Customer need gives rise to a market opportunity, and a market emerges. To judge the worth of this market, an estimate of market potential is important. If the market appears attractive, the strategist takes the next step of delineating the market boundary. This section examines the potential of the market. Simply stated, market potential is the total demand for a product in a given environment. Market potential is measured to gain insights into five elements: market size, market growth, profitability, type of buying decision, and customer market structure.

The first element, market size, is best expressed in both units and dollars. Dollar expression in isolation is inadequate because of distortion by inflation and international currency fluctuations. Also, because of inflationary distortion, the screening criteria for new product concepts and product line extensions should separately specify both units and dollars. Market size can be expressed as total market sales potential or company market share, although most companies through custom utilize market share figures. The second element, market growth, is meant to reflect the secular trend of the industry. Again, the screening criteria should be specified for new product concepts and product line extensions. The criteria and projections should be based on percentage growth in units. Projections in industrial settings often are heavily dependent on retrofit possibilities and plans for equipment replacement. The third element in this evaluation of strategic potential is profitability. It usually is expressed in terms of contribution margin or in one of the family of return calculations. Most U.S. companies view profitability in terms of return on investment (ROI), return on sales (ROS), or return on net assets (RONA). Return on capital employed (ROCE) is often calculated in multinational companies. For measuring market potential, no one of these calculations appears to function better than another. The fourth element is the type of buying decision. The basis for a buying decision must be predicated on whether the decision is a straight rebuy, a modified rebuy, or a new task. The fifth and final element is the customer market structure. Based on the same criteria as competitive structure, the market can be classified as monopsony, oligopsony, differentiated competition (monopsonistic competition), or pure competition.

DEFINING MARKET BOUNDARIES

The crux of any strategy formulation effort is market definition: The problem of identifying competitive product-market boundaries pervades all levels of marketing decisions. Such strategic issues as the basic definition of a business, the assessment of opportunities presented by gaps in the market, the reaction to threats posed by competitive actions, and the decisions on major resource allocations are strongly influenced by the breadth or narrowness of the definition of competitive boundaries. The importance of share of market for evaluating performance and for guiding territorial advertising, sales force, and other budget allocations and the growing number of antitrust prosecutions also call for defensible definitions of productmarket boundaries. Defining the market is difficult, however, since market can be defined in many ways. Consider the cooking appliance business. Overall in 1997 about 18 million gas and electric ranges and microwave ovens were sold for household use. All these appliances serve the basic function of cooking, but their similarity ends there. They differ in many ways: (a) with reference to fuels primarily gas versus electricity; (b) in cooking method heat versus radiation; (c) with reference to type of cooking function surface heating, baking, roasting, broiling, etc.; (d) in design freestanding ranges, built-in countertop ranges, wall ovens, counter-top microwave ovens, combinations of microwave units, and conventional ranges, etc.; and (e) in price and product features. These differences raise an important question: Should all household cooking appliances be considered a single market or do they represent several distinct markets? If they represent several distinct markets, how should these markets be defined? There are different possibilities for defining the market: (a) with reference to product characteristics; (b) in terms of private brand sales versus manufacturers’ brand sales; (c) with reference to sales in specific regions; and (d) in terms of sales target, for example, sales to building contractors for installation in new houses versus replacement sales for existing homes. Depending on the criteria adopted to define the market, the size of a market varies considerably. The strategic question of how the marketer of home cooking appliances should define the market is explored below.

Dimensions of Market Boundaries

Traditionally, market boundaries have been defined in terms of product/market space. Consider the following: A market is sometimes defined as a group of firms producing identical or closely related products. . . . A preferable approach is to define the markets in terms of products. . . . [What is meant by] a close relationship among products? Goods and services may be closely related in the sense that they are regarded as substitutes by consumers, or they may be close in that the factors of production used in each are similar. Some identify a market with a generic class of products. One hears of the beer market, the cake mix market, or the cigarette market. According to others, product markets refer to individuals who have purchased a given class of products. These two definitions of the market the market as a class of closely related products versus the market as a class of people who purchase a certain kind of product view it from one of two perspectives: who are the buyers and what are the products. In the first definition, buyers are implicitly assumed to be homogeneous in their behavior. The second definition suggests that the products and brands within a category are easily identified and interchangeable and that the problem is to search for market segments. In recent years, it has been considered inadequate to perceive market definition as simply a choice of products for chosen markets. Instead, the product may be considered a physical manifestation of a particular technology to a particular customer function for a particular customer group. Market boundaries should then be determined by choices along these three dimensions.

Technology. A particular customer function can be performed by different technologies. In other words, alternative technologies can be applied to satisfy a particular customer need. To illustrate, consider home cooking appliances again. In terms of fuel, the traditional alternative technologies have been gas and electricity. In recent years, a new form of technology, microwave radiation, has also been used. In another industry, alternative technologies may be based on the use of different materials. For example, containers may be made from metal, glass, or plastic. In defining market boundaries, a decision must be made whether the products of all relevant technologies or only those of a particular technology are to be included.

Customer Function. Products can be considered in terms of the functions they serve or in terms of the ways in which they are used. Some cooking appliances bake and roast, others fry and boil; some perform all these functions and perhaps more. Different functions provide varying customer benefits. In establishing market boundaries, customer benefits to be served should be spelled out.

Customer Group. Agroup refers to a homogeneous set of customers with similar needs and characteristics. The market for cooking appliances, for example, can be split into different groups: building contractors, individual households buying through retail stores, and so on. The retail stores segment can be further broken down into traditional appliance specialty stores, mass merchandisers, and so on. Decisions about market boundaries should indicate which types of customers are to be served. In addition to these three dimensions for determining market boundaries, Buzzell recommends a fourth level of production/distribution. A business has the option of operating at one or more levels of the production/distribution process. For example, producers of raw materials (e.g., aluminum) or component products (e.g., semiconductors, motors, compressors) may limit their business to selling only to other producers, they may produce finished products themselves, or they may do both. Decisions about production/distribution levels have a direct impact on the market boundary definition. This point may be illustrated with reference to Texas Instruments: The impact that a business unit’s vertical integration strategy can have on competition in a market is dramatically illustrated by Texas Instruments’ decision, in 1972, to enter the calculator business. At the time, it was a principal supplier of calculator components (integrated circuits) to the earlier entrants into the market, including the initial market leader, Bowmar Instruments. As most readers undoubtedly know, TI quickly took over a leadership position in calculators through a combination of “pricing down the experience curve” and aggressive promotion. For purposes of this discussion, the important point is one of a finished product. Some other component suppliers also entered the calculator business, while others continued to supply OEMs. In light of these varying strategies, is there a “calculator component market” and “calculator market,” or do these constitute a single market?

Market boundaries are defined in terms of customer groups, customer functions, and technologies. The fourth dimension, level of production/distribution, is not included in the diagram because it is not possible to show four dimensions in a single chart. The exhibit shows a matrix developed around customer groups on the vertical axis, customer functions on the right axis, and technologies on the left axis. Any three-dimensional cell in the matrix constitutes an elementary “building block” of market definition. An automatic teller machine (ATM) for cash withdrawals at a commercial bank is an example of such a cell.

Redefining Market Boundaries As markets evolve, boundaries may need to be restated. Five sets of “environmental influences” affect product/market boundaries. These influences are technological change (displacement by a new technology); market-oriented product development (e.g., combining the features of several products into one multipurpose offering); price changes and supply constraints (which influence the perceived set of substitutes); social, legal, or government trends (which influence patterns of competition); and international trade competition (which changes geographic boundaries). For example, when management introduces a new product, markets an existing product to new customers, diversifies the business through acquisition, or liquidates a part of the business, the market undergoes a process of evolution. Redefinition of market boundaries may be based on any one or a combination of the three basic dimensions. The market may be extended through the penetration of new customer groups, the addition of products serving related customer functions, or the development of products based on new technologies.