The core purpose of a commercial enterprise is to provide products and services and make profits. This article is mainly about how to roughly look at service companies from different perspectives.
Among the four most important points for analyzing industry characteristics (details can also see value investing paper)
- Industry cyclicality (CYC) (less cyclicality, the better)
- capital intensity (ROIC), measured by return on tangible fixed assets (less Capex/fixed assets needed, , the better)
- Purchase cycle (one-time purchase/repeat purchase, the more repeated purchases, the better).
- “product “cycle(life). (the longer the life of the product or service itself, the better)
Each industry has its inherent advantages and disadvantages. The above four points are determined by the characteristics of different industries. It is not determined by its location/region / even its competitive advantage.
Human resources companies in China or the United States, are not much different, from online classified ads (for example car classified advertising companies, auto home(China), British auto trader(Uk), car.com(USA) ), their business model are same, There is no essential difference in business characteristics.
However, the service industry itself is relatively regional. Competition is also from local players, Due to the level of managers, population, labor costs, and corporate culture (Western companies prefer outsourcing / specialized labor division), service industries in some regions are more likely to grow. Margin may be a little better than global peers.
The Paper Contain Six major parts and/few major points highlighted.
- Advantages and disadvantages of the service industry
- Advantages
- Disadvantages
- four major industry characteristics (CYC, Capital intensity, customer purchase cycle, own product cycle)
- Four major types of service companies,
- Grow with NO labor / NO CAPEX
- Grow with labor added/ NO CAPEX
- Gros with no labor/ Capex added
- Grow with more labor/ Capex added
- business logic
- examples of service companies
a) 1: Data processing company (IT service)
b) Professional (professional service), professional business / industry consulting / financial / financial information (industrial service)
c) Stock exchange (financial services)
d) Asset / wealth management company (financial services)
e) Commercial service, labor-intensive outsourcing company, cleaning, catering management, equipment maintenance, security
f) Airport
1: Advantages and disadvantages of service industry
The service business has many advantages vs the goods business. (3 points)
I. No /little inventory required, more deferred revenue, increased cash flow conversion rate
from the perspective of cash flow, the service type industry basically require little or no inventory, and many service industries can collect cash in advance
For example, education tuition fees, advance receipts in the IT service industry, airline & hotel reservations, casino chips, etc. This reduces the working capital requirements and increases the cash flow conversion rate.
II. Lower upfront capex needed, increased the ROIC (tangible fixed asset).
From the perspective of ROIc, a lot of service type companies sometimes requires manpower to increase, but generally does not require too much capex in fixed assets. This increases ROIC, and because the service industry largest cost is people, it also increases the flexibility of companies to control costs by their own means.
III. Longer product life , less technology advanced, harder to be replaced.
From the perspective of the "product" life , unlike the companies that produce and sell products, the service industry provides a longer "product" cycle, in fact technology advanced normally benefit service companies, can reduced cost of service companies, because it required little people. so that the service industry is easier to transform in a difficult situation.
Disadvantages of the service industry.(2 points)
I. Hold large account receivables. Reduce cash conversion.
Some service industries, especially those dealing with enterprises customer, hold more accounts receivable, such as advertising companies and HR companies, IT service. It increasing working capital and reduced cash conversion rate. <!—nextpage-->
II. Easier to entry, more competition.
Due to the high ROIC , the required start-up capital is small, easy to enter, and fierce competition makes it difficult to creat long-term industry barriers
2: Service Classification by industry (GICS industry)(9 major industry types)
1) Energy (Energy): (Equipment & Services) / Midstream companies, oil and gas transportation such as pipelines (midstream), oil service
2) Industrials: Commercial & Professional services, commercial services, including commercial printing, waste disposal / , labor-intensive cleaning, equipment repair / maintenance, uniform rental, security, etc. / Professional services like human resources services and research and consulting services, like business information , quality inspection services, etc.)
3) Industrials: transportation services (transportation), including (airline, railways, logistics and infrastructure (airports, highways, ports, etc.)
4) Consumer Discretionary: Consumer services, including (casinos, hotels, restaurants and leisure services (parks/ gyms) (Hotels, restaurants and leisure), / Other Consumer Services (Specialized Consumer Services) (Such as education, funerals, legals, etc.)
5) Healthcare (health care): medical services including (health care facilities (Health Care Facilities) hospitals, health care services (such as laboratory testing, dialysis centers, etc.))
6) Information technology: Information service, IT service, including data processing, background automation, IT consulting, cloud web hosting services, etc.
7) Finance: Financial services (financial) includes (banks, insurance, leasing, custodian banks, capital markets, capital markets including asset / wealth management, investment banks, brokers, and financial information and exchanges, etc.)
8) Communication Services: including Telecommunication Services & Media & Entertainment. Media and entertainment mainly include advertisements, TV stations, cable TV, publishing houses, online advertising / review sites in interactive media, etc.
9) Real estate: real estate (mainly commercial real estate with lease), or real estate management and intermediary.
3: four major industry characteristics (CYC, Capital intensity, customer purchase cycle, own product cycle)
a) Cyc: (cyclicality)
The so-called cyclical nature is the change of volume and price.
In terms of prices, prices in the service industry are generally stable. The CYC is mainly reflected in the quantity(volume) change. For example, the decline in exchange trading volume, the decline in the number of investment bank IPOs, and the decline in data processing volume.
b) Capital intensity.
A lot of service industries are asset-light industries. Consumer service/ transportation service/ real estate in general required much larger capex.
c) Purchase cycle
Large-scale service projects. One-time purchase: decoration, construction. The CYC is relatively strong.
Repeat purchases: daily needs, small amounts, like data processing companies, stock trading, airport. Testing industry, catering, etc. The cyc is relatively weak and the stability is higher.
d) Products cycle(life)
The "product" cycle of the service industry is in general long.
4: Four major type of service companies
The biggest cost in the service industry is people. According to its capital-intensity / labor-intensive and sales radius, I mainly divide service-oriented enterprises into 4 categories.
A. Grow with NO labor / NO capex
These type of companies can have unlimited growth to a certain extent, but they require less manpower and capex, Because the biggest cost of the service industry is people, such companies need fewer people. They often have a very high ROIC and operating profit margin 》 20%
Some example:
Data processing industries, such as Automatic data processing (ADP), credit card companies (visa),
Asset management, stock exchange,
Media companies such as cable TV stations, advertising / online advertising (online classified ads)
Restaurant chains and hotel franchise, etc., Yum brand (KFC, Pizza Hut, tacobell parent company),
Researching & Consulting on business information, such as IHS markit, Nielsen Holdings, credit reporting company Equifax Inc, TRANSUNION,
Companies that provide financial information such as Bloomberg, Moody's, MSCI, etc. (A large part of this business model is a subscription database.)
B. Growth NO CAPEX/ add labor
They can grow, but they need a lot of manpower growth. Many are outsourcing labor-intensive service companies, generally with long contract periods and large accounts receivable. Such companies have a high ROIC and a lot of headcounts. And these companies like to grow through acquisitions, many companies have a lot of goodwill. Operating margin is generally 10-15%.
example:
IT, accounting, Catering management, cleaning / testing and inception, equipment maintenance, human resources and advertising agencies, real estate management,
Examples companies
testing and inspection, (Intertek, SGS, Bureau Veritas)
Ad agency (Omnicom Group, wpp, Publicis Groupe, and so on)
C. 3: large capex / no labor
The biggest cost is depreciation and amortization, and ETBIDA margin is high. High cash conversion rate, often accompanied by monopoly.
This type can be regarded as a bond like stock, which requires a large amount of fixed assets / capital investment. The potential for rapid growth is limited.
example:
infrastructure. Airports, high-speed ports, commercial real estate leasing, telecommunications, such enterprises require a lot of capital investment, but do not need too much manpower.
D. Grow labor add/ capex added
Due to the small sales radius, such enterprises are very regional, not only need capital investment in different locations, but also need to increase manpower.
For example, airlines, more revenue need more more planes (capex) and also add flight attendants(people)
Open more restaurants need more managers, chefs, waiters and so on(people) and more furniture & kitchen equipment ( capex)
However, the advantages of this type of business are that most of the services face consumers and the accounts receivable are small, so the conversion rate of cash flow is high. And can be easily expansion.
example:
Restaurants, hotels, hospitals, education (schools), airline , etc
5: business logic
Most of important three parts of Business logic are Revenue recognition (business model), cost (largest 2-3 items, in goods, cost of goods/ R&D/AD, Labor in case of service)
), tangible assets( largest 2-3 tangible assets)
A. Revenue recognition (how they make money/ business model)
1: Sales service repeated
2: Sale service (one time)
B. COST side
The largest cost of service sold in the service industry is people.
Other costs
SG & A
R & D costs, not a lot R&D for service..
Advertising costs: Compared to consumer goods, it is smaller.
C. Operating margin (in normal times exclude recession)
Operating margin <5% “5-10%” “ 10-15%” “ 15-20%” > 20%
Some examples in each category
<5% examples HR companies, Freight forward
5-10% examples majority of full-service restaurants.
10-15%, industrial service (labor-intensive companies) , Ad agency, IT service, and so on.
15-20%, or >20% examples. Professional services like business information.
Financial services like Asset managers/exchange. IT service (Data processing companies).Commutation Services like cable networks/ or interactive media etc.
Largest tangible asset
Building & improvement, in case of capital-intensive service.
Telecom equipment in case of less capital-intensive service.
D. Service industry by channels
self-sales and third parties
Third parties: service distributors often commission based revenue model, For example, asset managers can sell through brokerages and banking or platforms, and hotel airlines sell through third-party websites such as Ctrip and Booking. Transportation companies through freight forwarding (freight forwarding) and so on.
Self-selling: Most business services for businesses are self-selling. Such as asset managers can also have special account for wholesale clients.
E. by end market
Enterprise/Consumer
F. competitiveness (competition)
It is relatively easy to enter the service industry, and it is difficult to form long-term competitiveness.
Competitive advantages mainly include
I. Long-term contract: catering management, cleaning, etc., consulting services. Among them, data processing companies such as payment processing / payroll processing, and subscriptions axed such as financial data.
II. Monopoly franchise: casino license, infrastructure. stock exchange. Telecommunication services.
III. Network effect (network effect): credit card (visa, mastercard), GDR / such as airline hotel company reservation system (travelsky, amadeus, sabre corp, etc.), network effect, like online classified ads / social network ( such as FB, WEIBO).
6: example of few service companies.
Talk about several business models,
A: Data processing company (IT service)
Data processing is one of the best business models, whether it is payment processing / employee salary processing / hotel reservation processing (generally software + data).
Revenue recognition / business model
Process data and charge a small fee according to the processing volume. Some enterprises provide additional services.
Operating profit margin> 15%, often >20%
CYC: From a cyclical point of view, Repeated consumption, price stable, but can have changes in volume will cause a certain revenue change, but their cyc is smaller than the of large-scale services such as decoration and construction.
ROIC( Return on tangible asset): the asset-light companies large sales radius, and computers in the same location can process data from customers in different provinces.
The largest fixed asset (PP&E) is generally some computer equipment. With the advancement of computer equipment, the number of people in this type of business is also decreasing.
Customer: From the customer's perspective, since processing large amounts of data / and this data is essential to the daily operation of the enterprise, the price of each processing is small, changing of vendor is troublesome, and this type of customer normally stay with them.
In summary, asset-light, with / small cyclical, easy to grow, and customer chum rate low.
B: Professional (professional service), professional business / industry consulting / financial / financial information
Revenue recognition
subscription. Sometimes with added value service
One of the biggest costs of such companies is the purchase / processing of raw data.
Operating profit margin >15%, often greater than 20%
CYD: From a cyclical point of view, subscription fees basically have no CYC.
ROIC: the asset-light companies of such companies have a large sales radius.
In summary, asset-light, no or little cyc, , easy to grow, and customer chum rate low.
C. Stock exchange (financial services)
Revenue recognition
REVENUE is more diversified, such as cyclical revenue including the number of transactions / IPOs in the current year , non CYC revenue include such as data subscriptions and the number of all stocks traded on the exchange (Listing fee).
Cyclical, the disadvantage is that the cyc is relatively high. For example, the decline in IPO / transaction volume will affect the current income.
Return on tangible asset(ROIC) : asset-light industry, the largest capital investment is computer equipment and some software. The return on capital is very high.
Competition: due to licenses and other reasons, most of exchange have little competition.
Summary: asset-light, high cyc., customer chum rate low.
D.Asset / wealth management company (financial services)
Revenue recognition
Management fees on their asset management assets (AUM), some will earn performance fees.
Largest cost is people compensation.
Operating profit margin》 20%
CYC: High. The amount of asset management companies that manage assets will change revenue significantly.
Capital intensity: low. Fixed assets are office equipment / computer equipment the sales radius is large, and there is no geographical restriction. Only require one location, and For example, 100 people can manage 1B of assets. But the same 100 people can manage 10B of assets.
No capex, customer chum rate high. The competition is fierce.
E,: Commercial service, labor-intensive outsourcing company, cleaning, catering management, equipment maintenance, security
Revenue recognition
Provide corresponding services. a lot of them long term contract.
Operating margin 10-15%
Cyc low, generally long-term contracts for enterprises.
Capital intensity: asset-light industry, but overall, due to the need for human expansion to increase the sales radius, it is not as high as like asset managers
Summary: light assets (not the highest), low cyc, and high customer chum rate low.
G. Airport
Revenue recognition
aircraft landings / tolls / advertising + shop rental etc.
purchased cycle: Repeated consumption,
CYC, it has cyc, but much lower than airlines.
Capital intensity: capex high. The ROIC is less than 20%.
Product life cycle: "product" cycle is very long, which is basically not affected by any technological changes.
Competition: monopoly