Industry analysis is a market strategy tool used by businesses to determine if they want to enter a product or service market. Company management must carefully analyze several aspects of the industry to determine if they can make a profit selling goods and services in the market. Analyzing economic factors, supply and demand, competitors, future conditions and government regulations will help management decide whether to enter an industry or invest money elsewhere.
Economic factors of industry analysis include raw materials, expected profit margins and the interference of substitute goods. The cost of raw materials is an important factor in industry analysis because over-priced goods will not sell in an established market. Profit margins are closely linked to materials costs because offering discounts or sales prices will shrink company profits and lessen cash inflows for future production activity. Substitute goods allow consumers to purchase a cheaper good that performs relatively like the original item.
Supply and Demand
A supply and demand analysis helps management understand if enough consumers are willing to purchase more goods in an industry. If demand is high and supply is low, a company may be willing to enter the market and offer goods near the market price to gain a competitive advantage in the industry. A trend of declining demand indicates an industry that is oversold, and any new competitors will likely lose money because consumers are not interested in current goods or services.
The number of competitors is an important factor for proper industry analysis. If few competitors exist in a market, they may be charging consumers higher prices because of limited availability of products or services. As new competitors enter the market, existing companies can lower prices to maintain their current market share; newer competitors may not be able to match these price cuts if their products costs are too high. As industries contract, inefficient producers are forced out.
While no company managers can predict the future of an industry, they can try to determine where the industry is in the business cycle. If the industry is in an emerging market stage, companies can enter an industry and expect to earn a profit from rising consumer demand. If the industry is in a plateau stage, then only the most efficient producers with the lowest costs can continue to earn profits. At the end of a business cycle, demand is declining and producers leave the industry for more profitable markets.
Some industries have heavier regulations or taxes than others, which must be considered by companies looking to enter new markets. Taxes and other government fees add to the cost of doing business, which eats into profits earned by companies. Properly understanding the amount of government regulation in an industry helps management to determine if expected profit margins will earn a high enough return to cover these costs.