Good business strategy means understanding what external factors can affect your business. That includes understanding how your market works, and what can affect your business or its point of difference, so you can keep ahead of it.

This page has four steps for you to follow. By the end of it, you should be well on your way to understanding your market and your position within it. You might find a great strategy that helps you stand out from the competition and improves your profit or position in the market.

A market's structure is just a way to explain competition, looking at how many businesses there are and how they interact with each other. Markets can be made up of any number of businesses. At one extreme, known as perfect competition, there are countless businesses offering similar products or services. At the other extreme, there’s just one business, a monopoly. Your market is probably somewhere in between. Read about these market types and then use the strategy planning worksheet to write notes about your market.

Perfect competition’s an idea worth understanding

Experts talk about the idea of perfect competition. It doesn’t really exist in practice but it’s helpful to understand.

A market has perfect competition if there are lots of businesses offering standard products or services, and customers have plenty of information to compare them. It’s easy for businesses to start up or shut down, with few barriers. In perfect competition, your business has little power and can’t set prices. You just have to accept the going rate, because customers can easily switch to a competitor if your prices rise by even one cent above others. For example, you might buy flour for baking without knowing or caring which farm it came from. No farm could easily raise their price for this standard ingredient.

Generally, you want your strategy to move your business away from perfect competition so you stand out from the competition and have more power and control.

Monopolies are the other extreme

A monopoly is the opposite of perfect competition. There’s just one big business, with no competition. Maybe it’s tough to set up or shut down a business, eg it’s hard to get the necessary skills or the equipment needed is highly specialised and expensive. This powerful business serves many customers. It can charge what it likes and make large profits. If you had the only gluten-free bakery in a city, or the only hotel in a remote location, you’d have a monopoly.

Real-world markets fit somewhere in the middle

Most markets are somewhere in between the two extremes. It’s worth looking at a couple of examples of real-world markets: fragmented markets and concentrated markets.

Fragmented markets

A market is fragmented if there are lots of similar businesses. It’s about as close as you get to the perfect competition idea — businesses offer similar products and there is no barrier to entry for new businesses. Because there are so many businesses, you have to charge something similar to what others charge, instead of being free to charge what you want. The café scene in New Zealand cities is an example of a fragmented market. There are lots of small cafés and they offer similar selections at similar prices, so customers are often happy to go to different cafés.

Because of low profits, most businesses in a fragmented market can’t afford the resources to establish a brand or create much of a niche for themselves. For example, you might want to introduce live music or different food in your café to increase value and customer loyalty, but lack the time or money to do it. If you’re one of the few who can, you might expand across the area and enjoy increased profits.

Concentrated markets

There are often only a few businesses in a market, meaning what one does affects the others. For example, because there are so few of them, it’s easy for customers to see what they charge. As a result, they charge similar prices. Examples include building renovators, vineyards, car tyre workshops, florists and other specialist businesses. If a florist drops its price, it’s not long before their competitor down the street drops theirs too.

A typical concentrated market is dominated by three significant competitors, who between them control something like 70% to 90% of the market. These three competitors are usually a similar size, with the largest having no more than four times the market share of the smallest. They each occupy a unique position that customers value in the market. That lets them set the price for that specialisation. As a result they can work on understanding and catering to their customers’ tastes, making it harder for competitors and boosting their profits. But on the downside, they could become too specialised in a specific segment of the market. And if things suddenly change it can be a risky place to be.

Trying to grow a smaller competitor to increase market share is difficult. They tend to lose their niche focus before they become big enough to compete directly with the top three competitors. This doesn’t mean a small business can’t dominate a particular market. If you lead a niche area, eg in a particular town or a particular specialisation, you can become effectively a local monopoly. For example, supermarkets nearby may sell a variety of baked goods but your freshly baked, handmade bread makes you the local monopoly in your area.

When we think of competition, we normally think of other businesses who do the same thing. They may offer bargain prices, introduce new features, or launch slick marketing campaigns. But there’s more to competition than that. Competition could be caused by other factors, eg the power your customers or suppliers have over your business or the threat from other new businesses entering your market.

The strongest competitive forces set how profitable an industry is. They’re the most important for a successful strategy. Good business strategy means being aware of where competition could come from, understanding who holds the power, and figuring out a way of dealing with it. Read about these competitive forces and then use the strategy planning worksheet to write notes about your market.

Power of customers

If your customers are only one or two big businesses that place large orders, they may be able to demand discounts or premium service. You’re particularly vulnerable if there’s nothing to stop them from buying from your competitors.

To deal with this challenge, figure out if it affects you by reviewing your customers and competitors. Find a way to make your offering unique and give your customers a reason to stay with you.

Threat of new entrants

New entrants to a market increase either the size of the market or the level of competition. If you run the only dairy in a growing town, you face a threat that a second dairy might arrive to satisfy the demand. New entrants may slash prices, offer new products or services, or use state-of-the-art equipment. For example, a new taxi service might charge less, offer a sleek app, or run a more modern, eco-friendly fleet.

To deal with this challenge, try to make it difficult for new players to copy you or do things better than you. Lock down your suppliers and distributors or introduce new services that add to the unique value of your business.

Threat of substitutes

Customers could be lured away by substitute products or services that are similar to yours, even if they’re not identical. They might be from another industry altogether! For example, taxis, buses, private cars, and even bicycles and scooters are alternative ways to travel around a city, so they are in competition with each other. And newspapers, television, radio, and social media are alternative ways of delivering news.

To deal with this challenge, add something unique to your product or service — something that customers value and that the substitute doesn't offer. Keep your prices attractive and make it difficult for your customers to switch by understanding what they value.

In some situations you might see other businesses in your market as competitors, or as potential partners with similar goals, or a bit of both. Think about cooperative and competitive opportunities. For example, you might work with some of your competitors to develop strategies that help both of you, especially when competing against a big business.

Whenever you work with competitors you need to ensure you’re not engaging in anti-competitive behaviour, eg price fixing. Competition is good for the consumer. It generally keeps prices down and encourages businesses to innovate. This means cooperation that reduces the competition in a market is generally bad for the consumer. You’ll need to be familiar with the Competitor Collaboration Guidelines from the Commerce Commission.

Competitor Collaboration Guidelines [PDF, 1.9 MB](external link) — Commerce Commission

Plan strategic responses in advance

Looking ahead helps you prepare for new or changing competition in your market. Preparing in advance will make it easier to respond quickly and effectively when the time comes. For example, here’s how you might plan ahead for competition from rivals.

• Look out for your market starting to compete only on price. If this happens, try to differentiate your business from others to protect your prices.
• Compete in a different way by gaining new skills or capability. You can do this by cooperating or joining with businesses that fit well with what you do.
• Keep up with technology or other innovations that could reshape the competition in your industry.
• Be ready to move some of your business into another part of the market with less competition. This could mean targeting a new group of customers or focusing on a new location.

Use the strategy planning worksheet to identify likely scenarios for competition and plan how you would respond.

Cooperate and compete

Small business often don’t have the time, skilled staff or money to do everything they need to. What about pooling resources? Working together doesn’t mean sharing all your business know-how. Cooperation can help everyone. Success doesn’t have to be at someone else’s expense and you could benefit the whole industry and your customers.

Some businesses join or set up a cooperative. They’re a major part of our economy — the top 30 cooperatives contribute over $42 billion to New Zealand’s economy each year. Different types of cooperatives cater to different groups, such as producers, consumers and workers. For example, dairy farmers in producer cooperatives work together to market their products better. Builders in purchasing cooperatives buy their raw materials together and reduce their costs that way.

Another way to cooperate is to pool resources for a quality scheme, where an organisation offers certification that shows your product meets a high standard. Displaying their logo identifies you as part of the group, while letting your business remain independent. For example, the Woolmark quality mark for wool products is funded cooperatively by thousands of wool producers. Companies with the Woolmark logo have a clear quality brand, and have more opportunity to focus on other things.

You could even cooperate with businesses that are different to yours, if your products work well together. If you make tortilla chips, why not run a joint promotion with a salsa producer? If you build websites, why not partner with someone who tests them?

Use the strategy planning worksheet to identify opportunities to cooperate with other businesses.

Every business, product or service needs to have its own profile of price, performance and customisation. These define your position in the market. A different profile can set you apart from someone who otherwise looks like a direct competitor.

Use the tool below to compare a business, product or service against its competitors. You’ll reflect on price, performance and customisation to see how you stand out.

Based on your profile, we’ll rate whether you have a strong position in the marketplace. We’ll help you identify some common opportunities and risks.

Record the key points from your results in the strategy planning worksheet.