Porter on Portals

One of the key elements in our analysis of stocks relates to Prof Michael Porter’s view of competition within industries as it relates to profitability. Prof Porter of Harvard Business School is a widely respected authority on competitiveness with Porter Analysis taught in business schools globally as a systematic methodology for identifying industries capable of producing exceptional long-term profits.

Porter took the view that there were a number of sources of competition for enterprises and that the way these interacted determined the success of the firm. Thus the most attractive industries are those where the firm has suppliers who don’t have pricing power, customers who also have no pricing power, its competitors behave rationally (Graeme Sammuel didn’t hear that), there are high barriers to entry and the prospect of substitutes is low. Some examples in the Australian economy are the grocery chains and commercial banks.

Internet portals exhibit many of the characteristics Porter identifies. These portals are the successors to classified ads in newspapers, the “the rivers of gold” as they were once famously described. Classified ads were so profitable because once a player achieved dominance sellers followed the potential buyers and vice versa. Barriers to entry were very high, competition was limited until the advent of the internet, and substitutes were viewed as unlikely.

In the Australian market the main internet portals are: REA Group (real estate), Seek (employment) and Carsales (car sales) how do they fit into Porter’s framework? Our major investment is in REA Group so let’s examine it further.

REA is the dominant company in the sector, with twice the audience of its nearest competitor – competition within the industry is limited. Barriers to entry seem high; there have been a number of larger companies that have tried unsuccessfully to break in including major media companies and Google.

Suppliers (in this case, real estate agents who supply the listings) are numerous, and while REA has been careful to protect its position they are in a strong position. Paradoxically, suppliers are also customers (a wonderful situation where customers provide their own content) and are also not in a position to dominate REA. Substitutes are hard to visualise at this point in time.

On this basis it would look as though REA stacks up well. The challenge is for the company to continue to increase its share of the real estate advertising market. With costs largely fixed, additional revenue flows to the bottom line. Porter would approve.

Hugh MacNally, March 2011