The March–April 1974 issue of HBR carried an article that reported on Phases I and II of a project sponsored by the Marketing Science Institute and the Harvard Business School. The basic purpose of the project is to determine the profit impact of market strategies (PIMS). The earlier article established a link between strategic planning and profit performance; here, with additional data, the authors come up with a positive correlation between market share and ROI. The authors discuss why market share is profitable, listing economies of scale, market power, and quality of management as possible explanations; then, using the PIMS data base, they show how market share is related to ROI. Specifically, as market share increases, a business is likely to have a higher profit margin, a declining purchases-to-sales ratio, a decline in marketing costs as a percentage of sales, higher quality, and higher priced products. Data also indicate that the advantages of large market share are greatest for businesses selling products that are purchased infrequently by a fragmented customer group. The authors also analyze the strategic implications of the market-share/ROI relationship. They conclude by advising companies to analyze their own positions in order to achieve the best balance of costs and benefits of the different strategies.
It is now widely recognized that one of the main determinants of business profitability is market share. Under most circumstances, enterprises that have achieved a high share of the markets they serve are considerably more profitable than their smaller-share rivals. This connection between market share and profitability has been recognized by corporate executives and consultants, and it is clearly demonstrated in the results of a project undertaken by the Marketing Science Institute on the Profit Impact of Market Strategies (PIMS). The PIMS project, on which we have been working since late 1971,1 is aimed at identifying and measuring the major determinants of return on investment (ROI) in individual businesses. Phase II of the PIMS project, completed in late 1973, reveals 37 key profit influences, of which one of the most important is market share.
There is no doubt that market share and return on investment are strongly related. Exhibit I shows average pretax ROI figures for groups of businesses in the PIMS project that have successively increasing shares of their markets. (For an explanation of how businesses, markets, and ROI results are defined and measured in the PIMS project, see the sidebar.) On the average, a difference of 10 percentage points in market share is accompanied by a difference of about 5 points in pretax ROI.
While the PIMS data base is the most extensive and detailed source of information on the profit/ market-share relationship, there is additional confirming evidence of its existence. For instance, companies enjoying strong competitive positions in their primary product markets tend to be highly profitable. Consider, for example, such major companies as IBM, Gillette, Eastman Kodak, and Xerox, as well as smaller, more specialized corporations like Dr. Scholl (foot care products) and Hartz Mountain (pet foods and accessories).
Granted that high rates of return usually accompany high market share, it is useful to explore the relationship further. Why is market share profitable? What are the observed differences between low- and high-share businesses? Does the notion vary from industry to industry? And, what does the profitability/market-share relationship imply for strategic planning? In this article we shall attempt to provide partial answers to these questions by presenting evidence on the nature, importance, and implications of the links between market share and profit performance.
Why Market Share Is Profitable
The data shown in Exhibit I demonstrate the differences in ROI between high- and low-market-share businesses. This convincing evidence of the relationship itself, however, does not tell us why there is a link between market share and profitability. There are at least three possible explanations:
- Economies of scale: The most obvious rationale for the high rate of return enjoyed by large-share businesses is that they have achieved economies of scale in procurement, manufacturing, marketing, and other cost components. A business with a 40% share of a given market is simply twice as big as one with 20% of the same market, and it will attain, to a 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 by the Boston Consulting Group.2 According to BCG, total unit costs of producing and distributing a product tend to decline by a more or less constant percentage with each doubling of a company’s cumulative output. Since, in a given time period, businesses with large market shares generally also have larger cumulative sales than their smaller competitors, they would be expected to have lower costs and correspondingly higher profits.
- Market power: Many economists, especially among those involved in antitrust work, believe that economies of scale are of relatively little importance in most industries. These economists argue that if large-scale businesses earn higher profits than their smaller competitors, it is a result of their greater market power: their size permits them to bargain more effectively, “administer” prices, and, in the end, realize significantly higher prices for a particular product.3
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