Yesterday we said that the stage in the Industry Life Cycle is an important parameter in determining the profitability of companies in a given industry. Let us look at the different stages of the cycle, before we see the implications to the profitability of the companies.
Introduction stage: In this stage of the cycle, the industry is in its infancy. It mainly concerns the development of a new product, from the time it is initially conceptualized to the point it is introduced in the market. The firm having an innovative idea first, will often have a period of monopoly, until competitors start to copy and / or improve on the product.
There is significant risk to investors during the introduction stage as the companies will need a significant amount of cash to promote their products.
The principal points of risk at this stage are: technical problems in manufacture, packaging, storage, etc., insufficient production capacity – inability to meet demand, obstacles in distribution and inadequate display at the point of sale, customer resistance to new products and reluctance to change consumption habits.
Growth stage: If the new product is successful, sales will start to grow and new competitors will enter the market, slowly eroding the market share of the innovating firm. The product may begin to be exported to other markets and substantial efforts are made to improve its distribution. During this phase competition mainly takes place on the basis of product innovations rather than on the basis of price.
In the growth stage, there are multiple companies in the industry seeking to differentiate themselves and earn market share. Like the introduction stage, the growth stage requires a significant cash outlay from the companies, but the funding is used toward more focused marketing efforts and expansion. It is during this phase that companies may start to benefit from economies of scale in production. This stage of industry growth, while still presenting risk to investors, demonstrates the viability of the industry.
Maturity Stage: At this stage, the product has been standardized, is widely available on the market and its distribution is well established. Competition increasingly takes place over cost and a growing share of the production takes place in low cost locations. This is the stage where the industry will start to see slowed growth with the rate of sales growth often slowing to the rate of overall economic growth. Late entrants appear in this stage seeking to capture market share through lower-cost offerings, thus requiring the existing companies to continue their marketing efforts. For investors, maturity of an industry can mean relatively stable stock investments with the possibility of income through dividends.
Decline stage: As the product begins to become obsolete, production essentially takes place in low costs locations. Production and distribution economies are actively sought as profit margins decline. Eventually, the product will be retired, an event that marks the end of its life cycle. A decline is inevitable in any industry as technological innovations and changing consumer tastes adversely affect sales. At this stage, some companies may exit the industry or merge and consolidate. An investor should approach stocks in declining industries with caution.