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How to do an industry analysis? A step-by-step framework, using Michael Porter 5 forces. Potential entrants, Substitutes, Suppliers and Buyers
14 min read

How to do an industry analysis?

Different industries have different particularities. Some of them have higher barriers to entry, others have smaller profit potentials. Some of them are industries that are growing, others are already in decline. You need to know which is each, to have realistic expectations and to take your margin of safety. Some things will take longer than expected, especially when you are doing them the first time. In other circumstances, you will need to dig a little further to have an overall understanding of the subject. It is important to not let yourself under the spell “make a business from your passion!”, without doing the due diligence necessary for this decision. Knowing how to do an industry analysis can be the first step in growing your business.

Why industry analysis is so important?

Industry analysis is crucial for business success because it helps you to understand the market conditions of the industry in which you are trying to build a business. Through an industry analysis, you will find out all the information necessary to build an integrated business strategy.

An industry analysis is an “x-ray” of the marketplace! 

It will give you the answer to questions like:

  1. Is the industry in a developing phase, plateau, or in decline?
  2. Who are the competitors?
  3. Who is the market leader?
  4. How big is the market?
  5. What are the substitution products?
  6. What position does each competitor occupy on the brand ladder in the mind of the customer?

After finding the answer to all these questions, you will have all the information necessary to craft a winning strategy. This strategy will allow you to occupy the open position that you identify in the mind of your future customer.

How to do an industry analysis step-by-step?

When you are doing research for an industry, you need a systematic approach. “I will find out all there is to know about the industry” is not a realistic approach, and probably will not help you in this step of the process. Rather will make you feel overwhelmed.

I will use the “holly bible” of Industries analysis, to guide you through this process. I’m talking about Competitive Strategy – by Michael Porter. For this stage, you need to use just the information that can be found in the first chapter.

What are the 5 forces of Michael Porter that shape industries?

  1. Threat of entry
  2. Intensity of rivalry among existing competitors
  3. Pressure from substitute products
  4. Bargaining power of suppliers
  5. Bargaining power of buyers

For a big picture, you need to understand what are the forces that are influencing the marketplace in which you want to build a business. Even if you plan to build a bike shop, a distributing company or an IT company, you will need to understand the depth of the image presented below.

With this in mind, you can create your strategy, update it when necessary (usually when you will have access to new information), and navigate your way to success.

To have a better understanding of the big picture, we will analyze every force, one by one.

First, you need to understand that direct competitors are not the only ones that can influence your success in the market. You need to address all 5 forces presented above to thrive in any industry. Usually, the intensity of these 5 forces will determine the profitability of the industry.

1. Threat of entry.

The new entrants in an industry are a threat because they are actively contributing to shaping the market space. They bring new resources, they bring new capacities for serving the market, and usually, this will activate the other forces. Suppliers will tend to rise/inflate the prices for the raw materials, because of the raise in demand for raw materials. Buyers will tend to negotiate lower prices because of the rise in the supply of goods and services that you produce.

You will assess the threat of entry using the barrier of entry that already exists. In general, we have 6 major entry barriers that are usually impacting the industries. This will bring us to a sub-analysis of these forces because it is important to have a clear picture.

What are the entry barriers in an industry?

1.       Economy of scale

Refers to decline in cost/unit of production once your capability passes a certain quantity/a specific period. This means that a new entrant in an industry with this kind of barrier will have two choices:
1.1 Enter at a large scale, with a big investment from the beginning, and this usually will trigger a response from a direct competitor. Either will start a price war, to stop the new entrant from becoming profitable, or they can try to block the access to the traditional distribution channel.
1.2 Or they can try to overpopulate the market with their products, by offering better payment terms for their partners, etc. Enter the market at a low scale, and bear the higher cost of production/unit. This will give you a disadvantage when it comes to the pricing power. It will take you longer to become profitable and ultimately it will be harder to invest in technologies to scale up your business or to keep up with the advancement of new technologies.
Scale economy can be present in every function of a business: You can find this in marketing, sales, purchasing, manufacturing, or service networks. For example, if you have larger budgets for Marketing, it will be easy to do A-B testing in all your market segments. Next, adjust and implement new strategies at a large scale. If you have a distribution company, you will have greater bargaining power, if you buy in large quantities, etc.

2.       Product Differentiation

This refers to big established firms that are already in the industry, and have a strong brand and many loyal clients. Look at brands like Apple or Google. It is hard for any new entrant to take customers from these brands. Usually, these barriers can be overcome by investing heavily in brand image and customer locality. You can do this by building a great product, keeping up to your promises, and having a consistent positioning strategy.
On the other hand, you can invest in customer loyalty by building a community and having an ongoing conversation with your customer. Let them take part in your product improvements by listening to their suggestions and reviews or offering great support. These can be done with substantial investment, which is risky to make. In case of failing to penetrate the market and reach the brake-even point, all of them will be in vain.

3.       Capital Requirements

This force is determined by the amount of capital that you need to start the business. The larger the amount, the bigger the barrier. For example, if you are planning to produce a car, the initial financial investment will be considerably larger than if you are trying to start an online marketing agency or a design agency.

4.       Switching Costs

These are one-time costs that your future clients will need to encounter if they decide to switch to your product/services. For example, if you are selling Dell laptops, but your client is using Apple products, they will have the cost of switching to other software as well as the cost of retraining their employees.
Last, but not least, consider the cost of distribution. If your direct competitors have control over the distribution channel, it will be hard and costly to build additional distribution channels. Direct control in these instances will mean that the distribution channels are part of the same group of companies, as your competitors. Indirect control will mean that your competitors have exclusivity or the revenue obtained by the distribution firm is largely made from selling the competitor’s product.

5.       Cost Disadvantages Independent of Scale

Some industries have their particularity regarding some additional costs. Here we have:

    • Cost of licensing technologies or patents.
    • Favorable access to materials.
    • Favorable location.
    • Government subsidies.
    • Learning or experience curve. This is something that can be found in production or services as well. You need to take into consideration this because the cost of learning is a cost that is usually overlooked. You can learn by doing training, but sometime you need to learn by “try in errors”, or by a-b testing. In the short-terms, this can create a disadvantage in terms of costs.

2. Pressure from substitute products

In a large sense, all industries have internal competition, but at the same time, external competition, under the form of substitute products. These substitute products usually are the ones that can put a ceiling on prices. This is true even where the main industry is thriving, and it is an ever increase in demand. This is the case, for example, with sugar. Even if the demand is greater every year, the price has a ceiling limit that is created by substitutes like corn syrup or sugar substitutes.

We need to pay extra attention to newcomers, which are built based on a trend. This is true especially in the fashion industry, where time to time the materials change. At one point it is a lather purse in style, the next day that lather purse can become obsolete and its place can be taken by a cork backpack, made from biodegradable materials.
Here, the cork purse is the substitute product for the leather purse, and even if it is not a direct competitor, it can “eat” a significant market share.

A substitute product can come from a different industry with a higher margin of profit, as a result of a breakethrough from the R&D department in that industry. These usually are the ones that create real trouble in an established industry. Take for example Uber or Airbnb.

3. Bargaining power of buyers

Buyers, in groups, are trying to force the industry to lower the prices. They are doing this by asking for personalized products or services, extended guarantees, additional services (like training the personnel), or better payment terms, eroding the profits of the industry. Usually, the group of buyers that have the power to “bend” industries have one or more of the following characteristics:

  1. The buyer purchases a large volume compared with the company sales.
  2. The products purchased inside the industry are standard and undifferentiated.
  3. Has few or no cost of switching to another seller.
  4. Buyers can easily backward integrate.
  5. The industry product is not relevant to the quality of the client’s product or service.
  6. The buyer has full information on the market. The cost of production, demand, trends, and seller’s financial situations.

4. Bargaining power of suppliers

    1. If the suppliers are represented by a few big players, and they are a united force. The best example is OPEC in the oil industry.
    2. There are not yet on the market substitute products, or not on a scale to satisfy the entire demand.
    3. The buyer is not an important group for the suppliers, or it has small buying power.
    4. The supplier group can make a strategic move of forward integration, becoming in this way a concurrent for the buyer.

5. Intensity of rivalry among existing competitors

This force has different intensity depending on the particularity of the industry. If the industry is growing, usually the rivalry between competitors is not so intense. If the industry is mature, the rivalry will be more intense. In this case, take into consideration the following aspects:

  1. Number of Equally Balanced Competitors:

    If there is not a leader in the market, instability can occur for different reasons. It is easy for a price war to start, an overflow in the product’s market, by raising the capacity without justification from one competitor.

  2. Slow Industry Growth:

    If this is the case, the competition between the competitors will increase constantly, because the competitors will try to take market share from each other.

  3. High Fixed or Storage Costs:

    High Fixed cost, or high storage cost, can make price cutting appear suddenly when the capacity is met. This is especially true for products that need special storage (like frozen products, or products with expiration dates).

  4. Lack of Differentiation or Switching Costs:

    If your product or service is perceived as a comedy, clients will be more price-sensitive, and they will usually buy the cheapest material, paper is a good example. On the other hand, products that have strong differentiator, are better protected when new joiners occur in the market because their price doesn’t have a high price elasticity. Apple or Tesla is a good example.

  5. High Exit Barriers:

    This part is meant to answer to the question: “How easy is to liquidate your business, if you decide to retire, or you have a better opportunity?”.

    These barriers can occur from:
    Specialized Assets, usually when equipment or the expertise of the employee can’t be transferable in other industries.
    Emotional attachment, especially of the CEO of the company is the founder, or if the management team had a long history together in building the company.
    Governmental or social restriction, this may occur in special condition where the government make pressure to not close the facility to keep the jobs. Usually when the facility has a strategic importance. Example being a national aviation company, military equipment production, or medical research.

Who are the companies in the industry?

It’s important to know from the start:

    • Which are the main competitors?
    • Who is the leader (if there is one)?
    • Who are the local competitors?
    • Who are the newcomers?

All these answers to the questions above will help you narrow down the companies for which you need to find row data. Also, they are important because they give you right from the beginning the type of raw data you should find, what are the competitive advantages of the main competitors in your industry, and so on.

You will find data for these questions in:

    • Industry studies
    • Annual reports
    • Companies’ directory and statistical data
    • Business press
    • Industry magazines

After you have a list of all the important companies that you need to study, you will need to make a folder for each of them. Further, you need to feel out the table presented below, for each of the companies.

These tables will give you the structure that you need, to put the data in a logical way. You will have the possibility to compare the companies that you study and to take a big picture of the industry. This picture will help you choose your industry wisely and understand the Competitive Strategy that is already in place in the industry.

Now that you have done these steps, you can make a complete analysis of the strengths and weaknesses of the industry that you want to enter. Further, this will play a big role in the planning phase, when you will need to find out what is the financial investment necessary to make this move.

If something is not clear, I would recommend you to read the first chapter of the book: Competitive Strategy by M. Porter. More than that, you can leave a comment with your question, or contact me via email, and together we will find the answer to your questions.

How to do an industry analysis? – Template

name
Functional areas Data Categories Year n-2 YOY (%) Year n-1 YOY (%) Year n
Financial Profitability
ROI
Debt
Assets
Growth
Rate
Growth
Determinants
Technologies Technology of production and distribution
Cost structure
Economies of scale
Value added
Innovation
Type
Sources
Rate
Economies of Scale
Marketing Marketing and selling
Marketing segmentation
Marketing practices
Product lines
Buyers and their behavior
Complementary products
Substitute products
Operational Suppliers
Distribution channels
Logistic
Strategy Competitors – strengths and weakness, strategies, goal, assumptions
Social, political, legal environment
Macroeconomics environment
HR Number of employees
Employee Branding
Strategy of employment (best on the market, internships and after trainings, etc.)

 

The knowledge should be a good starting point, unless you know better, and, if you do, please share with us. I would be grateful to hear your feedback and to improve my knowledge!

Conclusion

This would be the second step after finding out Where to start as an entrepreneur? Don’t look for shortcuts! In order to build a proper business, you need to set the bases for success right from the beginning. In order to do that, you need to make a detailed analysis of the industry. It may seem hard, but is worth it. Do it right, and you will create a business in an industry that will continue to grow many years ahead.

Skip this step, and most probably you will have a hard time finding market fit. Also, it will be hard to find an open position in the market, or a scalable solution.

If you are serious about building a business and determine to succeed, let’s get to work!

Additional resources for how to do an industry analysis?

  1. Download the Free Industry Analysis Template
  2. Competitive strategy – Michal Porter

 

 

 

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