Equity Research Industry - 5 Forces Analysis

I’m doing some research on the equity research industry (particularly on how independent research fits into the broader industry) and was hoping to get some insights from people who are knowledgeable in this area. To facilitate the discussion I have attempted to do a five forces analysis on the industry, based on my current perspective. Please let me know if you agree or disagree with anything I’ve said. I’ve also posted some additional questions at the bottom… Thanks in advance for the help, much appreciated.

Competitive Rivalry

In general, competition is intense given that there are many competitors and switching costs are low. Furthermore, non-independent firms use their research as a tool to help facilitate their other business areas, meaning it doesn’t need to be profitable standalone. Given the number of potential clients and the diversity of their needs, there is level of differentiation (particularly for independent firms, given they don’t have obligations to their bank owners), which eases competitive pressure.

Bargaining Power of Clients

The bargaining power of clients will vary depending on level of differentiation in the research. They with have higher power when dealing with commodity type research:

• Low switching costs
• Fragmented market

They will have lower power when dealing with more differentiated research:

• Although switching is easy, generally it doesn’t make sense given that a) having multiple perspectives is better than having one and b) cost of research is relatively low in comparison to the amount of capital clients are putting at risk
• Losing a client is manageable given how fragmented the buy-side market is
• Vertical integration is not a credible threat given that it would be difficult to replicate the timely information and multiple perspectives that the research industry provides

Bargaining Power of Suppliers

The only significant suppliers are analysts / associates. Although they are critical to the research firm and their skills are normally transferable, their bargaining power is generally limited given that:

• Labour costs make up the majority of a research firm’s input costs, making price a sensitive issue
• There is a deep pool of talented labour

It is possible for the employee to maintain significant bargaining power if the risk of them switching firms is significant:

• Achieved by maintaining the client relationships, the access to information sources and the skills needed to develop good ideas

Threat of Substitutes

There are no real substitutes.

Threat of New Competition

There are minimal barriers to entry, making the threat of new competition high:

• Minimal capital costs, no significant regulatory barriers, low switching costs, no location and distribution channels advantages and profitability does not require economies of scale

Some protection can be achieved by developing a strategy that is difficult to replicate:

• Proprietary research methodologies - it’s difficult to replicate the manner in which a research provider gathers, analyzes and interprets data
• Strong industry network - provides clients with access to management teams

The strongest barrier to entry is likely having trusted client relationships combined with specialized knowledge and experience.

Additional Question

• How often do buy-side firms use independent research providers?
• How much will buy-side generally pay independent firms, and what are payments terms (i.e. pay per report or subscription based)?
• How difficult is it for new research firms to get recognized by the buy-side?
• How do independent firms normally get introduced to the buy-side?
• Who are the most prominent independent research firms?