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Buy Right Sit Tight Insights - February 2019

Blog Blog Details
  • February 14, 2019
  • Mr. Raamdeo Agrawal|
  • Chairman
Dear investor friends,

Competitive landscape of an industry can make or break the fortunes of incumbent players. In our investment philosophy QGLP (Quality, Growth, Longevity at reasonable Price), competitive landscape is a key determinant of one aspect of Q, Quality of business. (The other aspect of Q is Quality of management.)

In this edition of BRST Insights, I share some perspectives on Michael Porter’s highly popular Five Forces Framework to assess competitive landscape of industries.

Inter-firm rivalry – the core of Quality of Business

Porter’s Five Forces
The starting point of assessing the investment attractiveness of any stock is to assess its industry attractiveness, which in turn, is highly dependent on the industry’s competitive landscape. Conventionally, competition is deemed to exist only between rival companies. However, Michael Porter, the guru of competitive analysis and strategy, offers a different perspective. According to Porter, competing for profits involves multiple players, not just rivals. Besides rivals, companies compete for profits also with - 

•Customers, who would always want to pay less and get more,
•Suppliers, who would always want to be paid more and deliver less,
•Producers who make substitutes, and
•Potential rivals (i.e. new entrants).

Porter captured all these dimensions of competition in his highly famous Five Forces Framework depicted on the next page.

Five Forces perspectives – Inter-firm rivalry is key

In their book Playing To Win, authors A G Lafley and Roger Martin offer some interesting perspectives on the Five Forces Framework. They write – 

“The five forces can be divided into two axes. The vertical axis … determines how much value is generated by the industry (and is therefore available to be split up among industry players). If it is very difficult for new players to enter the industry and there are no substitutes to the industry’s product or services to which buyers can turn, then the industry will generate high value.”

“The horizontal axis determines which entity will capture the industry value – suppliers, producers or buyers … The degree to which there is fierce rivalry affects which group captures value too. If rivalry between competitors is high, the dynamic will facilitate the appropriation of value by suppliers or buyers. A low degree of rivalry will protect profitability for the producers.”



It is insightful to note that Inter-firm rivalry is at the centre of both axes i.e. it influences both value creation and value distribution in any industry. This is best explained by two contrasting examples.


Inter-firm rivalry – Telecom & Paints
Both Telecom and Paints are consumer-facing businesses. In India, there are only 4 major players in both. And yet the profit trend in both are in stark contrast to each other.

The profit trend of three telecom majors (Exhibit 2) reflects the impact of inter-firm rivalry. Till FY-2008, the market had only these three players, and profits were on the rise. In 2008, a slew of new telecom licenses were issued, the impact of which was felt FY-2011 onwards. Then, in FY-2012, the Supreme Court cancelled all the 2008 telecom licenses, and profits began to look up again. However, the last three years have seen the entry of Reliance Jio, and the industry has gone into losses, despite there being only 4 major players (Bharti, Vodafone, Idea and Jio). Vodafone and Idea have now merged, but there’s no respite in profits which continue to decline in the first half of FY-2019.

Contrast the above with the Paints sector (Exhibit 3). Profits here have risen consistently, suggesting benign inter-firm rivalry.
Key takeaways
•Inter-firm rivalry is the core determinant of a company’s Quality of business. Higher the inter-firm rivalry, lower the Quality of business and vice-versa.
•The number of incumbents is not that important. Inter-firm rivalry can be high even when incumbents are few.
•Businesses with intense inter-firm rivalry don’t create value for shareholders, and are best avoided.

I welcome your feedback and suggestions for improvement. Please email the same to insights@motilaloswal.com.


Raamdeo Agrawal
Chairman

Note: The source of all data used in this bulletin is MOAMC internal analysis, unless otherwise mentioned.

Disclaimer: This bulletin has been issued to explain our investment philosophy. The information/stocks mentioned in this document is for general/illustration purposes only and should not be construed as investment advice to any party. The stocks may or may not be part of our portfolio/strategy/schemes. Past performance may or may not be sustained in future. Readers shall be fully responsible/liable for any decision taken on the basis of this bulletin. Past performance may or may not be sustained in the future. This bulletin is not for circulation in general and is meant for intended recipient only. The bulletin does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements.
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