Market structures, competitive positioning and the art of ‘knowing your enemy’
There have been a lot of articles written about pricing, price wars and war gaming, and a lot has also been written on the strategies and tactics required to avoid and/or deal with a price war.
However, most of these articles are written in the context of large corporations who are often well funded and employ professional managers who have the requisite tools and capabilities to deal with a price war. There has been few to none written for small businesses. Although the guiding principles are the same for all “for-profit” companies, some of the prescribed solutions are not apt for small businesses.
It is important for small businesses to define their industry structure and market trends and develop a purposeful pricing objective. Only then can small businesses determine their pricing strategy, let alone deal with, or avoid engaging in, a price war.
The strategic context of pricing
I have often wondered as to how much purposeful thought small business owners and SME marketers have given to their pricing strategy.
Pricing strategically is a core requirement that will determine the long term sustainability of a small business entity. Pricing is the purse string of any company. You mess with it and you are damned!
Most small businesses that I have interviewed do not consider aspects beyond cost-plus pricing to price their goods and services.
There are multiple pricing tools and frameworks that a small business owner or an SME marketer can deploy to sustain and win in the marketplace. We will discuss this in detail later. First, it is important to consider a small business’ position in the marketplace, relative to the overall market.
Simply put, the structure of a market affects the behaviors of all the companies that play in it.”– John Lincoln, author
Market structure and entry barriers
In discussing real-world competition which most small businesses encounter daily, it is important to first focus and truly understands the market structure.
In essence, market structure is the number of companies in a market and the overall barrier to entry for others to enter in your space. For example, no small business can realistically aspire to be a utility or telecom operator as the initial investments are untenable and beyond the reach of most SMEs. In addition, meeting government and regulatory requirements require investment in a battery of lawyers and regulatory experts. Additionally, hiring professional managers competent in the relevant technology or commercial aspects of the industry are certainly insurmountable for a small business investor.
Of course, most small business owners and SME marketers are smart and will not venture into such an endeavor. I am only attempting to illustrate an extreme example of what an entry barrier truly means.
If the entry barrier is low, then the long term profit prospects for a company are low as well. So remember that when you develop your SME plan or your annual operating plans. Keep in mind that there are many others who can enter and disrupt your profits in your market space.
Always be smart enough to hire people brighter than yourself.”– John Lincoln, author
Measuring industry structure
First, here are some basics that small business owners must be aware of:
Perfect competition with an infinite number of companies and a monopoly are polar opposites. Monopolistic competition and oligopoly lie between these two extremes. Monopolistic competition is a market structure in which there are many businesses selling differentiated products. Oligopoly is a market structure in which there are a few interdependent firms.
Most global industry structures where small businesses operate fall almost entirely between monopolistic competition and oligopoly – perfectly competitive and monopolistic industries are nearly nonexistent.
Marketers in large companies often use one of two methods to measure the industry structure. They are the concentration ratio and the Herfindahl Index.
The concentration ratio is the percentage of industry output that a specific number of the largest companies have. The most commonly used concentration ratio is the four companies’ concentration ratio. The higher the ratio is, the closer the industry structure will be to an oligopolistic or monopolistic type of market structure.
The Herfindahl Index is an alternative method used by marketers to classify the competitiveness of an industry. It is calculated by adding the squared value of the market shares of all firms in the industry.
I personally prefer this method. There are two advantages of the Herfindahl Index. It takes into account all companies in an industry and it also gives extra weight to a single company that has an especially large market share. Also, the Herfindahl Index is the method used by the US Justice Department for allowing or disallowing mergers to take place. If the index is less than 1,000, the industry is considered competitive,
whereby allowing a merger is actively considered.
Relevance of industry structure for business survival
By now you must be wondering why all this is important. Classifying the industry structure is important because structure affects a company’s behavior. The greater the number of sellers, the more the likelihood that the industry structure in which a small business operates is competitive.
The number of businesses in an industry plays a role in determining whether small businesses explicitly take other companies’ actions into account. In reality though (when there are many sellers as in monopolistic competition), they do not take into account their competitors’ reactions.
If you are running a retail store or restaurant, this might not be very important for you. However, in many countries, there are many traders and distributors for large manufacturers or technology companies ranging from cell phones, computers and servers to sophisticated telepresence and medical equipment.
In addition, there are many boutique management and technology consulting companies competing with well-known global brands. I am sure those businesses that are competing in these market spaces can see the relevance of really understanding their industry structure.
Words like de-layering (when management is terminated) to right-sizing or reorganization are terms which should NOT be used when having to let employees go.”– John Lincoln, author
A word on monopolistic competition
By now you must also be wondering as to why a hyper-competitive industry structure is called monopolistic competition. It seems so counter-intuitive. The “many sellers” characteristic gives monopolistic competition its competitive aspect; the need and capability for business proposition differentiation give monopolistic competition its monopolistic aspect.
SMB owners and SME marketers must ensure that their proposition is truly differentiated. And they must successfully communicate their unique value propositions to the market.
This is a fundamental rule for any small business. Most small businesses operate in an environment where the entry barrier is very low and there are many sellers. Then, if there is no unique value proposition, or if the unique value proposition is not communicated well, the business is doomed to fail.
JohnLincoln.one –The business growth hacker