Definition of Industry Analysis

An industry is a group of firms that have similar technological structure of production and produce similar products. For the convenience of the investors, the broad classification of the industry is given in financial dailies and magazines. Companies are distinctly classified to give a clear picture about their manufacturing process and products. The table gives the industry wise classification given in Reserve Bank of India Bulletin.

Industry Groups

The table shows that each industry is different from the other. Textile industry is entirely different from the steel industry or the power industry in its product and process.

These industries can be classified on the basis of the business cycle i.e., classified according reactions to the different phases of the business cycle. They are classified into growth, cyclical, defensive and cyclical growth industry.

Growth Industry

The growth industries have special features of high rate of earnings and growth in expansion, independent of the business cycle. The expansion of the industry mainly depends on the technological change. For instance, inspite of the recession in the Indian economy in 1997-98, there was a spurt in the growth of information technology. It defied the business cycle and continued to grow. Like wise in every phase of the history certain industries like colour televisions, pharmaceutical and telecommunication industries have shown remarkable growth.

Cyclical Industry

The growth and the profitability of the industry move along with the business cycle. During the boom period they enjoy growth and during depression they suffer a set back. For example, the white goods like fridge, washing machine and kitchen range products command a good market in the boom period and the demand for them slackens during the recession

Defensive Industry

Defensive industry defies the movement of the business cycle. For example, food and shelter are the basic requirements of humanity. The food industry withstands recession and depression. The stocks of the defensive industries can be held by the investor for income earning purpose. They expand and earn income in the depression period too, under the government’s umbrella of protection and are counter cyclical in nature.

Cyclical Growth Industry

This is new type of industry that is cyclical and at the same time growing. For example, the automobile industry experiences periods of stagnation, decline but they grow tremendously. The change in technology and introduction of new models help the automobile industry to resume their growth path.

Industry Life Cycle

The industry life cycle theory is generally attributed to Julius Grodensky. The life cycle of the industry is separated into four well defined stages such as

Pioneering stage

Rapid growth stage

Maturity and stabilization stage

Declining stage

Pioneering Stage

The prospective demand for the product is promising in this stage and the technology of the product is low. The demand for the product attracts many producers to produce the particular product. There would be severe competition and only fittest companies survive this stage. The producers try to develop brand name, differentiate the product and create a product image. This would lead to non-price competition too. The severe competition often leads to the change of position of the firms in terms of market shares and profit. In this situation, it is difficult to select companies for investment because the survival rate is unknown.

Rapid Growth Stage

This stage starts with the appearance of surviving firms from the pioneering stage. The companies that have withstood the competition grow strongly in market share and financial performance. The technology of the production would have improved resulting in low cost of production and good quality products. The companies have stable growth rate in this stage and they declare dividend to the share holders. It is advisable to invest in the shares of these companies. The pharmaceutical industry has improved its technology and the top companies in this sector are giving dividend to the shareholders. Likewise power industry and telecommunication industry can be cited as examples of expansion stage. In this stage the growth rate is more than the industry’s average growth rate.

Maturity and Stabilization Stage

In the stabilization stage, the growth rate tends to moderate and the rate of growth would be more or less equal to the industrial growth rate or the gross domestic product growth rate. Symptoms of obsolescence may appear in the technology. The keep going, technological innovations in the production process and products should be introduced. The investors have to closely monitor the events that take place in the maturity stage of the industry.

Declining Stage

In this stage, demand for the particular product and the earnings of the companies in the industry decline. Now-a-days very few consumers demand black and white T.V.innovation of new products and change in consumer preferences lead to this stage. The specific feature of the declining stage is that even in the boom period; the growth of the industry would be low and decline at a higher rate during the recession. It is better to avoid investing in the shares of the low growth industry even in the boom period. Investment in the shares of these types of companies leads to erosion of capital

Factors to be Considered

Apart from industry life cycle analysis, the investor has to analyse some other factors too. They are as listed below

Growth of the industry

Cost structure and profitability

Nature of the product

Nature of the competition

Government policy

Labour

Research and development

Growth of the Industry

The historical performance of the industry in terms of growth and profitability should be analysed. Industry wise growth is published periodically by the Centre for Monitoring Indian Economy. The past variability in return and growth in reaction to macro economic factors provide an insight into the future. Even though history may not repeat in the exact manner, looking into the past growth of the industry, the analyst can predict the future. The information technology industry has witnessed a tremendous growth in the past so also the scrip prices of the IT industry. With the Y2K millennium bug creating a huge business opportunity even beyond the year 2000, the sector is expected to maintain its growth momentum.

Cost Structure and Profitability

The cost structure, that is the fixed and variable cost, affects the cost of production and profitability of the firm. In the case of oil and natural gas industry and iron and steel industry the fixed cost portion is high and the gestation period is also lengthy. Higher the fixed cost component, greater sales volume is required to reach the firm’s breakeven point. Once the breakeven point is reached and the production is on the track, the profitability can be increased by utilizing the capacity to full. Once the maximum capacity is reached, again capital has to invest in the fixed equipment. Hence, lower the fixed cost, adjustability to the changing demand and reaching the break even points are comparatively easier.

Nature of the Product

The products produced by the industries are demanded by the consumers and other industries. If industrial goods like pig iron, iron sheet and coils are produced, the demand for them depends on the construction industry. Likewise, textile machine tools industry produces tools for the textile industry and the entire demand depends upon the health of the textile industry. Several such examples can be cited. The investor has to analyse the condition of related goods producing industry and the end user industry to find out the demand for industrial goods.

In the case of consumer goods industry, the change in the consumers’ preference, technological innovations and substitute products affect the demand. A simple example is that the demand for the ink pen is affected by the ball point pen with the change in the consumer preference towards the easy usage of pen.

Nature of the Competition

Nature of competition is an essential factor that determines the demand for the particular product, its profitability and the price of the concerned company scrips. The supply may arise from indigenous producers and multinationals. In the case of detergents, it is produced by indigenous manufactures and distributed locally at a competitive price. This poses a threat to the company made products. The multinational are also entering into the field with sophisticated product process and better quality product. Now the companies’ ability to withstand the local as well as the multinational competition counts much. If too many firms are present in the organized sector, the competition would be severe. The competition would lead to a decline in the price of the product. The investor before investing in the scrip of a company should analyse the market share of the particular company’s product and should compare it with the top five companies.

Government Policy

The government policies affect the very nerve of the industry and the effects differ from industry to industry. Tax subsidies and tax holidays are provided for export oriented products. Government regulates the size of the production and the pricing of certain products. The sugar, fertilizer and pharmaceutical industries are often affected by the inconsistent government polices. Control and decontrol of sugar price affect the profitability of the sugar industry. In some cases entry barriers are placed by the government. In the airways, private corporate are permitted to operate the domestic flights only. When selecting an industry, the government policy regarding the particular industry should be carefully evaluated. Liberalization and delicensing have brought immense threat to the existing domestic industries in several sectors.

Labor

The analysis of labor scenario in a particular industry is of great importance. The number of trade unions and their operating mode has impact on the labour productivity and modernization of the industry. Textile industry is known for its militant trade unions. If the trade unions are strong and strikes occur frequently, it would lead to fall in the production. In an industry of high fixed cost, the stoppage of production may lead to loss.

When trade unions oppose the introduction of automation, in the product market the company may stand to lose with high cost of production. The unhealthy labour relationship leads to loss of customers’ goodwill too.

Skilled labour is needed for certain industries. In the case of Indian labour market, even in computer technology or in any other industry skilled and well-qualified labour is available at a cheaper rate. This is one of the many reasons attracting the multinationals to set up companies in India.

Research and Development

For any industry to survive the competition in the national and international markets, product and production process have to be technically competitive. This depends on the R & D in the particular company or industry. Economies of scale and new market can be obtained only through R & D. the percentage of expenditure made on R & D should be studied diligently before making an investment.

Pollution Standards

Pollution standards are very high and strict in the industrial sector. For some industries it may be heavier than others; for example, in leather, chemical and pharmaceutical industries the industrial effluents are more.

SWOT Analysis

The above mentioned factors themselves would become strength, weakness, opportunity and threat (SWOT) for the industry. Hence, the investor should carry out a SWOT analysis for the chosen industry. Take for instance, increase in demand for the industry’s product becomes its strength, presence of numerous players in the market, i.e. competition becomes the threat to a particular company in the respective industry. The progress in the research and development in that particular industry is an opportunity and entry of multinationals in the industry and cheap imports of the particular products are threat to that industry. In this way the factors have to be arranged and analysed. To make the industry analysis more explanatory it has been carried out on the pharmaceutical industry and SWOT analysis results are also given.

Pharmaceutical Industry

Growth of the Industry

The industry has witnessed healthy growth in the recent past and investment in pharmaceutical industry is continuing. The product output is also increasing and operational and business management efficiency also seem to have improved. This is shown by the increase in the output of the industry as given in table

Value of Production of Bulk Drugs and Formulations during the Years 1993-94 to 1997-98 (Rs in Crs.)

Structure of the Industry

Pharmaceutical industry adopts high technology and produces high value added products. The process is very complex in nature. The processes are classified into primary and secondary. The primary process requires uninterrupted power supply, maintaining of conditions under which the molecules react and yield a new product, excellent manufacturing conditions and well-trained personnel. Specific plants costs less but, they have the risk of obsolescence. Multipurpose plants are expensive and have no risk of obsolescence but, they have the risk of cross contamination. The secondary process is the conversion of bulk drugs into formulations. The secondary process is not much technology intensive and has low capital cost. Hence, there are many players in the market.

Nature of the Product

The products of the pharmaceutical industry are broadly classified into bulk drugs, formulations and intravenous fluids. Bulk drugs are like Ciproflaxacin, Ibuprofen, Ranitidine, Ethanbutol, etc. The major manufactures of the products are Ranbaxy, Cipla, Cadilla, Dr.Reddys’ Lab and Lupin. Some companies manufacture formulations from bulk drugs and market them under brands. Companies also manufacture formulations for other companies. Some of the companies in the formulation segment are Ranbaxy, Cipla, Wockhardt, Lupin etc.

Intravenous fluids are preparations which aid in quick replenishment of body fluids. Bulk drugs and formulations companies produce intravenous fluids also. The formulations are produced by firms from all over the country. Andhra Pradesh stands first in the production of bulk drugs.

Demand for the Product

The Indian pharmaceutical market which was worth Rs90 billion in 1997, is growing at 13.7% rate. But only three out of ten Indians have access to allopathic drug. Even in this segment vast majority of them belong to urban area. Investments in medical and public health declined from 2% of the total capital outlay in the sixth five year plan to 1.75% in the Eighth five year plan. In the year 1996-97, the portion in the annual budget was of 1.7%.

The less than 15 age segment of the population is expected to grow at 0.5% but the fastest growth is expected in the 50-59 groups. This has led to a shift in the demand from the life saving drugs to life enhancing drugs. It is referred to as a shift from age old diseases to old age diseases.

Competition

The industry is having 2400 players within the organised sector and around 15,000 in small-scale sector. The low entry barriers, government’s encouragement given to small sector units and low capital cost are the reason for the presence of large number of units in the pharmaceutical sector. This has lead to price crash in the bulk drug.

Apart from internal competition, the industry is facing international competition too. There is a large import of bulk drugs from China. The Chinese products are a significant competitor for the Indian pharmaceutical industry. Multinational corporations like Pfizer, Abbot labs and Novartis also pose threat to the local producers.

Government Policy

The drug companies operate in a highly politicised environment. The product development, prices, safety are regulated by the government. The pharmaceutical industry functions under the Drug Price Control Order. The prices of drugs are regulated to make them available to the masses at affordable prices. The DPCO is issued from time to time to keep the policy in tune with the changing demands.

The Patent Law in India provides patent only for process and there is no product patent. But, with signing of GATT, India is required to amend the Patent Law. Once the product patent comes into force, the reverse engineering route to introduce new molecules will not be available to Indian companies.

Research and Development

The average sum spent by the 15 largest Indian pharmaceutical companies for R & D is around 2 percent of turnover. This is drastically low and research is mainly concentrated towards the area of process development rather than on new molecular searching.

Strength

Despite economic slowdown, the industry registered double digit growth rate.

Indian pharmaceutical market is growing at 13.7%.

Net exporter of bulk drugs and formulations.

Low cost in process development and R & D.

Third largest scientific pool in the world.

Weakness

Decline in plan investment in medical and public health.

Only three out of ten Indians have access to allopathic drugs.

Various price controls.

Opportunity

With increase in purchasing power, health care expenditure would increase.

Non Japan Asia’s share of world health care spends will double.

Patent law will lead to consolidation of industry.

Threat

Fall in the price of bulk drugs and imports from China.

60 major products may lose patent protection.