Watch Out for Potential Drags on Margin

As you design your business model, focus on your product’s positioning, marketing, and sales process without worrying excessively about competition. You don’t win the race by looking backward. By the same token, completely ignoring the competitive landscape can adversely affect your model. Here are some factors that can drag down your margin:

  • Attractive market: High potential markets attract competitors. Competition drives down margins. In the late 1990s, dozens of large companies rushed to the phone and data transport business, creating a world-wide glut of capacity. Many of these companies, such as Global Crossing and WorldCom, went bust.

    Today you see a piranha-like frenzy to create iPhone and Android apps. Plenty of companies, such as Zynga, are doing well, but it remains to be seen how many of these companies will have staying power.

  • Fast-changing technology: Disruptive technology can be dramatically less expensive and can wreak havoc on margins. Blockbuster, BlackBerry, and the U.S. Postal Service have all had to deal with this issue.

  • Inconvenience: Inconvenience could mean anything from a physical location off the beaten path to the inability of the customer to buy everything needed from you. Small vendors are experiencing this issue with large companies that refuse to buy from vendors with only one item they need.

    In fact, some vendors have been forced by companies like Walmart to sell to another of their vendors simply to streamline Walmart’s buying process. One vendor had a margin of 75 percent selling directly to Walmart, and its margin dropped to 35 percent after being forced to sell to the larger vendor.

  • Lack of integration: In some instances, vertical integration by competitors can be a cost advantage for them and force your margins down. For example, Starbucks’ Keurig-style coffee maker doesn’t need to sell for a profit.

    The Verismo machine’s purpose isn’t to generate profits from its sale. The machine was designed to sell Starbucks coffee for home use. The Amazon Kindle tablet computer is reportedly sold for $5 less than it costs to make. Why? Because the Kindle is a portable store to purchase Amazon books and products.

  • Me-too product: Products with no must-have features sell for much less.

  • Operational inefficiency: If your operations are less efficient than your competition, you may need to lower margins to compensate.

  • Poor salesmanship: Many a great business model calls for a sales price of $X but the under-skilled sales force sells it for $½X. Every dollar the salesperson discounts comes straight out of your margin.

  • Shrinking market demand: Similar to excessive competition, a declining overall market lowers the tide for all boats. The next step is for one of your competitors to get desperate and lower pricing.

  • Superior buying power of competitors: Generating superior margins is difficult if you buy a pallet of material at a time and your competitor buys a truckload.

  • Too many competitors: There are only so many buyers. If too many competitors are chasing too few deals, prices tend to fall. Airlines, auto manufacturers, and granite countertop installers are all examples of markets with limited buyers.

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