Winner-take-all vs. Multiple-winner businesses

Broadly speaking, there are two types of businesses or business models.

• Those that rely on increases in volume as the primary variable for growth (and subsequently have high barriers to entry)
• Those that rely on increases in price as the primary variable for growth (and subsequently have lower barriers to entry)

This creates two types of market conditions.

1. Winner-take-all
2. Multiple winners

High volume-based businesses (units, customers or users) typically require large amounts of capital to startup, maintain and grow. They need large amounts of capital to produce the first unit/MVP and that startup capital, once invested, becomes sunk (irrecoverable). Because of the capital-intensive nature of the business and the risk involved with production prior to receiving market acceptance, it means there are high-barriers to entry for new entrants in that market (capital is scarce and when that capital is being used for a high-risk, capital-intensive startup project, the cost of that capital becomes prohibitive for most entrepreneurs to acquire and service).

Therefore because of their capital-intensive nature, businesses that rely on volume for growth tend to exist in a winner-take-all environment. By that I mean there may only ever be one or a handful of successful businesses in that particular industry or product category. In fact, because the business requires large-volumes for growth, if they reach and sustain those volumes (capture the marketplace), a self-fulfilling prophecy for that winner starts to take shape.

Take the food retail industry here in Australia. It is dominated by two main players, Coles and Woolworths. Because of the large volume of product they shift every week (through their unparalleled distribution network), they achieve enormous economies of scale. These economies of scale allow them to force prices down, making margins tighter and tighter, while still remaining profitable. Smaller competitors (without the economies of scale) can no longer compete with this duopoly on price and instead must de-commoditise and differentiate based on other variables such as service/quality/niche products (notice the rise of organics as a niche variable in this industry).

The same is true for businesses that have a hugely diverse product range, and as a result require heavy systems/large overheads (such as P&E, re-ordering, reporting, quality control, product design, marketing etc) to manage the complexities of holding/producing so many different stock lines. To continue the Coles and Woolworths example, not only do they shift large volumes of each stock item, they also have a very diverse stock list. This allows them to achieve economies of scope, which again drive out smaller competitors who hold fewer product lines and therefore can’t spread the fixed cost of the systems to manage that less diverse stock list over more stock lines.

Coles/Woolworths are examples of entities that sell other peoples products (i.e. an intermediary between the producer and the consumer), but what about the producers themselves? Proctor & Gamble is a good example of a producer that acquires a competitive advantage through economies of scope (they produce hundreds of FMCG’s and can spread the R&D, design, production and marketing fixed costs over more product lines, keeping prices low while still maintaining profitability and market dominance). They also tend to reap the benefits of a winner-take-all environment.

Want more examples? How about businesses which require large investment in IP development, R&D, product design and experimentation to start or commercialise. Think the bio-tech, web-tech, life sciences & pharmaceutical industries. Vast amounts of research and experimentation takes place in the development of a new drug or a new technology and often it is done before there is any kind of certainty in getting the product past regulatory authorities or accepted by the market. That long and complex development cycle raises the barriers to success and therefore the few companies and products that push through the barriers tend to capture the marketplace very quickly (assuming un-serviced market demand), achieving economies of scale and distribution, further forcing new entrants out of the game.

What about Coca-Cola? Huge costs (both real and opportunity) are incurred in recipe development (raises barriers to entry). Then, if the recipe wins the hearts and minds of the market, it makes it very hard for multiple winners to exist or new entrants to enter the market (Pepsi and Coke are really the only dominant force in the Cola category). On the opposite end of the spectrum, you could have a new entrant with all the time/energy/effort (and even money) in the world to out-market Coke, but unless they’ve got the recipe to beat Coke, they will always struggle.

This continues to be true for established incumbents. Nike constantly experiments in the pursuit of innovation and maintaining market dominance. This comes with significant costs, but the upside potential is massive. In a report by Jenny Vandyke titled “The secret sauce of our most innovative companies”, she writes:

“Nike tops the 2013 list for branching out from their highly successful sporting apparel and footwear product lines into wearable tech. They’ve also reinvented their manufacturing processes with a new shoe which substantially cuts down on manufacturing costs without compromising quality. They acknowledge that these successful ideas are amongst many others that ended up on the cutting room floor, never getting past the experimental phase. They understand that investing in experimentation is critical to coming up with those few breakthrough ideas.”

Experimentation carries significant costs with no guarantee of finding the ‘breakthrough ideas’. But for those companies that do, it can create a winner-take-all, even blue-ocean market environment.

But here is the saving grace for small business…

In industries and product categories which don’t require large volumes to establish profitability and growth, nor require large investment in IP development, R&D, experimentation or capital to get to the first sale, you can operate in a market environment where there are multiple winners (I’m not just talking a handful of players — I’m talking 10–20% of the entire industry). This is often the arena of the agile, service-based small business.

They can leverage technology to out-service and out-manouvere their larger competitors. They can cheaply develop new products and rapidly validate whether or not there is existing, un-serviced demand for those products in the marketplace. Instead of selling thousands of units of product each year, they only need to sell a few hundred to create a highly profitable, scaleable business. Instead of needing to spend thousands or even tens of thousands of hours in IP development, R&D or experimentation, they can partner with other people and organisations that have already incurred that cost and leverage off their experience, expertise, recipes and formulas.

The morale to this story is not that either business model is right or wrong, in fact, the former is often far more lucrative (if you can push through the initial barriers to entry and have the funding to achieve market acceptance followed by dominance). The trick is to know which business you are in. If you’re in the former — chasing one big win of capturing the marketplace and being bought out by your largest competitor — just know that it is highly competitive and requires huge investment before you see any glimmer of success. Also know that in the mean time, you won’t make money, you’ll actually haemorrhage money at a fast rate — this is what’s required to achieve market dominance and economies of scale in this kind of business. Ultimately, just remember it is a winner-take-all environment.

If you are just starting out in business, then entering a market environment where there can be multiple winners is often a good way to go. You don’t need much capital to start and you don’t need to spend tens of thousands of hours in product development. All you need to do is to hustle together the pieces of the puzzle you need to rapidly go to market and then promote & sell the pants off your product to get your minimum quota of clients per year that hits your revenue targets and ROI hurdle.

Your turn…What business are you in and do you see multiple winners in your industry or only a select few?