In 1988 laptop computers were the "in" thing. Everyone raved about how technology could compress a huge computer into such a small box. These early models did not have a hard disk but two fixed disk drives. A few months later hard disks were incorporated, initially with a capacity of 20 megabytes. The memory was increased to 40 megabytes. In 18 months, the laptop gave way to the notebook and now palmtops are the last word in compressedcomputing.

This case illustrates how technological advances make a highly regarded product obsolete. In the same ways technological advances in one industry can affect another industry. The Jute industry declined when alternate and cheaper packing materials began to be used. The popularity of cotton clothes in the West affected the manmade (synthetic) cloth industry. This is why bankers always examine the industry within which a company operates since it has a tremendous effect on its results and its existence.

A company's management may be superior, its balance sheet strong and its reputation enviable. However, the company may not have diversified and the industry within which it operates may be in a depression. This could result in a tremendous decline in revenues and can threaten the viability of the company.

CycleThe first step in industry analysis is to determine the cycle it is in or the maturity of the industry. All industries evolve through the following stages: Entrepreneurial or sunrise ornascent; expansion or growth; stabilisation or stagnation or maturity, and decline or sunset.

At the first stage the industry is new and in the early days it may actually make losses. At this point, there may be only a few companies in the industry. The first 5 to 10 years are the most critical as chances of failure are highest then. It takes time to establish companies and new products. There may be losses and the need for large injections of capital. At this time if a company or an industry is not nurtured or husbanded it can collapse.

A good journalist I know began a business magazine to be edited by journalists without interference from industrial magnates or politicians. It was exceptionally readable but it did not have the finance needed in those critical years to keep it afloat and so it folded up. Had it, at that time, had the finance it needed it may have survived and thrived. In short at this stage investors take a high risk with the promise of great reward should the product succeed.

Oncethe industry has established itself it enters a growth stage. At this time many new entrants enter the industry for there is high reward and low risk as demand outstrips supply. A good example currently is the pharmaceutical industry. Products have been improved by those companies that have survived the first stage and some are able to even lower their prices. Bankers are not averse to lend now as companies would have demonstrated their ability to survive. The industry then matures and stabilises. Rewards are low and so are risks. Growth is moderate. Though sales may increase it will be at a slower rate than before. Products are standardised and less innovative and there ar several competitors.

The industry then declines. This occurs when the products are no longer popular. This can happen due to factors such as a change in social habits (the film and video industry were hit by cable and satellite TV), changes in laws and increase in prices. The risk at this time is high but the returns are low. Returns caneven be negative.

Bankers would begin to lend when the industry is at the end of the entrepreneurial or nascent stage (normally not at the first stage as mortality is high) and the growth stage and would begin to exit when an industry is at the end of the mature stage as it will begin to decline.

The industry in relation to the economy

Bankers try to ascertain how an industry reacts to changes in the economy. Some industries do not perform well during a recession or as well as other industries during a boom while certain industries are unaffected in a depression or a boom. What are the major classifications?

1. Industries that are unaffected in general during economic changes are evergreen industries - those that individuals need like the food or agro-based industries (dairy products etc.)

2. Cyclical industries are volatile. They do extremely well when the economy is booming and do badly in a depression. The prime examples are durable goods, consumer goods and shipping. During hard timesindividuals postpone buying consumer goods.

3. Interest sensitive industries are those affected by interest rates. When interest rates are high industries such as real estate and banking do not do well.

4. Growth industries whose growth is higher than other industries and growth occurs even when the economy may be suffering a setback.

Competition

Initially, competition in an industry leads for efficiency, improvements in products and innovation. As competition increases price cuts set in resulting in lower margins, smaller profits and finally companies begin to make losses. The more inefficient companies even close down. In other words, if the return is high, newcomers will invest in the industry and there funds will flow in. Existing companies may also increase their capacity. However, if the returns are low or lower than that which can be procured elsewhere, funds will not be invested and there will be an outflow.

It is the competitive forces in an industry that determine the extent of thefund inflow, returns and the ability of companies to sustain these returns. These forces are the barriers to entry, the threat of substitution, the bargaining power of buyers, the bargaining power of suppliers and the rivalry among competitors.

(In the concluding part next week, the author will discuss these barriers)