Page 3 Product Life Cycles Profits and the PLC
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Page 3 Product Life Cycles Profits and the PLC
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Exhibit 1 |
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The relationship between a product’s sales and its profitability as it transitions through its life cycle stages is illustrated in Exhibit 1. Profits typically are negative throughout a product's introduction stage. Negative profits are a result of the very high costs associated with new product introduction, combined with the obvious low levels of sales during this stage. Low sales during introduction often can be traced to the same factors we discussed in the last topic that tend to retard a new product’s diffusion into the market. Lack of relative advantage, difficulty in sampling the product prior to commitment, excessive product complexity, and value incompatibility can slow the growth in sales of new products.
Several additional factors also contribute to retarded sales during the PLC’s introductory stage. These include:
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Delays in the expansion of production capacity to handle increased sales; |
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Technical problems experienced with the production and/or functionality of the new product; and, |
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Problems convincing wholesalers and retailers to stock and sell the product [1]. |
Costs are extremely high during the introduction stage because of the heavy investment needed to establish distribution channels and effectively promote the new product to customers and distributors. Substantial advertising and sales promotion budgets are required to convince the trade (middlemen) to accept the product. Manufacturers may need to pay 'slotting fees' to obtain adequate representation on the retail shelf. Finally, large investments in promotion are needed to generate adequate levels of awareness, interest, and trial by consumers.
During the growth phase of the product life cycle, sales climb dramatically. Similarly, profits grow at an accelerated rate. The tremendous increase in profits can be traced to three phenomena:
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First, the rapid increase in sales leads to scale economies in production. This results in a substantial decline in unit manufacturing costs. |
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Second, promotion and other marketing costs are spread over a larger production and sales volume. This further tends to drive unit costs down. |
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Finally, there may exist experience curve or learning curve effects that enhance the decline in manufacturing costs resulting from scale economies. Experience curve effects are associated with declines in variable costs per unit. These added savings usually result from labor efficiencies in which workers find ways to save time, eliminate waste, and reduce the time spent on product rework. |
Competitors begin to enter the market during the growth stage, as they perceive the promise of potential profits. Competitive entry naturally drives down market prices. However, the natural decrease in prices throughout the growth phase is more than offset by the decline in unit manufacturing and marketing costs. The net effect is the increase in profitability.
As additional competitors enter the market, two things happen that begin to slow the increase in profits as maturity is approached. First, as the number of competitors increases, so does the intensity of competitive interaction. Coping with increased competition generally translates into increased spending on strategies aimed at generating selective demand. Selective demand is demand for the firm’s brand. This means that firms, in their battle for market share, will spend larger and larger sums to "buy market share" from competitors. Moreover, increased competition naturally drives prices down. Second, as maturity approaches, the growth in sales naturally slows. This slowing is primarily a result of the declining pool of new adopters for the product category. This transition to market saturation further intensifies competitive interactions and generates additional price reductions. This, of course, ultimately translates into even greater spending as firms fight more intensely for market share.
Profits reach their maximum at the end of the growth phase. Once maturity is attained, profits industry-wide begin their down-hill trend. This decrease in profits is nothing more than a continuation of trends set into motion during the later part of growth. Market saturation, combined with ever intensifying competitive interactions, all tend to force marketing and, to some extent, production costs up. At the same time, prices are continuing to decline as a result of competitive interactions.
Profits continue to erode during maturity and, of course, into the decline phase. The continued erosion in profitability is, again, traced to the intensity of competitive interaction, as well as to technological advances and changes in consumer buying patterns. We may also see a significant number of international competitors enter the market. All of these factors lead to over-capacity in the industry, further price cutting, and more increases in promotional spending. All of these translate into continued profit erosion.
1. Robert D. Buzzell, "Competitive Behavior and Product Life Cycles, " New Ideas for Successful Marketing, Ed. John S. Write and Jack Goldstucker (Chicago: American marketing Association, 1956), P.51.
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Page last modified: February 19, 2001
