Economic theory states that the absence of monopoly power and barriers to entry will reduce the competitive advantage of each firm in an industry and reduce its profits to zero over time.
Although this is merely economic theory, it raises some interesting questions: does the competitive advantage of a firm last longer in some sectors than in others? And if so, which industries have the most competitive advantage?
To answer this question, we’ve examined all initial public offerings (IPOs) on the NYSE and NASDAQ over the past 30 years and tracked how each firm performed after its IPO. We have tracked how the profits of a particular company have shifted over a decade by looking at the margins of its IPO: Pre-Income Tax (EBT), Operating, Net and Total.
We have calculated how a firm’s margins change over time by measuring the difference between a particular year and the firm’s IPO year. We used the differences between the industries to represent the sector as a whole.
Although margins and profitability are not perfect proxies for competitive advantage, they offer a firm idea of how a firm changes position and develops in its sector. When a new entrant in an industry has a single demand-driven product driven by unique intellectual property, it will likely generate higher profits and margins in its IPO. When other companies try to capture and replicate or improve its product, the margin of new entrants will decrease as its competitive advantage in the sector will decrease.
The first interesting acceptability from our analysis is the diversity of firm profit changes by sector. For example, the medieval aerospace and defense industry firm has reduced its EBT margin by 0.04 percentage points from 0 or 9 in its IPO year.
Nine-year post-IPO: What has changed?
|EBT margin||Gross margin||Net margin||Management Boundaries|
|Space and defense||-0.04%||0.45%||0.49%||0.10%|
|Engineering and construction||-1.16%||-5.43%||-1.08%||-1.71%|
|Oil and gas||-0.26%||-2.14%||2.47%||0.17%|
Indeed, the sharp middle drop between competitive advantage using four margin measurements is the two industries computer hardware and biotechnology. Median computer hardware firm’s gross margin fell 2.45 percentage points in the nine years following the IPO. Intermediate biotechnology companies lost 7.99 percentage points over the same period.
The performance of the computer hardware sector is particularly surprising because of how many years Apple has maintained its high margin: Apple’s total margin has expanded considerably and its net margin has more than doubled, from 10% in 2005 to 21% in 2020.
At the other end of the spectrum, pharmaceuticals and entertainment are the two sectors that gain the most in terms of competitive advantage after the IPO. In the nine years following the IPO, the median pharmaceutical firm’s gross margin expanded by 6.03 percentage points, while the median entertainment company’s margin increased by 1.19 percentage points.
To gain more insight into how these post-IPO margins evolved, we focused on two more extreme industries কম্পিউটার computer hardware and pharmaceutical manufacturing এবং and how the margins of companies between them changed after the IPO.
Median Computer Hardware Firm Performance Post-IPO
Median Drug Manufacturer Firm Performance Post-IPO
Taken together, our results suggest that most companies lose one percentage point in margins nine years after their IPO. But in some sectors – software, entertainment, and pharmaceuticals, for example – the medieval organization improved its margins as the years progressed.
What explains this “getting better with age” phenomenon? It could be cost-effectiveness, regulatory lobbying, the power of an organization’s intellectual property, some combination or something else entirely. Determining which can be further investigated.
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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
Photo Credit: © Getty Images / Ryan McVeigh
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