Industry and company analysis - Industry life cycle and comp...

Learning Outcomes

This article explains how to perform industry and company analysis using the industry life cycle framework and key drivers of competition, including:

• Identifying, describing, and distinguishing the main stages of the industry life cycle and linking each stage to typical patterns of demand growth, pricing power, profitability, risk, capital needs, and cash‑flow profiles.
• Applying Porter’s Five Forces systematically to evaluate the intensity of industry competition, long‑run profitability, and an industry’s ability to pass input‑cost inflation through to customers.
• Relating industry structure and life cycle stage to firm‑level strategy choices, sources of sustainable competitive advantage, and expected return on invested capital (ROIC) relative to the cost of capital.
• Distinguishing clearly between industry‑wide conditions and company‑specific strengths or weaknesses so that you avoid common CFA exam traps when interpreting vignettes and multiple‑choice options.
• Using life cycle and Five Forces analysis to support revenue, margin, and cash‑flow forecasts, select appropriate valuation approaches, and judge whether a firm’s current performance is likely to improve, deteriorate, or revert toward industry averages.
• Integrating qualitative assessments of competitive dynamics with simple, exam‑style calculations to comment on how shifts in bargaining power, entry barriers, or rivalry may affect future profitability and valuation multiples.

CFA Level 1 Syllabus

For the CFA Level 1 exam, you are required to understand how the industry environment affects company performance and valuation, with a focus on the following syllabus points:

• Describe the stages of the industry life cycle and key characteristics of each stage
• Explain factors affecting industry competition using frameworks such as Porter’s Five Forces
• Assess how industry structure and competition influence a firm’s performance, competitive strategy, and valuation
• Distinguish between industry analysis and company analysis and explain their relevance to equity valuation

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which industry life cycle stage is most likely to exhibit the most intense price‑based rivalry?
   1. Introduction
   2. Growth
   3. Maturity
   4. Decline
2. In Porter’s Five Forces framework, which of the following most directly reduces an industry’s ability to raise prices when input costs rise?
   1. Weak supplier power
   2. Strong buyer power
   3. High barriers to entry
   4. Few close substitutes
3. Market saturation and slowing demand growth are most characteristic of which life cycle stage?
   1. Introduction
   2. Growth
   3. Shakeout
   4. Maturity
4. Which statement about companies and industries is most accurate?
   1. All companies in the same industry share the same competitive advantage
   2. A strong brand always implies high industry profitability
   3. Companies in the same industry can be at different life cycle stages
   4. Industry structure is irrelevant once a firm achieves cost leadership

Introduction

Industry and company analysis are fundamental for security valuation and investment decision‑making. Analysts rarely value companies in isolation; they interpret a firm’s prospects in the context of its industry’s growth potential, structure, and competitive intensity. Knowing where an industry sits in its life cycle and how strong competitive forces are helps in forecasting revenue, margins, and ultimately cash flows.

Key Term: industry life cycle
The sequence of stages—typically introduction, growth, shakeout, maturity, and decline—that an industry passes through from inception to possible disappearance.

Key Term: industry structure
The configuration of an industry in terms of number and size of competitors, degree of product differentiation, barriers to entry and exit, and the balance of power among suppliers, buyers, and producers.

Key Term: Porter’s Five Forces
A framework that explains industry profitability in terms of five competitive forces: threat of new entrants, threat of substitutes, bargaining power of buyers, bargaining power of suppliers, and rivalry among existing competitors.

Key Term: competitive advantage
A firm’s ability to generate returns above its cost of capital on a sustained basis through unique resources, capabilities, or positioning relative to competitors.

Key Term: pricing power
A firm’s ability to raise prices without losing significant sales volume, often arising from differentiation, brand strength, or limited substitutes.

Frameworks such as the industry life cycle and Porter’s Five Forces support consistent, objective assessments of industry opportunities and threats. They also help you judge whether a company’s current high profitability is likely to persist or be competed away—central to many CFA Level 1 valuation questions.

INDUSTRY LIFE CYCLE FRAMEWORK

The industry life cycle framework divides an industry’s development into sequential stages, each with distinctive patterns in competition, profitability, cash flows, and risk. The five classic stages are:

Key Term: life cycle stage
A distinct phase in an industry’s evolution, characterized by typical patterns in sales growth, competitive intensity, investment requirements, and profitability.

Introduction Stage

• Innovation is high; products are novel and often untested. Demand is uncertain and may grow slowly as customers learn about the product.
• Entry barriers can be significant because of required technology, specialized knowledge, or regulation. The number of competitors is small.
• Marketing and development costs are high; economies of scale are not yet realized.
• Little price competition—firms often focus on educating customers and improving the product rather than undercutting prices.
• Few (if any) firms are profitable; cash flows are usually negative. Financing tends to be equity‑heavy and risky.

Typical strategic priorities:

• Building awareness and trial use
• Refining product design and resolving technical issues
• Establishing initial distribution channels and intellectual property protection

Growth Stage

• Demand grows rapidly as product acceptance spreads and customer awareness increases. Industry sales growth often exceeds overall economic growth.
• New entrants are attracted by growth and early profits. The number of firms increases, but rapidly expanding demand can allow many to grow without immediate intense rivalry.
• Profitability improves as firms move down the cost curve and achieve economies of scale.

Key Term: economies of scale
Cost advantages that arise when higher production volume allows fixed costs to be spread over more units or enables more efficient production methods.

• Cash flows turn positive for successful firms but are often reinvested heavily in capacity, R&D, and marketing.
• Competitive advantages often stem from scale, patents, unique technology, or strong early branding.

Typical strategic priorities:

• Expanding capacity and market share
• Strengthening brand and distribution
• Driving down unit costs through scale and learning effects

Shakeout Stage

• Growth starts to slow as early adopters are largely served and the market approaches saturation.
• Excess capacity emerges because firms built for continued high growth.
• Competition intensifies; weaker firms struggle to cover fixed costs and may exit, merge, or get acquired.
• Price competition may begin, especially if products are not well differentiated.
• Industry becomes more concentrated around stronger players with cost or differentiation advantages.

Strategic priorities:

• Consolidation (mergers and acquisitions)
• Aggressive cost management and capacity rationalization
• Differentiation to avoid competing purely on price

Maturity Stage

• Market is saturated; demand growth is minimal and often tracks overall economic growth. Replacement demand dominates new adoption.
• Industry structure is more stable; a few large firms often dominate (oligopoly).
• Competition focuses on gaining share from rivals rather than expanding the total market. Price competition can be significant, particularly for undifferentiated products.
• Firms emphasize operational efficiency, cost leadership, and incremental product differentiation.
• Returns tend to approach the cost of capital for the average firm; sustaining above‑average returns becomes difficult.

Cash flow and financing patterns:

• Cash flows are typically positive and stable.
• Capital expenditures may decline as a percentage of sales.
• Dividends and share repurchases become more common.

Decline Stage

• Demand falls, often because of technological substitution, changing consumer preferences, or regulatory shifts.
• Excess capacity and high exit barriers (e.g., specialized assets, labor contracts) can intensify price competition.
• Profitability declines; some firms may suffer losses.
• Firms exit, are acquired, or pursue niche strategies (serving loyal segments or specialty uses).

Strategic options:

• Harvesting (minimizing new investment and maximizing cash flow)
• Quickly exiting or divesting the business
• Focusing on defensible niches where demand remains stable

Life Cycle and Company Differences

Although the framework describes industries, not individual firms, companies within the same industry can be at different life cycle stages. A new entrant with a novel business model can still be in a growth or “startup” phase while the industry as a whole is mature. This can make its performance less cyclical and its growth higher than that of the industry leaders.

From a capital structure standpoint, early‑stage firms typically rely more on equity and perhaps secured or convertible debt, while mature firms with stable cash flows can support more unsecured debt at lower cost. This evolution mirrors the industry life cycle but is not identical.

Worked Example 1.1

A company operates in the personal computer industry. Sales growth for the industry has plateaued, several competitors have left the market, and the remaining firms are investing primarily in cost reductions and brand loyalty programs. Cash flows are positive and relatively stable.

Which life cycle stage is most likely?

Answer:
The industry is most likely in the maturity stage. Demand growth is slow, some firms have exited, and the strategic focus is on efficiency and defending market share through branding rather than rapid expansion.

INDUSTRY COMPETITION: PORTER’S FIVE FORCES

Michael Porter’s Five Forces framework provides a structured way to assess the intensity of competition and the attractiveness of an industry for potential investors. It links industry structure to long‑run profitability.

Key Term: barriers to entry
Factors that prevent or hinder new firms from entering an industry profitably, such as high capital requirements, strong brands, regulation, or access to distribution.

Threat of New Entrants

This force reflects how easily new competitors can enter and compete effectively.

Factors that raise barriers to entry (and reduce the threat):

• Large capital requirements or high fixed setup costs
• Strong economies of scale for incumbents
• Powerful brands and customer loyalty
• High switching costs for customers
• Tight regulation, licensing, or patents
• Difficult access to key distribution channels or inputs
• Expectations of aggressive retaliation by incumbents

When barriers are high, incumbents are more likely to sustain above‑average returns.

Threat of Substitutes

Substitutes are different products or services that satisfy the same basic customer need (for example, streaming video vs. traditional cinema).

The threat is high when:

• Close substitutes exist that are cheaper or more convenient
• Customers can switch easily and at low cost
• Performance of substitutes is improving faster than industry offerings

Strong substitutes cap the prices that firms can charge and limit their pricing power.

Bargaining Power of Buyers

Buyers (customers) can pressure firms to lower prices, demand higher quality, or better service.

Buyer power is strong when:

• Buyers are concentrated or large relative to sellers
• Products are standardized and switching costs are low
• Buyers can credibly threaten bringing production in‑house (doing it themselves)
• Buyers are very price sensitive and have many alternative suppliers

In some consumer markets (e.g., beer in parts of Europe), large retail chains have substantial bargaining power over producers, pressuring margins and limiting price increases even when input costs rise.

Bargaining Power of Suppliers

Suppliers can impact industry profitability by raising input prices or lowering input quality.

Supplier power is strong when:

• Few suppliers exist and they are large relative to buyers
• Inputs are differentiated and switching suppliers is costly
• There are no good substitutes for the input
• Suppliers can credibly move downstream into the industry

Strong supplier power can compress margins, especially when firms cannot easily pass higher input costs on to customers.

Rivalry Among Existing Competitors

Rivalry captures the extent and type of competition among current firms.

Rivalry is intense when:

• Many similar‑sized competitors operate in the industry
• Industry growth is slow, so firms must steal share from each other
• Products are undifferentiated and switching costs are low
• Excess capacity or high fixed costs encourage price cutting
• Exit barriers are high, keeping weak competitors in the market

Rivalry tends to be limited when products are differentiated, capacity is well aligned with demand, and a few firms dominate the market.

Five Forces and Inflation

An industry’s ability to pass through rising input costs to customers depends heavily on these forces. For example:

• In an oligopolistic beer market with fragmented distribution channels, brewers may successfully raise prices roughly in line with consumer inflation.
• In markets where large retailers dominate and can exert strong buyer power, producers often struggle to pass on full cost increases, leading to margin compression.

Understanding this linkage is important when forecasting revenue and costs in inflation or deflation scenarios.

Worked Example 1.2

An analyst is evaluating the packaged foods sector. She identifies a few large competitors, strong brand loyalty among consumers, significant R&D requirements, and high costs for distribution infrastructure. Large retailers, however, are becoming more concentrated and negotiating aggressively on price.

Using Porter’s Five Forces, what can she infer about the intensity of competition and profitability?

Answer:
High barriers to entry and strong brands reduce the threat of new entrants, supporting profitability for incumbents. However, increasing concentration and bargaining power of large retailers raise buyer power, which can pressure prices and margins. Overall, the industry may remain profitable but faces growing pressure on pricing from powerful buyers.

COMPANY ANALYSIS: COMPETITIVE ADVANTAGE

Within an industry, some firms outperform others by establishing sustainable competitive advantages.

Key Term: strategic positioning
The combination of a firm’s activities aimed at delivering superior value to a target market relative to rivals, given the industry’s structure and competitive forces.

Three classic generic strategies are:

Key Term: cost leadership
A strategy in which a firm aims to be the lowest‑cost producer in its industry, enabling it to undercut competitors on price or earn higher margins at similar prices.

Key Term: differentiation strategy
A strategy in which a firm seeks to offer products or services perceived as unique along dimensions valued by customers, allowing it to charge a premium price.

Key Term: focus strategy
A strategy in which a firm concentrates on serving a narrow segment (by geography, product type, or customer group), using either cost leadership or differentiation within that niche.

Sources of Competitive Advantage

• Cost leadership:

  • Economies of scale in production, marketing, or R&D
  • Superior process efficiency and learning curve effects
  • Access to cheaper inputs (e.g., long‑term contracts, favorable locations)
  • Efficient logistics and supply chain management

• Differentiation strategy:

  • Strong brands and marketing
  • Superior design, quality, or features
  • Customer service, customization, or network effects
  • Proprietary technology or intellectual property

• Focus strategy:

  • Strong knowledge of niche customer needs
  • Specialized products or services
  • Local relationships or tailored distribution

Key Term: return on invested capital (ROIC)
A measure of how efficiently a company generates operating profit from the capital invested in its operations, often used to assess whether a firm is earning more than its cost of capital.

Sustainable competitive advantages allow a firm to maintain ROIC above its cost of capital despite competitive forces. However, high ROIC attracts competitors, and industry forces constrain how long these advantages persist.

Interaction with Life Cycle Stage

• In introduction and growth, differentiation and innovation are often critical; cost advantages grow as scale builds.
• In maturity and decline, cost leadership and operational efficiency usually become more important because price‑based competition increases.
• Focus strategies can be effective at any stage, particularly when the broader industry is competitive but specific niches remain attractive.

Worked Example 1.3

Two similar companies compete in the athletic apparel industry. Company A invests heavily in R&D and brand marketing, establishing a reputation for innovation and premium performance. Company B closely follows Company A’s designs, uses cheaper materials, and consistently undercuts on price.

Which strategy is Company B pursuing, and what risks does it face in a mature market?

Answer:
Company B is following a cost leadership strategy by using lower‑cost inputs to offer similar‑looking products at lower prices. In a mature (saturated) market, this exposes it to risks of margin compression and price wars, especially if larger rivals can match or exceed its cost savings using superior scale or technology.

Worked Example 1.4

An industry is facing increasing bargaining power from a few very large retailers. Analyst 1 expects manufacturers’ operating margins to fall as retailers demand lower prices, while invested capital stays roughly constant. Analyst 2 believes manufacturers can hold margins by offering longer payment terms and higher inventories to retailers, which will double invested capital.

Which scenario leads to a higher ROIC for manufacturers, assuming sales stay flat?

Answer:
Even though Analyst 2 assumes stable margins, doubling invested capital cuts ROIC roughly in half. Analyst 1’s scenario of lower margins on the same capital base may result in a higher ROIC than Analyst 2’s scenario. This illustrates that stronger buyer power can reduce profitability either through lower margins or through higher capital intensity, and both must be considered when assessing returns.

PRACTICAL APPLICATIONS

Industry and company analysis support several tasks central to Level 1 questions:

• Revenue and profit forecasting:

  • Life cycle stage informs expected growth rates and pricing power. Growth industries typically support higher volume growth; mature or declining industries may depend on modest price increases or share gains.
  • Five Forces analysis helps judge whether an industry can pass on input cost inflation via higher prices or whether margins will compress.

• Valuation modeling:

  • For early‑stage industries with uncertain cash flows, analysts may emphasize scenario analysis and pay close attention to entry barriers and the risk of rapid technological change.
  • Mature, stable industries often justify valuation using earnings or dividend multiples that assume modest growth and returns near the cost of capital.
  • Understanding whether a company’s high ROIC is due to firm‑specific advantage or favorable industry structure helps decide whether to project that advantage as persistent or fading.

• Risk assessment:

  • Structural risks include technological substitution (raising threat of substitutes), deregulation (lowering barriers to entry), or consolidation among buyers or suppliers.
  • Shakeout and decline stages tend to be riskier because of excess capacity, potential price wars, and heightened exit barriers.

• Distinguishing industry vs. company factors:

  • A strong brand is a company‑level advantage, not an industry characteristic.
  • Slow overall growth is an industry‑level feature, not evidence that any particular firm is weak.
  • Many CFA questions test whether you can tell when a vignette is asking about the industry context or the firm’s own strategy and capabilities.

Worked Example 1.5

A vignette describes an industry with the following features:

• Demand growth has slowed to low single digits
• Capacity utilization is high but stable
• Products are standardized, and price discounting is common
• Firms generate steady positive cash flows and pay regular dividends

Which combination of life cycle stage and principal competitive force best describes this industry?

a) Introduction stage and threat of new entrants
b) Growth stage and threat of substitutes
c) Maturity stage and rivalry among existing competitors
d) Decline stage and supplier bargaining power

Answer:
The description—slow growth, standardized products, price discounting, and stable cash flows—is typical of the maturity stage, where price‑based rivalry among existing competitors is often the dominant competitive force. The correct choice is c).

Exam Warning

Many candidates confuse company‑level strengths (like a well‑known brand or efficient operations) with industry‑wide characteristics (like slow growth, high barriers to entry, or strong buyer power). On the exam, pay attention to whether a question asks about:

• The industry, which affects all firms, or
• A specific company, which may outperform or underperform the industry

Misclassifying this can lead to incorrect conclusions about expected growth, margins, and valuation multiples.

Revision Tip

Focus your revision on practicing life cycle and Five Forces analysis using real or hypothetical industries (for example, smartphones, streaming services, airlines, or utilities). For each:

• Identify the likely life cycle stage
• Assess each of the Five Forces qualitatively (high, medium, or low)
• Decide which generic strategy (cost leadership, differentiation, or focus) seems most viable

This practice builds speed and confidence for CFA exam questions.

Summary

The industry life cycle framework and Porter’s Five Forces provide a structured way to analyze industry structure and competitive intensity. Recognizing the life cycle stage helps set realistic expectations for growth, profitability, cash flows, and financing. Five Forces analysis explains why some industries consistently earn high returns while others struggle to earn more than the cost of capital.

At the company level, understanding competitive strategy—cost leadership, differentiation, or focus—and how it interacts with industry forces is important for assessing whether a firm’s competitive advantage and ROIC are likely to be sustainable. Accurate industry and company analysis underpins robust valuation and investment decisions, which is why these tools are emphasized in the CFA Level 1 curriculum.

Key Point Checklist

This article has covered the following key knowledge points:

• Identify and characterize the five stages of the industry life cycle
• Explain how industry structure and life cycle stage influence growth, profitability, and risk
• Apply Porter’s Five Forces to evaluate industry competition and attractiveness
• Understand how competitive advantage and generic strategies allow some companies to outperform peers
• Distinguish clearly between industry‑level factors and company‑specific factors when analyzing performance and valuation

Key Terms and Concepts

• industry life cycle
• industry structure
• Porter’s Five Forces
• competitive advantage
• pricing power
• life cycle stage
• economies of scale
• barriers to entry
• strategic positioning
• cost leadership
• differentiation strategy
• focus strategy
• return on invested capital (ROIC)