Strategy Dynamics Briefing 30: When resources bring access to others

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One specially useful case where resource attributes arise is when one resource brings access to other potential resources, most often customers…

One specially useful case where resource attributes arise is when one resource brings access to other potential resources, most often customers – a new product makes it possible to sell to a certain number of previously unavailable customers, and adding a new distributor makes it possible gives access for our products to their end-customers, for example. We describe the first resource as “primary,” and the resource to which it brings access is “secondary.” This terminology does not imply any importance — both are vital.The most visible example to the general public of this principle is when opening a new retail store in an additional town gives access to consumers who we could not previously reach. We constantly hear of new outlets opening for Starbucks, Wal-Mart, IKEA, etc., and many of us change our shopping habits when an appealing new store appears in our neighborhood. Behind this expansion lie sophisticated procedures for assessing the likely customer-base, sales and profitability of each new unit.But gaining access to potential customers is not the same as actually winning those customers. Having opened a new store, we must of course offer products and services that its target consumers want at prices that offer good value. Then there is the question of how far to push that expansion. Early in the life of a retail chain, every new store can be opened in a locality that is new for that chain, and where there are large numbers of potential consumers. As expansion continues, however, two things change:

  • locations for new stores reach only smaller numbers of potential consumers
  • each new store’s catchment area increasingly overlaps with existing units, so much of its sales only arise by taking sales from neighbors.

In the figure below, an initially successful retailer expands its network of stores over a 10-year period. With its first stores able to reach 20 000 consumers who each spend $500/year on its goods, management believes there is potential for over 200 stores reaching up to five million consumers. For the first five years, plans go well, but as expansion passes the target number of stores, consumer numbers and sales fall short of expectations. Nevertheless, with each new store seeming to win enough consumers to be worthwhile, and sales continuing to grow, the company presses on with expansion.

New retail stores bring access to ever-fewer new potential customers

New retail stores bring access to ever-fewer new potential customers

Unfortunately, hidden beneath the reasonable top-line indicators there is a sharp fall in the true number of new consumers won with each new opening, and new stores increasingly succeed only by taking sales from others. Furthermore, the later consumers turn out to spend less with the stores than those captured from around the initial locations. The costs of operating these later stores is not covered by the incremental revenues and gross profit from the sharply reducing rate of new consumers, and profits go into decline.

The generic structure this example illustrates consists of:

  • The in-flow of new stores (the primary resource) brings with it an attribute co-flow or new potential customers (the secondary resource)
  • That growing potential of the attribute resource is then converted into an active resource, in this case consumers who really use the stores
  • The secondary resource (customers) drives revenue, and costs are incurred
    [a] adding the primary resource (stores)
    [b] operating that resource (running the stores) and
    [c] converting potential customers into active ones.

Had this company cut its expansion rate when the additional numbers of consumers with each new store dropped sharply (e.g. as shown in grey text about half way through its expansion in year six), it would have attracted most of the potential market, kept profits at $32m/year, and only had to invest $240million of capital rather than the $385million it eventually spent.

You (or your students!) can explore this strategic management of market saturation in the Beefeater Restaurants business game. In addition to this issue, the game includes the impact of product development on expanding market potential, the pressure to accelerate progress when a competitor is pursuing the same opportunity, and the need to satisfy investors’ requirements in order to attract the capital to continue expansion.

This is not to say that management should give up at the first sign of having “used up” their business opportunity. It is often possible to find ways to serve smaller markets profitably. Second, many retail chains have expanded the potential market, and thus lifted the ceiling on viable growth by extending the range of products and services offered in the same space. Many have also developed slimmed-down units, offering limited product-ranges and incurring much reduced operating costs precisely to enable them to reach smaller local markets.

These principles can readily be adopted with suitable adjustment by businesses in other sectors and applied to other kinds of resource. We have featured the low-fare airline Ryanair in early briefings – a company that has relentlessly opened large numbers of new airports and routes over many years. Each new airport gives access to new potential travelers, and additional routes are one important means of developing those people into active customers. This issue is explored in another business game – the LoFare Airline microworld

Product-range extension can also give access to additional potential customers, but again can be over-done. In one country market, a confectionery company sold over 30 distinct products, but still had lower sales than Mars, who offered only 18. The competitor kept adding new products in the hope of winning new consumers, but each new line took more sales from its own range than from Mars.

Until next time…

 

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Real-world examples

Even world-leading retailers fall into this trap. Starbucks, for example, had to close over 500 stores during 2008, and more in 2009 because of inadequate sales, at a very high cost and having spent hundreds of millions of wasted dollars to open them in the first place, just a few years earlier (see my video presentation ” Lessons from the crisis ” (Note: Duration is 72 mins)

Strategic Management Dynamics book coverThis strategic error can lead to further difficulties, such as damage to the firm’s reputation in the market as it is seen to operate second-rate units, diversion of management attention onto solving the problem they themselves created, damage to investor confidence, and poor morale amongst middle – and front-line management. It is worth recalling that McDonalds’ too once got into this difficulty. In its 2002Annual Report letter to shareholders, the new Chairman stated that the business was “in transition from a company that emphasizes adding restaurants to customers to one that emphasizes adding customers to restaurants.” The company also cut its target annual profit growth rate. Result? – a subsequent increase in profit growth and a strong recovery in its stock price.

This briefing summarises material from chapter 5 of Strategic Management Dynamics, pages 274-280.

Read more about the book on our website

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