Influences other than the economy are part of the business environment. Demographics, changes in technology, and political and regulatory environments will affect the cash flow and risk prospects of different industries.
In the past 50 years, the United States has had a baby boom, a baby bust, and is now enjoying a baby boomlet as members of the baby-boom generation (those born between the end of World War II and the early 1960s) have children. The influx of the baby boom and “the graying of the baby boom” have had a large impact on U.S. consumption, from advertising strategies to house construction to concerns over social security and health care. The study of demographics includes much more than population growth and age distributions. Demographics also includes the geographical distribution of people, the changing ethnic mix in a society, and changes in income distribution. Wall Street industry analysts carefully study demographic trends and attempt to project their effect on different industries and firms.
In the 1990s, the fastest-growing age groups in the United States were those in their forties and fifties, teens, and those over 70; among the declining groups were those between ages 18 and 24.
As of the early 2000s, more than one in eight Americans are 65 years of age or older. The chang- ing age profile of Americans has implications for resource availability, namely, a possible short- age of entry-level workers leading to an increase in labor costs and difficulty in finding qualified persons to replace the retiring baby boomers. The aging U.S. population also affects U.S. sav- ings patterns, as people in the 40 to 60 age bracket usually save more than younger people. This is good for the financial services industry, which offers assistance to those who want to invest their savings. Alternatively, fewer younger workers and more “saving seniors” may have a neg- ative impact on some industries, such as the retailing industry.
Lifestyles deal with how people live, work, form households, consume, enjoy leisure, and edu- cate themselves. Consumer behavior is affected by trends and fads. The rise and fall of jeans,
“designer” jeans, chinos, and other styles in clothes illustrate the sensitivity of some markets to changes in consumer tastes. The increase in divorce rates, dual-career families, population shifts away from cities, and computer-based education and entertainment have influenced numerous industries, including housing, automobiles, convenience and catalog shopping, services, and home entertainment. From an international perspective, some U.S.-brand goods—from blue Lifestyles
Demographics Consumer Sentiment International Economics
jeans to movies—have a high demand overseas. They are perceived to be more “in style” and perhaps higher quality than items produced domestically. Sales in several industries have bene- fited from this exercise of consumer choice overseas.
Trends in technology can affect numerous industry factors including the product or service and how it is produced and delivered. There are literally dozens of examples of changes that have taken or are taking place due to technological innovations. For example, demand has fallen for carburetors on cars because of electronic fuel-injection technology. The engineering process has changed because of the advent of computer-aided design and computer-aided manufacturing.
Perpetual improvement of designs in the semiconductor and microprocessor industry has made that industry a difficult one to evaluate. Innovations in process technology allowed steel mini- mills to grow at the expense of large steel producers. Advances in technology allow some plant sites and buildings to generate their own electricity, bypassing their need for power from the local electric utility. Trucks have reduced railroads’ market share in the long-distance carrier industry, and planes, not trains, now mainly carry people long distances. The “information super- highway” is becoming a reality and may lead to linkages between telecommunications and cable television systems. Changes in technology have spurred capital spending in technological equip- ment as firms try to use microprocessors and software as a means to gain competitive advan- tages. The future effect of the Internet is astronomical.
The retailing industry is a user of new technology. Some forecasters envision “relationship merchandising,” in which customer databases will allow closer links between retail stores and customer needs.5Rather than doing market research to focus on aggregate consumer trends, spe- cialized retailers can offer products that particular consumer segments desire in the locations that consumers prefer. Technology may allow retailers to become more organizationally decentral- ized and geographically diversified.
Major retailers use bar-code scanning, which speeds the checkout process and allows the firm to track inventory. Use of customer credit cards allows firms to track customer purchases and send custom-made sales announcements. Electronic data interchange (EDI) allows the retailer to electronically communicate with suppliers to order new inventory and pay accounts payable.
Electronic funds transfer allows retailers to move funds quickly and easily between local banks and headquarters.
Because political change reflects social values, today’s social trend may be tomorrow’s law, reg- ulation, or tax. The industry analyst needs to project and assess political changes relevant to the industry under study.
Some regulations and laws are based on economic reasoning. Due to utilities’ positions as nat- ural monopolies, their rates must be reviewed and approved by a regulatory body.6Some regu- lation involves social ends. For example, the Food and Drug Administration protects consumers by reviewing new drugs. Public and worker safety concerns spurred creation of the Consumer Product Safety Commission, the Environmental Protection Agency, and OSHA. Notably, heavy regulation of an industry can result in increasing a firm’s costs and restricting entry into the industry.
Politics and Regulations Technology
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5Carl E. Steidtmann, “General Trends in Retailing,” in The Retail Industry—General Merchandisers and Discounters, ed. Charles Ingene (Charlottesville, Va.: Association for Investment Management and Research, 1993): 6–9.
6Technology can change natural monopolies. We mentioned earlier how some firms are generating their own electrical power. Advancing technology resulted in AT&T losing its monopoly in the early 1980s. Another example is that, cur- rently, numerous states are allowing electric utilities to compete for customers.
Regulatory changes have affected numerous industries. A recent example is the numerous regulations and inspections following the September 11, 2001, attacks. Changing regulations and technology are bringing the various aspects of the financial services industry—banking, insur- ance, investment banking, and investment services—together.
Regulations and laws affect international commerce. International tax laws, tariffs, quotas, embargoes, and other trade barriers affect different industries and global commerce in various ways.
An interesting example is how the retail industry is affected by numerous regulatory factors.
First is the minimum-wage law, which impacts many retail employees. A second factor is employer-paid health insurance, which would dramatically affect the labor costs of labor- intensive service industries, such as retailing. Third, because goods must first be delivered to the stores, regulations that affect the cost of shipping by airplane, ship, or truck will affect retailers’
costs. Finally, trends toward the reduction of tariffs and quotas will allow retailers to offer imported goods at lower prices, which will expand their international marketing.
EVALUATING THE INDUSTRY LIFE CYCLE
An insightful analysis when predicting industry sales and trends in profitability is to view the industry over time and divide its development into stages similar to those that humans progress through as they move from birth to adolescence to adulthood to middle age to old age. The num- ber of stages in this industry life cycle analysiscan vary based on how much detail you want.
A five-stage model would include 1. Pioneering development 2. Rapid accelerating growth 3. Mature growth
4. Stabilization and market maturity 5. Deceleration of growth and decline
Exhibit 14.3 shows the growth path of sales during each stage. The vertical scale in logs reflects rates of growth, whereas the arithmetic horizontal scale has different widths representing differ- ent, unequal time periods. To estimate industry sales, you must predict the length of time for each stage. This requires answers to such questions as: How long will an industry grow at an accel- erating rate (Stage 2)? How long will it be in a mature growth phase (Stage 3) before its sales growth stabilizes (Stage 4) and then declines (Stage 5)?
Besides being useful when estimating sales, this analysis of an industry’s life cycle also can provide some insights into profit margins and earnings growth, although these profit measures do not necessarily parallel the sales growth. The profit margin series typically peaks very early in the total cycle and then levels off and declines as competition is attracted by the early success of the industry.
To illustrate the contribution of life cycle stages to sales estimates, we briefly describe these stages and their effects on sales growth and profits:
1. Pioneering development. During this start-up stage, the industry experiences modest sales growth and very small or negative profit margins and profits. The market for the industry’s product or service during this time period is small, and the firms involved incur major development costs.
2. Rapid accelerating growth. During this rapid growth stage, a market develops for the product or service and demand becomes substantial. The limited number of firms in the industry face little competition, and individual firms can experience substantial backlogs.
The profit margins are very high. The industry builds its productive capacity as sales grow
at an increasing rate as the industry attempts to meet excess demand. High sales growth and high profit margins that increase as firms become more efficient cause industry and firm profits to explode. During this phase, profits can grow at over 100 percent a year as a result of the low earnings base and the rapid growth of sales and net profit margins.
3. Mature growth. The success in Stage 2 has satisfied most of the demand for the industry goods or service. Thus, future sales growth may be above normal but it no longer acceler- ates. For example, if the overall economy is growing at 8 percent, sales for this industry might grow at an above normal rate of 15 percent to 20 percent a year. Also, the rapid growth of sales and the high profit margins attract competitors to the industry, which causes an increase in supply and lower prices, which means that the profit margins begin to decline to normal levels.
4. Stabilization and market maturity. During this stage, which is probably the longest phase, the industry growth rate declines to the growth rate of the aggregate economy or its indus- try segment. During this stage, investors can estimate growth easily because sales correlate highly with an economic series. Although sales grow in line with the economy, profit growth varies by industry because the competitive structure varies by industry, and by individual firms within the industry because the ability to control costs differs among companies. Competition produces tight profit margins, and the rates of return on capital (e.g., return on assets, return on equity) eventually become equal to or slightly below the competitive level.
5. Deceleration of growth and decline. At this stage of maturity, the industry’s sales growth declines because of shifts in demand or growth of substitutes. Profit margins continue to be squeezed, and some firms experience low profits or even losses. Firms that remain profitable may show very low rates of return on capital. Finally, investors begin thinking about alternative uses for the capital tied up in this industry.
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Stage 1 Pioneering Development
Stage 2 Rapid Accelerating
Growth
Stage 3 Mature Growth
Stage 4 Stabilization
and Market Maturity
Stage 5 Deceleration of Growth and
Decline Time Net Sales
Log Scale 32
16
8
4
2
0
EXHIBIT 14.3 LIFE CYCLE FOR AN INDUSTRY
Although these are general descriptions of the alternative life cycle stages, they should help you identify the stage your industry is in, which should help you estimate its potential sales growth.
Obviously, everyone is looking for an industry in the early phases of Stage 2 and hopes to avoid industries in Stage 4 or Stage 5. Comparing the sales and earnings growth of an industry to similar growth in the economy should help you identify the industry’s stage within the industrial life cycle.