NISM Series XV: Research Analyst Certification Exam - Chapter VI: Industry Analysis (Part 3 of 3)

This section covers the strategic frameworks (Porter's Five Forces, PESTLE, BCG Matrix, SCP) used to evaluate industry competitiveness, major industry drivers, and the critical role of taxation on business operations.

1. Michael Porter's Five Forces Model

1.1 Evaluating Industry Attractiveness

Analyzing any industry requires examining it from several strategic angles to reach a reliable conclusion regarding its overall attractiveness as an investment proposition. Market participants employ different methodologies to make this analysis, with Porter's Five Forces model (developed by Dr. Michael Porter in 1979) being one of the most widely recognized frameworks.

1.2 The Five Forces Defined

The model maps five distinct forces that shape an industry's competitive landscape:

• Industry Rivalry (Center Force): The core intensity of competition among the existing players currently operating in the market.
• Bargaining Power of Suppliers: The leverage suppliers have to raise prices, restrict supply, or lower the quality of raw materials and services.
• Bargaining Power of Buyers: The leverage customers hold to negotiate lower prices, demand higher quality, or play competitors against one another.
• Threat of New Entrants: The ease with which new competitors can enter the industry, set up operations, and dilute the market share of incumbents.
• Threat of Substitutes: The risk of customers switching to alternative products or services from other industries that meet the same consumer needs.

2. PESTLE Analysis

PESTLE is a comprehensive external macro-environmental scanning framework used by analysts to evaluate six key external drivers affecting an industry:

• Political Factors: Macro-environmental elements including government stability, political structure, approach to social schemes, and freedom of the press.
• Economic Factors: Key financial metrics such as Gross Domestic Product (GDP), inflation rates, national income distribution, prevailing interest rates, and aggregate consumption levels.
• Socio-cultural Factors: Broader societal parameters such as demographics, lifestyle trends, consumer preferences, and deep-seated cultural traits.
• Technological Factors: Variables focusing on the availability and cost of technology, along with active research and development (R&D) activities.
• Legal Factors: Elements of the legal architecture, including the efficiency of the legal system and existing tax systems.
• Environmental Factors: Ecology-driven factors such as pollution levels, environmental awareness, and conservation initiatives.

3. Boston Consulting Group (BCG) Analysis Matrix

3.1 Structural Classification

The BCG Matrix classifies different business segments or products of a company into four distinct quadrants based on two axes: Market Growth Rate (which dictates cash usage) and Relative Market Share (which dictates cash generation).

• Stars: Business segments where market growth is rapid and the company maintains a large market share.
• Cash Cows: Mature segments characterized by low market growth but high market share. These segments require low cash infusion and provide a steady, reliable cash flow.
• Question Marks: Business segments operating in a fast-growing market, but currently holding a low market share.
• Dogs: Disadvantaged business segments that exhibit slow growth rates and face intensive competitive dynamics.

3.2 Matrix Summary Table

4. Structure Conduct Performance (SCP) Analysis

The SCP framework examines the logical flow from an industry's structural setup to its final financial and wealth outcomes:

• Structure Analysis: Evaluates competitive intensity (number of active players), business concentration within the sector, relationships among the various players, total market size, and the industry's growth rate. This analysis is highly similar to what is studied under Porter's Five Forces and SWOT models.
• Conduct Analysis: Focuses on how businesses within the industry behave. This depends on parameters such as pricing strategies, product innovation, and industry-specific cyclicality.
• Performance Analysis: Examines quantitative financial metrics and numerical ratios. The structure and conduct of an industry ultimately generate the financials for investors and owners. Businesses with a high return on capital are the ones which successfully create long-term wealth for shareholders and owners.

5. Key Industry Drivers

Analysts monitor specific variables that act as key drivers of growth and operations for various sectors. The primary industries identified include:

• Telecom
• IT / BPO / KPO (Information Technology / Business Process Outsourcing / Knowledge Process Outsourcing)
• Banking / NBFC / Housing (Non-Banking Financial Companies)
• Media
• Retail
• Airlines and other transportation and logistics
• Automobiles and capital goods
• Consumer goods

6. Taxation and Its Impact on Industry

Taxation serves as a critical fiscal tool that governments deploy to achieve dual objectives: generating state revenue and systematically guiding corporate behavior.

• Revenue Generation: Taxes allow the government to earn income to meet public expenses.
• Behavioral Tool: Governments actively use taxes to encourage or discourage specific industries.
  • Example: In 2017, the state government of Kerala introduced a fat tax, levying an additional 14.5% tax on junk foods to actively discourage the junk food industry.

6.1 Direct Taxes

• Definition: Taxes where the incidence of the tax and the legal liability for the tax fall on the same person. The entity that bears the actual tax burden is also the one legally obligated to pay it to the government.
• Corporate Direct Taxes in India: Corporate income taxes in India consist of four key components:
  1. Income Tax
  2. MAT (Minimum Alternate Tax)
  3. Surcharge
  4. Cess

6.2 Indirect Taxes

• Definition: Taxes where the person bearing the actual economic burden of the tax is different from the person legally liable to collect and deposit it.
• Mechanism: The tax is levied on the seller of goods or services. However, the seller collects this tax from the customer and deposits it into the government's account, meaning the end consumer ultimately bears the tax.
• GST Consolidation: India historically featured a variety of indirect taxes. To simplify the system, the government introduced the Goods and Services Tax (GST), consolidating most indirect taxes and removing legacy taxes.
• Exemptions from GST Consolidation: Certain specific products and activities remain excluded from the unified GST and are still covered under legacy systems:
  • Fossil fuels
  • Liquor
  • Imports
• Types of Indirect Taxes:
  • Goods and Services Tax (GST)
  • Excise Duty
  • Value Added Tax (VAT)
  • Customs Duty

6.3 Other Taxes

Analysts must also factor in transaction-specific and regional taxes:

• Road tax
• Stamp Duty
• Security Transaction Tax (STT)

7. Key Takeaways

• Angle-Based Review: Porter's Five Forces and PESTLE analyses allow analysts to view an industry from multiple strategic perspectives before determining its long-term investment viability.
• Strategic Allocation: The BCG Matrix helps identify where business units stand regarding cash requirements (growth rate) and cash generation (market share).
• Wealth Creation: The SCP model demonstrates that structural traits and strategic conduct dictate financial performance, proving that only industries with a high return on capital consistently generate long-term wealth.
• Taxation as a Lever: Taxes are not just revenue tools; governments frequently use direct, indirect, and targeted excise duties to penalise or promote specific business designs.
• The GST Shift: While GST consolidated most indirect taxes in India, fossil fuels, liquor, and imports still navigate legacy tax systems.

8. Glossary of Important Terms

• Porter's Five Forces: A framework evaluating competitive forces—rivalry, supplier power, buyer power, substitution, and entry barriers—to evaluate sector attractiveness.
• PESTLE: A macro-environmental scanning tool covering Political, Economic, Socio-cultural, Technological, Legal, and Environmental factors.
• Stars (BCG Matrix): High-growth, high-market-share business segments.
• Cash Cows (BCG Matrix): Low-growth, high-market-share segments generating steady, low-infusion cash flows.
• Question Marks (BCG Matrix): High-growth, low-market-share business segments.
• Dogs (BCG Matrix): Low-growth, low-market-share segments facing intense competition.
• Direct Tax: A tax where the economic incidence and legal liability fall on the exact same entity.
• Indirect Tax: A tax shifted from the collecting entity to the end consumer, who bears the actual cost.
• MAT (Minimum Alternate Tax): A specific corporate tax component in India.
• GST (Goods and Services Tax): A consolidated indirect tax system in India that replaced multiple legacy taxes.