Archive for the 'Industry Analysis' Category

Factors Affecting the Business Cycle

The business cycle refers to the swings in gross domestic product from recovery to recession. There are several factors influencing the business cycle.

Consumers tend to be the most important, reflecting 60-70% of GDP in developed countries. Trends in consumer spending can be monitored through retail sales and personal income data.

Business spending on inventories and investment is a smaller but more volatile component of GDP. It can be tracked using surveys such as PMI or ISM.

Monetary policy is used by governments to dampen the overall business cycle. The ability to use monetary policy as a business cycle lever is dampened by inflation, the pace of growth, unemployment levels and capacity utilization.

Posted on 18th February 2009
Under: Economic Analysis, FInancial Planning, Industry Analysis, Investment Returns, Portfolio Management | No Comments »

Business Cycles in the Economy

The typical business cycle can last as long as 10 years or more. It is typically represented by several stages.

In the recovery stage, there is still a large gap between output and capacity. Bond yields are bottoming and stocks often surge. Taking risk (cyclical and risky stocks, high yield bonds) tends to offer above-average rewards.

In the early upswing, the economy experiences robust growth without causing inflation because output is still below capacity. As the capacity utilization improves, so does profitability. Short rates begin to rise, though long-term rates remain stable.

In the later stages of the upswing, the output gap closes and overheating becomes a danger. Inflation can pick up, resulting in rising interest rates and stock market volatility.

In a slowdown, the slowing economy becomes sensitive to potential shocks. Interest rates are peaking, and interest-sensitive stocks tend to perform well.

In a recession, declining GDP leads to falling short-term interest rates and bond yields. The stock market bottoms out and often starts to rise well ahead of the business cycle recovery.

Posted on 18th December 2008
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Inventory Cycles in Business

Inventory cycles tend to last two to four years. As business improves, greater confidence in future sales cause management to build inventory in anticipation of those sales. At some point, the sales fall below expectations and the inventories form a glut.

In order to clear inventories, prices are cut and fewer inventories are ordered. Eventually the inventory gets worked down. When sales do finally pick up again, this can sometimes lead to shortages.

Posted on 18th November 2008
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Model Uncertainty and Input Uncertainty

Model uncertainty is the risk that a selected model is inappropriate or incorrect for the purpose used.

Input uncertainty relates to whether the inputs fed to a model are accurate.

Input and model uncertainties make it difficult to evaluate potential inefficiencies or market anomalies.

Posted on 18th September 2008
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Global Industry Analysis

Companies that operate in global industries are subject to influences from both their country of domicile and their industry. As a result, both country analysis and global industry analysis are typically needed.

Country analysis can include not just the country of domicile, but also the major end markets in which a company operates. In each significant country market, analysts and economists typically monitor a wide range of economic, social and political variables. These can include:

  • Expected real and nominal growth
  • Monetary and fiscal policy
  • Investment climate
  • Business cycle stage
  • Long-term sustainable growth
  • Competitiveness
  • Factors affecting employment and wages
  • Social and political environment

Business cycles across countries are not fully synchronized, so some countries may recover or enter recession sooner than others. However, as markets become more globally integrated international business cycles tend to converge.

To estimate long-term sustainable growth, there are two primary competing theories.

  • Neoclassical growth theory assumes that the marginal productivity of capital declines as more capital is added.
  • Endogenous growth theory assumes that technological advances and improved labor force education can result in efficiency gains. These can prevent the decline in marginal productivity of capital.

As industries become more global, the country factors are also becoming less significant. Industry factors to consider include:

  • Demand analysis – how is the global market for the company’s products and services growing?
  • Value creation – Where on the supply chain is value created? Are there advantages to size, scale or scope? Is there a productivity learning curve in the industry?
  • Industry life cycle – is the industry a pioneer, accelerating growth, mature, stable or decelerating industry?
  • What is the industry’s competitive structure?
  • What is the competitive advantage pursued by each industry participant?

Posted on 25th August 2008
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Why Eliminating Rivals is a Risky Strategy

In the January 2008 Harvard Business Review Michael Porter updates his five forces model and discusses merger and acquisition strategies merely designed to eliminate rivals (rather than improve cost or quality) are risky.

Based on the five forces model, the reduced competition should increase industry profitability in the short term. However, the additional profits often attracts new competitors and a backlash from customers and suppliers.

Posted on 27th June 2008
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How Structural Changes Affect Industries

There are many factors that influence the investment performance of securities and industries. Only some of these are related to the general economy. Structural changes in a variety of categories can affect the prospects for companies and industries.


Changes in birth rates can have a profound impact on the overall economy. The “baby boom” in the US drove many trends as the needs of a large segment of the population evolved from diapers to education, from first homes to child-raising and finally to retirement. As the group retires, it may result in wage increases as the workers must be replaced from a smaller pool or in greater demand for financial services advice.


Are people living in cities or moving to suburbs? Is the divorce rate rising or falling? Are more people buying second homes or discretionary items? All of these can influence industry prospects.


Technology can make some products obsolete, and introduce entirely new products. It can also effect the efficiency of the overall economy.

Politics and Regulation

Regulations affect many industries, and the political climate, lifestyles and social values can impact the future of those regulations. New regulations, changes to existing regulations, and deregulation can all have profound impacts on company and industry prospects.

Posted on 1st June 2008
Under: Economic Analysis, Industry Analysis, Investing in Stocks, Security Selection | No Comments »

Industry Analysis: External Factors

There are many issues outside the control of company management or industry participants that nonetheless affect an industry’s viability. Understanding these factors is critical to industry and company research. The primary external factors affecting industries include technology, government, social changes, demographics and foreign influences.

New technologies can render existing products obsolete, but do not always. The automobile superseded the horse and buggy, but the airplane did not replace the auto. Other technologies have emerged and died without ever really challenging existing technology, while others are simply adapted into the existing products.

Government can play a large role in many industries, primarily through regulations. Laws can change over time, altering the competitive dynamics. Whole industries have been created around loopholes in regulations (such as the competitive local exchange carriers or CLECs following the 1996 Telecom Act in the United States) but closing the loophole can kill off the industry. Other industries sell to the government (such as defense or health plans reimbursed by Medicare). These too are dependent upon laws and the budget process, rather than market forces, to prosper.

Social changes are the result of the attitudinal shifts among the population. Smoking, once considered chic, is now frowned upon. Social changes are related to, but often distinct from fashion. In the 1980’s thin neckties were a fashion. In the 1990’s workplaces tended to move toward more casual attire. This may either be a fashion or a social change, depending upon whether neckties and business suits “come back” or gradually disappear.

Demographic shifts are often considered relevant to long-term trends. The large surge in population due to the baby boom has led to industry success depending on the boomer’s life stage.

Foreign influences have increasingly emerged through advances in communication technology and the global economy. “Offshoring” of high technology jobs is a case in point. At the same time, increasing standards of living in developing countries could lead to new demand for industries previously considered mature.

Posted on 1st December 2007
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Industry Classification: Business Cycle Reaction

Market based economies do not grow in a straight line. Growth tends to trend in cycles, with acceleration, deceleration, decline (recession) and recovery all being part of the normal course of business. However, not all industries follow the same cycle as the overall economy. Certain industries perform better at different stages of the business cycle. The primary classifications by business cycle reaction are growth, defensive and cyclical.

Growth industries tend to perform better than the overall economy throughout the business cycle. Often growth industries can expand even during a recession. Growth industries are generally characterized by new products or technology.

Defensive industries tend to be stable throughout the business cycle. These tend to be mature industries that will grow well during expansionary times but may see a modest dip if the economy turns down.

Cyclical industries tend to go through boom and bust cycles. However, these cycles may not correlate with those of the overall economy. In fact, some cyclical industries are counter-cyclical relative to the overall economy and perform best during a recession. Cyclical industries tend either to market discretionary products (customers can wait for until they are more confident before buying) or capital intensive. Capital intensive industries often see stable demand, but supply must be added in large “steps.” The sudden availability of excess supply hurts pricing until demand catches up, then eventually another large source of supply must be added and again results in an industry downturn.

Posted on 1st November 2007
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Industry Analysis: Competitive Strategies

Porter’s Five Forces can be used to estimate the overall competitive structure of an industry, and can also be useful in helping understand a company’s position within the industry and in shaping each firm’s competitive strategy. In order to succeed in the long run, a firm must cultivate some sort of sustainable competitive advantage. The three generic strategies that can result in such an advantage are cost leadership, differentiation and focus.

Cost leadership refers to the cost of production, not the price charged to customers. In a market where price is determined by supply and demand, the company with the lowest cost of production will enjoy the highest profits. Cost leaders cannot ignore differentiation – if its products are deemed inferior it will not be able to charge the same price as competitors and the lower cost will not produce sustainable advantage. The key is to maintain approximate parity with regard to differentiating factors while achieving the lowest cost.

Differentiation exploits customer willingness to pay more for something perceived to be of greater value. This can be quality, service, marketing or other factors. Differentiators cannot ignore cost – they must ensure that any additional costs incurred in differentiation are exceeded by the premium customers will pay for the differentiated product.

A focus strategy is based on serving a narrow segment of the overall industry and tailoring its strategy to the unique needs of its focus segment. Typically a focus strategy entails one of the other two strategies – being either a cost leader or a differentiator within the focus niche.

Posted on 2nd October 2007
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