A common pitfall when talking about Business Strategy is that Market size is somehow undefined and then perceived as unlimited.
If this baseline, under a certain approximation, may be seen as true thinking about the final consumer – since in this case the number of potential Clients is incredibly higher when compared to the number of Companies that might satisfy their needs – this is not the case when looking at specific market segmentations involving either final consumers or intermediate entities, like other Companies.
If this baseline, under a certain approximation, may be seen as true thinking about the final consumer – since in this case the number of potential Clients is incredibly higher when compared to the number of Companies that might satisfy their needs – this is not the case when looking at specific market segmentations involving either final consumers or intermediate entities, like other Companies.
In particular, Market size might be static for some time and then considered limited or growing steadily – typically linearly – or through a step which doubles or more the Market from a certain moment on.
The scenarios that a Strategy Analyst might face with are then the following:- One or more Companies competing for a static Market
- One or more Companies competing for a Market which is growing at a certain rate
- One or more Companies fighting for a Market that under certain conditions – e.g. an innovation related to the product being sold or a sudden availability of cash – immediately grows in size all of a sudden
The question that immediately comes up is: how does the Market behaves in such scenarios?
In other words: is this behavior predictable?
The answer is yes and may be given studying the Prey vs Preyers equation in the version known as Lotka-Volterra model
In other words: is this behavior predictable?
The answer is yes and may be given studying the Prey vs Preyers equation in the version known as Lotka-Volterra model
dx/dt = ax (1 – x)
that as a discrete differential equation becomes
x(t+1) = x(t) + ax(t) [1 – x(t)]
This model - where x represents a Company or an Industry and a is a growth rate - may be applied to examine a single Competitor – a Monopolist – who acts within its own Market or two/many Competitors who compete with each other to win the Market.
Results – already mathematically explored in literature – are quite interesting.
Monopolist and Market Size
When a Company lives in a Market thanks to a specific competitive advantage – whatever the reasons that may be the source for such an advantage – it may substantially grow in one of three ways.
Slowly – and in this case it will reach the asymptote of the Market quota after some time. This kind of Company experiences a good rate of growth along its childhood and then reaches the fullest while aging. The adjective that may be used to describe this condition is “stable”, meaning that such a Company – in a world where innovations or new entrants or suppliers are not a threat – is not a risk for itself. The interesting point is that the growth of the Company is a consequence of the rate growth but the curve which describes the growth – a reversed exponential – has always the same shape when the growth rate is under a certain value.
Fig.1 - Slow growth
Quickly – this is the case of a Company which wants everything now, maybe to establish a consolidated position before others might step in or just because it is necessary to grow quickly given a business plan – and a financing plan – that requires this approach to justify a return on the investment. As wisely observed by Michael Porter in his article “What is Strategy”, growth – or exceptional growth – tends to drive revenue reduction. A Company which grows very quickly “consumes” the Market liquidity at a high speed, then a period of low sales shows up and a resize of the Company or a strict cost reduction policy is necessary to stay in the Market waiting for the next wave. This kind of Company experiences some ups and downs whose reasons are usually searched within many factors – Management, Strategy, Focus, Market mood – but the ultimate driver is the excessive growth that wants to be pursued.
Fig.2 - Quick growth
Extremely Quick – and in this case a disaster immediately shows up. A Company whose growth is exceptional and is able to saturate the Market in the short term builds an infrastructure – an organism – that immediately afterwards cannot find cash available enough to live or survive. Despite the mathematical model in this case behaves chaotically – giving the impression that it is always possible to hook at the next positive wave and then resort – the truth is that the Company dies. The size of the Company is not the reason of its death – this happen whatever the size of the Company: the unique reason is the exceptional growth rate which exhausts the cash availability – i.e. the overall spending capacity – of the Market in which it operates.
Fig.3 - Extremely Quick growth
Many Competitors in the Same Market
Given the examples above, it should be clear which might be the behavior of a Market where many Competitors are fighting for the same source of revenue – i.e. within the same “Industry”.
If on average they exhibit a low attitude to growth, they will all get their own position within the available Market. If they should grow quickly or too quickly – or even if one of them should be able to perform this way – the survival of all of them might compromised and an economical catastrophe would emerge.
The latter consideration is particularly helpful to understand those exceptional growths – both on promising (e.g. the new economy) – and on consolidated Markets (e.g. Banking, Finance, Real Estate) that ends up with a general crisis. The system – as a whole – burns so much liquidity that the sustainability of the systems itself is then compromised.
It helps – strategically thinking – to understand why a Company who wants to enter within a Market through a diversification growth approach might decide to make the “price war” to burn the Market trying to establish itself as the main leader after some time.
It is also necessary to understand why – under certain conditions – a free market with no rules may lead to unpleasant conclusions. Years ago the China government had to fight against internal free market desire, offering the explanation – among others – that a sudden freedom would have led to chaos. Despite the means adopted that time and the unfortunate events the public opinion had to witness – like the Tiananmen protests – the Lotka-Volterra model clearly proves that their fears would have possibly become true.
What if the Market Size Grows?
Market size is the consequence of many factors: the number of Clients available – which might be static by nature (e.g. the number of Banks on a certain period) – or the product positioning: the higher the price, the lower the number of Clients (this will be a subject for another article on this Blog).
Sometimes a new technology or a product improvement makes the Market size grows: in this case, which is the behavior that we might expect?
It all actually depends – again – on the growth rate: if the Market growth rate is higher than that of the Competitors who are fighting for it, then a period of stability is granted. Nevertheless, when the Market size has reached its new maximum size or whenever the Competitors aggressiveness should be higher, then the behaviors depicted before would immediately show up. A Market growth shifts a possible problem in time but does not prevent it from happening.
Results – already mathematically explored in literature – are quite interesting.
Monopolist and Market Size
When a Company lives in a Market thanks to a specific competitive advantage – whatever the reasons that may be the source for such an advantage – it may substantially grow in one of three ways.
Slowly – and in this case it will reach the asymptote of the Market quota after some time. This kind of Company experiences a good rate of growth along its childhood and then reaches the fullest while aging. The adjective that may be used to describe this condition is “stable”, meaning that such a Company – in a world where innovations or new entrants or suppliers are not a threat – is not a risk for itself. The interesting point is that the growth of the Company is a consequence of the rate growth but the curve which describes the growth – a reversed exponential – has always the same shape when the growth rate is under a certain value.
Fig.1 - Slow growth
Quickly – this is the case of a Company which wants everything now, maybe to establish a consolidated position before others might step in or just because it is necessary to grow quickly given a business plan – and a financing plan – that requires this approach to justify a return on the investment. As wisely observed by Michael Porter in his article “What is Strategy”, growth – or exceptional growth – tends to drive revenue reduction. A Company which grows very quickly “consumes” the Market liquidity at a high speed, then a period of low sales shows up and a resize of the Company or a strict cost reduction policy is necessary to stay in the Market waiting for the next wave. This kind of Company experiences some ups and downs whose reasons are usually searched within many factors – Management, Strategy, Focus, Market mood – but the ultimate driver is the excessive growth that wants to be pursued.
Fig.2 - Quick growth
Extremely Quick – and in this case a disaster immediately shows up. A Company whose growth is exceptional and is able to saturate the Market in the short term builds an infrastructure – an organism – that immediately afterwards cannot find cash available enough to live or survive. Despite the mathematical model in this case behaves chaotically – giving the impression that it is always possible to hook at the next positive wave and then resort – the truth is that the Company dies. The size of the Company is not the reason of its death – this happen whatever the size of the Company: the unique reason is the exceptional growth rate which exhausts the cash availability – i.e. the overall spending capacity – of the Market in which it operates.
Fig.3 - Extremely Quick growth
Many Competitors in the Same Market
Given the examples above, it should be clear which might be the behavior of a Market where many Competitors are fighting for the same source of revenue – i.e. within the same “Industry”.
If on average they exhibit a low attitude to growth, they will all get their own position within the available Market. If they should grow quickly or too quickly – or even if one of them should be able to perform this way – the survival of all of them might compromised and an economical catastrophe would emerge.
The latter consideration is particularly helpful to understand those exceptional growths – both on promising (e.g. the new economy) – and on consolidated Markets (e.g. Banking, Finance, Real Estate) that ends up with a general crisis. The system – as a whole – burns so much liquidity that the sustainability of the systems itself is then compromised.
It helps – strategically thinking – to understand why a Company who wants to enter within a Market through a diversification growth approach might decide to make the “price war” to burn the Market trying to establish itself as the main leader after some time.
It is also necessary to understand why – under certain conditions – a free market with no rules may lead to unpleasant conclusions. Years ago the China government had to fight against internal free market desire, offering the explanation – among others – that a sudden freedom would have led to chaos. Despite the means adopted that time and the unfortunate events the public opinion had to witness – like the Tiananmen protests – the Lotka-Volterra model clearly proves that their fears would have possibly become true.
What if the Market Size Grows?
Market size is the consequence of many factors: the number of Clients available – which might be static by nature (e.g. the number of Banks on a certain period) – or the product positioning: the higher the price, the lower the number of Clients (this will be a subject for another article on this Blog).
Sometimes a new technology or a product improvement makes the Market size grows: in this case, which is the behavior that we might expect?
It all actually depends – again – on the growth rate: if the Market growth rate is higher than that of the Competitors who are fighting for it, then a period of stability is granted. Nevertheless, when the Market size has reached its new maximum size or whenever the Competitors aggressiveness should be higher, then the behaviors depicted before would immediately show up. A Market growth shifts a possible problem in time but does not prevent it from happening.
