The Ground Floor Trap

Posted in Entrepreneurship, strategy
By David Kaplan -
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Entrepreneurs naturally look for growing markets.  The opportunity to “get in on the ground floor” in a fast emerging market is certainly attractive.   Most business analysts would agree that the easiest way to grow any business is to position it to serve a growing market.  Still, fast emerging markets also present a set of predictable strategic risks that entrepreneurs will want to consider with care.

Sharply rising demand drives up prices and so induces incumbent firms to increase production and new firms to enter the market.  Some new market entrants will have had no prior role in the industry, and others may have been suppliers who wish to forward integrate and/or distributors who decide to go directly to OEM suppliers in order to control a larger segment of the value chain. During this rapid growth in the industry, most new players must rely on outdated industry intelligence.  Neither existing players nor new entrants can know of all the others and so they plan their own production capacity based on dated, under-informed projections of supply.

No industry can long sustain an increasing number of competing firms.  Inevitably excess capacity creates market over-supply.  Whether growth in supply exceeds the ongoing growth in demand or demand flattens out or diminishes, the result is the same: The market place becomes saturated with goods and prices fall.  Competition intensifies throughout the industry.

Financially stronger players will deploy manufacturing efficiencies and short term price competition to drive the weaker ones out of the market.  Increasing price competition will eventually drive prices down to commodity levels and only the makers of exceptionally desirable products and the lowest cost producers will survive.  Lower margins will force some players into insolvency. Larger players may acquire the protected, novel technologies of a few small competitors, but most small companies will fail;  their expensive capital equipment now worth practically nothing in an over-supplied industry.  By all these mechanisms the industry will contract.  Increasingly cutthroat competition, sustained price wars, and company failures will continue until supply falls sufficiently to meet demand and enable price stability.

What is the lesson of this predictable cycle of fast growth in emerging markets?  Do not jump in without a clear understanding of how to compete effectively.  Large companies will often watch the emerging market for opportunities to acquire small firms with proprietary technologies that make the best and cheapest product.  Small firms and especially start-ups need to think particularly hard about competitive differentiation. It makes no sense to enter even a fast growing market in direct competition with the big established players and a whole host of new small competitors.  Start-ups must take special care not to over-rely on their innovative technologies; a fast growing emerging market may spawn lots of new product ideas.  Not all of them can be winners.  Entrepreneurs may want to focus on developing a unique business model; one that takes advantage of the forces driving the market growth without needing to confront all the mainstream players. Find a niche and own it!

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