Revenue Drivers
The analysis involves identifying drivers, which are causative factors that explain the level of and changes in an output variable (here, revenues), and understanding the evolution of the drivers over time.
Analysts can take a bottom-up or top-down approach to determining revenue drivers.
A bottom-up approach decomposes revenues into drivers such as sales volume and price, or revenues by product line, segment, or geography, which may be further broken down into other drivers.
A top-down approach expresses revenues as a function of drivers such as market share, the addressable market or market size, and GDP growth. The two approaches are often used together.
Pricing Power
Pricing power refers to a company’s ability to set prices and other economic terms with customers without affecting its sales volumes.
A low-cost producer (with costs below—in some cases, well below—those of a marginal producer) can, however, earn long-run returns above its cost of capital in a highly competitive industry, but it requires the low-cost position to be sustained against competition over time.
Highly competitive markets often do not start as highly competitive but, rather, become more competitive as new firms enter, the pace of innovation slows, and imitation becomes widespread, a process known as commoditisation.
Top-Down Revenue Analysis
Analysts can also take a top-down approach to analysing revenue by expressing it as a function of drivers such as market size and a company’s share of that market. This approach will be discussed in more detail in the next module (on industry and competitive analysis).
