Fundamental analysis helps investors gain a clear picture of a company's financial position and its position within the marketplace. This information leads to better investing decisions, since share price appreciation tends to follow sound fundamentals. Fundamental analysis starts with examining a company's financial documents, such as its financial statements, annual and quarterly reports, and stock performance. The most shrewd investors go beyond looking at a company's financial position and study the potential effects of external forces on the company's health. One of the most effective tools for this is Porter's Five Forces.
An Overview of Porter's Five Forces
Porter's Five Forces is an analytical framework developed in 1979 by Michael Porter. Porter's goal was to develop a thorough system for evaluating a company's position within its industry and to consider the types of horizontal and vertical threats the company might face in the future. A horizontal threat is a competitive threat, such as customers switching to a substitute product or service, or a new company entering the marketplace and appropriating market share. A vertical threat is a threat along the supply chain, such as buyers or suppliers gaining bargaining power, that can put a company at a competitive disadvantage.
The Five Forces model evaluates three potential horizontal threats and two vertical threats. Industry competition, the threat of new entrants and the threat of substitutes represent the horizontal threats. The vertical threats come from the increased bargaining power of suppliers and the increased bargaining power of buyers. Using the Five Forces framework, investors can determine the most viable threats to a company. With this information, they can evaluate whether the company has the resources and protocol in place to respond to likely challenges.
An Overview of Delta Air Lines
Delta Air Lines, Inc. (NYSE: DAL) is the oldest airline still in operation in the United States. The company was founded in 1929 and has its headquarters in Atlanta, Georgia. As of January 2018, Delta ranks third in domestic market share for U.S. airlines at 16.9%, trailing Southwest at 18.3% and American at 18.4%. Delta's sheer size and status as a longtime leader in the airline industry has helped ensure its continued success. The company's market capitalization is around $39 billion.
The level of competition in the airline industry is high. The big airlines essentially fly to the same places out of the same airports for about the same prices. The amenities, or lack of amenities, they offer are similar, and the seats in coach are just as cramped no matter which airline you choose. Delta's traditional rivals include United and American, but the company also faces major competition from the growing popularity of value carriers, most notably Southwest but also JetBlue and Spirit. Because the air travel experience for a customer is remarkably similar no matter which airline he takes, airlines are constantly threatened by the prospect of losing passengers to competitors. Delta is no exception. If a customer is planning to book a flight from Houston to Phoenix on Delta but a third-party price aggregator, such as Priceline, reveals a better deal from United, the customer can make the switch with a simple click of the mouse. Delta manages these competitive threats with extensive marketing campaigns that focus on brand awareness and the company's longstanding reputation.
Bargaining Power of Buyers
Buyers have immense bargaining power over airlines because the cost and effort required to switch from one carrier to another is minimal. The emergence and raging popularity of third-party trip-booking websites, and smartphone apps, exacerbates this issue for the airlines. Most travelers do not contact an airline, such as Delta, directly to book a flight. They access sites or apps that compare rates across all carriers, enter their trip itineraries and then choose the least expensive deal that accommodates their schedules. Delta can respond to this market force by conducting market research and offering more direct flights at low prices to the destinations fliers search for most frequently on third-party platforms. Additionally, the company should strengthen relationships with credit card companies and strive to offer the best reward programs; customers are loath to switch carriers when they have accumulated what they view as "free" miles with a particular airline.
Threat of New Entrants
Potential new entrants to the marketplace represent a minimal threat to Delta. The barriers to entry in the airline industry are remarkably high. The operating costs are massive, and the government regulations a company must navigate are numerous and exceedingly complex. There is not a single airline founded during the 21st century that has even 2% market share. JetBlue, founded in 1998, represents the newest airline to make a dent in the industry, and its market share is still less than one-third of Delta's.
Bargaining Power of Suppliers
The list of airline suppliers is actually quite long. The list of airlines for suppliers to sell to, however, is short. This asymmetry places the bargaining power directly in the hands of the airlines. Bargaining power is particularly strong for Delta, given its position as the world's largest airline by total passengers. Put simply, Delta's suppliers have a strong incentive to keep the relationship on good terms. Delta can likely find a replacement supplier without problem if the relationship goes bad. The supplier, by contrast, is unlikely to find another buyer capable of replacing the sales volume represented by Delta.
Threat of Substitutes
A substitute, as defined by the Five Forces model, is not a product or service that competes directly with the company's offerings but acts as a substitute for it. Thus, a United flight from New York to Los Angeles is not considered a substitute for a Delta flight with the same start and end points. Examples of substitutes are making the trip by train, car or bus. Unless a trip is very short, such as traveling from Los Angeles to Las Vegas, no methods of travel rate as viable substitutes for air travel. New York to Los Angeles is a 6.5-hour flight. The trip takes 41 hours by car or bus, and a train cannot get you there much faster. Until a new technology comes along that supplants air travel as the fastest and most convenient way to travel long distances, Delta faces little threat from substitute methods of travel.