As strategy consultants in Private Equity we often work on small markets with a limited number of competitors, between 5 or 6 and 20, and frequently with 10 to 12 players who matter. When we get to understand the strategy of each player, we get to build the aggregate “Vista” of the market: their vision, understanding and predictions for key market parameters: market size, market growth, reasons for market growth, their own market share, now and in the future.
What we often find is that, on aggregate, the Vista does not make sense. More often than not, all the Vista market parameters cannot be all true at the same time:
- sometimes there aren’t enough customers to sustain the expected market growth or they cannot consume as much as one might hope;
- there may be market alternatives that limit future growth;
- not all competitors can gain market share, etc.
In other words, if the Vista is the aggregate of all the business plans of all competitors seen together, it is impossible that they all turn into reality.
The Vista actually is a bubble.
Even though the bubble is often overlooked, it is perhaps not surprising. There is abundant research arguing that, on average, managers are overly optimistic. They are excessively confident in the future, typically overestimating market size, future growth, their own market share or their future gain of market share.
Their business plans inflate the future and create a permanent state of bubble. It is a small, ordinary, non-threatening bubble – but a bubble nonetheless.
Managers are optimistic because their focus is on their objectives and course of action: they expect to succeed and they are expected to be successful, most of the time. The future state of a market however is the result of a set of constraints that determine market size, growth, respective market shares, etc. The future state of a market is not the outcome of managerial expectations.
When investors rely mainly on interviews to understand the market, inevitably they get the inflated Vista as an outcome. One should not rely on managerial expectations to build a relevant outline of the future. Only a carefully tailored combination of descriptive and predictive analytics will help the investor understand the set of constraints that drives the future. As the Private Equity investor is looking for a realistic market view, this is the high road: understanding the market constraints through the lens of analytics.
This article was originally published as a blog post on our corporate web site: http://www.sokrates-advisors.com