Porter's Five Forces: what it is and what to do instead

The idea worth keeping

Not as boxes to fill, but as questions that fall out of the maths of the goal:

• What return does the client need, and what price and volume would give it?
• Who can push our price down: rivals with spare capacity, or powerful buyers?
• Who can push our costs up: a few powerful suppliers?
• Could new entrants or substitutes take volume, and how quickly?

Why reaching for it fails in an interview

• It is generic. All five forces apply to every industry, so listing them shows nothing about this one.
• It misses the driver that matters. In cement, one pressure (spare capacity in a regional market) sets the price, and it gets the same airtime as four that hardly matter.
• It sounds rehearsed. A tour of five named boxes sounds like a textbook, and interviewers can tell.

What to do instead: a worked case

1. 1

   Pin the question

   Decide whether a new 2 million tonne plant would earn at least the investor's 10% required return.

2. 2

   Write the maths of the goal

   • Profit per year = tonnes sold x (price minus cash cost minus freight per tonne)
   • Return = profit per year / cost to build the plant
3. 3

   Use what you know about the business

   • Cement is heavy and cheap, so it is sold within a few hundred kilometres: each region is its own market.
   • Plants have high fixed costs, so when a region has spare capacity, producers cut price to keep plants running.
   • So the deciding pressure is regional capacity against demand, not the list of all five forces.

   The structure that falls out of it

   • Price per tonne
     • Regional demand compared with capacity after we build
     • How rivals price when plants are not full
   • Cost per tonne
     • Cash cost to make
     • Freight to customers
   • Volume and investment
     • Tonnes we can sell
     • Cost to build

   Hypothesis: Adding capacity to a region that already has enough will push prices down, so I expect the return to fall short.

4. 4

   Find the facts that decide it

   • Regional demand is 10 million tonnes against 11 million of capacity. A new 2 million tonne plant takes capacity to 13 million, so plants would run at about 77% on average.
   • Even before any price cut: price 60, cash cost 40, freight 8, a margin of 12 a tonne. Selling 1.6 million tonnes (80% of capacity) earns 19.2 million a year on a 300 million plant: a return of 6.4%, below the 10% required.
5. 5

   Say so what

   Do not build. Even at today's prices the plant returns about 6.4% against the 10% required, and the extra capacity would push the region into price cutting. Look instead at buying an existing plant, or at a region where demand exceeds capacity. The risk of waiting is that a rival builds first in a region with a gap.

Build the acumen behind it

The worked case used two things a list cannot give you: the five moves, and knowing how this kind of business makes money. These pages teach both.