Investors and market analysts often seek different perspectives for market analyses of companies to gain a better picture of companies' positions and strengths within their particular industries. One tool for fundamental analysis that goes beyond just examining financial metrics such as the price-to-book ratio (P/B) is Michael Porter's Five Forces Model.
The Porter Five Forces Model
Michael Porter developed the Five Forces method of analysis in 1979. The Five Forces model aims to examine five key forces of competition within a given industry. The main force examined by Porter's model is the level of competition within an industry. A person could even argue that Porter's model is essentially an analysis of the competitiveness or noncompetitiveness of an industry. The other four forces considered in Porter's model all impact the level of competition. They include the threat of new entrants to the marketplace, the threat of consumers opting for substitute products, the bargaining power of suppliers within the industry, and the bargaining power of buyers or consumers within the industry's marketplace.
Apple in the Marketplace From a Five Forces Perspective
Through its Macintosh computers and operating system, the iPad, iPhone and other products, Apple, Inc. (NASDAQ: AAPL) has achieved massive success as a company despite going through a number of up and down cycles since its founding in 1976. In 2014, Apple achieved the notable distinction of being the first U.S. company to ever attain a market capitalization greater than $700 billion. Apple's success is attributed largely to its ability to innovate and bring unique products to market that have engendered substantial brand loyalty. Its product development and marketing strategies reveal an awareness of the need to deal with the major marketplace forces that can impact Apple's market share and profitability.
A Five Forces analysis of Apple's position in the technology sector shows industry competition and the bargaining power of buyers as the two strongest marketplace forces that can impact Apple's profitability. The bargaining power of suppliers, the threat of buyers opting for substitute products, and the threat of new entrants to the marketplace are all weaker elements among the key industry forces.
The level of competition among the major companies that compete directly with Apple in the technology sector is high. Apple is in direct competition with companies such as Google, Inc., the Hewlett-Packard Company, Samsung Electronics Co., Ltd. and Amazon, Inc. All of these companies expend significant capital on research and development (R&D) and marketing, just like Apple. Thus, the competitive force within the industry is strong. One thing that makes the industry so highly competitive is the relatively low switching cost. It does not require a substantial investment for a consumer to ditch Apple's iPad for an Amazon Kindle or other tablet computers. The threat of marketplace competition is a key consideration for Apple, which it has dealt with primarily through continually developing new and unique products to increase and strengthen its market share position.
Bargaining Power of Buyers
The element of low switching cost referred to above strengthens the bargaining power of buyers as a key force for Apple to consider. There are essentially two points of further analysis within this force: the individual bargaining power of buyers and their collective bargaining power. For Apple, individual bargaining power is a weak force, since the loss of any one customer represents a negligible amount of revenue for Apple. However, the collective marketplace bargaining power of customers, the possibility of mass customer defections to a competitor is a strong force. Apple counters this strong force by continuing to make substantial capital expenditures in R&D, enabling it to keep developing new and unique products such as the Airpods and the Apple Watch, and by building significant brand loyalty. Apple has been very successful in this area of competition, establishing a large customer base that, basically, would not consider abandoning its iPhones in favor of another smartphone competitor.
Threat of New Entrants to the Marketplace
The threat of a new entrant to the marketplace that could seriously threaten Apple's market share is relatively low. This is primarily due to two factors: the extremely high cost of establishing a company within the industry and the additional high cost of establishing brand name recognition. Any new entrant to the marketplace of personal computing or smartphones needs to have a massive amount of capital just to spend on R&D and manufacturing to develop and produce its own product portfolio prior to ever bringing its products to market and beginning to generate revenue. Such an entrant faces the already identified strong competition within the industry that exists between Apple and its major competitors, all of which are large, well-established firms. The secondary challenge is establishing brand name recognition within an industry that already has several companies, such as Apple, Google, and Amazon, with very strong brand recognition.
Although it is possible some new company, perhaps a Chinese firm with financial backing from the government, might eventually challenge Apple's position within the industry, for the immediate future, the likelihood of such a challenger arising is remote. Nonetheless, it is important for Apple to continue strengthening its competitive position through new product development and building brand loyalty to place any potential new entrants to the industry at a larger competitive disadvantage.
Bargaining Power of Suppliers
The bargaining power of suppliers is a relatively weak force in the marketplace for Apple's products. The bargaining position of suppliers is weakened by the high number of potential suppliers for Apple and the ample amount of supply. Apple is free to choose from among a large number of potential suppliers for component parts for its products. The industries of its parts suppliers, such as the manufacturers of computer processors, are themselves highly competitive. The switching cost for Apple to exchange one supplier for another is relatively low and not a significant obstacle. Plus, Apple is a major customer for most of its parts suppliers, and, therefore, one its suppliers are very reluctant to risk losing. This strengthens Apple's position in negotiating with suppliers, while conversely weakening their positions. The bargaining power of component parts suppliers is not a major consideration for either Apple or its major competitors.
Threat of Buyers Opting for Substitute Products
Substitute products, within the framework of Porter's Five Forces Model, are not products that directly compete with a company's products but possible substitutes for them. In the case of Apple, an example of a substitute product is a landline telephone that might be a substitute for owning an iPhone. This market force is relatively low for Apple due to the fact that most potential substitute products have limited capabilities compared to Apple's products, as in the example of a landline telephone compared to an iPhone that has the capability to do much more than just make telephone calls.