Industry vs industry segment

In an earlier posting I noted that "the industry definition should capture a set of related companies selling similar kind of products". In this posting I would like to develop the idea of an industry consisting of several industry segments. I would also like to describe how an industry segment is related to terminology used in marketing (e.g. product category, product type, product version).

This is post three in a series on industry analysis.

We can understand the idea of an industry or an industry segment from two perspectives; either by starting with the whole economy and dis-aggregate, or by starting with individual products and aggregate. 

Top-down approach. There are two sources of data for a top-down approach. Financial information providers classify all listed companies into various sub-indices and government statistical agencies classify all companies into various classes.

The most useful classification system from the financial information providers is the Global Industry Classification System (GICS). It is global and has been designed in a very thoughtful manner. Generally it is possible to assign a company to one unique sub-industry. This facilitates the analysis. The system is a hierarchical; 10 sectors break into 23 industry groups, which break into 59 industries, which break into 123 sub-industries. The classification system is reviewed on a yearly basis. The ten sectors are Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Information Technology, Telecommunication Services, and Utilities.

The sub-industry is often a useful staring point for industry analysis. The higher level categories are generally too broad.  The figure below illustrates the 31 sub-industries within the Consumer Discretionary sector.

Illustration of one sector of the GICS

The alternative is to use a classification system from a government statistical agency. These systems are more detailed, but can sometimes be quire dated. Furthermore, it is often difficult to find data the more detailed level. The North American system is called North American Industry Classification System (NAICS) and was recently updated. Sometimes the two systems correspond with each other, but on other occasions they turn out to be very different. There is 1,065 industries in NAICS. NAICS codes are a replacement for the sometimes more familiar SIC codes

The figure below illustrates how the GICS sub-industry Household Appliances has a corresponding NAICS category called Household Appliance Manufacturing, which is broken down into more detailed categories.

3352	Household Appliance Manufacturing
33521	Small Electrical Appliance Manufacturing
335210	Small Electrical Appliance Manufacturing
33522	Major Appliance Manufacturing
335221	Household Cooking Appliance Manufacturing
335222	Household Refrigerator and Home Freezer Manufacturing
335224	Household Laundry Equipment Manufacturing
335228	Other Major Household Appliance Manufacturing

Illustration of one section of the NAICS

Bottom-up approach. The second approach is bottom-up. This approach is more common in marketing, which is generally focused on individual products. At the bottom level there are different product variants, at a slightly higher level of aggregation we have product types, and at an even higher level of aggregation we have product categories. Electrical coffee makers is a product category. Drip coffee makers and espresso coffee makers are two product types in this category. Each individual version of these product types is called a product variant. The top-down and bottom-up perspectives can be reconciled by realising that the GICS sub-industry is typically an aggregation of a number of product categories. In the above case the GICS sub-industry would be Household Appliances.

In reality we can only observe product variants. We cannot directly observe higher levels of aggregation like product type, product category or sub-industry. They are socially constructed aggregations, in other words there could be more than one way to aggregate product variants. Sometimes an aggregation is fairly straightforward, but in other situations the analyst must create novel categories. 

The most useful level to conduct an industry analysis on is the GICS sub-industry level or the product category level. Data is generally more available on the sub-industry level, but in most cases proprietary data is also available on the product category level.

Industry vs industry segment. In industry analysis we normally use the term Industry for the overall five forces analysis, which is conducted on the GICS sub-industry level or on the bottom-up product category level. However, in a more detailed analysis the industry is divided into several Industry segments.

There are few hard rules how to divide the industry into industry segments. However, industry segmentation should take both production and marketing into account. The level of detail can vary depending on the purpose of the analysis. In fact it can be quite a creative exercise, sometimes generating new insights, especially when novel segments are included. Both production and marketing related factors should be taken into account because industry segmentation will form the basis for how the company's value chain is structured.

• Different product categories might have different economics of production, e.g. assembly line vs batch production (related to economies of scale), requiring differently skilled or unskilled, requiring supplied from different types of companies. 
• The broadest difference between customer groups is probably between consumer and corporate buyers. In addition, different customer groups might have different requirements on their interaction with the company, e.g. personal sales vs. internet sales, high quality vs low price. Different geographical locations can also have different requirement.

An industry segmentation matrix can easily become a large matrix (e.g. 8 customer groups and 23 product categories). It is better to start big and then narrow it down in size. The industry segmentation differs from a customer segmentation in marketing in two respects. First it also takes the product categories into account and second it is less detailed than a typical customer segmentation in marketing.

The figure below illustrates two possible ways to do an industry segmentation. In the first case the focus is on one product category, and in the second case on a sub-industry. The manual espresso machine require batch assembly from a skilled craftsman and the components are generally expensive due to low volume. The drip coffee machine is a mass-produced product that can be assembled by lower skilled employees.  

Once the industry segments have been identified it is useful to analyse the five forces as they apply on the different industry segments.

Note on identifying industry segments and companies active in those segments. A good starting point is the GICS sub-industry code, which is available for all publicly listed firms. This information is proprietary, but is available in the large commercial financial databases like Thomson One. A quick perusal of the larger companies will provide a better understanding of how to create product categories. However, note that GICS codes are not available for non-listed companies. A cross-check with the more detailed NAICS (or the equivalent for Europe, China, India, etc.) will provide useful ideas about product categories within the sub-industry. You should also try creatively to find new ways of segmenting the industry. Another useful source is proprietary industry reports, the outline of which often are available on the internet for free. A search on amazon.com or other e-commerce sites will also give information about useful ways to create industry segments. The e-commerce sites will also identify company names or at least brand names that can be linked to companies with a simple search.