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The Leader's Trap

by Donald Potter

PHASE ONE: Margin Comfort

Being the market leader should be an advantage. But leadership also has its dangers. Many times, in a range of industries, leaders have allowed themselves to be trapped.

Danger of Comfort

Danger comes in a market dominated by two to four large players with comparable pricing structures and good returns. Customers are generally well-served. The industry hasn't faced hostility for years.

Then a new competitor enters, offering a comparable product or service, but a lower price. Often the price is only slightly lower (perhaps 5-10%). Nevertheless, this new entrant gets business from the price sensitive segment.

PHASE TWO: Shift in Share

"Eventually, customers insist on better prices."

With a toehold in the market, the new entrant expands. He takes a bit of share from established players. He begins to gain a track record. As a small, lean player with high capacity utilization, he is a good bet to get additional funding for further growth.

Now pressure begins to build. Customers see their competitor enjoying a cost advantage; they seek out this new, low priced entrant. Share begins to shift. Still, the market leader tries to hold his price to maintain margins. It doesn't work. Eventually, customers insist on better prices. The ripple of movement in the market reaches even the leader.

To stop share loss, the market leader must eventually lower price. Share stops shifting, but the damage is done. Prices are down, margins are squeezed, and-perhaps most important-customers are angry. They have had to fight their traditional supplier to get competitive prices, and have learned to mistrust him.

Misleading Arguments

"Leaders can avoid the trap of share loss by responding to price discounts immediately."

Leaders allow their market to become hostile. Why do they do this? Often, because they are lulled by conventional arguments that mislead even very good companies:

The new competitor doesn't have to take that much volume to upset the market for all established players, even the leader. The new competitor doesn't even have to succeed – often he will fail. The danger isn't the new entrant
per se, but the market disruption he causes.

The leader often will not lose share to the new entrant – at first. Usually the new entrant takes share from the other, somewhat weaker, competitors. Soon, though, those other competitors respond, lowering their prices and, if possible, taking share from the leader. The ripple effect will eventually reach the top.

Once share begins to shift, customers are sending a clear signal: they are satisfied with the quality they can get at a lower price.

This may not be a real choice. Leaders with high prices almost always lose share. Since cost virtually never drop as quickly as volume, margins are squeezed. Only then does the leader reduce price. By trying to maintain margins, a leader actually invites a worse scenario: robust new competition, falling prices, a smaller customer base, and customer dissatisfaction that could lead to even further share loss and will certainly raise selling costs.

If Share Moves, Respond

Can the leaders still respond, and reassert their leadership? Of course. Today, the automobile, computer, copier, hotel, and airline industries all offer examples of companies fighting back to reassert their leadership. But they would have been better off to avoid the fight.

Any perceptible share shift is a warning. Leaders can avoid the trap of share loss by responding to price discounts immediately, before new entrants have the chance to grow. The response does not necessarily have to match exactly the price of the new entrant. But it must stop share erosion.

  • In evaluating share movements, management would want to consider:

  • Is the company maintaining a price premium over any competitor who is gaining share?

  • Regardless of price premiums is any competitor gaining share faster than the company?

Does any competitor's share gain threaten the company in the longer term?

(Note: This Perspective was written in the context of the economy in 1991. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)