This article is part of our Rising Star Portfolios Series.
As an investor, I have a process. There are things I simply need to know in order to make a well-informed decision. It may not be totally foolproof, but it usually works pretty well. And when it doesn't, at least I have some accountability. A quick examination of the process can shed some light on what went right (or dare I say, wrong), and how I can become a better investor for it all.
Take my very first Rising Stars recommendation, Activision Blizzard (Nasdaq: ATVI). As part of my process, I like to take a quick look at companies through the lens of Porter's Five Forces. I have written about Porter's model before. These five points of focus (barriers to entry, threat of substitutes, power of buyers, power of suppliers, and industry jockeying) can shed some light on a company's competitive advantage. And because it can change with time, it's a handy tool to have in your investing toolbox.
It's a rainbow of fruit flavor!
The graph below is my take on the Five Forces, and how they are playing out right now for Activision Blizzard. The forces are represented by colors. Red means the risk is high, green means it's low, and yellow puts it somewhere right in the middle:
Barriers to entry
It's reasonable to believe Activision possesses an advantage with its scale and catalogue of games, not to mention relationships with third-party developers like Bungie. However there are few real barriers to entry in this business. All it takes is a creative mind and some programming skills and you can develop a game. Activision's advantage lies in its scale as the leading publisher in the business today. So a lot of its advantage boils down to manufacturing and distribution, two areas where Activision really shines.
Threat of substitutes
There are no substitutes for games like Call of Duty and World of Warcraft (unless you want to go to jail), which is why they are so unbelievably successful. Of course, there are other games from companies like Electronic Arts (Nasdaq: ERTS), but there is no denying the success of Activision's key franchises. Nevertheless, companies like Netflix (Nasdaq: NFLX) and Walt Disney (NYSE: DIS) are constantly competing for our entertainment dollars. On this note, I found it very interesting when Activision CEO Bobby Kotick made mention of a possible StarCraft movie at a recent conference. Activision will need to pursue these types of opportunities in order to stay relevant in a very competitive environment.
Power of buyers
Retail stores are in a tough spot, and it isn't getting any better with the advent of online distribution. As customers continue to obtain content at their discretion via the Internet, power is shifting more directly to the consumer. And with the Internet spreading like wildfire, more consumers are gaining access. Close to half the company's net revenue stems from digital content today, and they expect this trend to grow. Given Blizzard's strength in digital content, this makes the merger in 2008 that much more important.
Power of suppliers
Activision relies on the talent to churn out hits. What's more, they pay a license fee for each platform on which their games are played. So between the talent and the platforms, suppliers hold some of the cards here. As digital distribution grows and becomes cheaper, the cost of producing these games will come down. However, given Activision's global reach and reputation, developers and console makers have good reason to maintain a healthy relationship with the company.
Industry jockeying
Simply put, gaming is a competitive industry, and entertainment is even more so. This is an important distinction to make too, because Activision's in the entertainment business, not just the video game business. Again we see the importance of the merger with Blizzard here as it joined two companies with hit franchises. Social gaming is another consideration, especially with the growth of smartphones. And the trend toward digital distribution should continue to bring down development costs, opening the field to potentially more players.
Press "Start"? Or "Game Over"?
Activision's success is anything but a slam dunk. They face some serious hurdles in building their competitive advantage as the dominant player in the gaming industry. And if we look at it in the broader scope of the entertainment industry, then it just gets that much more competitive. Maybe that's why its stock price is more or less where it was three years ago.
Gaming is a real phenomenon though, and one that I think will only grow more popular as time goes on. Given the company's resources and innovative nature, Activision Blizzard should remain a very powerful force in the industry for years to come. Agree? Don't agree? Swing on by my discussion board and let's talk. You can also follow me on Twitter.
