Industry size, growth, profitability and concentration

How big is the industry, and how fast is it growing?

Industry size is the total annual sales of the product, measured from the product or customer view. It is not the sum of every constituent’s total sales, because a constituent may have segments in other industries. A carmaker’s insurance arm, for instance, does not count toward the size of the car industry.

Many industries include private companies and small businesses that publish no figures. Analysts then estimate size from government statistics, consultancy surveys or issuers’ presentations, and check that the estimates are reasonable.

Growth is measured year by year or as a compound annual growth rate (CAGR) over several years. Where possible, split it into volume and price/mix, because a market growing on price alone is a different story from one growing on units.

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

Is it a growth or a mature industry, defensive or cyclical?

Comparing the industry’s growth with the broader economy, in recessions and expansions, characterizes it on two separate dimensions. Together they give the industry growth style box .

A growth industry has not yet reached full saturation of its addressable market, so it has growth drivers of its own, often a new technology. The key questions are how long high growth will last and where penetration will peak, and both are harder to answer the newer the industry is. A mature industry has fully penetrated its market. Its growth is in line with the economy or falls as customers move to a substitute, so the questions are about disruption, the intensity of competition and the speed of decline.

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

Sensitivity to the business cycle comes from the business models in the industry.

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

Be careful with the labels. A severe downturn hurts almost every company, so the difference is often of degree. And a young firm with a new technology can keep growing inside a cyclical industry.

Exam tip Two separate questions, two separate answers. “Slow growth” does not make an industry defensive, and “sensitive to the cycle” does not make it a growth industry.

How profitable is the industry?

Industry profitability is best shown by the distribution of ROIC across the industry’s companies over time, for example the 25th, 50th and 75th percentiles each year. ROIC captures after-tax operating profit per unit of capital and does not depend on how the companies are financed. The data are rarely available for private companies, so analysts commonly measure the public companies and assume that private rivals are similar, estimate the private ones from production costs and prices, or use government or consultancy surveys of margins.

A profitable industry is better than an unprofitable one, but the trend matters more than the level. If profitability is rising or falling, the analyst needs to know why.

Who has the market share, and how concentrated is the industry?

Market share is a company’s annual sales divided by the industry size, calculated each year.

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

Because the industry size is itself an estimate, read shares as a range. The trend is again more informative than the level: it shows whether customers are choosing a company’s products over its rivals’. Check how a share gain was made. Buying a competitor is a share gain, but what matters is whether the company is gaining share organically.

Industry concentration says how much of the industry sits with a few firms. Low concentration (many small competitors) usually means intense competition, unless the industry is service-oriented, local or highly differentiated. Rising concentration (consolidation) is associated with weaker competition and higher profitability. The usual measure is the Herfindahl-Hirschman Index (HHI) .

$$HHI = \sum_{i=1}^{n} s_i^2$$

Shares go in as whole numbers: a 50% share is 50, not 0.50. A monopoly scores 100² = 10,000. Equal firms score 10,000 ÷ n, so four equal firms score 2,500. Antitrust regulators in some countries treat an HHI of 1,500 to 2,500 as moderately concentrated and above 2,500 as highly concentrated. As a rule of thumb, a merger in a highly concentrated market that raises the HHI by more than 200 points often gets challenged.

The change from a merger depends only on the two firms that merge, because squaring (a + b) adds an extra term 2ab.

$$\Delta HHI = 2\,s_A\,s_B$$

Merging the two 10% producers instead adds 2 × 10 × 10 = 200, taking the HHI to 2,650: highly concentrated, but exactly at, not over, the 200-point rule of thumb. Any merger raises the HHI, and the bigger the merging firms, the bigger the jump.

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

Go deeper Why industry size is often an estimate

Where small and private firms make up much of an industry, no one counts their sales exactly. Analysts triangulate: a government census of businesses, a consultant’s survey and the investor presentations of large players. When three sources land close to each other, confidence rises. When they do not, say so and treat the size, and therefore every market share, as a range.

Go deeper Why a share bought by acquisition says little

A company that buys a rival adds the rival’s share overnight, but its own products have not become more attractive. Organic share, the change excluding acquired sales, shows whether customers are choosing the company. Also watch for a disruptive entrant: a pioneer that wins a large share of a new channel is a threat to the established players even while they still hold most of the total.