Choose Profit over Market Share
24 April 2007 Frank Bilstein
Frank Bilstein and Hermann Simon of SKP outline some competitive strategies for use in contested markets.
In the summer of 2003 we presented the CEO of a world-renowned public company with a sophisticated strategy that would secure its path towards profitable growth. She waited with growing impatience for the end of the presentation to crush six months of work with one sentence: "That's all very well and good, but I want to destroy my competitors!"
In the years since then the company has drastically reduced its formerly attractive margins in numerous important markets, but despite these strong attacks it has not succeeded in ousting even one competitor from its relevant markets.
This experience reflects the mindset of many established companies with leading market positions that they can minimise or eliminate competitors through aggression, even in mature markets with limited growth where companies have long ceased to offer any superior benefits.
Aggression usually means aggressive prices, but this strategy seldom works. As revealed in the case above, the competitors usually survive and everyone ends up with less profit.
The problems of the world's leading PC manufacturer Dell are a good example. After Dell clinched the top position in their market through a price war in 2001, the two arch-rivals Compaq and Hewlett Packard reacted by merging their businesses. IBM's laptops are now in the hands of the world's number-three manufacturer, the Chinese company Lenovo, which is in the process of re-establishing its cost leadership. It is no wonder that the stock market keeps asking when Dell is going to start benefiting from its aggression.
The companies' and investors' mindset is moving away from market share orientation towards profit-oriented management. Lothar Meyer, CEO of Germany's second largest insurance group Ergo, announced in a recent press conference that they will stay out of a price war in the automotive and industrial insurance businesses: "We would also accept some loss of market share."
In January 2007 Bob Lutz, Vice Chairman of General Motors (GM) declared that "within reason it would be better to sell slightly fewer [vehicles] at higher margins. We've tried to sell more at lower margins and it's what got General Motors into trouble."
The GM case is especially intriguing: Just over a year has gone by since GM subjected itself to one of the biggest discount battles in history. This action forced its competitors Ford and Chrysler into a price war that had little effect other than burning money. Not only did the minimum target remain unfulfilled, but GM's market shares sunk even further.
The stock market can differentiate between what market share gain is good and what is bad. In one of its last quarterly reports Amazon justified its weakening margins by its plan to expand its market position even further. Despite a 22% revenue increase that was purchased through lower prices and free delivery, the stock price initially dropped more than 20%.
Deutsche Telekom wasn't spared either as they announced last May that they would give priority to revenue over profit in order to regain market share. The shares fell below the IPO level.
How can an established company adapt its competitive strategy to avoid fatal mistakes? Three areas have proven to be particularly important: mindset, planning and communication.
Make the following insight into the foundation of your mindset: Business is not war!
The primary goal of a company is to satisfy the customer and generate profits, not to destroy the competition. That is the core of profit-oriented management. If there is no true innovation a choice has to be made between market share growth and profit growth.
Management must be re-educated to understand the benefits of peaceful competition and that price wars only destroy the profit potential of the entire market. This must also be reflected in their incentive systems.
Once the mindset change is complete, the competitive strategy must be re-oriented. In which markets should we refrain from aggressive measures against competitors either because it cannot be done profitably and sustainably, or because we do not deserve a bigger market share? And where do we have to hit back hard at competitive actions?
When the Evening Standard was attacked by two free afternoon papers, London Lite and thelondonpaper, in August 2006 it reacted with a price increase of 25%. A smart move as its circulation has only dropped by 12% by January 2007 and thus its cover revenue actually increased. The Evening Standard was smart enough to realise that to fight on price against 'free' is a hard battle to win profitably.
The new competitive strategy only works if the market understands what the company wants. Otherwise, employees, customers, competitors and investors could interpret deliberate restraint as a sign of weakness or intentional defence as a full offensive attack – with fatal results.
This clarity can be achieved through consistent actions and explicit public communication. Companies are repeatedly sending out signals to the public through the media regarding profit orientation.
AOL's CEO in Germany was recently asked if the company would have to pick up steam. He responded: "If picking up steam means more revenue, then maybe, but we place greater emphasis on profitability, for which our growth is just right."