Like every person has to go through different stages of life, every industry has to go through its industry life cycle.
A fortnight ago, I wrote an article, How to do industry analysis, where I covered the steps in writing industry analysis.
Today, we will see, different stages in industry life cycle. There are stages in everybody’s life like childhood, adult, middle age and then old age. Likewise, there are four stages in every industry’s life cycle.
If you observe the Gaming industry closely, you will find that there are many firms out there having high investment rates, high rates of return on investments and low rates of dividend payout. The same observation can be conducted on steel industry and you will find firms with low rates of investment, low rates of return and higher dividends payout. What could be the possible reason for this difference? Let’s find out.
In Recent times, better opportunities have been created by available technologies for substantially profitable investment of resources. Patents safeguard new products and there are high profit margins. Such rewarding opportunities allure the firms in putting all profits back into the firm and the growth of firms, on an average, is speedy.
However, the growth must slow down in due course of time. Looking at the high profit rates, more and more firms are encouraged to enter into the industry. As a result, the competition increases affecting the prices and profit rates. Advanced and new technologies start becoming more obvious, extent of risks decreases making the entry easier. The degree of reinvestment in these firms reduces as the internal opportunities become less lucrative and the cash dividends become high.
Eventually, cash cows are noticed in a mature industry. By cash cows I mean firms having consistent cash flows, dividends and low risk levels. Growth rates may be analogous to that of overall economy. High risk and high returns on investments are offered by industries in initial stages of their life cycles. On the other hand, low risk and low returns are offered by mature industries.
Thus, from above analysis we can say that an industry life cycle can be classified into 4 stages:
Industry life cycle stages
Start-up stage in which growth is extremely fast, consolidation stage in which growth is not as fast as start-up stage but is faster than the general economy, maturity stage in which growth is not faster than the general economy and the relative decline stage in which the growth rate is less than that of general economy.
1. Start-Up Stage
New technologies like personal computers or wireless communication portray the initial stages of an industry life cycle. At this stage, it is very difficult to anticipate which firms will succeed; some firms will be a total success while some might fail completely. Hence, the risk involved in selecting any specific firm in the industry is quite high at this stage.
However, at this stage, since the new product has not yet flooded its market, there will be a rapid growth in sales and earnings at industry level. Like, for example, in 1980’s, personal computers were a part of very few houses, while on the other hand, products like fans or even refrigerators were part of almost every household. So naturally, the growth rate of products like refrigerators will be much less.
2. Consolidation Stage
Once the product has proved itself in the market, several leaders in the industry start surfacing. The start-up stage survivors become more stable and market share can be easily envisaged. Thus, the performance of the industry in general will be more minutely tracked by the performance of the firms that have survived. As the product breaks through the market place and is used commonly, the growth rate of the industry is still faster than the rest of economy.
3. Maturity Stage
The product has attained the full aptitude to be consumed at this stage by the users. So, any growth from this point just tracks the growth of the economy in general. At this stage, as the product gets more and more standardized, it compels the producers to compete heavily on price basis. As a result, the profit margins are lowered and add to the pressure on profits. Most often, firms at this stage are referred to as cash cows as their cash flows are quite consistent but offer very little opportunity for growth of profit. Instead of reinvesting the cash flows in the company, they are best milked from.
4. Relative Decline
In this stage following features are identified.
• costs become counter-optimal
• sales volume decline or stabilize
• prices, profitability diminish
• profit becomes more a challenge of production/distribution efficiency than increased sales.
Which industries do you think will give highest returns in the next 2-3 years?
I am sure, you are now clear about the different stages in industry life cycle.
Want to become a sector or industry specialist?
Here are some courses that will help you to become a top-class industry analyst: