This piece first appeared as Steve Wunker's piece for Ivey Business Journal
By Steve Wunker
Capturing new markets is an excellent way to grow. But if such markets were easy to crack, they would not hold so much potential for profit. By using strategies appropriate for this unique business environment, companies can vastly improve the odds that they will triumph in this uncertain terrain. Readers of this article will learn how to develop and execute five important strategies.
The greatest business successes in history – from Standard Oil to Facebook – have stemmed from the company’s ability to capture new markets. Tapping into fresh types of consumption – new products, customers, or occasions – can create vibrant, long-term growth for companies in old and new industries alike. These markets can generate additional sources of profit, bolster the position of firms’ related businesses, and keep competitors always on the defensive.
Unfortunately, such goals are very tough to achieve. A big challenge is the need to adopt strategies well suited to these new markets. Much as the principles of Newtonian physics break down on a nano-particle scale, the traditions of business strategy in established fields fail to provide appropriate guidance for capturing new markets. As this article will show, a distinctive approach is essential.
The task is worth the effort. For companies in mature industries, breaking in to new markets can expand the full potential of their business. Look at the example of Green Mountain Coffee Roasters. In a highly competitive, long-established industry, Green Mountain built a new source of growth by buying an obscure start-up called Keurig, which made machines that brewed single servings using a lock-and-key system of proprietary coffee cartridges. Both office customers and home users embraced the Keurig system for its convenience and low up-front cost. While consumer brands were fighting each other in the grocery store, and Starbucks struggled against rival coffee bars, Green Mountain cleaned up. Revenues from its Keurig business in 2010 were US$728 million, not bad for a business purchased for just US$104 million in 2006.
Indeed, companies in established industries can look to countless examples of rejuvenation through the opening of new markets. For example, in just two decades, Exchange-Traded Funds became so popular that they created a $1.5 trillion segment of the total asset management sector. Enterprise Rent-A-Car grew to become a giant in its industry, with over 150 locations throughout Canada, by emphasizing its neighborhood locations and avoiding the giants serving business travelers at the airport. Walgreens has become the U.S. leader in workplace health clinics, reinforcing its pharmacy business in the process. Though these are not the high-tech businesses that many first think of when talking about new markets, they can be major contributors to corporate growth.
Of course totally new industries produce winners as well. Twelve out of the twenty-five largest firms in Canada began operations in industries that were once new, from telecommunications to rail transportation and energy production. Today, start-ups abound in new industries, not just in technology, but also in low-tech fields such as garage organization systems and dog waste removal.
The Distinctiveness of New Markets
If new markets are so enticing, why do established companies often struggle in them? A big reason is that their traditional approaches to charting strategy can fail utterly in these unique environments. Tools such as those for tracking market share, competitive offerings, and profit-margin trends accomplish little when the customer, competitive products, and the extent of competition are all mostly unknown. The use of familiar tools is predicated on a world where trend lines can be extrapolated, and the universe of customers and competitors is understood. Clearly, those conditions do not apply in new markets.
The differences between new and established markets also extend to the reasons why companies plan strategy in the first place. In large firms, strategy is a mechanism for allocating annual budgets and holding people accountable. It is a way for top executives to exert control over their companies. Yet a firm grafting this process onto dynamic new markets risks missing important opportunities. This is due to the lack of flexibility inherent in the firm’s control systems, as well as the tendency to become wedded to losing propositions simply because they are the basis of the current year’s plan. In a dynamic environment, strategy is seen a means of choosing between the innumerable options a company has for developing products, customers, and business partners; it provides a lens for making tough decisions, but it does not create a compass pointing in one fixed direction.
Whether they work for big companies or tiny start-ups, individuals crafting strategy for new markets should pay attention to five critical ways in which their approaches should differ from developing strategy for established markets.
1. Generate demand before vanquishing competitors
Strategists often see their blueprint as a tool for beating the competition. However, the real battle in new markets is not against another firm trying to tap the same opportunity, but rather one against customer inertia. The imperative is to jumpstart demand for a new offering. It does not matter who the dominant player is in a marketplace that barely exists. The fact is that nobody is winning.
In the quest to convert wavering prospects into buyers, competitors can be allies. They help educate customers, call attention to the fact that a new category should be taken seriously, and reduce the perceived risks of making a new kind of purchase. When the companies built on the concept of using cell phones as interactive marketing tools were first formed, they struggled to be seen as a legitimate option by marketers accustomed to using glitzy ads and splashy Internet banners. A succession of firms calling on the big accounts gradually changed perceptions, making it easy for large firms to experiment without forever tying themselves to an unfamiliar vendor. The companies banded into an industry association that publicized successes, shared best practices, and established a code of conduct. Once the mobile marketing industry gained traction, the firms could then stress their differences from rivals and focus more intently on grabbing market share.
2. Time market entry rather than move immediately to exploit opportunities
New markets are littered with firms that were too concerned about being “first in.” Though they led the market they were out in front too early. Friendster, VisiCalc, and Diners Club each had dominant positions in their industries, but it did not take long for them to lose their advantage. In some new markets, it is possible to be a follower and still do well.
The first imperative is to recognize when pioneers have the upper hand. Zipcar, for instance, has 80 percent of the North American market for hourly car rentals, and giants like Hertz have had little success in dislodging it. The company has captured many of the best customers and locations, and it has “Kleenexed” its category to be the brand consumers most frequently associate with the hourly proposition. In a very different industry, The Wiggles are far-and-away the world’s leading rock band catering to young children. They have a television show, cast of well-developed supporting characters, major concert tour, line of toys, and many other advantages that upstart musicians just cannot match, particularly in catering to an audience not looking for fresh hits. Early movers can entrench themselves if they can create entry barriers, avoid locking-in to inappropriate models, and have minimal upfront costs. Table 1 shows how Zipcar and the Wiggles have done these things well.
If an industry is immune to these early-mover advantages, fast followers stand a chance. They have a few strategic options. Facebook was able to surpass Friendster by focusing initially on the well-defined market of university students. Although Friendster had many more users at first, Facebook needed just a few hundred on a campus to establish critical mass.
Another option is to ride a different horse into the market, tying a venture’s fortunes to a powerful platform gaining momentum. Excel vanquished the first popular spreadsheet programs such as VisiCalc and Lotus 1-2-3 by being the first to run on Microsoft’s Windows.
A third route to success is to leverage the power of a network. Bank of America had modest success with its credit card offering in the early 1960s, in the face of Diners Club’s early advantages. However, it executed a strategic masterstroke in 1965 when it licensed its card operations to banks in other states, instantly creating a network of institutions eager to push both consumer uptake and merchant acceptance. Now called Visa, this program has gone on to dominate a massive industry.
3. Sell to customers directly before leveraging powerful sales channels
Channels form a sort of superhighway for commerce – so long as all the traffic is moving predictably to well-known destinations, they offer important infrastructure and supporting services. However, when a destination is poorly understood and the route to it may require revisions, it is better to take a country road. A country road strategy requires that a company sell directly to customers and rely less on outside partners. There is more work to be done on the country road, but such a route offers better control, flexibility, and immediate learning from customers. See Table 2 for criteria on when to choose a superhighway or country road.
Ultimately a market may mature to the point that channels become interested in the proposition. If this occurs, a company may need to ramp up on to the superhighway. This can be a hard transition. David Aronoff, a leading venture capitalist at the firm Flybridge Ventures, puts it this way, “Sometimes channels trying to push boxes will need a company’s direct sales force to help educate the customer. Every customer has to bring a few customers to the table through initial direct sales, and then channels will be interested in partnership.” This arrangement can seem unfair to the pioneering firm shouldering the cost of both a direct sales force and channel margins. But it is a price of doing business in a new market, rather than an established one.
4. Win in targeted footholds prior to targeting big markets
Somewhat counter-intuitively, the quickest path to getting big in a new market is to aim small. By creating a proposition that is good enough only for a particular type of buyer in a foothold market, firms avoid the time and expense required to satisfy broad swaths of customers. The company then has a narrow target for its sales efforts. It also can attain scale within the niche, such that early customers can serve as useful positive references even if their experiences would be meaningless to people outside the foothold.
Some of the first smart phones created around 2000 by industry leaders such as Nokia, Ericsson and Motorola, were elegant pieces of technology. These companies had grand visions of how important smart phones could become, and they crammed dozens of features into the devices in an effort to lead the new market. The machines synchronized calendars, contained addictive games, and even sent faxes. They were also complicated, expensive, and poorly targeted. By contrast, the upstart company, Research in Motion (RIM), produced a device, launched in 1999, that was little more than a two-way pager. It did not even handle phone calls. But the device was carefully aimed at a foothold market of corporate managers and their IT staffs, and it provided both a high-quality keyboard and secure enterprise data access. RIM soon became famous in this niche, and it expanded steadily from there.
5. Retain flexibility instead of trying to leverage fixed costs
In established industries it is important to establish scale and leverage fixed costs, but in new markets companies need to be nimble so as to experiment easily. It does no good to take the cost-efficient route to the wrong destination. Joseph-Armand Bombardier learned this lesson well. In 1937 he invented a tracked snowmobile bus that could be used during heavy winters in his native Québec. Rather than scale up the business with fixed costs, he fashioned the early vehicle bodies out of wood and sourced his engines from third parties. His eponymous company was therefore able to shift quickly into the production of All Terrain Vehicles (ATVs) for the mining, oil, and forestry industries, where, as he discovered, there was demand for tracked machines. Later, he found that the big demand for snowmobiles was not for bus-like contraptions but rather for small vehicles used largely for recreation. Because he had kept his approach flexible, Bombardier could shift quickly into new uses for his core tracked-vehicle technology and attain strong positions in a host of new markets.
Especially in large firms, managers will often spend a great deal of time charting customer segments, running studies of price sensitivity, and estimating demand for new products. They will then create complex spreadsheets arriving at detailed financial estimates for new markets’ viability, just as they would for established markets.
The problem is that data on new markets are either inherently backward looking or even fictional. In 1980, AT&T commissioned a major study to estimate the global demand for cell phones in the year 2000. The answer: 900,000 (they were off by 750 million). Detailed financials are critical for investments that require a big upfront cost and reliable estimates of demand, but neither one is a factor in new markets. The numbers may be soothingly convincing, but they distract attention from what matters.
The success or failure of a new venture often comes down to a handful of risks that can be identified up-front. Accordingly, spreadsheets can focus on the implications of a small number of variables and what assumptions would need to hold true for the venture to be viable. This is the critical discussion to have. If managers can understand those risks better, they will either fail quickly and with little expense, or they will learn enough to re-direct their ventures and be successful.
Once managers have singled out the key risks and uncertainties, they can target a foothold market. The purpose of a foothold is to provide a fast entry point, so it is essential that the first customers is adopt new offerings quickly. It can be tempting to pursue a large marquee customer as a ringing endorsement of the new proposition, but these buyers can be highly demanding and slow moving. Before the leading battery maker A123 Systems installed its advanced devices to power the Chevrolet Volt, it focused on the foothold market of power tools. That industry took much less time to penetrate than the one for major automakers, and it provided fast, real-world feedback about A123’s solutions. Campbell Soup has a similar philosophy in a very different business – to test a new concept, it will set up “lemonade stands” in grocery stores to see who is willing to buy the product, and for how much. Rather than spending countless hours making projections in a conference room, these companies get real products to actual customers, fast. That experience provides learning that no deck of slides can match.
Like any good venture capitalist, an established company pursuing new markets needs a portfolio of investments. The average venture fund exceeds the rate of return of public companies by about 25 percent, and yet 60-70 percent of its investments will be total write offs. The secret to success is to fail quickly and cheaply, and then to double down on the winners. To do so, a fund needs a portfolio of opportunities that balance varying types of risks and maturity, much as a personal investment portfolio would do. In established markets, companies can carefully pick a few shots, but in new markets humility matters. Despite the best preparations possible, there will always be surprises.
The challenge of new markets is the flipside of their allure. If they were easy to crack, they would not hold so much potential for profit. By using strategies appropriate for this unique business environment, companies can vastly improve the odds that they will triumph in this uncertain terrain.