MBA Course Knowledge Center: The Industry Life Cycle, Sales growth and Profit Margins

Wednesday, March 7, 2012

The Industry Life Cycle, Sales growth and Profit Margins

Industry life cycle can be seen as consisting of five stages

•Pioneering development

•Rapidly accelerating industry growth

•Mature industry growth

•Stabilization and market maturity

•Deceleration of growth and decline

Pioneering development

During this stage the market for the industry’s product or service is small, the firm or firms involved have to incur major development costs both in regard to the product and in regard to the market. The product is yet to be proved in the commercial market. Hence, the industry experiences modest sales growth and very small or negative profit margins and profits.

Rapidly accelerating industry growth

This stage starts when the product of the industry is accepted by the market. Further demand increases rapidly. The number of firms in the industry is limited at this stage and hence the firms can experience substantial backlogs of orders. Hence prices can be increased or discounts can be decreased and therefore profit margins are high. The capacity utilization goes up and even though productive capacity is increased, sales increase more rapidly. Hence high profit margins occur simultaneously with high sales growth. Profits explode. Sales growth can be high up to even 50 percent year and profits can grow over 100 percent a year as a result of the low earnings base and high profit margins and increasing efficiency of the firms.

Mature industry growth

During mature growth stage, the rapid growth in sales comes down match the growth industry definition. The definition of growth industry is that it has a growth rate which is double that of economy. Growth no longer accelerates. The rapid growth attracts more number of firms, which causes an increase in supply and lower prices. This will force margins to decline from the levels witnessed in accelerating growth phase.

Stabilization and market maturity

This phase could the longest phase for the industry. The growth now becomes approximately equal to the growth rate in the economy. Competition produces tight profit margins and rates of return on capital are competitive. There will be differences in profitability of industries as well as in profitability of companies due to competitive structure and ability to control costs.

Deceleration of growth and decline

In this stage first the growth rates decline below that of growth in the economy. Substitutes offering better output may appear at this stage. Profit margins get squeezed and some firms experience low profits or even losses.

References

Reilly, Frank F., and Keith C. Brown (2006), Investment Analysis and Portfolio Management, 8^th Edition, Thomson South Western, (Main text for the series of revision articles on Security Analysis)