High Growth and Falling Profits

Recently, Europe passed legislation aimed at breaking long standing monopolies in Europe’s equity trading systems. As a result, a number of alternative trading systems poured into Europe’s equity markets.

The new market entrants are offering new technology and lower prices. They have succeeded in shifting significant market share away from the former industry leaders. In fact, four of the new entrants now control 16% of the trading in Europe’s equity markets. (See the Symptom and Implication, “Most share shifting in the industry seems to be coming from volume gained within existing customer relationships rather than from new customers” on StrategyStreet.com.) There is one problem, however, the margins are razor thin. The problem is pricing. While all these new entrants poured into the market, the prices fell as they jousted with one another to gain their market shares. One of the companies has reduced its prices three times within the last four months. Industry prices are now down about 20%. What are these new firms going to do about their poor profits? What any self-respecting low-end competitor would do if it has the opportunity. They are going to expand into other more complex markets and other asset classes that carry higher margins. This expansion will add relatively little cost because most of their trading systems costs are fixed. (See Video #6: Competition and Low-Cost Expansion on StrategyStreet.com.) In addition to improving margins, at least temporarily, this move into new asset classes and customer markets may help them in another way. These new trading systems will become more attractive because they become more of a one-stop shop for customers in the industry. The ability to offer one-stop shopping is usually a benefit offered by the industry’s leaders, whom we call Standard Leaders. This is one important reason that Standard Leaders dominate an industry.

Posted 5/28/09