Tax/Regulation Motivated Financial Innovation


Dec 6, 2012 (5 years and 6 months ago)


Porter Analysis

P.V. Viswanath

Valuation of the Firm

Before Valuation

A 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 Analysis

Porter’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
type analysis to evaluate the
firm within this environment.

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

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?


Porter: Five Strategic Forces


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 firm’s products are distinct and non
copiable, new firms won’t be able to come in and take away

Brand Identification

To the extent that there is brand identification, customers
will remember the firm’s product and will resist switching.

Switching Cost

If 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 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
won’t 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

Experience and Learning Effects

If experience is necessary for a firm to figure out how to
operate efficiently, established firms have a distinct

Barriers to Entry: Examples

Regulatory restrictions (e.g. banking license)

brand names (e.g. Xerox, McDonalds

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 Action

Industry Protection

Industry Regulation

Consistency of Policies

Capital Movement Amongst Countries

Custom Duties

Foreign Exchange

Foreign Ownership

Assistance Provided to Competitors

Industry Competition:

Rivalry 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, there’s 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


Industry Competition:

Rivalry 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 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 Stakes

If 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 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.

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

Emotional Barriers

Government and Social Restrictions

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’

This would reduce supplier power

Differentiation or Switching Costs of Suppliers’

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 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

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
industry’s products is obvious.

Buyer’s Switching Costs

This is relevant both in terms of switching to competitors’
products and switching to products manufactured by other

Buyer’s 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.

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 Industry

This is similar to the previous point, but in a more
quantitative fashion.

Buyer’s Profitability

The more profitable buyers are, the more amenable they are
to paying more for their input products.


Some 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 Substitutes

User’s Switching Costs

Substitute Producer’s Profitability and

Where is the substitute product located on the
Price/Value dimensions?

Porter Model Applied:

Pharmaceutical Industry 1990s

Barriers to Entry

Very Attractive

Steep R&D experience curve effects

Large economies
scale barriers in R&D

Critical Mass in R&D and marketing
required global scale

Significant R&D and marketing costs

High Risk inherent in the drug
development process

Increasing threat of new entries from
biotechnology companies

Porter Model Applied:

Pharmaceutical Industry 1990s

Bargaining Power of Suppliers

Mostly Commodities

Individual Scientists may have some
personal leverage

Porter Model Applied:

Pharmaceutical Industry 1990s

Bargaining Power of Buyers: Mildly

Buying Process is price sensitive

consumer did not pay and the buyer did not

Large power of buyers

plan sponsors with
an incentive to contain costs

order pharmacies obtain large discounts
on volume drugs

Large aggregated buyers

hospital suppliers,
large distributors, government institutions

Porter Model Applied:

Pharmaceutical 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

Porter Model Applied:

Pharmaceutical Industry 1990s

Intensity of Rivalry: Attractive

Global Competition Concentrated Amongst fifteen
large companies

Most companies focus on certain types of disease

Competition amongst incumbents limited by patent

Competition based on price and product

Government intervention increases rivalry

Strategic alliances establish collaborative agreements
among industry players

Very profitable industry, but declining margins

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

based Views of the
Firm: Intangible Assets

Intangible assets include such things as

company reputations,

brand names,


technological knowledge,

patents and trademarks, and

accumulated learning and experience.

Firm Resources:

Organizational 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.

Putting things together

Now 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 cashflows

Evaluating investment risks

A useful place to find relevant information is
the firm’s 10
K filing, particularly the “Risk
Factors section.”