Market Sales Potential

Market sales potential is a quantitative approximation of effective demand. Specifically, market sales potential is the maximum level of sales that might be available to all organizations serving a defined market in a specific time period given 1) the marketing mix activities and effort of all organizations, and 2) a set of environmental conditions. As this definition indicates, market sales potential is not a fixed amount. Rather, it is a function of a number of factors, some of which are controllable and others not controllable by organizations. For example, controllable marketing-mix activities and marketing related expenditures of organizations can influence market sales potential. On the other hand, consumer disposable income, government regulations, and other social, economic, and political conditions are not controllable by organizations, but do affect market sales potential. These uncontrollable factors are particularly relevant in estimating market sales potential in developing countries.

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Calculating Market Share

Market share is the ratio of the competitor’s annual sales to the total annual sales of competitive products in the market being served by the competitors. It is usually measured by dividing the  competitor’s sales in dollars by the total sales volume in dollars for the industry. Dollars are used in the calculation because monetary value is usually easy to obtain.

As may be seen from the dimensions describing the horizontal axis of the economic experience curve. It would make more sense to measure the market share in units sold during the year. Dollar volume does not double when volume in units shipped doubles if price decreases with experience.

The dimensions of the experience curve are fully allocated unit expense in constant dollars and cumulative number of units produced. The reference to doubling sales is measured in units shipped. Because this kind of measure could be counted off on the horizontal axis of the curve, it is possible to relate the growth in shipments to fully allocated expense in constant dollards, a reasonable profit margin, and the resulting dollar volume of sales.

The difficulty in obtaining the information needed to calculate market shares in terms of units shipped is often resolved by trade association data, which reports in both units and dollars. Still the associations may not include every possible competitor among their membership. In almost all cases, however, the non-members are not big enough to be significant. Even without the non-member data, the trade association information is a good approximation to the actual figures.

Given that sufficient data is available, it is not entirely necessary to know a competitor’s exact market share. The information most meaningful to a manager is market share compared to that of the nearest competitor. This gives rise to the concept of a market share ratio.

A proposed ratio that has special meaning when used in conjunction with the economic experience curve. The ratio may be best understood as:

Market Share Ratio =   Your Market Share __________

Market Share of Your Biggest Competitor

The interesting result of defining the ratio this way is that only one competitor has a ratio greater than one. All the others have functional ratios, less than one. For instance, if you the largest market share your biggest competitor will have a smaller share than you, and your ratio will be a number greater than one. If your biggest competitor has a market share larger than yours, your ratio will be less than one.

Because only one competitor has market share ratio greater than unity, the dominant competitor is identified by a number greater than one. Also, the degree of the biggest competitor’s dominance is indicated by the size of the number.

Typically, when a new business concept arises that can be represented by an economic experience curve, several competitors enter the marketplace within a very short span of time. There is an initial market penetratiuon in which market shares are established. Managers have learned how difficult it is to change the market share of the competitors once they have been established. Market shares among suppliers who are competing forcefully tend to remain reasonably constant. Cummulative experience relative to other competitors tends to be aligned with the market share ratios.

My Consultancy–Asif J. Mir – Management Consultant–transforms organizations where people have the freedom to be creative, a place that brings out the best in everybody–an open, fair place where people have a sense that what they do matters. For details please visit, Lectures, Line of Sight

Accrual Accounting and Cashflow

Before the end of World War 1 most managers kept track of cash out and cash in. many senior citizen owner-managers still do today. There is an inherent problem in keeping the records that way, however, if the business offers and receives much credit. Doing business on credit displaces the time of the exchange of cash from the exchange of goods and services. Sometimes very little cash comes in during a particular month and very much cash comes in during other months. The same is true of cash out.

Keeping in track of what you pay or get paid for credit transactions causes the monthly reports describing the operations to fluctuate from month to month even though the goods and services flowing in and out of the business may be very much the same. About 1920 the accounting profession began placing emphasis on the accrual method of accounting to overcome this difficulty.

The accrual method portrays the smoothed-out profit as if all the transactions had been for cash and as if the business had purchased only exactly what was needed to make the sale. It is not an accurate portrayal of everything going on in the business, but it is a good approximation of the net effect of those things that affect profit. The problem is that so much emphasis has been placed on the accrual method income statement and balance sheet that the importance of cash has been regulated to virtual obscurity.

Even this result is satisfactory when the reports are describing large businesses with access to external financing through the stock market, commercial paper, and bank loans at the prime interest rate. But companies that do not have access to these external sources of financing have a different problem. For them, the flow of cash through the business means life or death, whether the accrual based profit is great or terrible. When new or small businesses need cash they must turn to the bank, the banker will look to the personal savings and assets of the owner-manager for collateral.

Accountants have not forgotten nor overlooked the importance of cash. They recognize the need for cash in sufficient quantity to keep the business operating. For their purposes, however, they often infer the cash available to the business from the income statements and describe future cash availability with the balance sheets. They, and others, frequently describe it as: cash flow equals net profit after taxes plus depreciation and other noncash expenses, such as amortization.

This statement is incorrect except under some very stringent preconditions that rarely exist in practice for a small business. This statement is an approximation that is valid for large and stable businesses in which changes from year to year are small and the statements from which the cash flow is inferred are annual reports. For a small and new business looking at monthly financial reports this approximation is inadequate. In a small, growing business the net cash flow to the firm’s bank account does not equal the net profit plus depreciation. Profit is not cash nor is it cash flow.

Although this pronouncement may be unconventional, entrepreneurs are realistic. Successful entrepreneurs ask how it really works and then get on with building their business. In the conventional approach the analysts, having inferred cash flow from profit, depreciation, and amortization, stop there, allowing their readers to assume that the resulting cash is in the bank wiating to be spent.

My Consultancy–Asif J. Mir – Management Consultant–transforms organizations where people have the freedom to be creative, a place that brings out the best in everybody–an open, fair place where people have a sense that what they do matters. For details please visit, Line of Sight