The Rise and Fall of Businesses

As I had been very busy the entire week, I have not been able to blog much at all even though I had many ideas and issues floating in my head. One of these is about the interesting aspect of the rise and fall of businesses. As readers may know, all businesses technically have an “infinite” life and can last in perpetuity as they can have different owners while retaining the same name and registration number. However, most businesses tend to fall into cycles where they start-up, grow rapidly and then fizzle out (some go out spectacularly in a big BANG like a supernova !). This follows the teachings of most marketing textbooks which state the four phases of a business: Start-up, growth, maturity and decline. I will proceed to discuss each of these phases and give some examples. Readers are free to debate or discuss whether these examples are relevant and to give more examples where applicable.

Start-Up – This is the phase where a company acquires a core business, be it in Information Technology, Oil and Gas Support or a new industry such as Bio-Fuels. Start-ups are usually fraught with risks and most of them go belly-up within 2 years due to inability to manage costs and also inability to adapt to changing consumer preferences and tastes. To be fair, sometimes the fault does not lie with the Management; it may be that the dynamics of the particular industry are not conducive for long-term sustainability and profitability. In Singapore at least, the food industry is cutthroat and extremely competitive. One example of casualties are the numerous bubble tea shops which opened in 2001 and 2002 and subsequently went out of business as the bubble burst (no pun intended !).

Growth - A company which has survived the hardships of the start-up phase can now grow rapidly by establishing a solid customer base and also decent margins. Assuming it has a competitive advantage with respect to either cost control or product differentiation, it can now build up a sizeable business and market share in order to enjoy sustained profitability. This is the phase in which the company needs to either borrow heavily to expand or root for an IPO (raising funds through equity issuance). Many of the newly listed companies on SGX are examples of start-ups which have grown to a point where they need to raise funds to grow further. An IPO is one of the methods. Some recent examples of IPO would include China Zaino, China Eratat and Hisaka Holdings. During such a phase, the company’s products/services find quick acceptance and their revenues and profits grow very rapidly, to the order of 70-100% per year. However, such rapid growth usually cannot be sustained more than 2-3 years and the company will enter the maturity phase* after this. Some examples of listed growth companies will include Wilmar, Swiber, Ezra and many China companies seeking to increase market share in a huge market (China Hongxing, Celestial and Cosco come to mind).

*Note: There are companies which still manage to grow after 10 to 20 years by diversifying their product offering, keeping up with trends and offering better value to existing customers, but these are a rare few.

Maturity – In this phase, the company’s products and business units have stable customer base and their revenues and profits no longer enjoy rapid growth. It becomes harder to get new customers and the market may get saturated with other competitors who also begin to offer the same products and services. During such a phase, the company may generate more cash than it requires and may not know how to productively employ this cash. Companies can either gun for more organic growth through internal restructuring or product innovation, or acquire other businesses to complement their existing one. These moves are key to determining if the company moves back to the growth phase, or if they push it towards the decline phase. Examples of mature companies are many of the blue chips such as Great Eastern, Fraser and Neave, Yeo Hiap Seng, the local banks, SIA and Venture Corporation. Examples of mature companies which are mature but acquire to grow are Olam International, China Fishery and OSIM. Examples of mature companies which grow organically without acquisition (thus far) will include Boustead.

Decline – This is the saddest phase of a company’s life cycle, where its products begin to fall out of fashion or become victims of commoditization or competition. A decline can be defined as the phase of a company’s life where earnings and revenues fall, with declining margins and also less operating cash inflows. Declines can be short and sharp (when a company goes bust quickly by over-extending itself of expanding too quickly), or it may be long and protracted as the company slowly bleeds itself to death. At such a stage, assuming a company is listed, it will valiantly try to shore up capital by issuing rights and more equity (as its deteriorating balance sheet will make it an unsuitable candidate for bank loans or company-issued bonds). Assuming it is able to turn around (in rare cases), then it can slowly go back to the mature phase where operating cash flows can sustain the business, or perhaps they had found a new business to go into or a new way of positioning themselves which changes consumers’ perceptions. But in the majority of cases, companies will eventually liquidate and fold, with creditors getting pittance and shareholders usually getting nothing at all. Examples of once growing companies now in decline include Creative Technology and OSIM.

These 4 phases are anything but distinct in the real world, with some companies a hybrid of both growth and mature phases, while others may be in limbo alternating between mature and decline phases. It is never really very clear-cut but a shrewd investor should at least be aware of the life cycle stage his company is in so as to avoid unpleasant surprises. A careful study of companies’ fundamentals and the industries in which they operate is necessary in order to make an informed judgement, in order to save oneself from a lot of heartache and potential loss of capital.