What Is Industry Life Cycle Analysis?
Industry life cycle analysis is part of the fundamental analysis of a company involving the examination of the stage an industry is in at a given point in time. There are four stages in an industry life cycle: expansion, peak, contraction, trough. An analyst will determine where a company sits in the cycle and use this information to project future financial performance and estimate forward valuations (e.g., forward price-earnings ratios).
Key Takeaways
- Industry life cycle refers to the stages of growth, consolidation, and eventual extinction of an industry.
- It mirrors an economic cycle and consists of four main stages: expansion, peak, contraction, and trough.
- It is used to analyze a company's stock, depending on the stage that it is in during a life cycle.
Understanding Industry Life Cycle Analysis
Though not necessarily the case, the life cycle of a particular industry will follow the general economic cycle. An industry life cycle may lead or lag an economic cycle. It also can vary from an economic cycle's phases in terms of expansion or contraction percentages or duration of peak and trough stages.
- Expansion: During an expansion phase in open and competitive markets, an industry will experience revenue and profit growth. It will draw in more competitors to meet the growing demand for that industry's goods or services.
- Peak: The peak occurs when growth drops to zero; demand in the cycle has been met and prevailing economic conditions do not encourage additional purchases. Industry profits flatten out.
- Contraction: The contraction phase of the life cycle begins at some point after the peak arrives. It is characterized by falling profits as current period sales are lower relative to prior period sales (when demand was on the rise). The contraction phase could be concomitant with a recession in the economy or merely a reflection that short-term demand in the industry has been exhausted. During the contraction phase, the industry undergoes production capacity adjustments. Marginal players get shaken out and stronger companies lower their production volumes. Industry profits decrease.
- Trough: This adjustment process, combined with a firming of the economy observed in employment and personal income numbers and the consumer confidence index, leads to the trough phase of the industry life cycle. At this stage, lower levels of industry demand are matched by the output capacity.
As the economy gathers strength, the industry life cycle begins again with the expansion phase. As mentioned at the outset, an industry life cycle is typically tied to the economic cycle. The entertainment and leisure industry is an example of such an industry. The technology industry, on the other hand, has exhibited life cycle movements at variance with the economic cycle. For instance, tech industry profits have boomed even in times of no economic growth.
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Using Industry Life Cycle in Analysis
Analysts and traders often use industry life cycle analysis to measure the relative strength and weakness of a particular company's stock. A company's future growth prospects may be bright (or dim) depending on the stage that it is in during an industry life cycle. Porter's five economic forces change as an industry matures.
For example, rivalry is most intense between companies in a sector during the growth stage. Startups slash prices and ship products as quickly as possible in a bid to garner as many customers as possible. During this time, the threat of new entrants eating into an existing company's market share is high.
The scenario changes in the maturity stage. Less competitive startups and inferior products are weeded out or acquired. The risk of new entrants is low and the industry's product is mature enough to be accepted in mainstream society. Startups become established firms during this stage but their future growth prospects are limited in existing markets. They must search out new avenues and markets for profits or risk extinction.
Example of Industry Life Cycle Analysis
There was a boom in social media during the early 2000s due to the success of Myspace, a social networking site that surpassed Google as the most visited place on the internet in 2006. Sites like Orkut (a Google venture) and Bebo competed to gain users in a crowded landscape. Facebook (now Meta), which started in 2004, was also gaining traction among universities and was considered the second most popular social media site. There were signs of consolidation when Myspace was acquired by Rupert Murdoch's Newscorp. Ltd for $580 million in 2005.
But that valuation turned out to be inflated after Facebook overtook MySpace in rankings. MySpace eventually petered into insignificance after Facebook became a social media behemoth. With the exception of a few, like X platform (formerly Twitter), other social media sites also fell by the wayside. The social media sites that survived made a thumping debut on the stock market. Their valuations were considered high in comparison to their revenues, mainly because investors expected significant growth in the future as social media became popular throughout the world.
By May 2019, however, Facebook's valuation had declined and the company warned of plateauing growth figures in the future. Snap Inc., another social media company, was in a similar situation. Both companies responded by expanding the scope of their operations to include other products, such as cameras and drones, in their portfolio.
As of December 2021, Facebook has just changed its corporate parent name to Meta Platforms. The company has rebranded and is developing new products and technology. These developments resulted in both analysts and the company itself seeing Meta's valuation increase again.
Is the Industry Life Cycle the Same As the Economic Cycle?
The phases ofan industry life cycle have the same names as the general economic cycle: expansion, peak, contraction, and trough. These phases may overlap, with an industry's peak occurring at the same time as an economic peak, and an industry's trough at the same as an economic trough. However, whether or not this happens often depends on the industry itself. Some industries may see their peaks at the same time as the overall economy experiences a trough, or they may be in an expansion phase when the economic cycle is at a peak.
What Is the Product Life Cycle?
The product life cycle has to do with how specific products or services are developed and offered to the public. This cycle has five phases: development, introduction, growth, maturity, and decline. This is separate from the industry life cycle since many products are developed within a single industry, or even within a single company.
What Are the 3 Main Parts of Industry Analysis?
Performing overall industry analysis requires looking at three things: the overall appeal (or attractiveness) of an industry, both to customers and investors; the factors that determine an individual company's success or failure within an industry; and the wider economic, political, and social forces that influence an industry.
The Bottom Line
The industry life cycle is the stages of growth and decline that an industry goes through as it is created, expands, and eventually becomes extinct. This mirrors the four main stages of the economic cycle: expansion, peak, contraction, and trough.
Industry life cycle analysis is used to analyze a company's stock. Researchers, analysts, and investors can look at the overall stage of an industry's life cycle to understand why a company's stock is valued the way it currently is and whether that is likely to change in the future.
