Company life cycle and the addressable market
Start-ups build a business model with little revenue; growth companies grow above trend, so analysts size their market; mature firms pick a generic strategy; firms in decline cut costs and exit. The total addressable market narrows to the serviceable market (focus, geography), then the obtainable market (current scale, strategy).
Before this: Competitive strategy: cost leadership, differentiation and focus, Industry size, growth, profitability and concentration
On the exam
- Explain a company’s competitive strategy and position within an industry
Explain a company's competitive strategy and position within an industry. Expect: which life-cycle stage a description fits and the strategies typical of it, which constraint separates the serviceable market from the obtainable market, which figure is the total addressable market, and what limits a growth company's revenue potential.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
What is the company life cycle?
Companies are commonly grouped by stage in a company life cycle : start-up, growth, mature and decline. Revenue rises slowly, then fast, then levels off and eventually falls. Cash flow is negative at first, because the company spends before it earns, and turns positive as it grows.
Strategy and position change a great deal across these stages. For start-ups and young growth companies there is little history to analyze, so analysts must rely on factors beyond past results.
- Start-up Memorize little or no revenue, negative cash flow, few assets; build the business model; innovation, partnerships, equity for research
- Growth Memorize above-trend growth, turning profitable; size the market; expand within constraints
- Mature Know the idea established model and record; cost leadership, differentiation or focus
- Decline Memorize revenue falling or lagging the economy; excess capacity; cut costs, restructure, exit or reinvent
The stages first appear in Corporate Finance, where they shape how a company funds itself.
What do start-ups focus on?
Memorize
A start-up company has little or no revenue, negative cash flow and few assets. Its first job is to establish a business model: build a prototype, or otherwise show it can meet a need customers have that nobody else meets. The risk of failure is very high.
Start-up strategy usually centers on innovation, partnerships and raising equity to pay for research and development (R&D). Lenders want steady cash flows, which start-ups do not have, so equity does most of the funding.
What sets growth companies apart?
Memorize
A growth company often turns profitable and grows revenue and earnings faster than the economy and its industry (above-trend growth). The analysis turns to how large its market could be and whether it can reach, and keep, that growth.
In an established industry with low barriers to entry, a new entrant can win share with business model innovation : selling the same product as the incumbents, delivered in a new way. A florist that sells weekly flower subscriptions by app and delivers by bicycle competes with high-street shops without opening a single shop.
Try this 0 of 3
- Visit all four stages
- Get every 'Name the stage' clue right
- In 'Size the market', make capacity stop being the limit
Revenue rises slowly, then fast, then levels off and eventually falls; cash flow is negative at first and turns positive during growth. Pick a stage to see what marks it and the strategy typical of it.
- Revenue
- Cash flow
Year (illustrative)
Revenue rises slowly, then fast, levels off near 100 around year 12 and falls to about 49 by year 18. Cash flow is lowest, about −13, around year 3, turns positive at about year 5 during growth, reaches about 20 by year 8 and falls to about 10 in decline. Start-up covers years 0 to 3 here.
Illustrative: a stylized company, not real data.
1/4Start-up
Little or no revenue, negative cash flow and few assets. The first job is to establish a business model, and the risk of failure is very high.
- Revenue growth (steady)Little or no revenue
- Cash flow (falling)Negative
- Risk (rising)Very high
- Financing (steady)Equity
Typical strategy
- Build a prototype and a business model
- Partner with established firms
- Raise equity for research and development (R&D)
How big is the market a company can reach?
Memorize
Analysts size a company’s revenue potential in three nested steps, for each of its products or services.
- Total addressable market (TAM) : the largest possible market for the good or service.
- Serviceable market (also called the serviceable addressable market): the TAM narrowed by the constraints of the company’s focus (what it chooses to sell) and its geographic presence (where it sells).
- Obtainable market (also called the obtainable addressable market): the serviceable market narrowed further by the company’s current scale and strategy, such as its capacity, its fleet, its outlets or its sales network.
- Serviceable market Memorize narrowed by focus and geographic presence
- Obtainable market Memorize narrowed by current scale and strategy
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A growth company’s revenue potential depends on how far it can expand within its serviceable market, given its operational constraints in the near term: capacity, financing, people, rules. A second plant would double Oatfield’s obtainable market to CAD 200 million, 56% of the serviceable market. Growing past CAD 360 million needs a wider focus (other drinks) or a new geography (the United States), which moves the serviceable boundary itself.
Rules and substitutes shape these markets. Some countries bar foreign airlines from flying domestic routes, which shrinks a foreign carrier’s serviceable market; a fast rail line between two cities is a close substitute that limits what any airline can win on that route.
Lesson 3 uses these markets for a top-down revenue forecast: project the three markets, then the company’s share of its obtainable market.
Exam tip TAM, serviceable, obtainable: each step adds a constraint. Focus and geography make the serviceable market; current scale and strategy make the obtainable market.
Why do companies decline, and what do they do about it?
Memorize
A company in decline has revenue that is falling, or growing well below nominal gross domestic product (GDP) or well below its competitors, usually with falling profitability. The causes: changing tastes and weaker demand, attractive new substitutes, or technology that makes the product obsolete.
Declining industries often have excess capacity : more plants, stores or networks than demand needs. That intensifies rivalry, because every firm fights to fill its capacity.
Common strategies: cost management, restructuring operations, downsizing or exiting businesses. Sometimes a company reinvents a weak business line instead.
New innovations that make existing products obsolete, called creative destruction , threaten most businesses at every stage, whether a firm is trying to scale up or is downsizing.
Between growth and decline sits the mature company , with an established business model and a track record. Its strategies (cost leadership, differentiation, focus) are Lesson 1.
How do cash flow and financing follow the life cycle?
Know the idea
Start-ups and young growth companies usually have negative free cash flow to equity (FCFE): they invest heavily and lack the steady cash flows that would support debt, so they are financed with equity. As they mature, they need less new investment and can carry more debt. Lesson 5 builds FCFE and capital structure from the statements.
The forecasting module shows how analysts build a different forecast model for each stage.
Memorize this
MemorizeLife-cycle stages
| Stage | Marks | Typical strategy |
|---|---|---|
| Start-up | little or no revenue, negative cash flow, few assets, very high risk | business model, prototype; innovation, partnerships, equity for research and development |
| Growth | turning profitable, above-trend growth | expand within the serviceable market; business model innovation |
| Mature | established model and track record | cost leadership, differentiation or focus |
| Decline | revenue falling, or growing well below the economy or rivals; excess capacity | cost management, restructuring, downsizing or exit; sometimes reinvention |
Memory hook Build, scale, defend, shrink (or reinvent).
Know it cold Excess capacity in decline intensifies rivalry.
MemorizeThe three markets
| Market | Narrowed by |
|---|---|
| Total addressable market (TAM) | nothing: the largest possible market |
| Serviceable market | the company's focus and geographic presence |
| Obtainable market | the company's current scale and strategy |
Memory hook T-S-O: Total, then where and what it Serves, then what it can Obtain now.
Know it cold Growth = expanding within the serviceable market, within operational constraints.
- Start-up Memorize little or no revenue, negative cash flow, few assets; build the business model; innovation, partnerships, equity for research
- Growth Memorize above-trend growth, turning profitable; size the market; expand within constraints
- Mature Know the idea established model and record; cost leadership, differentiation or focus
- Decline Memorize revenue falling or lagging the economy; excess capacity; cut costs, restructure, exit or reinvent
- Serviceable market Memorize narrowed by focus and geographic presence
- Obtainable market Memorize narrowed by current scale and strategy
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How it is asked
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Which market?
Spanish cargo-bike sales EUR 300 million; the company's factory can make EUR 45 million a year.
Obtainable: EUR 45 million (scale). EUR 300 million is the serviceable market; choosing it is the trap.
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What narrows it?
TAM to serviceable market: which constraints?
Focus and geographic presence. Current scale is what narrows serviceable to obtainable.
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Which stage?
Revenue below nominal GDP growth, excess capacity, plant closures.
Decline. Cost management, restructuring and exits are its strategies.
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Growth potential
What limits a growth company's revenue potential?
How far it can expand in its serviceable market, given near-term limits such as capacity and funding. The TAM is the prize, not the forecast.
Exam traps
- Mixing up the two narrowing steps. Focus and geography make the serviceable market; current scale and strategy make the obtainable market.
- Treating the TAM as what the company can sell. It is the largest possible market, usually far beyond the company's reach.
- Judging a start-up or growth company on its history. There is little of it; the market's size and the company's ability to grow matter more.
- Expecting a firm in decline to raise equity for new research. Its typical moves are cost management, restructuring, downsizing and exits.
- Thinking excess capacity eases competition. It intensifies rivalry, because every firm fights to fill its capacity.
Checkpoint
3 exam-style questions. About 90 seconds each.
1A Spanish maker of electric cargo bikes sells only cargo bikes and only in Spain. Bicycle sales in Europe total EUR 20 billion a year, cargo-bike sales in Spain EUR 300 million, and the company's one factory can make bikes worth EUR 45 million a year. The company's obtainable market is closest to:
2For five years a company's revenue has grown about 1% a year while nominal GDP grew about 4% and its main rivals grew about 5%. Its industry has more plants than demand needs. The strategies most typical for a company in this position are:
3An analyst starts covering a company that listed three years ago, has grown revenue about 50% a year and reported its first profit last year. Compared with covering a mature company, the analysis will most likely rely more on:
Key takeaways
- Start-ups build a business model; growth companies grow above trend; mature firms choose cost leadership, differentiation or focus; firms in decline cut costs, restructure and exit.
- Young companies have little history, so analysts size their market and their ability to grow.
- TAM → serviceable market (focus and geography) → obtainable market (current scale and strategy).
- Excess capacity in a declining industry intensifies rivalry; creative destruction threatens firms at every stage.
Questions about this lesson?
Where this comes back
- Revenue drivers and pricing power Company Analysis
- Model construction by company life cycle: from venture to decline Financial Statement Forecasting
Questions candidates ask
What are the stages of the company life cycle?
Start-up (little revenue, negative cash flow), growth (above-trend growth, turning profitable), mature (an established business model) and decline (revenue falling or well below GDP). Strategy changes at each stage, from building a business model to cutting costs and exiting.
What is the difference between TAM, serviceable market and obtainable market?
The total addressable market is the largest possible market. The serviceable market narrows it to the company's focus and geography. The obtainable market narrows that to what the company can reach with its current scale and strategy.
What strategies do declining companies use?
Cost management, restructuring, downsizing or exiting businesses, and sometimes reinventing a weak line. Declining industries often have excess capacity, which makes rivalry fiercer.
Why is analyzing a growth company different?
It has little history, so analysts focus on how large its market could be and whether it can expand within its serviceable market, given its capacity and other near-term constraints.
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