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Bodie−Kane−Marcus: Investments, Fifth Edition
V. Security Analysis
© The McGraw−Hill Companies, 2001
17. Macroeconomics and Industry Analysis
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CHAPTER 17 Macroeconomic and Industry Analysis
Figure 17.10 The industry life cycle.
Sales
Rapid and increasing growth
Stable growth
Slowing growth
Minimal or negative growth
Start-up
Consolidation
Maturity
Relative decline
Eventually, however, growth must slow. The high profit rates will induce new firms to enter the industry. Increasing competition will hold down prices and profit margins. New technologies become proven and more predictable, risk levels fall, and entry becomes even easier. As internal investment opportunities become less attractive, a lower fraction of profits are reinvested in the firm. Cash dividends increase. Ultimately, in a mature industry, we observe “cash cows,” firms with stable dividends and cash flows and little risk. Growth rates might be similar to that of the overall economy. Industries in early states of their life cycles offer high-risk/high-potential-return investments. Mature industries offer lower-risk, lower-return combinations. This analysis suggests that a typical industry life cycle might be described by four stages: a start-up stage, characterized by extremely rapid growth; a consolidation stage, characterized by growth that is less rapid but still faster than that of the general economy; a maturity state, characterized by growth no faster than the general economy; and a stage of relative decline, in which the industry grows less rapidly than the rest of the economy, or actually shrinks. This industry life cycle is illustrated in Figure 17.10. Let us turn to an elaboration of each of these stages. Start-Up Stage The early stages of an industry are often characterized by a new technology or product such as VCRs or personal computers in the 1980s, or wireless communication in recent years. At this stage, it is difficult to predict which firms will emerge as industry leaders. Some firms will turn out to be wildly successful, and others will fail altogether. Therefore, there is considerable risk in selecting one particular firm within the industry. At the industry level, however, sales and earnings will grow at an extremely rapid rate, because the new product has not yet saturated its market. For example, in 1980 very few households had VCRs. The potential market for the product therefore was the entire set of television-watching households. In contrast to this situation, consider the market for a mature product like refrigerators. Almost all households in the United States already have refrigerators, so the market for this good is primarily comprised of households replacing old refrigerators. Obviously, the growth rate in this market will be far less than for VCRs. Consolidation Stage After a product becomes established, industry leaders begin to emerge. The survivors from the start-up stage are more stable, and market share is easier to predict. Therefore, the performance of the surviving firms will more closely track the