Successful investors seek to learn as much as they can about a company and its financial position before adding it to their portfolios. Conducting fundamental analysis is the most effective way to project if good things are ahead in a company's financial future. Fundamental analysis includes examining a company's financial statements, 10-K and 10-Q reports, stock performance and paying especially close attention to certain financial ratios, such as the price-to-earnings (P/E) ratio and debt/equity (D/E) ratio.
The savviest investors do not stop at analyzing the company itself. External factors influence a company's direction greatly. A particularly useful tool for studying how certain external factors influence a company is the Porter's Five Forces model.
Porter's Five Forces Model: An Overview
Michael Porter developed his Five Forces model in 1979. He felt the existing tools to examine market forces, such as the SWOT analysis that considers a company's strengths, weaknesses, opportunities and threats, were insufficient and lacking in scope.
The Porter's Five Forces model seeks to determine a company's threats from competition. It examines three potential horizontal threats, meaning threats from actual competitors, and two potential vertical threats, meaning supply chain threats that could put the company at a competitive disadvantage. The horizontal threats considered are industry competition, the threat of new entrants and the threat of substitutes. The vertical threats considered involve the bargaining power of suppliers and buyers.
An Overview of Verizon
Verizon Communications, Inc. (NYSE: VZ) is the largest wireless communications service provider in the United States. Its market share of 35% as of 2018 beats rivals such as AT&T (34%), T-Mobile (17%) and Sprint (12%). Despite a reputation as one of the more expensive companies in the industry, Verizon has dominated market share on the strength of its expansive coverage network and its reputation for outstanding customer service. The company tends to cater to higher income consumers than its less-expensive competitors, such as Sprint. While Verizon costs more than competing providers, the company has successfully imbued its service with the perception of value.
A Five Forces analysis of Verizon reveals its strongest horizontal threats are from industry competition and substitutes, while the strongest vertical threat comes from the bargaining power of buyers. The company faces less significant threats from new entrants to the market and the bargaining power of suppliers.
The threat of competition in the wireless industry is fierce. Verizon's biggest and most longstanding rival is AT&T. The typical customer profile for the two companies is similar, and AT&T claims the highest market share in the industry behind Verizon. Additional competition comes from T-Mobile, which has a smaller market share but, as of 2016, is adding customers more quickly than any other carrier, and Sprint, which has launched aggressive price promotions to turn around its sagging market share.
Verizon's coverage network has been the strongest in the industry since at least the early 2000s, but its competitors have invested much capital into catching up. The coverage difference between Verizon and its competitors is smaller than ever, and the gap could disappear completely within five to 10 years as other companies add towers and advance their technologies. If this happens, Verizon must find a new way to set itself apart from its competitors.
Bargaining Power of Buyers
Buyers have significant bargaining power in the wireless industry. Switching carriers is easy and inexpensive, and Verizon's competitors constantly run promotions offering perks specifically to customers who switch from Verizon. For example, Sprint ran a campaign in late 2015 and early 2016 to cut Verizon customers' bills by half. The promotion even covered the cost of terminating a Verizon contract early.
Customers can switch to another carrier within an hour or less while keeping the same phone number and experiencing no service interruption. Verizon must continue to give its customers reasons to stay. Up to this point, the company has done so by touting its superior network and its lower rates of dropped calls and texts. As these advantages wane, the company must seek a new edge.
Threat of New Entrants to the Marketplace
New entrants to the marketplace pose a very low threat to Verizon. The cost of establishing a wireless company and building a network that can compete with a low-budget carrier, much less an industry behemoth such as Verizon, is substantial. Additionally, a wireless service company must navigate a labyrinth of government regulations before earning a dime. Even if a new player can bear the cost and get past the regulations, next comes the process of building a brand name that can compete. Verizon has been around since the early days of the industry and has spent years building its name. It is unlikely that a new company can arrive on the scene and clear the necessary hurdles to compete with Verizon.
Bargaining Power of Suppliers
Verizon's suppliers have little bargaining power and represent an insignificant threat to the company. Verizon calls on suppliers for products to help build and expand network infrastructure and for components to manufacture physical products. The number of suppliers Verizon has to choose from is huge. By contrast, the number of companies as big and deep-pocketed as Verizon that these suppliers have the opportunity to do business with is not large. This asymmetry places most of the leverage firmly in Verizon's hands. Verizon can negotiate from a position of power, and in most cases, it can switch from one supplier to another without much trouble if necessary.
Threat of Substitutes
The threat of substitutes is perhaps the biggest one Verizon faces. The company would argue that service from AT&T, T-Mobile or Sprint is not a perfect substitute for Verizon service, as these companies offer less extensive coverage and, according to consumer surveys, inferior customer service. However, the chasm is narrowing between Verizon's network and those offered by competitors, and lower prices are a constant looming temptation for Verizon customers. If financial winds shift in an ugly direction and the economy goes through a repeat of 2008, many customers might be tempted to let Sprint cut their wireless bills in half or to take advantage of similar promotions that competitors undoubtedly will be running.