What is the growth potential of your company?

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A holistic approach to assessing a firm’s Potentially Available Market (PAM) lays the foundation of sustainably profitable growth.

By DMITRI KRYVOZYATEV

 

Potentially available, not the total market…

To evaluate Enterprise Growth Potential (EGP) business planners assess parameters such as market size, demand growth rates, competition intensity, market share trends and so on. As a rule, all these steps of market analysis are well known by practitioners and performed by the book. However, in more than half of the cases we had to deal with, results and conclusions were either wrong or misleading. Why? The answer was not difficult to find. Practically every company on our list that drew erroneous conclusions about its growth potential (either under- or overestimating it) made the same logical blunder. Instead of measuring the Potentially Available Market (PAM), the total market for goods or services was analyzed.

Then what is the PAM and how its inner workings are different from the traditional techniques of market analysis? In short, the PAM is the specific part of the total market (for a good or a service) that a firm can win from its rivals and potentially monopolize. For very few enterprises (i.e. indisputable industry leaders) the PAM equals the total market, thereby rendering their growth potentials dependent on overall demand dynamics. However, for the great majority of businesses the PAM is significantly lower than the total market (the fact frequently ignored in investment budgeting) and follows its unique growth curve. To correctly assess its current and future PAM a firm can apply a simple logic that consists of four steps:

  1. Calculate the total market size[1] today for a given good or a service and make growth projections based on historical trends and strategic foresights;
  2. Break up the total market into a set of uniquely defined micro segments striking a balance between the level of granularity and the effort required to collect and analyze data;

Identify and quantify factors that reduce the total size of demand by segment for an

[1] In volume terms (if it is allowed by the nature of an industry) as very often value metrics contain cost elements irrelevant for a firm’s business, for example middlemen’s margins, value-added tax, customers’ logistical costs, etc.

 

  1. enterprise today (to infer the PAM volume) and evaluate the impact of positive and negative PAM drivers in the future;
  2. Make PAM volume estimates and projections by segment and multiply these volumes by corresponding prices to be charged by a firm in net terms to arrive at PAM values.

The final step is to sum up individual segments’ PAMs to arrive at the conclusion about a firm’s aggregate market potential today and in the foreseeable future.

While sizing their companies’ current PAMs, strategists are usually confronted by one important and highly precarious question: what factors actually reduce the total market for a firm and which ones have no effect? Although a PAM evaluation process is always company-specific, we can generalize a set of factors that must always be evaluated for inclusion. A list consists of five factors reducing the total market size for a company today:

  • Sales volumes “protected” by a strong rival (or rivals).
  • Price segments the firm is unable to compete in.
  • Volumes that are currently taken by a low-cost entrant.
  • Volumes constrained by an industry regulation.
  • Volumes that are likely to be lost to a substitute.

As this list suggests, correct PAM assessment rests on good market insights, well-grounded strategic accumen and the valid judgments about a firm’s strengths and weaknesses.

To determine what factors will influence PAM development in the future a strategist must gain insights into market dynamics, possible changes in a comeptitive landscape and likely alterations in the buying behavior of customers. For example, for one Nordic producer of wild-life products we identified the recoiling local production of reindeer meat, increase in the demand for moose and growing reindeer imports to be the prevailing factors affecting the company’s future PAM. These three drivers were first thoroughly measured (in volume and value terms) and then assigned the top strategic importance ranking by the executive team.

 

[1] In volume terms (if it is allowed by the nature of an industry) as very often value metrics contain cost elements irrelevant for a firm’s business, for example middlemen’s margins, value-added tax, customers’ logistical costs, etc.

Dmitri Kryvozyatev

Such a “standardized” market view creates a number of strategic hindrances, the most acute of which is head-on rivalry over the same group of customers with similar product offerings in very few and congested sales channels.

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Dmitri Kryvozyatev

Then what is the PAM and how its inner workings are different from the traditional techniques of market analysis? In short, the PAM is the specific part of the total market (for a good or a service) that a firm can win from its rivals and potentially monopolize.

A target share of the PAM as a catalyst of Enterprise Growth Potential

Having measured its current and future PAMs, a company must evaluate two other parameters (by segment) that have a direct impact on its EGP. The first one is the firm’s current PAM share, while the other is its future PAM target share. As it follows, EGP is the difference between a firm’s current and target PAM share in a given forecast period.

Assessing a firm’s current share is the straightforward task: the company’s sales (volumes) must be divided by the current PAM volume. An interpretation of results is not difficult either. If the firm’s current PAM share “touches the ceiling” approaching 95%, expansion potential is very limited and renders any growth investment a cash flow destroying endeavor. If, on the other hand, its current PAM share is 50% or lower, the firm has significant growth potential and must carefully assess the feasibility of future investments. Any other result falling within the range of these two extremes requires an in-depth analysis of growth openings and corresponding cash outlays. As any business strategy dilemma, the “go” or “no-go” decision must be based exclusively on the tenets of the shareholder value creation framework. As a rule, a company’s share of the total market is significantly lower than its PAM share, thus forging up the bogus beliefs about strong growth potential laid out for the enterprise. In many cases such an ambiguity can mislead company management to making investment decisions that are driven by the ungrounded expectations of future higher sales and earnings.

The next step is to evaluate a firm’s target share of its future PAM. This step requires the strong capability of making sound and measurable projections about highly uncertain future events that are likely to have a strong impact on the business. To define its target share of the future PAM a company can choose to apply one of the two approaches: target-based or growth-based.

The target-based approach allows a company to define its desired share of the future PAM in a given market segment as some strategic goalpost. For example, one Finnish producer of electrical accessories evaluating its growth potential in e-cabinets for an Eastern-European market set the PAM target share at 95% by key customer segment to be achieved in three years. The company’s strategic choice for early dominating the selected segments was strong brand recognition and superior customer relations. Also the two strategic assets served as both the foundation of strong growth and the barrier against hostile competitive entries.

The growth-based approach is rooted in a gradual and usually linear-shaped upturn trajectory stemming from a firm’s current PAM share. This approach is best applied when a company opts to follow the conservative growth scenario which key aim is to maximize cash flow efficiency (even at the expense of rapid market share expansion). For example, one international financial services provider deployed the growth-based approach to project its PAM share increase at 3 percentage points anually to reach the target of 83% by the end of 2020. The company was constrained by the highly demanding requirements of annual return on investment and thus had to minimise its appetite for growth despite a strong market position.

Finally, the question arises about the factors to be taken into account while determining a company’s future PAM target share. From experience, we can draw a list of the five upside and three downside factors to be considered in the process of setting a firm’s target PAM share. The five upside factors (whose individual impacts on PAM share must be thoroughly computed) are the additional percentage points to the current PAM share that a firm can win

  1. From weaker rivals;
  2. Due to a launch of new products (services);
  3. From an inferior substitute;
  4. Due to channel efficiency improvements;
  5. By attracting new customers.

Conversely, the three downside factors that can seriously impede a firm’s growth potential are the percentage points from the current PAM share a company can lose, as a result of:

  1. Superior offerings launched by a head-on rival;
  2. Superior substitutes;
  3. Entry of a more cost-efficient actor.

At the final stage of EGP assessment, a strategist must multiply the target share by the PAM and deduct current sales. The resulting difference is Enterprise Growth Potential to be measured in volume and value terms in a given market segment. The company’s overall growth potential is the summation of individual EGPs by market segment.

An aggregate EGP is a highly efficient metric for evaluating investment proposals, defining strategic priorities and directions and also for developing and executing growth programs spanning short- and mid-term time horizons.

 

 

Dmitri Kryvozyatev

The next step is to evaluate a firm’s target share of its future PAM. This step requires the strong capability of making sound and measurable projections about highly uncertain future events that are likely to have a strong impact on the business.

Contact us to organise a meeting where we will tell you in full detail how our PAM® method can benefit your company´s growth strategy.

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