Sunday, August 28, 2016

Why Markets Consolidate

Source: Marketing Science Institute
Over time, markets tend to consolidate, and they tend to consolidate because market share is related fairly directly to profitability. One rule of thumb some of us use is that the profits earned by a contestant with 40-percent market share is at least double that of a provider with 20-percent share.

And profits earned by a contestant with 20--percent share are at least double the profits of a contestant with 10-percent market share.

That is why one of the main determinants of business profitability is market share. Generally, entities that have high share are much more profitable than their smaller-share rivals.

And that is likely to be especially true for business products that are not purchased frequently, or are hard to understand, such as business communication products and services.

Source: Marketing Science Institute
For infrequently purchased products, the return on investment of the average market leader is about 28 percentage points greater than the ROI of the average small-share business.

For frequently purchased products (those typically bought at least once a month), the correspondingly ROI differential is approximately 10 points.

There are reasons for that differential.

Infrequently purchased products tend to be durable, higher unit-cost items such as capital goods, equipment, and consumer durables, which are often complex and difficult for buyers to evaluate.

One might argue that communications services also are products buyers generally find complex to understand and hard to evaluate on metrics other than recurring cost or upfront investment.

Since there is a bigger risk inherent in a wrong choice, the purchaser is often willing to pay a premium for assured quality.

Frequently purchased products are generally low unit-value items where risk in buying from a lesser-known, small-share supplier is less crucial.

Source: Marketing Science Institute

Such differentials also occur when buyers are fragmented, and no small group of consumers accounts for a significant proportion of total sales.

In such cases,  the ROI differential is 27 percentage points for the average market leader.

However, when buyers are concentrated, the leaders’ average advantage in ROI is reduced to only 19 percentage points greater than that of the average small-share business.

When buyers are fragmented, they cannot bargain for the unit cost advantage that concentrated buyers receive.

And that tends to be true even for highly-fragmented markets or sub-markets. So it is that six regional master agencies (sales organizations for telecom and cloud services)  have teamed up to form Technology Solutions Exchange (TSX).

The stated goals include broadening their footprints, improving negotiating power with suppliers and growing revenue. All of those motivations are consistent with the general principle that market share matters.

TSX members include P2 Telecom, TDM Inc., Connectivity Source, CTG3, Netstar Inc. and Telcorp International.

The entity is lead by Bill Patchett, founder and CEO of P2 Telecom, and Robert Bowling, president of TDM, who were elected as co-chairs.  

The formation of TSX illustrates the business advantage of market share.

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