Target Markets

I was reminded in the last few weeks that the idea of brands having a target market is not particularly well-understood. Some people might feel it is unfair for a brand, or any business, to focus more on some groups of customers than others, while others might not see the point in it at all. After all, plenty of small business owners don’t bother with it. So today, I thought we’d bring together a few different concepts to understand why a business would target a particular group of buyers. 

Economic Profit

First off, we’ll need to introduce the idea of economic profit. Most of you will think about profit in the way that accountants do: a business has some amount of revenue, from which you subtract the operating costs, and the residual amount is the profit (or loss). It’s a simple concept and it’s quite useful, but it’s not sufficient for economists. 

That’s because we also want to understand if a firm’s resources — it’s capital, management, real estate, etc — could be better used elsewhere in the economy. So we also factor in the opportunity costs of those resources: the market value of the things that a business sometimes gets for free or at a discount. A common example here is the manager of a small business: they often take a salary from the business that is less than they would receive if they were employed elsewhere. That reduced salary isn’t recorded on the books and so it’s not an expense, but it’s still a cost the manager has to bear. That’s what economists are interested in. An accounting profit only looks at the actual expense made while an economic profit would consider the owner’s full market value. Another example is the capital which has been invested into the business by its owner or others. To determine our economic profit, we need to consider the returns which that capital could have made in other investments.

If you think of someone with a struggling small business run out of a friend’s otherwise-vacant property, they might be eking out a small accounting profit. But if they were to factor in the full market value of their own labour or the property they are using, it’s unlikely that the business would be making an economic profit. This matters as it means the business is not sustainable: sooner or later, those resources will end up being used elsewhere. The owner will see the bigger salary they could earn elsewhere, the friend will see an opportunity to rent out the property for more money, and the business will close down. If a firm is making an economic loss and there’s no obvious way for them to become profitable, it’s far preferable for society that those resources go to others who can make better use of them.

But while some businesses are making an economic profit or a loss, it’s much more common for businesses to be breaking even: making an accounting profit but not necessarily bringing in a lot more money than the owner-manager would make if they took an equivalent position working for somewhere else. In economics, we call this a ‘normal profit’ and it is no bad thing; in fact, it’s really the default position for most firms in the long run. And it’s socially desirable: we don’t want firms to be running at a loss and closing down, but we don’t want them to be making wild profits either. We want owners and managers to be appropriately compensated so they can keep doing what they do. 

Of course, no business owner really wants to be breaking even. Everyone wants to be making an economic profit — to be making a better return from their business than they could get from working or investing elsewhere — and almost every business has a strategy which will supposedly lead them there. The surprising thing is how many business strategies and plans are made by people who don’t understand economic profit, much less how to get a business there. 

We can break down economic profit into two different activities: achieving profit and then sustaining it. Achieving profit is arguably the easier of the two. It involves coming up with some genuinely valuable insight, like noticing there’s a large group of people with some unmet need that you could fulfil, or figuring out some way of manufacturing a product better or cheaper than others can. Once that opportunity has been identified, achieving the economic profit is essentially just implementation.

The harder part is sustaining that profit. Any genuinely profitable opportunity will attract attention from other businesses. Those competitors will try their best to copy the idea, so they can share in the profits. If the opportunity is something which is easily replicated — like a new dish in a restaurant — it will be virtually impossible for the business to sustain that profit for very long. But if there is some way to exploit an opportunity which others cannot easily duplicate, then it’s possible that the profit will not be competed away for some time, and the firm will remain profitable at least in the short or medium term. 

So any manager who is serious about their business needs to understand economic profit, how they can achieve it in the first place, and how they can sustain it. Business strategy is just a coherent plan for how this is to happen. Any ‘strategy’ which omits economic profit is close to worthless (though, in my experience, that describes most strategies anyway). 

Strategy and the Retailers

For businesses within a competitive marketplace — like our own FP industry — the first thing that occurs to them when thinking about strategy is that it’s harder than it first appears. There’s no easy ways to make an economic profit. If there were, other businesses would have already exploited those obvious opportunities. So profit either comes from exploiting more obscure opportunities or from finding new opportunities that have come about through changes in the market. 

For retailers, achieving an economic profit requires you either get your prices up or your costs down. Getting prices up is easy to understand: if your costs are the same as every other retailer but you’re able to sell at a 20% premium — either because of superior service, salesmanship, or simply because your buyers don’t care to shop around — then your business is going to be more profitable than the competition. Getting costs down typically involves selling a much higher volume of product. This allows the firm to make better use of their resources, lowering the cost of each unit sold, while selling at the same prices as the competition. However they get it done, lowering costs can enable the retailer to achieve a profit.

Neither of these guarantee that an economic profit can be made but one or the other is necessary in order to achieve it. Goulet Pens is a superb example. I don’t want to diminish the hard work of Brian and Rachel and their staff, but I don’t agree with Brian when he says their success was all about implementation. I give more credit than that: ultimately they were successful because they managed to identify an opportunity which hadn’t been exploited by others. They figured out a way to sell pens nationally rather than to their local geographic market using the internet and they happened to do this at a time when interest in FPs was growing. While existing retailers might have been aware of one phenomenon or the other, none were taking advantage of it. That left the opportunity wide open for the Goulets, and they were able to dramatically outsell the competition, getting their unit costs down, and putting them in a position where they were able to achieve an economic profit.

The present challenge for the Goulets is sustaining that profit. It persisted for a surprisingly long time — more than five years — but it seems other retailers have finally decided to pursue the same opportunity. Now we increasingly see Anderson Pens, Goldspot Pens, Pen Chalet, and Vanness Pens all trying to take a chunk of Goulet’s market share for themselves. If these competitors are successful, it means Goulet will lose some of their sales volume, thereby raising their average costs and reducing profit. At the same time, the competitors’ sales will rise and increase their profit. Eventually, we’ll start to approach an equilibrium where each firm will be earning a normal profit. Any activity that yields a profitable advantage over the competition — marketing skills, superior internal organisation, etc — will be identified and duplicated. That’s why we see Vanness Pens on Instagram, Anderson Pens on Periscope, Pen Chalet sponsoring podcasts, and just about everyone sponsoring blogs. 

The only way for a firm to make an economic profit in this environment is to figure out something they can do which the competition cannot. Often, this means specialising in one segment of the market at the exclusion of others: restructuring the entire business so that you can better serve one particular group of customers. Other firms cannot compete in that same space without also restructuring their business, which means they would have to give up their existing customer base without any certainty that they will capture new customers. Unless that segment is so profitable that it can comfortably accommodate two firms, the risk will be enough to deter other FP retailers from trying to enter that space. 

Strategy and the Brands

Of course, all of this takes time. It took years for other retailers to begin copying the success of Goulet Pens, and although we’re now tracking towards an equilibrium state, it might be some years before we get to that position. But we don’t need to imagine how that will play out, the transformation has already happened in the upstream market. Most of the major brands have chosen their area of specialisation and built their businesses principally around serving a particular market. 

You might remember that I discussed some of this in the post about Montblanc, where I pointed out that their success had come from a particular target market. They identified a niche, structured their business around serving one particular group of customers, and did exceedingly well from doing so. That advantage has only eroded because of demography, as their customers have become older and started leaving the market. 

Just as Montblanc has found their target market, so have most other brands. Within the German brands alone, you can see that Montblanc, Pelikan, Graf von Faber-Castell, and Lamy all have a very different design aesthetic, brand image, and pricing strategy. Rather than fight it out where there are no profits to be made, all of them have settled into their niches. It’s interesting to look at the entry-level pens offered by the three latter brands. Lamy have gone after the cheaper end of the market with a very basic model, Faber-Castell have gone after buyers who are willing to pay slightly more for a more modern design, while Pelikan have gone after buyers who want a really high-quality instrument (and aren’t so concerned with size). 

If you believe that all of these brands are pursuing the same group of buyers, you might be a bit perplexed about some of their choices. It won’t make sense why Montblanc charge so much for their pens or why Pelikan’s entry-level pen is so small. But if you recognise that each brand has decided to focus on some buyers, and cede the rest of the market to other brands, then it starts to make more sense.

This isn’t to say that brands will refuse to sell to customers who aren’t in their niche — of course that isn’t true. But they will have done market research to understand the different groups of buyers. The brands will have figured out the types of products that each group wants to own, how much they are willing to pay, and what sort of quantities they are willing to buy. The brands would then have looked at their internal capabilities, their strengths and weaknesses, to figure out which segments were a good match, and finally considered where the other brands might go. I suspect that Pelikan has gazed longingly at Montblanc’s segment — a group Pelikan would be fairly well-equipped to serve — but avoided it, knowing that its much more profitable to dominate their own niche than to fight with another brand for theirs.

Choosing a particular segment doesn’t mean that a brand is totally uninterested in other buyers or that they would refuse to sell to them. Rather, it means that they’ve found one segment to be more profitable than trying to serve everyone, and so they have built their business around serving a particular group of customers. This point seems to be more commonly accepted by bigger businesses than smaller ones. In my experience, a lot of small business owners are terrified about giving up on any customers, so they can never quite bring themselves to specialise in a particular niche. That attitude is one I can totally understand but it’s always going to limit the success of their business.

Segmentation is an interesting phenomenon. Once you understand it, you start looking at businesses in different ways: you start to understand that they are more interested in some buyers than others, and the subtle ways they signal this. It’s rarely about exclusive but it’s often about making their business as appealing as possible to the target group. If you walk into a Montblanc boutique, you immediately sense the type of buyer that they typically serve and their staff can sometimes struggle to interact with folks who don’t fit that group. It often comes off as the staff being snobs or stand-offish, but I suspect it’s really just because they’ve never been trained for some types of people and they’re not entirely sure how to behave. I’m extremely casual in my behaviour and there’s an obvious tension with the level of formality in those stores; that isn’t because the staff are rejecting me or think I’m not good enough to buy their products, but because they don’t know what to do. Should they match how casual I am or continue to act formally? (Similarly, if you were to walk into a discount store and act extremely formally, I think the staff there would also struggle with the right way to accommodate you.)

Segmentation also helps you to understand the behaviour of particular buyers. If you have a decent understanding of someone’s preferences — not something that’s always possible, of course, even with good friends — you can probably figure out which brands or products will be most appealing to them. It’s just a matter of matching their preferences with the value proposition of the different brands. That might strike people the wrong way but it’s the exact same behaviour we exhibit when we recommend bands or restaurants to friends. 

Conclusion

We’re not yet at the point where online retailers will start to pursue this strategy. They obviously still see the general market is more profitable and so they are increasingly copying one another to try and capture market share. That approach will continue until the economic profits are gone and everybody is back to earning normal profit. Once we reach that equilibrium, it will still take a while before retailers start specialising in the same way as brands — but it’s a development seems almost inevitable. 

Right now, it’s not at all clear which segments might end up emerging, so it’s not possible for me to forecast or even guess which retailers will target which markets. I’m also not sure how country borders will dictate things: whether we will see some retailers dominate globally or whether we’ll continue to see some division along regional borders (eg Europe, North America, etc). But it will nonetheless be interesting to see how much changes in the next 3-5 years. My guess is that the players might not change all that dramatically but their market positions and strategies certainly will.

The biggest beneficiaries out of all this is, of course, the consumers. As we approach equilibrium, competition between the retailers will grow more intense. As retail prices are typically set by the brands, they won’t fall because of this (though they may fall for other reasons) so we’re likely to see improvements in the quality of customer service, more sponsorship of blogs/podcasts, and other investments that the retailers see as valuable to consumers. Retailer exclusives (like the Goulet/Edison exclusive, the Wonder Pens/Franklin Christoph exclusive, etc.) are also likely to become more common though I’m not sure whether this is actually a positive development or not. And the amount of products carried will grow until they carry approximately the same range as each other. Beyond equilibrium, there will still be some general retailers but firms specialising in different niches will give much greater diversity, much like the pen brands of the present give an enormous diversity of product design, features, and price. I’m very much looking forward to it.