Product Life Cycle Model

The Product Life Cycle Model can be used to analyse the maturity stage of products and industries

Product life cycle

1. Background

THE idea of the Product Life Cycle was first developed in 1965 by Theodore Levitt in an article entitled “Exploit the Product Life Cycle” published in the Harvard Business Review on 1 November 1965.

2. Benefit of the Product Life Cycle model

For a business, having a growing and sustainable revenue stream from product sales is important for the stability and success of its operations. The Product Life Cycle model can be used by consultants and managers to analyse the maturity stage of products and industries. Understanding which stage a product is in provides information about expected future sales growth, and the kinds of strategies that should be implemented.

3. Product Life Cycle model

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The “Product Life Cycle” is the name given to the stages through which a product passes over time. The classic Product Life Cycle has four stages:

  1. Introduction,
  2. Growth,
  3. Maturity, and
  4. Decline.

3.1 Introduction

At the market introduction stage the size of the market, sales volumes and sales growth are small. A product will also normally be subject to little or no competition. The primary goal in the introduction stage is to establish a market and build consumer demand for the product.

There may be substantial costs incurred in getting a product to the market introduction stage. Substantial research and development costs may have been incurred, for example, thinking of the product idea, developing the technology, determining the product features and quality level, establishing sufficient manufacturing capacity, preparing the product branding, ensuring trade mark protection, etc. Marketing costs may be high in order to test the market, launch and promote the product, develop a market for the product, and set up distribution channels.

The market introduction stage is likely to be a period of low or negative profits. As such, it is important that products are carefully monitored to ensure that sales volumes start to grow. If a product fails to become profitable it may need to be abandoned.

Some of the considerations in the introduction stage include:

  • Product development: research and development of the basic technology and product concept, determining the product features and quality level.
  • Pricing: should penetration pricing or a skimming price strategy be used? A skimming price strategy might be appropriate where there are very few competitors.
  • Distribution: distribution might be quite selective until consumer acceptance of the product can be achieved.
  • Promotion: marketing efforts are aimed at early adopters, and seek to build product awareness and to educate potential consumers about the product.

3.2 Growth

If the public gains awareness of a product and consumers come to understand the benefits of the product and accept it then a company can expect a period of rapid sales growth, enter the “Growth Stage”. In the Growth Stage, a company will try to build brand loyalty and increase market share.

Profits are driven by increased sales volume (due to growth in market share as well as an increase in the size of the overall market). Profits might also be driven by cost reductions gained from economies of scale, and perhaps more favourable market prices. Competition in the Growth Stage remains low, although new competitors are expected to enter the market. When competitors enter the market a company might be subject to price competition and increase its marketing expenditure.

Some of the considerations in the Growth Stage include:

  • Product improvement: product quality might be improved, additional features and support services added, and packaging updated.
  • Pricing: if consumer demand is high the price might be maintained at a high level.
  • Distribution: distribution channels might be added as consumer demand increases.
  • Promotion: promotion is aimed at a broader audience. A company might spend a lot of resources on promotion during the Growth Stage to build brand loyalty.

3.3 Maturity

When a product reaches maturity, sales growth slows and sales volume eventually peaks and stabilises. This is the stage during which the market as a whole makes the most profit. A company’s primary objective at this point is to defend market share while maximising profit.

In this stage, prices tend to drop due to increased competition. A company’s fixed costs are low because it is has well established production and distribution. Since brand awareness is strong, marketing expenditure might be reduced, although increased marketing expenditure might be needed to retain market share and fight increasing competition. Expenditure on research and development is likely to be restricted to product modification and improvement, and perhaps research into improved production efficiency and product quality.

Some considerations for the mature product market include:

  • Product differentiation: increased competition in the mature product market means that a company must find ways to differentiate its product from that of competitors. Strong branding is one way to do this.
  • Pricing: prices may be reduced because of increased competition. Firms in the market should be careful not to start a price war.
  • Distribution: distribution intensifies and incentives may be offered to encourage preference to be given over competing products.
  • Promotion: promotion will focus on emphasising product differences and creating/maintaining a strong brand.

3.4 Decline

A product enters into decline when sales and profits start to fall. The market for that product shrinks which reduces the amount of profit available to the firms in the industry. A decline might occur because the market has become saturated, the product has become obsolete, or customer tastes have changed.

A company might try to stimulate growth by changing their pricing strategy, but ultimately the product will have to be re-designed, or replaced. High-cost and low market share firms will be forced to exit the industry.

As sales decline, a company has three strategy options:

  • Hold: maintain production and add new features and find new uses for the product. Reduce the cost of manufacturing (e.g. move manufacturing to a low cost jurisdiction). Consider whether there are new markets in which the product might be sold.
  • Harvest: continue to offer the product, reduce marketing expenditure, and sell possibly to a loyal niche segment of the market.
  • Divest: Discontinue production, and liquidate the remaining inventory or sell the product to another firm.

Some considerations for a declining market include:

  • Product consolidation: the number of products may be reduced, and surviving products rejuvenated.
  • Price: prices may be lowered to liquidate inventory, or maintained for continued products.
  • Distribution: distribution becomes more selective. Channels that are no longer profitable are phased out.
  • Promotion: Expenditure on promotion is reduced for products subject to the Harvest and Divest strategies.

4. Criticisms

The Product Life Cycle is useful for monitoring sales results over time and comparing them to products with a similar life cycle. However, the Product Life Cycle model is by no means a perfect tool. Products often do not follow a defined life cycle, not all products go through each stage, and it is not always easy to tell which stage a product is in at any one time. Consequently, the life cycle concept is not well-suited for the forecasting of product sales.

The length of each stage will vary depending on the product and the marketing strategies employed. A Product Life Cycle may be as short as a few months for a fad or as long as a century or more for a product like petrol cars. In many markets the product life cycle is longer than the planning cycle of the organisations involved. Major products often hold their position for several decades or more, indeed, Coca-Cola was introduced in 1886 and is still the leading brand of cola.

The Product Life Cycle is only one of many considerations that a company must bear in mind. The product life cycle of many modern products is shrinking, while the operating life for many of these products is lengthening. For example, the operating life of durable goods like household appliances has increased substantially. As a result, a company that produces these products must take their market life and service life into account when planning.

Some critics have argued that the Product Life Cycle may become self-fulfilling. For example, if sales peak and then decline a manager may conclude that a product is on the decline and cut back on marketing, thus precipitating a further decline.

[For more information on consulting concepts and frameworks, please download “The Little Blue Consulting Handbook“.]

Five C Analysis of Borrower Creditworthiness

When a company is trying to borrow money, executives, entrepreneurs and consultants should be aware that there are five criteria that most lenders care about

5 C Analysis of Borrower Creditworthiness

(Source: Flickr)

What are lenders looking for?

IT IS important to understand what lenders look for when they lend money because companies often need to borrow money for various reasons: increase cash reserves, refinance existing debt, pay regular operating expenditures, research and development, capital expenditure, product development, expansion into new markets, strategic acquisitions, etc.

There are five criteria that most lenders use to assess a borrower’s creditworthiness:

  1. capacity to generate sufficient cash flows to service the loan;
  2. collateral to secure the loan in case the borrower defaults;
  3. capital that shareholders have invested in the business;
  4. conditions prevailing in the borrower’s industry and broader economy; and
  5. character and track record of the borrower and the borrower’s management.

It is important to keep in mind that lenders don’t give equal weight to each criterion and will use all five criteria to create an overall impression of a company’s creditworthiness. Lenders are typically cautious and weakness in one of the five criteria may offset strength in all of the others. For example, if a company is in a cyclical industry (e.g. construction, auto, or aviation) the company may find it difficult to borrow money during an economic downturn even if the company shows strength in all of the other criteria. Similarly, if a company’s management has a bad reputation and poor track record then the company may find it difficult to borrow money even if it has strong financial statements.

Taken together, these five criteria indicate a borrower’s ability and willingness to repay its debts. As such, if you are advising a company in relation to raising finance, you must ensure that each of the five criteria is fully addressed in your loan request.

Let’s consider each of the five criteria in a little more detail:

1. Capacity

Capacity to repay a loan is the most important criterion used to assess a borrower’s creditworthiness. The borrower must be able to satisfy the lender that it has the ability to repay the loan. To satisfy itself of the borrower’s capacity, the lender will consider various factors including:

  1. Profitability: What are the revenues and expenses of the borrower?
  2. Cash flows: How much cash flow does the business generate? The lender is interested not only in cash flows from operations, but also cash flows from investing and financing activities. What are the timing of cash flows with regard to repayment?
  3. Payment history: What is borrower’s payment history and track record of loan repayment?
  4. Debt levels: How much debt does the borrower have? How much debt can the borrower afford to repay?
  5. Industry evaluation: What is the normal debt/liquidity level for companies in the borrower’s industry?
  6. Financial ratios: There are a number of financial ratios, such as debt and liquidity ratios, that lenders will evaluate before lending money: e.g. debt to equity ratio, debt to asset ratio, current ratio, quick (acid test) ratio, operating cash flow ratio, working capital ratio, etc.

2. Collateral

While cash flows are the primary source for the repayment of a loan, collateral provides lenders with a secondary source of repayment. Collateral represents the assets that are provided to the lender to secure a loan. In the event that the borrower fails to repay the loan, the collateral may be seized by the lender to repay the loan.

The borrower must usually provide the lender with suitable collateral. To do this, the borrower normally pledges hard assets like real estate, office equipment or manufacturing equipment. However, accounts receivable and inventory might also be pledged as collateral.

Service businesses and small companies may find it difficult to provide lenders with the collateral they require because they have fewer hard assets to pledge. If the borrower doesn’t have the necessary collateral, the lender may require personal guarantees from the borrower’s directors or from a third party such as the borrower’s parent company.

3. Capital

Capital is the money that shareholders have personally invested in the business. Capital represents the money that shareholders have at risk should the business fail.

Lenders are more likely to lend money to a borrower if shareholders have invested a large amount of their own money in the business. If the business runs into financial difficulty, then the capital of the business provides a cushion for repayment of the loan. If shareholders have a large amount of capital invested in the business, this indicates they have confidence in the business venture and that they will do all that they can to ensure the borrower does not default on the loan.

4. Conditions

Conditions refer to two factors that the lender will take into account. Firstly, conditions refer to the overall economic climate, both within the borrower’s industry and in the economy generally, that could affect the borrower’s ability to repay the loan. For example, during recessions and periods of tight credit it becomes more difficult for small businesses to repay loans and more difficult for lenders to find money to lend. Thus, during these periods a small business will find it difficult to borrow money and must present lenders with a flawless loan application.

In considering the overall economic climate a lender may consider various questions including:

  1. What is the current business climate?
  2. What are the trends for the borrower’s industry? How does the borrower fit within them?
  3. What is the short and long-term growth potential in the industry?
  4. How is the market characterised? Is it an emerging or mature market?
  5. Are there any economic or political hot potatoes that could negatively impact the borrower’s growth?

Secondly, conditions refer to the intended purpose of the loan. The borrower’s reasons for seeking the loan should be spelt out in detail in the loan application. Will the money be used to buy new equipment for expansion? Will the money be used to replenish working capital to prepare for a seasonal inventory build-up?

5. Character

Character refers to the general impression that the borrower makes on the prospective lender. The lender will form a subjective judgement as to whether the borrower is sufficiently trustworthy to repay the loan.

Lenders want to put their money with companies that have impeccable credentials. Relevant factors that a lender may consider in deciding whether the borrower is sufficiently trustworthy include:

  1. What is the character of each member of the management team?
  2. What reputation do management have in the industry and the community?
  3. What educational background and level of experience does management have?
  4. What is management’s track record?
  5. What is the overall consumer perception of the borrower?
  6. Is the borrower progressive about its waste disposal, quality of life for its employees, and charitable contributions?
  7. Does the borrower have a track record of fulfilling its obligations in a timely manner?
  8. What is the borrower’s payment history and track record of loan repayment?
  9. Are there any legal actions pending against the borrower? If so, what is the reason for these legal actions?

[For more information on consulting concepts and frameworks, please download “The Little Blue Consulting Handbook“.]