Finance: Never mind the width, feel the quality

Maximum market share, the goal of all good business planning, may be a red herring.
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The Independent Culture
IF THERE is a single guiding principle that is reckoned to be behind success in business, it is probably gaining market share. This is the thinking behind much of the current crop of mergers; for example, those that created the accounting behemoth Pricewaterhouse Coopers, "the world's biggest professional services firm". Aiming to be number one is seen as such a self-evidently grand strategy that to question it is thought of as naive in the extreme. Get lots of revenue and profits will inevitably follow, not least because of the resulting economies of scale, goes the argument.

But while this sort of approach may have worked for Lord Weinstock when he was building up GEC, it does not seem as powerful today as many merger partners would have you believe. Indeed, some of PWCoopers' rivals in the professional services field take the view that there are some clients they would rather not have, and there is a growing school of thought that believes that "market share is dead".

As Adrian Slywotzky and David Morrison of Mercer Management Consulting point out in their book The Profit Zone (John Wiley & Sons, pounds 16.99), some disturbing examples have subverted "the widespread faith in market share as the ultimate goal and guarantor of business success". Such well-known US companies as IBM, Digital Equipment, General Motors, Ford, Kodak and Sears Roebuck have achieved leading market shares and yet seen their profitability, and hence their share values, eroded during the 1980s.

Some of these organisations have recovered of late, but the authors attribute that recovery at least in part to focusing on profit, rather than just market share. In short, they have realised that, though market share was "the grand old metric, the guiding light, the compass of the product-centric age", it is no longer.

The thoughtful manager will probably have come to this conclusion, simply by looking around and seeing how many companies - particularly in the high-tech arena - have made healthy profits just by operating effectively in niches. But it is quite another thing to work out a way of turning a company focused on market share into one that concentrates on profitability.

Slywotzky and Morrison argue that this is dependent on understanding the concept of "no-profit zones", or the "black holes of the business universe". These come in various forms. They can be part of the value chain - for example distribution in computers. They can be customer segments - ie, consistent bad debtors, if you are a utility, or those who remain steadfastly in the black and carry out few transactions if you are a bank. They can be entire industries - for example, environmental remediation. Or they can be entire business models, such as the integrated steel mills that have been bested by the "mini-mills".

Once this concept is clear, the theory goes, managers will be able to identify "profit-zones". The Mercer consultants illustrate their case with instances of well-known business leaders such as Jack Welch of General Electric of the United States, former Coca-Cola chief executive Roberto Goizueta and Michael Eisner of Disney who have seen how they can create value for their organisations.

At Disney, for example, Eisner has used merchandise licensing to knit the empire together. Mickey Mouse, the Lion King and other characters are pressed into action to provide a common link between films, theme parks, hotels, videos and even clothes. There is little risk of somebody, particularly a child, just seeing a film, or visiting a theme park. It is little wonder that Slywotzky and Morrison reckon Disney is able to take as much of 75 per cent of a family's holiday spend - by owning the hotel, the theme park, the restaurants, the merchandise.

But this is not the only way of achieving the "right kind of growth". While Disney is not too fussy about who its customers are, so long as they spend lots of money, other companies clearly take the view that some customers are more valuable than others.

This is most apparent in financial services, where insurance companies, for instance, will refuse to take on certain high risks because their strategy is to offer low premiums to particular customers. This approach helps to explain how some new entrants to the market have proved very successful while older established names have often struggled. It also helps explain why the Texas-based company Dell is a darling stock of the computer business despite being a manufacturer of hardware, and therefore much less profitable, supposedly, than processor or software businesses.

According to Orit Gadiesh and James Gilbert, partners at the Bain & Co consultancy, the company founded in 1984 by Michael Dell got into trouble when it decided to break with its original strategy of selling by mail order. Going into retail produced plenty of growth - 50 per cent a year from 1989 to 1993 - but the company stopped making money and actually suffered losses.

In an article in the Harvard Business Review, Gadiesh and Gilbert quote Kevin Rollins, the company's vice-chairman, as saying that "Dell had lost its focus on the most profitable customer segments and on a distribution model that is at heart more efficient than what the retailer can provide."

Analysing the data, the company's executives concluded that retail was simply not a profitable channel for Dell - or for most other companies selling computers. Moreover, when the company pulled out of retail in 1994, it geared its business to serving only the most profitable segments of its customer base, such as large companies. In the years since then, the company has regularly "resegmented" its customer base, tracking shifts in what the consultants call the "profit pool" so that it can respond more quickly than competitors to changes in the market. And when it entered the mass consumer market, which it had habitually stayed away from, it took care - through the product mix and their pricing - to attract customers who are technologically more sophisticated, and hence more profitable, than entry-level buyers.

Profit zone or profit pool: though the detail is different, the concept is the same. Successful companies are realising that, even though going for growth is probably more sustainable than cost-cutting, growth alone is not enough. It is the type of growth that counts and that means acknowledging that not all customers are created equal - and that not all business is good business.