Saturday, 8 February 2014

Understanding Market Saturation: Why You Should Never Hesitate in Business

A new technology, culture shift, social phenomenon, or even a crisis can create a new market that could be potentially worth millions (or even billions) of dollars to your business. But how long it will last is purely a numbers game – one that doesn’t end well for the hesitant.

This article reveals truths about market saturation, and why market share is on a first-come, first-served basis.

What is Market Saturation?

A market is formed when there is a sudden need for a product or service that is sufficient enough to compel the forces of demand and supply to coexist in such a space, necessitating commercial exchange on the basis of price and quality.

When a market is created, the first to enter the market attracts a sizable portion of the market regardless of entry price (because the need for the product or service is so great). 

The market dynamics favor the initial entrant – until there is a new competitor.

The second entrant into the market will most likely enter with a lower price for a reasonably similar level of quality. The result? There will be sizable defections from the original demand enjoyed by the first entrant to the second, as well as new demand created purely by the introduction of the second entrant.

[Related Article: How to Figure Out Your Optimal Number of Business Outlets]

Things will now look rosy for the second entrant while the first entrant may suffer demand losses (but still retain market lead due to brand loyalty and large initial market capture). 

These conditions will only be reversed if the second entrant comes in with a higher price or significantly lower quality than the first (a faux pas). In which case, the second entrant will attract very little demand and the first entrant will attract even higher demand and more brand loyalty.

These scenarios are repeated when newer entrants penetrate the market – the only constant fact is that the actual market size available for new competitors reduces with each additional entrant into the market.

This happens until there is virtually no demand space left for a new entrant – a phenomenon known as market saturation.

Visualizing Market Saturation

Market saturation is as much a mathematical phenomenon as it is an economic phenomenon. With every new market entrant, the size of available demand for a new competitor becomes exponentially smaller with lower likelihood of profits.         

At the simplest level, market saturation is based on the following mathematical model:

The mathematical nature of market saturation means we can visualize it graphically and better understand why we need to act quickly when breaking our products and services into new or existing markets.

The graph below shows how market saturation works:

The graph shows a simulation for a market with 100 million subscribers. A very active market, the first entrant is able to whip up more than 40 million subscribers (40% market share) – and assuming 100% brand loyalty at this stage, this leaves only 60 million subscribers for any other new competitors to engage.

Realistically, the entrance of a second competitor would pull a portion of the first competitor’s demand, but overall, loyalty remains high and our model remains consistent.

The graph also shows that the second competitor enters the market, but is only able to pull in over 30 million subscribers (30% market share). Again, if we assume near-100% brand loyalty at this stage, this means the market is already 40% + 30% = 70% saturated, with only roughly 30% of the market up for grabs for any new competitor – this just after 2 entrants into the market.

Also bear in mind that the work new entrants have to do in order to capture demand from other camps increases with the increasing number of entrants into the market, because consumers start to adapt and normalize to currently available offerings (demand equilibration).

Statistical models show that most markets become saturated after only 5 competitors.

What does this mean for your business?

In short, it is never a good idea to enter a market late in the game. Always try to get in as early as possible to increase your chances of success.

Also, before launching a product, ensure that only a handful of major competitors exist. 

Entering a saturated market will render your product dead-on-arrival (DOA) unless you have some killer marketing strategy or something very special to offer that will help you win back some of the core demand lost to already established competitors.