The Business Life Cycle: What Changes at Each Stage

A business life cycle is the sequence of states a business passes through as what it is short of changes: first customers, then capacity, then somewhere useful to put its own cash, and eventually a reason to carry on. One state is separated from the next by neither age nor size, but by the direction the cash is moving and the constraint that binds. Both readings are legible in the statements already to hand.

Two things sit under that answer, and both are ordinarily to hand. One is a set of statements, where the revenue line, the operating result and the movement of cash are all visible. The other is a question that can be put to any business without knowing a thing about its history: what is it short of, right now, this period? With that question asked and the cash inspected, a stage stops being a label handed over by somebody else and becomes something read off the accounts.

Two invented companies carry the arithmetic in this guide. Anjani Stationers Private Limited manufactures stationery and sells it to a few dozen business buyers, and its revenue and operating result are used here exactly as they were built. Setu Bazaar runs a marketplace where fifty thousand people a year buy from independent sellers, and it keeps a slice of the money that passes through. Neither company trades anywhere. Both exist so that every figure below can be recomputed by hand.

What is the business life cycle?

Four names get used for the states, and here they are, once. Introduction is a business that exists and has almost no customers. Growth is a business whose demand arrives faster than it can be served. Maturity is a business that makes more cash than it can sensibly put back to work. Decline is a business selling something that fewer people want each period.

The naming stops there, and four labels give very little. A reader who has learned four labels and nothing else has learned nothing they can use. Set any one of those names against a real set of accounts and consider what it supports. Not what the company will do next. Not how long anything lasts. Not what the company should do instead, and certainly not what it is worth. The label is a summary of a reading, and the reading has not been taken yet.

The shape is also borrowed, and it is worth saying whose it is. Theodore Levitt set out the product life cycle in the Harvard Business Review in 1965, and Larry Greiner set out a sequence of growth phases in the same journal in 1972. Both were describing something they had watched happen. Both men are named in the table below for the shape they described, not for any claim that a business has to follow it.

The method below is different from naming: two readings taken directly off a set of statements, in order, and then what those two readings can and cannot settle. The names become shorthand for the readings. The dependence runs one way: readings first, label second, and a label carried without the readings underneath it is only a word.

Which way is the cash moving?

A household shows the identical shape. A tailoring business run out of a front room spends before it earns: cloth, a second machine, a signboard, and the months where the rent is paid and the orders have not arrived. Somebody funds that gap from outside, usually a savings pot or a relative. Years later, if it works, the same business pays for next month's cloth out of last month's takings and there is something left over. The tailoring did not change. The direction of the money did.

Not an opinion and not a label, the direction of cash is a subtraction anyone can do, and that makes it the most honest single indicator of the state a business is in. Everything that follows depends on that subtraction coming first and the argument about the name coming afterwards.

Take Setu Bazaar. Rs 500 crore of goods move through the marketplace in a year. Its take rateWhat a marketplace holds back from each transaction it carries, instead of handing the whole amount to the seller. is set at 4.00 per cent, so Rs 20 crore of that stays with Setu Bazaar and the rest goes to the sellers. Rs 20 crore is therefore its revenue for the year. Of that revenue, Rs 10 crore survives as contributionWhat is left of the money a customer brings once the costs that move with that customer are paid, and before any cost that would exist anyway. once the costs of serving those buyers are met. Its fixed costs for the year are Rs 12.5 crore. Rs 10 crore less Rs 12.5 crore is minus Rs 2.5 crore, so the year ends with more money having left than arrived.

Money leaves in a second way that the result line does not show at all. Each buyer costs Rs 6,000 to acquire, and that customer acquisition costWhat a business spends to bring one new customer in, counted once at the point the customer arrives rather than spread over the years afterwards. is paid once and up front. The Rs 2,000 of contribution that buyer brings arrives a year at a time. The money goes out before it comes back, and the two are on different clocks. The mismatch of clocks is why a business can be sound on every buyer and still be short of cash in the room.

Now put Anjani Stationers beside it. Revenue of Rs 2,70,00,000 and earnings before interest and tax (EBIT) of Rs 41,50,000 give an operating margin of 15.37 per cent. The subtraction runs the other way: the operating line produces money rather than consuming it, and nothing in the figures suggests a large spend going out to find the next buyer. Two companies, two subtractions, two opposite answers, and neither answer says which is the better business.

One caution before that reading is carried anywhere. An operating result is not cash. A business can post a profit while cash goes out through inventory and unpaid bills, and the cash flow statement is where the direction is actually settled. The operating result is the fastest first look, not a replacement for the statement underneath it.

What is this business short of?

The second reading is a question rather than a number, and it can be asked of a business about which nothing else is known. Consider a food cart outside a college gate. In the first month the binding constraint is that nobody knows the cart is there: it could serve four times as many plates as it sells. Solving that with a month of word of mouth moves the constraint, without warning, to how many plates one cart can actually push out between noon and two. Solving that with a second cart moves it again, to whether there is anyone left at that gate who has not already eaten.

The constraint changes even when the business does not. Nothing about the food improved between the first month and the third. The cart did not become a different cart. The change was in which shortage was doing the limiting, and the vendor can feel that change before any number shows it. A business can also move between states without doing anything differently. A second college opening down the road, or the office block behind it emptying out, alters the shortage binding the cart while the vendor stands exactly where they were.

Of the four constraints, only the first two are about demand at all. A business short of customers and a business short of capacity are both trying to sell more. A business short of anywhere to put its own cash has a completely different problem, and it is the pleasant one: reinvestmentPutting money the business has already made back into the business, rather than holding it or paying it out. absorbs less than the operating line produces, and the money piles up. High capacity utilisationHow much of what a business could produce or serve it is actually producing or serving, usually stated as a share of the total it could manage. with nowhere sensible to add more capacity is the ordinary way a business arrives there.

The fourth constraint is the uncomfortable one, and it is not the same as saturationThe point at which almost everyone who would buy a thing already has it, so extra selling effort finds fewer new buyers.. A saturated seller can be perfectly steady. A business short of a reason to continue is one where what it sells is wanted by fewer people every period. Why a field stops wanting something, and whether a field was ever a good one to be in, is covered under Industry Structure and Sector Behaviour.

Why can two businesses of the same age sit in different states?

Because age is a fact about the calendar and a state is a fact about this period. Each settles a different question. People reach for the calendar version because it is printed on the certificate of incorporation and costs nothing to look up.

A state is a description of what is true now, and not a description of how old the business is. Both directions of that hold, and readers reliably learn only one of them. The half everyone learns is that a young business can already be settled: a three year old workshop with steady repeat orders and every machine running at full tilt is short of capacity, not of customers, and reads exactly like a business three times its age.

The half almost nobody learns is the other direction, and it matters more. A forty year old manufacturer that has just opened a new line is, in that line, short of customers. The new line has no orders yet, the company is spending to find them, and the rest of the company being a settled incumbentA business already established in what it sells, with customers and a position that a newer entrant has to work against. does not change the reading for that line one bit. The forty years bought reputation and a balance sheet. The forty years did not buy customers for a product nobody has tried.

Both readings are therefore taken line by line rather than once for the whole company. A company is often in two states at the same time, and a single label pinned across the whole of it hides exactly the part worth seeing. The two questions belong to a line of business, not to a registration number.

What does a loss say about which state a business is in?

Less than almost anyone assumes, and this is the sharpest point in the whole reading. A loss appears in the earliest state and in the last one, and the loss on its own does not say which end is in view. A business that has just started spends before it earns and posts a loss. A business that is running out of reasons to continue earns less than it costs to stay open and posts a loss. The bottom line can be the same figure to the rupee.

The separation is one level up, at the unit. Ask whether a single customer, taken on its own, brings in more than it costs to serve. A business losing money with a profitable unit is buying something; a business losing money with an unprofitable unit is doing something else entirely. The first is spending on customers and capacity that it expects to keep. The second is selling at a shortfall and getting a little further behind with every sale it makes.

Work it with real figures. Setu Bazaar loses Rs 2.5 crore in the year, because Rs 10 crore of contribution meets Rs 12.5 crore of fixed costs. Every one of its fifty thousand buyers contributes Rs 2,000. The company loses money and every buyer is profitable at the same time, and there is nothing paradoxical about it: the fixed cost baseThe costs that stay roughly where they are whether the business serves one more customer or a thousand more, such as premises, core staff and systems. sits above the unit line and is not covered until enough units have stacked up under it. Here that number is 62,500 buyers, 25.00 per cent more than the fifty thousand it has.

Now build the same loss the other way. Suppose a business where each buyer contributes minus Rs 200, so serving a buyer costs Rs 200 more than that buyer brings, across the same fifty thousand buyers. Fifty thousand buyers at minus Rs 200 each is minus Rs 1 crore of contribution. Give it a small fixed cost base of Rs 1.5 crore and the result is minus Rs 2.5 crore, identical at the bottom to Setu Bazaar's year. But the two are opposites. Setu Bazaar reaches break even at 62,500 buyers. The second business reaches break even at no number of buyers at all, because every extra buyer widens the loss. Operating leverageHow strongly a result moves when volume moves, which depends on how much of the cost stays fixed as volume changes. runs in reverse when the unit itself is negative.

So the order of operations is fixed: the unit comes before the naming of a state. How the unit is built, and how the cost of acquiring a customer is set against what that customer brings, is worked out in full under Unit Economics: Profitability at the Level of One Customer.

How do the two readings place Anjani Stationers and Setu Bazaar?

This is what the two companies are for. The two readings are taken in order, on each company, and only what the readings support is written down.

Setu Bazaar first. The cash reading: Rs 10 crore of contribution against Rs 12.5 crore of fixed costs is minus Rs 2.5 crore, so money went out over the year, and more went out on top of that to acquire buyers at Rs 6,000 each. The constraint reading: it is short of buyers, and exactly how short can be stated, because break even sits at 62,500 and it has fifty thousand. Both readings on Setu Bazaar are consistent with an early state.

Anjani Stationers second. The cash reading: revenue of Rs 2,70,00,000 producing an EBIT of Rs 41,50,000, an operating margin of 15.37 per cent, with the operating line generating money rather than consuming it. The constraint reading: it is not short of buyers, because it is selling steadily to the ones it has. Whether it is short of capacity or short of somewhere to put what it makes is not in these figures, and the honest thing to do is say so rather than pick.

Two readings place a business without any reference at all to how old it is, and they place it without saying which company is the preferable one to hold. Putting one of them above the other means choosing a test to rank them by, and any test worth applying would need inputs the two readings do not supply.

Every figure in that table can be rebuilt from its parts. Setu Bazaar's revenue is 4.00 per cent of Rs 500 crore. Its contribution is Rs 2,000 from each of fifty thousand buyers, which is Rs 10 crore, and Rs 10 crore less Rs 12.5 crore is minus Rs 2.5 crore, which is minus 12.50 per cent of Rs 20 crore. Its shortfall of buyers is 62,500 less 50,000. Anjani Stationers' margin is Rs 41,50,000 divided by Rs 2,70,00,000, or 15.37 per cent.

What does naming a stage not support?

Three things, and they are the three people reach for first. A stage is a reading of the present and never a forecast. The picture is a row of states, and a row invites the eye to run along it, so the refusal has to be made explicitly rather than left to good manners.

A state name does not support a claim about what happens next. Nothing in a shortage of customers implies that the customers arrive. Businesses stay in an early state indefinitely, close from one, or are bought out of one, and the reading describes the period it was taken from and no other. A state name does not fix how long anything lasts either. A state has no clock attached to it, and any duration attached to one came from somewhere other than these two readings.

A state name also settles nothing about what a business is worth. Putting a value on a business needs assumptions about what it will do and what that is worth today, and the two readings supply none of them. A growth rate is an input to a valuation rather than something read off the statements, and no set of statements produces one. Value belongs to the subjects that deal in prices, and this one deals in description.

The two readings do support something worth having on its own. Between them they give the shortage that binds this period, the direction the money is moving, and whether the unit pays for itself. Three sentences of that kind are usually more than whoever handed over the label had.

How does a lender or an analyst use the two readings in practice?

In one order, and always the same order. A lender assessing a working capital facility asks which way the cash is moving before anything else, because that answer decides whether repayment comes out of what the business earns or out of somebody else's money arriving later. A business with money going out is not automatically refused. Such a business is assessed differently, against the purpose of the spending.

The second question is the shortage that binds. The lender cares because that answer names what the loan would actually fund. Money lent to a business short of capacity buys machines and space that exist afterwards. Money lent to a business short of customers funds a search, and a search has no salvage value if it does not find anything. Both are lent against every day. The two loans are not the same risk, and the two readings separate them in about a minute.

An analyst comparing two companies in the same field uses the readings to stop an unfair comparison before it starts. Setting a business that is spending to find buyers against one that stopped spending to find them years ago, and then noting that the second has the better margin, compares two different states and calls it a comparison of two companies. The readings exist to show when two sets of statements are not answering the same question.

And a version of the check that costs nothing: a person deciding whether to join a small company can ask both questions in one conversation. Which way is the money going, and what is the business short of? An honest answer to the second is often more informative than the first, because a business that cannot name what it is short of has usually not looked.