© 2000 John Petroff
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© 2000 John Petroff |
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In this phase, a much wider market is approached, but the rate of sales growth moderates. All the product defects (both technological as well as those stemming from customer preferences, poor customer service and inadequate marketing strategy) must have been worked out. The product has been accepted by the market. But, new modifications broaden the range of customers that can be served. Lowering of price is unavoidable even for a technology leader. Main stream customers who would not have thought of using the product years ago, now consider buying it for the first time. The market broadens further.
To support the new expanding sales, the improvements that are now necessary are in manufacturing. Large volume of production necessitated by assured continuous sales expansion, justifies an entirely new approach to purchasing, production and distribution. Henry Ford's assembly plant approach to car manufacturing comes again as an outstanding example. Firms will shift some of their attention to process technology away from product technology. The major gains of lowering cost (described in the learning curve of Chapter 9 Section C-2) can now be harvested with automation of some aspects of manufacturing, lower purchasing costs due to volume and lower distribution costs. Together, these savings ad up in rising profit margins. The larger sales volume must be adequate to cover the overhead which, itself, has now increased with automation (as further discussed in the last paragraph of this section). If the gross margin is large enough, profits are peaking. Dividends can now be distributed for the first time. New investors are attracted by a proven success of the firm and a perceived stability of a broader product market. Relentless stock price rises eventually force a stock split, which is further good news for the company. But, earlier investors may cash in on their capital gains, and switch to other newly emerging growth stocks. For, while sales growth is continuing, the rate of growth is moderating. The stock is no longer seen as a growth stock.
The aircraft manufacturing industry can be used as a good example of an industry that has completed its maturation phase, as can be studied in Graphs G-14.6 and G-14.7 below.
Observe the rate of growth of the aircraft industry starting in the 1970's in Graph G-14.7: it is still substantial thereafter but not at the levels achieved before 1970 and it is punctuated by prolonged contractions. Graph G-14.6 confirms that aircraft sales volume at the end of the 1990's is barely higher than the peak achieved twenty years prior, and that shows that the industry has completed its maturation phase, and is possibly already in the next phase. The picture is very different for computers in Graph G-14.2: while there is a small plateau in 1990, then computer sales take off after that. The rate of growth in Graph G-14.3 is less than what it was in the 1980's, but it is not subsiding. This suggests that either the expansion phases may not yet have been completed, or the industry is just entering its maturation phase. Finally, if we look at Graph G-14.4, we see that photocopying equipment sales continue to rise. But Graph G-14.5 shows that the rate of growth has slowed to less that 10% a year compared to 2 to 5 times that much twenty years ago. This indicates that the photocopying equipment industry is toward the end its maturation phase.
The balance sheet of companies in the maturation phase improves considerably with bulging accounts receivables and inventories. The accumulated retained earnings finally replenish the cash balance. Quick and current ratios become impressive. The moderate debt contracted up until now allows the company to boast about a splendid interest and fixed payments coverage ratio. With such credentials, it is the proper time for a company to borrow. And, for internal strategic reasons it is also the proper time to finance automation with at least some debt rather than the more expensive equity. Banks are especially eager to lend to such a trustworthy and liquid borrower. But, floating a corporate bond may be preferred by the company.
Nevertheless, the real outlook may not be as rosy as it appears. The major threat stems from the success of the product itself and the best methods to manufacture it. The remaining firms in the industry have become more efficient by adopting the best practice, and grown larger and more powerful through mergers and alliances. They now can put all their entrepreneurial talent or corporate power to develop close substitutes. If need be, these competitors can even go around any patent protection by filing for their own patent on some small variation of the device. Far from diminishing, commercial risk is rising with foreign competitors entering the market. The company must fight back to conserve its market share with further price reductions, larger spending of advertisement, and new, but only marginal, product improvements. (Product improvements are kept marginal in order to use the same manufacturing process that has just recently installed.) But, a defensive strategy is likely to be insufficient. The company that will survive is the company that has sufficient financial strength to acquire even more weaker competitors. Consolidation continues in this phase. Automobile manufacturers were reduced to 10 from 71 in this phase.
Another threat comes from the company's heavy investment in the manufacturing process. To its commercial risk, the company is adding operating risk because it has increased it fixed assets to automate (see Chapter 10 Section D-2). Automation pushes the break-even point higher. However difficult continued sales expansion may be, sales expansion is no longer a sign of success, it is an absolute requirement. It is needed to cover much larger overhead. More threats are lurking in annual payments required to service the newly assumed debt. This is financial risk, on top of operating and commercial risk (as discussed in Chapter 11 Section D). It is also in this phase that sales may start to be cyclical because a wider market is more sensitive to income level. This is apparent in Graph G-14.4 for photocopying equipment which experiences four consecutive contractions after 1981, whereas it had only one in 1967 prior to that. Should sales level off, financial difficulties will rapidly be experienced because the company has had only a few profitable years to build up its free cash. The company is still vulnerable. To secure new expansion, a company must look for foreign markets, but entry in these markets imposes new risk and financial requirements. If the company fails to expand its sales sufficiently, or if sales growth is hampered by customer dissatisfaction or by a recession, the company may face bankruptcy. A larger competitor may be interested in acquiring the goodwill of a failing company for the market share it represents.
See review questions Q-14B4.1 through Q-14B4.17.
See research assignment R-14B4.1.
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