In my ongoing series on using different frameworks and models to help us in doing due diligence and analysis on companies and industries, I elaborated on various several including the SWOT analysis, PEST analysis and Porters Five Forces analysis (Parts 1 and 2).
In this article, I would like to introduce the Product Life Cycle model and how investors can use this model to assess which stage a company’s products or services are at. They can then decide if the company has good growth prospects, and whether the company should take on a new or complementary business line, or divest the product line in favour of a better one.
The Product Life Cycle
Source: Malakooti, B. (2013). Operations and Production Systems with Multiple Objectives. John Wiley & Sons.
The diagram above shows the product life cycle (PLC) in full. It shows the level of sales plotted against time, and the four different phases demarcated by dotted lines representing the four phases in which a product or service would find itself at any point in time.
When a new type of product or service is introduced, it is said to be in the introduction phase. Companies selling such products typically experience rapid growth as new customers flock to embrace the new technology. Though this may signal that such companies may be attractive investments, investors need to be wary of companies which expand too quickly and incur significantly more expenses than the revenue they can generate. As these tend to be early-stage companies with new products, the failure rate of such start-ups may also be high.
In the growth phase, companies continue to experience rapid sales growth as the product catches on in multiple countries or with a wider spread of demographic groups. This is also the phase where intense competition builds up, as everyone wants to grab a piece of the lucrative pie. Companies whose product sales are growing fast typically may also see expenses rising quickly as they build up their sales force and marketing team. With the entrance of new competition, prices may also be pressured and though the companies can increase sales volume rapidly, overall sales revenue may remain constant or even dip depending on the level of price competition, and whether competitors behave rationally.
The mature phase of the PLC is where sales volume remains constant or dips slightly, as the product becomes more entrenched in society and has become commonplace. Buying companies whose products are in this phase may be a good idea as these companies would be the larger, stable and more established ones (i.e. the weaker, smaller ones would have been eliminated in the “growth” phase). However, with prospects for growth being weak, investors should expect them to be yield companies (i.e. with a high dividend pay-out ratio) which pay out consistent dividends, rather than retaining profits for further growth.
If a company’s products or services are in decline, this means revenue and profits would also be in terminal decline unless the company can find a new lease of life or transform its business model. Investors would do well to avoid such companies unless they are expecting a turnaround.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.