Debunking The Debunking Of The Market Share Myth

from the depends-on-what-you're-doing dept

Since so much of the economics we focus on around here look at the value of complementary goods to boost other markets, it caught my eye to see a former Forrester technology analyst, Carl Howe, claiming that using loss leaders to help grow another business has officially been debunked, and then using that claim to explain why Apple has been so successful lately. According to Howe, it's because the company focuses on profit first, rather than trying to build marketshare through the use of loss leaders. That struck me as odd, because a huge part of Apple's recent success has been its recognition of the importance of complementary goods and its ability to use music as a loss leader for its other products. This also comes just as we were pointing out how much of Google's success is also based on its recognition of the importance of complementary goods in building its own dominant position.

Howe points out one example from the report, supposedly showing that while Microsoft and Sony beat each other up fighting for marketshare in the gaming console space, Nintendo won by focusing on how it could profit from the Wii. That's somewhat misleading, and helps show why Howe is wrong in claiming that the focus on marketshare isn't important. In fact, half the problem that Sony has faced with the PS3 was that it was too focused on profit rather than marketshare initially. That is, it priced the PS3 way too high, trying to cover more of its costs, making it quite difficult for most people to afford it. The Wii's success had less to do with a focus on profit and much more to do with a focus on growing the overall market by expanding it into a new realm, attracting a different type of game console buyer.

It's that last point that's the key. An effective use of complementary goods isn't to take marketshare in a stagnant market (which is what the study Howe points to shows), but in using it to expand a market into new areas. That's what Apple has done. It's what Google has done and it's what Nintendo has done. That doesn't damn the use of loss leaders or complementary goods. Far from it. It shows how you absolutely should be using them to help expand primary markets for other goods allowing you to not only gain marketshare, but also profits. Howe acts as if the fight for marketshare and for profits are mutually exclusive. It certainly is true that focusing on marketshare exclusively doesn't make sense, but giving up some profits to focus on growing a market and taking marketshare in that new realm isn't just perfectly reasonable, it's the story behind many of the greatest business successes of all time.


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  1.  
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    Ajax 4Hire, Dec 27th, 2007 @ 7:31am

    so funny!, Internet web pages are loss leaders

    Web pages are free to the user.

    The web page leads users to places where they can spend money.
    It is not advertising in the old world sense in that many sites provide services, information, news, entertainment, search results and that leads the user to opportunities to spend money.

    Web Sites are the perfect example of loss leaders.

     

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  2.  
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    PaulT (profile), Dec 27th, 2007 @ 7:39am

    I'd actually have a slightly different view re: Sony vs. Nintendo:

    Sony suffered from the same hubris that Nintendo had suffered from during the 90s. Sony's big problem with that it had an eye on larger marketshare beyond the console market. It's well known that many people bought the PS1 instead of an N64 due to its CD playing capabilities. The PS2 was a reasonably-priced DVD player, and that acted as a trojan horse to push the PS2's success in that market.

    With the PS3, Sony had an eye on the next-gen DVD market, and decided to use the console as a trojan horse to push Blu-Ray. Unfortunately, the massive problems getting the Blu-Ray drives manufactured, combined with other costs (such as the Cell processors, another new technology) pushed the PS3 price up. Even this would have been fine if Nintendo had stayed on the "same system, but better" approach taken to the hardware of the last few generations, but they didn't.

    The PS3 would probably be a major seller, as well as a couple of hundred dollars cheaper, if they had taken Microsoft's lead and released Blu-Ray as a separate drive. The race isn't over, but it would take major mistakes from both Microsoft and Nintendo for Sony to "win" this round.

     

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    Duodave, Dec 27th, 2007 @ 8:17am

    Re:

    PaulT has some good points. An incremental system, essentially a PS2 with a Blu_Ray drive but priced under $250, probably would have paved the way for blu-ray dominance and let Sony concentrate on a next-gen system (such as what is offered with the PS3).

    As for the Nintendo Wii, I bought one but in comparison to the X-Box 360, the Wii is pretty gimmicky. It's genuinely too much work to play some Wii games (messed up my elbow playing Tiger Woods 07), the controller can be finnicky and imprecise, and the graphics are sub-par.

    In the future, I may end up buying Wii games that are only offered for the Wii, now that I have an X-Box 360.

     

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  4.  
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    David, Dec 27th, 2007 @ 8:28am

    I think the focus of the article is more on the R&D side of the business as opposed to the marketing once the products were on the shelf. Nintendo went in with the intention of creating a system that was profitable Day 1 with no loss per device sold. Microsoft and Sony went into development trying to capture a % of the existing market through upgraded systems. It was the focus at this stage on profit vs. market that made the long-term difference.

    One of the catches of innovation is that market share does not necessarily come with it. It was because Nintendo decided to be innovative that they also had to be profit focused. Similarly, when Apple first release the iPod it was an innovative product but priced for profit and not market share. Both companies, Nintendo and Apple, went in trying to make money off of an innovative product and wound up gaining market share as a by-product. The key third ingredient now becomes innovation.

    Innovation alone does not guarantee success which is why the profit motive becomes so important. Any successful product now becomes a driver for more innovation because the profits can be reinvested to allow a company to overcome poor performances in other products. Microsoft and Sony have put themselves in a situation where they have no profit-center for their lines if failure occurs. Nintendo would have had the ability to start again since they were not invested in the inventory in the market with the Wii.

    I guess my point is that market share is the by-product of good product design and should rarely be the focus of product development. Google, Apple, Nintendo, etc focus on the product design and price it to be profitable while hoping to win in the market. Sony and Microsoft focus on the market and its tolerance while hoping to win a profit with a generic design.

     

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  5.  
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    Anonymous Coward, Dec 27th, 2007 @ 9:41am

    Umm, has this twit ever looked into Gillette's marking practices? Razor handles are loss leaders - they make profits from razor blade sales. HP? Printers are loss leaders - they mark profits from ink cartridges.

     

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  6.  
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    Anonymous Coward, Dec 27th, 2007 @ 9:44am

    Re:

    Let's not forget mobile phone operators. Cell phones are loss leaders - the make profits from service sales. I'm sure we could list dozens more examples.

     

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  7.  
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    Shun, Dec 27th, 2007 @ 11:09am

    Author may have a point

    I'm not hard-core about profits before everything else. I'm just saying if businesses exist to make money, then they should probably focus on a business strategy that allows them to do that. It makes no sense, from a business and social perspective, to be the market leader in a segment, but be bankrupt. Yeah! I'm #1 in consoles, but I can't afford to pay my workers, so we'll be shutting down. Who's going to develop games for that platform? Better question: what are all the stranded customers going to do? I'm sure they'll think of creative ways to "return" their consoles.

    The focus on the current console wars is misleading. First, the writer doesn't mention Atari, Intellivision, Coleco, Sega, or any of the innumerable detria of game console goodness that got us here. Why did these guys die? Let's just take Sega. Why did they fall off the map? If the author had a convincing argument for that, I might buy it.

    Also, an oft mentioned point is that one of the greater competitors to PS3 sales is PS2 sales. That's right. People are still buying PS2's, like people are still installing Windows XP on new machines (hmm...something of a lesson to be learned there. Nope, forget it). Also, everybody hates Microsoft. Don't ask me how that affects console sales, but I'm sure that's a factor in deciding which console to get, if any.

    On the Apple front: I have never known Apple to pass up a profit. Their hardware products are over-priced, but they make up for it in their user interfaces. Something that Linux geeks (myself included) never seem to figure out is: most people don't want to spend 8 hours learning how to use their computer, or phone, or stereo. Most people want to be able to plug it in and go. Apple thinks about "expanding the pie" as well. They want to be able to get their product into the hands of every person living on this planet. If they had a way to market to fetuses, I'm sure Apple would be there, with some pre-birth, easy-to-use, slick-user-interface product. I don't know what it is, but I'm sure Steve Jobs is thinking about this problem as I type.

    What's strange, to me, is that Sony used to be the innovator. They first saw the potential of the transistor radio. Their vision was a radio in every hand. Now, they want to monopolize and monetize the media experience. I would say "oh, how the mighty have fallen" but it's more along the lines of "the bigger they are..." Nintendo, oddly, has inherited the innovator title. Let's see how long they can hold it.

    Now, if Apple were to develop a game console...too soon?

     

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  8.  
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    Anonymous Coward, Dec 27th, 2007 @ 11:54am

    The article that Howe, somewhat incorrectly illustrates, makes a very specific point that has merit. Here is a link to the article he cites with a pdf download of the academic paper. The article makes the point, well known in economics, that increased market share does not necessarily translate into higher profit or margin.

     

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    Mike (profile), Dec 27th, 2007 @ 12:14pm

    Re:

    The article makes the point, well known in economics, that increased market share does not necessarily translate into higher profit or margin.

    Right. I never meant to imply otherwise, and I'm sorry if you got that impression. I was merely debunking Howe's incorrect claim that extrapolated those results into meaning you should never use loss leaders or complementary products to increase marketshare.

    The point is that you should focus on profit, but one way to do that is to look for ways to expand marketshare. It's rather obvious that increasing marketshare in a way that has no impact on profits is a bad idea. I don't think anyone needed a study to show that.

     

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  10.  
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    Carl Howe, Dec 27th, 2007 @ 1:19pm

    Not convinced

    I'm the author of the article you referenced. I just wanted to point out that I'm not a Forrester analyst any more, nor have I been for the last five years.

    Also, I disagree with your point about Apple using music as a loss leader. To my knowledge, Apple has never lost money on music sales -- even back in 2002, the $0.99 per song price was established so that music would be sold at a gross profit of about $0.24 a song. Net profit to Apple was estimated at that time to be something around $0.10 a song, so I still claim they are an example of a company chasing profit, not market share.

    Your point about expanding markets is an interesting one, but I don't think it necessarily requires the use of loss leaders. Nintendo is a great example: it has cleaned both Microsoft's and Sony's clocks in gaming by expanding the market and never used loss-leading products to do so. It is also the most profitable gaming company in the industry. So tell me again why loss leader products to gain market share is a good strategy?

    Carl

     

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  11.  
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    Mike (profile), Dec 27th, 2007 @ 2:40pm

    Re: Not convinced

    Hi Carl,

    Thanks for stopping by to comment.

    I'm the author of the article you referenced. I just wanted to point out that I'm not a Forrester analyst any more, nor have I been for the last five years.

    Yes, I know. That's why I wrote "former Forrester analyst."

    Also, I disagree with your point about Apple using music as a loss leader. To my knowledge, Apple has never lost money on music sales -- even back in 2002, the $0.99 per song price was established so that music would be sold at a gross profit of about $0.24 a song. Net profit to Apple was estimated at that time to be something around $0.10 a song,

    The point about it being a loss leader is sourced directly from Steve Jobs (follow the links). Here's what he said: "We would like to break even/make a little bit of money but it's not a money maker."

    Even if it's not a complete "loss" leader, it is clear that it has little to do with Apple's strategy, which is to sell hugely profitable devices. The music just helps make that possible.

    so I still claim they are an example of a company chasing profit, not market share.

    I'm still confused as to how these are mutually exclusive goals? In fact, I'd argue that Apple is very much chasing marketshare and profit simultaneously -- and they did so (as described in the post) by basically reinventing the category of digital music players, expanding that market greatly. That was very much a marketshare move. It's just that they did so in a way that also allowed them to profit. If Apple was merely seeking profit, it would have created a system that was somewhat better than what was out there already, not redefining the entire market, as it did.

    Your point about expanding markets is an interesting one, but I don't think it necessarily requires the use of loss leaders.

    Nor did I mean to imply that loss leaders are "required." However, I'd argue (and actually have argued) that the more you understand complementary goods, the more you realize that almost *every* good has some kind of loss leader component to it.

    Nintendo is a great example: it has cleaned both Microsoft's and Sony's clocks in gaming by expanding the market and never used loss-leading products to do so. It is also the most profitable gaming company in the industry. So tell me again why loss leader products to gain market share is a good strategy?

    Nintendo redefined the market, and did so in a profitable way, but I'd argue that it had little to do with the focus on "profit" and much more to do with the focus on redefining the market by making a different type of game that was fun in different ways and for different audiences. I never said that it required a loss leader, but it is about recognizing the importance of complementary goods in the form of a more family oriented gaming system.

    I think part of the disagreement is that you're too focused on the question of "loss leaders," which are actually quite valuable marketing tools in many different industries (especially the technology field). I don't care so much whether or not something is specifically a "loss leader," but the value of complementary goods, whether at a loss or a profit are huge important in driving new product innovations.

     

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  12.  
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    Anonymous Coward, Dec 28th, 2007 @ 7:54am

    How can something be a loss leader if it doesn't produce a loss?

     

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