Maybe I’m not speaking for everyone when I say this, but I found many of the models and theories presented at university to be largely theoretical and not very practicable. CAPM comes to mind immediately, as do many of the monetary policy theories. However, on reflection, a few make honest sense. There’s some difference in Porters 5 Forces.
For example, I recently posted on the principal-agent problem and it’s salience in regard to public vs. private markets. It is a model that underpins the very existence of these markets; no complexity, few assumptions, and a concept of much clarity. I concede that it is hardly a solution to a common problem, but I think it goes quite far in supporting the concept of private equity.
Similarly, Porter’s 5 Forces model won’t give you the meaning of life, but it is an honest, simple, applicable and highly useful model for the private equity industry. Again, it won’t give any profound answers, but it will go a long way to understanding whether an industry is attractive. I say this because as private equity pros, we know there are many sources of value creation, but an attractive industry is always a salubrious start. Something to keep in mind though, is that the model is designed to analyse industries, not businesses, sectors or markets. Be diligent with your definition of an industry or see web resources for further guidance.
I’ll give a very brief description of each of the Porters 5 forces (see the image above for a pictorial representation):
Based on each of these porters 5 forces, an industry receives an arbitrary rating. For example, a 5 star industry is one that is attractive and one that receives a positive rating for each force. A 0 star industry is unattractive for similar reasons. However, this doesn’t necessarily mean that a particular underlying business is given the same porters 5 forces rating; great managers use differentiation to stand out in any industry; their job is just easier (and success is more likely) in attractive industries.