Debunking The Market Share MythWritten By Mary Seaman
Article Date: 09-01-2005
Copyright (C) 2005 Associated Equipment Distributors. All Rights Reserved.
Market share does not automatically mean higher profits.
There are three types of companies in the world – market share leaders, profit share leaders and everyone else, says Richard Miniter in his book, “The Myth of Market Share: Why Market Share is the Fool’s Gold of Business.” “A profit leader is a firm that earns the highest rate of return in its line of business, as defined by standard industry classification,” he says. “A market leader is the firm with the largest share of sales in that same line of business,”
While being able to control the largest share of industry sales is, it shouldn’t drive how a company conducts business, says Miniter. He explains that companies that focus on market share tend to crash and burn, while those that strive to be profit leaders, develop market share secondarily.
In the construction equipment industry, it’s no secret manufacturers place a lot of emphasis on market share.
As R. Dale Vaughn, president and CEO of OCT Equipment in Oklahoma City and Past AED Chairman, puts it, “Market share is a part of a manufacturer’s DNA.”
Manufacturers measure their own performance based on market share, says Vaughn. Market share is volume to manufacturers, and they are driven as much by volume as they are by market share.
“As for manufacturers pressuring dealers for market share,” says Vaughn, “when times are good, manufacturers embrace their partners. When times are bad, partners tend to be a necessary evil and manufacturers believe they are not pulling their weight.”
AED Chairman and president of Berry Companies Walter Berry, says “If we’re at or above their national average, they don’t have any argument. If we’re below the national average then market share becomes an issue.”
At AED’s 2005 Industry Round Table, one dealer said he wasn’t sure a partnership exists between manufacturers and dealers when it comes to market share.
“If I say we’re not going to sell that machine for 10 percent,” he said, “and it’s going to sit on the yard until I can get 14 percent, my dealer rep will walk in the next day and complain that my market share is dropping. If manufacturers said, ‘Build your value proposition,’ and gave us a reprieve from a specific market share number, we could get that 14 percent or 15 percent margin.”
According to Miniter, market share should be used as a tool, not a growth strategy.
Uncovering The Myth
In his book, Miniter seeks to debunk several widely held beliefs about market share, saying that the “myth of market share” is wrecking the world’s great companies.
To make his case, he cites the now-defunct Pets.com as a case of absolute belief in market share. Companies with this “transcendental belief,” says Miniter, often argue profits will come later once they have gained the dominant spot in market share. Pets.com executives admitted that the company would lose money until it gained the dominant share of the market; their theory didn’t work and the company went under.
In 1997, Donald V. Potter, president of Windmere Associates, a California-based consulting firm, studied more than 3,000 public companies in 240 industries and found that more than 70 percent of the time the company with the largest market share did not have the highest rate of return. The industries studied had at least five competitors whose individual annual sales were greater than $50 million.
Among the top four firms in each category, the market share leader led the industry in pretax returns on assets only 29 percent of the time – only 4 percent better than chance. And, the firms in the number four position, the ones with the smallest market share, had higher returns than each of their three rivals 23 percent of the time.
“If market share were an essential ingredient to above-average profitability,” says Miniter, “these relatively small fry companies should not even have been contenders. Instead, almost one out of every four times, they were the most profitable. Clearly market share alone doesn’t seem that closely connected to profits.”
Miniter explains that companies in search of market share can make questionable moves that can lead to the company’s ultimate demise, such as reducing profit margins, harming brand identity and long term health. Some of the pitfalls of “market share mania,” he says, include discounts that sap the strength of brands, foolish mergers and focusing on the competition, not the customer.
Cutting margins to boost volume invites competitors to match the new lower prices. Instead, Miniter suggests companies should give customers a definite reason for buying a product other than price. According to Miniter, when you discount products, you’re sending the message to buyers that they shouldn’t care so much about your brand.
“Dealers don’t want to discount the product so much we’re giving it away to gain market share if there is no long-term result,” says Berry. “If we don’t get the service work and aftermarket sales, there is no real benefit in giving away the product to get market share.”
Distributors try to maximize gross profit on every transaction, says Vaughn.
“That doesn’t diminish the importance of presence in the market,” he says. “On the other hand, if I went out and focused solely on market share, I wouldn’t be around to enjoy the benefits of it.”
Five widely held beliefs about market share come from Professor Robert D. Buzzell, author of the 1975 study “Market Share – A Key To Profitability.” Buzzell’s overwhelming theme throughout his study is that the benefits of market share are largely automatic.
Myth 1: Leadership And Market Power
One of Buzzell’s arguments is that the company with the largest share can set prices. In other words, “The guy with the biggest slice of the market never goes hungry.”
While it’s true, says Miniter, that the companies with the majority of an industry’s production capacity can and do lower prices, the question is whether they can raise prices. He argues that there isn’t enough evidence to support the idea that these companies can raise prices and keep them there. While market leaders can boost prices by reducing marginal profits, it’s difficult to determine why they should try to trim margins to increase sales, he says.
“If the percentage reduction in price per unit is larger than the percentage increase in market share, the firm loses money,” says Miniter. “There is no such thing as market leadership based on share alone.”
Berry agrees that companies should not focus on market share alone.
“If you become the market share leader,” says Berry, “it can lead to repeat sales, and people think of you first.
“But you can’t go after market share blindly just because that’s what the manufacturer wants. You need a plan as to how it will lead to greater profitability. You can be profitable without growing market share.”
Myth 2: Size Creates Higher Returns
Buzzell’s second widely held belief is that “as market share increases, so do profits.”
In the 1970s, he developed a formula to support that idea: on average a difference of 10 percentage points in market share is accompanied by a difference of about 5 points in pretax ROI.
But says Miniter, this formula does not apply in today’s hypercompetitive global economy.
“Increased profitability is not the automatic prerogative of size,” says Miniter, “and share is not even a good rule of thumb for finding the most profitable firm in a particular line of business.”
Myth 3: The Economies Of Scale Kick In
The more widgets you make, the cheaper they are per unit. That’s the third argument in favor of the automatic benefits of market share. Buzzell argued that the business with 40 percent share of a given market is simply twice as big as one with 20 percent share of the same market, and it will operate more efficiently.
“An enterprise with 40 percent of the market might be able to wring more concessions from its suppliers, workers and bankers,” says Miniter. “But it might not be as energized to do it as its smaller rivals.’”
On the flip side, with the economies of scale come the diseconomies of scale, he says: As companies become bigger, they add management and other overhead costs.
In addition, there are always markets cheaper for a niche player to serve than a mass producer.
“Why go after the next 10 percent of market share when necessary price reductions will bring demands for discounts from the 30 percent you already serve?” says Miniter. “Among the 30 percent, there are almost always customers who cost more than they are worth?
“In both cases, attempts to maximize market share mean lower profits.”
Myth 4: The Experience Curve Improves Efficiency
Costs decline as a company increases its output because it becomes more efficient at making its product – a Boston consulting group developed this theory of the experience curve in the 1960s, and Buzzell used it in his study.
However, Miniter argues the efficiency gains are not automatic. Instead cost cuts come through negotiation and suppliers wanting to maintain their margins. For manufacturers, increased output means enlarging the production process. For distributors, the logistical problems of increased business can overwhelm managers.
Miniter says the experience curve should be viewed as a target for increased efficiency not an automatic prize for getting bigger.
Myth 5: Quality Management Leads To Growth According to this myth, managers are drawn to higher market share. Companies with growing market share are better able to attract and retain quality managers than companies with smaller market share. Miniter says this idea is often cited as a key reason why managers must focus on market share.
“What draws prime managerial talent is not market share,” says Miniter, “but the manager’s own opportunities at the firm for advancement and enrichment.”
Retaining top talent requires creating a positive corporate culture at every level.
How To Become A Profit Leader
How does a company become a profit leader?
“Profit leaders plan for profitable growth and let market share come to them,” says Miniter. “And profit leaders usually avoid mistakes such as reckless discounts, mindless brand extensions, brand erosion and pointless mergers.”
According to Miniter, there are several ideas that every profit leader understands and implements:
Ultimately, Berry says, dealers need to be profit-motivated. “It’s easier if you’re the market leader to do business, but it can’t be the only focus,” he says. “You can’t go to the bank and borrow money on market share. You have to have profit.”
- A democratic and focused corporate culture – At many profit leaders, the corporate culture has been designed to break the barriers between departments and rid the company of hierarchies. Communication among departments and between managers and employees is easy and direct.
Financial incentives play a role in overcoming corporate inertia. Increasing employee stock ownership and awarding productivity bonuses are good ways to encourage employees to work together.
- Cost control – Profit leaders do it well.
- Channel control – Profit leaders use a version of the direct sales model, but it’s not the only way to control a sales channel. For example, McDonalds sells products through franchises, but networks them together to detect market shifts and tests new approaches through its storeowners.
- Focus on short-term profits.– Profit leaders focus on making money now, not in the future.
- Customer selection – Profit leaders know who their customers are and focus on meeting their needs. These companies aim for customer delight, not just customer satisfaction. “One must have a definable and defendable market niche,” says Miniter.
- Coherence – “The business models of most profit leaders – their corporate culture, their customer selection, their unique value proposition, their sustainable competitive advantage – usually fit together in a coherent self-reinforcing way,” says Miniter.
- Vision and management – Profit leaders have managers who have a clear idea of where they want to go and how to get there, combined with the persistence necessary to overcome corporate inertia.
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