© 2000 John Petroff
|
|
© 2000 John Petroff |
As already stated numerous times, the marketing strategy of a firm depends on the phase of the product life cycle; this dictates what resources are needed, and, in turn, the type of financing a firm should use (which will be discussed fully in Chapter 14). There is also a pattern of debt usage which parallels the product life cycle, and which is called the corporate life cycle.
a)- Introduction phase:
The firm should only use equity financing because it needs all the flexibility available to change resources, adapt to market conditions and meet customer needs. The risk born by all providers of capital would be too great for any lender to accept. The firm incurs large losses throughout the period and no lender would accept that. Only trade financing may be used as soon as receivables build up.
Most financing should be with equity because of the need to accumulate resources that are to stay permanently in the company. As soon as the company starts to break-even, short term financing should be used. The profits are not sufficient to pay interest on long term debt and the company is still too risky.
The company becomes very profitable. Short term and long term debt are now accessible on good terms. Lenders are attracted by a high growth and profitability track record. Still, equity represents a good portion of capital. Acquisition of smaller firms in the industry uses up free cash and retained earnings.
d)- Standardization and obsolescence:
As the product market stabilizes, risk diminishes and profits become more steady. Lenders, both short and long term, see the company as a good credit risk and the repayments are indeed assured as long as the customers keep buying the products. The company needs to expand its sales, and for that, plant and equipment must be expanded. There are savings in automation to boot. Plant and equipment needs can be financed with long term debt. The company now follows a very conservative dividend policy that attracts shareholders who prefer income or defensive type of stocks. Equity as a proportion of total assets is reduced because most of the assets growth is financed by debt.
e)- Corporate restructuring and new products:
A firm will not continue existing with a product that becomes obsolete. The firm would be forced to close down, if it did. All firms must keep seeking new ways to serve their customers. As they do, they enter a new corporate life cycle and this mandates financial restructuring: to move through a new series of phases. New equity capital will be needed to pay some of the debt accumulated in the last phase of the previous cycle.
One can naturally imagine companies that go simultaneously through different phases of corporate cycles while handling products at different stages of maturity. Their needs for borrowing are more of a mix; there isn't one optimum capital structure for all firms. One way to determine if a given company is close to its own optimum is once again by looking at its costs of different sources of funds.
-- examples--
See review questions Q-11E2.1 through Q-11E2.5.
See research assignment R-11E2.1.
| Previous: 1-Minimum_cost |
|
Next: 3-Irrelevance |