Analyzing Porter's Five Forces on Goldman Sachs (GS)

A Porter's Five Forces analysis of Goldman Sachs Group, Inc (NYSE: GS) demonstrates that America's dominant investment bank has a very well-protected position with respect to new entrants or substitute services, but it faces a nearly omnipotent supplier in the U.S. government.

Goldman Sachs was founded in 1869 and is headquartered in Lower Manhattan, New York, though it has major offices in London, Tokyo and other financial hubs. As of 2016, Lloyd C. Blankfein serves as chairman and CEO, and Gary Cohn serves as president and COO. The company generated $39.2 billion in revenue in 2015 and reported total assets of $861 billion.

Goldman Sachs splits its business model into four business segments: investment banking, institutional client services, investing and lending, and investment management. The investment banking segment focuses on assisting corporations and other banks to raise capital, go public, restructure, spin off or engage in merger and acquisition (M&A) activity. This is different from investment management, where Goldman Sachs advises clients on their portfolios; the investment management segment is also responsible for offering mutual funds and private investment funds. Institutional client services, the most profitable segment, is Goldman Sachs' primary market-making wing; it clears huge orders of stocks, bonds and commodities for large institutional investors. The investing and lending segment handles Goldman Sachs' own investments, as well as some lending operations for other companies and individuals.

There is no question that Goldman is one of the most influential and well-connected corporations in the world. Former Goldman executives Robert Rubin and Henry "Hank" Paulson went on to serve as Secretaries of the Treasury under Bill Clinton and George W. Bush. Other executives ended up as the president of the European Central Bank, as Prime Minister of Australia, and governors of the Bank of Canada and the Bank of England. Any analysis of the investment bank's competitive forces needs to include its close (and often controversial) relationships with many world governments and central banks.

Goldman Sachs underwent significant changes and restructuring in the aftermath of the 2007-08 financial crisis, during which the company received an emergency rescue investment of $10 billion from the United States Department of the Treasury. The bank also received a total of $589 billion in loans from the Federal Reserve's overnight credit facility. According to Fed transaction data, Goldman received a grand total of almost $785 billion in emergency financial assistance between the summer of 2007 and early 2009.

Harvard Business School's Michael Porter developed the Five Forces Model to examine defining characteristics within an industry and how those characteristics influence strategy and operations for a specific business.

The Five Forces Model first considers competition among leading firms in the industry, which is a major determinant of market efficiency. Next, the model considers the relative impact of four other characteristics: bargaining power of suppliers, bargaining power of consumers, threat of new entrants into the industry, and the presence or threat of substitute services.

Porter believed his model "reveals the roots of an industry's current profitability while providing a framework for anticipating and influencing competition (and profitability) over time." He operated on the assumption that the nature of profits doesn't change from industry to industry. Instead, the specific and relative forces of competition ultimately determine profits, return on investment (ROI) and long-term viability.

In terms of all four business segments, Goldman Sachs major competitors include JPMorgan Chase, Morgan Stanley and Deutsche Bank AG. Though JPMorgan is the only financial institution that ranks ahead of Goldman Sachs in terms of revenue and assets, it is widely held that Goldman Sachs considers Morgan Stanley its chief rival. Morgan Stanley and Goldman Sachs are the only two standalone investment banks in the United States.

Domestic banking was as concentrated as ever in 2015. This pattern had held true since 2010, when Congress passed the Dodd-Frank Act and made it very hard for any new entities to enter major investment banking activities. JPMorgan boss Jamie Dimon, whose company absorbed Bear Stearns during the financial crisis, estimated that Dodd-Frank regulations added between $400 million and $600 million in annual costs. Smaller firms would be hard-pressed to survive those compliance expenses.

Still, competition is strong for Goldman Sachs. There are very low switching costs for investment banking clients. There is very little service differentiation between banks because of how tightly products and services get offered, so Goldman Sachs must rely heavily on pre-existing relationships and its reputation.

Some modern Porter's analyses start with supplier power, since suppliers inform a company's input prices. Fewer suppliers means more power per supplier, in which case a firm might be beholden to an "upstream" player.

Investment banks don't have conventional suppliers, at least not in a Porter's model. One could consider institutional clients and high-net-worth clients as suppliers, since Goldman Sachs' investment services rely on huge amounts of invested capital. Businesses in need of investment banking services -- such as when Apple used Goldman Sachs in 2013 to offer $17 billion in bonds -- are a form of product supplier. As you can see, this blurs the line between the bank's suppliers and its consumers.

Ultimately, however, the intensely regulated and concentrated nature of investment banking means that few suppliers (no matter how you identify them) have significant differentiated competitive power. Who really controls the input costs and product offerings of Goldman Sachs? The U.S. government, through the Treasury Department and Congress, as well as the Federal Reserve Bank. It would be difficult to imagine suppliers with stronger bargaining power than these entities -- they literally define which products and services can be offered, how they are advertised and what compensation can be accepted.

Individual consumers, especially high-net-worth banking clients and businesses looking for investment banking services, don't have a lot of bargaining power. Goldman Sachs can survive the loss of virtually any non-institutional client, even if it means the client ends up over at Morgan Stanley. Still, Goldman Sachs addresses the risk of depositor flight by extending additional services and account bonuses.

Domestically, there is very little any smaller bank can do to compete with the likes of Goldman Sachs, JPMorgan, Merrill Lynch or Morgan Stanley. Intense regulatory constraints make it cost inefficient for new companies to offer investment banking services -- especially for institutional clients. Since Goldman Sachs is identified as a systemically important financial institution (SIFI), it has an implicit put option on all major business activity from the Treasury Department and Federal Reserve.

This means that even when Goldman Sachs makes bad decisions, such as underwriting its products with junk quality subprime mortgages, the company is very unlikely to go bankrupt or be forced to sell major assets. Unless the U.S. regulatory climate changes, all new entrants in the major investment banking industry are likely to come from international markets.

Traditional banks face plenty of substitute services from a modern, technologically advanced world. In this sense, the investment and lending wing of Goldman Sachs must compete with online peer-to-peer lenders and crowdfunding tools. There are few opportunities for additional investment banking services because of how securities, exchanges and capital markets are limited through regulation. The Securities and Exchange Commission (SEC) limits what any potential competitors to Goldman Sachs can offer in terms of licensing, compensation, filing, advertising, product creation or fiduciary responsibility.