How does market share determine profitability?

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By :  ,  Financial Writer

What is market share?

Market share shows the percentage of a market dominated by a single company or product. Market share can show how dominant or intrusive one company is by comparing the sales of a business to the total sales of its market.

Market share is calculated by taking the company’s sales over a period of time and dividing it by the total sales of the industry over the same period of time. This figure gives a general estimate of the size of a company in relation to its sector and its competitors. Market share can also be used to determine a county’s export relative to the rest of the world.

The company with the largest market share is considered a market leader. Market followers are companies who copy what the leader does in order to maintain a share, albeit a smaller one than the market leader. Market followers typically don’t seek to disrupt the market.

Why is market share important for a business?

Market share is an easy way to gauge consumers’ preferences for one product over a similar product. Companies with higher market shares experience higher sales with less effort, and they create a strong barrier for other companies seeking to enter the same space.

If more people become interested in a product or service and the market expands, such as video-conferencing software during the COVID-19 pandemic, the leading market will obtain more new customers than its competitors in the market.

However, being the market leader also pressures companies to be more innovative than their competitors, as the best way for them to gain more customers is to expand their target market.

Most companies don’t shoot for 100% market share, as the effort to completely eliminate competing brands and win hyper-local audiences can be costly. Having too strong of an identity with one service or product can also negatively impact a brand’s efforts to branch into other markets or introduce new products.

How do you determine market share?

Market share is determined by dividing a company’s total revenue or sales by the industry’s total over an entire fiscal period. You can calculate market share for a fiscal year, standard year, or over several years.

Once you have determined the time frame you want to use, you would calculate the company’s total sales over that period. Then you’d determine the total number of sales of the company’s industry as a whole. Once you divided the company’s total revenues by the industry’s total sales, you’ve determined its market share.

Companies typically report their market share for specific countries. You can obtain these records from the company’s quarterly or annual reports, or from independent sources like trade groups and regulatory bodies. Of course, some industries are harder to than others.

Market share calculation example

Let’s say a business sells $80 million worth of a product in one year, and the total market is worth $200 million, the company’s market share is 40%. In many industries, a 40% market share would be enough to make a company a market leader.

However, if only two companies dominate an industry, 40% would not be enough to qualify as the market leader. This is the case with Boeing and Airbus. They are virtually the only two companies making large-scale aircrafts and have developed a notorious duopoly that’s lasted decades. 

Is a high market share good?

A high market share is typically seen as a positive indicator. A connection between market share and profitability is widely recognized as a key influence on company profits, according to the Marketing Science Institute. These correlations occur because the more of a market a company corners, the more money it makes compared to competitors.

When a business’s market share increases, several growth figures usually follow:

  • Profit margin grows
  • Purchase to sale ratio decreases
  • Product or service quality increases
  • Marketing costs as a percentage of sales decrease

What is considered a large market share?

A large market share depends on how competitive the industry is. In a crowded marketplace, the company with the largest market share may only have 30% of the market. In more condensed markets, a company may need to have over 50% of the market.

A company with the largest share of a market is known as a market leader. Some market leaders become so dominant they turn into monopolies, like Google, which has captured over 92% of the search engine market share. Others are duopolies, like Boeing and Airbus, which both own about 50% of the market share.

What is a low market share?

Low market share companies are those which control less than half of the industry leader’s share. They may be new companies just launching, or local businesses that are focused on servicing a specific region.

How to use market share in company analysis

 Tracking a company’s market share over several periods can give an indication of its current and future growth. Increases and decreases in market share can indicate the relative competitiveness of the company’s products or services.

It’s important to remember market share has a larger impact on a company’s performance in a mature industry where there is low growth. In younger industries still growing, companies have the ability to grow sales even if their market share decreases. In these situations, sales growth and margins are larger indicators of performance.

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