Seminar Paper, 2012
20 Pages, Grade: 1,0
2. Declining industries: characteristics and reasons
3. Strategic options in a declining industry environment
3.1 Factors influencing the attractiveness of a declining industry
3.2 Strategic options for companies in declining industries
4. Trajectories of industry change
5. Summary and conclusion
List of tables
Table 1: Structural factors that influence the attractiveness of declining environments, own illustration interconnected from Harrigan (1980a) and Harrigan and Porter (1983)
Table 2: Strategies for declining industries, adapted from Harrigan and Porter (1983)
Table 3: Trajectories of industry change, adapted from McGahan (2004)
List of figures
Figure 1: Industry life cycle, adapted from Cox (1967)
At some point in time, business students around the world will most likely be confronted with the famous product and industry life cycle. This tool is mainly used as a marketing instrument. It offers advertising and investment directions for each of the three to five stages of the cycle. Everything in this theory seems obvious and clear, until the “decline” stage of the cycle is reached. The question is, is there really only one option, namely to harvest and then divest, in the last phase of the life cycle? Is the decrease in revenues and profits inevitable?
The past shows that this is not necessarily the case. Some companies actually did generate profits and proved to be quite successful in a difficult market environment. Take for example the fountain pen maker Mont Blanc. The market for fountain pens has been declining for decades due to technological change (invention of typewriters and computers) and also consumer preferences. However, Mont Blanc has set up a selective shrinkage (“niche”) strategy by attracting high-income professionals and promoting their fountain pens as a luxury good. As a result, the company has achieved stable revenues and high margins within a declining industry (Grant 2010).
In the following, this paper will examine what a declining industry is, what characteristics a declining industry shows and what strategic options companies within such an industry environment have.
In order to define a “declining industry” it is necessary to give a short overview of the concept of the industry life cycle. According to Klepper (1997) an industry life cycle can be described as the evolution of a (technologically advanced) industry. The industry life cycle concept is a derivation of the product life cycle theory, which was developed as a marketing instrument. Initially, the product life cycle concept shows the progression and stages of a certain product and determines which strategy to apply in every given stage. The industry life cycle is based on the same concept, but adapted to a whole industry instead of a single product (Klepper 1997).
In most approaches, the industry life cycle consists of four stages (Cox 1967): Introduction, Growth, Maturity and Decline (Figure 1). The introduction stage is characterized by low market volumes, high uncertainty within the industry, many variations and firms entering the market and an evolving production technology, is the first phase (Jovanovic and MacDonald 1994). Subsequently, the growth phasefollows. In this stage, the industry shows higher output than before, the production technology is rather evolved and more standardized and the industry is stabilizing (Jovanovic and MacDonald 1994). The third phase is called maturity. Characteristic features are a slowdown in growth, very few new entrants into the market and a focus on production technology standardization (Jovanovic and MacDonald 1994). The last and most relevant stage for this paper is the decline phase. In general, we can say that the declining stage is marked by lower entry rates, respectively increasing exit rates, a slowdown in growth and output and a decrease in innovation. This stage is also determined by declining demand and a necessary adjustment of capacities to this demand (Gort and Klepper 1982).
Often, this leads to aggressive price wars and high competition among the remaining firms (Grant 2010).
The duration of the mentioned phases depends on the industry and on how difficult it is to reproduce the initial innovation (Gort and Klepper 1982).
illustration not visible in this excerpt
Figure 1: Industry life cycle, adapted from Cox (1967)
The most common reasons for the transition from maturity to decline are technological substitution (e.g. typewriters), changes in demography (e.g. declining demand for toys in Western Europe) and changes in consumer preferences (e.g. the declining demand for tailored men’s suits) (Harrigan and Porter 1983). Another reason might also be upcoming foreign competition (e.g. textiles in developed nations) (Grant 2010).
The most sophisticated strategy formulations for declining industries have been conducted by Harrigan (1980a, 1980b, 1983). Harrigan realized that some firms within an declining environment were able to actually generate high profits and outperformed firms within up and coming industries. To analyze the reasons for this, she conducted a survey among sixty firms within eight “declining” industries in order to find out what strategy is most appropriate for companies facing such an environment. The findings of Harrigan reflect earlier research by Hamermesh and Silk (1979) who uncovered three key characteristics of successful firms in declining industries: Identification of niche segments, focus on product quality and an improvement of manufacturing and distribution networks. Harrigan built upon this generalization and found out under which circumstances the mentioned strategies strategies work. The result was that not a sole strategy leads to success, but that various strategies can be used during the decline phase. In fact, Harrigan concluded that the success of a strategy is dependent on the structural conditions of an industry and the competitive strength of the respective firm. After analyzing the factors which influence the attractiveness of a declining industry, this paper will examine the strategic options companies have.
According to Harrigan and Porter (1983), there are three major factors which determine environmental attractiveness: The conditions of demand, the height of exit barriers and the determinants of rivalry.
The conditions of demand are important to analyze, since those factors determine the way companies assume future demand and profitability prospects, which in turn determines the intensity and type of competition within that phase of the life cycle. If the decline of demand is highly volatile, that means not foreseeable and uncertain, firms cannot plan and reduce their capacities in an orderly manner. Price wars and high competition with the goal to keep the competitive position might be the result. An example therefore would be the price wars of the baby food industry after the “Baby Boomers” phase was over. Furthermore, the attractiveness of an industry depends on the existence and structure of so-called “demand pockets”. For profit perspectives it is essential that those niches exist and customers are relatively price insensitive, as costs per unit increase with shrinking unit sales. The premium cigar industry took advantage from those facts and generates profit even though the market is diminishing. A favorable demand pocket is also marked by non-existing substitution products and little bargaining power of the customer (Harrigan and Porter 1983).
In General, Exit barriers can be described as factors which deter companies from pulling off from an industry easy and quickly. The lower the exit barriers, the more hospitable and attractive is a shrinking industry for firms. One of the most severe exit barriers for a company are highly specialized and durable assets. Those assets are obviously hard to liquidate, since the number of buyers is restricted and the target group is affected by the industries decline as well. As a side effect, more companies are bound to the industry since they can only sell their assets at enormous discounts. This in turn leads to excess capacity and diminishing profit margins. An option for managers would be to expand their search for buyers, e.g. overseas. ThyssenKrupp, a major player in the declining German steel industry, sold some of their assets in the early 2000’s to various upcoming Chinese steel companies (ThyssenKrupp verkauft Stahlwerke 2001). High fixed costs, such as labor settlements or dismantling costs for facilities, may also be a significant barrier for companies to exit the market.
Besides economic factors, strategic considerations might impose an exit barrier. First, if a business is of high importance (e.g. essential to corporate identity) it might not be a good idea to pull it off the market even though the product is not contributing to profits and the outlook of the industry is rather pessimistic. Second, by exiting the market, the financial credibility of the whole group could be affected. Even though the pull off rationale is given, it might raise cost of capital for a company if the businesses contribution is relatively big to the total. Third, an exit of a business will have an impact on the whole Supply Chain if the company is highly integrated, vertically and horizontally.
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