What Are The Causes That Limit A Company's Financial Growth?
Limits to Continued Growth
Saturation
Sales of a hot new consumer product can grow at astronomical rates for a time. Eventually, however, everybody who cares to will own one (or two, or some other finite number that the consumer believes is enough). At that point, potential sales will be limited to replacement sales plus growth in population, that is, the increase in the number of potential purchasers.
Entry of Competition
Rare is the company with a product or service that cannot either be copied or encroached on by a “knockoff” sufficiently similar to tap the same demand, yet different enough to fall outside the bounds of patent and trademark protection.
Increasing Base
A corporation that sells 10 million units in Year I can register a 40% increase by selling just 4 million additional units in Year 2. If growth continues at the same rate, however, the corporation will have to generate 59 million new unit sales to achieve a 40% gain in Year 10.
In absolute terms, it is arithmetically possible for volume to increase indefinitely. On the other hand, a growth rate far in excess of the gross domestic product’s annual increase is nearly impossible to sustain over any extended period.
By definition, a product that experiences higher-than-GDP growth captures a larger percentage of GDP each year. As the numbers get larger, it becomes increasingly difficult to switch consumers’ spending patterns to accommodate continued high growth of a particular product.
Market Share Constraints
For a time, a corporation may overcome the limits of growth in its market and the economy as a whole by expanding its sales at the expense of competitors. Even when growth is achieved by market share gains rather than by expanding the overall demand for a product, however, the firm must eventually bump up against a ceiling on further growth at a constant rate.
For example, suppose a producer with a 10% share of market is currently growing at 25% a year while total demand for the product is expanding at only 5% annually. By Year 14, this supergrowth company will require a 115% market share to maintain its rate of increase. (Long before confronting this mathematical impossibility, the corporation’s growth will likely be curtailed by the antitrust authorities.)
Basic economics and compound-interest tables, then, assure the analyst that all growth stories come to an end, a cruel fate that must eventually be reflected in stock prices. Financial reports, however, frequently tell a different tale.
It defies common sense yet almost has to be told, given the stakes. Users of financial statements should acquaint themselves with the most frequently heard corporate versions of “Jack and the Beanstalk,” in which earnings—in contradiction to a popular saw—do grow to the sky.
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