Monday, December 18, 2006

Industry Life Cycle

According to Buddhism, there are four phases in Life: Birth, Aging, Sickness and Death. The funny thing is, business schools teach a similar theory about industries.

This is the what makes investment interesting I guess. It is not just about making money. It encompasses knowledge from different fields like philosophy, religion, social science, accounting, economics, finance etc. Which means you have to know a lot before you can invest and make money. Investment is about knowledge. Investment is also about your style, your view of the world and about your ability to stomach losses and conquer your greed.

Okay, back to the main topic, so similar to Buddhism, industries follow a four phase life cycle:

1) Infancy: Few players, growth rate: 10-20% e.g. Fuel Cell
2) Growth: Many players, growth rate: 50-400% e.g. LCD TV
3) Mature: Ogliopoly, growth rate: 5% e.g. Oil majors like Shell
4) Decline: Ogliopoly, growth rate: -5 to 0% e.g. Photo film

Industries can be broken down into these four phases and depending on which phase an industry or company is in, we can see some characteristics pertaining to that phase and frame our expectations accordingly.

1) Infancy: This phase marks the beginning of a new industry, technologies are only recently discovered and business models are still evolving. Growth is limited due to limited demand and lack of funding and interest. Usually marks the 1st 5-10 yrs of a new industry.

2) Growth: At a certain point, an infant industry hits an inflexion point and starts to grow spectacularly. Competitors also start to enter the industry causing prices to come down. But declining prices lead to even stronger demand for products. Stock market starts to get very interested at this stage. Growth phase usually marks the next 10-30 yrs of strong growth.

3) Mature: A growth industry will eventually mature when penetration rate reaches a certain level and/or demand runs out. Growth rate declines to single digits. Weak players exit the business as they cannot compete at low prices and low sales volume. Industry usually consolidates to a few strong players.

4) Declining: This is similar to death in Buddhism life cycle. The industry cannot continue to exist as there is no longer any demand for its products.

It is important to note that these are theories. They do not work perfectly in the real world. Some industries go from Infancy and straight to Decline (e.g. MD players?). Some enjoy growth for 40-50 yrs (autos: is it still growth or mature?). Some industries reach mature stage in 3 yrs (Internet auctions, online stores?). Some industry simply cannot fit into any phase (e.g. consulting?).

Once we understand which phase an industry or company is in, we can better size up its growth potential, investment return and other big picture aspects.

See also Porter's 5 Forces
and Secular Trends