31 July 2012 09:00

How to forecast sales growth

Sales Big

Unless you are a company insider with access to accurate shipment and order data, it is pretty much impossible to predict how many products a company will sell in the near-to-medium term. However, you can improve the quality of your guesswork by asking yourself a few key questions:

How fast is the market growing for that company's products?

What is the company's share of that market?

Is the company poised to win or lose market share?

Market growth rate

Let's start with the pace of market growth. For example, if you were trying to predict the future growth of a company such as consumer goods giant Proctor and Gamble, you would have to take into account that they are primarily operating in a mature market. Therefore, you wouldn't expect the company to grow much faster than the economy as a whole.

Markets that have yet to reach the point of maturity are known as growth markets, and technology is a prime example. For instance, just ten years ago Apple was known primarily as a computer manufacturer. Fast forward to the present day, and Apple is now a major player in the fast-growing smartphone and tablet markets. In order to assess Apple's future growth prospects in these markets, you have to estimate the percentage of people who already own smartphones, the percentage of new smartphone buyers, and the percentage of customers that Apple may be able to lure away from its competitors.

Market share

The next thing that you need to look at is the market share that a company enjoys. For example, does the company dominate the market? In the case of a company that does, such as Intel with its 80% share of the PC processor market, it is hard to see how they will grow sales at a rapid rate if it already has the lion's share of that market.

However, dominant players can sometimes use their strong position to make even more gains. Starbucks and Honda are good examples of firms who have used the strength of their brand to grow market share over a number of years.

On the other hand, some small companies can grab market share very quickly. A good example of this would be budget airline Easyjet, which grabbed a huge chunk of the European airline business within just a few years thanks to an innovative business model.

In industries where the balance of power is always shifting, it can be hard to estimate future sales growth. A good example of this is the soft drinks industry, where Coca Cola and Pepsi have been winning market share off each other for decades. In cases such as these, it can be hard to predict future sales growth.

Pricing power

One of the biggest drivers of sales revenue growth is the pricing of products and services. If a firm can raise prices and maintain volume, then sales revenue will grow. However, higher prices can drive customers away, so it can have the opposite affect in terms of sales revenue.

The pricing power of a company can have a major effect on the relationship between sales revenue and prices. For example, pharmaceutical companies can charge whatever they like for drugs while they are under patent. Similarly, Apple can get away with charging a lot more for their products, despite similar manufacturing costs to their rivals, simply because of the strength of the brand and consumers' affinity with it. This is exceptional in a consumer tech market in which there is constant pricing pressure from cheaper competitors.

The product mix is important to bear in mind. For example, if Ford decided that it was going to concentrate on high-end models such as its Lincoln cars over its lower-priced family sedans, the higher margins involved could have a positive impact on sales growth - although it could have the opposite effect if the strategy shift results in falling overall sales.

It can be very difficult for an investor to forecast sales growth rates without any insider knowledge. However, if you ask the right questions about market growth, market share, and pricing power, then you can go a long way towards improving your guesswork.

 

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