Financial Education

The industrial life cycle is a term used for classifying industry vitality over time. Industry life cycle classification generally groups industries into one of four stages: pioneer, growth, maturity and decline.

In the pioneer phase, the product has not been widely accepted or adopted. Business strategies are developing, and there is high risk of failure. However, successful companies can grow at extraordinary rates.

In the growth phase, the product market has been established and there is at least some historical guide to ground demand estimates. The industry is growing rapidly, often at an accelerating rate of sales and earnings growth. Companies will still face relatively frequent execution issues.

As the product matures, growth slows as penetration reaches practical limits. Companies began to focus on market share rather than growth. Industry demand tends to follow the overall economy.

At some point, many industries peak and begin a steady decline. Shifting tastes or new technologies render some products less relevant. Some firms exit the industry by focusing on other products, bankruptcy or being acquired by rivals. The focus for management shifts to managing expenses and exiting gracefully.

An important factor in whether a firm can be profitable is the attractiveness of the industry in which it operates. A company’s ability to earn at least its cost of capital is strongly influenced by the competitive dynamics of its industry. Porter’s Five Forces Model is a conceptual approach to examining industry dynamics that can be useful in determining industry attractiveness.

Porter’s model says that five factors influence an industry’s profitability because they influence the prices, costs and investments required of industry participants. These five forces are:

1. Buyer bargaining power
2. Supplier bargaining power
3. Availability of substitute products
4. Threat of new entrants
5. Intensity of rivalry between existing firms

The collective strength of these five forces determines the ability of firms in the industry to earn average rates of return that exceed their cost of capital.

An important part of researching a potential investment is understanding the company’s position within its industry, as well as the broad trends facing all companies in the industry. According to the CFA Institute, an effective industry analysis should consider all of the following:

• Industry Classification

• Life cycle position

• Business cycle

• External factors

• Technology
• Government
• Social
• Demographic
• Foreign

• Demand analysis
  • End users
  • Real and nominal growth
  • Trends and cyclical variation around trends
• Supply analysis
  • Degree of concentration
  • Ease of entry
  • Industry capacity
• Profitability
  • Supply/demand analysis
  • Cost factors
  • Pricing
• International competition and markets