The Arbitrage Impact of Lifecycle Analysis

April 1, 2011 § Leave a comment


By Doug Brockway and George Daniels

Buyers and sellers of assets agree on a price at the time of the transaction but each is hoping, expecting and planning that the actual value is better than the price paid.  To this end, accurately understanding the value of an asset is key to success in buying and selling.

Value calculations are based on historical performance as well as projected future revenues and profits.  Plexius uses lifecycle diagnosis and analysis to quickly and deeply inform on the accuracy of that view and whether, at the current price, it actually represents good value.

One way to illustrate the power of lifecycle analysis is to look at Apple, Inc.  Today, Apple is the second largest company in the world, when measured by market value, behind only Exxon/Mobil.  In 2000 Apple was a successful company, to be sure, but since then their success has been explosive.

What has occurred in the last decade is a multi-pronged relentless assault on both the corporate and the consumer markets.  Apple has not only introduced a series of products on a near-maniacally consistent pace of new products every year, but products seemingly aimed at one market spawn products in entirely different markets and then merge back together or feedback on each other with increasingly positive revenue.

The IPOD Case

The iPod family provides a telling illustration.  Introduced in October of 2003, over the next five years there were seven major releases of the iPod itself.[1] Each new product provided a combination of new features that drew existing and new customers back into the stores.  Memory would increase to handle more songs.  The user interface would change or the look of the device itself.  By the fifth release images and video were added and eventually the “standard” iPod was replaced by the iPod Touch which looks like and has all the features of an iPhone without the phone.  To date there have been two releases of the Touch.

In the 7 years of this analysis there have been 6 new products or branches on the iPod tree.  There were two versions of the iPod Mini, five of the iPod Nano, and three of the iPod Shuffle, all compact, stylish players.  There was an interim iPod Photo which added the ability to take and display pictures, subsumed into the standard iPod in release five.

The regularity of the releases is striking.  On average, across the family, there is a new release of a product every 1.2 years.  If you remove the iPod Shuffle, which averages 1.6 years/release from that analysis, Apple, in each branch of that family tree, adds a new release once a year.

Apple’s success includes many factors.  Two of them are deeply insightful understanding of markets and marketing combined with a product introduction juggernaut that both defines new markets and effectively cripples less nimble competitors.  Everything about Apple is organized around the ability to look beyond the current product and, while realizing the rewards of a successful current product actively designing, developing and delivering its replacement without waiting for the lifecycle curve to turn downwards towards commoditization.

– Plexius’ Reinforcing Innovation Model –

As a standalone product the iPod was successful.  It protected its revenue steam and expanded its market and dominated its market.  But, it was the iPod (and iTunes) piled on by the iPhone (and the App Store) then piled again with the iPad, that revolutionized Apples revenue growth in the 2007 to 2010 time window growing from $37 million to $65 million.  It is difficult to recall such a compounding of product and market innovation in so short a period.  How would you have valued Apple in 2005 if all you saw was historical performance without examining the development pipe line? The stock market price was from $30 and $70 during 2005.  Apple is now trading at $350 per share.

If you are thinking of buying a company that has a very successful line of products but for which there are relatively few replacement products in the pipeline ready to replace the current offerings at their peaks then the future cash flows of that company must be discounted.  However dominant the products are they will soon fall prey to commoditization and competitors.  The prices you are able to charge customers will go down, the marketing costs needed to maintain share and volume will go up and funds for reinvestment will be compressed.  Expect a squeeze.

Conversely, if you are thinking of selling a company that has a good set of products but each of them has replacement products in line and in the course of delivery ready to not only replace your installed base but that of your competitors you should hold out for a very good bid.  Expect a premium.

The information needed to reasonably estimate life-cycle positions for a company and its competitors offerings can be obtained through an examination of readily available data. The value of such insights to the buyer or the seller is priceless.   By having that information you are in a position to arbitrage, to your advantage, any acquisition or sale of an asset.  “To the [best informed] go the spoils.”

Doug Brockway and George Daniels are Principals with The Plexius Group


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