The market growth rate shows us the percentage change in market size. It can be positive or negative and varies over time due to several factors such as changes in consumer income and consumer tastes and preferences.
Positive growth is more desirable for businesses as it indicates more money is available in the market. In addition, a growing market has implications for less competitive intensity because the company does not need to win over competitors’ customers to grow sales.
Then, the company also uses the market growth rate as a comparison indicator to measure business success. Management usually compares it with the company’s sales growth rate to evaluate whether the strategy implemented is effective or not. A higher sales growth rate is more desirable.
Finally, the market growth rate also varies over the product life cycle. During the introduction phase, the growth rate is low and then accelerates during the growth phase. As the market saturates and enters the mature phase, the growth rate slows down before finally entering negative territory during the decline phase.
Why calculate market growth rate
Several reasons to calculate the market growth rate and why it is important for companies.
Planning. Companies look at market growth rates when making plans ahead. Say the company forecasts the market growth rate and market size in the next year. The company then uses it to set sales growth targets or its market share in the next year. And, the targets set ultimately affect aspects such as the chosen marketing strategy, promotional spending, and cash flow.
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Strategy selection. Market growth trends affect the chosen competitive strategy. For example, a growing market indicates more dollars are available in the market for acquisition. As a result, the company has a greater chance of generating revenue without adopting an aggressive strategy – avoiding competitive reactions from competitors.
- On the other hand, management has to face tougher competition when market growth declines or is negative. Thus, management must adopt an effective strategy to at least maintain the company’s market position.
Barometer for success. Management uses the market growth rate as a comparison indicator to assess the company’s marketing success. By comparing the company’s sales growth with market growth, they evaluate whether the strategy implemented is effective or not.
Say, sales growth is lower than the market growth rate. It became an alarm for management. First, management has to investigate why it happened. Then, they have to find out the cause, whether it is, for example, due to too high a price or inadequate advertising. Then, management took steps to improve it going forward.
On the other hand, if sales growth is higher than market growth, it can indicate an effective competitive strategy of the company. As a result, the company’s market share increased. Therefore, management can maintain it or improve it in the future.
How to calculate the market growth rate
Before we calculate using an example, let’s discuss two approaches to calculating growth rates and see what the formulas look like.
Market growth rate formula
The growth rate formula is very easy. For annual growth, we reduce the market size this year with the previous year. Then, we divide the result by the previous year’s market size. The final result is expressed as a percentage.
Easier still, we divide this year’s market size by last year’s market size. Then, we subtract the result by one and express the result as a percentage. This calculation will produce the same number as above.
Meanwhile, for market size, we can use:
- Sales volume of all companies in the market
- Sales value of all companies in the market (market value)
The next approach to calculating growth is the compound annual growth rate (CAGR). Under this approach, we can calculate the average growth over several years without calculating the growth rate in each year and average the results. Thus, CAGR is useful when historical data is unavailable because it only uses numbers from two different periods. But you have to remember, CAGR assumes growth is at a constant rate from year to year.
Here is the formula for the two approaches above:
Let’s take a simple example. In 2010, the market value for a product was $80 billion. Then, in 2018, the figure increased to $200 billion. A year later, in 2019, it was worth $220 billion. Calculate:
- Growth in 2019
- Growth during 2010-2018
To calculate growth in 2019, we can apply the first formula as shown in the image above. As for growth during 2010-2018, we can use the compound annual growth rate (CAGR) because there is no historical data. As I already mentioned, if we use CAGR, we assume a constant growth rate over 2010-2018.
From the calculations, we get:
- Growth in 2019 = (220/200)-1 = 0.1 = 10%.
- Growth during 2010-2018 = ((200/80)^(1/(2018-2010))-1) = 0.121 = 12.1%.
Why does the market growth rate vary from year to year?
Market growth varies from year to year. It can happen for several reasons:
Economic growth – the economy fluctuates from time to time – the ups and downs are called the business cycle. It affects income and employment prospects for households. When the economy grows high, there are more jobs and income for households. Business activity also increases; it usually leads to an increase in the demand for goods and services.
Consumer income – higher income increases the willingness and ability of consumers to pay for products. Consumers have more money to spend, enabling more demand for products and market growth.
Changes in consumer tastes and preferences – changes in consumer tastes can lead to a preference for a particular product, which increases the demand for it and drives the growth of its market up. Or, conversely, tastes may turn against the product, driving down demand and market growth.
What is the relationship between market growth rate and market share?
Market growth measures the increase or decrease in market size over time. Meanwhile, market share measures the proportion of a company’s sales to market size. The two are related. And, sales growth by the company is the connecting factor of the two indicators.
Now, assume the market size and sales of the company are both growing positively.
- The company’s market share falls if its sales growth is lower than market growth.
- Market share increases if sales grow higher than market growth.
- Market share is constant if the company’s sales growth and market growth are at the same level.
Of the three, increasing market share is the preferred one. It shows the company’s competitive strategy is successful. The company may book higher sales growth than the market because it may adopt the following strategies:
- Lower the selling price of the product, attracting more people to buy.
- Increase ad spends more aggressively than competitors, thereby reaching more consumers.
- Introducing new products to attract new demand rather than relying on consumers’ repeat purchases of old products.
Then, the increase in market share allows the company to reach higher scales. It makes the average cost decrease, increasing its profitability.