June 19, 2024 by Cyril Noirot

Does market share lead to profitability? An analysis of Bourantas and Mandes' study

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For decades, businesses chased market share like the holy grail. In the realm of business strategy, the notion that a higher market share translates to greater profitability has been a long-standing axiom. This idea primarily stems from the findings of the Profit Impact of Marketing Strategies (PIMS) study, which suggested a robust correlation between market share and return on investment (ROI).

This article delves into the nuances of this relationship as analyzed in the paper by Dimitris Bourantas and Yiorgos Mandes, exploring when and why market share might influence profitability and under what circumstances this maxim holds true.

The PIMS study

The PIMS study posited that businesses with larger market shares generally enjoy higher profitability. It quantified this relationship, indicating that a 10% increase in market share typically correlates with a 5% increase in pre-tax ROI. This assertion is grounded in three primary mechanisms, as highlighted in Bourantas and Mandes' paper:

  • Economies of scale and experience effects: Larger market shares enable businesses to lower production and distribution costs.

  • Market power: A greater market share provides leverage in bargaining, pricing control, and achieving higher prices.

  • Quality of management: Successful managers often command higher market shares and exhibit greater efficiency in cost control and productivity.

Limitations and alternatives views

  • Hamermesh, Anderson, and Harris highlighted cases where companies with low market shares still achieved high profitability. Their success was attributed to strategic factors such as efficient market segmentation, effective use of research and development funds, a focused approach, and strong executive influence.

  • Michael Porter emphasized that the relationship between market share and profitability is contingent upon industry-specific factors, particularly the economies of scale in manufacturing, distribution, and advertising. His research revealed that in some industries, low-share companies were more profitable than their higher-share counterparts.

  • Carolyn Woo’s research further complicated the picture, suggesting that market share leadership does not universally guarantee high profitability. Factors such as industry environment, product characteristics, competitive strategies, and organizational autonomy play crucial roles in determining profitability.

  • William Fruhan warned against the blind pursuit of market share increases, highlighting potential negative consequences such as overextension and inefficiencies.

Given the conflicting views and empirical evidence, it is clear that the relationship between market share and profitability is neither straightforward nor universally applicable. Bourantas and Mandes argue that the traditional PIMS approach has been criticized for its mechanical and statistical treatment of the relationship, failing to account for the complex interplay of various factors.

The organic and dynamic approach to understanding market share and profitability recognizes that these are not isolated factors, but rather outcomes influenced by a complex web of variables. This approach is more holistic and realistic than simplistic cause-effect models

Independent variables

  • Resources and competencies:

    • Facilities: physical assets of the company (e.g., factories, offices).
    • Equipment: machinery, technology, and tools used in operations.
    • Personnel skills: expertise and capabilities of the workforce.
    • managerial capabilities: leadership and decision-making process of the management team.

  • System of objectives: The business’s priorities and the relative value placed on different objectives. It includes how the company balances different objectives like growth, profitability, market share, innovation, or sustainability.

  • Business strategy: The ability of the company’s strategy to capitalize on opportunities and mitigate threats within its environment.

Intermediate Variables

  • Marketing Mix: Product quality, price, distribution systems, advertising, and promotion efficiency.

The key insight here is that market share and profitability are not directly manipulated. It is essential to note that the statistical correlation between market share and profitability may sometimes be spurious. This means that both variables might appear correlated due to their common underlying determinants rather than a direct causal relationship. Instead, they are the results of how well a company leverages its resources, aligns its objectives, executes its strategy, and fine-tunes its marketing mix.

The Profitability function and dynamic interactions

The dynamic model proposed by Bourantas and Mandes suggests that market share and profitability influence each other over time through their effects on the independent variables.It’s a model where market share and profitability are in a continuous feedback loop:

$$ \text{Market share} → Profitability$$

Higher market share can lead to:

  • Economies of scale: reducing costs and improving the $\frac{sales}{investment}$ ratio.
  • Market power: Ability to command higher prices, improving profit margin.
  • Learning effects: more experience leading to efficiency gains.

$$Profitability \rightarrow \text{Market share}$$

Higher profitability provides resources for:

  • Innovation: developing new products or improving existing ones.

  • Marketing: more funds for promotional activities to gain market share.

  • Talent acquisition: hiring better managers and employees.

  • Competitive pricing: ability to lower prices to gain market share if needed.

This creates a virtuous cycle:

Higher market share → Higher profitability → More resources → Better strategies → Even higher market share

This dynamic model provides a more nuanced view of business performance than static models. It suggests that success is not about maximizing either market share or profitability in isolation, but about managing the complex interplay between them over time.

References

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