“OK, keep going, what’s this business about ‘concentration’?” asks Herbie.
“’Concentration doesn’t just mean ‘big’, says the Mentor. ”It means ‘what percentage of the market is controlled by the 3 or 5 largest players’?.
“What’s the difference?” asks Herbie.
“OK, think about convenience restaurants. There are billion dollar companies, like McDonald’s and Starbucks. And there are also thousands and thousands of small diners and sandwich shops and pizzerias. The point is, McDonalds, Starbucks and KFC do not have a dominant share of the convenience restaurant market, even though they are each billion dollar companies. So I would not say the industry is very concentrated (everything is relative).
Now, if you are an airline, even a tiny one, think of the Jet Fuel sector of Oil and Gas. There are also billion dollar companies. But there are only a few “small” companies and no Mom and Pop’s. So this sector is highly concentrated, much more so than convenience restaurants, even though there are big companies in both.
Finally, there are local exceptions. I have been to small towns on the highway where there are 2 or 3 national franchise restaurants, one local diner and that’s it. Nowhere else to eat for many miles. In that town, the convenience restaurant industry is extremely concentrated.
Now let’s apply this. Remember our framework- over towards the right is “high profit potential" for that industry or industry sector:
As the graphic indicates, if your competitors are highly concentrated, this is good for industry profitability- though not necessarily for your profitability. The reason this is good for industry profitability is that the larger market leaders can impose some discipline on the market, preventing price wars and other destructive behavior. They will also advertise and collectively expand the market, which is good for all participants. Further, large players will lobby regulators for favorable conditions. To repeat though, all of this is good for the industry, but not necessarily good for you. But right now, we are discussing industry attractiveness.
Next, if the suppliers to the industry are highly concentrated, this is bad for industry profitability. The reason is that powerful suppliers will extract as much profit from the industry as possible. Think of my earlier example of jet fuel suppliers.
Finally, if the people you sell to are highly concentrated, they will demand discounts and stringent performance requirements. It is tough to be a vendor to Walmart or AT&T.”
Now Herbie, remember, the most important part of what of what I have said is that collecting this data is not easy. It is not just sitting there for you to look up- you have to do original analysis.
You should listen to podcasts and follow the business press. In a recent episode of the podcast CannaInsider (@CannaInsider), Todd Harrison from CB1 Capital (@CB1Cap) said something very powerful… he said the industry is evolving “from a cottage industry to an industrial complex”. That is a good way of stating things. Anyway, one way to think your way through a statement like that is what it means for industry concentration in the sector you are considering, and the implication for the profitability of that sector. Don’t just stop at the statement. Think about what it means.
“This is starting to make sense”, says Herbie. “Especially the part about needing qualified consultants and executives. This is some deep shit”.
“I will take that as a complement”, says the Mentor. “See you next week. We’re almost done with the “landscape” phase of your learning”.
“You’re really into this ‘Mentor’ thing, aren’t you”, says Herbie. “But if you ever call me ‘grasshopper’, we’re done”.