At Delaware Investments, fundamental research is our calling card. But what does that entail exactly? In an effort to better educate our investors about various aspects of the fundamental research process, we present the first in a series of articles concerning Porter's Five Forces. An explanation of Porter's Five Forces and how they may be used to analyze industries or companies for potential investment, are set forth in Michael Porter's groundbreaking book, Competitive Strategy: Techniques for Analyzing Industries and Competitors (The Free Press, 1980).
Created by Harvard professor Michael Porter, "Porter's Five Forces" is considered a framework for analyzing an industry's structure as well as its relative attractiveness for investment in relation to other industries. The five forces — barriers to entry, supplier power, buyer power, threat of substitutes, and rivalry among existing firms — shape every industry and every market. They determine the intensity of competition, and hence the potential profitability and attractiveness of an industry. This article focuses on the second of the Five Forces: supplier power.
Supplier power, also known as the market of inputs, concerns the bargaining power suppliers have over a given industry. Suppliers of raw materials, components, labor, and services (such as expertise) may be able to dictate price and influence availability, which ultimately affects a company's profit margin. Several factors can come into play, including:
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Supplier concentration. The fewer the number of suppliers for a given product, the more power they will have over the company.
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Switching costs. Suppliers become more powerful as the cost to change to another supplier increases.
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Uniqueness of product. Suppliers that produce products specifically for a company will have more power than commodity suppliers.
Size plays a factor as well. If the company is much larger than its suppliers, and purchases in large quantities, then the supplier will have relatively little power to negotiate. There are "big box" retailers, for example, that have overwhelming advantages over smaller retailers in that they can dictate the price they pay the supplier. If the supplier does not reduce the price, it will be left with a much smaller market for its products.
When conducting a Five Forces industry analysis, low supplier power makes an industry more attractive and increases profit potential for the buyer, while high supplier power makes an industry less attractive and decreases profit potential for the buyer.
To illustrate "supplier power analysis" in action at Delaware Investments, we've included examples of companies that our investment teams follow:
Delaware Core Equity team. A global leader in glass container production operates in an industry that is highly concentrated (that is, comprised of few competitors) across most regions, with three producers accounting for approximately 80% of the market in Europe, for example. In addition to this advantage, the supply of glass containers in the market has been limited in recent years, in part because of the company's need to close higher cost furnaces. The company has been able to consistently pass on single-digit price increases to customers, even in the midst of falling demand during the current downturn.
Delaware Emerging Growth team. Producers of large mining machinery operate in an even more concentrated industry, with two companies essentially constituting a duopoly. The extreme industry concentration limits the severity of pricing declines as demand weakens and enables the companies to raise prices in times of high demand. The team also believes these companies are well-positioned to potentially benefit in the event of a rebound in commodity prices.
Important Information
Carefully consider a Fund’s investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Fund’s prospectus, which may be obtained by clicking here or calling 800 523-1918. Investors should read the prospectus carefully before investing.
Investing involves risk, including the possible loss of principal.
Views expressed and the information contained in this publication are current as of August 2009, and should not be considered a recommendation to buy, hold, or sell any security and should not be relied on as research or investment advice.
Article is for informational purposes only and not meant to predict actual results. Information should not be construed as financial advice.
The Funds are distributed by Delaware Distributors, L.P., an affiliate of DMHI, and MGL.
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