Feb 18 2019
No industry is immune to cycles. Understanding the stage of an industry’s life cycle should be one of the first steps before entering an industry or before considering lending to, advising or investing in a company.
Let’s explore how to identify an industry’s life cycle and why an industry’s life cycle stage can inform the type of services a company might require.
The Importance of Industry Life Cycles
Industries are born to meet new demand from consumers or other businesses, and usually enjoy decades of sustained growth as the industry’s products and services evolve and operational systems advance. Inevitably, an industry will face challenges, whether due to competition, trade or technological advancement, that lead to decline. While some industries die or become obsolete, most evolve to meet new conditions of demand.
According to Harvard professor Michael Porter, 19% of a company’s profitability is determined simply by which industry it operates in; the state of an industry has a direct impact on a company’s profitability.
This underscores the importance that industry life cycles have on an industry and the performance of companies operating within it.
An industry’s life cycle reveals important information about the industry’s product strategy, growth prospects, opportunities and challenges, and its supply chain. It is also a very important indicator of company performance.
Having a good understanding of where an industry is within its life cycle will allow you to better understand what your clients are going through and to offer business advice in line with your client’s current needs, opportunities and challenges.
Conversely, misunderstanding an industry’s life cycle stage can have dire and expensive consequences. Take the newspaper publishing industry, for example.
Newspaper publishers watched idly as the digital age aggressively swept through the industry. It should come as no surprise then that the newspaper publishing industry is in the decline phase of its life cycle.
The implications of not proactively tackling the issues faced in a declining industry saw newspaper publishing companies scrambling to innovate and stay afloat as intense competition from other media and steep declines in newspaper readership propelled consolidation. As Warren Buffett once famously said,
When an industry with a reputation for difficult economics meets a manager with a reputation for excellence, it is usually the industry that keeps its reputation intact.
Despite being in the decline stage of the industry life cycle, however, newspaper publishers are adapting and developing new products and services in their new digital landscape. With an industry shakeout underway, newspaper publishers must innovate or consolidate.
Industry Life Cycles Explained
An industry’s life cycle is based on its performance relative to the overall economy. All industries, no matter how old or new, go through the life cycle stages of growth, maturity and decline. In the growth stage the industry is growing faster than the overall economy. In the mature stage the industry is growing at about the same rate as the economy and in a declining stage the industry is growing slower than the overall economy.
Four key indicators determine the pace of growth within any given industry:
- Product performance
- The number of enterprises
- Technological change
- Market acceptance
Analyzing each of these life cycle indicators is imperative to accurately determining which stage an industry is in.
However, the cyclical nature of industry life cycles means that industries move in and out of different stages over the years. Surprisingly, the length of industry life cycles has remained much the same over hundreds of years. In fact, industry data tells us that in advanced economies, most industries have a life cycle length of 35-40 years, although some industries have life cycles less than 35 years while some have life cycles of over 70 years.
Knowing how an industry is faring against the overall economy is great, but being able to visualize its position in the economy provides a clearer picture of what you are up against.
Industry Life Cycles Visualized
Being able to see an industry’s position within the overall economy puts its current life cycle into perspective. Looking at the example chart below, we can see that the Spirit Manufacturing industry in Australia is in the growth stage of its life cycle.
The chart also plots the life cycle stages of the industry’s key suppliers, buyers and competing industries. This provides you with greater context about the opportunities and challenges you or your clients face within their industry and supply chain.
Most industries move counter-clockwise around the chart segments: from growth (quantity then quality) to maturity and then to decline.
IBISWorld’s proprietary Industry Life Cycle chart
One notable feature of the chart is the breakdown of growth into ‘quantity’ and ‘quality’ growth. Quantity growth represents the rush of new entrants to an industry as it becomes established. It is characterized by increased capital investment and plentiful business ideas, but the market is not big enough for all ideas or poorly managed companies. In quantity growth, the emphasis is on establishment growth rather than growing economic importance. The Spirits industry is experiencing a boom in enterprise growth as demand for premium and super-premium liquors has driven value-added growth and new products have attracted younger drinkers.
In quality growth, the situation is reversed. The market has determined the best ideas and strongest management. This flight to quality may be caused by several external issues (such as the market crash for dot-com companies), or changes caused by structural issues (e.g. producer economies of scale, better developed market preferences). Industries in this zone are strong performers, and their share of the economy is growing.
Maturity is the stage where an industry’s quality growth has created a small number of powerful companies to merge with or acquire the competition to cut production costs or rationalize products.
Exploiting Industry Life Cycles
You can instantly unlock a wealth of knowledge about an industry by understanding where it is in its life cycle. For example, we understand that the Spirits industry is in a growth stage. Therefore, product innovation is high, demand for new products is on the rise and the number of players entering the industry is trending upward. However, learning how to strategically use that information will allow you to better navigate the industry. Without understanding an industry’s idiosyncrasies, an investor or manager will struggle to exploit, or even survive, the broader business environment.
Growing Industries Need Resources and Services
The ‘new economy’ sectors, such as professional services and personal services, are where growth industries typically live. These industries have unique characteristics that distinguish them from other industries, such as trade and globalization levels, regulation and volatility.
The rapid rate of change within growth industries results in a need for resources and services, such as capital to fund wages, capital goods and services. As a result, growth industries will be hungry for services from banks, accountants, investment banking and private equity, marketing and consulting.
Mature Industries are Looking for Business Advice
Mature industries grow at about the same rate as GDP. As an industry matures, firms begin to consolidate, the number of products slows as companies focus on the most profitable products, and the market wholeheartedly accepts those products. For example, the Bottled Water Production industry is currently in the mature stage of its life cycle. The industry is not focused on developing new products, instead companies are focused on product branding.
Firms operating in a mature life cycle will seek business advice. Marketing, for example, will see a rise in demand as businesses focus on product branding to cement their place in a consolidating industry. Companies will require other professional services, such as consulting, to reposition current products or move into foreign markets. Demand typically rises for business valuation, investment banks, lawyers and accountants in mature industries as consolidation intensifies.
Declining Industries are Trying to Manage Risk
Industries in decline are characterized by severe consolidation, stable and clearly segmented product groups, and changes in demand as the market shifts its product preferences. Surviving companies must adapt or die, given that the industry might not exist in the future without significant adjustments to its products, markets or technology.
Decline is the riskiest stage of a life cycle, so businesses in these industries will seek help in managing risk. Consolidation within the market means that surviving companies often have relatively healthy profit margins, but they must use those margins to invest in product and process development to prolong or re-energize the industry life cycle. Demand for banking will increase as companies seek to reinvigorate their products and brands.
IBISWorld: Providing Industry Life Cycle Intelligence for Nearly 50 years
Success is knowing where you and your clients are within your respective industry life cycles and reacting accordingly with a winnable strategy, structure and operational implementation. IBISWorld offers industry life cycle intelligence on thousands of industries, giving you instant access to the current “life story” of the industries you and your clients work in. Download a free sample report today or find out more about a membership with IBISWorld.