Time to Enter New Markets? How to Make the Call

    Entering a new market is a little like robbing a bank.  Anyone coming away with armfuls of cash is going to have had three things: a motive, a viable opportunity and the know-how to follow through.

    In the case of a bank robbery, these might respectively have been gambling debts, lax security at a vault and the ability to crack safes.

    In the case of market entry, things are a little more complex. Importantly, though, the issues of motive, opportunity and know-how are often unhelpfully conflated in the business context.

    To avoid confusion, then, let’s separate three key questions we can ask about market entry:

    1. Why might you want to enter new markets?
    2. Should you enter a specific new market?
    3. How would you go about entering that market successfully?

    Failure to separate these distinct questions in articles like this can lead to discussions becoming muddled or missing their mark.

    Here, we will focus our attention on questions one and two above. One reason for doing so is that anyone getting to question three will have already had to have found positive answers to one and two – which may or may not be possible. Beyond this though, it is easier to provide general guidance for these first two points. The answer to three will depend a lot on the specific context a business finds itself in. In any case, there are plenty of resources online about modes of market entry for you to refer to separately.

    Why Enter New Markets?

    We will start by considering why a company might go to the trouble and expense of entering a new market. What are the potential upsides of making this kind of investment? Two key drivers will be the prospect of growth and the security of diversification:

    Growth

    It might not be a concern when you first start building a business, but, if you are selling a product or service, the size of the market you operate in will ultimately cap how much you can grow that enterprise. Even the most desirable product will eventually saturate all possible demand.

    Of course, if you are operating in a truly huge and highly contested market this might be less of a pressing concern. Some markets are so large that topping out demand will always remain a hypothetical and growth by selling more of the same can continue effectively indefinitely.

    For example, whilst they might diversify in practice, Coca Cola can expect to do perfectly well for decades to come without straying outside the beverage business. Everyone needs to drink, after all, and the majority of the world’s population can afford a Coke, so the potential customer base is in the billions. The first priority of Coca Cola will thus always be to increase their sales within that existing market.

    However, if you are selling a more niche offering, you might very sensibly want to expand into new markets.

    For example, you might be selling a very effective specialist anti-dandruff shampoo. However, the market for this product is going to be inherently reasonably limited. You might rise to the top of the pile in the anti-dandruff game very rapidly, but where do you go after that?

    One solution might be to expand into the more general shampoo market, perhaps leveraging the positive reputation of your specialist product to boost the sales of more generic shampoos.

    Another option might be to expand into other remedies for minor ailments. Perhaps you might enter the specialist moisturiser game to combat not just dry scalps but the rest of the body. Perhaps you offer an athlete’s foot product or similar.

    Note that multiple different options are available – we will return to this idea later when we consider opportunity cost.

    Diversification

    Growth is not the only reason to spread operations across multiple markets.

    An investor diversifies their portfolio so as to reduce their vulnerability to unforeseen fluctuations in any one holding’s performance. In the same way, a business might spread itself across multiple markets which are unlikely to fully correlate in their expansion and contraction over time. As such, the security of diversification can be another reason to expend capital in entering into new markets.

    To take a real-life example, passenger airlines operate in potentially huge markets. Realistically, no one carrier is going to be able to run up against a final cap on their growth in global passenger aviation. 

    However, these businesses can be particularly vulnerable both to specific world events and to general economic fluctuation. The events of 2020 have certainly shown us this, with several airlines going bust and/or requiring government bailouts.

    One way which many airlines diversify their operations it to run airfreight operations in addition to flying passenger routes. In 2020, several airlines who have seen their passenger numbers slashed to near-zero have been kept afloat by freight operations which have continued to operate.

    Should I Enter a New Market?

    We can see the possible advantages of entering a new market. However, this does not make the decision a foregone conclusion. We first have to establish that this is worth the cost.

    The key to making the call here is to think like an investor. This means taking a global view of all the options and acting to maximise your return on investment.

    Fundamentally, we first have to make sure that the new market can actually be expected to be profitable for us.

    This means making sure that the revenue extracted from the new market will more than equal the costs.

    We also need to be aware of our other opportunities. There are always other options which we need to consider – including just banking your money and doing nothing. Before we act, we need to have analysed all of these alternatives properly.

    Opportunity Cost

    Deciding to do something means deciding not to do something else. Thus, the question of whether you should enter one particular new market cannot be sensibly separated from the question of why you should NOT enter some other market.

    The opportunity cost for any investment is effectively what you lose by not expending your capital on the best alternative opportunity available to you.

    What this next best opportunity is will depend quite heavily on the industry you are operating in as well as the specific qualities of your company and the general economic backdrop.

    Especially if high interest rates can be obtained, the next best alternative might well be to effectively do nothing and either bank your money or invest it in other businesses.

    However, perhaps more salient here, alternative opportunities are likely to include alternative new markets.

    Our specialist shampoo company above needs to decide whether it would be best served breaking into the generic shampoo business or 

    Revenue

    Whilst this is probably the easiest quantity to estimate, it is also probably the hardest to calculate with a great deal of precision.

    Market sizing is a fairly routine activity. Typically, we begin by estimating the fraction of a population who are potential customers – meaning that they both want and can afford to buy from us.

    We then work out how much we can expect each of our target segment over a give time period. We multiply this by the number of said customers

    Estimates can be more or less precise depending on how finely we differentiate different groups in the population and their different spending habits.

    Cost

    Entering a new market will mean expending capital in some form – whether through financial cost or man-hours. Whatever the form of this cost, we have to quantify it.

    At a basic level, this will mean the simple costs of doing business. What will be the variable costs associated with providing the new products to each new customer? How will the fixed costs of the company’s overheads increase?

    Importantly, though, the precise costs here will eventually depend somewhat on the answer to question three from the introduction. That is, on our market entry strategy.

    For instance, breaking into a new market might require an aggressive – and potentially costly – marketing exercise. It might also require taking lower margins in order to compete. In effect, this would mean the existing parts of the business bankrolling the new endeavour until it became established (Amazon’s expansion is a particularly good example of this approach). 

    We will consider these cost later, though, as a modifier to the simpler costs of doing business in the new market.

    And the Answer Is…

    Understanding the potential revenues and expected costs resulting from entering a new market allows us to calculate the 

    Assuming this is a positive value over the time period we are looking at (a negative value would mean a loss and generally render the exercise not worth pursuing), we then need to compare this potential return on investment to our other opportunities to deploy the same capital.

    If entering the new market is expected to be profitable and to be so to a greater extent than our other options, we can say that we have a viable opportunity that we ought to pursue.

    From here we can develop a market entry strategy. This will likely mean adding a little to our costs with initiatives to help us displace existing market players and establish some initial market share. This might feed back into our profit calculation form before and could render the venture either no longer viable or no longer our best expected return on investment. Assuming this does not happen, though, we can then proceed to launch our market entry!

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