Industry and Competitive Analysis

Equity Investments, LOS weight share 1.4 percent of the 365 Level I learning outcomes.

Equity InvestmentsIndustry and Competitive Analysis

Airlines face barely any threat of new entrants and still cannot earn their cost of capital, because the exam's real lesson is that a weak rival is not the same as a weak force, and the force actually squeezing the industry is the one candidates check last.

Before you watch

Answer these three first. Getting them wrong now is normal, and it helps the lesson stick. Reveal the answers when you're done, then read on.

1. A small number of large distributors purchase most of a pharmaceutical manufacturer's largely undifferentiated generic output, and those purchases represent a major cost line for the distributors. This scenario best illustrates:

Answer: B. Buyer power is high when buyers are few and concentrated, the product is undifferentiated, and the purchase is a significant cost to the buyer, all three of which are present here; this describes the distributors' power over the manufacturer, not a supplier relationship.

2. An analyst wants to assess whether an industry is structurally likely to earn returns on invested capital above its cost of capital over time. The combination of conditions most supportive of that conclusion is:

Answer: A. Weak rivalry preserves pricing power among incumbents, high barriers keep new competitors out, and scarce substitutes remove customer alternatives; all three support sustained profitability. High supplier power would compress margins even with weak rivalry and high entry barriers, which is why that third combination does not support the same conclusion.

3. A coal producer faces growing cost-competitiveness from solar and wind power generation. This is best described, under Porter's framework, as:

Answer: B. Threat of substitutes refers to alternative products from outside the industry that satisfy the same underlying customer need, here electricity generation; solar and wind are not coal-industry rivals, they are substitutes for what coal itself provides, so this is substitute threat, not internal rivalry.

The lesson

The video lesson for this unit is recorded and waiting to be published. Everything it teaches is written out below.

The reading

Five to ten minutes on this one unit: what the exam wants, the idea in plain words, then straight into the trap and the practice.

The exam wants you to describe the steps in industry and competitive analysis, apply Porter's five forces and PESTLE to judge an industry's structural profitability, identify which single force a described scenario is actually testing, and compare cost leadership against differentiation as competitive strategies.

Industry analysis exists to answer one question: does this industry's structure support sustained profitability above the cost of capital, and where does a specific company sit inside that structure. The work runs in order. Classify the industry. Characterize its size, its growth rate, and its profitability trend together, since a slowing growth rate alongside stable margins and ongoing consolidation is the signature of a maturing industry, not necessarily a distressed one. Then analyze the structure itself with two complementary frameworks, and only then evaluate the specific company's own strategy against that structure.

Porter's five forces read the competitive dynamics already inside the industry: rivalry among existing competitors, the threat of new entrants, the threat of substitutes, and the bargaining power of suppliers and of buyers. PESTLE, political, economic, social, technological, legal and environmental factors, reads the external context that can shift those five forces over time. The two frameworks are complementary, not alternatives: Porter's shows how profit is distributed right now, and PESTLE shows what is likely to change that distribution later.

The exam's most repeated trap is treating rivalry as though it summarized the other four forces. It does not. Rivalry, buyer power and substitute threat mainly bear on pricing power, a company's ability to raise prices without losing customers. Supplier power bears on the cost side of the business instead, entirely independent of how much pricing power the company has. The textbook case is an airline squeezed by jet fuel pricing regardless of how few competitors it faces. Entry threat bears on a third, separate question: how long current profitability can actually last before new competitors erode it. A concentrated industry with only a handful of rivals can still be structurally unprofitable if supplier or buyer power is high; low rivalry says nothing at all about the other four forces, and a favorable read on industry structure requires checking every one of them, not just the one that happens to be weak.

A company's own competitive strategy is judged against that structure in one of two ways. Cost leadership means being the lowest-cost producer in the industry, which is not the same claim as charging the lowest price: a cost leader that prices at the industry average earns wider margins than its rivals precisely because its own costs sit below theirs. Differentiation means offering something distinctive enough, brand, quality, technology, that customers accept a premium price rather than switching to a cheaper alternative. Evaluating a company's strategy means asking which of these two paths it is actually on, and whether that choice fits the structure the five forces and PESTLE analysis just revealed.

Porter's five forces around industry rivalry Industry rivalry New entrants Substitutes Supplier power Buyer power
Five forces press on industry rivalry from every side: new entrants, substitutes, and the bargaining power of both suppliers and buyers. Rivalry sits in the middle, shaped by all four.

The trap

A substitute threat always comes from outside the industry as classified, not from a rival competing inside it: a watchmaker losing business to another watchmaker is rivalry, but a watchmaker losing business to smartphones is a substitute threat, and the line between the two is which industry the competing product is classified in, not how similar the products feel.

Learning outcomes covered by this module

Verbatim from the 2026 CFA Level I topic outline. Every practice question and key rule below is tagged to one of these where the stem and explanation make the match clear.

  1. describe the purposes of, and steps involved in, industry and competitive analysis
  2. describe industry classification methods and compare methods by which companies can be grouped
  3. determine an industry's size, growth characteristics, profitability, and market share trends
  4. analyze an industry's structure and external influences using Porter's Five Forces and PESTLE frameworks
  5. evaluate the competitive strategy and position of a company

Key rules

Written from this module's own lesson and the 2026 CFA Level I topic outline, in teaching order, each tagged to the learning outcome it belongs to where that is clear.

LOS 01

Industry and competitive analysis exists to judge whether an industry's structure supports sustained profitability, not to describe a company in isolation

The purpose of the analysis is to determine an industry's likely long-run profitability and a specific company's position within that structure, proceeding through defined steps: classify the industry, size and characterize it (growth, profitability, market share trends), analyze its structure with Porter's Five Forces and PESTLE, then evaluate the company's own competitive strategy and position against that backdrop, in that order.

LOS 02

Industries can be grouped by classification system, and by economic behavior such as cyclicality

Formal classification systems (such as standardized industry-code schemes) group companies by what they produce or the market they serve, a useful starting point for identifying peers, though imperfect since diversified companies span categories. A separate, behavior-based grouping classifies industries as cyclical (revenue and profit rise and fall with the business cycle: autos, steel), defensive (stable demand regardless of the cycle: utilities, food, healthcare), or growth (revenue expands faster than the economy largely independent of the cycle), which is a distinct lens from the formal classification code and answers a different analytical question.

LOS 03

Sizing an industry means tracking growth, profitability, and market-share trends together, not any one alone

A complete read of an industry's size and health combines its revenue growth rate, its profitability trend (margins, returns on capital), and how market share is shifting among competitors; a slowing growth rate alongside stable or rising margins and ongoing consolidation is the signature of a maturing industry, not necessarily a distressed one, while margin compression alongside share churn signals a structurally weakening industry regardless of headline growth.

LOS 04

Porter's Five Forces analyzes structure from within the industry; PESTLE captures the external forces that can change that structure

The five forces, rivalry among existing competitors, threat of new entrants, threat of substitutes, bargaining power of suppliers, and bargaining power of buyers, describe the competitive dynamics currently distributing profit within the industry's value chain. PESTLE, political, economic, social, technological, legal, and environmental factors, describes the external macro context that can shift those forces over time, a technological shift (streaming replacing physical media) directly raises the substitute threat force, and a regulatory change directly raises or lowers entry barriers. The two frameworks are complementary, not alternatives: one reads the current structure, the other explains what might change it.

LOS 04

Rivalry, buyer power, and substitute threat mainly bear on pricing power; supplier power mainly bears on cost structure; entry threat bears on how long current profitability can last

Not every force acts through the same channel: weak rivalry and scarce substitutes and buyers preserve a company's ability to raise prices without losing customers, which is pricing power; strong supplier power instead squeezes the cost side of the business regardless of pricing power, the airline industry's relationship to jet fuel pricing being the canonical case; and low barriers to entry threaten the durability of current profits even when the other four forces look favorable today, since new competitors can arrive and compete margins away.

LOS 05

Evaluating a company's competitive strategy means identifying whether it is competing on cost or on differentiation, and checking whether its position matches the industry's structure

A cost leadership strategy means being the lowest-cost producer in the industry, which is not the same as charging the lowest price, a low-cost producer pricing at the industry average earns higher margins than its rivals precisely because its costs are lower. A differentiation strategy means offering something distinctive enough, brand, quality, technology, that customers accept a premium price rather than switch. Evaluating a company well means checking that its chosen strategy is coherent with the industry's own structure: a differentiator needs weak substitute threat and low buyer power to sustain a premium; a cost leader needs scale and operational efficiency few rivals can match.

The trick

Authored only where a key rule has an arbitrary number, list, or formula shape worth a memory device; a module with none of those has no tricks here, on purpose.

Substitute threat comes from outside the industry, not from a rival inside it

A luxury watchmaker competing against another luxury watchmaker is rivalry. A watchmaker losing customers to smartphones is a substitute threat. The line is whether the competing product is even classified in the same industry.

Cost leadership means low cost, not low price

A cost leader can price at the industry average and still out-earn every rival, because its margin is wider at the same price point. Confusing the strategy (cost structure) with the tactic (pricing decision) is the recurring trap.

A concentrated (few-competitor) industry is not automatically a profitable one

Weak rivalry from having few competitors says nothing about supplier or buyer power; an oligopoly can still be squeezed hard by a powerful supplier or a powerful buyer, exactly the airline industry's fuel-supplier problem.

The method

Authored, ordered steps for answering this module's question types; a calculation module's calculator-dependent step ends with a bracketed BA II Plus keystroke sequence.

  1. Work the analysis in order: classify the industry, characterize its size and growth and profitability trend, apply Porter's Five Forces and PESTLE to its structure, then evaluate the specific company's strategy against that structure.
  2. For a force-identification question, isolate which single force the facts describe before reading the answer choices: is the tension between the company and its customers (buyer power), its input providers (supplier power), potential new competitors (entry threat), an outside product serving the same need (substitute threat), or existing rivals (rivalry)?
  3. For a profitability-outlook question, check all five forces together, not just rivalry; a weak-rivalry industry can still be structurally unprofitable if supplier or buyer power is high.
  4. When PESTLE and Porter both appear in a scenario, ask whether the PESTLE factor is changing one of the five forces, technological change usually raises substitute threat or lowers entry barriers, regulatory change usually raises or lowers entry barriers directly.
  5. For a strategy question, confirm cost leadership is being tested as a cost-structure claim, not a pricing claim, before selecting an answer.

One card

Condensed from the key rules and tricks above, nothing new. What you'd want on one index card the night before.

Practice questions

Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own explanation. 10 question(s) available for this unit.

Question 1Exam level

An analyst is evaluating the pharmaceutical industry and finds that a small number of large distributors purchase the majority of drugs from manufacturers. The manufacturers sell largely undifferentiated generic drugs that represent a major cost for the distributors. Which of Porter's Five Forces is MOST relevant to this situation?

How sure are you?

Correct: A. The exam tests exactly one thing here: buyer power is HIGH when buyers are few and concentrated, the product is undifferentiated (standardized), and the product represents a significant portion of the buyer's cost structure. All three conditions are present. This is buyer (customer) bargaining power, not supplier power. A common error candidates make when reading quickly.
B. Supplier power would describe the manufacturers pushing back on the distributors, but the scenario describes the opposite direction: a few large distributors, the buyers here, concentrated and price sensitive on an undifferentiated product that is a major cost line for them. That combination, few concentrated buyers, a standardized product, and high cost weight, is the textbook description of buyer power, not supplier power.
C. You might be tempted to choose the threat of substitutes because the drugs are undifferentiated, but remember, the high bargaining power of buyers stems from their concentration and cost sensitivity, not from the availability of substitutes, which is more about product differentiation and switching costs.

Unit: industry-and-competitive-analysis

Question 2Exam level

According to Porter's Five Forces framework, which of the following industry characteristics is MOST likely to reduce the threat of new entrants?

How sure are you?

Correct: A. High switching costs are a classic barrier to entry. When customers face significant costs (time, money, disruption) to switch providers, new entrants cannot attract customers even with lower prices. Giving incumbents a structural advantage. Option A (low fixed costs) actually lowers barriers because it reduces the capital required to enter. Option C (growth stage) increases the attractiveness of entry.
B. Choosing B might seem logical if you think growth attracts more entrants, but in Porter's framework, a growth stage industry actually attracts more entrants, increasing competition, which is the opposite effect you are looking for to reduce the threat of new entrants.
C. You might think that many competitors of similar size would deter new entrants by saturating the market, but this actually increases competitive rivalry, not barriers to entry, unlike high switching costs which directly hinder new entrants from attracting customers.

Unit: industry-and-competitive-analysis

Question 3Exam level

An equity analyst is using Porter's Five Forces to assess whether an industry is likely to generate returns on invested capital (ROIC) above the cost of capital over time. Which combination of force characteristics would MOST support this conclusion?

How sure are you?

Correct: A. The CFA curriculum explicitly links Porter's Five Forces to long-run profitability and ROIC. Weak rivalry preserves pricing power among incumbents. High barriers to entry prevent competitors from eroding margins. Few substitutes mean customers have no alternatives, supporting pricing power. Option C is incorrect because high supplier power would compress margins even if rivalry is weak and entry barriers are high. Options A and D describe competitive, low-profit industries.
B. Option C is incorrect because high supplier power would compress margins even if rivalry is weak and entry barriers are high.
C. Option C is incorrect because high supplier power would compress margins even if rivalry is weak and entry barriers are high.

Unit: industry-and-competitive-analysis

Question 4Exam level

A company operates in an industry where it can increase prices without losing customers to competitors or substitutes. This characteristic is most likely described as:

How sure are you?

Correct: A. The CFA curriculum defines pricing power as the ability to raise prices without significant customer attrition. It is a direct outcome of Porter's Five Forces analysis: when buyer bargaining power is low, substitutes are scarce, and rivalry is weak, firms retain pricing power. This is distinct from competitive advantage (which is the broader strategic position) and market concentration (which is a structural characteristic that may or may not confer pricing power).
B. Choosing competitive advantage might seem right if you think it encompasses all aspects of a company's market position, but competitive advantage refers to a broader strategic edge that includes factors beyond just pricing, whereas pricing power specifically denotes the ability to raise prices without losing customers.
C. Choosing market concentration might seem logical if you think it directly leads to pricing power, but market concentration only refers to the number and size distribution of firms in a market and does not inherently guarantee a firm can raise prices without losing customers.

Unit: industry-and-competitive-analysis

Question 5Exam level

According to the CFA curriculum, which of the following is the MOST appropriate way to classify an industry as 'cyclical'?

How sure are you?

Correct: A. The CFA curriculum classifies industries as cyclical (revenues and profits rise and fall with the business cycle. E.g., autos, steel, chemicals), defensive (stable demand regardless of economic conditions. E.g., utilities, food, healthcare), or growth (above-average revenue growth independent of the cycle. E.g., certain technology segments). ROIC and barriers to entry relate to profitability analysis, not cyclicality classification.
B. You might be tempted by high barriers to entry because they can protect profits, but this choice confuses profitability analysis with cyclicality classification, which focuses on how revenues and profits fluctuate with the business cycle.
C. You might be tempted by choice C because industries in the mature stage often have stable revenues, but this stability is related to the product life cycle, not the sensitivity to the business cycle that defines a cyclical industry.

Unit: industry-and-competitive-analysis

Question 6Exam level

Which industry life cycle stage is characterized by the HIGHEST level of competitive rivalry, price competition, and industry consolidation, most likely?

How sure are you?

Correct: B. The mature stage is characterized by slow growth, intense rivalry, price competition, and consolidation as weaker players are acquired or exit. In the pioneer stage, the focus is on developing the market with little competition. Growth stages see expanding revenues with multiple competitors but less intense rivalry. The decline stage has exiting competitors and shrinking demand. Rivalry is high but the dynamic is different from the price competition of the mature stage. The exam frequently asks candidates to match industry characteristics to life cycle stages.
A. You might be tempted by the growth stage because it involves expanding revenues and multiple competitors, but this stage actually sees less intense rivalry and price competition compared to the mature stage, where slower growth triggers fiercer competition and consolidation.
C. You might be tempted to choose the decline stage because it involves exiting competitors, but in this stage, the focus is on shrinking demand rather than intense price competition and consolidation seen in the mature stage.

Unit: industry-and-competitive-analysis

Question 7Exam level

A pharmaceutical company has developed a patented drug with no effective generic substitute. Its raw materials are widely available from multiple commodity suppliers. Its customers (hospitals) require the drug for critical care procedures. Which of Porter's Five Forces poses the GREATEST threat to this company's profitability, most likely?

How sure are you?

Correct: B. The exam tests identification of the dominant force in a scenario. Patent protection reduces the threat of new entrants. No substitute reduces substitute threat. Multiple commodity suppliers mean weak supplier power. However, large hospital systems and government payers (Medicare, Medicaid) represent concentrated, powerful buyers with significant negotiating leverage on drug pricing. As demonstrated historically by hospital group purchasing organizations (GPOs) forcing price concessions. This is buyer bargaining power. The dominant threat in this scenario.
A. You might think that commodity inputs from multiple suppliers could constrain margins, but in this scenario, the availability of multiple suppliers actually weakens their bargaining power, not the company's profitability, unlike the strong bargaining power of concentrated buyers who can negotiate volume discounts.
C. You might be tempted by the idea that a lack of substitutes directly correlates to a lack of competitive threat, but this overlooks the significant bargaining power of buyers, who can still exert considerable pressure on prices despite the absence of substitutes.

Unit: industry-and-competitive-analysis

Question 8Exam level

In the PESTLE framework used alongside Porter's Five Forces, a major technology shift that enables internet streaming to replace physical DVD rentals would most likely be classified as which type of external influence?

How sure are you?

Correct: C. PESTLE stands for Political, Economic, Social, Technological, Legal, and Environmental factors. The shift from physical to digital distribution of media is a technological disruption. It changed the cost structure, competitive dynamics, and substitution threat across the entire entertainment industry. The CFA curriculum uses PESTLE as a complement to Porter's Five Forces to capture external macro influences that change industry structure. This is a classic example the curriculum uses to illustrate how technological change can make entire business models obsolete.
A. You might be thinking that the shift to internet streaming affects the economic costs for companies, making choice A tempting, but this overlooks the specific focus on technological change required by the question, which is better captured by choice C as it directly addresses the technological shift enabling internet streaming.
B. You might be tempted to choose Social because the shift to streaming could affect social behaviors and media consumption habits, but this overlooks the core technological innovation driving the change, which falls under the Technological category in the PESTLE framework.

Unit: industry-and-competitive-analysis

Question 9Above the exam

An industry has high fixed costs, commoditized products with little differentiation, slow overall demand growth, and high exit barriers (specialized assets with little resale value). Combining Porter's Five Forces framework with the industry life-cycle concept, this combination of characteristics most likely signals:

How sure are you?

Correct: B. This combination is a classic signature of intense rivalry within Porter's framework: high fixed costs create pressure to run at high volume (encouraging price cuts to fill capacity), commoditized products remove any basis for competing on anything but price, slow demand growth means firms can only grow by taking share from rivals, and high exit barriers keep weak or excess competitors in the industry rather than allowing supply to shrink. Together, these point to a mature or declining industry with weak, structurally pressured long-run profitability.
A. A young, high-growth industry typically shows the opposite pattern: firms can grow without directly taking share from rivals (limiting rivalry intensity), and the specific combination of high fixed costs, commoditization, slow growth, and high exit barriers described here is a late-stage, not early-stage, industry signature.
C. Porter's Five Forces framework applies across the industry life cycle, including mature/declining industries; if anything, this scenario is a textbook illustration of the framework identifying WHY rivalry becomes intense, not a case where the framework fails to apply.

Unit: industry-and-competitive-analysis

Question 10Above the exam

An analyst notes that Industry X has only three major suppliers of a critical, hard-to-substitute input, while Industry X itself sells to thousands of small, fragmented buyers with no individual buyer purchasing a meaningful share of output. Combining the bargaining power of suppliers with the bargaining power of buyers within Porter's framework, Industry X's overall profitability is most likely to be:

How sure are you?

Correct: A. Supplier power is high when suppliers are concentrated (few options) and their input is hard to substitute, exactly as described; this lets suppliers extract more favorable pricing terms from Industry X, squeezing its margins. Buyer power, by contrast, is typically LOW when buyers are numerous and fragmented, with no single buyer large enough to negotiate favorable terms or threaten to walk away meaningfully; that is the case here too. Combining both forces, the pressure on Industry X's profitability comes predominantly from the concentrated supplier side.
B. A large NUMBER of buyers, on its own, does not create strong buyer power; buyer power comes from CONCENTRATION (each buyer purchasing a large, meaningful share) or the buyer's ability to credibly threaten to switch. Thousands of small, fragmented buyers each buying a tiny share is a classic LOW-buyer-power scenario, the opposite of what this choice claims.
C. The two forces do not automatically offset each other; each force's strength depends on its own specific conditions (concentration, substitutability, switching costs), and in this case the conditions point toward strong supplier power and weak buyer power simultaneously, not a neutral, self-canceling outcome.

Unit: industry-and-competitive-analysis

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