Recommendations
Consequently, the company is seeking to turn things around and get back on the growth track. The company is considering two options which all involve entering new markets. One option entails entering a new market that is similar to the firm's primary market, while the other alternative entails entering a new market which is very different than the one the company is currently operating. Based on a critical analysis of the two options, the second proposal would be the best for the company. The firm should enter the new market that is very different from the one it is in currently. This will be a form of a diversification strategy, in which the company will enter a new industry or market in which it does not presently operate, whereas also creating new products for the new market. Diversification into new products and service lines could offer a practical path to fast growth, as the company will establish new markets where it can sell the new products.
One of the reasons why the company should consider option two is for survival purposes. By definition, a firm which specializes in a narrow range of commodities will only have access to a finite number of buyers (Shapira, 2017). Focusing on a single product line and market might be okay because currently the company's market is large enough to support different competing businesses. However, it is evident that the pool of clients is small, and in the long-run, the cost of operating the business could outweigh the potential for income. Besides, the company's sales have shown slow growth over the last decade, and the company gets most of its revenues from taking market share away from its competitors. Although this strategy may work in the short-run, it might be difficult for the company to sustain it in the long term as the companies could reclaim their market share through being innovative and introducing new products in the market. Therefore, diversifying into a new line of product lines and the new market would be vital to the long-term feasibility of the business.
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Another reason why the company should adopt option two is that this alternative takes into consideration most of the challenges the company is facing today. First, the company is facing a slow growth of its products. However, while alternative two is a relatively new market, it has a potential for high growth and a very profitable venture. Besides, the projected returns for this option far surpass the company's IRR problem, even though the projected cash flows are potentially too optimistic. One issue which could be due to entering this very different market for the company is that it would require the firm to acquire new skills and knowledge in the development of product and also new understandings of market behavior concurrently. Entering a new market will both needs gaining new skills and expertise, as well as acquiring new resources such as new facilities and new technologies, which could expose the company to higher risk levels. However, this is not something to worry about because, with alternative two, the company will neither need new skills and knowledge nor new facilities and resources, as the production and sales will be done off-shore in developing markets through contracting with low-cost, low-growth manufacturers and distributors. This means that the company will incur the costs of developing new skills and knowledge as well as acquiring new resources and facilities as it can contract production and sales at low prices locally in the off-shore market.
Lastly, due to the changes being witnessed in the economy, the expenditure patterns of customers are bound to change. Diversifying into various product lines or different industries could help in creating a balance for the company during recessions and booms. Currently, some of the hurdles the company is facing such as low cash reserves for both short and long term debt which is higher than what the company would usually consider acceptable is due to the recent economic recession (Shapira, 2017). Manifestly, unpleasant surprises will always emerge within a single investment. Diversification could aid in balancing these surprises. Also, diversification could help in maximizing the utilization of potentially underutilized resources. Some industries, like the one the company is presently operating in, might fall for a specific time frame, as a result of economic conditions. Consequently, diversifying would offer shift away from activities that might be declining.
There are primarily two reasons why the company should not pursue option. One, entering this new market which is similar to the firm's primary market would not be a wise decision as the company has been operating in the same market for a long time now and while it has been successful, it has been facing various challenges. Therefore, the company needs to consider venturing into another market and diversifying its products, which will serve as a cushion during hard economic times like the one it is experiencing currently. Another reason why it is not viable to consider option one is that, although the project meets the company's IRR hurdles, there are few unknowns. The company is not guaranteed that if it pursues the same market it is currently operating in it will succeed, given the uncertainty of the constantly changing market. The company should avoid taking the risk of focusing solely on one market and expand its operations to cover a wide range of products and to serve various customers. The company should be concerned of these few unknowns since it does not know what the future holds and these risks could crumple the new venture even before it stabilizes. Pursuing the same market the company is currently operating will not make much difference because it will encounter the same challenges it is now facing. So, for the company to survive, it should venture into a different market and product line, and establish itself before other big corporations enter. This will give the company a first-mover advantage by gaining a competitive market by controlling the industry resources.
Funding
For the company to venture into the proposed project, it should consider equity markets and issue out stock as its funding method. At the moment, the company's short and long term debt is higher than the firm would usually consider acceptable. Besides, it is projected that for short and long term interest rates will increase. Thus, it would be not prudent for the company to go to the debt markets and issue out bonds. According to Lewis & Tan (2016), bonds are debt, while stocks are ownership stakes and the company would not want to continue amassing more debt, with the interest rates expected to increase, as well as with the company's higher than ordinarily acceptable short and long term debt.
The company should go to the equity market and issue out more stock because it will probably be able to raise more funds through issuing stock compared to borrowing. Likewise, by issuing stock, the company will not be obligated to making monthly or annual payments to stockholders. Instead, the company will have other owners of the new venture with whom it can share risks associated with the new investment. Because the company will not have debt obligation, it will not pay any finance fees. On top of these financial benefits, if the company takes on stock investors, it could bring motivated experts into the circle (Lewis & Tan, 2016) . If the company wants to grow the new business, and which it has little previous experience, bringing on investors would aid in making the new business successful.
Additional benefit of issuing stock rather than bonds will be that the company will be able to preserve cash. Interest fees and face value repayment on bonds require to be paid periodically. These will drain money from the company. Cash dividends are not compulsory payments to stockholders, and most companies do not pay common stock dividends, helping them preserve cash (Lewis & Tan, 2016). The company could follow this path as a way of increasing its cash reserves. Additionally, the firm could omit or cut dividends if possible without causing a default. Failure to pay an interest fee on the debt could plunge the firm into liquidation and bankruptcy.
Nevertheless, the issuance of stock as a financing method has its downside. Based on a long-term viewpoint, issuing stock would minimize the company's future potential on prospective incomes. The company will have to share earnings of the proposed venture with other investors. Similarly, issuing stock would mean that the company gives up a certain degree of control.
Risk Assessment
Option one
Short-term, Medium-level Risk
A significant risk of pursuing option one is slow growth and lower margin. Slow growth means that it might take the company many years to grow and realize a return on investments (ROI). Also, a small profit margin is an indication of poor operational efficiency. This means that the company would need to better its performance. It is a sign that most of the companies within this industry can manage their operations better than the company is. So, moving forward and investing in the same industry with low margins and slow growth would be a risky venture for the business, as other companies in the industry are already outcompeting it. However, this risk is medium as slow growth, and low margins could be as a result of the current economic recession.
Option two
Short-term, High-level Risk
The main disadvantage of entering into a new market different from what the company now operates in is that the company does not have previous experience in the new market and there is no guarantee that the new line of product will be successful. In essence, the company has little prior knowledge of the new venture, and this could be detrimental to the proposed project. Also, entering into a new market would demand a new set of skills and lack of these skills in the new area could prove to impede the company.
Long-term, high-level risk
One long-term, high-level risk which the company could encounter is the high cost of operating the business. Even though the initial cash requirements for starting the business will be low, it could increase considerably in year three and beyond, subject to how much the company achieves early success. Therefore, in the long run, the cost of operating the business would be high, and this could present a high-level business risk to the company.
The company could face a long-term, high-level risk of stiff competition in the long-run. Although the industry is in its initial phases and there are no major competitors at the moment, major corporations are considering investing in this emerging opportunity. As a result, this would present formidable competition for the company in the long-term. This is a high-level risk, considering that it would adversely affect the company's profitability in the long-term.
References
Lewis , C. M., & Tan, Y. (2016). Debt-equity choices, R&D investment and market timing. Journal of Financial Economics , 119 (3), 599-610.
Shapira, Z. (2017). Entering new markets: The effect of performance feedback near aspiration and well below and above it. Strategic Management Journal , 38 (7), 1416- 1434.
