When it comes to market profitability, not all industries are created equal. According to Bloomberg’s Industry Leaderboard, while Apple commands the largest percentage of the computer hardware market, that market ranked No. 51 (of 60) in terms of profitability. The most profitable markets include banking, tobacco, biotech, internet media and rail freight transportation.
When determining your business’ performance, assessing your market’s profitability helps you determine whether or not your company can attain success selling a given product or service to your target audience.
Determining Market Profitability
While finding a niche market for your business may seem simple, determining the potential profitability of that market is more complex. Market profitability refers to the financial factors that affect a company’s ability to make money after subtracting overhead costs like employee salaries, rent and equipment. Whether you’re starting a new business or just introducing a different product in your market, it’s important that you determine whether the market can support you and your goals.
Along with determining the interest level in your product, you need to assess the competition among similar industries in the area. One of the most useful frameworks for determining market profitability is known as “Porter’s Five Forces.” Developed by economist Michael Porter, the framework assesses the following elements that affect a market’s profit potential:
- Buyer power refers to the ability of customers, or buyers, to influence companies in a given market. When there are many sellers and few buyers, the buyers have more power over the price of goods and services. On the other hand, when there are few sellers and many potential buyers, the business can usually determine the prices for its products.
- Supplier power is similar to buyer power, but the company is now the buyer, not the seller. A supplier is any entity that supplies a company with what it needs to produce its goods, such as raw materials, labor or machinery. In cases where the cost of changing suppliers is high, suppliers can charge more for their raw materials and therefore have more influence on a company.
- Barriers to entry affect the ease with which businesses can enter a given market and may include factors like falling prices, government restrictions or limited distribution capacity. The lower the barrier, the easier it is to enter that market, which drives up competition and brings down prices. Before determining their potential market profitability, businesses must consider how any barrier to entry will affect how they market a product to their niche audience.
- Threat of substitute products refers to products that can be substituted for both yours and your competitors’ products, therefore affecting demand for the goods in your market. For example, a substitute for television is internet video. A substitute for Coke or Pepsi is water. The easier it is for a customer to switch to an alternative, the greater the threat to your entire market.
- Rivalry among competitors is affected by several factors, including the number of businesses in a given market, the cost of exiting the industry and the degree of similarity between competing products. In a competitive market, profits are often low because customers have the option of buying from the less-expensive brands. An important note to keep in mind is that rivalry refers only to prices. If firms within the same market are not competing on price, there is actually not a lot of rivalry, even though there may be a lot of competition.
If your analysis of the Five Forces turns out to look bad in terms of market profitability, you may want to consider altering either your business model or your place of operation to achieve a better outcome.
Why Market Profitability Is Important
Finding your market profitability is an effective way of analyzing your business’ financial health. By understanding how forces influence parts of a given market, you can begin to make important decisions about starting a new business or ensuring your existing venture remains competitive in your chosen area.
Once you’ve determined how much business you need to stay profitable, you can assess if and how you will be able to gain that volume of clients. If profitability is impossible within your current business model, you may want to consider expanding your business to include new product offerings. Businesses should research what their competitors are doing and, if necessary, adjust their own strategy accordingly. You can also tailor your offerings to accommodate your most profitable clients and take steps to alleviate decreasing profit margins. For example, you could decrease operational costs by changing suppliers or improve your sales approach to reach new customers.
When assessing your potential market profitability, choosing the right factors to examine is crucial. By performing a thorough market analysis that encompasses suppliers, buyers, rivals and other relevant factors, you can preserve the success of your business venture in the coming years.