porter analysis p.v. viswanath valuation of the firm
TRANSCRIPT
Before ValuationA key part of Valuation is forecasting the future cashflows of the firm.For that, it’s 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.
Porter AnalysisPorter’s 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.
Five Forces model of Porter
Ease of entry of competitorsHow easy or difficult is it for new entrants to start to compete, which barriers do exist?
Threat of substitutesHow easily can the product or service be substituted, especially cheaper?
Bargaining power of buyersHow strong is the position of buyers, can they work together to order large volumes?
Bargaining power of suppliersHow strong is the position of sellers, are there many or only few potential suppliers, is there a monopoly?
Rivalry among the existing playersIs there a strong competition between the existing players, is one player very dominant or all all equal in strength/size?
Government InterventionCan government policies be used to the advantage of the firm?
From http://www.valuebasedmanagement.net/methods_porter_five_forces.html
Porter: Five Strategic Forces
www-mime.eng.utoledo.edu/people/faculty/rbennett/engineering_management/Powerpoint%20Slides/ch09.ppt
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 DifferentiationTo the extent that the firm’s products are distinct and non-copiable, new firms won’t be able to come in and take away customers.
Brand IdentificationTo the extent that there is brand identification, customers will remember the firm’s product and will resist switching.
Switching CostIf it is costly for the customer to switch, new entrants won’t be able to convince them to do so.
New Entrants: Barriers to Entry
Access to Distribution ChannelsIf the firm has preferential or monopolistic access to distribution channels, it is more resistant to competition.
Capital RequirementsIf capital requirements are high, new under-capitalized firms won’t be able to enter the industry.
Access to Latest TechnologyIf 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 EffectsIf experience is necessary for a firm to figure out how to operate efficiently, established firms have a distinct advantage.
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. WalMart’s “hot docking” technique of logistics management)Accumulated experience (cf. learning curve)
New Entrants/ Industry Competition:
Government ActionIndustry ProtectionIndustry RegulationConsistency of PoliciesCapital Movement Amongst CountriesCustom DutiesForeign ExchangeForeign OwnershipAssistance Provided to Competitors
Industry Competition:Rivalry Among CompetitorsConcentration and Balance among Competitors
To the extent that there is no single large competitor, the firm is better off
Industry GrowthIf the industry is growing, there’s more room for everybody; less pressure on the firm
Fixed CostThe higher the operating leverage, the more competitors are going to be hungry for revenue – downside risks are greater
Product DifferentiationIf products are differentiated, markets are in a sense, segmented, and there are no competitors
Industry Competition:Rivalry Among CompetitorsIntermittent 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 CostsThe extent to which it’s 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 StakesIf the strategic stakes are high – for example, if there is only room for a few players, then firms will fight harder
Industry Competition:Barriers to Exit
Asset SpecializationIf 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 ExitFor 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 BusinessesEmotional BarriersGovernment and Social Restrictions
Bargaining Power of Suppliers
Number of Important SuppliersThe 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 powerDifferentiation or Switching Costs of Suppliers’ Products
If it’s 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
Bargaining Power of Suppliers
Industry Threat of Forward IntegrationTo 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 SuppliersThis goes to the same issue as above, but from a more quantitative perspective.
Importance of the Industry to Suppliers’ Profits
Bargaining Power of Customers
Number of Important BuyersThe 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 industry’s products is obvious.
Buyer’s Switching CostsThis is relevant both in terms of switching to competitors’ products and switching to products manufactured by other industries.
Buyer’s Threat of Backward IntegrationThe 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.
Bargaining Power of Customers
Industry Threat of Backward Integration The entire buyer industry might integrate backward.
Contribution to Quality or Service of Buyer’s Products
The greater the contribution of the firm’s 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 Buyer’s Cost Contributed by the IndustryThis is similar to the previous point, but in a more quantitative fashion.
Buyer’s ProfitabilityThe more profitable buyers are, the more amenable they are to paying more for their input products.
SubstitutesSome of these points have already been addressed in looking at buyers/suppliers. However, it’s useful to consider it again from the product perspective, rather than from the perspective of other economic actors.
Availability of Close SubstitutesUser’s Switching CostsSubstitute Producer’s Profitability and AggressivenessWhere is the substitute product located on the Price/Value dimensions?
Porter Model Applied:Pharmaceutical Industry
1990s
Barriers to Entry – Very AttractiveSteep R&D experience curve effectsLarge economies-of-scale barriers in R&DCritical Mass in R&D and marketing required global scaleSignificant R&D and marketing costsHigh Risk inherent in the drug development processIncreasing threat of new entries from biotechnology companies
Porter Model Applied:Pharmaceutical Industry
1990sBargaining Power of Suppliers
Mostly CommoditiesIndividual Scientists may have some personal leverage
Porter Model Applied:Pharmaceutical Industry
1990s
Bargaining Power of Buyers: Mildly Unattractive
Buying Process is price sensitive – the consumer did not pay and the buyer did not payLarge power of buyers – plan sponsors with an incentive to contain costsMail-order pharmacies obtain large discounts on volume drugsLarge aggregated buyers – hospital suppliers, large distributors, government institutions
Porter Model Applied:Pharmaceutical Industry
1990s
Threat of Substitutes: Mildly Unattractive
Generic drugs weakening branded drugsMore than half the patent life spent on product development and approval processTechnological development is making imitation easier – reverse engineeringConsumer aversion to chemical substances erodes the appeal for pharmaceutical drugs
Porter Model Applied:Pharmaceutical Industry
1990sIntensity of Rivalry: Attractive
Global Competition Concentrated Amongst fifteen large companiesMost companies focus on certain types of disease therapyCompetition amongst incumbents limited by patent protectionCompetition based on price and product differentiationGovernment intervention increases rivalryStrategic alliances establish collaborative agreements among industry playersVery profitable industry, but declining margins
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 firm’s balance sheet. They include real estate, production facilities, and raw materials, among others. Although tangible resources may be essential to a firm’s strategy, due to their standard nature, they rarely are a source of competitive advantage.
Source: David Collis and Cynthia Montgomery
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.
Firm Resources:Organizational CapabilitiesOrganizational 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.
Putting things togetherNow that we have looked at the firm’s environment and its assets, we need to look at the firm’s 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 cashflowsEvaluating investment risks
A useful place to find relevant information is the firm’s 10-K filing, particularly the “Risk Factors section.”