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The loss of £7.2bn of shareholder wealth at Tata neatly illustrates the importance of using a very simple tool to analyse industries.
The framework was provided by Michael Porter of Harvard decades ago. It provides a simple check list for assessing the pressures causing persistent low pricing, resulting in poor returns on capital employed in an industry.
Conversely, where these pressures are low, and likely to remain low, sustainable high returns on capital are to be expected for the players in that industry. These industries are of great interest to investors.
Was the Tata blunder predictable?
Well, this is what I wrote in my book, Valuegrowth Investing (now The Financial Times Guide to Value Investing) published in 2002, five years before Tata bought Corus (British Steel, etc):
“Some industries have an appalling position vis-à-vis the five forces and thus make very poor returns. Take steel production in Europe for example.
Here are some of the largest and most efficient plants in the world. As things stand the steel firms could hire the best team of managers in the world but they would still not make good rates of return.
All the five forces are against them.
The suppliers of raw materials tend to be large groups with strong bargaining power (three producers dominate the world’s iron ore business, for instance).
Many of their customers are enormous groups (particularly the big six car makers who are quite prepared to switch steel supplier unless the keenest prices are offered).
There are dozens of low-cost new entrants in Asia and the Soviet Union chomping at the bit to take market share.
Within Europe there is intense rivalry between existing players because of the need for each participant to produce at a high volume due to the necessity of spreading high fixed costs. This is exacerbated by the difficulty of achieving exit from the industry: many companies are seen as national champions and important employers; they thus receive more than just a sympathetic ear from government (does this ring bells in 2016 down Port Talbot way?).
On top of all of this there is the continual threat of substitutes, for example, the aluminium producers are a constant worry.” (Chapter 9, The Analysis of Industries)
I do not claim any great intellectual insight to arrive at these conclusion – it was all very basic thinking, and had been obvious for decades.
I remember saying to myself in 2007: “What on Earth are Tata doing? Then again, perhaps they have some special formula that I don’t know about that will allow them to bust open Porter’s Five Forces. I’ll wait and see”. Well, now we know.
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