What Causes Markets To Take Off?

Marketers looking for a strong upward spike in their sales charts will claim that once a price drops to a certain level, such as the magical $500 price point for consumer electronics like CD players, the mass market will rush to buy their product. But falling prices aren't the key factor, argue Rajshree Agarwal, assistant professor of strategic management at the University of Illinois at Urbana-Champaign, and Barry L. Bayus, professor of marketing at the University of North Carolina's Kenan-Flagler Business School. “Price itself is unimportant in causing sales in the market to take off,” says Agarwal. She and Bayus provide evidence that the entry of competitors is the real cause.

In “The Market Evolution and Sales Take-Off of Product Innovations,” published in the August 2002 issue of Management Science, the authors describe their analysis of 30 consumer and industrial product innovations that resulted in successful and entirely new product markets over the past 150 years. In the evolution of every market, from sewing machines and CD players to heat pumps and antibiotics, a surge in industry sales growth was preceded by an uptick in the number of competing firms.

The authors posit that increased competition leads to rapid mass-market adoption through several intermediate mechanisms. Price drops are one such mechanism —firms lower prices to attract sales in the presence of competition — but this doesn't always occur. In some of the markets they studied, such as turbojet engines, sales increased even as prices rose. The study determined that price declines are least important for innovations with relatively high R&D costs, such as turbojets, cathode-ray tubes and piezoelectric crystals.

However, even in markets that show price declines, other intermediate mechanisms might dominate. In fact, the authors believe that product improvements explain rising sales better than do reductions in price. As competitors enter the market, primitive early product offerings improve dramatically in quality and performance, with producers often tailoring these improvements toward niche markets. With a greater variety of product offerings in the market, firms must innovate faster. These innovations have a greater impact than price on whether customers accept these new products.

Beyond price drops and product improvements, there are other mechanisms that may explain an increase in sales. For instance, the presence of more competitors could enhance sales and distribution channels (for example, sewing machines require retail outlets), spur infrastructure developments (for example, automobiles require roads and gasoline outlets), or improve advertising and promotion efficiency. Like-wise, the entry of a large competitor into a market populated by small innovators could signal the legitimacy of the product market to other potential competitors, supply chain partners and buyers.

If increased competition is so beneficial, should an innovator encourage competitors to jump in? Not exactly. “There is a difference between our level of industry analysis, and what we can tell an individual firm to do,” Bayus points out. Pioneering firms face a tradeoff, however — they can own a large share of a market they grow alone, or they can own a small share of a larger market that followers help to build with them (with a possible loss of the power to set prices).

While the authors wouldn't recommend dropping patent protections and encouraging copycats, they might recommend working with potential competitors in alliances or cross-licensing arrangements. For example, consumer electronics manufacturers agreed upon technical standards for CD players to ensure that music producers would publish music in the same format. That enabled the rapid growth of the CD player market, even though manufacturers may have lost some proprietary technologies and pricing power.

On the other hand, pioneering companies with better mousetraps might go it alone if they were sure they had adequate resources. Those pioneers might not need competitors to help boost the rate of product innovations, develop a market infrastructure, or promote the new product market. The market probably won't grow as fast as it could, but the pioneer's monopoly profits would likely keep it happy.