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A fragmented industry is a business sector with many competitors but with no one company holding a large enough market share to influence the business decisions of all. Each player is small relative to the extent of the market. This does not imply that the industry is not profitable or is not experiencing growth; rather, it is more a sign that there are few barriers to new competitors and the opportunity for profit is perceived to be higher than in other ventures.
Small business is the norm for a fragmented industry, which often caters to the most common consumer needs. Restaurants, hair salons and auto repair shops are examples of businesses thriving in a fragmented industry. Startup costs are typically modest and there is no economy of scale that decisively favors a large provider over a small enterprise. Many businesses have carved out a market niche where they deliver a unique product or specialized service. Diversity of consumer preference often allows several industry players to profitably coexist within one geographic market.
Several factors that contribute to the formation of a fragmented industry have been identified. Foremost among them is the ease with which a competitor may enter or exit the industry. There is no substantial initial investment in product development, employee training or specialized equipment. Industry regulation does not discourage new competition or subsidize established enterprises. Upon exiting the industry, there is usually no need to take losses on expensive assets that cannot be sold or repurposed.
Economies of scale lower the unit cost of a product by spreading the cost of production over a large number of uniform goods. This strategy is not applicable in a fragmented industry where novel products and specialized services predominate. Niche markets are not best served by mass production. While an economy of scale would increase the geographical reach of a major firm, its absence in a fragmented industry tends to limit the geographic extent of the competitors' market.
High transportation costs in the distribution of a product tend to favor an environment of multiple producers within a limited market area. This can be seen in the building material industry with cement, concrete and similar products. It is typically less expensive to produce them locally than to transport them over a long distance. A fragmented industry is encouraged where the competitors enter and exit the market with the increase and decline of local construction projects.
Consumer perception and preference also plays an important role in the formation of a fragmented market. Diversity of personal taste creates market opportunities for a wide array of restaurants, clothing stores and entertainment venues within a community. Many consumers find it reassuring to deal directly with a local supplier than with the representative of a faraway corporation. In highly specialized services such as law and medicine, personal trust may be a paramount consideration.
It is not necessarily true that businesses in a fragmented industry have low start-up costs for equipment and employees.
A restaurant is a great example. Starting a restaurant business requires the purchase of kitchen equipment, seating and decor, among other things.
In addition, even a smaller restaurant needs cooks, bus boys, waiters and other personnel for each shift.
Many people have been known to invest their life savings into opening a restaurant.