Market share An ongoing study of 57 companies reveals a link a key to between roi and market share the bigger the better profitability Robert D Buzzell, Bradley T. Gale, and Ralph G.M. Sultan The March-April 1974 issue for businesses selling It is now widely recognized that one of the main of HBR carried an article products that are pur. determinants of business profitability is market that reported on Phases I chased infrequently by a share. Under most circumstances, enterprises that and II of a project spon- fragmented customer have achieved a high share of the markets they sored by the Marketing group. The authors also serve are considerably more profitable than their Science Institute and the analyze the strategic The basic purpose of (h smaller-share rivals. This connection between mar- arvar implications of the market-share/ROI rela ket share and profitability has been recognized by tionship. They conclude by demonstrated in the results of a project undertaken the profit impact of mar- advising companies to ket strategies (PIMS) analyze their own positions by the Marketing Science Institute on the Profit Im The earlier article estab- in order to achieve the pact of Market Strategies(PIMS). The PIMS project, lished a link between stra- best balance of costs and on which we have been working since late I97I, tegic planning and profi is aimed at identifying and measuring the major performance; here, w strategies determinants of return on investment(ROI) in in additional data, the authors dividual businesses. Phase II of the PIMS project, come up with a positive Mr. Buzzell, who is re completed in late 1973, reveals 37 key profit influ- correlation between market search director of the share and ROI. The authors PIMS project, is professor ences, of which one of the most important is market discuss why market share of business administration share profitable, listing econo- and chairman of the mies of scale, market marketing area at the There is no doubt that market share and return on power, and quality of Harvard Business School investment are strongly related. Exhibit I shows management as possible Mr. Gale, associate pro- average pretax ROI figures for groups of businesses explanations, then, using fessor of economics at the in the PIMS project that have successively increasing the PIMs data base, University of Massachu- shares of their markets. (For an explanation of how they show how market setts-Amherst, is currently businesses, markets, and ROI results are defined and share is related to ROI on sabbatical to direct the measured in the PIMS project, see the ruled insert Specifically, as market economic analysis of the share increases, a business PIMS project. Mr Sulta on page Ios. On the average, a difference of Io per is likely to have a higher chief economist of the? centage points in market share is accompanied by a profit margin, a declining Royal Bank of Ca difference of about s points in pretax ROL. anada purchases-to-sales rati Montreal, was a member a decline in marketing costs of the Harvard Business rs'note: We wish to acknowledge the ntage of sales, School faculty. He MS project to the results reported in t as a percen higher quality, and higher directed the PIMS project ut numerous analyses very and cheerfully. The priced products. Data from its inception in are, of course, solely responsible for any errors or misinterpretations also indicate that the late 197I until early 1973 dvantages of large earlier article on Phases I and II of the project by Sidney Schoeffle ). Buzzell, and Donald F, Heany, " Impact of Strategic-Planning arket share are greatest Performance, HBR March-April 1974
Harvard Business Review January-February 1975 Exhibit I Relationship between market share and pretax ROI Economies of scale: The most obvious rationale for the high rate of return enjoyed by large-share busi nesses is that they have achieved economies of scale in procurement, manufacturing, marketing, and other cost components. a business with a 4o% share of a given market is simply twice as big as one with 2o% of the same market, and it will attain, to much greater degree, more efficient methods of operation within a particular type of technology Closely related to this explanation is the so-called experience curve phenomenon widely publicized Under%10-20%20-30% 130-40% lover 40% by the Boston Consulting Group. According to BCG, larke Share total unit costs of producing and distributing a prod uct tend to decline by a more or less constant per centage with each doubling of a companys cumula While the PiMs data base is the most extensive and tive output. Since, in a given time period, businesses detailed source of information on the profit/market- with large market shares generally also have larger share relationship, there is additional confirming cumulative sales than their smaller competitors, they evidence of its existence. For instance, companies would be expected to have lower costs and corre- enjoying strong competitive positions in their pri- spondingly higher profits mary product markets tend to be highly profitable. Consider, for example, such major companies as D IBM, Gillette, Eastman Kodak, and Xerox, as well Market power: Many economists, especially among as smaller, more specialized corporations like Dr. those involved in antitrust work, believe that econ Scholl (foot care products) and Hartz Mountain (pet omies of scale are of relatively little importance in foods and accessories most industries. These economists argue that if large-scale businesses earn higher profits than their Granted that high rates of return usually accompany smaller competitors, it is a result of their greater high market share, it is useful to explore the rela- market power: their size permits them to bargain tionship further. Why is market share profitable? more effectively, "administer" prices, and, in the What are the observed differences between low- and end, realize significantly higher prices for a particu high-share businesses? Does the notion vary from lar product.a industry to industry? And, what does the profitabil- ity/market-share relationship imply for strategic O lanning? In this article we shall attempt to provide Quality of management: The simplest of all explana- partial answers to these questions by presenting tions for the market-share/profitability relationship evidence on the nature, importance, and implica- is that both share and RoI reflect a common under tions of the links between market share and profit lying factor: the quality of management. Good man performance. agers including, perhaps, lucky ones!) are successful in achieving high shares of their respective markets they are also skillful in controlling costs, getting maximum productivity from employees, and so on Moreover, once a business achieves a leadership Why market share is profitable position-possibly by developing a new field-it is much easier for it to retain its lead than for others to catch up data shown in Exhibit I demonstrate the dif- nces in ROI between high- and low-market-share These explanations of why the market-share/profit- businesses. This convincing evidence of the relation- ability relationship exists are not mutually exclusive ship itself, however, does not tell us why there is a To some degree, a large-share business may benefit link between market share and profitability. There from all three kinds of relative advantages. It is im- are at least three possible explanations portant, however, to understand from the available
Market share Relationships of market share to key financial and operating ratios for overall PIMS sample of businesses Financial and 20%-30% Over 40% ent/sales 67.74 14.08 13.96 Inventory/sales 9.30 3一 Pretax profit/sales 0.16 4.84 1316 Purchases/sales Manufacturing/sale 3176 Marketing/sales R&D/sales 260 一 Capacity/utilization 74.70 77.10 78.10 78.00 Product 20.40 43.00 Relative price 2.65 Number of businesses Average value on 5-point scale o or more lower than leading competitors average; 1= 10% or more higher than competition information how much of the increased profitability ing shares over 4o%, we are not observing differences that accompanies high market share comes from in costs and profits within a single industry. Each each of these or other sources subgroup contains a diversity of industries, types of products, kinds of customers, and so on Differences between high-and How market share relates to roi low-share businesses The data in Exhibit II reveal four important differ- ences between high-share businesses and those with Analysis of the PIMS data base sheds some light on smaller shares. The samples used are sufficiently the reasons for the observed relationship between large and balanced to ensure that the differences market share and ROI. Businesses with different between them are associated primarily with varia market-share levels are compared as to financial and tions in market share, and not with other factors operating ratios and measures of relative prices and These differences are product quality in Exhibit Il. In examining these figures, remember that the PIMS sample of busi- 1 nesses includes a wide variety of products and in. As market share rises, turnover on investment rises dustries. Consequently, when we compare businesses only somewhat, but profit margin on sales increases with market shares under Io%, say, with those hav- sharply. ROI is, of course, dependent on both the rate of net profit on sales and the amount of in- vestment required to support a given volume of 2. Boston Consulting Group, Inc, Perspectives on Experience (Boston, 1968 sales. Exhibit II reveals that the ratio of investment and 197o to sales declines only slightly, and irregularly, with 3. This general argument has been made in numerous books, articlc speeches dealing with antitrust economics, see, for example increased market share. The data show too that ca Indnstrial Organization, and edition (New York, John Wiley & Sons pacity utilization is not systematically related to market share
Harvard Business Review January-February 197 Exhibit Ill Effect of vertical integration on investment/sales ratio Vertical Market share Under 10% 30%-40% Over 40% High 男m ExhibitⅣv Purchase-to-sales ratio corrected for vertical integration Market share Over 40% 28 46 On the surface then, higher investment turnover on sales exhibits a strong, smooth, upward trend as does not appear to be a major factor contributing to market share increases higher rates of return. However, this observation is subject to some qualification. Our analysis of the Why do profit margins on sales increase so sharply pims data base shows that investment intensity (in- with market share? To answer this, it is necessary vestment relative to sales tends to vary directly with to look in more detail at differences in prices and a business's degree of vertical integration. operating expenses (The degree of vertical integration is measured as 2 the ratio of the total value added by the business to The biggest single difference in costs, as related to its sales. Both the numerator and denominator of market she n the purchases-to-sales ratio. As the ratio are adjusted by subtracting the pretax in- shown in IL, for large-share businesses-those come and adding the PIMS average ROI, multiplied with shares over 40%-purchases represent only 33% by the investment. J of sales, compared with 45% for businesses with shares under Io% Vertical integration thus has a strong negative rela tion to the ratio of purchases to sales. Since high How can we explain the decline in the ratio of pur- market-share businesses are on the average some- chases to sales as share goes up? One possibility, as what more vertically integrated than those with mentioned earlier, is that high-share businesses tend smaller shares, it is likely that investment turnover to be more vertically integrated-they"make/rather increases somewhat more with market share thanthan"buy, and often they own their own distribu- the figures in Exhibit II suggest. In other words, as tion facilities. The decline in the purchases-to-sales shown in Exhibit Ill, for a given degree of vertical ratio is quite a bit less see Exhibit IV) if we control integration, the investment-to-sales ratio declines for the level of vertical integration. A low purchases significantly, even though overall averages do not. to-sales ratio goes hand in hand with a high level of vertical integration Nevertheless, Exhibit ll shows that the major reason for the ROI/market-share relationship is the dra- Other things being equal, a greater extent of vertical matic difference in pretax profit margins on sales. integration ought to result in a rising level of manu- Businesses with market shares under Io% had aver- facturing costs. For the nonmanufacturing business- age pretax losses of oI6%. The average ROI for busi- es in the PIMS sample, "manufacturing" was defined nesses with under Io% market share was about 9%. as the primary value-creating activity of the busi Obviously, no individual business can have a nega. ness. For example, processing transactions is the tive profit-to-sales ratio and still earn a positive ROI. equivalent of manufacturing in a bank. But the The apparent inconsistency between the averages data in Exhibit II show little or no connection be- reflects the fact that some businesses in the sample tween manufacturing expense, as a percentage of incurred losses that were very high in relation to sales, and market share. This could be because, de sales but that were much smaller in relation to pite the increase in vertical integration, costs are investment In the PIMS sample, the average return offset by increased efficiency
Market share This explanation is probably valid for some of the important cost advantage from their ability to utilize businesses in the sample, but we believe that, in the the most efficient mass-advertising media majority of cases, the decline in costs of purchased materials also reflects a combination of economies In addition, leading brands of consumer products of scale in buying and, perhaps, bargaining power in appear to benefit to some extent from a"bandwagon dealing with suppliers. Economies of scale in pro- effect"that results from the brand's greater visibil- curement arise from lower costs of manufacturing, ity in retail stores or greater support from retail marketing, and distributing when suppliers sell in store sales personnel. For example, Anheuser-Busch large quantities For very large-scale buyers, custom- has for some time enjoyed lower advertising costs designed components and special formulations of per case of beer than its smaller rivals-just as the materials that are purchased on long-term contracts advertising expense per car of General Motors is may offer"order of magnitude"economies significantly lower than that of other competing auto manufacturers Still another possible explanation of the declining purchases-to-sales ratio for large-share businesses 4 might be that they charge higher prices, thus in- Market leaders develop unique competitive strategies creasing the base on which the percentage is figured. and have higher prices for their higher-quality prod This does not, however, appear to be the case ucts than do smaller-share businesses. The figures in Exhibit ll do not show smooth, continuous relation In Exhibit II we give measures of price relative to ships between market share and the various com- competition for each group of businesses that in- ponents of price, cost, and investment.Indeed, it dicate otherwise. Because of the great difficulty of appears that one pattern operates as share increases computing meaningful relative price-index numbers up to 40%, but a somewhat different pattern above the measure we used here is rather crude. We asked that figure the PIMS participants to indicate on a five-point scale whether their prices were"about the same"as major Particularly, there are substantial differences in rela competitors,"somewhat"higher or lower, or"sub- tive price and product quality between market lead stantially higher or lower for each business. The ers and the rest of the sample Market leaders obtain average values of this scale measure are virtually higher prices than do businesses with smaller market identical for each market-share group, except for shares. A principal reason for this may be that mar- those with shares over 4o% ket leaders also tend to produce and sell significantly higher-quality products and services than those of Despite the similarity of relative prices for the first their lower-share competitors four share groups, the purchases-to-sales ratios de- cline in a regular, substantial fashion as share in- We measured quality as follows: We asked the par creases In light of this, we do not believe that the ticipating companies to judge for each business the decline in purchase costs is a reflection of higher proportions of total sales comprised of products and price levels imposed by "market power. services that were "superior, ""equivalent, "and"in- ferior"to those of leading competitors. The figures 3 shown in Exhibit II are averages of the differences As market share increases, there is some tendency between the superior quality and the inferior quality for marketing costs, as a percentage of sales, to de. percentages cline. The difference in marketing costs between the smallest and largest market-share groups amounts The measures we used for relative price and relative on the average to about 2% of sales. We believe that quality are not, of course, directly comparable. Thus this reflects true scale economies, including the it is impossible to determine which is greater-the spreading of fixed marketing costs and the ability price premiums earned by market leaders, or the dif of large-share businesses to utilize more efficient ferential in the quality of their products. But it is media and marketing methods. In the case of indus- clear that the combination of significantly higher trial products, large scale permits a manufacturer prices and quality represents a unique competitive to use his own sales force rather than commissioned position for market leaders. agents and, at some point, to utilize specialized sales forces for specific product lines or markets For con- Market leaders, in contrast to their smaller com sumer goods, large-scale businesses may derive ar petitors, spend significantly higher amounts on re search and development, relative to sales. As shown