Porter's five forces
Whether the industry makes money at all, asked before whether this company does.
Moat analysis asks what protects this company. Porter's five forces asks a wider question first: is this an industry where anybody can make money?
The two fit together. A wide moat in a structurally miserable industry is often just the least-injured participant, and knowing that before you look at the company saves a lot of work.
Michael Porter's framework, published in 1979, is not an investing tool by origin — it was written for managers deciding which markets to compete in. That turns out to be the same question an investor asks, approached from the other side of the table.
The five forces
Each force is a claim on the profit an industry produces. The more of them that are strong, the less is left over for shareholders.
Note that only two of the five are about competitors. Substitutes, buyers and suppliers are where industries quietly lose their profitability, and they are the three most often skipped.
Working it from the outside in
A useful order, because it fails fast:
- Industry first. Run the five forces. If four are strong, be sceptical of
any moat claim you are about to read — including your own.
- Then the company. Ask which of the five moat sources applies, and where
the advantage lives.
- Then the direction. Forces move. An industry with one new entrant this
year and eleven next year is a different industry.
The order matters because moat analysis done first is easy to talk yourself into. It is much harder to argue a company out of a bad industry than it is to argue a good story into one.
Where this shows up in a report
The committee is doing a version of this whether or not it names Porter. Munger's disqualifying factors are largely industry structure — he is asking whether the game is worth playing before asking who is winning it. Fisher's scuttlebutt is buyer and supplier power gathered by talking to people rather than by reading a table.
When a panel splits on a company that looks good on the numbers, industry structure is usually what they are disagreeing about.
The last lesson in this chapter is about the thing all of this is trying to anticipate: what it looks like when a moat starts to go.
Follows Michael E. Porter, “How Competitive Forces Shape Strategy”, Harvard Business Review, March 1979.