Whether reviewing business strategy and current performance, considering entering a new market, or evaluating an acquisition or investment, understanding market attractiveness is an important step. Market attractiveness analysis provides a view of profit potential based on an examination of the underlying market factors. While the operating performance of a business may determine the actual level of profitability, market attractiveness sets the boundaries around profitability potential. The best performing company in a market with low attractiveness can only achieve a mediocre return. A company operating in a market that is highly attractive has the potential for high returns, given a strong strategy and effective implementation.
An understanding of market attractiveness is an essential part of the situation analysis in strategic planning, the step where we examine the business environment and the company’s position as the foundation for the business strategy. In making choices about the future direction of a business, market attractiveness is key. Market attractiveness is also a critical part of valuing an existing business. A common pitfall of investors is solely relying on past financial performance as a predictor of the future without ever looking at the underlying market attractiveness.
A recent consulting project provides a good illustration of the value of understanding market attractiveness. The client was interested in vertically integrating into a market (call it Mkt. A) that they saw growing. They asked our consulting firm to help them understand this market and guide them through planning and implementing the steps necessary for market entry. During our analysis we realized that Mkt. A was not particularly attractive but there was an adjacent market space, Mkt. B, that was much more attractive. Mkt. A was relatively unstructured; it was difficult to clearly define customers and competitors, but there were a lot of competitors. The customers were generally small, poorly-capitalized installers. The customers’ customers were open to a wide variety of substitute products. The buying factors were dominated by price. All of this meant that players in the market were under constant price pressure and margins were likely to be low. The adjacent Mkt. B, on the other hand, was highly structured and stable. The customers were capable and well-financed. There were only two viable competitors. The buying factors were predominantly product specifications and quality. While Mkt. A was larger and growing more rapidly, the profit potential in Mkt. B was greater. It was going to take a little more work for the client in terms of product development and manufacturing process improvement, but they were capable and the return on investment was likely to be much greater. Our analysis convinced the client to re-focus on the more attractive market and laid out a plan for market entry into Mkt. B.
While market size and market growth are often the first things that people think of in assessing market attractiveness, there are other more important considerations. The relative importance of various factors will be different for each company based on its vision, goals, and objectives. If the vision is to become a billion-dollar company, market size may be critical. On the other hand, for a company in the 95% of businesses that are less than $10 million in revenue, there may be many other factors more important than market size as it considers the means to maximizing return on investment.
In general terms, the factors of market attractiveness can be grouped into three overlapping areas: differentiation potential, pricing potential, and growth potential. Within each of these three areas are a variety of factors. The following might be some of the factors that determine market attractiveness.
Differentiation potential – The ability to differentiate, that is, to provide a unique value to customers, is a key factor in driving the potential profitability of a business. Certain elements of market attractiveness contribute to the ability to differentiate, and therefore to the potential return.
- Customer factors – Who are the customers? Are they identifiable? How definable are their needs or buying factors? How complex are their needs? (Complex might be good or bad.) Are there opportunities to develop unique product or service offerings to meet customer needs? How well are their needs currently being met?
- Technology factors – What sort of technology is involved in the product or in the production process? How mature is the technology? What opportunities are there for developing unique technology, either in product or process? Are there opportunities to develop unique and defendable intellectual property?
Pricing potential – Pricing potential is partially dependent upon the ability to differentiate but the industry structure and competitive environment determine the intensity of competition and the pressure on pricing.
- Industry structure factors – How much leverage do buyers have in price negotiations? Are there many choices available to them, either in the number of suppliers or in alternative or substitute products? How much leverage do suppliers have in this industry? Can suppliers squeeze margins of the competitors?
- Competitive factors – Who are competitors in this market? Are they identifiable? What are their capabilities? How intense is the competition? How easy is it for new entrants to come into the market?
Growth potential – Market size and growth is relevant but the most important part of market and growth is understanding the specific market segments that are to be addressed.
- Market size – What is the market size? What is the growth rate? How will the market size and growth rate change over time?
- Market factors – What factors are the drivers of the market? What are the growth opportunities? What are the risks regarding market size and growth? What are the segments or potential segments of the market?
Each particular business has its own market idiosyncrasies that determine market attractiveness. The challenge is to look beyond the simple and easy factors to develop a clear understanding of the structure of the market and the factors that will present either restraints on sales revenue and profitability or opportunities that can be exploited through a well-crafted strategy and action plan.
Do you understand the relative attractiveness of the market in which you operate? Are there opportunities to focus on more attractive market segments?