EI 9 Industry and Competitive Analysis

Valuation models built on discounted cash flow, relative multiples, or disaggregated earnings produce numbers, but numbers alone do not make a research case. Those inputs need to sit inside a credible picture of the environment a firm operates in and the risks it carries. Industry and competitive analysis supplies that picture: it turns a spreadsheet forecast into a narrative that a reader can judge. The work is usually iterative, because what an analyst learns about an industry feeds back into the model and reshapes the assumptions.

Firms that sell similar goods or services to the same kind of customer tend to share the same opportunities, threats, and value drivers. Grouping them into an industry lets the analyst study those shared forces once rather than firm by firm. The process moves through five ordered steps.

The first four steps concern the industry as a whole and are the subject of this lesson. The fifth step, evaluating a single firm’s competitive strategy and its past, present, and expected performance, belongs to the following learning module.

Defining the firm’s industry

Before an analyst can compare a firm with its rivals, the boundary of the industry has to be drawn. Third-party classification schemes are one common way to do this. As an illustration, Novo Nordisk A/S, the Danish company concentrated in diabetes and obesity treatments, is placed within the health care sector and, more precisely, the pharmaceuticals industry under the Global Industry Classification Standard (GICS).

Reading structure and external forces

Once the industry is defined and surveyed, its competitive structure is examined through Porter’s Five Forces: the threat of entrants and of substitutes, the bargaining power of both customers and suppliers, all feeding into the rivalry among existing competitors. Where several of these pressures run strong, industry returns tend to be squeezed toward the cost of capital.

External forces sit outside the five competitive forces but still move an industry. Political, economic, social, technological, legal, and environmental influences, captured under the PESTLE label, shape growth rates and shifting market positions. Government involvement in health care is a clear political example: because many governments regulate medicine, drug makers depend on approval to sell and on reimbursement policy to make therapies affordable. Eli Lilly first filed for a patent on tirzepatide in 2016, ran three trial phases that concluded in 2021, won approval for diabetes use (marketed as Mounjaro) in 2022, and secured approval as a weight-loss medication (Zepbound) in late 2023. That regulatory timeline directly governs when and how hard a rival can challenge an incumbent.

An industry is best understood as a set of firms that, from the customer’s point of view, offer comparable products or services. Firms grouped this way usually face similar competitive pressures and value drivers, which is why classification underpins peer multiples and, more broadly, every valuation approach. Third-party schemes bring uniformity to that grouping, yet analyst judgement still matters, because no fixed taxonomy fits every purpose.

Third-party classification schemes

Three global commercial schemes dominate: the Global Industry Classification Standard (GICS) from MSCI and S&P Dow Jones Indices, the Industry Classification Benchmark (ICB) from FTSE Russell, and the Refinitiv Business Classification (TRBC). Each sorts companies by the similarity of what they sell, applies worldwide, and is refreshed at least once a year, with new listings added more often. Regional systems such as the North American Industry Classification System (NAICS) and the European classification of economic activities (NACE) serve country or regional needs. GICS and ICB cover listed companies; TRBC extends to private firms, non-profits, and government bodies. Data vendors such as Bloomberg, FactSet, and S&P Capital IQ and exchange operators either adopt these schemes or run close equivalents.

All three are strict hierarchical taxonomies: a company sits in a single group at the lowest tier, and those groups nest upward into broader ones. The tier names and cut points differ from scheme to scheme, as summarized below.

Where the schemes fall short

These systems are a useful start, not a final answer. Analysts run into four recurring limits: groups that mix very different business models or bundle in substitute products; firms active in several industries that still get filed under one; geographic differences that reduce comparability; and reclassifications over time that break the continuity of historical statistics. When a group looks too narrow or too broad, an analyst can move up or down a tier or build a custom grouping suited to the question at hand. The first limit is easy to underestimate, because two firms in the same official group can run economically different businesses.

Strict taxonomies also force a multi-industry firm into the single group tied to its largest product or service by revenue. That can hide competitors that live inside a differently classified parent. Amazon.com is a case in point: with more than 60 percent of global revenue still in online retail, GICS keeps it in Consumer Discretionary alongside a company like Starbucks, even though its Amazon Web Services cloud business drove much of its performance for years. Some providers, such as the Bloomberg Industry Classification Standard, let analysts break a company into segments, so Amazon appears across e-commerce, cloud computing, internet advertising, and, through Whole Foods, the traditional supermarket industry.

Global schemes suit large, recognizable firms whose goods travel worldwide. Companies serving national or local markets are harder to compare across borders, whether because of customer behavior, transport costs, or regulation. Health care services, for example, are usually studied nation by nation, since governments license facilities and physicians and often fund care directly. Classifications also drift: in 2023 GICS moved Visa and Mastercard out of Data Processing in Information Technology into Transaction and Payments Processing Services within Financials. Listings, delistings, and mergers reshape groups too, so analysts should work from restated statistics that match the current groupings.

Grouping companies by other criteria

Industry is not the only lens. Two alternatives recur. A geographic grouping sorts firms by country, then aggregates countries into developed, emerging, and frontier stages. Country here usually means the place of incorporation, primary listing, or headquarters, not where revenue or assets sit. Firms in one jurisdiction may share political, economic, and social drivers more closely than sector peers abroad. The Nifty India Consumption Index, for instance, gathers 30 companies focused on domestic Indian demand across consumer goods, health care, autos, and media; a firm like Hindustan Unilever may track the Indian consumer more than its global sector. A caution: geographic labels ignore revenue mix and asset location, so Toyota falls under Japan even though North America is its largest market and holds most of its assets.

A business-cycle grouping sorts firms by how much economic swings move their sales and profits. Cyclical companies swing widely; defensive companies stay steadier. Discretionary and durable goods (housing, cars, appliances, capital equipment) are long-lived, so buyers can delay purchases, making these industries cyclical, and high fixed costs magnify the profit swings. Defensive industries supply essentials with inelastic demand and vary little over the cycle. A third category, growth companies, stays relatively insensitive to the cycle because it has not yet saturated its market.

For growth industries the pressing questions are how long above-trend expansion will last and how profitable the industry becomes as it matures. Pairing business-cycle categories with geography can help when countries sit at different points in their own cycles.

After placing a firm in an industry, the analyst measures the industry itself: how big it is, how fast and in what way it has grown, how profitable it is, and who the major participants are. A firm’s market share, its slice of total industry sales over a period, anchors much of this work. The survey describes the current state of play, which later frameworks then project forward.

Measuring industry size

Two routes exist. A top-down estimate takes total industry revenue for a period, usually from a reputable data provider or a government agency; the weakness is that official releases may be too coarse to separate one product category from another. A bottom-up estimate adds the revenue that participants earn from the specific goods or services in question. This is not the same as summing whole-company revenues: adding all of Amazon.com would drag in cloud computing and other segments and overstate the supermarket industry. Bottom-up work shines when a few large listed firms with clean segment reporting dominate, but it struggles when many private firms hold meaningful share or when multi-industry firms disclose segments inconsistently. Where firm-level data cannot produce a reliable total, analysts lean on top-down figures, whether government indicators, consultancy surveys, or issuer presentations.

Reading growth characteristics

An industry’s historical growth is judged against the wider economy and across the cycle. Because all industries together must grow with the macroeconomy, mature industries that have reached most of their addressable customers tend to grow at or below the economy’s pace; here investors watch for disruption, shifts in competitive intensity, and the onset of decline. Growth industries expand faster than the economy and stay largely insensitive to the cycle, because they have not yet fully penetrated their addressable market; the open questions are how long above-trend growth persists and where penetration peaks. Cyclicality tends to be greatest where sales are discretionary, involve durable or capital goods, or ride the interest-rate cycle. Structural shifts and severe shocks can override the usual pattern. During the 2020 pandemic, global passenger air travel fell by 60 percent while surging online demand lifted global air freight yields by about 30 percent; primary energy demand dropped 4 percent, roughly half from reduced road traffic and over a third from the fall in air travel; and although overall US retail sales dipped slightly, e-commerce sales jumped more than 30 percent.

Measuring profitability

Because one-off gains, losses, and non-operating items distort earnings, industry profitability is usually read through the operating margin or through return on invested capital (ROIC).

When ROIC exceeds the weighted average cost of capital (WACC), the industry earns an excess accounting return to all providers of capital, debt and equity alike. This mirrors the residual-income idea of return on equity above the required equity return. ROIC is often tracked over time, sometimes as the ratio ROIC divided by WACC, where a reading above one signals value creation.

When private firms make up a large part of an industry, profitability is harder to observe. Two workarounds are common: measure the listed constituents and assume private peers are similar, or draw on official statistical agencies or outside consultancies, for instance a bureau that surveys retailers’ gross margins and operating expenses. As with revenue, profitability changes measured against the economy reveal how sensitive an industry is to the business cycle.

Market share is each participant’s annual revenue divided by total industry revenue. Because industry size itself is estimated, market shares are best read as ranges rather than precise points. Large moves in share, or the arrival of new participants, often flag intensifying rivalry.

Concentration is a central part of the survey. Lower concentration usually means fiercer competition, unless the market is segmented or products are highly differentiated. Rising concentration or consolidation tends to come with softer competition and fatter profits. The standard gauge is the Herfindahl-Hirschman Index (HHI), the sum of the squared market shares.

A single-firm monopoly scores 100 squared, or 10,000, the maximum. Regulators in some countries treat an HHI above 1,800 as highly concentrated, and a proposed deal that would lift the index by more than 100 points in such a market can draw closer scrutiny and possible challenge.

Share changes over time reveal the intensity of rivalry among incumbents and the effect of newcomers. It helps to separate growth from mergers and acquisitions and to ask whether a firm is gaining or losing share on an organic basis. Measuring these figures well can require blending top-down and bottom-up data, as the global beer market shows.

The beer comparison also carries a broader message: setting the top-down total of USD750 billion against the bottom-up USD250.87 billion implies that close to two-thirds of worldwide beer volume comes from small, mostly private brewers in segmented local markets. Gauging both overall size and the degree of segmentation is therefore central to reading competitive intensity, and multiple approaches are worth using because any single estimate rests on judgement.

The survey describes an industry’s past; the next step reads the living forces that will shape its future. Porter’s Five Forces are the threat of entrants, the threat of substitutes, the bargaining power of customers, the bargaining power of suppliers, and the rivalry among existing competitors. Where several of these run intense, industry ROIC is unlikely to clear the cost of capital, echoing the perfectly competitive case where price equals marginal cost. Where the pressures are mild, high profitability can persist. For young industries with little or no earnings history, structural analysis points to the likelihood, timing, and eventual level of profit.

Investors such as Warren Buffett describe a durable competitive advantage as an economic moat, a water-filled trench around a fortified castle. The wider the moat, the longer a firm can keep returns above its capital costs. A wide moat may protect every firm in a small industry such as an oligopoly, or it may shelter just one or two firms in an otherwise brutally competitive industry whose average returns fall short of WACC.

Threat of new entrants

Reading share trends is the first clue to how newcomers will affect an industry, but their impact matters as much as their number. Incumbents sometimes neutralize a threat by acquiring it, as with Alphabet’s purchase of YouTube or Meta’s of WhatsApp; other entrants, such as Tesla in autos, remain a lasting challenge and can push incumbents into partnership. Regulation can bar or ease entry: it may grant a utility exclusive rights to a region, or its compliance cost may itself deter smaller rivals, and subsidies, licensing rules, and patents all shape access. A patent is a finite barrier, so an analyst has to value the advantage over the protected window.

Some barriers can hold entrants off indefinitely, and they overlap with the sources of an economic moat: intangible assets such as patents and loyalty-commanding brands (consumer luxury and food-and-beverage brands keep customers even where a drug patent could not); switching costs, which lock customers in unless the long-run gain clearly beats the near-term cost (moving business software from SAP to Salesforce is slow and costly, whereas swapping a simple smartphone-app service is not); the network effect, where a product grows more valuable as adoption spreads, as with social platforms such as Meta and payment networks such as Visa and Mastercard; a cost advantage, often reinforced by proprietary technology, scale, or economies of scope, where producing several goods together costs less than producing each alone (bundling cable television, wi-fi, and telephone service); and efficient scale, where a commoditized market with inelastic demand and high entry costs supports only a few operators, so newcomers have no incentive to add capacity, as on shared freight-rail networks.

Threat of substitutes

Substitution rises when another product meets the same customer need, especially at a lower price, and it can arrive from a seemingly different industry. Videoconferencing is a vivid case: usage jumped more than thirtyfold in 2020, but rivalry among Slack, Zoom, Microsoft, and Alphabet predated the pandemic. Slack, later bought by Salesforce, focused on customizable integration with third-party apps but stayed text-centric; Zoom, public since 2019, won on video quality and ease of use; Microsoft Teams (2017) rode its bundling inside Microsoft 365, and Google Meet (2017) rode the Google Workspace ecosystem. Beyond competing with one another, these tools substitute for in-person meetings, business travel, and office space, while opening room in remote education and telemedicine.

Bargaining power of suppliers and customers

Supplier power rises with the concentration of available suppliers, the degree to which inputs are unique or tailored, and the cost of switching providers. When only a few provide a critical input, their power can be very high: Apple, the largest buyer of semiconductor chips, sources its most advanced chips from TSMC, though it retains the designs and intellectual property. Licensing of proprietary technology or content, such as chip designs or live-sports streaming rights, works the same way, and high switching costs reinforce it. Specialized labor also counts: skilled, licensed, or well-organized workers, such as unionized factory staff or airline crews, can push wages up, and strikes disrupt manufacturers and airlines. Supplier power is lowest where many small providers sell commoditized, interchangeable inputs, as in private-label clothing or basic food service, and large buyers can then dictate price, quality, delivery, and terms.

Customer power depends on the product and the customer base. Where goods are commoditized or switching costs are tiny, customers hold the upper hand, pushing firms toward price competition, differentiation, bundling, and loyalty schemes. Convenience stores show the pattern: sitting in high-traffic spots and charging premium prices for quick purchases, they face many substitutes, so operators such as Alimentation Couche-Tard use loyalty points, fuel subscriptions, and a mobile app to turn one-off shoppers into repeat ones. Concentrated buyers who take a large share of an industry’s output likewise gain leverage over pricing and terms.

A common response to strong supplier or customer power is vertical integration, extending operations to an earlier or later stage of the supply chain. Moving upstream (backward integration) takes control of inputs through supply agreements, joint ventures, or outright ownership. As electric vehicles made batteries the most valuable component, over a third of vehicle value, automakers moved to secure critical minerals concentrated in the Chinese Mainland: Tesla, once reliant solely on Panasonic, partnered with miners and began its own Gigafactory production in 2016 while adding LG Energy Solutions and CATL; General Motors formed the Ultium joint venture with LG in 2019; and Ford chose to own new US battery plants while licensing CATL technology. Moving downstream (forward integration) removes intermediaries to capture more of the value chain, as when Amazon built its own logistics network.

Rivalry among existing competitors

Rivalry pulls the other forces together, and analysts weigh price competition, product differentiation, the relative size and shifting shares of major players, and industry growth and profitability. No fixed formula ranks these; the point is to see which factor may dominate under a given scenario. The passenger airline industry brings the forces together.

Porter’s Five Forces explain what drives profitability inside an industry. The PESTLE framework looks outward, at political, economic, social, technological, legal, and environmental forces that shape an industry’s growth rate and the shifting positions of firms within it, based on how well each firm anticipates and adapts. These external forces help an analyst frame the themes that flow into a valuation. The 2020 pandemic is a compact example: it hurt transportation and physical retail immediately while accelerating digital payments, and its remote-work legacy still weighs on air travel and commercial real estate.

Political

Political influences run from trade, fiscal, and monetary policy and regulation through to geopolitics, and sometimes to the state directly buying or selling an industry’s output. Government ownership is common in commodities and utilities, such as the oil producers Saudi Aramco and PetroChina, the power producer EDF, and the copper miner Codelco, which raises the political stakes of analysis. Even in privately held industries, the threat of new rules, restrictions, or taxes can dent future revenue, while subsidies and reimbursements can lift it; several governments, for instance, offer buyers direct tax credits for new electric vehicles and indirect relief because electricity escapes fuel taxes. Health care shows the reimbursement channel clearly: while Lipitor held its patent, US programs such as Medicaid covered it and still reimburse its low-cost generics, whereas Ozempic reimbursement was confined to diabetes for its first years, constraining Novo Nordisk’s revenue from the obesity use.

Economic

Economic influences span short-run fluctuations and long-run growth and structural shifts. Forecasts should line up an industry’s expected performance with expected growth and inflation, adjusted for whether it is defensive, cyclical, or in an above-trend phase. Longer-run development matters too: capital flows into developing countries, lifting labor productivity and growth above developed-market rates, which pushes goods production toward low-wage locations and services toward business process outsourcing (BPO). The Philippines has become a large BPO hub, with revenue above USD35 billion in 2023 and 1.7 million people employed serving financial, health care, and e-commerce clients such as JPMorgan Chase, UnitedHealthcare, and Amazon, often cutting the cost of those tasks in half. Exchange rates matter as well: a depreciating home currency raises the cost of imported inputs and squeezes margins unless firms can pass it on, but it makes exports more competitive abroad.

Social

Social influences include cultural and consumer trends, demographic shifts, and changing lifestyles and attitudes. They often follow economic change: as per-capita income rises in developing countries, demand moves from low-cost necessities toward higher-quality, branded goods, and spending on durables such as appliances and cars and on leisure and travel grows. In developed markets, differentiation leans on quality, brand, and features rather than price, including convenience, health consciousness, and transparency about sourcing and labor practices. Firms that adapt to local tastes travel best; restaurant chains such as McDonald’s and Subway tailor menus and source ingredients locally to blend steady developed-market growth with faster developing-market expansion.

Technological

Technological change can create new products, remake business models, incrementally improve existing offerings, or render them obsolete. It helps to place an advance by two dimensions: its domain, meaning the product, process, or market segment it applies to, and the problem it addresses. Whether each is well defined or not gives four categories, shown below.

Basic research explores fundamental principles with no immediate commercial use, often funded by governments and universities but also by technology, manufacturing, and pharmaceutical firms; in medicine, laboratory or animal studies test a compound long before human use, and commercial payoff is years away and uncertain. Breakthrough innovation creates a new product, service, or model with effects across industries, as the rechargeable lithium-ion battery did after its early-1990s commercialization opened the way to phones, computers, tools, and cars. Sustaining innovations, usually led by incumbents, improve performance or add features without changing core function, such as shrinking a battery or extending its life. Disruptive innovations create or reshape a market around a value proposition that established, satisfied customers may not want at first; internet streaming began as a rough alternative to cable television and grew to overtake it in subscribers. Entrants risk little in pursuing disruption because they have no profitable business to defend, while incumbents must choose between investing in the disruption, which hastens the decline of their existing business, and adopting slowly while harvesting near-term profits and ceding share.

Legal

Legal influences are changes in laws and regulations that impose costs, alter business practices, or open or close whole activities, and they can steer firms toward friendlier jurisdictions. The pharmaceutical industry is tightly regulated: new medicines must clear clinical-trial protocols and approval from bodies such as the US FDA and the European Medicines Agency. Differing regimes shaped India’s rise as a generics power; with low production costs, skilled labor, and policies favoring generics, India supplies over 20 percent of the world’s generic drugs and more than 40 percent of the US generic market, and Dr. Reddy’s Laboratories was the first Indian firm to bring a generic drug to the United States market, in 2001. Tobacco and cannabis show legal pressure at work: heavy taxes and smoking bans pushed tobacco firms toward smokeless products, now over a third of industry revenue, while cannabis faces a patchwork, legal in Canada and Germany, mixed across US states, and banned in much of Asia, with edibles a growing share.

Environmental

Environmental influences usually travel with political, social, and legal ones, and they weigh most on energy producers and heavy energy users. The central issue is the energy transition, the government-driven shift to cut greenhouse-gas emissions, which unfolds at different speeds and with different mixes of taxes and subsidies. Two European utilities respond differently: RWE has committed over EUR50 billion in renewables through 2030, split roughly 40 percent to onshore wind and solar, 35 percent to offshore wind, and the rest to hydrogen and batteries, aligned with Germany’s coal-and-nuclear phaseout; Enel has committed about EUR43 billion over three years, around 60 percent to expanding and digitalizing electricity grids, aiming to fit 80 percent of customers with smart meters by 2025. The same transition risks and opportunities reach energy consumers such as airlines, shipping, autos, and other manufacturers, where changing rules, taxes, and preferences will keep pushing firms to cut carbon or lose share to lower-emission rivals.