & Drivers

– Competitive Landscape (key success factors, barriers to entry)

– Major Players/ Companies Analysis

– Trends, Issues, Threats

– Opportunities and Strengths

– Long Range Forecast

There is a caveat regarding your Industry Analysis: it may prove prudent to outsource this analysis due to the theory of “paralysis of analysis.” This theory states that Managers who collect too much information may be unable to make a business decision. In conjunction with this debilitating factor, more time is spent doing the analysis phase than making the business decisions.

As with any analysis or model used, judgment is critical in the oversight of analysis; it is judgment that will define the difference between analysis and insight.

Summary:

  • Industry analysis is important because it allows business owners to gauge how much profit they can generate from business operations.
  • No company operates in isolation, and every industry is a part of a supply chain which operates within the overall economy
  • The industry a company operates in accounts for 19 percent of its profitability
  • Outsourcing your Industry Analysis can ensure your armed with the right analysis for business critical decisions, without getting caught in lengthy analysis phases

Mike works for leading Industry Analysis publisher IBISWorld www.ibisworld.co.uk

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