Why it pays to be different

Competitive Markets

Free markets are efficient—some more, some less. But the general rule in any free market is that capital flows from businesses with low profit potential to those with high. High potential businesses are determined by a combination of profit margin, product turnover, and market size. If we assume a given market is fixed in size, how then does a business become high potential? Let’s start by examining how it does not. 

Econ 101 teaches us that in a perfectly competitive market where producers all make the same good, costs equal revenues and there are no profits. The necessary assumptions are that producers have equivalent cost bases and buyers are agnostic to the producer of the good. Under these circumstances, price competition eventually drives the margins to zero. High competition and product commoditization then are the detractors of profits.

Increasing your profit potential

Strive to be different. While product differentiation gets most of the attention, it is not the only differentiation that matters. Companies in industries with high product differentiation over time spend revenues disproportionately on R&D while companies in industries with low differentiation spend disproportionately on marketing.  A prime example of this is tech companies who on average spend upwards of 20% of their revenues on R&D while consumer product goods companies (think toothpaste) spend less than 2%.

Even when selling the same product, companies must differentiate to drive profitability. The classic example of a market with a single product that is dominated by brand differentiation is the one for vodka. US TTB regulations prior to 2021 classified vodka as "a type of neutral spirit so distilled, or so treated after distillations...as to be without distinctive character, aroma, taste, or color" (new guidelines allow for some character). While some distillers touted the purity of their product, the quantity and magnitude of product differentiation in the market was relatively limited, leading to a high dependence on brand differentiation to boost margins. Brand associations with luxury, sophistication, fun and more reinforce perceptions from buyers and those around them. These intangible benefits created significant profits for producers of a product that was a commodity by definition.

Unlocking the difference makers for your company

To move your company towards higher value potential, it is essential to have a comprehensive understanding of several key areas. First, know your customers. This involves identifying who they are, what they value, and what their specific use cases and pain points are.  It is also important to understand what they like and dislike about your product or service, as well as what their opinions are on competing ones.  Second, know your competition. This means being aware of who is selling what, how they are selling it, where their products are available, who their customers are, and the volumes at which they are selling. And last, a thorough knowledge of your company’s capabilities and articulation of its mission is necessary. This includes reflecting on what excites you and your team, assessing how much capital the company can raise and at what cost, and articulating a clear vision that defines your company's mission and scope.

Thoughtful and systematic analyses of these areas will reveal your strengths, weaknesses, opportunities and threats (SWOT), which then will form the basis of practical recommendations you can deploy with confidence.