© 2000 John Petroff
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© 2000 John Petroff |
If the company was successful in expanding its sales while fending off new competition, its future becomes more and more stable. Product sales growth can no longer be expected to be higher than population rate of growth, or at best the rate of growth of the economy. The company has attracted a large following and must defend this market share, but new domestic customers will be hard to come by. If they do, they will come from the late adopters group of customers who are the most difficult to convince. Yet, once these customers are captured, they will make an even more steady clientele. Promotion on the basis of price becomes even more important than before, but brand loyalty is now a second major theme. With the product becoming common and ubiquitous, the various producers face the same steady market. All patents and trade secrets have lapsed or have been overcome by other patents and trade secrets. There is a little opportunity for minor technological improvements for either one firm to lead the overall market, or for price cutting to fight for market share. But, there is no longer the threat of losing an entire market to an unexpected competitor. If there is competition it is more from other unrelated products to which consumers allocate their income (as well as from newly introduced products in other markets). The purchase of this product becomes even more income sensitive. As a result, the industry becomes cyclical just as customer's income is, even if initially the sector would not normally be affected by business cycles.
Shown below in Graph G-14.8 is the real growth rate of telephone and telegraph output whose expansion years are well behind: growth is barely exceeding domestic product and the pattern is clearly cyclical.
While growth has slowed to a trickle, the overall volume is so substantial that lowering product price is not a threat in itself. The company can and must achieve lowest possible costs from economies of scale with automation of the entire manufacturing process. This is possible because the product is now in its most evolved state. Even variations in color, size or design can be scheduled into an automated batch production. Operating leverage and financial leverage are better tolerated because commercial risk has subsided with the steadying of the market. The balance sheet reflects this with the bulk of assets being fixed and the largest proportion of funds coming from long term debt used to finance fixed assets. Bondholders are attracted by the stability of the company and the protection provided by mortgage on fixed assets. Even if gross margins are slim, and even if overhead and interest payments are large, there is enough volume to generate adequate return on equity. Yet, the return that looks pale by comparison to prior years. Still, accumulated retained earnings have now given an adequate cash cushion to present a very healthy liquidity position.
The threat is that competitors will find ways to cut costs, and therefore price, even more than this company. A company that loses market share may not achieve its break-even point and quickly face financial difficulty because of the high levels of financial and operating leverage. Once again, the example of the automobile industry bears this out: from 10, the number of American car companies shrank to three in the 1980's (and almost two when Chrysler experienced difficulties).
To reduce costs, a company can move its production to low cost countries. This forces other companies to do the same sooner or later. By globalizing production, a company also increases its sales opportunity abroad. But foreign markets present other challenges stemming from the need to adapt to local tastes and to government imposed standards and restrictions. Also a company's domestic market is no longer the only market. The company now faces global competition. This imposes a new round of mergers (e.g. between Chrysler and Daimler) for the remaining firms to retain a market share that justifies their sales expectations and the consequent global production and financing strategies that shareholders expect of multinational corporations.
In the domestic stock market, the company is no longer a high flier. Its product market stability is moderated by its modest but steady dividends.From Table T-14.2 which presents the standard deviation of annual rate of change of large assortment of consumer products from 1929 to 1998, one can be surprised that so many sectors show very little variability, but also hardly any growth, less than the average GDP growth rate of 3.3%, in many cases. For example, water and sanitation industry experienced only 3.13% growth over that period, as can be seen in Graph G-14.9 below.
Yet, if the sales are not too cyclical, the company stock can attract investors seeking an assurance of steady dividend payments, even if the dividend is rather modest. The company can continue to attract such interest as long as its product is considered a household item.
See review questions Q-14B5.1 through Q-14B5.10.
See research assignment F-14B5.1.
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