Michael Porter's book Competitive Advantage explores the elements that give a company an edge in its market. Porter enumerates five simple, straightforward "forces" that help an investor determine the value and durability of an enterprise.
McDonald's (NYSE:MCD)and Intel (NASDAQ:INTC) are two companies struggling in the face of determined and innovative competition in their respective markets these days. Those forces are pushing hard against them. Can they withstand the pressure?
Listen to the entire podcast by clicking here. A full transcript follows the video.
Gaby Lapera: If we want to round back up to Michael Porter's book, he describes five different forces -- referred to as "Porter's Five Forces" -- for assessing an industry's dynamics when it comes to competitiveness. I'll just list them out and then we'll circle back and talk on them.
The level of competition among participants who are within the industry, the power of a 'buyer to price to product', the power of suppliers to effect the product entry barriers, and the threat of substitutes. Where do you want to start?
John Maxfield: Let's start with this: Porter breaks the analysis down into two different component pieces. You have the competitive dynamics of an industry. There are some industries that have characteristics that make them more prone to allowing companies therein to have durable competitive advantages. Those five components that you talked about are what an investor would use to assess an industry.
Let's talk about two different industries in particular to flush these things out. First, you have restaurants. You have McDonald's going along, really struggling a lot recently. A lot of their franchise owners are complaining about the over emphasis on the value menu because you're selling things for $1.50, or $1 that they used to be able to sell for twice that. There isn't a lot of margin in that. The reason McDonald's is struggling in the margin category is because the restaurant business as an industry doesn't have large entry barriers. Anybody can start a restaurant. As long as you know how to cook and you can get a little capital together to rent a place and put a stove in, you can start a restaurant.
The fact that so many people can come into it is driving those margins down and making it difficult so even an established industry player like McDonald's to get along in that regard. Let's talk about another dynamic that impacts this: chip making. You have Intel -- I live in Portland, Oregon.
This is not where Intel is based, but Intel has a large chunk of their manufacturing facilities based here. When you drive by these things -- in fact, my brother in law works for them -- these are enormous. Then when you see the Intel commercials online and you see the sophistication of the technology that's in one of these, that makes it clear that -- say you and I wanted to start a business. God forbid you'd have to start a business with me. That would be miserable for you. Let's say we wanted to start a business. Let's say we got a couple hundred thousand dollars in capital together to start this business.
It would take billions of dollars in capital to get into the chip making business that Intel is in. You have that huge entry barrier to the industry itself that has allowed Intel, over decades, to generate such a wide profit margin. That's the first piece of the analysis, of looking at the industry.
Lapera: That's true. For our listeners out there who are more well versed in technology, I will say that I just got schooled by our technology editor 10 minutes ago about Intel. Apparently, out of China there's a lot more chip makers now. So Intel is actually starting to struggle to maintain its hold on its market share.
Maxfield: That's exactly right. This is a relatively new thing, and China is kind of a new entrant to the market, so the dynamics are certainly changing for Intel. Where Intel really makes its money on that cutting edge stuff, it's still got the advantage, but is it durable? Not necessarily, but it is certainly a competitive advantage.
Lapera: I interrupted you. You were about to go into the second component that you want to talk about.
Maxfield: The second piece of Porter's analysis, you look at the industry overall -- and another industry to think about in this regard and they provide positive competitive dynamics -- that's utilities. Your water companies, electric companies, even your waste management companies. Waste Management picks up our garbage, but it's not like Waste Management can compete with the Portland Garbage Service to pick up more garbage.
The City of Portland actually gives Waste Management an exclusive license to operate in certain areas. I don't know if it's the whole city, or if it's certain areas, or how that works; but you're giving a monopoly for a specific industry segment to a company in the utilities sector. That monopoly allows them to earn higher profits, as long as they're able to operate efficiently. That's another observation point to throw into your analysis when you're thinking about competitive dynamics on an industry level.