Earlier this week, I was reading and article written in the 1980s by Michael Porter of Harvard Business School. The article discussed fragmented markets.
the following factors are indicators of a potentially fragmented market:
- The market is populated by a large number of small and medium-sized companies. Often these are family-owned firms.
- Often there is an absence of a clear market leader with the power to shape the market.
- The market is characterised by differentiated products.
- The market is most likely technologically sophisticated. This does not mean that it competitors are cutting edge firms but that specialist equipment is required to operate in the market. the example given by Porter is a distiller who needs specialist equipment like coppers and condensers.
Markets become fragmented through underlying economic causes. The market will have low entry barriers. If entry barriers were high, there wouldn’t be so many small firms in it.
There is an absence of economies of scale and there is no steep learning curve.
There are high transportation costs in the market which means production must be local to the end user and there is a limit on the size of production plant.
There are high inventory costs and erratic sales fluctuations. An example would be a musical instruments retailer. Inventory costs are high and you will likely have to hold onto stock for a significant period of time. There will be times when sales are low and times, like Christmas, when sales are high.
There will be no advantage with organisational size when dealing with suppliers and buyers. Suppliers may be so large that even the biggest firms in the market have no discount leverage. Alternatively, there are lots of small suppliers in the market and large powerful retailers e.g. the Supermarkets.
A fragmented market will have some diseconomies of scale. This is and important factor in fragmented markets. This could be caused by rapid product change e.g. high fashion or technological advances. Market companies may need to have a wide product range. For example, guitar manufacturers often need to make a wide range of models to suit different musical styles such as classical nylon string guitars, steel string acoustics, hollow body jazz guitars, rock guitars with humbucker pick-ups, etc.
Consumers in fragmented markets have diverse needs. So, again with guitars, some players prefer Gibson guitars with fat necks, others prefer Fender guitars with slim necks. Often the choice of instrument goes with the style of music. Heavy metal guitarists will prefer Jackson or Schechter guitars. Progressive rock players will like Ibanez Gems. Market companies will often offer bespoke products and some market consumers will pay a premium to obtain them. Instrument manufacturers like Fender, Gibson and Paul Reed Smith have custom shops where instruments are made to the requirements of individual consumers.
Products in fragmented markets have distinct product images which results in product differentiation. So some musicians will sign for specialised labels dealing with jazz, indie, classical or dance music rather than signing for a major multi-segment company like EMI or BMG. This may be because of the image the band or musician wants to develop.
A fragmented market may have exit barriers. These keep marginal firms in the market so as to avoid these exit barriers. this means that the market cannot consolidate.
fragmented markets often have local regulation i.e. there are British Standards in the industry not European Standards or International standards. Such local regulation restricts the size and scope of the market.
Government may prohibit such consolidation within a market. For example, the UK government has rules regarding media plurality so one company cannot dominate the newspaper sector.
Fragmented markets are often new markets where no one firm has yet developed the skills and resources to command significant market share.
I’m sure the above criteria are known to many readers of this blog!
So how do you cope in a fragmented market?
Industries are all different so there is no ‘one size fits all’ solution to the fragmented market situation. Porter developed his generic marketing strategies; Differentiation, Cost Focus and Niche; with fragmented markets in mind.
To survive in a fragmented market companies will need:
- Tightly-managed Decentralisation: Local management and operations are vital. there may be high levels of personal service. Senior management must also have tight control of what their local managers are doing. It requires a careful balance between central control and the ability for small offices to be as autonomous as possible. this will likely mean tight targets for local managers and performance related rewards.
- Formula Facilities: For example, Macdonald’s Drive-through restaurants are often built to a common set of plans. In fact, the building may arrive prefabricated on the back of a lorry. Hotel chains will have identical room layouts and décor.
- Increased value-added: You could offer increased service levels to accompany a sale or allow local managers to part fabricate finished product e.g. dealer vehicle specifications.
- Specialisation by Product Type or Market Segment: So Ferrari operate in the sports car market; they do not make people carriers.
- Specialisation by Customer Type: Target certain customers within a market, so Top Shop targets teenagers whilst other clothes retailers will target the over-40s.
- Specialisation by Type of Order: An off-licence will sell wine by the bottle but a retail wine merchant will sell wine by the case. Direct marketers like Laithwaites sell wine by the mixed half dozen bottles. You may offer quicker delivery, smaller minimum order sizes or be less price sensitive than your customers. You may develop the ability to take custom orders.
- Geographic Focus: You may concentrate on certain parts of a country or region. This allows you to economise on the size of your sales force or to have more efficient advertising. you might only need one distribution centre.
- Bare Bones: You may develop a no frills position in the market with low overheads, low staffing costs and lower margins. This may give you the best position to compete on price.
- Backward Integration: You integrate your suppliers into your business and put pressure on your competitors who cannot afford such expenditure.
The article by Porter was written in the late 1980s. Looking at it in 2020, where we have technological disruptors, mass customisation, and markets are increasingly fragmented, Porter’s guidance is particularly apt.