Porter Analysis

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Porter Analysis
P.V. Viswanath
Valuation of the Firm
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Before Valuation

• A key part of Valuation is forecasting the future
  cashflows of the firm.
• For that, its important to have a good
  understanding of what the firm is, its strengths,
  where it is, who its competitors and their
  strengths.
• A firm does not operate in a vacuum.
• Forecasting cashflows is impossible without
  knowing the environment.

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Porter Analysis

• Porters Five Forces model Analysis is a
  systematic way of analyzing the industry
  environment in which the firm finds itself.
• Following this, it is necessary to do a SWOT-type
  analysis to evaluate the firm within this
  environment.

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Five Forces model of Porter

• Ease of entry of competitors
• How easy or difficult is it for new entrants to
  start to compete, which barriers do exist?
• Threat of substitutes
• How easily can the product or service be
  substituted, especially cheaper?
• Bargaining power of buyers
• How strong is the position of buyers, can they
  work together to order large volumes?
• Bargaining power of suppliers
• How strong is the position of sellers, are there
  many or only few potential suppliers, is there a
  monopoly?
• Rivalry among the existing players
• Is there a strong competition between the
  existing players, is one player very dominant or
  all all equal in strength/size?
• Government Intervention
• Can government policies be used to the advantage
  of the firm?

From http//www.valuebasedmanagement.net/methods_p
orter_five_forces.html
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Porter Five Strategic Forces
www-mime.eng.utoledo.edu/people/faculty/rbennett/e
ngineering_management/Powerpoint20Slides/ch09.ppt

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New Entrants Barriers to Entry

• Economies of Scale
• To the extent that there are economies of scale,
  it will be difficult for a new firm to come in
  and compete with established firms.
• Product Differentiation
• To the extent that the firms products are
  distinct and non-copiable, new firms wont be
  able to come in and take away customers.
• Brand Identification
• To the extent that there is brand identification,
  customers will remember the firms product and
  will resist switching.
• Switching Cost
• If it is costly for the customer to switch, new
  entrants wont be able to convince them to do so.

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New Entrants Barriers to Entry

• Access to Distribution Channels
• If the firm has preferential or monopolistic
  access to distribution channels, it is more
  resistant to competition.
• Capital Requirements
• If capital requirements are high, new
  under-capitalized firms wont be able to enter
  the industry.
• Access to Latest Technology
• If technology is important in the industry, new
  firms are less likely to have access to them,
  which is good for established firms.
• Experience and Learning Effects
• If experience is necessary for a firm to figure
  out how to operate efficiently, established firms
  have a distinct advantage.

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Barriers to Entry Examples

• Regulatory restrictions (e.g. banking license)
• brand names (e.g. Xerox, McDonalds can develop
  customer loyalty hard to develop and/or imitate)
• patents (illegal to exploit without ownership
  e.g. new drugs cf. also RIM)
• A small co., NTP, had a patent on crucial
  technology that RIM used for its Blackberry
• unique know-how (e.g. WalMarts hot docking
  technique of logistics management)
• Accumulated experience (cf. learning curve)

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New Entrants/ Industry Competition Government
Action

• Industry Protection
• Industry Regulation
• Consistency of Policies
• Capital Movement Amongst Countries
• Custom Duties
• Foreign Exchange
• Foreign Ownership
• Assistance Provided to Competitors

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Industry CompetitionRivalry Among Competitors

• Concentration and Balance among Competitors
• To the extent that there is no single large
  competitor, the firm is better off
• Industry Growth
• If the industry is growing, theres more room for
  everybody less pressure on the firm
• Fixed Cost
• The higher the operating leverage, the more
  competitors are going to be hungry for revenue
  downside risks are greater
• Product Differentiation
• If products are differentiated, markets are in a
  sense, segmented, and there are no competitors

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Industry CompetitionRivalry Among Competitors

• Intermittent Overcapacity
• The extent to which firms have overcapacity from
  time to time, leading them to find additional
  sources of orders to keep resources fully
  employed.
• Switching Costs
• The extent to which its easy for customers to
  switch from this firm to other firms products
  will also determine how much other firms will
  exert themselves to get them to switch
• Corporate Strategic Stakes
• If the strategic stakes are high for example,
  if there is only room for a few players, then
  firms will fight harder

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Industry CompetitionBarriers to Exit

• Asset Specialization
• If assets are specialized, firms will not want to
  exit quitting the industry can be costly in
  terms of lower prices for assets no longer in
  use.
• One-time Cost of Exit
• For example, if businesses are required to pay
  for any environmental costs before they exit or
  if they have to set aside funds to pay for
  potential future lawsuits, they are less likely
  to exit a business
• Strategic Interrelationships with Other
  Businesses
• Emotional Barriers
• Government and Social Restrictions

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Bargaining Power of Suppliers

• Number of Important Suppliers
• The fewer the number of important suppliers, the
  more power they have over the firm, and the
  greater their ability to extract producer
  surplus.
• Availability of Substitutes for the Suppliers
  Products
• This would reduce supplier power
• Differentiation or Switching Costs of Suppliers
  Products
• If its difficult for the firm to switch to other
  suppliers, the current suppliers can charge more
• Suppliers Threat of Forward Integration
• To the extent that suppliers might potentially
  themselves become competitors, they are less
  reliable and need to be looked at strategically

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Bargaining Power of Suppliers

• Industry Threat of Forward Integration
• To what extent is it possible that the entire
  supplier industry might integrate forward?
• Suppliers Contribution to Quality or Service of
  the Industry Products
• How crucial are suppliers in the maintenance of
  the quality of industry products? Clearly, this
  will determine supplier power. Also, if this is
  an important factor, then the supplier industry
  might be more important, and might integrate
  forward.
• Total Industry Cost Contributed by Suppliers
• This goes to the same issue as above, but from a
  more quantitative perspective.
• Importance of the Industry to Suppliers Profits

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Bargaining Power of Customers

• Number of Important Buyers
• The greater the number of important buyers, the
  less power does the firm have to manipulate
  prices
• Availability of Substitutes for the Industry
  Products
• The impact of this on price elasticity of demand
  for the industrys products is obvious.
• Buyers Switching Costs
• This is relevant both in terms of switching to
  competitors products and switching to products
  manufactured by other industries.
• Buyers Threat of Backward Integration
• The buyer might choose to integrate backward and
  manufacture his input goods, himself. This means
  that buyers have to be looked at strategically
  they also have more power over the prices they
  are charged.

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Bargaining Power of Customers

• Industry Threat of Backward Integration
• The entire buyer industry might integrate
  backward.
• Contribution to Quality or Service of Buyers
  Products
• The greater the contribution of the firms
  product to the quality of the product, the
  greater the power of the firm. On the other
  hand, this might also impel the buyer to
  integrate backward.
• Total Buyers Cost Contributed by the Industry
• This is similar to the previous point, but in a
  more quantitative fashion.
• Buyers Profitability
• The more profitable buyers are, the more amenable
  they are to paying more for their input products.

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Substitutes

• Some of these points have already been addressed
  in looking at buyers/suppliers. However, its
  useful to consider it again from the product
  perspective, rather than from the perspective of
  other economic actors.
• Availability of Close Substitutes
• Users Switching Costs
• Substitute Producers Profitability and
  Aggressiveness
• Where is the substitute product located on the
  Price/Value dimensions?

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Porter Model AppliedPharmaceutical Industry
1990s

• Barriers to Entry Very Attractive
• Steep RD experience curve effects
• Large economies-of-scale barriers in RD
• Critical Mass in RD and marketing required
  global scale
• Significant RD and marketing costs
• High Risk inherent in the drug development
  process
• Increasing threat of new entries from
  biotechnology companies

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Porter Model AppliedPharmaceutical Industry
1990s

• Bargaining Power of Suppliers
• Mostly Commodities
• Individual Scientists may have some personal
  leverage

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Porter Model AppliedPharmaceutical Industry
1990s

• Bargaining Power of Buyers Mildly Unattractive
• Buying Process is price sensitive the consumer
  did not pay and the buyer did not pay
• Large power of buyers plan sponsors with an
  incentive to contain costs
• Mail-order pharmacies obtain large discounts on
  volume drugs
• Large aggregated buyers hospital suppliers,
  large distributors, government institutions

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Porter Model AppliedPharmaceutical Industry
1990s

• Threat of Substitutes Mildly Unattractive
• Generic drugs weakening branded drugs
• More than half the patent life spent on product
  development and approval process
• Technological development is making imitation
  easier reverse engineering
• Consumer aversion to chemical substances erodes
  the appeal for pharmaceutical drugs

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Porter Model AppliedPharmaceutical Industry
1990s

• Intensity of Rivalry Attractive
• Global Competition Concentrated Amongst fifteen
  large companies
• Most companies focus on certain types of disease
  therapy
• Competition amongst incumbents limited by patent
  protection
• Competition based on price and product
  differentiation
• Government intervention increases rivalry
• Strategic alliances establish collaborative
  agreements among industry players
• Very profitable industry, but declining margins

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Resource-based Views of the Firm Tangible Assets

• Tangible assets are the easiest to value, and
  often are the only resources that appear on a
  firms balance sheet.
• They include real estate, production facilities,
  and raw materials, among others.
• Although tangible resources may be essential to a
  firms strategy, due to their standard nature,
  they rarely are a source of competitive
  advantage.

Source David Collis and Cynthia Montgomery
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Resource-based Views of the Firm Intangible
Assets

• Intangible assets include such things as
• company reputations,
• brand names,
• cultures,
• technological knowledge,
• patents and trademarks, and
• accumulated learning and experience.

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Firm ResourcesOrganizational Capabilities

• Organizational capabilities are not factor inputs
  like tangible and intangible assets
• they are complex combinations of assets, people,
  and processes that organizations use to transform
  inputs into outputs.
• Includes a set of abilities describing efficiency
  and effectiveness low cost structure, lean
  manufacturing, high quality production, fast
  product development.

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Putting things together

• Now that we have looked at the firms environment
  and its assets, we need to look at the firms
  strategy within this environment and how this
  relates to the other parties identified in the
  five forces model.
• We must keep in mind, however, that our objective
  is not to craft new strategy for the firm, but
  rather to appreciate its current and potential
  strategy in
• forecasting future cashflows
• Evaluating investment risks
• A useful place to find relevant information is
  the firms 10-K filing, particularly the Risk
  Factors section.