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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