Professor Crocker H. Liu Rev. 2/19/99
Industry Analysis from a Finance Perspective
General Comments: When you think of an industry analysis, you think of benchmarks or
• The industry should be compared to the economy as a whole as proxied by the S&P500.
• Each firm in your industry should be compared against the industry and also the S&P500
q Life cycle of the industry. To ascertain which stage of the life cycle your industry is in, plot on
a graph the sales growth for your industry versus the sales growth for the S&P500 over time
using log of sales for the y-axis and time (year) for the x-axis. Do a similar graph of profit
margins and also earnings growth. One source of data is the S&P Analysts Handbook, Annual
Edition. See my website for other sources of data. Please discuss your results. Appendix A
provides further elaboration of the life cycle concept.
Logic: Is your industry growing or starting to grow only as fast as the economy (on average)?
This could have implications on cash flow forecasting at the industry and at the firm level.
q Business Risk. Please calculate the amount of business risk that your industry has. In
addition to this, please calculate the business risk for the main firms, which comprise your
industry and provide some discussion of your results. (If you do not know how to calculate
business risk or know what it is, please refer to the power point presentation on my website).
Logic: business risk is the relative dispersion in a firm or industry’s EBIT due to its cost
structure, product demand characteristics, and intra(inter)-industry competitive position. Such
business risk is a direct result of the firm’s investment decision.
q Degree of Operating Leverage, Degree of Financial Leverage, and Degree of Combined
Leverage. Please calculate the degree of operating leverage (DOL), the degree of financial
leverage (DFL), and the degree of combined leverage (DCL) that your industry has. Peform the
same calculations for the S&P500. In addition to this, please calculate the DOL, DFL, and DCL
for the main firms which comprise your industry. Provide some discussion of your results. (If you
do not know how to calculate DOL, DFL, and DCL please refer to the power point presentation
on my website).
Logic: This should provide an indication of the extent to which fixed operating cost and/or fixed
financing costs magnify profits or losses. This analysis should give you insights into the
appropriate mix of debt and equity to maximize shareholder wealth.
q Estimation of Sustainable Growth via DuPont Model. Please calculate the expected growth
rate for your industry and the major firms in your industry using the DuPont Model. This model
partitions the growth into the 5 major drivers. Do the same calculations of growth and its 5
components for the last 5 years and graph of your results. Compare the sustainable growth rate
with the actual growth rate. Discuss your results e.g. what’s driving high or low growth.
Bloomberg does the analysis for you in the detailed ratio section. (For a further discussion of the
DuPont model, please refer to the power point presentation on my website).
Logic: This analysis provides an indication of what are the key or dominant growth drivers from
a financial perspective e.g., is growth purely due to increasing your leverage or more efficient
use of your assets?
q Profitability. Please report and graph the profitability ratios for your industry such as return on
assets and return on equity (a component of the sustainable growth rate using the DuPont
model) over time (say a period of 7-10 years) against those for the S&P500 or S&P400 (see
S&P Analyst Handbook). Discuss your findings.
Publishing Industry: The Internet: The New Frontier.
Please look at my general comments and address these in your revision.
What drives profits and growth for this industry? Look at revenue and cost drivers. Some of the
keys to analyzing this industry include:
Ø Judging correctly the demographic trends, such as increased high school and college
• Although your group has a section on Consumer Demographic Trends (pg 17), you
do not provide a forecast of population growth and the growth of various age groups
over the next 5-10 years. (please look at my information sheet on my website).
Rather, you report on what’s currently happening. I want to see numbers and a
graph. Compare this forecast to the recent past. What does this trend portend in
terms of sales growth?
• An implicit assumption in focusing on the Internet is that most people are “wired”. I
need a sense of the degree to which the age group you’re focusing on, say people
aged 35 and over, have computers or have access to one. It’s akin to taking a
telephone survey to ask a question when the audience you’re targeting may not own
a phone. To some extent, what has been the trend in computer sales and the typical
buyer? I also need some sense of the traffic on the Internet in order to judge sales
growth. To what extent has the number of people on the internet grown over time
and what is the age breakdown relative to your target audience? It should give your
group a sense of potential internet sales.
Ø Evaluating the future impact of labor, paper, printing, and postage costs on profits (Please
provide numbers and a graph (s))
• While some costs such as rent have declined through distribution channel changes,
the continuing increase in postal rates or UPS rates could have a significant effect on
the industry over the long term.
• What is the impact of the trends in the price and availability of both newsprint and
coated papers on booksellers? Ditto for printing costs. These should affect all
booksellers regardless of whether they use the Internet as their distribution channel.
Quick-Service Industry: Fast Foods.
Please look at my general comments and address these in your revision. (This report is one of
the better ones in terms of focusing on revenues and costs. Besides this, your group actually
lists the major players by product type. Your group has done an admirable job for a preliminary
report). That said…
Ø Role of franchisees and their cost
• The recent news that McDonalds franchisees refused to go along with Mickey Ds
promotions suggest that there is definitely a cost associated with franchising ones
operations. I need to see to what extent various fast food operators use franchises
because the revenues and expenses will differ. To the extent that a company uses
franchises in order to grow, the company receives rent + sale percentages. If they
don’t use franchises, then revenue is based on sale percentages (no rent).
Ø Location, location, location
• A fast food retailer’s base assets are its locations. On a map, please provide % of
sales and profits by location e.g. on a state or regional basis. Are they equal for
each region? If they are not, this would suggest that an area’s demographics such
as per capita income and the percentage of people that eat out in a given region
become even more important.
• Also provide a percentage breakdown by domestic sales/profits vs. regions of the
world. One of the reasons that Coke is having problems is that 30% of their
revenues and profits come from Asia. Any economic turmoil in a particular region
could have an impact on sales.
Ø Sales and profit drivers
• Please provide a breakdown of revenues and profits e.g. numbers and percentages
by type of customer over time (say 5-7 years). More specifically, your analysis
focuses on the individual consumer. One way that some companies are growing is
through institutional sales. Starbucks, for example, has made a deal with United
Airlines to serve only Starbucks coffee on their flights. Some airlines as well as
schools have also made deals with hamburger chains such as McDonalds. You
briefly touch on this trend on page 21, but I want to see numbers or percentages e.g.
the whole profit “pie”.
• To what extent are toys and other promotional items driving sales? On a broader
basis, to what extent is tie-in businesses affecting sales and profits, if any?
Please look at my general comments and address these in your revision. In addition to this..
Ø Sales and profit drivers
• To what extent does growth come from foreign sales? The reason for this question
is that I understand that the drug approval process is much shorter abroad so that
products some to the market in less time.
• What percentage of revenue and profits come from each customer group that is
enumerated on page 6 of your report? Please provide numbers and percentages of
this sales and profit breakdown. I’m particularly interested in the tie-in arrangement
between drug companies and biotech firms since I suspect that this is where the bulk
of revenues for the biotech firms come from. If so, what is (are) the tie-in
arrangements? Who is partnered with whom? This is important since your group
states that the large drug firms provide funding for the biotech firms. To some
extent, isn’t the funding provided to biotech firms by drug companies dependent on
how well that particular drug company is doing?
• After discovering what markets various firms in your industry serves, you need to
address the existing and/or potential size of the market(s), what is the growth rate in
those markets, and what is the company’s position in those markets? Again, I would
like to see numbers and percentages.
• Is your last column on page 28, R&D expenses? If so, please state them as a
percentage of sales as well as the dollar amounts. Graph the percentage R&D to
sales ratio against profitability ratios for the major players in this industry over time.
Discuss your results.
Ø Biotech as key man businesses with intangible assets
• One topic which your group has only briefly addressed are the key players in the
industry and in each company. Biotech firms to some extent are like football teams
or restaurants. Lose the key players or chef and the team’s fortunes start to slide.
Do some companies have a competitive advantage in certain areas? This is
especially important in areas of research/product markets where firms overlap. Who
are the key players on each team?
While this industry is certainly interesting, I’d like to see more analysis in terms of revenues,
costs, growth, and profit in your revision to this section.
Wireless (Telecommunications) Industry.
Please look at my general comments and address these in your revision. Considerations:
Ø Report your results on a per subscriber basis
• For each major player in your industry as well as for your industry as a whole, report
revenues and profits on a per subscriber basis. Also report the capital investment
per subscriber over time. In valuing these types of firms where subscriptions are the
key e.g. the credit card business, internet providers, etc., one method used is a per
subscriber method. What has been the trend in revenue per subscriber over time?
Ø Drivers of revenues and profits
• Report numbers and percentage breakdowns of sales, income, and profit margins,
by geographic area – state and/or regional basis as well as international basis. To
what extent are sales and profits driven by any one area. Is the current crisis in Asia
affecting profits? Also report numbers and percentage breakdowns of sales, income,
and profit margins, by age. Are some age groups the main users of cell phones?
• Has the telecommunications industry and in particular, the wireless communication
subsector relied on pricing for its growth? I agree that pricing is an important factor
but that said, you need to address this issue since you talk about pricing throughout
• What is the key cost(s) in this business? For example, is controlling marketing costs
the key to meeting the competitors prices? Have cellular service plans increased
margins and profitability by tailoring sales commissions and marketing costs to
usage patterns? If not, how have margins and profitability increased?
• Are wireless operators being hampered in their efforts to put up more towers to
transmit signals? This could have growth implications.
• What are the major costs of this industry? Are costs changing over time e.g. are
they declining? Is capital being increasingly substituted for labor? Is the productivity
of capital improving for the industry as a whole?
• There are no 5 year forecasts provided of sales (profit) growth for the industry or
what will account for this growth.
Ø Market Share: What is the market share of each player?
Ø Substitutes for Product: Aren’t there two new kinds of cellular service that are emerging to
compete with established wireline and nonwireline operators: enhanced specialized mobile
radio and PCS, a miniaturized celluar system? Also, aren’t cellular companies expanding
into paging and data transmission?
This report is weak with respect to revenues, profits, and growth from an industry perspective.
Please look at my general comments and address these in your revision. You’ve made a good
start at identifying the revenue and cost drivers of the industry. That said, you need to provide
further details which I’ve enumerated below.
Ø Drivers of revenues and profits
• Report numbers and percentage breakdowns of sales, occupancy rates, income, and
profit margins, by geographic area – state and/or regional basis as well as international
basis. To what extent are sales and profits driven by any one area?
• To what extent does the upscale lodging segment which you focus on, use the sale and
leaseback method? For example, motels such as LaQuinta Inns set up a REIT which
they sell their properties to with a long term leaseback arrangement.
• Although your appendix contains a 5-year forecast for your industry, there is no
discussion of this in your report. What drives this forecast e.g. what assumptions were
made to do the forecast such as labor, transportation costs, etc.?
• While you do recognize the de-leveraging of the lodging industry and increased worker
productivity, your mention of these factors is very brief. Both of these factors continue to
drive profitability in the lodging industry. Moreover, these factors, which are unrelated to
occupancy or ADR growth, have effectively lowered the economic breakeven occupancy
in the industry from 67% in 1986 to 56% in 1997. The point that I’m trying to make is
that you can’t simply place graphs of these in your appendix. You need a little bit more
elaboration of both of these important concepts.
Ø Market share
• What is the market share of each player in your defined sub-industry?
Appendix A: DuPont Sustainable Growth Model
Appendix B: Industrial Life Cycle
1. Pioneering development. This is the start-up phase where sales growth is modest and
profit margins and profits are very small or even negative. During this time period the
market is small, and there are major development costs.
2. Rapid accelerating growth. During this interval, the product or service is recognized as
viable, and the demand is substantial. Because there are few firms in the industry, there
is little competition, backlogs are possible, and the profit margins are very high. As
productive capacity is built, sales grow at a rate that increases over time as the industry
attempts to meet excessive demand. Given the high sales growth and high profit
margins that likewise increase, as firms become more efficient, profits explode. For
example, during this phase profits may be growing at over 100 percent a year due to the
low base and rapid growth.
3. Mature growth. Because of the great success during the second stage, a lot of the pent-
up demand has been satisfied. Further, given the larger base of sales, future sales
growth may still be above normal, but it is not accelerating. As an example, if the overall
economy is growing at 8 percent, this industry might be growing at 15-20 percent a year
with a tendency for the rate of growth to stabilize. Also, because of the rapid growth and
previously high profit margins, there is an influx of competition and the profit margins
begin to decline to normal levels.
4. Stabilization and market maturity. During this stage the rate of growth is consistent
with the aggregate economy or the segment of the economy related to this industry (e.g.,
Disposable Personal Income, Personal Consumption Expenditures). During this stage
(which is probably the longest stage) it is relatively easy to estimate growth because
sales are closely related to an economic series. While sales grow in line with the
economy, profit growth varies by industry and for individual firms within the industry
based upon management ability to control costs. Because of the competition, profit
margins are very tight, and returns to capital are at the competitive level or slightly below.
5. Deceleration of growth and decline. At this stage the mature industry experiences
declines in growth due to lower sales because of shifts in demand or an increase in
substitutes. Profit margins continue to be squeezed, and some firms experience low
profits or losses. Even those firms that have profits may experience very low rates of
return on capital and begin thinking about alternative uses for the capital tied up in this
Example: Following is a discussion of the life cycle process and its impact with respect to sales
growth as applied to the beverage-soft drink industry.
1977 110.70 224.24
1978 131.17 251.32
1979 152.95 292.38
1980 177.47 327.36
Log Bev Sales
Log S&P Sales
1981 193.30 344.31
1982 195.77 333.86
1983 213.51 334.07
1984 217.22 379.70
1985 240.68 398.42
1986 264.37 387.76
1987 286.85 430.45
1988 348.14 486.92
1989 382.27 541.38
1990 447.17 594.55
1991 498.58 586.86
1992 563.42 601.39
1993 629.08 603.62
1994 731.96 631.51
Source: S&P Analysts Handbook: 1995 Annual Edition
Example of Analysis - The graph on the next page reveals that the soft drink industry is in the mature
growth phase of the industrial life cycle. However, the charts also show that soft drink sales exhibit above
normal growth relative to sales of the S&P Industrials indicating that expansion opportunities still exist.
More specifically, soft drink sales on a per share basis grew at an average rate of 14% from 1990-1994
compared to a sales growth of 3% per annum for S&P Industrials over the same time period1. While most
1 Detailed Calculations of Sales Growth for Past 5 years.
1989 382.27 541.38
1990 447.17 594.55
1991 498.58 586.86
1992 563.42 601.39
1993 629.08 603.62
1994 731.96 631.51