Economic theory suggests that without monopoly powers or barriers to entry, every company’s competitive advantage in an industry will diminish over time, leading to a decline in profits.
However, this theory prompts interesting questions: Does a company’s competitive advantage tend to last longer in some sectors than others? And if so, which industries have the most sustainable competitive advantage?
To answer these questions, we conducted a study on all initial public offerings (IPOs) on the NYSE and NASDAQ in the past 30 years. We tracked the performance of each company following its IPO and analyzed how its profitability changed over time, specifically looking at earnings-before-taxes (EBT) margin, gross margin, net margin, and operating margin.
We compared a company’s margins in a particular year to those in its IPO year to determine how its competitive advantage in the sector evolved. While margins and profitability are not perfect indicators of competitive advantage, they provide insights into a company’s standing in its sector. Initially, a new entrant with a unique product driven by intellectual property may generate high profits and margins. However, as competitors catch up and replicate or improve upon the product, the new entrant’s margins will decline as its competitive advantage diminishes.
The study revealed significant variation in profitability changes across sectors. For example, the median aerospace and defense industry firm experienced a slight 0.04 percentage point drop in EBT margin from the IPO year to nine years later. On the other hand, the median biotechnology company saw a substantial 2.95 percentage points decrease in EBT margin over the same period.
Nine Years Post-IPO: What’s Changed?
| EBT Margin | Gross Margin | Net Margin | Operating Margin | |
| Aerospace and Defense | -0.04% | 0.45% | 0.49% | 0.10% |
| Agriculture | -2.07% | -2.60% | -0.69% | -1.75% |
| Apparel Manufacturing | -1.28% | 2.61% | -1.08% | -1.87% |
| Apparel Retail | 2.10% | 1.02% | 1.31% | -1.21% |
| Asset Management | -0.74% | -0.29% | 0.32% | -3.05% |
| Biotechnology | -2.95% | -7.99% | -1.10% | -4.11% |
| Beverages | -0.02% | 5.46% | -1.31% | 1.30% |
| Building Materials | -0.85% | 0.91% | -0.20% | 0.23% |
| Chemicals | 0.36% | 4.13% | 1.88% | 2.32% |
| Communication Equipment | -1.05% | 0.86% | 0.75% | -2.41% |
| Computer Hardware | -7.63% | -2.45% | -1.32% | -8.50% |
| Drug Manufacturers | 0.90% | 6.03% | 1.60% | 1.18% |
| Electronic Components | -1.20% | -0.37% | -0.41% | -3.83% |
| Engineering and Construction | -1.16% | -5.43% | -1.08% | -1.71% |
| Entertainment | 3.40% | 1.19% | 5.87% | 5.87% |
| Farming | -1.80% | -0.83% | -0.90% | -0.17% |
| Information Technology | 0.23% | -3.55% | 2.04% | -1.30% |
| Leisure | -1.74% | -2.49% | -1.34% | -3.98% |
| Medical Care | -0.16% | -3.92% | 3.55% | -0.43% |
| Medical Devices | 0.71% | 5.72% | 2.79% | 0.48% |
| Oil and Gas | -0.26% | -2.14% | 2.47% | 0.17% |
| Package Foods | 1.26% | 2.73% | 0.88% | 1.11% |
| Restaurants | -0.18% | -2.51% | 0.05% | -0.44% |
| Semiconductors | -4.56% | -1.07% | 0.82% | -2.10% |
| Software | 0.23% | 5.66% | 4.29% | 4.14% |
| Telecommunications | -2.93% | -4.55% | 2.55% | 0.44% |
| Utilities | -6.22% | -5.21% | 0.06% | 0.02% |
Interestingly, the computer hardware and biotechnology industries experienced the most significant drops in median competitive advantage according to all four margin measures. The gross margin of the median computer hardware firm fell 2.45 percentage points in the nine years following its IPO. Similarly, the median biotechnology company saw a staggering 7.99 percentage points decline in gross margin during the same period.
These findings are particularly surprising considering how well Apple has maintained its high margins over the years, with substantial expansions in gross and net margins. Apple’s gross margins have more than doubled from 10% in 2005 to 21% in 2020.
On the other hand, drug manufacturers and the entertainment industry experienced the largest gains in competitive advantage post-IPO. The median pharmaceutical firm’s gross margins expanded by 6.03 percentage points in the nine post-IPO years, while the median entertainment company saw a 1.19 percentage points increase in margins.
To gain further insights into the development of these margins post-IPO, we examined the performance of median firms in two extreme industries: computer hardware and drug manufacturing.
Median Computer Hardware Firm Performance Post-IPO
Median Drug Manufacturer Firm Performance Post-IPO
Overall, our results indicate that most firms experience a one percentage point decline in margins in the nine years after their IPO. However, in certain sectors such as software, entertainment, and drug manufacturing, the median firm actually improves its margins over time.
The reasons behind this “getting better with age” phenomenon are yet to be fully understood. Possible factors include cost-cutting measures, regulatory lobbying, the strength of a company’s intellectual property, or a combination of these and other influences. Further investigation is needed to determine the exact causes.
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All opinions expressed in this post are solely those of the author and should not be construed as investment advice. The views of this post do not necessarily reflect the opinions of CFA Institute or the author’s employer.
Image credit: ©Getty Images / Ryan McVay
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