Equity Investments【Reading 51】Sample provides, framework, understand, 2012

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Industry analysis is most likely to provide an analyst with insight about a company’s:

A) competitive strategy.

B) pricing power.

C) financial performance.

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Industry analysis provides a framework for an analyst to understand a firm in relation to its competitive environment, which determines how much pricing power a firm has. Competitive strategy and financial performance are aspects of company analysis.

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An aggressive price reduction to gain market share is most likely to be associated with a:

A) cost leadership strategy.

B) product differentiation strategy.

C) service differentiation strategy.

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Michael Porter identified two competitive strategies: cost leadership and product or service differentiation. A firm that uses a cost leadership or low-cost strategy seeks to have low production costs that will enable it to offer lower prices than its competitors to protect or gain market share. A product or service differentiation strategy seeks to gain a price premium for its products by making them distinctive to the consumer.

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Which of the following industries is most likely to operate in a fragmented market?

A) Oil services.

B) Pharmaceuticals.

C) Confections.

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Most areas of the oil services industry are characterized by many small competitors. The confections and pharmaceutical industries each have a small number of very large firms.

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The competitive forces identified by Michael Porter include:

A) threat of substitute products and rivalry among suppliers.

B) rivalry among existing competitors and bargaining power of buyers.

C) bargaining power of existing competitors and threat of new entrants.

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Porter’s five competitive forces are: (1) rivalry among existing competitors; (2) threat of new entrants; (3) threat of substitute products; (4) bargaining power of buyers; (5) bargaining power of suppliers.

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Economic profits are most likely to be earned by firms in an industry that is characterized by:

A) low threat of substitute products and high rivalry among existing competitors.

B) high barriers to entry and low bargaining power of buyers.

C) high bargaining power of suppliers and low threat of new entrants.

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High barriers to entry (low threat of new entrants) and low bargaining power of suppliers both increase the potential for economic profits within an industry. The five forces that shape industry competition are rivalry among existing competitors, threat of new entrants, threat of substitute products, bargaining power of buyers, and bargaining power of suppliers. The stronger any of these forces are within an industry, the less potential that industry has to generate (or continue to earn) economic profits.

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Pricing power for the firms in an industry is most likely to result from low:

A) levels of capacity.

B) barriers to entry.

C) industry concentration.

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Low capacity is associated with pricing power because it increases the likelihood that supply in the short run will be less than demand at current prices. Low barriers to entry and low industry concentration (a fragmented market) typically suggest firms have little pricing power.

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Which of the following conditions is most likely to indicate that barriers to entry into an industry are low?

A) The industry has significant economies of scale.

B) Investment capital is available at low cost.

C) Market shares have been stable over the last two business cycles.

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Readily available capital tends to make entry into an industry easier. If an industry is composed of the same firms over a long period of time, barriers to entry are likely high. Economies of scale are a barrier to entry because existing firms are likely to be producing at a lower cost per unit than a new competitor can achieve.

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Market share stability within an industry is least likely to result from a high level of:

A) barriers to entry.

B) switching costs.

C) product innovation.

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Frequent introductions of new products and innovations tend to make firms’ market shares within an industry less stable. High barriers to entry into the industry and high switching costs for customers to change to a competing product both contribute to market share stability.

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A firm is most likely to have pricing power if:

A) costs to exit the industry are high.

B) its product is differentiated.

C) its market share is high.

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Firms offering products that are differentiated in terms of quality and features are more likely to have pricing power than firms that produce undifferentiated (commodity-like) products. High market share does not necessarily imply pricing power; for example, if four firms each have 25% market share, none of them are likely to have significant pricing power. High exit costs can create overcapacity in an industry and result in a high degree of price competition as firms try to maintain production volume during a period of reduced demand.

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Declining prices that result from the development of substitute products are most likely to characterize an industry in the:

A) shakeout stage.

B) decline stage.

C) mature stage.

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The decline stage of the industry life cycle is often characterized by declining prices as substitute products or global competition emerge, or as a result of decreasing demand due to societal changes.