Everyone wants their business to strike gold with a product that explodes onto the scene to get a secure market share while also exponentially growing in revenue. Yet the reality of managing such a product while not blowing through all of your investment cash is a nightmare to manage.
That’s why you need to know the benefits of two types of products known as a cash cow vs rising star.
In this post, we here at Aimably will show you how to categorize your products and how to best manage them in a way that lets you reinvest in your own company using your existing products, rather than wasting your bulwark of funding.
We will cover:
- What are cash cows and rising stars?
- Assessing and categorizing your products
- Cash cow vs rising star investment tips
- How to create a product P&L
Let’s dive right in.
What are cash cows and rising stars?
“Cash cow” and “rising star” in business terms are products that have high market shares, but low or high growth respectively. Originally known as cash cows and “stars”, these categorizations were first formalized by the founder of consulting firm BCG, Bruce Henderson, in their original 1970 Growth Share Matrix.
Origins: The Growth Share Matrix
BCG’s matrix of market share versus growth was created to help companies tackle one of their most difficult aspects; knowing which products are worthwhile to reinvest in, which are good money-makers but have limited growth potential, and which are worth (at best) caution or cutting losses with and divesting.
The idea was simple. Companies with a significant market share gain recognition, experience, and brand prestige in a way that is difficult to replicate, along with being able to rely on a consistently large sum of revenue from their market presence (depending on the total addressable market size, but more on that later).
However, it can be incredibly difficult for companies to know which of their products they should be investing in and how best to do so in order to create more value. That’s where the matrix came in. By assessing products versus their relative market share and growth rate, BCG was able to categorize them in one of four ways:
- Cash cows (high market share, low growth)
- Stars (high market share, high growth)
- Question marks (low market share, high growth)
- Pets (low market share, low growth)
Cash cows, stars, question marks, and pets
Cash cows are the backbone of a successful company, in that they provide you with the money that will allow you to reinvest in new or existing products. They’re consistent revenue machines with a high market share but low growth - they aren’t going to expand in the market much more, and so require little investment.
Star products are what many companies dream of having. They’re that lightning in a bottle that already has a high market share but is also growing quickly and has massive potential to skyrocket in value.
In the tech industry these products are instead referred to as “rising stars” due to the expectation of continued growth expansion. By emphasizing the untapped potential in the name, you help to stress the value that can be gained by reinvesting in it. Speaking of which, these rising stars are where you’re going to want to put a good chunk of the profits raised by your cash cows, with the expectation that anything invested will be reflected in extra value through a larger market share.
Question marks are your wild cards. With a low market share they’re less immediately valuable than a rising star or cash cow, but their high growth rate should be assessed carefully to judge their worth versus potential investment.
Question mark products are a gamble. Maintaining a high growth rate through to them having a significant market share will usually make any investments to get there (bar extortionate ones) worthwhile. However, it’s ultimately down to your company’s financial situation, willingness to take that gamble, and how promising the product is. If it doesn’t make the cut, it’s time to divest.
Speaking of which, unless you have money to spare and a belief in the value of a product outside of monetary gain, divestiture or pivoting is the fate of all products known as “pets”. As the name implies, these are items with low market share and a low growth rate. Generally these are considered to be failures of a product or (as the name implies) pet projects that you know you aren’t going to earn money back on.
Assessing and categorizing your products
Before we can show you how to handle your cash cow vs rising star products, you need to be able to assess and categorize your products accurately. An overestimated market share could lead to question marks being labeled as rising stars without acknowledging the extra risk in investing in them.
To do this you first need to analyze every product line from the perspective of their financial performance and categorize them in the Growth Share Matrix.
This will require carrying out two further analyses:
- A market size analysis
- A revenue growth analysis
The market size assessment is also known as a Total Addressable Market analysis (or TAM), and there are two ways to go about doing this. The first is a top-down approach which uses industry research to roughly calculate your TAM, usually by examining (through secondary market research) the estimated number of total users in your market and what the total value of that user base is.
The second method of calculating TAM is a bottom-up approach. This will generally be more accurate than using vague market research that doesn’t necessarily reflect your actual market size, but does require a little more work in calculating.
Find out what the total number of accounts in your industry is, multiply that by the annual contract value (ACV) of your product or service, and that is your TAM. So, if you had a product that could be sold to 5,000 customers or vendors across your addressable locations (say, the East Coast) and your ACV from your current customers was $2,000 per year, your TAM would be $10,000,000.
Next is the revenue growth analysis, which involves comparing the month-to-month change in revenue for a specific product. So, you take your revenue for month B, subtract the revenue from month A, divide the whole thing by the revenue from month A, then multiply that figure by 100 to get a percentage.
So, a product that brought in $5,000 of revenue last month and $6,000 this month would be calculated like so:
((6000-5000) / 5000) x 100 = 20% revenue growth rate
What’s considered to be a “healthy” growth rate will differ depending on which sector you’re in, but generally anything between 10-20% is considered to be good, with more than that being even better.
Once you have your TAM and revenue growth rate for each product, you can plot where each of them fits in the Growth Share Matrix. This will tell you what category they are (cash cow vs rising star vs question mark vs pet), and thus inform your decision of what to do with them.
It’s hard to recommend investing your capital in a question mark product due to their unknown nature, and pets should always be invested in minimally if you’re hoping to grow your business. To be as successful as possible you should look into divesting these options as soon as possible (in the most beneficial way you can).
Then you’re left with your cash cows and rising stars.
Both of these will require investment to reach their full potential or simply maintain their current trajectory, but the exact method shouldn’t be the same. What works for a cash cow will stifle a rising star, and investing too much in the wrong way to a cash cow will simply result in wasted money.
So how should you reinvest?
Cash cow vs rising star investment tips
Judging your relative investment into cash cows vs rising stars is always a question of balancing the value you receive with the money you put in.
Rising stars have great potential, but they aren’t intended to be reliable profit generators lie cash cows. This means that your goal is to not sink your business while investing heavily in the tools that will help your business to grow.
You need to keep your gross margins small (i.e. target your COGS to be at 20% of your revenue) but be willing to spend all of your revenue on sales, marketing, research and development to make your product reach the heights it can achieve. All of this is an investment in your future growth, so it pays to not be stingy.
Just be sure not to sink the ship you’re floating on while you do it.
Cash cows are a different matter. Your goal here is to optimize your gross margins and profitability, usually by turning as much of your inbound revenue into cash and profitability as possible. One of the best ways to do this if you have both a cash cow and a rising star is to reinvest the cash from your cow to fund the rising star without having to dip into any of your investment dollars.
To do this you’ll need to isolate each product’s Profit and Loss statement (P&L) into its own report.
A cash cow’s P&L will have fairly stable revenues, so your job is to make sure that you have as much of it available as possible to reinvest in your rising star. The best way to do that is to reduce your Cost of Good Sold (COGS) down to 20% or less of the cash cow’s revenue and to keep your Operating Expenses (OpEx) as low as you possibly can. Remember, the cash cow’s function here is to be a consistent profitability generator, not to drain the funds you have available for product investment.
A rising star’s P&L will show the revenues generated growing at a good rate (hence why the star is “rising”), so your task with these is to reduce COGS to roughly 20% of revenue while also reinvesting more into the product. That means that your OpEx will be high, but should still be thoughtfully managed and invested to make sure that your EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) / profitability is zero. However, it’s also reasonable for your rising star’s EBITDA to be the inverse of your cash cow’s, as this will simply mean that the cow is funding the investment into the star for further growth.
How to create a product P&L
We breezed over it in the previous section, but creating a solid Profit and Loss statement for your products can be a daunting task.
For some businesses it will be easy. You can simply use an accounting dimension found in any system such as Class to associate all (or a percentage) of every expense with each of your products. This will let you see the merits of your products separately and judge how much you should be reinvesting in your rising stars.
However, for AWS customers this gets a little more complicated. Since there is no way to break down your bill by product lines (like you can with other cloud hosting providers) you’ll need to either do it manually or use a tool such as Aimably’s Invoice Management software.
Using this tool will let you automatically attribute expenses to specific products in order to keep everything separate. Invoice and usage statistics are gathered into one easy-to-use tool that not only allows you to quickly create P&L statements for each product, but also see discrepancies in your bills, increase transparency across your finance and development teams, and manage invoice approval faster than ever before.
