8.4 Relevance of industry life cycle

INDUSTRY CYCLE

The industry life cycle approach has important implications for the investor. It gives an insight into the apparent merits of investment in a given industry at a given time. An industry usually exhibits low profitability in the pioneering stage, high profitability in the growth or expansion stage, medium but steady profitability in the stagnation or maturity stage and declining profitability in the decay stage.

Even though the industry life cycle approach provides a useful framework for industry analysis by an investor, its limitations should not be overlooked. It is not always easy to detect which stage of development an industry is in at any point in time. The transition from one stage to the next is slow and unclear. It can be detected only by careful analysis. Further, the classification of industries under this approach is the general pattern. There can be exceptions to this general pattern.

The life of an industry may, for instance, be extended after the stagnation and decay stage through appropriate adaptation to changes in the environment. Careful analysis is needed to detect such exceptions. The standard model typically deals with manufactured goods, but today's Indian economy is more an economy of services. Thus, proper analysis is important if you wish to be a long-term investor.

Industry Cycle Vs Economic Cycle

We have discussed economic cycle in the previous chapter. However, a specific industry cycle is not necessarily the same as a business cycle. Very often a specific industry will out-perform or even drive in the opposite direction to the general economic cycle. For example, pharmaceutical stocks are generally resistant to the business cycle. Most individuals buy drugs for the sole purpose of curing illness. For this reason we cannot assume that there will be much correlation between demand for medicine and the economy (one could make that the case if recession leads to people getting ill because of an increase in stress levels but no such research has been done). These industries are termed as 'counter-cyclical'.