Read an Excerpt
Chapter One
Fool's Gold: Why the Myth of Market Share Is Wrecking the World's Great Companies
In reading the history of nations, we find that, like individuals, they have their whims and their peculiarities; their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it . . .
-Memoirs of Extraordinary Popular Delusions Charles Mackay (1841)
THE OBSESSION
Business leaders are gripped by the cult of size, the dogma of bigness.
They are mad for market share. Nearly every company is mesmerized by it. Keeping it, growing it, justifying it-try to talk to a senior executive without the subject coming up. "I can't predict the economy," Scott McNealey, the legendary chief executive of Sun Microsystems, told Barron's recently, "but we will gain share."
Nearly every time I meet with a CEO or senior executive, market share comes up. The reason is no mystery: Top executives know that they are measured by it, and they know that they measure their subordinates by it.
Market share is also an obsession among Wall Street analysts, institutional investors, financial journalists, growth-minded entrepreneurs, high-flying consultants, self-styled gurus, and almost everyone with a 401(k). It seems like a neat shorthand for understanding the value and growth potential of any stock or business plan. It is easy, deceptively easy-and, too often, wrong.
Why do so many people believe that market share naturally and inevitably leads to world-beating profits?
Most business schools are temples to market share and churn out more acolytes every year. The guy in the big corner office is always asking about it. On the conference call, the fund manager wants to know why share isn't growing. The consultants always seem to have a magic plan to produce more market share. And when was the last time you heard someone say that his business plan would succeed in reducing market share?
Like all dogmatic beliefs, followers explain away all of the contrary evidence or simply ignore what they cannot explain.
Periodically, a researcher will emerge with new evidence about market share and profits. Eyes weary from poring over earnings reports, the unwelcome prophet will say something like: "Market share is the fool's gold of business. It looks valuable and it takes a lot of hard work to get-but it is nearly worthless. It wastes time and money while the competition is digging out the real thing. It hobbles, cripples, and kills great companies!" And, like most prophets, he will be ignored.
Maybe the discouraged prophet will drop his yellow legal-size tablets on the ground, allowing us to read his notes: "The market-share obsession, based on flawed and outmoded theories, drags down corporate profits and pushes companies into costly moves. It makes companies bigger without making them more profitable." Sometimes it seems to coincide with profits; too often it does not.
This book is about two powerful ideas: the obsession of market share and the proven path to profits. Once decision makers understand the misguided role that market share plays in corporate strategy, this book will show them how some companies achieve strong growth and above-average profits, using techniques that have worked in a broad array of industries.
It will not make the true believers happy.
THE CULT OF SIZE
Let's start by looking into the world that really matters-the realm of results.
Consider the roll call of companies that achieved large shares of the market in their industry sector or dominated their line of business. Far from being dominant giants, many were sold, were acquired in hostile takeovers, or simply went bankrupt. And the rest? They remain ailing giants-respected behemoths whose executives mumble that Wall Street analysts don't understand their business or claim their sector is having a "cyclical downturn." Still others say they are just one more restructuring effort away from the golden age of profits and market dominance. Sure.
The following companies-in vastly different sectors-have only two things in common: They focused on market share and failed to earn as much money as their competitors.
*Amazon.com is a Brobdingnagian straight out of Jonathan Swift's Gulliver's Travels, which it probably sells more of than any other bookstore in the world. It is easily the nation's largest online book purveyor and moves more volumes than almost all of its bricks-and-mortar rivals. One small problem: Despite seven years of market-share growth, it didn't report a net profit until January 2002. The profit was tiny: $5 million on $1.12 billion in sales. Even that slim profit would have disappeared if the euro hadn't declined against the dollar, slashing some $16 million worth of its euro-denominated debt.
*DEC once had a large share of the minicomputer business. But profits slipped, as market share remained firm. DEC was rescued by Compaq. Now Compaq itself is in trouble. But Compaq's CEO, Michael Capellas, told Fortune magazine that he will not make DEC's mistakes; "We will cede market share to protect profits." Mr. Capellas must have learned something since March 1996 when he stated that he would sacrifice profit to build market share. But, in the end, Compaq couldn't transform itself into a profit-centered company. Old habits die hard. By 2001, Compaq was desperate to be acquired by Hewlett-Packard, a merger effort that soon led to a nasty proxy battle.
Even today's most successful companies could be more profitable if they cared less about market share.
*Wal-Mart, founded by the legendary Sam Walton, is hugely profitable. But, as a case study later in this chapter reveals, the company is focused on expanding into new markets-whether they are fully profitable or not. As a result, Wal-Mart is less profitable than its two smaller competitors, Family Dollar and Dollar General, from which investors earned more on a rate-of-return basis.
*3M, the maker of Scotch tape and Post-it notes, is gargantuan, a $15 billion business that towers over its competitors in nearly every product category. At least in size. Yet others earn more profit in many categories. "3M is a $25 billion business trapped inside a happy, fat $15 billion company," one consultant, who has worked with 3M for more than a decade, told me. 3M is too busy running after tomorrow's products to catch today's profits, too busy innovating to focus on selling and serving its customers. Less innovative rivals quickly move in, snatching sales that should have been 3M's. Innovation is good, but failing to fully exploit the profit potential of its new products in the name of market share hasn't helped 3M become the next GE.
IS BIGGER BETTER?
The more that one looks for evidence of big companies exploiting their market share and superior scale to earn outsize returns, the more one finds evidence to the contrary.
It appears that larger market share, by itself, doesn't equal larger profits. Although some companies have succeeded in exploiting the benefits of size, most have only become bigger.
Take the American banking sector. The biggest originator of home mortgages in the first half of 2000 was Chase Manhattan Mortgage. Was it the most profitable on a net earnings basis? Not by a long shot. The most profitable was Washington Mutual, the number five ranked lender, which earned $452 million. By contrast, Chase Manhattan Mortgage earned less than $123 million.
Why didn't Chase Manhattan do better?
Bankers are fond of saying that the cost of servicing a $100,000 mortgage is equal to the cost of servicing a $200,000 mortgage. All other things equal, the bank that has the highest average loan size is the most profitable.
Chase's problem was its low average loan size: $120,000. In terms of average loan size, Chase ranked thirty-ninth nationwide. To generate high volume, it had to take on many smaller, relatively less profitable loans. So Chase was bringing in more volume, but with a lower return. Why build volume instead of profiting like Washington Mutual? Market-share madness is the most likely culprit.
Indeed, market-share madness seems to grip every industry-and analysts and investors are starting to notice. When three European steel companies announced a three-way merger to form the world's largest steelmaker, I phoned a London-based Commerzbank steel industry analyst, Peter Dupont. He immediately summed up the foolish fascination with market share in that industry: "A touching sign of faith for the cult of size."
ARTICLES OF FAITH
Market share is treated like an article of religious faith, unquestioned and unquestionable. Virtually every study on market share-and over the last forty years a small mountain of market-share studies has been published on both sides of the Atlantic-simply assumes a direct connection between market-share growth and profitability. Here is an old, but classic, example: "Capturing a dominant share of a market is likely to mean enjoying the highest profits of any companies serving that market," Paul Bloom and Philip Kotler once wrote in a 1975 Harvard Business Review article.
That sentiment appeared over and over again in dozens of major business journal articles in the past few decades and it was often the unstated assumption in hundreds more. Those studies became part of the curricula at business schools around the world and worked their way into the popular business press-everything from Harvard Business Review and the Wall Street Journal to Fortune and Business 2.0. Over the years, managers decided to listen to the "experts"-and those studies became the bricks in the foundation of thousands of business plans and corporate strategies. Soon nearly everyone believed that market-share growth meant higher profits. Few bothered to actually look at what the research showed about the tenuous link between market share and profits.
Even powerful dissenters were ignored. One of the giants of American economics, Harold Demsetz, a professor emeritus at the University of California at Los Angeles, noted: "Alternative explanations for this data generally were ignored because the market concentration doctrine had won the imagination of investigators and given direction to their thoughts, much as Ptolemaic astronomy [the idea that the sun revolved around the earth] provided the signposts for the study of heavenly bodies the four hundred years surrounding the life of Christ."2 In other words, researchers saw what they wanted to see.
But what about the evidence to the contrary? What about the studies that tested the assumed correlation between market share and higher than average returns and found the dogma lacking? In 1982, Carolyn Y. Woo, a professor at Purdue University's Graduate School of Management, and Purdue professor Arnold C. Cooper published a powerful article in the Harvard Business Review. It was called "The Surprising Case for Low Market Share." It detailed a number of companies that earned much higher returns than their much-larger competitors. Their conclusion challenged the conventional wisdom with a wealth of evidence: "Low market share does not inevitably lead to low profitability. Despite the well-accepted correlation between market share and profitability, market share is not a necessary condition for profitability." But Ms. Woo and Mr. Cooper were challenging the consultant catechism, and the "cult of size" kept most of its believers.
Other researchers pointed out that the much-touted correlation between market share and profitability was in fact mistaking cause for effect. One study warned against accepting the idea that market share and profitability were linked.3 Instead both are dependent on product quality, price, costs, distribution, marketing, resources, strategic objectives, and so on. Market share, rather than leading to profitability, was the result of successful business practices that also led to profitability. Profits may be the result of "unobservable factors such as managerial skill and luck. . . . That is, market share may not strictly cause business success but rather be a consequence/outcome of it," noted another study.4 But these voices in the wilderness were soon forgotten. The conventional wisdom remained impervious to contrary evidence. Consultants had advice to sell, executives had plans to justify, and entrepreneurs had dreams to choose.
Market-share madness marched on without missing a step. Why? Perhaps these studies simply made too many consultants and executives uncomfortable. How can you question what everyone "knows"?
The most thorough student of market share and profitability I've talked to is Donald V. Potter, president of Windermere Associates, a Moraga, California-based consulting firm. A veteran of Andersen Consulting with more than thirty years of experience in a range of businesses, Mr. Potter is an affable Californian with an easy manner, but also a former U.S. Marine with a tenacious will. He, too, compares belief in the power of market share to pure faith. "It is like trying to change someone's religion," he told me.
He and his team examined more than 3,000 public companies in 240 industries. Mr. Potter's results shatter the conventional wisdom on market share and profits. He discovered that more than 70 percent of the time the firm with the biggest share of the market doesn't have the highest rate of return.
The 1997 Windermere study examined some 240 industries that have at least five competitors whose individual annual sales are each greater than $50 million. Among the top four firms in each of 240 industries, the market-share leader led the industry in pretax returns on assets only 29 percent of the time-only 4 percent better than random chance. Barely beating random chance doesn't seem like much of a benefit for a corporate strategy that costs tens of millions of dollars in management time and consulting fees-but that is the best the market-share strategy can deliver on average.
And, chances are, the lucky 29 percent-who lead their industry in both size and profits-are doing something very different from their less successful peers in other industries. (We will find out what sets these companies apart in Chapter Five.)
Now let's look at the other end of the spectrum: the firms in the number four position, the ones with the smallest market share among the top four in each line of business studied. Twenty-three percent of the time, these firms had higher returns than each of their three larger rivals did. If market share were an essential ingredient to above-average profitability, these relatively small fry 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.
Some might think their industry is special-that in their case, market share is essential. Highly concentrated, capital-intensive enterprises-everything from petroleum refineries to food processing conglomerates-need scale and market share to be competitive, or so goes the theory. Again, the Windermere research and the evidence do not support this view. In highly concentrated industries, market leaders did only slightly better than average. They had the best industry returns only 38 percent of the time, according to the Windermere study. If market share alone were the key to success in these industries, wouldn't the biggest enterprise be the most profitable much more than one-third of the time? Remember, in highly concentrated sectors, there are usually only a handful of real contenders. Dumb luck may prove to be a better predictor of outsize profits in highly concentrated businesses-not market share.
Others say that high-growth sectors require market-share strategies. But, again, the facts tell a different story. High-growth industries actually did slightly worse than average, according to the Windermere study. Only 27 percent of high-market-share businesses in high-growth sectors had the best industry rate of return-compared with the average of 29 percent for all industries.
Though the Windermere study tracked profits in terms of return on assets, the results would be virtually identical if profits were measured in terms of return on equity, says Mr. Potter.
The bottom line seems inescapable-size doesn't automatically lead to profits. After all, firms with big shares of the market usually underperform their peers while relatively smaller firms are about as likely to prosper.
