Though the term industry has existed for a long time, there is a common misunderstanding about what it really refers to. An industry is a group of firms producing, extracting and processing similar products and services. For example, companies like Toyota, Honda and GM, are grouped together as the automobile industry. Why? Because their products have similar usage, similar raw materials and more or less similar market segments.
Also, there is a prevailing belief that industries and sectors are the same. However, a sector is a large segment of an economy formed by an industry group. For instance, the airline and the automobile industry collectively form the transportation sector.
Why Are Industries Important to Know?
Knowing this helps with strategic analysis, investment decisions, and understanding government policies.
Strategic Industry Analysis
Strategic analysis helps firms to form better business decisions in identifying opportunities, recognizing threats and analyzing the firm’s position relative to its competitors.
Investment & Portfolio Management
Companies within an industry are correlated. So, a factor that influences a line of business is more likely to influence every company within that industry.
Hence to minimize the risk of such changes, investors diversify their portfolio across a variety of industries. Knowing an industry helps an investor to reduce their risk exposure and improve the performance of their portfolio.
Understanding Government Policies
Government applies tariffs, subsidies and quotas to a similar group of companies. By knowing industries, governments and companies can assess the impact of such policies on a macroeconomic level and at the same time correct their position in time to maximize their wealth.
Interactions Between Industries
Economy is a giant feedback machine. It constantly takes input and produces output. This dynamic is propelled by different sectors and industries coming together. An input for one industry becomes output for another; ultimately building an ongoing relationship between them.
For example, the output of the aluminium mining industry is the raw materials for the automobile line of business. Similarly, the vehicle is an important tool of the travel industry. Then the travel industry influences the workforce to work in the aluminium industry. This, in turn, is ultimately forming an ecosystem of industries working together.
If one of the above industries were to be affected, all of the participating industries will experience the fallout. Suppose, there was a shortage of aluminium. This shortage would reduce automobile production. A reduction in the number of automobiles would inflate the prices of automobiles and as well as travel. Hence, we can positively say that there is a correlation between the industries.
Types of Industries
Industries are labeled as a a few standard categories. They are categorized mainly into the following 3 types.
Primary industries are involved in the extraction and production of raw materials from nature. For example the mining and agriculture industry. In our previous example, the aluminum industry is an example of a primary industry. In general, primary industries are usually the backbone of any economy.
Secondary industries use the raw materials provided by the primary industries to produce products. These industries are largely made up of manufacturing companies and produce tangible products. For instance, food processing industries, energy industry and much more are part of the secondary industries.
Tertiary industries produce services rather than products. Some examples of tertiary industry are finance, hospitality, entertainment and trading. Recently, the tertiary industry has been subdivided into a fourth type called Quaternary industries. These types of industries include advanced technologies, research, development, and biotechnology.
How To Classify a Industry
Industries are usually classified based on the capital required to establish them, ownership structure, raw materials, finished goods and strength of labor. Generally the government of the country specifies a capital threshold which helps to classify industries.
For example, any industry that requires a capital of more than 50 million can be classified as a large-scale industry.
Strength of Labor
Industries can be classified on the basis of strength of labor. Strength of labor is the number of workers and type of workers working in an industry. It’s generally safe to assume that large-scale industries employ a larger number of workers in comparison to small-scale industries.
Large-scale industries are capital intensive industries with huge infrastructure and manpower. Additionally, they have suppliers and buyers all over the globe.
Since they are capital intensive, they are generally public companies with many shareholders. The capital composition of these industries consists of both equities and debts. Examples of a large-scale industry are the automobile, steel, and tech industry.
Medium-scale industries are less capital intensive than large scale industries and employ less people comparatively. They are active within the borders of a specific country.
The capital composition of these industries can also be a mix of both equities and debt. Examples of medium scale industries would be auto-parts manufacturing, media houses and garment manufacturing.
Small-scale industries are labor intensive. They operate on a regional level and are less capital intensive. These industries employ semi-skilled workers and their suppliers are locally based.
Since their capital requirement is less and they are usually small partnerships or sole proprietorships. Examples of such industries would be woodworking, paper manufacturing and chocolate manufacturing.
Raw Materials & Finished Goods
Raw materials are the primary elements required to produce or construct goods and services. Some industries are classified on the basis of raw materials used.
Heavy industries are capital intensive and produce large and heavy equipment and facilities. These industries usually produce products for other industries instead of individuals and are business oriented. Some examples of the heavy industry would be the aircraft, steel, and chemical industry.
Light industries produce light or small products for individuals. They are less capital intensive and are customer oriented. For example, the food and beverage, clothing, and consumer electronics.
Ownership is the ultimate legal right to a lawfully claim a business. It’s one of the most important classifications because businesses operate to meet owners’ goals. The primary motive of the private sector industries is to maximize profit but, the same might not be true for the public sector.
Private sector industries are owned and operated by individuals or groups of individuals. The sole motive of these industries is to maximize profit. They are usually funded with equities and debts. Private airlines private banks are some examples of private sector industries.
Public sector industries are under the control of the central, state or local government. The motive of this sector is to work for the welfare of the economy and to earn profit. These are usually initially funded by tax money. Both the private sector and public sector can coexist. There can be both government banks and private banks, or public airlines and private airlines.
Joint sector industries are the ones where the ownership is between both the government and private companies or individuals. Both the public sector and private sectors come together to form a new enterprise. The joint sector can also be producing the same goods and services as the private and public sector.
Industries which are owned by producers of raw materials or the workers or both are classified under co-operative sector. Basically all the producers of raw materials come together and form an enterprise, forming the cooperative sector.
For example, the producers of milk come together and form a dairy company. Therefore they are reducing the middleman and ensuring the producers of raw materials are not exploited by corporations.
Industries are also classified based on their location and where they operate.
Domestic industries produce goods and services within the borders of a country. Though the production is limited within the country borders, they can export outside the borders.
Domestic industries are the backbone of a country because they not only provide employment but also retain the profits within the country industries like telecommunication and defense have always been domestic because they are crucial to national security.
Foreign industries operate outside their home country. These industries usually are capital intensive and are considered good for an economy as they provide employment opportunities, pay taxes to the government, and help in technological exchange. The technology industry, for example, is a solid example of foreign industry since they operate in different countries and regions.
Examples of Industry Categorizations
Industries are categorized on the basis of products and services they produce. This classification helps investors and analysts understand the common factors influencing the performance of the companies within an industry.
On the top level, they are classified into three types as mentioned above, but they can also be identified by their produce like:
- Automotive – Toyota Motors
- Banking – JPMorgan Chase
- Capital equipment – Caterpillar
- Construction – Turner Construction
- Chemical – ExxonMobil
- Pharmaceutical – Pfizer
- Mining – Norilsk Nickel
Understanding Industry Helps You To Better Position Yourself
Industry classification helps to easily compare statistics of business activities making it easier to formulate policies and decisions. As an investor, understanding an industries helps you to do an industry analysis to maximize your returns. Also, it helps you to diversify your portfolio and minimize risk. Moreover, it also helps you to assess future opportunities and threats.
All this information can undoubtedly be overwhelming. But, if you are ready to invest, you might want to hire a professional financial advisor. Not only do they provide help with personal wealth management, they also recommend you on specific investment plans and strategies.