Examining industries: The importance of industry analysis for financial institutions

When you ask someone what they analyze when considering their business, the majority of professionals would say their individual competitors, or their own performance over a given period of time. They gauge themselves in the marketplace by comparing their financials with peers in the same industry using different metrics that evaluate everything from COGS to Net Profit and ROI. Whatever the case, the same pattern usually follows suit; they use industry data to benchmark themselves against their own past performances, or someone else’s.
But how do you analyze an industry you are not familiar with? The following method for industry analysis was outlined in a recent Abrigo webinar. These questions and considerations can guide your financial institution to a better understanding of industry markets in your area.

Barriers to entry: Is this an industry that is easy to get in or out of? Are there high capital or technological costs? Are there many regulatory requirements? Industries with high barriers to entry can pose challenges for new businesses but make well-established businesses a more secure investment.

Intensity of competition: Are there one or two dominant players that control the market? Understand the landscape and what large and small businesses are making the most impact on the market to gauge the risk of banking the industry.

Power of suppliers: How much control do suppliers have over the business? Particularly since the pandemic, suppliers have faced unforeseen issues such as staffing or parts shortages that can severely impact margins.

Power of buyers: What power do the customer’s buyers hold? If the industry only has a few large buyers, for example, if the business mainly contracts with the government, they are subject to whatever offers those main buyers make and have little control over pricing.

Threat of substitute products: How likely is the product or service to be replaced? Technological advances boot out products over time—cars replacing horses, for example. Today, public policy can also determine which products are viable.

Political, economic, social, environmental, and technological factors: What external factors might influence the industry? Agricultural businesses are likely to have been impacted by all five of these factors in the last ten years—should those factors influence your credit risk pricing?

Obsolescence: What does the future of the product look like? In the past, technology has pushed older products into obsolescence, but today, delivery systems can also change the operations of many industries. Books are easier to buy online than in a store, for example, which may impact your decision to bank a new bookstore.

These questions can help your financial institution determine which industries are a good fit based on industry performance in your area and your unique risk appetite.