The Importance of Market Share
Market share is one of the most important metrics in Recurve’s investment process. Any company steadily losing market share is problematic. Disruptive companies gobbling up market share can be interesting. However, there are layers of nuance that we should consider before writing off every share loser and owning every share gainer. What we are looking for is steady market share gains that generate very attractive, profitable growth. And we are looking for share gains across cycles and environments for the right reasons – because customers love the brand, products, and/or services, and they keep coming back for more because they love the price/value, quality, and other important attributes.
In this post, we will discuss the dynamics of market share gains, how we assess the long-term viability of sustainable share gains, and how these apply to Carvana. Let’s dive in.
Why Does Market Share Shift?
There are myriad ways to explain why spending shifts between companies within segments of the economy. In the end, it comes down to share gainers offering superior value across one or many of the dimensions of value, which include:
Economic – money is saved
Functional – purpose is fulfilled
Experiential – interactions with the company or brand are pleasant
Symbolic – meaning is created, e.g. creating a shared identity or mission between a brand and its customers
Not all humans behave rationally in all contexts, but on average, customers can sense when a company is saving them money, when it is delivering high functional value, when they feel good interacting with the brand, and/or when they feel like part of a company’s social fabric.
For instance, Tesla’s customers know they can buy cheaper cars from other manufacturers to get from point A to point B. However, by buying a Tesla, they see a plethora of benefits:
(a) Saving money on gas and maintenance over time.
(b) Driving a car with integrated technology that feels more like an Apple device.
(c) Interfacing with a digitally-native company when purchasing and servicing their cars.
(d) Doing their part in lowering greenhouse gas emissions, while also becoming a member of the Teslarati.
Not all Tesla owners identify with each dimension, but most of them likely attribute nonzero values to each. In contrast, what do customers get when they buy a GM car? It might be cheap and gets from point A to point B, but the higher order (technological) functional, experiential, and symbolic dimensions, more likely than not, are very low or zero values. GMs are more likely to be purely economic and functional purchases rather than pride-inducing purchases.
I’m sure we can think of companies that have real fanaticism behind them. Hermes, Rolex, Apple, Costco, Tesla, Nike, and others. What do they do that’s so different from the rest? How did they win those positions?
Let’s invert the analysis and think about share-losing companies. Why should a company perpetually lose share? It likely boils down to some combination of its products being inferior and/or too expensive, delivered by poor customer service. The brands likely don’t bring positive associations (or worse, they stand for something negative).
As we wrote about in our anti-models post on Charter Communications, cable companies were blessed with superior market positioning to deliver the highest bandwidth products for decades due to their infrastructure advantages, but they blew it on the other dimensions. Customers hated them, they were expensive, they had terrible customer service. Who knows how many online communities have been formed around hating Comcast and Spectrum. They have rested on their laurels and are desperately hoping (and expecting) not to be disrupted by competitors. Some investors are drawn to them because they believe their infrastructure advantage is so powerful that they can withstand all the pressure of delivering an expensive and disappointing experience to customers. We want a deeper, more fulfilling customer relationship from our companies.
We only look for companies that are steady, long-term share gainers in their industries. We avoid cheap stocks that have questionable longer-term market share dynamics. We tend to build our highest conviction in companies that use their vertical integration and larger scale to deliver faster/better/cheaper products and services, thereby convincing customers focused on Economic and Functional dimensions of value that they should use our brands. It turns out that most companies that obsess over delivering a superior and better-value product or service also tend to excel at customer service and end up engendering significant customer loyalty. A parcel delivered same-day by Amazon is simultaneously (a) Amazon’s lowest marginal cost to deliver, and (b) the customer’s highest satisfaction purchase. The same is true for Carvana’s same-day deliveries - they generate the highest customer conversion, highest satisfaction scores, and lowest marginal cost. It’s a nice virtuous cycle.
Now, let’s dive into how share shifts.
The Process of Winning Share
Even if a company has a vastly superior product at a better price, amazing customer service, and each product sold helps cure cancer, delivering a 10/10 on every dimension of customer value, it still cannot capture its “end state” market share in a short period of time. There are strong forces of inertia in existing purchasing patterns and customer relationships. Back to our cable example, even if most customers hate their cable providers (true) and can find a cheaper broadband solution from T-Mobile, AT&T, or Verizon (also true), most customers are on auto-pay and don’t want to deal with the hand-to-hand combat of cancelling a cable contract. A small minority of the subscriber base changes hands every year.
In markets with recurring contracts, only a fraction of the market is up for grabs at any given time, which is what makes service providers with subscription revenues highly attractive to investors. In transactional markets, disruption can happen much more quickly. However, are other dynamics worth discussing. Let’s explore some of these by digging into a case study on Carvana’s market share dynamics.
Carvana
We’ve written in past Insights about our belief in Carvana’s advantages in auto retail, powered by its vertically integrated production and distribution infrastructure. Its infrastructure allows the company to deliver better value to customers and an excellent experience via superior selection, home delivery, integrated financing and insurance options during checkout, no stressful negotiations, and more. It easily satisfies the economic, functional, and experiential dimensions of value. Perhaps one day the brand will be elevated into the symbolic dimension, but it’s not there yet.
Let’s explore the industry backdrop for how Carvana gains share. It competes in a field of tens of thousands of other used auto dealers and has only about 1% market share. Carmax, the largest, has 2-3% market share. The top 100 have 11% market share. There is significant open field and Carvana competes in a favorable market structure for our Builder Companies – a Fragmented Competitive one. Small dealers may bleed share to Carvana but can’t identify that it’s Carvana taking their share. They may blame the economy, interest rates, a sluggish consumer, and/or their sales associates for slowing momentum. Some of those may be true, but Carvana can grow while they shrink, and they won’t be able to specifically identify that it was Carvana who stole their customers.
The used auto market is relatively stable at 35-40 million units per year in the US. In 2023, the market declined about -5% as higher rates and still inflated used car prices stifled demand. The market is projected to be flattish this year.
Let’s talk about the factors that influence market share gains for Carvana:
Auto retail is an episodic, transactional market. Customers in the used market purchase every 4-5 years.
Not all consumers (yet) are comfortable purchasing a used car in an e-commerce transaction, but most start their purchasing journey by searching online. Carvana does not yet receive the full set of consideration from consumers, but there is growing acceptance of e-commerce auto retail, and this should serve as a tailwind for the company.
Carvana relies on its vertical production and distribution infrastructure and significant labor to power that infrastructure. It is prohibitively inefficient to run fully staffed at 1.3 million units of annual capacity if, for instance, only 600,000 units of demand show up. Managing capacity utilization to optimize for financial performance acts as a constraint on the growth of the business.
In its early years, Carvana was more of a local and regional retailer, but over time expanded to reach over 80% of the population in 316 markets. The company benefited from significant addressable market expansion from 2014 to 2020.
Carvana’s challenge is to attract interested buyers and sellers to its platform given the mix of these factors and more and to optimally conduct retail operations with them (buying and selling cars), while also efficiently interfacing with wholesale markets to buy and sell units optimally.
It can attract buying and selling volume by advertising across the marketing funnel, through word-of-mouth referrals, and by converting organic traffic to its web site. According to SimilarWeb, Carvana.com receives nearly 19 million monthly visits (by comparison, Carmax.com receives 22 million monthly visits). Carvana must convert its ~230 million annual web site visits into significant supply (by buying cars from customers) and demand (selling cars to customers). We expect Carvana to exceed 1 million total retail units (buying and selling) in 2025, a tiny fraction of its total traffic. Even small improvements in conversion can move the needle materially for the company.
It is non-trivial to produce and manage inventory levels nationwide to serve compelling selection, value, and delivery times to customers, while running vertical infrastructure efficiently. If it has too much unused inventory, labor, and production capacity, its financial performance will suffer. If it has too little inventory, its conversion, growth and market share may suffer, but its financial metrics should be fine.
Prior to 2022 and 2023, when the industry took steps backward due to inflation and rising rates, Carvana grew at incredible growth rates which far exceeded market growth rates.
Source: Carvana
So, how fast can Carvana grow now, especially after it focused its efforts over the last 18 months on efficiency over growth?
The short answer is that we’re not sure, but we feel strongly that current expectations of <20% are far too low. We have high conviction that Carvana’s value proposition across all important dimensions is strong and improving – and it is benefiting from the secular trend of e-commerce taking share from brick & mortar auto retail. After all, nobody feels excited about negotiating with used car salespeople (and their stubborn back-room managers). Most would strongly prefer instead to buy a great car from Carvana’s vast selection that has been reconditioned to strict standards and delivered to their door, all at a good price with attractive financing.
In Q1 2024, Carvana grew retail units sold +16% y/y and is guiding to an accelerating growth rate in Q2 (i.e. higher than +16% y/y). We like seeing the company driving q/q unit growth to the tune of +10% or so, implying >40% annual growth if it continues on that trajectory. What we know for sure is that Carvana’s important dimensions of value improve the bigger it gets. Its selection, value, and delivery times will improve at 1 million units vs. 500,000 units, and at 2 million vs. 1 million. With capacity for over 3 million units in its current physical footprint (with known expansions), there is a compelling amount of value yet to be delivered to customers – and shareholders.
Growing vs. Shrinking End Markets
It’s important to identify whether or not a company’s core value proposition to customers has changed, or if the setback is due to transitory factors in a weakening and pressured market. If the setback is permanent because a company’s value proposition to customers has worsened permanently, it’s a very dangerous situation for equity investors that will tend to lead to poor outcomes. If it’s a temporary setback but the core recipe to customers is intact, very often these are amazing situations for long-term investors.
Most disruptive companies take share faster when their end markets are healthy and growing. It makes sense – there is more consideration in the category and there are powerful flywheel effects for disruptive companies that aggregate consumer attention. They convert customers more efficiently, reducing customer acquisition costs and payback periods, which then releases more advertising and marketing dollars into additional customer acquisition channels. In a growing market, fewer competitors are cutting prices to convert excess inventory into cash. However, rapid growth markets also attract new capital and new competition, which was a challenge for many companies during the ZIRP era, when high-quality brands with strong business models had to compete with new entrants that were fueled by cheap and abundant growth capital.
By contrast, in a shrinking market, long-term disruptors and share gainers can find themselves temporarily losing share, or growing much slower than before. Competitors may revert to heavy promotional discounting to boost sales. Liquidations may occur, temporarily stealing share. Marketing budgets often shrink in concert with revenue declines, reducing the size of the customer funnel. The category may receive significantly less consideration, generating less “free” organic traffic than prior periods, extending advertising payback periods and reducing marketing effectiveness. Perhaps a disruptor (like Carvana in 2022) could find itself overbuilt on fixed capacity and labor relative to the demand trends, and it must pull back and right-size the organization for the new environment, leading to temporary share losses.
Luckily for Carvana, the auto retail market is large, fragmented, and now finding stability after a few difficult post-Covid years. Many of its e-commerce competitors were forced to exit the business and/or declare bankruptcy because they couldn’t achieve sufficient scale and/or find new funding in a difficult environment. Carvana is the only significant pure-play e-commerce player that was able to achieve enough scale to cross the chasm and achieve a market-leading position with excellent unit economics.
Carvana is on the cusp of a fact pattern that is reminiscent of Netflix achieving profitability in streaming video well before any of the legacy media companies. Netflix was able to invest strategically in content and distribution to generate significantly better unit economics than legacy companies that were reliant on old relationships and old architecture. When Netflix became self-funding with the ability to keep investing ahead of the competition, it became a runaway train in the streaming content market. We expect the same to be true for Carvana in e-commerce auto retailing.
Closing
Finding companies that can sustainably gain share is difficult, but they end up being some of the largest and most successful companies in the stock market. Even legacy leaders can be at risk of disruption from competitors if they do not stay vigilant on innovating on behalf of their customers to ensure they deliver exceptional value economically, functionally, experientially, and symbolically. The most impactful measure of disruption is not just growth, but customer loyalty. Winning customers for life is how significant terminal value is created and how flywheel effects take form. However, it is just as important to marry market leadership with a strong economic model to ensure that equity investors will be major beneficiaries of companies growth and customer loyalty.
We’ll end with a quote from Sam Walton to hammer this point home on how to sustainably gain market share and create long-term equity value: by treating customers well.
“If the associates treat the customers well, the customers will return again and again, and that is where the real profit in this business lies, not in trying to drag strangers into your stores for one-time purchases based on splashy sales or expensive advertising.”
