Market Share vs Profit Share: Which Path Should Startups Choose To Work Towards
The Dilemma Of Every Entrepreneur
“Build something 100 people love, not something 1 million people kind of like.” — Brian Chesky.
Photo by Sean Pollock on Unsplash
14 Years. That is the amount of time it took Amazon to be called a Profit Making business. The year was 1997, and Jeff Bezos openly writes to his new investors a letter stating the importance of Market Share.
It’s All About the Long Term
We believe that a fundamental measure of our success will be the shareholder value we create over the long term. This value will be a direct result of our ability to extend and solidify our current market leadership position. The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital.
That year Amazon’s sales increased by 838%, and their new customer accounts grew by 738%. Despite this insane level of growth, they were still a loss-making entity for another six years after 1997.
From 2003 onwards the company has been showing an increase in its profits at a rate of 15% or more. In 2019 they reported a net profit of over USD 11 Billion.
This business model of focusing on Market Share rather than Profit Share seemed to have paid off so well in the Long Term for Bezos and his company that almost every Startup in the world began following the same approach. What made this strategy come to life apart from the thriving example of Amazon was the belief that financiers and investors had in it.
They believed that if a business has a unique business proposition and founders who understand the market and niche they want to operate in, then the only help it needs is financing it with a little bit of touch up in execution and publicity.
Before we get into discussing the pros and cons of whether the Market Share Approach will work for businesses today, let’s take a look at a company which focuses solely on the Profit Share model.
Apple — The Profit Share Approach
Anybody who knows anything about Apple, understand that the company will never try and sell the most of any of their products. This holds about their Computers, iPods and their iPhones. Steve Jobs ensured that the pricing of his products only tried to capture less than 5% of the market share.
Here is a quick recap of the pricing of Macintosh computers. When Macintosh was introduced in the market, an average computer was sold for USD 1500, whereas Apple sold theirs for USD 2500. An increase in the price of 66% in a premium product category of its time.
This strategy has continued since Steve Jobs started his second innings at Apple in 1996. One of the reasons Apple has close to only 20% of the smartphone market today compared to Android’s 80% is because their focus is purely on Profit Share.
While globally, Apple has 20% Market Share of the smartphone market, it enjoys a Profit Share cushion of 75%. No other company in this business is even a close second.
As of 2020, Apple, as a company, is valued as the most expensive company in the world at over USD 1.6 Trillion with over USD 200 Billion in Cash Reserves alone. Theoretically speaking, they can buy Tesla today with the money lying in their Bank Account, as Tesla’s market cap has just crossed USD 200 Billion.
Having seen two businesses which have been successful with their respective approaches, we notice a clear bias towards the Amazon Business model by new-age Startups. This begs the question, Why is that so?
If Amazon Can Do It So Can We
Amazon’s success with going after the Market Share has inspired not just companies but also investors to follow in those tracks. On a superficial and broader level, this looks possible. The approach of burning capital in the hopes of making a gigantic return in the future is the new social norm in the Startup universe.
What a lot of people seem to discount is the change in the environment today as compared to when Amazon started. Amazon was one of the first of it’s kind to get into the E-Commerce business at a time when it had a handful of competitors.
So while many Startups focus on business strategies that help them beat the competition, all Amazon had to do was invest in itself without worrying about who or what it would compete against. A brilliant case study on first-mover advantage.
Amazon’s success also had to do with the fact that the internet at that point of time was still a very limited commodity to have in houses across the world. In a way, the Internet and Amazon were both evolving together. As the internet got bigger, Amazon stood there in the shadows to leverage from its growth.
Compare it to the times today, and you will see that if as an Entrepreneur you started a Messaging App which hit off in one geography, the very next month there could be another Application offering the same service in another region. This is mainly due to the strength of technological connectivity we have today which companies did not have in the ’90s, which was another reason Amazon was able to grow.
Easy Access To Capital
Before the Tech Revolution, if an Entrepreneur had to raise money, there were only two places she/he could approach. The bank and friends & family. The bank would have asked for interest and collateral, and friends & family would have have had limitations to the amount of financial help they could offer.
After the 21st Century, there has been a significant change in having access to capital. The options, outreach and availability of people that can fund your business idea have increased by substantial magnitudes.
Having easy capital access makes it so much more convenient to raise money without really being held personally accountable for it if things don’t work out. Thus, picking a good business idea that stands out from the rest of the crowd is getting harder by the day.
If a business fails, the investors can look at the most blacklist you from the investing community, unlike the banks, where they could in some cases also sell your house to recover their dues, if that is what you pledged as collateral.
Naval Ravikant explains the situation best with this quote:
Raising funding for good businesses is (slowly) getting easier. But picking good businesses is getting harder.
Running After Market Share Can Dilute The Core Purpose Of The Business
Uber, since its inception in 2009, has been burning over a billion dollars a year to increase Market Share. Some years they have crossed two billion dollars, and in the last eleven years, Uber has acquired over 11 companies. Why?
First, They took a while but eventually realised that there is nothing proprietary and unique about a taxi service available on an App. They had multiple competitors in major economies that they tried to penetrate and realised that running after Market Share on a global scale was close to suicide.
Too many companies offering the same service and having unbelievable valuations meant Uber could not buy them out to eliminate competition.
This meant that Uber’s core business has reached stagnation or was about to decline. After 11 years and billions of dollars spent chasing Market Share, the company had neither Market Share nor Profits.
Secondly, realising that the taxi service was not going to reap the benefits they thought it would, Uber had no choice but to divert from its core business model towards Food Delivery.
Thus, they began Uber Eats and started acquiring competitors in that space as well. Sure, one can say that companies like Uber are learning to adapt to the changing business environment. However, that does not justify their track record of buying businesses and not having any profit to show for it for over a decade.
Companies today must take the Market Share approach to a business only if they have a unique product or service which cannot be replicated or caught up with. This is why Amazon was successful in its approach. They had the timing, insight, location and network advantage. How many businesses have even two of those today when they choose a similar path?
Having a primary goal to turn profitable is probably the best reality check an Entrepreneur can give oneself. When you think of profitability, you also think of the sustainability of the business in the long run.
Don’t hesitate to capture a small market share and have profitability as your primary goal. If you think a small market share is a disadvantage, think of luxury clothing brands such as Louis Vuitton, where the owner is worth over USD 110 billion today and the third richest man in the world.
See you next time…
But can we argue that Jio used the Market share approach to get rid of the competition and then monetise the business. And it seems to work for then. Your thoughts??