The Market Share Paradox

The Market Share Paradox

          
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The Market Share Paradox

1970
Strategy
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    • BruceHenderson
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    • If you add capacity too soon, extra costs come without benefits. Add too late, and market share is lost.

    • If the same investment criteria were used by all firms, the low-cost firm would always expand capacity first.

    • Costs are a function of market share because of the experience effect. Lost market share leads to loss of cost advantage.

     

    Market share is very valuable. It leads to lower relative cost and, therefore, higher profits. Unfortunately most efforts to improve market share depress profits, at least short term.

    There are two principal reasons for a shift in market share between competitors. The most common is lack of capacity. The other reason is a willingness to lose share to maintain price.

    Lack of capacity is a common occurence. It must be. It is expensive to maintain unused capacity for very long. Even in the face of projected industry growth, it is not surprising that not all individual producers feel they can justify the incremental investment in added capacity. On the other hand, nothing is more obvious than the fact that your capacity limits your market share. If the market grows and your capacity does not, then whoever has the capacity takes the growth, and increases their share of the market – at your expense.

    The decision to add capacity is a fateful one. Add too soon, and extra costs are incurred with no benefits. Add too late, and market share is lost. Added capacity means more than bricks and machines. It also means capable personnel in the proper proportions in the proper place. The lead time required is long. The decision must anticipate the need.

    The competitive implications of all this are made more complex by the cost differentials among competitors. Simple arithmetic shows that the high cost producer must add capacity in direct proportion to the low cost firm, if relative market shares are to remain constant. But the high cost producer's return on the capacity investment is lower than that of the more efficient firm, because of the differential in profit margins.

    The market share paradox is that, if the low cost firm would accept the high cost producer's return on assets, the low cost firm would preempt all market growth. And the resulting increase in his accumulated experience would further improve his costs and steadily increase the cost differential between the competitors thereafter. In short, if the same investment criteria were used by all firms, then the low cost firm would always expand capacity first and other firms never would.

    All firms do not use the same investment criteria. The fact that market share is stable proves this. However, this also means that shares are unstable if there is vigorous competition.

    The low cost producer can take market share, but only if he is willing to sacrifice near term profit. The high cost producer can obtain a significant return only because he is allowed to do so in order to maintain current prices.

    The tradeoff is inviting. Since the low cost firm typically has the largest market share, his higher return expectations often lead him to sacrifice share to maintain near term margins. The loss of a modest amount of the market may seem far less costly short term than meeting a price concession of a minor competitor, or spreading the price reduction necessary to fill proposed new capacity over his entire sales volume.

    Unfortunately, the tradeoff is cumulative. More and more share must be given up over time to maintain price. Costs are a function of market share because of the experience effect. Lost market share leads to loss of cost advantage. Eventually there is no way to maintain profitability.

    The rate of growth is the critical variable in resolving the market share paradox and the tradeoff between share and near term profits.

    • Without growth, it is virtually impossible to shift market share. No one can justify adding capacity. Neither can anyone afford to lose share at the price of idle capacity. Under such constraints, since prices will tend to be very stable, the appropriate strategy is to maximize profits within existing market shares.

    • With only very little growth, a higher near term profit now may be worth considerably more than continued modest profit. Those who should hold share into the no-growth period are only those with enough share – and the resulting cost position – to anticipate satisfactory profits.

    • With rapid growth, market share is both very valuable and very easy to lose. On the one hand, any improvement in share will be compounded by growth of the market itself and then again by improved margins as cost improvement accrues from increased volume, and hence, experience. On the other hand, growth means that capacity must be added rapidly, in advance of the growth, or share will be lost automatically; to gain share, capacity addition must be based on preempting the growth component.

    Any shift in market share should be regarded as either investment or disinvestment. The rate of return can and should be evaluated just as it would be in any other business situation. Change in market share should be an investment decision.

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