A Profitable Market Is Not an Available One

A management team asks the board to fund entry into a market it does not currently serve. The analysis is already done, and it is sound: companies in that market earn better margins than the company earns today, the market is large enough to make a difference to the company's results, and the money comes back fast enough to clear the company's rule for approving investments.

What the team treats as settled, and never has to argue, is that the margin in that market is available to anyone who goes after it.

Sometimes the margin is available. More often it is the result of work somebody else finished: a product customers will pay more for, engineering that keeps it ahead, and relationships that let the supplier hold its price when the customer's buyers push for a cut. By the time a market shows margins like that, companies are established there, and the margin proves their work succeeded.

What a profit pool map shows

In most industries, profit is not spread evenly across the market. It is concentrated in a few places. One product line earns most of the profit while another the same size earns almost none, or the service work earns a better margin than the equipment it supports.

Those concentrations are the industry's profit pools, and companies map them to see which parts of their industry earn the most operating profit. Wherever the map shows a concentration, the management team has its case for entering.

The strongest version of that case is a market where customers are not being served well. The companies supplying them have gotten comfortable, the product has not changed in years, or a better operator could take the work away. That is sometimes true, but it cannot be a starting assumption. Market research has to show that customers are underserved before the company commits the capital.

Entering a new market

Breaking into a market where profit already exists means bringing the customer something they cannot get from their current supplier: a product that does more, a different answer to the problem, or something else that creates more value than what they buy today. Without one of those, the only thing left to offer is a lower price.

A lower price will win orders, because it is the one thing a buyer will always take. It also brings margins down across the market, starting with the margin that made the market attractive in the first place.

A company without that advantage will often look at cost instead, on the theory that it can supply the same product for less and win the business on price. That means taking costs out of its own operations: in an industrial business, running a tighter plant, buying materials better, and staffing to demand.

The companies already in the market have been working on all of that for years, and so have most companies that might enter. A supplier can no longer separate itself on cost.

Entering a market takes time to pay off. Learning what unfamiliar customers need means getting close enough to see how they operate, which in industrial markets means putting engineers on their sites and their production floors.

Building the capacity to supply them takes longer, and getting the product into the field and accepted takes even longer. The opportunity the team found in the analysis may no longer exist by the time all of that is done.

A profitable market does not stay profitable

Every market has a life cycle: it starts out, grows, develops, and matures, and its profitability changes at each stage. A market that was once profitable will not always be profitable, and the time a company can hold margins above its industry average keeps getting shorter.

The life cycle causes a second problem for the analysis, and it is the reverse of the first. In a market's development and growth years, suppliers invest heavily, so the market's profitability can make it look unattractive. Suppliers spend before they earn, and the analysis measures only what they earn.

A company entering a market still in development has to judge where the market will be years from now. That means projecting volume and margin forward, and the projection can differ from today's numbers in either direction.

A market earning little today can become profitable once someone brings a better solution into it. A market earning well today may have no margin left for the next company that enters it.

Reading which way a market is moving

Finding a profitable market is only part of the exercise. The other part is knowing which way that market is moving, and four things answer that: volume, the number of companies entering, margin, and the ingenuity going into what the market buys. Each can increase or decrease, and they do not always change in the same direction.

Volume. Demand in the market is growing, flat, or shrinking, and where a new supplier's orders come from depends on which. A growing market has room for another supplier, because the orders coming into it are new. In a flat market, every order a new supplier wins comes out of an established competitor's existing business, and that competitor will defend it on price.

Number of companies entering. Suppliers moving into a market are a sign that other companies saw the same profitability. Each one arrives needing to win business from someone who already has it. When several arrive at once and demand is flat, price competition starts before any single competitor announces a price move.

Margin. The margin to watch is the one across the market as a whole. A company's own margin is not a reliable guide, because one supplier can hold its price while margins fall across the rest of the market. When margins are falling across the suppliers in a market, most of the extra profit is already gone.

Ingenuity. The question is whether anyone in the market is still bringing new answers to it, or whether every supplier has settled into delivering the same thing the same way. A market still drawing ingenuity has room for a supplier with a better answer to the customer's problem. Where no supplier is bringing one, customers have nothing to choose between except prices.

A company reading all four together can see what stage the market has reached and which way it is heading. However, they do not answer the second question, which is about the company itself: can it compete there, with what it offers now and what it can build while the opportunity still exists.

The market no one had built yet

Entering a market someone else built is one path. A company can also build the market, and that is where some of the strongest positions come from.

At one of the companies I worked for, nobody asked us to do what we did. Our engineers found an opportunity no supplier was serving yet. Our customers bought a component from us, sourced the other pieces from several suppliers, and assembled the finished product themselves in the field.

Every supplier in that chain charged for its own handling, its own testing, and its own margin, so the customer was paying for the same work more than once. Our engineers spent enough time in those operations to see what that cost, and a few of them asked what it would take to close the gaps between those separate products and deliver the whole assembly ready to use.

We built the complete assembly and sold it ready to use. By taking the duplicated costs out of the supply chain, we created a larger, more profitable market than the one that existed before. Total operating profit in that market was higher after the product launched.

What made it work is the condition any entry has to satisfy: the price has to be lower than the value the product creates for the customer. Ours cost more than the component it replaced. It also saved the customer enough in their own operation that they came out ahead buying it, so the conversation with them was about what they gained rather than what they were spending.

Why answering a specification is not enough

Our customer did not ask for that product. A customer who asks for something has already worked out what they want and written it down. The customer can send that specification to any supplier, and every one of them can read it as easily as we could.

A supplier filling a requirement someone else wrote has no room for ingenuity, and without ingenuity, the only way into a market where profit already exists is a lower price.

The usual case for entering a market depends on showing that customers are underserved. Research can settle that, because how a market is served today is already visible to anyone who looks.

Where the market is heading is a different question, and a company has to model it. It builds that model from what its people learn by standing close enough to customers to see what they have not asked for yet.

For a closer look at which customers to pay attention to, see Where the Profit Actually Lives.

What goes on the page

All four measures fit on one page for any market a company is considering. Flat volume, more suppliers arriving, and margin compressing across the market describe a market late in its life, whatever its current profitability shows.

One thing more belongs on that page: what the company will bring to those customers that the suppliers already serving them cannot. If the answer is a lower price, the margin in the request is a forecast the position will not produce.