mgt490project

You work for a private equity firm similar to Blackstone Group, Fortress Investment Group, or Cerberus Capital. The firm is looking for industries with attractive opportunities which might involve investing in existing enterprises or starting up new firms.

Your project team is one of many in the firm that has been asked to select an industry and evaluate its attractiveness for sustainable profits over time. Your team will submit a written report of your industry analysis, plus present a 20 minute overview of the findings to the firm's executive committee.

Here are things to consider as your team conducts its analysis and prepares the report.

Industry name. What industry are you analyzing? Be sure to define the boundaries (a.k.a. scope) of the industry. A narrower scope is often better in order to better define the competitors and gather data. For example, the 'midwest regional retail banking' industry is better than just the 'banking' industry.

Output description. What is product and/or service that defines this industry? The output description should convince others that you've adequately defined the scope of your industry above. The output of this industry should be unique in some way. Otherwise, what you've defined as an industry is actually part of a different industry.

Geographic scope. Where are the competitors located? What geographic markets does the industry serve? A geographic breakdown (i.e., industry sells 30% of output in North America, 40% in Europe, and 30% in Asia) would be helpful. Think pie chart.

Supply chain picture. Diagram of the industry's supply chain. Who are key upstream supply industries? Who are key downstream Customer industries.

Industry size. How big is the industry? Size can be measured in many ways. Annual revenues is the 'standard' but not the only way. Annual output (in units or dollars), number of employees, number of locations can be useful. If you can show how size is changing over the last few years (e.g., industry revenues for 2003, 2004, 2005, 2006, 2007), that would be excellent.

Market value. Can you provide an estimate of the industry's market value? This is easier if you're analyzing an industry full of publicly traded companies than not.

Age. How old is the industry? Using the founding dates of some competitors often provides a good estimate.

Industry life cycle position. Where is the industry and how do you know? Caution: don't be fooled by a single competitor's recent results or by a novel product segment in the market. Focus on the life cycle position of the aggregate industry.

Competitors. How many? Who? Location? Age of each? Measure of size for each? Market share of each (again, think pie chart)

Aggregate financial and operational data. Financials: revenues, costs, profits. operational: Output, capacity (max output possible), capacity utilization (actual output/max output possible), employment. Other info as relevant. If you can show how size is changing over the last few years (e.g., industry revenues for 2003, 2004, 2005, 2006, 2007), that would be excellent.

Key trade publications. Again, usually at least one. If you can run these down, they'll usually prove outstanding sources of industry specific info for your analysis.

After accumulating as much of the above info as you can, you're ready to conduct a Five Forces Analysis.

Price-based rivalry. Are prices increasing or decreasing (e.g., evidence of 'price wars' in the industry).

Non price-based rivalry. New product innovations, quality improvements, capacity additions by current industry players.

Industry concentration. Estimate the industry concentration ratio CR4. How does it compare to benchmarkets suggesting reduced competition? Estimate the Herfindahl Index. How does it compare to benchmarks suggesting reduced competition? btw, here is some data on concentration ratios from US Census Bureau organized by NAICS industry classification.

Specific assets. Operations that require a lot of specific assets make it difficult to exit an industry. Related high fixed costs often tempt operators to lower prices and product output just to 'fill capacity.'

Stability of demand. Unstable demand often causes managers to overreact to demand surplus and shortage, causing excessive price changes and temptation to prematurely add capacity to the industry.

Product differentiation. If all products look alike, they're often viewed as commodities. One of the few market variables managers can adjust in commodity industry is price.

Buyer switching costs. Customers can incur costs when switching suppliers (think moving from Microsoft Windows to an alternative PC operating system like Linux). These costs can include retraining, new equipment, customer service, plus other things. Lower switching costs are conducive to increased rivalry.

Remember, a product is a viable substitute to an industry's output if it performs a similar function but has a different form. (e.g., tap water as a substitute for Coke, heating oil as a substitute for natural gas). Often, the more different the form while maintaining similar function, the more intriguing (i.e., threatening) the substitute.

Profitability of substitute industries. Generally, the more financially successful the substitute industry, the greater the threat.

Switching costs. The lower the cost of switching to the substitute, the greater the threat.

Supplier overview. Can you provide a cost breakdown for the industry? Which key industries serve as suppliers?

Supplier size. How does the size (various ways to measure--revenues, output, employees, geographic reach) of various industry suppliers compare to your industry?

Supplier concentration. The more concentrated the supplier's industry, the lower the potential for sustainable profits in your industry (e.g., 'Big Three' automakers like GM versus car dealers).

Supplier substitutes. Less available substitutes reduce profit potential. For example, there are few alternatives to the microprocessor for PCs, so PC manufacturers like Dell are subject to influence by Intel, AMD, and other chipmakers.

Importance of supplier input. The more important the input, the lower the profit potential in your industry. For example, bottlers of Coke depend on Coke's 'magic formula' in order to operate.

Threat of forward integration. If suppliers can integrate into your industry, then your profit potential is lower (you don't want to give them incentive to enter your industry). For example, oil refiners like Valero face the threat of forward integration into the refining business by the likes of Exxon, Chevron, and others (in fact, the big integrated oils already have a presence in the refining sector--that's why they're 'integrated').

Buyer overview. Who are the buyers of the industry's products? What key industries does your industry serve?

Buyer size. How does the size of industry customers compare to your industry. Bigger customers reduce profit potential. Wal-mart is perhaps the best example of the bargaining power that can be exerted from a large buyer.

Buyer concentration. The more concentrated the buyer's industry, the lower the profit potential for you. Pharmaceutical companies, for example, have been dealing with increasingly concentrated buyers such as HMOs like United Health and the US government. Buyer consortiums, where customers combine to increase their buying power, are also negative for profits.

Alternative buyers. If your industry sells products to a single buying industry, your profit potential is lower. There's no where else to sell your products.

Standard products. If the industry produces a standard product (e.g., commodities), then customers can easily move between industry competitors. Profit potential is reduced.

Switching costs. If the cost for buyers to switch to an alternative industry is low, then profit potential is reduced.

Threat of backwards integration. If your buyer can easily integrate backwards into your industry, then profit potential is lower. Facilities management companies like Viox Services, for example, face the threat of customers deciding to manager their own facilities.

Availability of full information. The fuller the information set that buyers have about your industry, the lower the profit potential. For example, realtors such as SibcyCline face a threat as more homebuyers can gather house price and quality information via the Internet (such as Zillow.com).

Entry decision model. Can you provide an example decision tree that models the entry decision of this industry?

Economies of scale. Do industry operators realize price declines as output/period increases? If not, potential entrants will be emboldened.

Product differentiation. What unique features of the products, such as brand loyalty effects, do industry products possess that might deter entry?

Capital requirements. How much does it cost to build a new operation? The higher the better in order to deter entry.

Access to distribution channels. Will new entrants have easy access to distribution channels? They're more prone to enter if they do. One huge entry barrier in soft drinks over the years has been access to key bottling and distribution networks. Exclusive agreements that Coke and Pepsi have developed with their distributors often 'lock out' potential entrants.

Excess capacity. If there's lots of spare capacity currently available in the industry, potential entrants are less emboldened. The key number here is capacity utilization (actual output/current capacity).

Learning/experience curve. What does the learning curve look like for your industry? Is it steep (costs go down significantly as more cumulative volume is produced--think building a new commercial jet airline model at Boeing) or is it shallow (costs pretty much stay the same with cumulative volume--think making burgers at McDonald's). The steeper the learning curve, the greater the barrier to entry.

Government policy. Are there regulations that govern entry into the industry? For example, do industry participants need a government license in order to operate (think telecom service providers like Verizon or broker dealers like Merrill Lynch). On the flip side, is government monetary and fiscal policy making it easier or harder for entrants? For example, when the Fed lowers interest rates the cost of borrowing goes down, which should encourage entry. Sometimes government enacts tax incentives/subsidies to encourage entry (think ethanol subsidies which has driven an explosion of entry into related sectors).

OK, now tie it all together. Given your 5 Forces analysis, how attractive is this industry for sustainable profits? I often apply a '- 0 +' rating to each force that I've evaluated, where - implies that the force will be negative for profits, 0 implies that the force has a neutral effect on profits, and + means that the force should exert a positive influence on profits. So an overall assessment might look like this

Force	Influence on Industry Profits	Key Drivers
F1 Intensity of Rivalry	-	6 month product life cycles Low industry concentration CR4 = 15 High year-to-year variation in demand
F2 Availability of Substitutes	0	Two potential substitutes Substitute industry profits low
F3 Bargaining Power of Suppliers	+	No input costs > 20% of total cost No large operators in any supply industry Little evidence of forward integration
F4 Bargaining Power of Buyers	-	Single customer market for all industry products CR4 of customer market has increased 50% in 5 yrs Two buyer consortiums formed over last 3 yrs
F5 Threat of Entry	-	Few large scale operations New operations cost <$250,000 Advertising as % of sales = 0.25% Industry learning curve = 97% (shallow) New competitors in last 5 yrs = 30% of total rivals Fed Funds rate decreased from 5% to 3% in last 18 months

The above table paints an overall unattractive picture for sustainable industry profits (based on the system employed above, the industry nets out to a 'two minus' industry). Non-priced rivalry appears intense. Bargaining power of buyers is growing. Entry barrier appear low and entry is already being observed. Our firm may be better off looking for opportunities in other industries.

Strategic Map. Finally, after your 5 Forces Analysis, draw a strategic map that positions the competitors along along two key strategic dimensions in the industry. What key clusters or groups are apparent, and how might these grouping affect industry structure going forward?

A couple of words about your report. Are you required to cover every single item noted above? No, but the more items you handle, the more comprehensive your analysis is likely to be--likely leading scoring more points on your project from a grade standpoint. Demonstrate to me that you can readily connect our classroom concepts to a real on-the-ground industry analysis.

Collect as much info and data as you can. Tables and graphs are a good thing for presenting data. Use footnotes for citations. The more the better. Also, higher quality citations score more with me. Fortune, Business Week, Wall Street Journal are more reputable sources than some obscure website. If you can access major trade publications of the industry, you'll likely find these to be a HUGE treasure trove of info that you can use.

Rest assured that if you achieve a high mark on this project, then you'll have developed a skill for industry analysis that's marketable and in demand among employers. Plus, you'll know a ton about the industry that you've studied, which should be good for jobs, investing, making decisions, and your overall understanding of business.

Industry Analysis Project (Updated 03/05/2008 12:00 PM)