Monday, 16 July 2007

Market share or Profitability?

The genesis of this note comes from discussions (arguments) I have had on the grounds that I believe a company searching for ”premium prices” and profitability should not search for market share as well, without defining very carefully its ”market”.

Example: Leather carry bags. Louis Vuitton is a “premium” player in the market. But has possibly les than 1% of global leather bag sales. (including non branded goods sold in open market places around the world).

Does LVMH set itself market share goals?

Or take Michelin. A “premium” product, which year after year also chases global market share of the tyre market. Clearly a formula for disaster, in my opinion.

While contemplating these ideas, I came across an article in the HBR by Vijay Vishwanath and Janathan Marc called “Your Brand’s Best Strategy”.

One of the key points I understood in this article is that a companies ambitions must be judged in line with the commoditisation of the industry it is in. Eg: mobile phones- dominated by 7 manufacturers that add to more than 70% of the market and are all focused on innovation and profitability. Each company focused on justifying a price premium. (Till the emergence of the “cheap phones” market in India and China, this model was working very well.)

Or Apple and the mp3 market. Still dominated by a number of players offering “innovation” and establishing strong margins.

Compare this to the tyre business. Consumers are neither “wowed“ by innovation, nor seem too concerned by lower priced products. No real innovation has come to the market in the last 30 years.

I want to continue with the Nokia example. Today Nokia has defined the category- with products from $50 in India to $800 in the developed world. So far, they have gotten market share as well as profitability.

Now, lets say that the market of the “low cost” phones grows 5 times more than the overall market for cell phones. Nokia will be forced to sell more in this segment. Unless it is then able to find a cost structure that allows it to have the same profitability ( in %) as for its more “upmarket phones”, its profitability will fall. (not overall profits, but profit per phone).

However, as the mobile phone gets more and more “commoditised”, it is likely that cheaper manufacturers in China will be able to deliver phones at $25 without having a high cost structure due to lower investment in R&D, manufacturing costs etc.

Would Nokia be able to match this? Should it?

Or should it then refocus on businesses that value its innovations and allow it to continuously charge premiums and reinvest profits into its innovations.

As an industry matures, many consumer segments emerge. Satisfying each segment well requires specific business models. Working and synchronising among these different models different skills in a company and eventually proves impossible.

Today Nokia and Apple can do so. Because their respective industries are still relatively new. Customer segmentation still relatively narrow. But it will not be the same 5 years from now. Where should these companies create competencies in their business models?

Perhaps it is for this reason that in a mature industry, there has never been a “premium”, innovator that has consistently maintained strong prices and continued to gain market share.

So, should financial analysts evaluate a company whose business is based on “innovations” based on “global market share”? Stupid idea.