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Learning Module 6 of Equity Investments 11–14% of the exam

Industry and Competitive Analysis

5 lessons. About 26 minutes in cram mode, 130 minutes in full.

Start with lesson 1 Learn with Sensei Read the module summary

Lessons

1
Why analyze an industry, and the steps to do it
describe 4 min cram, 20 min full
2
Industry classification: GICS, ICB, TRBC and other groupings
compare 6 min cram, 24 min full
3
Industry size, growth, profitability and concentration
determine 6 min cram, 28 min full
4
Porter's Five Forces and PESTLE analysis
analyze 6 min cram, 32 min full
5
Competitive strategy: cost leadership, differentiation and focus
evaluate 4 min cram, 26 min full

What the exam expects you to do

Describe the purposes of, and steps involved in, industry and competitive analysis.Why analyze an industry, and the steps to do it
Describe industry classification methods and compare methods by which companies can be grouped.Industry classification: GICS, ICB, TRBC and other groupings
Determine an industry’s size, growth characteristics, profitability, and market share trends.Industry size, growth, profitability and concentration
Analyze an industry’s structure and external influences using Porter’s Five Forces and PESTLE frameworks.Porter's Five Forces and PESTLE analysis
Evaluate the competitive strategy and position of a company.Competitive strategy: cost leadership, differentiation and focus

Module summary

The whole module on one sheet, organised by lesson: what to memorize, how the ideas fit together, the formulas and the key terms. No paragraphs, just what you need to revise.

Hide what I know

How deeply to learn each part

Know the idea: Understand it in general. It frames other topics, but you will not calculate with it.
Use it: Understand it well enough to solve a question with it. Recognize when it applies.
Memorize: Learn it by heart. The exam will not give it to you.

Why analyze an industry, and the steps to do it

Known

MemorizeThe four steps, in order

Step	Question it answers	Tools
1. Define	Who is in the industry?	GICS, ICB, TRBC, judgment
2. Survey	How big, how fast, how profitable, who has the share?	size, compound annual growth rate (CAGR), ROIC, shares, Herfindahl-Hirschman Index (HHI)
3. Structure and influences	Why is profitability and growth what it is?	Five Forces, PESTLE
4. Position	Can this company beat the industry?	generic strategies

Memory hook Define it, survey it, explain it, then judge the company. The company comes last, never first.

Know it cold Industry forces are a ceiling on long-run returns, not a floor. Competition pulls profitability toward the industry base rate.

MemorizeWhy industry analysis is done

Purpose	What it does	Example
Improve forecasts	anchors growth and margins on the industry base rate	forecast margin starts at the industry median
Identify opportunities	finds companies or industries the market misjudges	a firm stronger than peers; or an industry exposure

Memory hook Two uses: forecast better, find better ideas.

Know it cold Industry factors: structure, cycle sensitivity. Company factors: strategy, business model variation, size, execution.

Key terms

industry Use it
industry analysis Use it
return on invested capital (ROIC) Use it
economic profit Use it
base rate Memorize
competitive advantage Use it

The four steps of industry and competitive analysis

Industry and competitive analysisstep 2 of the company-analysis framework, between past and present (1) and forecasting (3)

1. Define the industry Memorize who sells similar products to the same customers?
- Use a classification scheme as a start then adjust
- Judgment calls substitutes, multi-product companies, geography
2. Survey the industry Memorize the facts and trends
- Size and growth and the character of growth
- Profitability ROIC distribution over time
- Market share trends and concentration
3. Analyze structure and outside influences Memorize the why behind the survey
- Porter’s Five Forces structure, so profitability
- PESTLE external influences, so growth and share
4. Evaluate competitive position Memorize strategy against the industry
- Strategy defends against the forces, fits the trends, can be executed
- Competitive advantage? a record of economic profit

Formulas

Economic profit spread Use it

S = \text{ROIC} - \text{WACC}

Quick example

A producer earns a 9.6% return on invested capital against a 7.1% cost of capital. 9.6 − 7.1 = 2.5 percentage points of economic profit. A negative spread means the company destroys value.

On your calculator

9.6−7.1= 2.5

9.6ENTER7.1− 2.5

ENTER enter (on the HP, puts the number on the stack)

Industry classification: GICS, ICB, TRBC and other groupings

Known

MemorizeLegacy schemes versus commercial schemes

	Legacy (SIC, NACE, ISIC)	Commercial (GICS, ICB, TRBC)
Groups by	production (supply)	products sold (demand)
Coverage	one country	global
Updates	infrequent	at least annually
Structure	hierarchical	strictly hierarchical, one place per company

Memory hook Commercial schemes follow the customer: what the company sells, worldwide, kept fresh.

Know it cold GICS and ICB cover public companies; TRBC also covers private companies, non-profits and government.

MemorizeFour limitations

Limitation	Cue in a question
Model variations and substitutes	two companies in one group that never compete; rivals in different groups
Multi-product companies	a division competes with a company filed in another sector
Geography	local services (hospitals) in a global group
Changes over time	new sector created; delisted companies drop out

Memory hook Models, Multi-product, Map, Moves over time: M-M-M-M.

Know it cold The fix is to adjust the grouping: use a higher or lower tier, or build your own peer set.

MemorizeCyclical versus defensive sectors

Cyclical	Defensive
Financials	Consumer staples
Basic materials	Health care
Consumer discretionary	Utilities
Industrials, energy

Memory hook Defensive = things you still buy in a recession: eat, heal, switch the lights on.

Know it cold Defensive does not mean immune. A severe downturn hurts everything; the difference is one of degree.

Key terms

Global Industry Classification Standard (GICS) Memorize
Industry Classification Benchmark (ICB) Memorize
Refinitiv Business Classification (TRBC) Memorize
strictly hierarchical taxonomy Use it
cyclical Memorize
defensive Memorize
statistical similarities Use it
developed, emerging and frontier markets Use it

Third-party industry classification schemes

Industry classification schemesa starting point for defining an industry

Legacy government schemes Use it SIC, NACE, ISIC
- Basis: production characteristics the "supply" view
- Country-specific built by government agencies
- Updated infrequently fell behind new business models
Commercial schemes Memorize GICS, ICB, TRBC
- Basis: similarity of products sold Memorize the "demand" view
- Global GICS and ICB cover public companies; TRBC also private, non-profit, government
- Reviewed at least annually Memorize new companies added more often
- Strictly hierarchical Memorize each company sits in one lowest-tier group

Four limitations of third-party schemes

Limitations of GICS, ICB and TRBCcheck that classified companies really compete

Groupings too broad or too narrow Memorize business model variations and substitutes
Multi-product companies Memorize one box per company, so a competitor may sit in another sector
Geography Memorize global groups fit global industries, not local services
Changes over time Memorize reclassifications, listings and delistings hurt comparability and add survivorship bias

Other ways to group companies

Grouping methods besides industryused in index construction and performance evaluation

Business cycle sensitivity Memorize cyclical or defensive, usually by whole sector
Statistical similarities Use it clusters of ratios, returns or size
- Valuation, growth, profitability ratios and market capitalization
- Price behavior volatility, momentum, return co-movement
Geography Use it by country, then developed, emerging or frontier
- Country set by incorporation, primary listing, headquarters, market perception
- Not set by where revenue is earned
ESG characteristics Know the idea carbon intensity, board diversity, exposure to tobacco or gambling

Industry size, growth, profitability and concentration

Known

MemorizeIndustry growth style box

	Defensive	Cyclical
Growth	not saturated, little cycle sensitivity (specialty medicines, subscription software)	not saturated, cycle sensitive (chip making, online advertising)
Mature	saturated, steady (utilities, soft drinks)	saturated, cycle driven (oil and gas, freight, cement)

Memory hook Two questions place any industry: has it filled its market (growth or mature)? Does it follow gross domestic product, or GDP (cyclical or defensive)?

Know it cold Growth industries: how long will growth last, and what is peak penetration? Mature industries: watch for disruption, competitive intensity and the speed of decline.

MemorizeFormulas to recall

Measure	Formula	Watch
CAGR	(end ÷ start)^(1/years) − 1	not total growth ÷ years
Market share	company sales ÷ industry size	range, not a point; organic vs acquired
HHI	Σ share² (whole numbers)	monopoly 10,000; decimals give a number below 1
Merger effect	ΔHHI = 2 × share A × share B	always positive

Memory hook Squaring makes big firms count most: equal firms give 10,000 ÷ n, so four equal firms give 2,500.

Know it cold HHI 1,500 to 2,500 moderately concentrated; above 2,500 highly concentrated; a merger adding more than 200 in a highly concentrated market draws scrutiny.

Key terms

industry size Use it
compound annual growth rate Memorize
industry growth style box Use it
growth industry Use it
mature industry Use it
industry profitability Use it
market share Memorize
industry concentration Use it
Herfindahl-Hirschman Index (HHI) Memorize

What an industry survey measures

Industry surveystep 2 of industry and competitive analysis

Size Use it annual sales of the product, from the customer or product view
Growth rate and character Memorize year-over-year or compound annual; split into volume and price/mix
- Growth versus mature Memorize saturation of the addressable market
- Defensive versus cyclical Memorize sensitivity to the business cycle
Profitability Use it ROIC distribution over time; the trend matters more than the level
Market share trends and concentration Memorize organic versus acquired; HHI

What makes an industry cyclical

Sensitivity to the business cyclea feature of the business models in the industry

Discretionary versus necessary sales Memorize purchases that can wait are cyclical
Pricing power Use it weak pricing power amplifies the swings
Interest rate exposure of the business model Memorize credit-funded purchases and borrowers
Durable or capital goods versus recurring purchases Memorize consumables and subscriptions are steadier

Formulas

Compound annual growth rate Memorize

g = \left(\frac{S_N}{S_0}\right)^{1/N} - 1

Quick example

Industry sales fall from 12.0 to 9.6 over 3 years. (9.6 ÷ 12.0)^(1/3) − 1 = −7.17% a year. The simple average, −20% ÷ 3 = −6.67%, is the trap.

On your calculator

9.6÷12=y^x31/x=−1= −0.0717

y^x power · 1/x reciprocal

9.6ENTER12÷31/xy^x1− −0.0717

ENTER enter (on the HP, puts the number on the stack) · 1/x reciprocal · y^x power

Market share Memorize

s = \frac{\text{company sales}}{\text{industry size}}

Quick example

A producer with sales of EUR 6.6 billion in an industry of EUR 55.3 billion. 6.6 ÷ 55.3 = 11.9%. Use the same units and the same period.

On your calculator

6.6÷55.3= 0.1194

6.6ENTER55.3÷ 0.1194

ENTER enter (on the HP, puts the number on the stack)

Herfindahl-Hirschman Index Memorize

HHI = \sum_{i=1}^{n} s_i^2 \quad (s_i \text{ as whole numbers})

Quick example

Five equal firms with 20% each. 5 × 20² = 2,000. A 50% share is typed as 50, never 0.50. Monopoly = 100² = 10,000.

On your calculator

20x²+20x²+20x²+20x²+20x²= 2000

x² square

20ENTER×20ENTER×+20ENTER×+20ENTER×+20ENTER×+ 2000, ENTER then × squares

ENTER enter (on the HP, puts the number on the stack)

Change in HHI from a merger Use it

\Delta HHI = 2\,s_A\,s_B

Quick example

Firms with 25% and 15% shares merge. 2 × 25 × 15 = +750. Check: (25 + 15)² − 25² − 15² = 1,600 − 625 − 225 = 750.

On your calculator

2×25×15= 750

2ENTER25×15× 750

ENTER enter (on the HP, puts the number on the stack)

Porter's Five Forces and PESTLE analysis

Known

MemorizeThe five forces: what raises profit pressure

Force	Pressure is higher when…
New entrants	low capital needs, no scale or network advantage, weak brands, low switching costs, open distribution, no regulation
Substitutes	a cheaper alternative does the same job, it is improving, and customers can switch or go without
Customers	few big buyers, standard product, big share of their budget, can build it themselves
Suppliers	few suppliers, costly to switch, specialized inputs, no substitutes for the input
Rivalry	price-cutting history, many equal rivals, same product, high exit barriers, slow growth

Memory hook Strong customers and strong suppliers both squeeze the industry: one pushes selling prices down, the other pushes costs up.

Know it cold Strong forces, low returns. The forces explain profitability, not growth.

MemorizeWhich framework answers which question

	Five Forces	PESTLE
Looks	inside the industry and its close neighbors	outside the industry
Explains	long-run profitability	growth and market share shifts
Reviewed	when the structure changes	slowly; not every quarter
Output	which forces to monitor	themes and trends

Memory hook Five Forces decide how much profit the industry keeps; PESTLE decides how fast the pie grows.

Know it cold PESTLE letters: Political, Economic, Social, Technological, Legal, Environmental. Matters most for: energy, healthcare and defense (political); cyclical sectors (economic); consumer products (social); energy, airlines, utilities, autos (environmental).

Key terms

Porter’s Five Forces Memorize
threat of new entrants Memorize
threat of substitutes Memorize
bargaining power of customers Memorize
bargaining power of suppliers Memorize
rivalry among existing competitors Memorize
network effects Use it
economies of scale Use it
economies of scope Use it
switching costs Use it
backward integration Use it
PESTLE analysis Memorize
sustaining and disruptive innovation Use it

The five forces and what drives each

Industry structureintense forces mean low returns on capital; benign forces mean high returns

Threat of new entrants Memorize weak when entry is hard
- Few recent entrants history of entry is a clue
- Network effects, economies of scale and scope a newcomer starts small and costly
- Brand loyalty and switching costs customers stay put
- Control of inputs or customer access distribution, shelf space
- Government policy licenses, patents, heavy regulation
Threat of substitutes Memorize different product, same job
- Cheaper alternative for the same need raises the threat
- Customers can go without deferrable purchases raise the threat
- Substitute improving fast raises the threat
- Hard to switch lowers the threat
Bargaining power of customers Memorize strong customers push prices down
- Few, concentrated buyers raises their power
- Standardized product raises their power
- Large share of the customer budget raises their power
- Product critical to the customer lowers their power
- Can backward-integrate build instead of buy
Bargaining power of suppliers Memorize strong suppliers push input costs up
- Few, concentrated suppliers raises their power
- Costly to switch supplier raises their power
- Specialized or scarce inputs such as skilled, licensed labor
- Substitutes for the supplier’s product lower their power
Rivalry among existing competitors Memorize the intensity of competition, shaped by the other four
- History of price competition raises rivalry
- Many roughly equal-sized rivals raises rivalry
- Undifferentiated products raise rivalry
- High exit barriers weak firms stay and keep competing
- Slow industry growth firms fight for share

PESTLE: external influences on growth and share

PESTLE analysislooks outside the industry; identifies themes to monitor

Political Memorize fiscal and monetary policy, government buying, regulation, geopolitics
Economic Memorize GDP, income, inflation, interest rates, exchange rates
Social Memorize demographics, culture, lifestyle, consumer trends
Technological Memorize sustaining and disruptive innovation
Legal Memorize the rules of the road: courts, laws, regulation of practices
Environmental Memorize low-carbon transition, waste and land rules, protections

Competitive strategy: cost leadership, differentiation and focus

Known

MemorizeGeneric strategies compared

	Cost leadership	Differentiation	Focus
Win by	lowest cost, low price	distinct product, premium price	one group served best
Defends against	entrants, customers, rivals	entrants, substitutes, customers, suppliers	entrants, substitutes, customers (in the niche)
Customers are	price-conscious, see little difference	value distinctiveness	poorly served by broad players
Main risk	cost inflation; technology erases lead	imitation; premium too high	larger rival undercuts; niche shrinks

Memory hook Cheapest, different, or niche. If it is none of the three, it is stuck in the middle.

Know it cold Focus is a strategy, not a sixth force. It uses cost or differentiation inside one narrow group.

MemorizeEvaluating a strategy

Test	Ask
Forces	does it defend against the five forces?
PESTLE	does it fit the outside trends?
Execution	does the company have the resources and capabilities?

Memory hook Forces, Trends, Capabilities: is it protected, is it in step, can it be done?

Know it cold The only proof is hindsight: a record of economic profit (ROIC above WACC). Intentional strategies usually beat unintentional ones.

Key terms

competitive strategy Use it
intentional and unintentional strategy Know the idea
cost leadership Memorize
differentiation Memorize
focus Memorize
stuck in the middle Memorize

Three tests of a competitive strategy

Is the strategy sound?forward-looking; proof comes only in hindsight, as a record of economic profit

1. Defense against the five forces Memorize does it blunt entrants, substitutes, customers, suppliers and rivals?
2. Fit with PESTLE influences Memorize does it benefit from, or at least not fight, outside trends?
3. Resources and capabilities Memorize can the company actually carry it out?

Porter’s generic competitive strategies

Generic strategiesa poor position is to be none of them: stuck in the middle

Cost leadership Memorize lowest cost, so it can price below rivals and still earn a margin
- How scale economies, favorable inputs, strict cost control, aggressive pricing for volume, low-cost distribution
- Defends against Memorize entrants, customers, rivals
- Suits capital-intensive, price-conscious customers, little innovation
- Risks cost inflation, lost discipline, technology that erases the cost lead
Differentiation Memorize a product customers value enough to pay more for
- How brand, quality, features, service, patents and trademarks, premium price
- Defends against Memorize entrants and substitutes, customers, suppliers
- Suits customers value distinctiveness; innovation in the industry
- Risks imitation, premium too high, buyers grow sophisticated, limits on share
Focus Memorize one customer group, product or region, using cost or differentiation
- How closeness to a group and deep knowledge of its needs
- Defends against Memorize entrants and substitutes, customers (within the niche)
- Suits a group that is hard or uneconomical for others to serve
- Risks bigger rivals undercut on price; the niche and the mass market converge

Cheat sheet · PDF · 5 A4 pages

Industry and Competitive Analysis on 5 pages

What to memorize, the concept maps, every formula with a worked example and keystrokes for the TI BA II Plus and HP 12C, how each idea is asked, and the traps. Print it, or keep it on your phone.

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