Harvard Business Review
The Idea in Brief
During the 1970s, Procter & Gamble moved aggressively to gain market share in the coffee business. Freed from a consent decree that had restrained its ability to grow geographically, Folgers, a P&G subsidiary, came east from its western stronghold and took on Maxwell House in a clash of the coffee titans. After the dust settled, Folgers indeed had moved to a new plateau of market share – from which it has not retreated. But its victory had a decidedly bitter taste. In committing to and achieving major gains in market share through its pricing actions, P&G effectively eliminated the industry profits of the entire “roast and ground” segment – a situation that persisted until the early 1990s.
What had gone wrong? Once Folgers had achieved its goal of gaining market share, why didn’t significant profitability follow? Could Folgers have known in advance that its plan wasn’t necessarily the best strategic move?
We believe that the answer is yes. Conventional wisdom holds that market share drives profitability. Certainly, in some industries, such as chemicals, paper, and steel, market share and profitability are inextricably linked. But when we studied the profitability of premium brands like Folgers – brands that sell for 25% to 30% more than private-label brands – in 40 categories of consumer goods, we found some surprising results. Chief among them, we discovered, was that market share alone does not drive profitability. In fact, market share explains only about half of the differences in profitability among brands; in some categories, there is hardly any correlation at all.
Instead, a brand’s profitability is driven by both market share and the nature of the category, or product market, in which the brand competes. A brand’s relative market share (RMS) has a different impact on profitability depending on whether the overall category is dominated by premium brands or by value brands to begin with. That is, if a category is composed largely of premium brands, then most of the brands in the category are – or should be – quite profitable. If, on the other hand, the category is composed mostly of value and private-label brands, then returns will be lower across the board. When we compared the actual profitability of the 40 premium brands we studied with their predicted profitability, using as variables RMS and the “premium” degree of a category, we found a strong correlation. (See the chart “What Explains a Brand’s Profitability?”)
The facial-skin-care category is filled largely with premium brands, and most players earn more than 15% pretax operating profit, or return on sales (ROS). What’s more, even brands with market share one-fifth to one-tenth that of the category leader, Oil of Olay, have operating profits only slightly lower than Oil of Olay’s. But processed meats, in which market leader Oscar Mayer and other premium competitors account for less than 40% of the category, are a different story. The brands with high relative market share earn about 10% ROS; those with low relative market share usually earn less than 5%. The category is what makes the difference. Developing the most profitable strategy for a premium brand, therefore, means reexamining market share targets in light of the brand’s category. In other words, managers must think about their brand strategy along two dimensions at the same time. First, is the category “premium” or “value”? (Is it dominated by premium brands or by value brands?) Second, is the brand’s relative market share low or high?
If we visualize a matrix with those two dimensions, we can map the position of any premium brand within one of four quadrants. Each quadrant has different implications for a brand’s profit potential. And each requires a different strategy. (See the matrix “Two Dimensions, Four Strategies.”)