What is a market?

First of all, a market is not an economic sector, as statistical institutes, central banks or professional associations would define it. Markets and economic sectors are two completely separate concepts. What is the market for pay TV operators such as BSkyB, Premiere, Telepiu` or Canalþ? It is the entertainment market and not just the TV market. Competition comes from cinema multiplexes, DVDs, live sporting events rather than from ITV, RTL TV, Rai Uno or TF1 that mainly sell advertising slots to advertisers seeking to target the legendary housewife below 50 years of age.

So, what is a market? A market is defined by consistent behaviour – e.g., a product satisfying similar needs, purchased through a similar distribution network by the same customers.

A market is therefore not the same as an economic sector. Rather, it is a niche or space in which a business has some industrial, commercial or service-oriented expertise. It is the arena in which it competes.

Once a market has been defined, it can then be segmented using geographical (i.e., local, regional, national, European, worldwide market) and sociological (luxury, mid-range, entry level products) variables. This is also an obvious tactic by companies seeking to gain protection from their rivals. If such a tactic succeeds, a company will create its own market in which it reigns supreme, as does Club Me´diterrane´ e, which is neither a tour operator nor a hotel group, nor a travel agency, but sells a unique product. But, before readers get carried away and rush off to create their very own markets arenas, it is well to remember that a market always comes under threat, sooner or later.

Segmenting markets is never a problem for analysts, but it is vital to get the segmentation right! To say that a manufacturer of tennis rackets has a 30% share of the German racket market may be correct from a statistical standpoint, but is totally irrelevant from an economic standpoint because this is a worldwide market with global brands backed by marketing campaigns featuring international champions. Conversely, a 40% share of the northern Italian cement market is a meaningful number, because cement is a heavy product with a low unit value that cannot be stored for long and is not usually transported more than 150–200 km from the cement plants.

Market growth

Once a financial analyst has studied and defined a market, his or her natural reflex is then to attempt to assess the growth opportunities and identify the risk factors. The simplest form of growth is organic volume growth – i.e., selling more and more products.

This said, it is worth noting that volume growth is not always as easy as it may sound in developed countries, given the weak demographic growth (0.2% p.a. in Europe). Booming markets do exist (such as DVDs), but others are rapidly contracting (nuclear power stations, daily newspapers, etc.) or are cyclical (transportation, paper production, etc.).

At the end of the day, the most important type of growth is value growth. Let’s imagine that we sell a staple product satisfying a basic need, such as bread. Demand does not grow much and, if anything, appears to be on the wane. So we attempt to move upmarket by means of either marketing or packaging, or by innovating. As a result, we decide to switch from selling bread to a whole range of speciality products, such as baguettes, rye bread and farmhouse loaves, and we start charging C¼0.90, C¼1.10 or even C¼1.30, rather than C¼0.70 per item. The risk of pursuing this strategy is that our rivals may react by focusing on a narrow range of straightforward, unembellished products that sell for less than ours; e.g., a small shop that bakes pre-prepared dough in its ovens or the in-store bakeries at food superstores.

Once we have analysed the type of growth, we need to attempt to predict its duration, and this is no easy task. The famous 17th century letter writer Mme de Se´vigne´ once forecast that coffee was just a fad and would not last for more than a week . . . At the other end of the spectrum, it is not uncommon to hear entrepreneurs claiming that their products will revolutionise consumers’ lifestyles and even outlast the wheel!

Growth drivers in a developed economy are often highly complex. They may include:

• technological advances, new products (e.g., high-speed Internet connection, etc.);
• changes in the economic situation (e.g., expansion of air travel with the rise in living standards);
• changes in consumer lifestyles (e.g., eating out, etc.);
• changing fashions (e.g., blogs);
• demographic trends (e.g., the popularity of cruises owing to the ageing of the population);
• delayed uptake of a product (e.g., Internet access in France owing to the success of the previous generation Minitel videotext information system).

In its early days, the market is in a constant state of flux, as products are still poorly geared to consumers’ needs. During the growth phase, the technological risk has disappeared, the market has become established and expands rapidly, being fairly insensitive to fluctuations in the economy at large. As the market reaches maturity, sales become sensitive to ups and downs in general economic conditions. And, as the market ages and goes into decline, price competition increases and certain market participants fall by the wayside.

Those that remain may be able to post very attractive margins, and no more investment is required. Lastly, readers should note that an expanding sector is not necessarily an attractive sector from a financial standpoint. Where future growth has been overestimated, supply exceeds demand, even when growth is strong, and all market participants lose money. For instance, after a false start in the 1980s (when the leading player Atari went bankrupt), the video games sector have experienced growth rates of well over 20%, but returns on capital employed of most companies are at best poor. Conversely, tobacco, which is one of the most mature markets in existence, generates a very high level of return on capital employed for the last few remaining companies operating in the sector.

Market risk

Market risk varies according to whether the product in question is original equipment or a replacement item. A product sold as original equipment will also seem more compelling in the eyes of consumers who do not already possess it. And it is the role of advertising to make sure this is how they feel. Conversely, should consumers already own a product, they will always be tempted to delay replacing it until their conditions improve and, thus, to spend their limited funds on another new product.

Needs come first! Put another way, replacement products are much more sensitive to general economic conditions than original equipment. For instance, sales in the European motor industry beat all existing records in 2000, when the economy was in excellent shape, but sales slumped to new lows in 2004 when the economic conditions were poorer.

As a result, it is vital for an analyst to establish whether a company’s products are acquired as original equipment or as part of a replacement cycle because this directly affects its sensitivity to general economic conditions. All too often we have heard analysts claim that a particular sector, such as the food industry, does not carry any risk (because we will always need to eat!). These analysts either cannot see the risks or disregard them. Granted, we will always need to eat and drink, but not necessarily in the same way. For instance, eating out is on the increase, while wine consumption is declining, and fresh fruit juice is growing fast, while the average length of mealtimes is on the decline.

Risk also depends on the nature of barriers to entry to the company’s market and whether or not alternative products exist. Nowadays, barriers to entry tend to weaken constantly owing to:

• a powerful worldwide trend towards deregulation (there are fewer and fewer legally enshrined monopolies – e.g., in railways or postal services);
• technological advances (e.g., the Internet);
• a strong trend towards internationalisation.

All these factors have increased the number of potential competitors and made the barriers to entry erected by existing players far less sturdy. For instance, the five record industry majors, Sony, Bertelsmann, Universal, Warner and EMI, had achieved worldwide domination of their market, with a combined market share of 85%. They have nevertheless seen their grip loosened by the development of the Internet and artists’ ability to sell their products directly to consumers through music downloads, without even mentioning the impact of piracy!

Market share

The position held by a company in its market is reflected by its market share, which indicates the share of business in the market (in volume or value terms) achieved by the company. A company with substantial market share has the advantage of:

• some degree of loyalty among its customers, who regularly make purchases from the company. As a result, the company reduces the volatility of its business;
• a position of strength vis-a`-vis its customers and suppliers. Mass retailers are a perfect example of this;
• an attractive position, which means that any small producer wishing to put itself up for sale, any inventor of a new product or new technique or any talented new graduate will usually come to see this market leader first, because a company with large market share is a force to be reckoned with in its market.

This said, just because market share is quantifiable does not mean that the numbers are always relevant. For instance, market share is meaningless in the construction and public works market (and indeed is never calculated). Customers in this sector do not renew their purchases on a regular basis (e.g., town halls, swimming pools and roads have a long useful life). Even if they do, contracts are awarded through a bidding process, meaning that there is no special link between customers and suppliers.

Likewise, building up market share by slashing prices without being able to hold onto the market share accumulated after prices are raised again is pointless. This inability demonstrates the second limit on the importance of market share: the acquisition of market share must create value, otherwise it serves no purpose. Lastly, market share is not the same as size. For instance, a large share of a small market is far more valuable than middling sales in a vast market.