How Market Leadership Drives Value over Time
Market leadership is the universal aspiration of venture funded companies. Most pitches include a claim to leadership even if the defined market is narrow or the claim tenuous. Market leadership is particularly important in winner-take-all or winner-take-most markets common among mobile or Internet consumer markets.
The benefits of market leadership within a sector are well understood as market leadership confers many advantages. It allows companies to hire better talent, access lower cost of capital, secure volume price discounts, engage with partners on a preferential basis and ultimately consolidate the market. Jack Welsh mandated an exit from any business in which General Electric was not #1 or #2. But #2 may be insufficient in winner-take-all or most markets characteristic of many tech sectors. As the chart below shows, many tech markets are winner take all or most situations in which the leader wins 80% or more of the market value.
But the impact of leadership may be under appreciated as markets converge over time. Often overlooked in the leader/follower calculus are the business extensions that leaders enjoy over time but are unavailable to followers. Trusted customer relationships give leadership permission to enter adjacent markets, thus realizing synergies, expanding profit margins and heightening barriers to entry. Who could have envisioned that an online book seller would have become the global leader in cloud services and extend its reach as Amazon has? With Amazon Prime, users are locked into Amazon’s ecommerce ecosystem, an advantage that it is now leveraging with entry into groceries, third party logistics and health as we have seen in recent weeks. Similarly, Apple has locked in customers into a line of consumer devices through interlocking data arrangements, which it is now extending to Health Kit, Home Kit and elsewhere. Google leverages its ability to monetize through advertising by undercutting competition in one market after another. The reach of Amazon, Apple, Facebook and Google extend well beyond the scope of these companies just five years ago and will look alter substantially again in the next five years.
This dynamic is more striking when observed over time. AMD, a perennial #2 to Intel, is at risk of losing relevance in a market where scale requirements continue to escalate. The gap in revenues doubled in the past 15 years while Intel expanded margins by 5% and AMD’s contracted by 12%. Google crowded out Yahoo, an early mover in the search market, while expanding margins by 7%. Looked from this perspective, Uber will likely extend its advantage v Lyft over time.
Today’s tech battles are now among champions as the encroach on and compete across many sectors. Google, the champion of search advertising, battles Facebook, the social media champion, for ad revenue. Apple competes with Samsung across the consumer electronics spectrum. Intel now looks beyond AMD to TSMC, Samsung, Qualcomm and Broadcom for leadership across the semiconductor sector. The same dynamic is playing out in China as Alibaba, Baidu and Tencent extend their reach and battle across many sectors.
The focus on venture funding and entrepreneurs on market leadership is thus well placed. Valuation premiums paid for aspiring market leaders anticipate outsized benefits adjusted for risk to varying degrees. It also helps provide context for the increasing capital intensity of new ventures as companies accelerate to achieve escape velocity before technology incumbents arrive. But is also reinforces the need to think about market leadership more broadly as the leaders one day may be fodder the next as markets converge.
